Source: https://www.federalregister.gov/documents/2013/12/27/2013-30976/comparability-determination-for-japan-certain-entity-level-requirements
Timestamp: 2018-04-20 05:13:36
Document Index: 93857328

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Federal Register :: Comparability Determination for Japan: Certain Entity-Level Requirements
78910-78923 (14 pages)
CFTC-2013-0112
B. Risk Management Duties (§§ 23.600—23.609)
Appendices to Comparability Determination for Japan: Certain Entity-Level Requirements
https://www.federalregister.gov/d/2013-30976 https://www.federalregister.gov/d/2013-30976
Notice of comparability determination for certain requirements under the laws of Japan.
The following is the analysis and determination of the Commodity Futures Trading Commission (“Commission”) regarding certain parts of a joint request by the Bank of Tokyo-Mitsubishi UFJ, Ltd (“BTMU”), Goldman Sachs Japan Co., Ltd., Merrill Lynch Japan Securities Co., Ltd., and Morgan Stanley MUFG Securities Co., Ltd. that the Commission determine that laws and regulations applicable in Japan provide a sufficient basis for an affirmative finding of comparability with respect to the following regulatory obligations applicable to swap dealers (“SDs”) and major swap participants (“MSPs”) registered with the Commission: (i) Chief compliance officer; (ii) risk management; and (iii) swap data recordkeeping (collectively, the “Internal Business Conduct Requirements”).
Start Further Info Start Printed Page 78911
Gary Barnett, Director, 202 418-5977, gbarnett@cftc.gov, Frank Fisanich, Chief Counsel, 202-418-5949, ffisanich@cftc.gov, and Jason Shafer, Special Counsel, 202-418-5097, jshafer@cftc.gov, Division of Swap Dealer and Intermediary Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
On July 26, 2013, the Commission published in the Federal Register its “Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations” (the “Guidance”).[1] In the Guidance, the Commission set forth its interpretation of the manner in which it believes that section 2(i) of the Commodity Exchange Act (“CEA”) applies Title VII's swap provisions to activities outside the U.S. and informed the public of some of the policies that it expects to follow, generally speaking, in applying Title VII and certain Commission regulations in contexts covered by section 2(i). Among other matters, the Guidance generally described the policy and procedural framework under which the Commission would consider a substituted compliance program with respect to Commission regulations applicable to entities located outside the U.S. Specifically, the Commission addressed a recognition program where compliance with a comparable regulatory requirement of a foreign jurisdiction would serve as a reasonable substitute for compliance with the attendant requirements of the CEA and the Commission's regulations promulgated thereunder.
On June 24, 2013, BTMU submitted a request that the Commission determine that laws and regulations applicable in Japan provide a sufficient basis for an affirmative finding of comparability with respect to certain Entity-Level Requirements, including the Internal Business Conduct Requirements.[4] BTMU provided Commission staff with a supplement on October 8, 2013. On October 29, 2013, the application was further supplemented with corrections and additional materials. On November 12, 2013, Goldman Sachs Japan Co., Ltd., Merrill Lynch Japan Securities Co., Ltd., and Morgan Stanley MUFG Securities Co., Ltd. requested that they be permitted to rely upon BTMU's submission as the basis for their request for a substituted compliance determination (BTMU, Goldman Sachs Japan Co., Ltd., Merrill Lynch Japan Securities Co., Ltd., and Morgan Stanley MUFG Securities Co., Ltd., are referred to herein as, collectively, the “applicants”). The following is the Commission's analysis and determination regarding the Internal Business Conduct Requirements, as detailed below.[5]
In evaluating whether a particular category of foreign regulatory requirement(s) is comparable and comprehensive to the Start Printed Page 78912applicable requirement(s) under the CEA and Commission regulations, the Commission will take into consideration all relevant factors, including but not limited to, the comprehensiveness of those requirement(s), the scope and objectives of the relevant regulatory requirement(s), the comprehensiveness of the foreign regulator's supervisory compliance program, as well as the home jurisdiction's authority to support and enforce its oversight of the registrant. In this context, comparable does not necessarily mean identical. Rather, the Commission would evaluate whether the home jurisdiction's regulatory requirement is comparable to and as comprehensive as the corresponding U.S. regulatory requirement(s).[9]
In this regard, the Commission notes that a comparability determination cannot be premised on whether an SD or MSP must disclose comprehensive information to its regulator in its home jurisdiction, but rather on whether information relevant to the Commission's oversight of an SD or MSP would be directly available to the Commission and any U.S. prudential regulator of the SD or MSP.[11] The Commission's direct access to the books and records required to be maintained by an SD or MSP registered with the Commission is a core requirement of the CEA[12] and the Commission's regulations,[13] and is a condition to registration.[14]
As represented to the Commission by the applicants, swap activities in Japan may be governed by the Banking Act of Japan, No. 59 of 1981 (“Banking Act”), covering banks and bank holding companies, and the Financial Instruments and Exchange Act, No. 25 of 1948 (“FIEA”), covering, among others, Financial Instrument Business Operators (“FIBOs”) and Registered Financial Institutions (“RFIs”). The Japanese Prime Minister delegated broad authority to implement these laws to the Japanese Financial Services Agency (“JFSA”). Pursuant to this authority, the JFSA has promulgated the Order for Enforcement,[15] Cabinet Office Ordinance,[16] Supervisory Guidelines[17] and Inspection Manuals.[18] The Securities and Exchange Surveillance Commission (“SESC”) is within the JFS and has promulgated, among other things, the Inspection Manual for FIBOs.
