By Rodney F. Tonkovic, J.D.
SEC Chair Gary Gensler spoke on May 11 before the annual meeting of the International Swaps and Derivatives Association. He observed that security-based swaps occasionally move from the corners of the markets to front and center, and their role in past and present "market jitters" helps inform how he thinks about them. In his remarks, Gensler highlighted the SEC's recent initiatives and proposals aimed at reducing risk, increasing transparency, and strengthening the integrity of the derivatives market.
A decade ago, as CFTC Chair, Gensler referred to the regulatory response to the 2008 financial crisis as a "new era for the swaps marketplace." He explained that a form of security-based swaps played an important role in the crisis as banks used credit default swaps to hedge their bank loan portfolios—"or so they thought." That swap market is relevant today, and Gensler noted the SEC's fraud charges against Archegos Capital Management based on manipulating stock prices using total return swaps. Gensler said that the role of security-based swaps in past and present "market jitters" helps inform how he thinks about them.
New new era. In his remarks before the ISDA, Gensler said that "we are embarking on yet another 'new era.'" While the CFTC has authority over the bulk of the swaps market, the SEC oversees security-based swaps. Many reforms have been made, Gensler said, but the Commission has work to do to update rules for the marketplace and fulfill its obligations under Dodd-Frank.
Risk reduction. The reforms to the swaps market reduce risk in two ways, Gensler continued. First, dealers must register with the SEC, meaning that they also must have key controls and cushions against losses; at the time of these remarks, there were 47 conditionally registered security-based swap dealers. The second part of the Dodd-Frank risk reduction scheme was central clearing, and the Commission regulates three clearinghouses for security-based swaps.
Transparency. Next, Dodd-Frank also called for more transparency in the security-based swaps market. To that end, Gensler pointed to a proposed framework for the registration of security-based swap-execution facilities that would harmonize with the CFTC's established and successful framework. If entities that register as security-based facilities are also registered as such with the CFTC, it would facilitate efficiencies for market participants, he said.
The Commission has also made efforts toward post-trade transparency, with two initiatives already implemented—that is, new rules on reporting of security-based swap data and the dissemination of data to the public—and a recent proposal on public reporting of large security-based swap positions.
Market integrity. Turning briefly to the topic of market integrity, Gensler highlighted two proposals intended to enhance the integrity of the security-based swap market. First, a re-proposed Rule 9j-1 would prevent fraud in connection with security-based swap transactions. In the same proposal is a prohibition against the coercion, misleading, or otherwise interfering with an SBS entity's chief compliance officer.
Crypto and complex products. Gensler then touched on the intersection of crypto assets with derivatives. Here, he reiterated the SEC's position that most crypto tokens are investment contracts and if a swap is based upon a crypto asset that is a security, then that is a security-based swap and subject to the SEC's rules. Platforms that offer securities-based swaps also must work within the securities regime, he added.
Finally, Gensler addressed the use of derivatives within structured and so-called complex products. The use of derivatives touches many parts of the markets, he said, and these investment products can pose risks even to sophisticated investors. Gensler said that he has asked the Division of Investment Management and Division of Examinations to take a "renewed and focused look at the use of derivatives by registered investment companies so that they’re compliant with our rules."