There has been significant commentary and media attention regarding SEC Chair Gary Gensler’s comments on all things crypto last week.

However, a less high-profile Gensler speech, which might have more practical consequence to asset managers in the short term, happened at an American Bar Association event last week. In the speech, Mr. Gensler returned to a corner of the market he knows extremely well through his previous role as Chair at the Commodity Futures Trading Commission (CFTC). The current SEC chair spoke at length about security-based swaps (SBS) reform.

Interestingly, Mr. Gensler chaired the CFTC from May 2008 to January 2014, and was seen as one of the leading regulatory reform figures throughout the global financial crisis. Strange as it may seem, much of the swap reform proposed from his CFTC term remains unfinished.

Unfinished business in the swaps market

It seems that Mr. Gensler now wishes to use his SEC chairmanship to revisit some aspects of Dodd-Frank and other swap-related rulemaking, working in tandem with the CFTC to conclude this unfinished business.

We have already flagged that the relatively new SEC chair has a full agenda to grapple with, and he has gotten quickly into his stride addressing the issues on his plate.

In the speech, Gensler harked back to the global financial crisis, and reminded listeners that credit default swaps were very much at the heart of the $180 billion government bailout of AIG. The firm’s near failure accelerated the great financial crisis and allowed certain banks to lower their regulatory capital requirements to dangerously low levels.

The notional value of credit default swaps is about $8 trillion today, not insignificant but still many times smaller than it was in 2010 as the crisis erupted, primarily because of regulatory restrictions implemented within Dodd-Frank and elsewhere.

A more contemporary event has also forced the SEC’s hand to revisit the swaps market, namely, Archegos Capital Management (Archegos).

Archegos Capital Management: Putting swaps back in the limelight

There are two primary areas purported to be addressed from the Archegos fallout:

1. One relates to the firm itself – how did the firm elude registration and reporting requirements?

Archegos’ status as a family office means that it was exempt from a lot of the standard regulatory disclosures demanded of registered participants. Historically, family offices have not had to register with the SEC because of an exemption for firms with 15 clients or fewer.

The Dodd-Frank Act that tightened regulations in the wake of the 2008 crisis removed this exemption to improve transparency. However, the SEC has generally allowed family offices to decide for themselves whether they should be registered and file the required reports.

In his comments, Gensler highlights the November 8 date where the SEC’s SBS reporting rules come into effect. These will require SBS transaction data to be reported to a swap data repository followed by public dissemination by those repositories beginning in February 2022.  This is very similar to what already occurs in Europe with European Market Infrastructure regulation (EMIR) and Securities Financing Transaction Regulation (SFTR) and elsewhere. 

2. The other relates to broader market risk – how did the various counterparties and the SEC have no knowledge of the total exposure Archegos had built?

That neither the SEC nor the various counterparties providing credit to Archegos had any idea of the aggregated position, due to lack of transparency, is seen as another factor. Each broker was seemingly unaware of the true exposure in the market to Archegos.

Prime brokers have estimated that Archegos managed about $10 billion of capital before the debacle, which was a lot for a family office that was hardly a hedge fund titan.

In his comments, Gensler addresses this market-reporting gap head on and flags a key upcoming November 1 deadline date for SEC registration for SBS dealers and major SBS participants.

It is expected that around 50 SBS dealers will register with the SEC. These registration requirements will also include new counterparty protections, capital and margin rules, prescribed internal risk-management obligations and a host of other recordkeeping and reporting procedures.

Gensler also recognizes the fact that the swaps markets are very much global and it is necessary to accommodate non-US SBS dealers and participants for mutual benefit of investors and markets.

He flags the recent reciprocal agreements with Germany, the U.K. and France to allow for swaps trading between these countries and the US, in an SEC process known as “substitute compliance determination”.  An SEC substituted compliance determination is much like the EU’s notion of “regulatory equivalence”. It allows the SEC to determine that certain non-US entities can be a participant in the U.S. security-based swap markets and be deemed compliant with SEC standards if they operate under a regulatory regime the SEC deem comparable to the US requirements.

Looking forward: What to expect from Mr. Gensler

Mr. Gensler also highlighted several additional potential new rules which might be brought to bear.  The proposals are very specific and well thought-through, which is not surprising given Gensler himself has been reflecting on these issues for the past decade. They include:

• Mandatory disclosure of trading positions (long and short) under Rule 10b of the Securities and Exchange Act of 1934, which largely governs against "manipulative and deceptive practices" in securities trading in the secondary market – non exchange traded and OTC derivative trading such as swaps. This appears to be a direct response to the non-reporting of the Archegos trades that slipped through a number of cracks in the reporting regimes.
• Completion of the SEC’s 2011 rules for registration of security- based execution facilities (SB SEFs).  This will require a certain degree of harmonization of the SEC’s rules with those which already exist at the CFTC and there’s long been uncertainty regarding jurisdictional boundaries for derivatives between the two agencies. Mr. Gensler suggests this could be brought about through supplementary notices or SEC comment rulemaking rather than full scale re-regulation.
• Bolstering of the SEC rules adopted within Dodd-Frank on fraud, manipulation and deception relating to security-based swaps which form part of Section 9(j) of the Exchange Act.

In conclusion, the new Chair of the SEC has already gotten into his stride in terms of grappling with some of the key issues exercising the markets.  It was by design that using an experienced hand at the tiller would mean he could get to rulemaking quickly in areas needed as certain market evolutions continue apace and other parts of the financial crisis need to move towards conclusion.

It’s fair to say the plate remains full and the SEC regulatory agenda will remain an area of vibrant debate for the rest of 2021 and on – should you wish to discuss any of the SEC current priorities please do get in touch.