In general, banks are subject to the Banking Act, relevant laws and regulations for banks, Supervisory Guidelines for banks, and Inspection Manual for banks, while FIBOs are subject to the FIEA, relevant laws and regulations for FIBOs, Supervisory Guidelines for FIBOs, and Inspection Manual for FIBOs.
Pursuant to Article 29 of the FIEA, any person that engages in trade activities that constitute “Financial Instruments Business”—which, among other things, includes over-the-counter transactions in derivatives (“OTC derivatives”) or intermediary, brokerage (excluding brokerage for clearing of securities) or agency services therefor[19] —must register under the FIEA as a FIBO. Banks that conduct specified activities in the course of trade, including OTC derivatives must register under the FIEA as RFIs pursuant to Article 33-2 of the FIEA. Banks registered as RFIs are required to comply with relevant laws and regulations for FIBOs regarding specified activities. Failure to comply with any relevant laws and regulations, Supervisory Guidelines or Inspection Manuals would subject the applicant to potential sanctions or corrective measures.
The applicants are each registered in Japan as RFIs or FIBOs under the supervision of the JFSA. In addition, each applicant is a member of several self-regulatory organizations, including the Japanese Securities Dealers Association (“JSDA”). The JSDA is a “Financial Instruments Firms Association” authorized under FIEA by the Prime Minister of Japan.[20]
The Commission's comparability analysis will be based on a comparison of specific foreign requirements against the specific related CEA provisions and Commission regulations as categorized and described in the Guidance. As explained in the Guidance, within the framework of CEA section 2(i) and principles of international comity, the Commission may make a comparability determination on a requirement-by-requirement basis, rather than on the basis of the foreign regime as a whole.[21] In making its comparability determinations, the Commission may include conditions that take into account timing and other issues related Start Printed Page 78913to coordinating the implementation of reform efforts across jurisdictions.[22]
In doing its comparability analysis the Commission may determine that no comparability determination can be made[25] and that the non-U.S. SD or non-U.S. MSP, U.S. bank that is an SD or MSP with respect to its foreign branches, or non-registrant, to the extent applicable under the Guidance, may be required to comply with the CEA and Commission regulations.
Finally, the Commission will generally rely on an applicant's description of the laws and regulations of the foreign jurisdiction in making its comparability determination. The Commission considers an application to be a representation by the applicant that the laws and regulations submitted are in full force and effect, that the description of such laws and regulations is accurate and complete, and that, unless otherwise noted, the scope of such laws and regulations encompasses the swaps activities[28] of SDs and MSPs[29] in the relevant jurisdictions.[30] Further, as stated in the Guidance, the Commission expects that an applicant would notify the Commission of any material changes to information submitted in support of a comparability determination (including, but not limited to, changes in the relevant supervisory or regulatory regime) as, depending on the nature of the change, the Commission's comparability determination may no longer be valid.[31]
The Guidance provided a detailed discussion of the Commission's policy regarding the availability of substituted Start Printed Page 78914compliance[32] for the Internal Business Conduct Requirements.[33]
In the Guidance, the Commission stated that, in connection with a determination that substituted compliance is appropriate, it would expect to enter into an appropriate memorandum of understanding (“MOU”) or similar arrangement[34] with the relevant foreign regulator(s). Although existing arrangements would indicate a foreign regulator's ability to cooperate and share information, “going forward, the Commission and relevant foreign supervisor(s) would need to establish supervisory MOUs or other arrangements that provide for information sharing and cooperation in the context of supervising [SDs] and MSPs.”[35]
The following section describes the requirements imposed by specific sections of the CEA and the Commission's regulations for the Internal Business Conduct Requirements that are the subject of this comparability determination, and the Commission's regulatory objectives with respect to such requirements. Immediately following a description of the requirement(s) and regulatory objective(s) of the specific Internal Business Conduct Requirements that the applicants submitted for a comparability determination, the Commission provides a description of the foreign jurisdiction's comparable laws, regulations, or rules and whether such laws, regulations, or rules meet the applicable regulatory objective.
Each SD and MSP must include a designation of a CCO in its registration application;Start Printed Page 78915
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as section 4s(k) of the CEA and Commission regulation 3.3.
