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The SEC’s Extensions of

Exemptions for Security-Based

Swaps

NY2 716883

Robert Dilworth, Bank of America Merrill Lynch

James Schwartz, Morrison & Foerster LLP

May 1, 2013

This is MoFo. | 2 This is MoFo. 2

Caveat

• This outline is for informational purposes only and does not constitute

legal advice or create an attorney-client relationship.

• Consult your own attorney for legal advice on the issues discussed in

this outline.

• IRS Circular 230 Disclosure

• To ensure compliance with the requirements imposed by the IRS, we inform you

that any tax advice contained in this communication was not intended or written to

be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties

under the Internal Revenue Code or (ii) promoting, marketing, or recommending

to another party any matters addressed herein.

• This outline may constitute attorney advertising.


Topics for Presentation

• Background regarding security-based swaps and

Dodd-Frank

• SEC Roadmap and final rules to date

• Timeline of relief granted by SEC

• Industry commentary

• Relief granted

• Interim final rules

• General exemptive order

• Exchange Act exemptive order


Swaps and Security-Based Swaps

• Swaps are subject to the jurisdiction of the CFTC and

include interest rate swaps, floors, caps and collars,

commodity swaps, cross-currency swaps, total return

swaps on broad-based security indices or two or more

loans and credit default swaps on broad-based security

indices.

• Security-based swaps are subject to the jurisdiction of the

SEC and include swaps on a single security, loan, or

narrow-based securities index.


Swaps and Security-Based Swaps

• “Narrow based security index” means, among other

things, an index with nine or fewer components, or in

which a component security comprises more than 30

percent of the index’s weighting.

• The SEC and CFTC have adopted joint rules for the

regulation of mixed swaps, which combine characteristics

of both swaps and security-based swaps.


Dodd-Frank Treatment of Security-Based Swaps

• Title VII of Dodd-Frank amended the Securities

Act of 1933 (the “Securities Act”) and the

Securities Exchange Act of 1934 (the “Exchange

Act”) to include “security-based swaps” in the

definition of “security” for purposes of those

statutes.



• Section 761 of Dodd-Frank amends the definition of “security”

contained in the Exchange Act to include security-based swaps.

• Section 768 of Dodd-Frank amends the definition of “security”

contained in the Securities Act to include security-based swaps.

• Trust Indenture Act of 1939 (the “Trust Indenture Act”) incorporates

the definition of “security” contained in the Securities Act.

• As a result, “security-based swaps” became subject to the provisions

of the Securities Act, the Exchange Act and the Trust Indenture Act,

and the rules and regulations thereunder that are applicable to

“securities.”



• Dodd-Frank did not amend the definition of “security” for

purposes of the Investment Company Act of 1940.

• Not clear why this amendment did not occur.

• Historically, definition of “security” under ’40 Act has been

broader than under Securities Act and Exchange Act.


Current Status

• As further described below, the SEC has granted broad

relief with respect to many of the consequences that arise

from the treatment of security-based swaps as

“securities”.

• The relief that the SEC has granted in its interim final

rules and in its exemptive orders is still in place and has

been extended to February 11, 2014.


SEC Roadmap

• The time frame for the SEC to complete its work under Title VII is not

clear.

• The SEC’s proposal regarding cross-border issues and the

parameters of the extraterritorial effect of Dodd-Frank with respect to

security-based swaps is expected this week.

• Expected to be lengthy, more than 1,000 pages.

• Last June, the SEC issued a “roadmap” for its rulemaking, a “general

sequence” for anticipated compliance dates of final rules to be

adopted by the SEC.

• The anticipated proposed cross-border rules, when finalized, will

complete the first of the five categories of rulemakings that the

roadmap identified.

• Many of the SEC rules have been proposed, but few have been

finalized.


SEC Roadmap

• First category: rules further defining (i) the terms ‘‘security-based

swap,’’ ‘‘security-based swap agreement,’’ ‘‘mixed swap,’’ ‘‘security-

based swap dealer,’’ ‘‘major security-based swap participant,’’ and

‘‘eligible contract participant,’’ and (ii) the rules concerning the

treatment of cross-border security-based swap transactions and non-

U.S. persons acting in capacities regulated under Subtitle B of Title

VII.

