SEC Proposes Rules for Risk Mitigation of Security-Based Swaps

The Securities and Exchange Commission (SEC) is proposing rules that would require the application of specific risk mitigation techniques to portfolios of security-based swaps not submitted for clearing.

Proposed Rules 15Fi-3 through 15Fi-5 would establish requirements for registered security-based swap dealers and major security-based swap participants (SBS Entities) with respect to:

• Reconciling outstanding security-based swaps with applicable counterparties on a periodic basis;
• Engaging in certain forms of portfolio compression exercises, as appropriate; and
• Executing written security-based swap trading relationship documentation with each of its counterparties prior to, or contemporaneously with, executing a security-based swap transaction.

The SEC says relationship documentation, portfolio reconciliation, and portfolio compression are important tools for increasing operational efficiency and reducing risk for SBS Entities. For example, requiring SBS Entities to document the terms of their trading relationship with each of their counterparties before executing a new security-based swap transaction should foster greater transparency and legal certainty by allowing market participants to have a clear understanding of each other’s rights and obligations from the outset of the transaction.

Portfolio reconciliation further supports these goals by providing counterparties with a mechanism for identifying any discrepancies in the terms of a transaction throughout the life of the trade. Finally, portfolio compression allows market participants to reduce their total number of open contracts—generally without affecting their net exposure—resulting in fewer trades to manage, maintain, and settle, and fewer opportunities for processing errors.

By proposing these rules, the Commission is taking another step in standing up its regime pursuant to Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Commission is requesting comment on how certain aspects of the proposed rules address how a security-based swap data repository (SDR) could potentially satisfy its obligation to verify the terms of each security-based swap with both counterparties to the transaction.