The Banking Act, FIEA, Order for Enforcement, Cabinet Office Ordinance, Supervisory Guidelines and Inspection Manuals for banks and FIBOs, collectively, require each bank and FIBO to:
Designate an individual to serve as a CCO in its registration application as a bank/FIBO;
Provide the CCO with the responsibility and authority to develop the regulatory compliance policies and procedures of the bank/FIBO;
Have the CCO report to the board of directors of the bank/FIBO;
Ensure the CCO has the background and skills appropriate for the position;
Ensure the CCO is not disqualified from registration; [38]
Have the CCO administer the regulatory compliance policies of the bank/FIBO;
Have the CCO take reasonable steps to ensure compliance and resolve conflicts of interest for the bank/FIBO;
Have the CCO detect and remediate non-compliance issues for the bank/FIBO;
Report regulatory compliance status to the board of directors as necessary and appropriate on behalf of the bank/FIBO; and
Submit an annual business report to JFSA which contains compliance facts, preventative and corrective actions taken, and other issues regarding the firm's compliance framework.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 3.3 by seeking to ensure firms have designated a qualified individual as the compliance officer that reports directly to a sufficiently senior function of the firm and that has the independence, responsibility, and authority to develop and administer compliance policies and procedures reasonably designed to ensure compliance with the CEA and Commission regulations, resolve conflicts of interest, remediate noncompliance issues, and report annually on compliance of the firm.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the CCO requirements of the Japanese standards specified above are comparable to and as comprehensive as § 3.3, with the exception of § 3.3(f) concerning certifying and furnishing an annual compliance report to the Commission.
Notwithstanding that the Commission has not determined that the requirements of Japan's laws and regulations are comparable to and as comprehensive as § 3.3(f), any SD or MSP to which both § 3.3 and the Japanese standards specified above are applicable would generally be deemed to be in compliance with § 3.3(f) if that SD or MSP complies with the Japanese standards specified above, subject to certifying and furnishing the Commission with the annual report required under the Japanese standards specified above in accordance with § 3.3(f). The Commission notes that it generally expects registrants to submit required reports to the Commission in the English language.
Section 4s(j) of the CEA requires each SD and MSP to establish internal policies and procedures designed to, among other things, address risk management, monitor compliance with position limits, prevent conflicts of interest, and promote diligent supervision, as well as maintain business continuity and disaster recovery programs.[39] The Commission adopted regulations 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606 to implement the statute.[40] The Commission also adopted regulation 23.609, which requires certain risk management procedures for SDs or MSPs that are clearing members of a derivatives clearing organization (“DCO”).[41] Collectively, these requirements help to establish a robust and comprehensive internal risk management program for SDs and MSPs with respect to their swaps activities,[42] Start Printed Page 78916which is critical to effective systemic risk management for the overall swaps market. In making its comparability determination with regard to these risk management duties, the Commission will consider each regulation individually.[43]
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as section 4s(j)(2) of the CEA and Commission regulation 23.600.
III-2-3-1-3(1) and III-3-7-1-2(1)(ii) of the Supervisory Guidelines and Inspection Manuals for banks and III-1(1)(ii) of the Supervisory Guideline for FIBOs generally require the board of directors of a bank/FIBO to establish a comprehensive risk management program aligned with the bank's/FIBO's strategic target. The risk management program required by the Supervisory Guidelines and Inspectional Manuals must be designed to monitor and manage risk, including without limitation, market (including foreign currency), credit, liquidity, legal, operational, and settlement risks.[44]
The review of a bank's/FIBO's overall risk management program must take into account how frequently the risk management division reports to the board of directors and whether reports are also filed on an as-needed basis. Pursuant to Article 19 of the Banking Act and Article 46-3 of the FIEA, a bank/FIBO must submit to the JFSA a business report referring to the risk management of derivative transactions annually within three months after the end of year period. In addition, pursuant to Article 24 of the Banking Act and Article 56-2 of the FIEA, JFSA requires a bank/FIBO to report to JFSA on a quarterly basis the data of derivative transactions such as the volume and profit and loss amounts within fifty days after the end of every quarter period.
Pursuant to the above Supervisory Guidelines and Inspection Manuals, a bank/FIBO must arrange for the approval of new products in a manner befitting the scale and nature of its business. III-1(1)(iv) of the Supervisory Guidelines for FIBOs and III-2-3-1-3(5)(6) of the Supervisory Guidelines for banks require JSFA to evaluate whether a bank's/FIBO's risk management program established a sufficient internal audit system. As part of this oversight, a bank/FIBO must receive an external audit by corporate auditors at least once a year.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.600 by requiring a system of risk management that seeks to ensure that firms are adequately managing the risks of their swaps activities to prevent failure of the SD or MSP, which could result in losses to counterparties doing business with the SD or MSP, and systemic risk more generally. Specifically, the Commission finds that the Japanese standards specified above comprehensively require SDs and MSPs to establish risk management programs containing the following critical elements:
Establishment of risk tolerance limits for each category of risk and approval of such limits by senior management and the governing body;Start Printed Page 78917
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the risk management program requirements of Japan's laws and regulations, as specified above, are comparable to and as comprehensive as § 23.600, with the exception of § 23.600(c)(2) concerning the requirement that each SD and MSP produce a quarterly risk exposure report and provide such report to its senior management, governing body, and the Commission.