• Second category: rules pertaining to the registration and regulation of

swap data repositories, the reporting of security-based swap

transaction data to swap data repositories, and the public

dissemination of security-based swap transaction data.


SEC Roadmap

• Third category: rules pertaining to the mandatory clearing process of

security-based swap transactions, clearing agency standards, and

the end-user exception from mandatory clearing.

• Fourth category: rules pertaining to the registration and regulation of

security-based swap dealers and major security-based swap

participants.

• Fifth category: rules pertaining to the mandatory trading of security-

based swap transactions, including the rules pertaining to the

registration and regulation of security-based swap execution

facilities.


SEC Final Rules

• As of today, relatively few SEC rules have been finalized under Title

VII of Dodd-Frank.

• The finalized rules include:

• Certain rules in relation to risk management procedures, controls and

rule changes for clearing agencies (such as central counterparties, or

“CCPs”);

• Further definitions of “Swap,” “Security-Based Swap,” “Security-Based

Swap Agreement”; Mixed Swaps, Security-Based Swap Agreement

Recordkeeping (jointly with CFTC);

• Process of Submissions for Review of Security-Based Swaps for

Mandatory Clearing; and

• Further definitions of “Swap Dealer,” “Security-Based Swap Dealer,”

“Major Swap Participant,” “Major Security-Based Swap Participant” and

“Eligible Contract Participant” (jointly with CFTC).


SEC Final Rules

• In addition, the SEC finalized a permanent exemption that applies to

security-based swaps that are cleared by a CCP.

• Under the permanent exemption, subject to conditions, security-

based swaps that are cleared by a CCP are exempt from the

provisions of the Securities Act, the Exchange Act and the Trust

Indenture Act (other than with respect to antifraud provisions).

• The exemption’s conditions include (i) that the CCP’s counterparties

to the relevant security-based swap are eligible contract participants

and (ii) in the case of the exemption from the Securities Act, that the

CCP makes available certain information regarding the swap,

including identification of the underlying asset relating to the security-

based swap in question.


Timeline of SEC Exemptive Relief

• Under section 774 of Dodd-Frank, the provisions of

Subtitle B of Title VII of Dodd-Frank were to take effect,

unless a provision required a rulemaking, 360 days after

the date of enactment of Dodd-Frank, or July 16, 2011.

• However, prior to July 16, 2011, the SEC took actions to

provide relief from the security-based swap provisions of

Dodd-Frank.



• On June 15, 2011, the SEC issued a general exemptive

order (the “General Exemptive Order”).

• The General Exemptive Order does not contain any

“sunset” provision, but, instead, its exemptions generally

expire on the compliance date of rules relating to each

provision with respect to which relief is granted.



• In addition, on July 1, 2011, the SEC issued both (i) interim final rules

(the “Interim Final Rules”) and (ii) another exemptive order,

specifically under the Exchange Act (the “Exchange Act Exemptive

Order”).

• In its release of the Interim Final Rules, the SEC stated that the

rules would remain in effect until the compliance date for final rules

further defining the terms “security-based swap” and “eligible

contract participant”.

•Similarly, by the terms of the Exchange Act Exemptive Order, the

relief granted in the order was to expire upon the compliance date

for final rules, as applicable, (i) further defining the terms “security-

based swap” and “eligible contract participant” or (ii) regarding

registration of security-based swap facilities.



• In April 2012, the SEC and the CFTC adopted regulations further

defining, among other things, the term “eligible contract participant.”

• In July 2012, the SEC and the CFTC adopted regulations further

defining, among other things, the term “security-based swap.”

• In the adopting release for these regulations, the SEC stated that

solely for the purposes of the Exchange Act Exemptive Order and

the Interim Final Rules, the compliance date for the final rules

further defining the term ‘‘security-based swap’’ would be February

11, 2013.

•There was no need to extend General Exemptive Order because

expiration of the relief that it provides is generally linked to compliance

dates for rules that had not yet gone into effect.



• Prior to February 11, 2013, the SEC took the following actions:

• Issued an extension of the Interim Final Rules; and

• Issued an extension of the Exchange Act Exemptive Order.

