By John Filar Atwood
The Securities Industry and Financial Markets Association (SIFMA) strongly opposes the SEC’s proposed extension of Reg. SCI to broker-dealers, a group for which the regulation was not originally designed. In a comment letter to the Commission, SIFMA outlined multiple objections, including that entities subject to Reg. SCI serve different roles in the markets than broker-dealers and operate under different regulatory expectations regarding their availability and accessibility.
Reg. SCI was adopted in 2014 to strengthen the technology infrastructure of the securities markets, and applies to certain self-regulatory organizations such as stock and options exchanges, registered clearing agencies, FINRA, and the MSRB. It also applies to alternative trading systems that trade NMS and non-NMS stocks exceeding specified volume thresholds, disseminators of consolidated market data, and certain clearing agencies.
In March, the SEC proposed to expand and update Reg. SCI by, among other things, extending it to registered security-based swap data repositories, all clearing agencies that are exempt from registration, and certain large broker-dealers that exceed a total assets threshold or a transaction activity threshold in national market system stocks, exchange-listed options contracts, U.S. Treasury securities, or Agency securities.
SIFMA’s managing director noted that the proposed expansion of Reg. SCI does not address the distinctions the Commission recognized when originally setting the scope for the regulation. In addition, he argued that SIFMA’s members have already developed robust technological resiliency as a result of the various existing regulatory obligations to which they are subject, and have done so without the imposition of the requirements of Reg. SCI.
Thresholds. In its comment letter, SIFMA argues that the proposed asset and trading thresholds to capture broker-dealers are not the appropriate means by which to impose Reg. SCI’s requirements, especially where the SEC has not explained how the proposed thresholds are an appropriate proxy for operational risk.
In SIFMA’s opinion, the actual experience of how the market operates undercuts any potential Commission justification for imposing Reg. SCI on broker-dealers, including that broker-dealers are generally easily substitutable for one another in the market and that buyside firms routinely diversify using multiple broker-dealers and sources of liquidity. In addition, SIFMA believes the SEC should address the fact that the proposed thresholds impose burdens on certain broker-dealers and not others, and consider how the proposed thresholds would impose significant compliance burdens on brokers.
SIFMA also warns that the by expanding Reg. SCI from systems facilitating trading to include systems that do the trading itself, the proposal creates a requirement that proposed SCI broker-dealers engage in trading by committing capital and taking on principal risk. The Commission offers no rationale for this fundamental change and fails to analyze its consequences, SIFMA said.
Not designed for brokers. SIFMA points out that Reg. SCI was originally designed to cover vital systems of entities that represent the critical trading infrastructure, including certain trading venues, entities essential to providing real-time market data, and entities that clear and settle securities transactions. Systems failures of these entities are what prompted Reg. SCI, SIFMA notes. In its view, when Reg. SCI is applied to broker-dealers, many of the core concepts and obligations of the original rule are unsuitable and unworkable.
SIFMA also objects to the compliance costs that will be imposed by the proposed changes. The association believes that the proposal does not justify the costs and cites no evidence that Reg. SCI is needed to solve an existing regulatory gap or that it would produce any net improvement in systems integrity for broker-dealers.
Third-party providers. SIFMA argues that its members already maintain robust third-party management programs and require the contracted service provider to adhere to applicable legal and regulatory obligations. A principles- and risk-based approach is crucial to ensure such programs are efficient and sustainable, SIFMA said, but the proposal would take a prescriptive approach that may disincentivize the use of third-party providers or limit the provision of certain valuable services.
On the issue of third-party relationships, SIFMA recommends that the Commission adopt a similar approach to the federal prudential regulators’ interagency guidance. That guidance acknowledges potential limitations and challenges in negotiating certain rights or gaining access to certain information, and grounds its expectations in the adoption of a risk-based approach throughout the entire third-party relationships lifecycle, according to SIFMA.
SIFMA also recommends that the SEC examine the experience and costs of Reg. SCI entities since its adoption and apply that knowledge before expanding the scope of Reg. SCI or adding additional requirements. The proposal lacks any concrete examples, SIFMA notes, where current Reg. SCI requirements have provided the Commission or the public with beneficial information that it has received and found actionable in any real-time way.
In reality, SIFMA said, Reg. SCI requirements have caused entities to divert resources from addressing potential issues merely to meet the arbitrary timeframe for certain reporting requirements. Nevertheless, the proposal seeks to prioritize reporting speed over system resiliency and recovery, in SIFMA’s opinion.