Notwithstanding that the Commission has not determined that the requirements of Japan's laws and regulations are comparable to and as comprehensive as § 23.600(c)(2), any SD or MSP to which both § 23.600 and the Japanese standards specified above are applicable would generally be deemed to be in compliance with § 23.600(c)(2) if that SD or MSP complies with the Japanese standards specified above, subject to compliance with the requirement that it produce quarterly risk exposure reports and provide such reports to its senior management, governing body, and the Commission in accordance with § 23.600(c)(2). The Commission notes that it generally expects reports furnished to the Commission by registrants to be in the English language.
Commission Requirement: Implementing section 4s(j)(1) of the CEA, Commission regulation 23.601 requires each SD or MSP to establish and enforce written policies and procedures that are reasonably designed to monitor for, and prevent violations of, applicable position limits established by the Commission, a designated contract market (“DCM”), or a swap execution facility (“SEF”).[45] The policies and procedures must include an early warning system and provide for escalation of violations to senior management (including the firm's governing body).
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as section 4s(j)(1) of the CEA and Commission regulation 23.601.
IV-2-3 of the Supervisory Guidelines for FIBOs and III-2-3-3-2(2)(vii) and (viii) of the Supervisory Guideline for banks of the Inspection Manuals generally require a bank/FIBO to establish internal position limits, risk limits, and loss limits for all financial products, including derivatives. The policies established by the bank/FIBO must provide a system to provide “alarm points” to the board of directors. Moreover, in accordance with Article 29-2 of the Business Rules of Japan Securities Clearing Corporation (“JSCC”) with respect to listed products, JSCC can take an appropriate action against clearing participants (RFIs or FIBOs) if JSCC finds their position is excessive compared with their net assets. Therefore, clearing participants have to monitor their positions in relation to their net assets. CCP's Business Rules, which are subject to JFSA's approval, are legally binding requirements.
The applicants represent that the position limits set internally by banks and FIBOs may not exceed position limits set by applicable law, including position limits set by the Commission, SEFs, or DCMs.[46]
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.601 by requiring SDs and MSPs to establish necessary policies and procedures to monitor the trading of the firm to prevent violations of applicable position limits established by applicable laws and regulations, including those of the Commission, a DCM, or a SEF. Specifically, the Commission finds that the Japanese standards specified above, while not specific to the issue of position limit compliance, nevertheless comprehensively require SDs and MSPs to monitor for regulatory compliance generally, which includes monitoring for compliance with position limits set pursuant to applicable law and the responsibility of senior management (including the board of directors) for such compliance.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the compliance monitoring requirements of the Japanese standards, as specified above, are comparable to and as comprehensive as § 23.601. For the avoidance of doubt, the Commission notes that this determination may not be relied on to relieve an SD or MSP from its obligation to strictly comply with any applicable position limit established by the Commission, a DCM, or a SEF.
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as Start Printed Page 78918section 4s(h)(1)(B) of the CEA and Commission regulation 23.602.
III-1-2-1-(2)(xi) and III-1-2-1-(2)(xiii) of the Supervisory Guideline for banks, the Checklist for Business Management (Governance) of the Bank Inspection Manual, III-1(1)(ii)C and IV-1-2-(1)(i) of the Supervisory Guideline for FIBOs, and II-1-1-3(3) and II-2-1 of the FIBO Inspection Manual generally require a bank/FIBO to ensure appropriate officers and employees are in place in order to properly conduct business, and to establish legal compliance and internal control systems.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.602 because such standards seek to ensure that SDs and MSPs strictly comply with applicable law, which would include the CEA and the Commission's regulations.[47]
Through the Supervisory Guidelines and Inspection Manuals, Japan's laws and regulations seek to ensure that each SD and MSP not only establishes the necessary policies and procedures that would lead to compliance with applicable law, which would include the CEA and Commission regulations, but also establishes an effective system of internal oversight and enforcement of such policies and procedures to ensure that such policies and procedures are diligently followed.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the internal supervision requirements set forth in the Japanese standards, as specified above, are comparable to and as comprehensive as § 23.602.
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as Commission regulation 23.603.
IV-3-1-6 of the Supervisory Guideline for FIBOs and sections III-6-1 and III-6-2(2)(i)(iii)-(v) of the Supervisory Guideline for banks require a bank/FIBO to establish a crisis management manual and a business continuity and disaster recovery plan that include procedures for, and the maintenance of, back-up facilities, systems, infrastructure, personnel, and other resources to achieve the timely recovery of data and documentation and to resume operations.