• The two extensions extend until February 11, 2014, the

expiration date of the relief granted in the Interim Final Rules

and the Exchange Act Exemptive Order.

• Still no need to extend General Exemptive Order because

expiration of the relief that it provides is generally linked to

compliance dates for rules that have not yet gone into effect.


Why Extend Rules and Exemptive Order?

• SEC had not completed its evaluation of the implications

of treating security-based swaps as securities.

• Intent to move forward deliberatively in implementing

Dodd-Frank requirements.

• Necessary to keep status quo to allow market participants

to continue to enter into security-based swaps.


Why Extend Rules and Exemptive Order?

• Concern about market disruptions in relation to security-

based swaps in relation to Dodd-Frank requirements,

including requirements to:

• Register offer and sale of security-based swaps under

the Securities Act;

• Comply with provisions of Exchange Act applicable to

classes of securities; and

• Comply with the indenture provisions of the Trust

Indenture Act.


Contrast with CFTC’s Approach

• CFTC has finalized many more rulemakings than SEC.

• Among the rulemakings that the CFTC has finalized are:

• Swap dealer registration (about 75 swap dealers have registered

with CFTC);

• Business conduct (many external business conduct rules are

scheduled to go into effect today);

• Swap data reporting and recordkeeping;

• Mandatory clearing (in effect for certain rate swaps and CDS for

category 1 entities such as dealers; will be phased in for category

2 entities next month and for all others in September of this year);

• End-user exception to mandatory clearing requirement; and

• Affiliate exception to mandatory clearing.



• However, although the CFTC has implemented many more rules

than the SEC, some of those rules have proven difficult to implement

in practice.

• CFTC has issued dozens of no-action letters, many of them providing

temporary relief.

• Value and use of reported swap data have been called into question.

• Immediately after recent no-action relief was granted, CFTC

Commissioner O’Malia issued a statement listing various

complaints, including his concern that the CFTC is facing

immense challenges in using data that the three SDRs are

reporting because of inconsistent and incomplete reporting,

technology shortfalls and integration issues.



• Notwithstanding its different approach to rulemaking, the CFTC still

has a number of important rulemakings to finalize:

• Margin Requirements for uncleared OTC swaps

• The margin requirements have not been finalized, although it is widely anticipated

that levels will be higher than for cleared swaps (keeping in mind, however, that

clearing houses and FCMs can increase the level of margin on a cleared swap).

• Cross-jurisdiction harmonization will be needed.

• Swap Execution Facility (“SEF)” Rules

• Dodd-Frank requires that all swaps that are required to be cleared be executed on

a designated contract market (“DCM”) or a SEF, unless the swap type is not

available for trading on any DCM or SEF, or another clearing exception applies.

• The CFTC has proposed rules governing SEFs that subject SEFs to specific

transparency requirements related to making bids, offers and trades available to

all market participants.



• Extraterritoriality

• In June 2012, the CFTC issued an exemptive order and also

proposed cross-border guidance, which permitted delayed

compliance with certain Title VII requirements for foreign entities.

• In December 2012, the CFTC extended the exemptive order

delaying compliance and modifying the “U.S. person” definition.

The SEC staff has stated that finalizing cross-border guidance is

an important priority for the agency.

• Considerable public debate is ongoing (and may be advanced by

the SEC’s upcoming release of extraterritorial guidance).


Scope of SEC Exemptive Relief

• Together, the General Exemptive Order, the Interim Final

Rules and the Exchange Act Exemptive Order provide

broad relief for entities transacting in security-based

swaps.

• However, certain provisions of the securities laws do

apply to security-based swaps, notably antifraud and anti-

manipulation provisions (Section 17(a) of the Securities

Act).


Industry Commentary

• Broad current relief, plus a deliberative approach, means

that industry has a comfort level with SEC’s process.

• However, it is still not clear how much relief will be

granted on a permanent basis.

• Industry participants have argued that permanent relief

from certain provisions would be appropriate.


Industry Commentary

• In particular, relief from Section 5 of the Securities Act, which

requires a registration statement to be in effect as to a security, is

seen as necessary.

