U.S. SEC Adopts Rules for Security-Based Swap Execution Facilities

On November 2, 2023, the U.S. Securities and Exchange Commission (the SEC) adopted Regulation SE (Regulation SE) under the Securities Exchange Act of 1934 (the Exchange Act) to create a regime for the registration and regulation of security-based swap (SBS) execution facilities (SBSEFs).¹ Regulation SE defines an SBSEF by cross-reference to the definition in Section 3(a)(77) of the Exchange Act as:

a trading system or platform in which multiple participants have the ability to execute or trade [SBS] by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility, that — (A) facilitates the execution of [SBS] between persons; and (B) is not a national securities exchange.

It is expected that many of the trading facilities currently operating swap execution facilities (SEFs) registered with the Commodity Futures Trading Commission (CFTC) will also choose to operate SBSEFs. Those trading facilities will be subject to both Regulation SE and the CFTC’s SEF regulations. Regulation SE will therefore operate in parallel with a number of CFTC regulations that apply to SEFs and that have been in force for many years.² In light of the preexisting regulation of SEFs by the CFTC, and to minimize additional compliance burdens for platforms that will be dually registered, the SEC attempted to align Regulation SE closely with the CFTC regulations governing SEFs and swap execution.

Who This Affects

Regulation SE will substantially affect trading facilities that provide for the execution of SBS between multiple counterparties because they will have to register as SBSEFs and operate in accordance with the requirements of Regulation SE, thereby affecting their day-to-day operations. Regulation SE will also affect the SBS end users, market makers, hedge funds, and other financial and nonfinancial entities that will use the services of SBSEFs and will be subject to their rules and procedures.

Implementation Schedule

Regulation SE becomes effective 60 calendar days following publication in the Federal Register. Thereafter, an entity that meets the SBSEF definition will be able to file a registration application. Any entity that acts as an SBSEF but does not file a registration application by 180 days after the effective date will be in violation of the registration requirement unless it can rely on an exemption. An entity that submits an application for registration within 180 days of the effective date and whose application is complete (having responded to all requests by SEC staff for revisions or amendments) within 240 days of the effective date may continue to operate as an SBSEF without being in violation of the registration requirement. If the SEC rejects the SBSEF application, the SBSEF must stop operating within 30 days.

Who Must Register and How

Who Is Required to Register?

Regulation SE requires an entity meeting the SBSEF definition to register as such or to register as a national securities exchange.

Who Is Not Required to Register?

Single-dealer “one-to-many” trading platforms for SBS that do not offer multiple-to-multiple trading are outside the scope of the SBSEF registration requirement.

Foreign trading venues with participants that are U.S. persons (and certain other categories of persons with a U.S. nexus) may seek an exemption from registration.

A carveout exists for registered clearing agencies that limit their SBSEF functions to operating trading sessions designed to further the accuracy of end-of-day valuations (i.e., “forced trading sessions”).³

The SEC explains in its adopting release that it is not adopting or incorporating into its rules the guidance issued by the CFTC’s Division of Market Oversight in CFTC Staff Letter 21-19 regarding the scope of the CFTC’s SEF registration requirement. The SEC notes that this letter “in large part refers to fact-specific circumstances that the [SEC] has yet to encounter” and that “the application of the SBSEF definition depends on the particular facts and circumstances of a platform’s structure and operations.” The SEC invites operators of SBS trading platforms that have questions to speak with SEC staff.

How to Register

To register, an applicant must file its completed Form SBSEF, including all required exhibits, using the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system, (which will also be used for purposes of subject product listing and rule filings). The applicant must also provide to the SEC, upon its request, any additional information and documentation necessary to review the application. Form SBSEF is also used for submitting any updates, corrections or supplemental information to a pending application.

Notably, the SEC declined to adopt abbreviated SBSEF registration procedures for CFTC-registered SEFs. The SEC expects that applicants that are SEFs will be able to use the information from their SEF applications to complete their SBSEF applications.

The SEC must approve or deny an application for registration by order within 180 days of the filing. If the SEC denies registration, it is required to specify the grounds for denial.

SBS Trade Execution Requirement

Section 3C(h) of the Exchange Act provides that if a transaction involves an SBS that is subject to a mandatory clearing determination by the SEC (under Section 3C of the Exchange Act), then the counterparties must execute the transaction on either a national securities exchange or a registered or exempt SBSEF. This is known as the “trade execution requirement” and is parallel to the trade execution requirement established under the Commodity Exchange Act for swaps. Currently, the SEC has not made any SBS subject to mandatory clearing. The trade execution requirement does not apply if no national securities exchange or SBSEF makes the SBS “available to trade” or it is subject to a mandatory clearing exception.

Rule 816 of Regulation SE sets out a procedure for an SBSEF to make an SBS listed for trading on its facility “available to trade” (assuming it is also subject to the clearing requirement) and also establishes certain exemptions from the trade execution requirement for (i) certain package transactions, (ii) SBS subject to an exception or exemption to mandatory clearing, and (iii) trades between affiliates.

Cross-Border Rules

Rule 832 — Cross-Border Mandatory Trade Execution

Rule 832 of Regulation SE explains when the trade execution requirement applies to a cross-border transaction. The trade execution requirement does not apply to an SBS transaction unless at least one counterparty is a “covered person.” A “covered person” is defined as any person that is (i) a U.S. person; (ii) a non-U.S. person whose performance under the SBS is guaranteed by a U.S. person; or (iii) a non-U.S. person who, in connection with its SBS dealing activity, uses personnel to arrange, negotiate, or execute a transaction who are (a) U.S. personnel located in a U.S. branch or office or (b) personnel of an agent of such non-U.S. person who are located in a U.S. branch or office.