Pursuant to III-8-2-(2)-(v) of the Supervisory Guideline for banks, JFSA requires banks to resume operation within the day of the event, especially for important settlement functions. Pursuant to IV-3-1-6(2) of the Supervisory Guideline for FIBOs, JFSA checks whether a FIBO's business continuity plan ensures quick recovery from damage caused by acts of terrorism, large-scale disasters, etc., as well as continuance of the minimum necessary business operations and services for the maintenance of the functions of the financial system.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.603 because such standards seek to ensure that any market disruption affecting SDs and MSPs, whether caused by natural disaster or otherwise, is minimized in length and severity. To that end, the Commission finds that the Japanese standards specified above seek to ensure that entities adequately plan for disruptions and devote sufficient resources capable of carrying out an appropriate plan in a timely manner.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the business continuity and disaster recovery requirements of the Japanese standards, as specified above, are comparable to and as comprehensive as § 23.603.
In addition, section 4s(j)(5) of the CEA and Commission regulation 23.605(d)(1) generally prohibits an SD or MSP from directly or indirectly interfering with or attempting to influence the decision of any clearing unit of any affiliated clearing member of a derivatives clearing organization (DCO) to provide clearing services and activities to a particular customer, including:
The Commission observes that § 23.605(d) works in tandem with Commission regulation 1.71, which requires FCMs that are clearing members of a DCO and affiliated with an SD or MSP to create and maintain an appropriate informational partition between business trading units of the SD or MSP and clearing units of the FCM to reasonably ensure compliance with the Act and the prohibitions set forth in § 1.71(d)(1), which are the same as the prohibitions set forth in § 23.605(d)(1) outlined above.
Finally, § 23.605(e) requires that each SD or MSP have policies and procedures that mandate the disclosure Start Printed Page 78919to counterparties of material incentives or conflicts of interest regarding the decision of a counterparty to execute a derivative on a swap execution facility or designated contract market (DCM) or to clear a derivative through a DCO.
In addition, the § 23.605(d) (working in tandem with § 1.71) seeks to ensure open access to the clearing of swaps by requiring that access to and the provision of clearing services provided by an affiliate of an SD or MSP are not influenced by the interests of an SD's or MSP's trading business.
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as Commission regulation 23.605.
Regulations Concerning the Handling of Analysts Reports have been developed by the JSDA to require JSDA members to appropriately manage the content of any unpublished analyst report that is considered to have a material impact on investors (to include the presentation of any conflicts) and to establish an appropriate compensation system to ensure the independence of the opinions of analysts.
More generally, FIEA and the Financial Instruments Business Ordinance require a FIBO/RFI to conduct business “in good faith and fairly to customers.” Specifically, I.2.(3)(iv) of the Checklist for Legal Compliance of the Bank Inspection Manual and II-1-2-1(4)(iii) of the FIBO Inspection Manual require each bank/FIBO to establish firewalls and take other measures to block the flow of information when necessary. Article 70-3(1)(ii)(d) of the Financial Instruments Business Ordinance and IV-1-3(3)(i)C of the Supervisory Guidelines for FIBOs require a FIBO/RFI to develop a control environment wherein it can choose or combine appropriate method(s), for example, notifying the customer of a conflict risk to establish a system for protection of customers.
The JFSA has informed the Commission that, in the process of its oversight and enforcement of the foregoing Japanese standards for FIBOs and RFIs, any SD or MSP would be subject to such standards and required to resolve or mitigate conflicts of interests in the provision of clearing services by a clearing member of a DCO that is an affiliate of the SD or MSP, or the decision of a counterparty to execute a derivative on a SEF or DCM, or clear a derivative through a DCO, through appropriate information firewalls and disclosures.
Commission Determination: The Commission finds that the Japanese standards specified above with respect to conflicts of interest that may arise in producing or distributing research are generally identical in intent to § 23.605(c) because such standards seek to ensure that research provided to the general public by an SD is unbiased and free from the influence of the interests of an SD arising from the SD's trading business.
With respect to conflicts of interest that may arise in the provision of clearing services by an affiliate of an SD or MSP, the Commission further finds that although the general conflicts of interest prevention requirements under the Japanese standards specified above do not require with specificity that access to and the provision of clearing services provided by an affiliate of an SD or MSP not be improperly influenced by the interests of an SD's or MSP's trading business, such general requirements would require prevention and remediation of such improper influence when recognized or discovered. Thus such standards would ensure open access to clearing.
Finally, although not as specific as the requirements of § 23.605(e) (Undue influence on counterparties), the Commission finds that the general disclosure requirements of the Japanese standards specified above would ensure equal access to trading venues and clearinghouses by requiring that each SD and MSP disclose to counterparties any material incentives or conflicts of interest regarding the decision of a counterparty to execute a derivative on a SEF or DCM, or to clear a derivative through a DCO.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the requirements found in Japan's laws and regulations specified above in relation to conflicts of interest are comparable to and as comprehensive as § 23.605.
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as Commission regulation 23.606.
Under the JFSA annual supervisory policies for banks and FIBOs for program year 2013, a bank/FIBO is required to enhance their management information systems through various initiatives such as implementing BCBS ”Principles for effective risk data Start Printed Page 78920aggregation and risk reporting,” which enable banks/FIBOs to meet the information requests of relevant regulators.