• The primary issue that Section 5 seeks to address, adequate

disclosure, would in many cases not be an issue for a security-based

swap.

• SEC business conduct standards are expected to require disclosures

of material information.

• Requiring registration statements in the context of security-based

swaps would be unduly burdensome and expensive.


Industry Commentary

• The industry also seeks permanent relief from certain provisions of

the Exchange Act.

• SIFMA has submitted to the SEC a letter dividing the provisions of

the Exchange Act into different categories:

• Provisions that should apply to security-based swaps (such as

antifraud provisions and certain entity-level requirements, such as

capital rules and financial reporting rules)

• Provisions that seem inapplicable or unworkable for security-

based swaps (such as issuer disclosures, rules on missing or

stolen securities)

• Provisions that are unnecessary for registered broker-dealers’

dealing and brokering activities because they overlap with

existing broker-dealer regulations (such as business conduct

rules)


Relief Under Interim Final Rules

• Interim Final Rules provide relief under each of the

• Securities Act

• Exchange Act, and

• Trust Indenture Act of 1939

• The postponements of expiration dates aim to maintain

status quo.

• They apply to those security-based swaps that prior to

July 16, 2011 were security-based swap agreements and

are defined as “securities” under the Securities Act and

the Exchange Act as of July 16, 2011 due solely to the

provisions of Title VII of Dodd-Frank.



• Specifically, the Interim Final Rules, subject to conditions,

exempt offers and sales of security-based swap

agreements that became security-based swaps on the

effective date of Title VII from:

• All provisions of the Securities Act (other than anti-

fraud provisions);

• Exchange Act registration requirements; and

• Provisions of the Trust Indenture Act.



• Securities Act Rule 240

• Provides that, other than antifraud provisions contained in Section

17(a) of the Securities Act, the Securities Act does not apply to

the offer or sale of any security-based swap that is:

•a security-based swap agreement, as defined in the

Securities Act as in effect prior to July 16, 2011; and

•entered into between eligible contract participants (as defined

in the Commodity Exchange Act as in effect prior to July 16,

2011).

• Rule will permit the offer or sale of these security-based swaps

between eligible contract participants without requiring compliance

with Securities Act Section 5, which requires a registration statement

to be in effect as to a security.



• In Securities Act Rule 240, the use of definitions in effect

prior to July 16, 2011 (“security-based swap agreement”

and “eligible contract participant”) is intended to preserve

the status quo ante and avoid uncertainty as to the

applicability of the Securities Act registration

requirements.

• In order to qualify as a “security-based swap agreement,”

an agreement had to be entered into between eligible

contract participants and subject to individual negotiation.



• Exchange Act Rule 12a–11

• Provides that the provisions of Section 12(a) of the Exchange Act

do not apply to any security-based swap offered and sold in

reliance on Rule 240 under the Securities Act.

• Section 12(a) of the Exchange Act provides that it is unlawful for a

member, broker, or dealer to effect any transaction in any security

(other than an exempted security) on a national securities exchange

unless a registration is effective as to such security for such

exchange.

• Exemption is intended to allow trading activities relating to those

security-based swaps that are security-based swap agreements with

eligible contract participants to continue, provided the parties rely on

the Rule 240 Securities Act exemption with respect to such security-

based swaps.



• Exchange Act Rule 12h–1(i)

• Adds an exemption for registration under Section 12(g) of the

Exchange Act for any security-based swap offered and sold in

reliance on Rule 240 under the Securities Act.

• Section 12(g) requires certain issuers engaged in interstate

commerce, one of whose classes of securities is held by either 2,000

persons or 500 persons who are not accredited investors, to register

such security with the SEC by filing a registration statement.

• SEC noted that, while it was not sure that there would be a class of

security-based swaps that would be subject to registration under

Exchange Act Section 12(g), it was appropriate to provide this

exemption while the SEC learns about and evaluates the types of

security-based swap transactions that have been and will be

transacted.



• Trust Indenture Act Rule 4d-12

• Provides that any security-based swap offered and sold in

reliance on Securities Act Rule 240, whether or not issued under

an indenture, is exempt from the Trust Indenture Act.