Rule 833 — Cross-Border Exemptions for Foreign Trading Venues and Relating to the Trade Execution Requirement

Rule 833 of Regulation SE provides a process by which the SEC may (i) grant exemptions from the Exchange Act definitions of “exchange,” “SBSEF,” and “broker” and (ii) exempt cross-border SBS from the trade execution requirement. Specifically, Rule 833(a) provides that a foreign SBS trading venue can request an exemption from registering as a national securities exchange, SBSEF, or broker by submitting an application for exemptive relief. The SEC would consider the submission as an application to exempt the foreign SBS trading venue with respect to its providing a market place for SBS. Rule 833(b) allows requests for exemptive relief from the trade execution requirement for SBS transactions executed on a foreign trading venue. For both the Rule 833(a) and (b) exemptions, the SEC must find an exemption to be necessary or appropriate in the public interest and consistent with the protection of investors.

Governance Requirements to Mitigate Conflicts of Interest

Section 765(a) of the Dodd-Frank Act required the SEC to mitigate conflicts of interest for SBSEFs and SBS national securities exchanges by adopting rules that may include limits on control and voting rights. Rule 834 implements this requirement. Specifically, it provides that each SBSEF and SBS exchange must not permit any of its members (whether alone or together with any officer, principal, or employee of the member) to (i) own (directly or indirectly) 20% or more of any class of voting securities or of other voting interest in the SBSEF or SBS exchange or (ii) directly or indirectly vote, cause the voting of, or give any consent or proxy with respect to the voting of any interest that exceeds 20% of the voting power of any class of securities or of other ownership interest in the SBSEF or SBS exchange. Notably, however, Rule 834 provides that these two limitations do not apply to an SBSEF that has entered an agreement with a national securities association, such as the Financial Industry Regulatory Authority (FINRA), or a national futures association, such as the National Futures Association, for the provision of regulatory services that encompasses, at a minimum, real-time market monitoring and investigations and investigation reports.

Appeals of SBSEF Actions to the SEC

The SEC amended its Rules of Practice to allow for appeals for (i) final disciplinary actions taken by an SBSEF, (ii) denials of or conditions on membership, and (iii) limitations or denials of access. The CFTC has similar procedures with respect to SEFs. These appeal rights are also consistent with appeal rights under the Exchange Act for the same types of actions when they are taken by self-regulatory organizations, such as FINRA, the national securities exchanges, and clearing agencies.

Rule and Product Filings

Rules 804 and 805 — Product Filings

Rules 804 and 805 of Regulation SE, which are modeled on CFTC Regulations 40.2 and 40.3, respectively, set forth the procedures by which an SBSEF may list products for trading on its venue. Rule 804 sets out the procedures for listing of products by certification (pursuant to which an SBSEF would self-certify that the product to be listed complies with the Exchange Act and the SEC rules thereunder), and Rule 805 sets out the procedures for voluntary submission of products for SEC review and approval (which the SEC notes is valuable to an SBSEF seeking the SEC’s concurrence that a new product does not violate the Exchange Act or the SEC’s rules thereunder).

The procedures are substantially similar to the parallel CFTC requirements under CFTC Regulations 40.2 and 40.3, except that the SEC must receive a self-certification submission under Rule 804 by the opening of business on the business day that is 10 business days preceding the product’s listing, which contrasts with the CFTC’s one-day review period for self-certification of products by SEFs. In adopting the 10-business-day review period, the SEC notes that the extended review period strikes an appropriate balance between allowing SBSEFs to list new products quickly and affording SEC staff a sufficient time period in which to assess those products prior to listing.

Rules 806 and 807 — Rule Filings

Rule 806 and 807 of Regulation SE, which are modeled on CFTC Regulations 40.5 and 40.6, set forth the procedures by which an SBSEF may submit new rules and rule amendments. Rule 806 sets out the procedures for the voluntary submission of rules and rule amendments for SEC review and approval, and Rule 807 sets out the procedures for the self-certification of rules and rule amendments. Both rules are substantially similar to the parallel CFTC requirements under CFTC Regulations 40.5 and 40.6. Consistent with Rule 804, Rule 806 also has a 10-business-day review period for self-certifications.

Exemptions for SBSEFs Regarding Securities Exchange and Broker Requirements

Amendments to Existing Exchange Act Rule 3a1-1 Exemptions From the “Exchange” Definition

The SEC exempted from the “exchange” definition (i) a registered SBSEF that provides a market only for securities that are SBS and (ii) an entity that has registered with the SEC as a clearing agency and limits its exchange functions to operating a trading session designed to further the accuracy of end-of-day valuations.

Rule 15a-12 — SBSEFs as Registered Brokers; Relief From Certain Broker Requirements

The SEC exempted a registered SBSEF from certain broker requirements while affirming that an SBSEF is a broker under the Exchange Act. 

¹Security-Based Swap Execution and Registration and Regulation of Security-Based Swap Execution Facilities, Release No. 34-98845 (Nov. 2, 2023), available at https://www.sec.gov/files/rules/final/2023/34-98845.pdf.
²The CFTC adopted its first regulations for SEFs in 2013 in connection with implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).
³This carveout codifies a series of exemptions granted by the SEC to SBS clearing agencies that operate “forced trading” sessions.