III-3-3(6) of Supervisory Guideline for FIBOs states that each FIBO must maintain electronic media storage systems that can accommodate internal audits and be responsive to client referrals and questions. Moreover, III.1.(6) of the Checklist for Market Risk Management of the Bank Inspection Manual requires that records be readily available for reconciliation with trade tickets, etc.
III-3-10-2(3) (iv) of Supervisory Guideline for banks specifically requires banks to have the personnel and systems to respond in a timely and appropriate manner to inspections and supervision provided by overseas regulatory authorities. In view of maintaining direct dialog and smooth communications with the relevant overseas regulatory authorities, this provision ensures the establishment of a reporting system which enables timely and appropriate reporting.
Similarly, IV-5-2(i) of Supervisory Guideline for FIBOs would ensure the availability of information to a regulator promptly upon request. Under this provision, the JFSA assesses whether a parent company of a FIBO ensures group-wide compliance with the relevant laws, regulations and rules of each country in which it does business by establishing an appropriate control environment for legal compliance in accordance with the size of its overseas bases and the characteristics of its business operations.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.606 because such standards seek to ensure that each SD and MSP captures and stores comprehensive information about their swap activities, and are able to retrieve and disclose such information as necessary for compliance with applicable law and for purposes of regulatory oversight.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the requirements of the Japanese standards with respect to the availability of information for inspection and disclosure, as specified above, are comparable to, and as comprehensive as, § 23.606.
Regulatory Objective: Through Commission regulation § 23.609, the Commission seeks to ensure the financial integrity of the markets and the clearing system, to avoid systemic risk, and to protect customer funds. Effective risk management by SDs and MSPs that are clearing members is essential to achieving these objectives. A failure of risk management can cause a clearing member to become insolvent and default to a DCO. Such default can disrupt the markets and the clearing system and harm customers.
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as Commission regulation 23.609.
III-2-3-2-1-2 (9) and (10)(i) of the Supervisory Guideline for banks and III.(8) and (9)(i) of the Checklist for Credit Risk Management of the Inspection Manual for banks generally require a bank to properly manage the credit risks of major counterparties to derivatives transactions, as well as the risks associated with the clearing of derivatives transactions with a central counterparty. More specifically, the Supervisory Guidelines for banks require a bank to properly manage the risks associated with cleared derivative transactions with central counterparties (“CCPs”), including the inherent risk of transactions with a CCP, the risk associated with material defects of regulations or supervisory schemes to which a CCP is subject, and the risk of loss of the bank's contribution to the default fund of a CCP.
IV-2-4 of the Supervisory Guideline for FIBOs and I-2-(4) of the Inspection Manual for FIBOs require FIBOs to properly manage counterparty risk. Counterparty risk is the risk of incurring losses due to a failure by a counterparty to fulfill its contractual obligations.
The JFSA evaluates a FIBO on whether it properly manages counterparty risk by developing a comprehensive control environment for risk management, properly recognizing and evaluating the risks, conducting internal screening when a new product or a new business is introduced and establishing a system of checks and balances based on the clear allocation of roles and responsibilities.
The JFSA strives to identify and keep track of the status of a FIBO's counterparty risk and its risk management through monthly offsite monitoring reports and hearings based thereon and, when necessary, requiring FIBOs to submit a report based on Article 56-2(1) of the FIEA and urge it to make improvement efforts.
The foregoing requirements apply to bank and FIBO risk management as clearing members.
In addition, if FIBOs/RFIs are clearing members of the JSCC, in accordance with the business rules of the JSCC, they are required to develop an appropriate structure for management of the risk of loss.
Finally, the JFSA has represented to the Commission that, in the process of its oversight and enforcement of the foregoing Japanese standards for banks, FIBOs, and RFIs, any SD or MSP subject to such standards that is a clearing member of a DCO would be required to comply with clearing member risk management requirements comparable to Commission regulation 23.609.
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to § 23.609 because such standards seek to ensure the financial integrity of the markets and the clearing system, to avoid systemic risk, and to protect customer funds.
The Commission notes that the Japanese standards specified above are not as specific as § 23.609 with respect to ensuring that SDs and MSPs that are clearing members of a DCO establish detailed procedures and limits for clearing member risk management purposes. Nevertheless, the Commission finds that the general requirements Start Printed Page 78921under the Japanese standards, implemented in the context of clearing member risk management and pursuant to the representations of the JFSA, meet the Commission's regulatory objective specified above.
Based on the foregoing and the representations above, the Commission hereby determines that the clearing member risk management requirements of the Japanese standards specified above are comparable to and as comprehensive as § 23.609.
Commission regulation 23.203, requires SDs and MSPs to maintain records of a swap transaction until the termination, maturity, expiration, transfer, assignment, or novation date of the transaction, and for a period of five years after such date. Records must be “readily accessible” for the first 2 years of the 5 year retention period (consistent with § 1.31).