• SEC does not believe the protections contained in the Trust

Indenture Act are currently needed with respect to security-based

swaps.

• Trust Indenture Act is aimed at addressing problems that unregulated

debt offerings pose for investors and the public, and provides a

mechanism for debt holders to protect and enforce their rights with

respect to the debt.



• Protections contained in the Trust Indenture Act are not needed to

protect eligible contract participants to whom a sale of security-based

swaps is made in reliance on Securities Act Rule 240.

• Security-based swaps are contracts between two parties and, as a

result, do not raise the same problem regarding the ability of parties

to enforce their rights under the instruments as would, for example, a

debt offering to the public.

• Enforcement of contractual rights and obligations under security-

based swaps would occur directly between the parties, and Trust

Indenture Act provisions would probably not provide any additional

meaningful substantive or procedural protections.


General Exemptive Order

• Unlike the relief under the Interim Final Rules, the relief

provided by the General Exemptive Order is aimed not at

relieving concerns arising from the treatment of security-

based swaps as “securities” under the Securities Act, the

Exchange Act and the Trust Indenture Act, but instead

assuring that market participants are not required

prematurely to come into compliance with requirements

imposed by Dodd-Frank.

• Relief is aimed at particular Dodd-Frank requirements.


Relief Under General Exemptive Order

• Relief for Security-based Swap Dealers and Major Security-based

Swap Participants – Swap Reporting:

•No reporting party for a security-based swap is required to

report any pre-enactment security-based swap until the date

that is six (6) months after the date on which security-based

swap data repository that is capable of accepting the asset

class of such security-based swap is registered with the SEC.

•Security-based swap dealers are expected generally to be

reporting parties for the security-based swaps to which they

are parties.




Swap Participants – Associated Persons

• Security-based swap dealers and major security-based swap

participants are excepted from a prohibition with respect to

permitting persons who are associated with the security-based

swap dealer or major security-based swap participant, and are

subject to a statutory disqualification, to effect or be involved in

effecting security-based swaps on behalf of such security-based

swap dealer or major security-based swap participant, but only

until the date upon which rules adopted by the SEC to register

security-based swap dealers and major security-based swap

participants become effective.




Swap Participants – Segregation of Collateral

• Security-based swap dealers and major security-based swap

participants are exempt from the requirement to segregate their

counterparty’s initial margin in relation to non-cleared swaps upon

the counterparty’s request until the date upon which the rules

adopted by the SEC to register security-based swap dealers and

major security-based swap participants become effective.



• Relief in Relation to Security-Based SEFs – Operation without

Registration

• Persons that operate a facility for the trading or processing of

security-based swaps that is not registered as a national

securities exchange or that cannot yet register as a security-

based swap execution facility because final rules for such

registration have not yet been adopted are exempt from the

prohibition on operating such a facility unless such facility is

registered as a security-based swap execution facility or national

securities exchange until the earliest compliance date set forth in

any of the final rules regarding registration of security-based

swap execution facilities.



• Relief in Relation to Security-Based SEFs – Identification of Trading

Venue

• Registered clearing agencies under section 17A of the Exchange

Act are exempt from the requirement that a national securities

exchange, if it also operates a security-based swap execution

facility, and employs the same electronic trade execution system

for securities-based swaps on both the exchange and the facility,

identify whether trading of such swaps is occurring on the

national securities exchange or on the execution facility, until the

earliest compliance date set forth in any of the final rules

regarding registration of security-based swap execution facilities.



• Relief for Security-based Swap Data Repositories – Data

confidentiality

• Entities meeting the definition of security-based swap data

repository are exempt from certain requirements contained in

section 13(n) of the Exchange Act relating, in part, to data

access, confidentiality and sharing, until the earlier of (1) the date

the SEC grants registration to the security-based swap data

repository and (2) the earliest compliance date for any of the final

rules regarding the registration of security-based swap data

repositories.



• Registered Clearing Agencies – Chief Compliance Officer

• Registered clearing agencies under section 17A of the Exchange

Act are exempt from the requirement to appoint a chief

compliance officer until the earliest compliance date set forth in

any of the final rules regarding the duties of a chief compliance

officer under section 3C(j)(2) of the Exchange Act.