The Commission notes that the comparability determination below with respect to §§ 23.201 and 23.203 encompasses both swap data recordkeeping generally and swap data recordkeeping relating to complaints and marketing and sales materials in accordance with § 23.201(b)(3) and (4).[48]
Comparable Japanese Law and Regulations: The applicants have represented to the Commission that the following provisions of law and regulations applicable in Japan are in full force and effect in Japan, and comparable to and as comprehensive as sections 4s(f)(1)(B) and 4s(g)(1) of the CEA and §§ 23.201 and 23.203.
A FIBO/RFI is required by provisions set forth in the FIEA, the OTC Derivatives Ordinance, and the Financial Instruments Business Ordinance to retain all records related to swaps transactions.
Articles 371, 381, 394, 396, and 436 of the Company Act require governance records including minutes of board of directors and audit reports of auditors to be retained for ten years. Also, Article 432, 435, and 444 of the Company Act require financial records including financial statements, business reports, and annexed detailed statements to be retained for five years.
Articles 12-3 and 52-71 of the Banking Act and Articles 37-7 and 156-48 of the FIEA further require each bank/FIBO to prepare and maintain records as part of its “complaint processing procedures.” Specific details regarding the storage of records detailing customer complaints are set forth in III-3-5-2-2(5)(ii) of the Supervisory Guideline for banks, II-2.1(3-4) and III-2.1(4) of the Checklist for Customer Protection Management of the Bank Inspection Manual, III-2-5 of the Supervisory Guideline for FIBOs, and II-1-2-1(7) of the FIBO Inspection Manual.
Article 37 of the FIEA and Article 72 of the Financial Instruments Business Ordinance require maintenance of records regarding marketing and sales materials.
III-3-3(6) of Supervisory Guideline for FIBOs states that each FIBO must maintain electronic media storage systems that can accommodate internal audits and be responsive to client referrals and questions. Moreover, III.1.(6) of the Checklist for Market Risk Management of the Bank Inspection Manual requires the records be readily available for reconciliation with trade tickets, etc.
FIEA and the Financial Instruments Business Ordinance generally require records to be kept for a minimum of five years, but certain records must be maintained from seven to ten years. III-1(vi) of the Checklist for Market Risk Management of the Bank Inspection Manual assesses whether voice recordings are maintained for all traders on a 24-hour basis and retained “under the control of an organization segregated from the market and back-office divisions.”
Commission Determination: The Commission finds that the Japanese standards specified above are generally identical in intent to §§ 23.201 and 23.203 because such standards seek to ensure the effectiveness of the internal controls of SDs and MSPs, and transparency in the swaps market for regulators and market participants.
In addition, the Commission finds that the Japanese standards specified above require SDs and MSPs to keep swap data in a level of detail sufficient to enable regulatory authorities to understand an SD's or MSP's swaps Start Printed Page 78922business and to assess its swaps exposure.
Further, the Commission finds that the Japanese standards specified above, by requiring comprehensive records of swap data, seek to ensure that SDs and MSPs employ effective risk management, seek to ensure that SDs and MSPs strictly comply with applicable regulatory requirements (including the CEA and Commission regulations), and that such records facilitate effective regulatory oversight.
Finally, the Commission finds that the Japanese standards specified above would ensure Commission access to the required books and records of SDs and MSPs by requiring personnel and systems necessary to respond in a timely and appropriate manner to inspections and supervision provided by overseas regulatory authorities.
Based on the foregoing and the representations of the applicants, the Commission hereby determines that the Japanese requirements with respect to swap data recordkeeping, as specified above, are comparable to, and as comprehensive as, §§ 23.201 and 23.203.
Second, in several areas, the Commission has declined to consider a request for a comparability determination, and has also failed to provide an analysis regarding the extent to which the other jurisdiction is, or Start Printed Page 78923is not, comparable. For example, the Commission has declined to address or provide any clarity regarding the European Union's regulatory data reporting determination, even though the European Union's reporting regime is set to begin on February 12, 2014. Although the Commission has provided some limited relief with respect to regulatory data reporting, the lack of clarity creates unnecessary uncertainty, especially when the European Union's reporting regime is set to begin in less than two months.
Similarly, Japan receives no consideration for its mandatory clearing requirement, even though the Commission considers Japan's legal framework to be comparable to the U.S. framework. While the Commission has declined to provide even a partial comparability determination, at least in this instance the Commission has provided a reason: the differences in the scope of entities and products subject to the clearing requirement.[8] Such treatment creates uncertainty and is contrary to increased global harmonization efforts.
4. For purposes of this notice, the Internal Business Conduct Requirements consist of 17 CFR 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606. The applicants subsequently submitted a separate application for the applicable Transaction-Level Requirements on September 20, 2013. This notice addresses only the Entity-Level Requirements.
11. Under §§ 23.203 and 23.606, all records required by the CEA and the Commission's regulations to be maintained by a registered SD or MSP shall be maintained in accordance with Commission regulation 1.31 and shall be open for inspection by representatives of the Commission, the United States Department of Justice, or any applicable U.S. prudential regulator.
15. Order for Enforcement of the Banking Act and Order for Enforcement of the Financial Instruments and Exchange Act.
16. Cabinet Office Ordinance on Financial Instruments Business (“FIB Ordinance”) and Cabinet Office Ordinance on Regulation of OTC Derivatives Transaction.
17. Comprehensive Guideline for Supervision of Major Banks, etc.(“Supervisory Guideline for banks”) and Comprehensive Guideline for Supervision of Financial Instruments Business Operators, etc.(“Supervisory Guideline for FIBOs”).
18. Inspection Manual for Deposit Taking Institutions (“Inspection Manual for banks”), consisting of the Checklist for Business Management (Governance), Checklist for Legal Compliance, Checklist for Customer Protection Management, Checklist for Credit Risk Management, Checklist for Market Risk Management, Checklist for Liquidity Risk Management, Checklist for Operational Risk Management, etc.
19. See Article 2(8)(iv) of the FIEA.
20. Because the applicants' request and the Commissions determinations herein are based on the comparability of Japanese requirements applicable to banks, FIBOs, and RFIs, an SD or MSP that is not a bank, FIBO, or RFI, or is otherwise not subject to the requirements applicable to banks, FIBOs, and RFIs upon which the Commission bases its determinations, may not be able to rely on the Commission's comparability determinations herein.
33. This notice does not address § 23.608 (Restrictions on counterparty clearing relationships). The Commission declines to take up the request for a comparability determination with respect to this regulation due to the Commission's view that there are not laws or regulations applicable in Japan to compare with the prohibitions and requirements of § 23.608. The Commission may provide a comparability determination with respect to this regulation at a later date in consequence of further developments in the law and regulations applicable in Japan.
38. See Article 29-4 of FIEA and Article 15-4 of the Order for Enforcement of FIEA, Article 33-5(1)(iii) of FIEA; Article 33-3(1)(vii) of FIEA, Article 47(1)(i) of the FIB Ordinance, Article 33-3(2)(iv) of FIEA, Article 47(1)(i)(ii) of the FIB Ordinance, and Article 4(2)(ii) of Banking Act. Pursuant to Article 33-5(1)(iii) of FIEA and its relevant provisions, RFIs are required to have a personnel structure sufficient to conduct RFI business in an appropriate manner. Accordingly, if the CCO is subject to disqualification, registration for the RFI would be refused.
39. 7 U.S.C. § 6s(j).
40. See Final Swap Dealer and MSP Recordkeeping Rule, 77 FR 20128 (April 3, 2012) (relating to risk management program, monitoring of position limits, business continuity and disaster recovery, conflicts of interest policies and procedures, and general information availability, respectively).
41. See Customer Documentation Rule, 77 FR 21278. Also, SDs must comply with Commission regulation 23.608, which prohibits SDs providing clearing services to customers from entering into agreements that would: (i) Disclose the identity of a customer's original executing counterparty; (ii) limit the number of counterparties a customer may trade with; (iii) impose counterparty-based position limits; (iv) impair a customer's access to execution of a trade on terms that have a reasonable relationship to the best terms available; or (v) prevent compliance with specified time frames for acceptance of trades into clearing.
42. “Swaps activities” is defined in Commission regulation 23.600(a)(7) to mean, “with respect to a registrant, such registrant's activities related to swaps and any product used to hedge such swaps, including, but not limited to, futures, options, other swaps or security-based swaps, debt or equity securities, foreign currency, physical commodities, and other derivatives.” The Commission's regulations under 17 CFR Part 23 are limited in scope to the swaps activities of SDs and MSPs.
43. As stated above, this notice does not address § 23.608 (Restrictions on counterparty clearing relationships). The Commission declines to take up the request for a comparability determination with respect to this regulation due to the Commission's view that there are not laws or regulations applicable in Japan to compare with the prohibitions and requirements of § 23.608. The Commission may provide a comparability determination with respect to this regulation at a later date in consequence of further developments in the law and regulations applicable in Japan.
44. See, e.g. Supervisory Guideline: Checklist for Comprehensive Risk Management, Checklist for Business Management, Checklist for Legal Compliance, Checklist for Market Risk Management, Checklist for Credit Risk Management, Checklist for Liquidity Risk Management, and Checklist for Operational Risk Management.
45. The setting of position limits by the Commission, a DCM, or a SEF is subject to requirements under the CEA and Commission regulations other than § 23.601. The setting of position limits and compliance with such limits is not subject to the Commission's substituted compliance regime.
46. See III-3-10 of the Supervisory Guideline for banks and IV-5-2(i) of the Supervisory Guideline for FIBOs for rules regarding management of overseas business by banks and FIBOs.
47. See III-3-10 of the Supervisory Guideline for banks and IV-5-2(i) of the Supervisory Guideline for FIBOs for rules regarding management of overseas business by banks and FIBOs.
48. See the Guidance for a discussion of the availability of substituted compliance with respect to swap data recordkeeping, 78 FR 45332-33.
[FR Doc. 2013-30976 Filed 12-26-13; 8:45 am]