• Non-Voidability:

• No contract entered into on or after July 16, 2011 will be void by

reason of section 29(b) of the Exchange Act (which provides

generally that contracts made in violation of the Exchange Act are

void) because any person that is a party to the contract violated a

provision of the Exchange Act that was amended or added by

Subtitle B of Title VII of Dodd-Frank and for which the SEC has

taken the view that compliance will be triggered by registration of

a person or by adoption of final rules by the SEC, or for which the

SEC has provided an exception or exemptive relief, until such

date as the SEC specifies.



• Eligible Contract Participant Requirement:

• A person meeting the definition of eligible contract participant as set

forth in section 1a(12) of the Commodity Exchange Act (as in effect

on July 20, 2010) was exempt from the requirement that, unless a

security-based swap is transacted on a registered national securities

exchange, each party to such swap must be an eligible contract

participant, until the effective date for the final rules further defining

the term eligible contract participant, provided that such person

effects such transaction with or for a person that also meets the

definition of eligible contract participant as set forth in section 1a(12)

of the Commodity Exchange Act (as in effect on July 20, 2010).

• The CFTC and SEC released joint rules further defining “eligible

contract participant” in May 2012, and this temporary relief is no

longer available.




Swap Participants – Swap Clearing:

•Security-based swap dealers and major security-based swap

participants were exempt from the requirement to clear

security-based swaps at the request of their counterparties

until the earliest compliance date set forth in any of the final

rules regarding the procedures according to which the SEC

will determine which security-based swaps should be

designated for mandatory clearing.

•The SEC issued rules relating to the process for submissions

for the review of security-based swaps for mandatory clearing

June 2012, and it appears that this temporary exemption is no

longer available.


Exchange Act Exemptive Order

• Exchange Act Exemptive Order addresses matters

pertaining to Exchange Act other than the registration-

related matters addressed in the Interim Final Rules.


Relief Under Exchange Act Exemptive Order

• First exemption is a broad temporary exemption in connection with

security-based swap activity.

• Subject to exclusions, each eligible person is exempt from the

provisions of the Exchange Act, and the rules and regulations

thereunder, solely in connection with the person’s activities involving

security-based swaps.

• Exemption is available to any person that meets the definition of

“eligible contract participant” as set forth in section 1a(12) of the

Commodity Exchange Act (as in effect on July 20, 2010), other than

registered broker-dealers (addressed in the second exemption,

below) and self-regulatory organizations.



• Second exemption is a temporary exemption specific to security-

based swap activities of registered brokers and dealers.

• Subject to exclusions, a broker or dealer registered under section

15(b) of the Exchange Act is exempt from certain provisions of the

Exchange Act solely with respect to security-based swaps.

• A registered broker or dealer will be exempt from the following

provisions in connection with security-based swaps solely to the

extent that those provisions or rules do not apply to the broker’s or

dealer’s security-based swap positions or activities as of July 15,

2011:

• Sections 7c, 15(c)(3), and 17(a) and (b), Regulation T, 12 CFR 220.1 et seq.,

Rule 240.15c3–1, Rule 240.15c3–3, Rule 240.17a–3, Rule 240.17a–4,

Rule 240.17a–5, Rule 240.17a–8, and Rule 240.17a–13.



• Third temporary exemption provides partial relief from sections 5 and

6 of the Exchange Act for market participants, including certain

brokers and dealers and central counterparties, in connection with

their security-based swap activities.

• Section 5 of the Exchange Act makes it unlawful for any broker,

dealer or exchange to use any facility of an exchange to effect a

transaction in a security unless the exchange is either registered as a

national securities exchange or exempted from registration.

• Section 6 of the Exchange Act states the conditions upon which an

exchange may be registered as a national securities exchange.



• The expiration of this exemption is tied to the earliest compliance

date for rules regarding the registration of security-based swap

execution facilities (not the compliance date for rules further defining

“security-based swap” and “eligible contract participant”).

• As a technical matter, this exemption was not extended by the SEC’s

February 2013 order extending other exemptions under the

Exchange Act Exemptive Order, but it remains in effect.

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