Significant Further Consideration of the SEC’s Proposed Rule 10B-1 is Needed

In December 2021, the Securities and Exchange Commission (SEC) proposed a new rule, 10B-1, that has the potential to undermine the liquidity and strength of U.S. capital markets by requiring one-day public disclosure of large security-based swaps (SBS) positions.  Key takeaways related to this proposal include:

• SBS are an important risk management tool and allow lenders to extend more credit to companies, which then funds job creation and economic growth. The proposal introduces new costs and risks which could decrease lending, with a direct negative impact on companies which need funding.
• Reduced lending capacity could increase companies’ cost of borrowing or risk of default, which could negatively impact their investors, employees, customers, and ability to create jobs and grow, exacerbating the economic challenges caused by inflation, rising interest rates, and global uncertainty.
• Rather than implement new rules which could harm economic growth, the SEC could instead analyze the data already being submitted under Regulation SBSR, which was fully implemented in April 2022 and governs reporting of SBS transactions. In addition, providing position data to regulators would offer the insight the SEC seeks, without the proposed rule’s potential negative consequences.

In our comments to the SEC, SIFMA noted, “Significant further consideration is needed before the Commission adopts Proposed Rule 10B-1, especially its public disclosure requirements. Rushing to implement those requirements is highly likely to result in a negative impact to the SBS markets and, importantly, to the global capital formation ecosystem that depends on vibrant SBS markets to hedge risk.”

Finalizing the rule is scheduled for the first half of 2023, according to the SEC’s reg flex agenda.  To avoid potential disruption to the legitimate uses of SBS for supporting capital formation and risk management, it is essential that the SEC does not adopt the rule as proposed but instead takes a data-driven approach that focuses on regulatory, not public, disclosure.

SBS are an important tool for risk-management, economic growth, and credit market stability

Security-based swaps are an important risk-management tool used by various market participants that help bolster economic growth. For example, lenders and brokers use SBS, like single-name credit default swaps (CDS), to hedge risk when extending credit to companies.  SBS enable them to extend more credit to more companies in need of capital to create jobs, innovate, and grow, which is especially important in times of economic stress.

Investors also use SBS to hedge risk and/or implement trade strategies, often after spending substantial time and resources on fundamental analysis and research. Such large-scale hedging and trading strategies using SBS are often executed across multiple transactions over the course of days or even weeks. One-day public disclosure of SBS positions carries with it the risk of undermining market participants’ ability to engage in these strategies by preventing them from maintaining confidentiality of their SBS positions, which constitute their propriety intellectual property.

The proposed disclosure could impact credit market stability

Under the proposal, any person owning an SBS position that exceeds certain thresholds would be required, within one business day of entering into the position, to publicly disclose their confidential positions and strategies, which represent valuable proprietary intellectual property, and could impair dealers’ ability to hedge their activity. CDS market liquidity has declined over the last decade, meaning that executing a trading strategy or hedging a position can take multiple days or longer. One-day public disclosure would expose this activity to the market prematurely and make it more difficult and costly for investors to execute their strategies and for dealers and lenders to hedge. It could also present confidentially concerns for ultimate borrowers, if the nature of their borrowing is indirectly disclosed by their lender as a result of SBS position reporting requirements.

In addition, given the generally confidential nature of the corporate loan market, disclosure of a bank’s loan positions relating to a CDS would present significant confidentiality concerns for the ultimate borrowers.

This can ultimately make it harder and more expensive for companies to raise capital, impair progress on corporate governance and other priority shareholder issues, and undermine the ability of lenders and investors to manage risk.

Conditions in the SBS market directly impact the broader capital markets. For example, there is an inherent connection between an SBS (for example, a single-name credit default swap on Apple Inc.) and the security referenced by that SBS (an Apple Inc. bond). There is also a direct link between such an SBS and swaps, such as a CDS on a broad index that includes Apple Inc. (regulated by the CFTC). We saw these dynamics play out during the Covid-related market turmoil in 2020:  as liquidity in individual corporate bonds declined, investors looked to index CDS to manage risk.  However, in its economic analysis on which the proposal was based, the SEC did not consider that a reduction in liquidity in the single-name CDS market caused by new public disclosure requirements could negatively impact liquidity in index CDS products and, therefore, could negatively impact stability in the overall credit market.

Further downside risk: enabling market behaviors the SEC seeks to prevent

If proprietary strategies are publicly revealed, the potential exists to increase opportunistic market behaviors that the SEC has historically sought to prevent, such as front running, manipulation, and reverse-engineering/copycatting, which increase risk (e.g., through

crowded trades) and drive up the costs of transactions for all market participants. This could also decrease the incentive for firms to conduct original research, hindering investment returns, increasing costs, and inhibiting investors’ ability to advance shareholder priorities through engagement with corporate management.

A better path forward

This new proposal is inconsistent with Dodd-Frank requirements for the reporting of transactions to SBS data repositories (SDRs) and long-standing regulatory precedent of requiring regulatory, not public, disclosure of confidential position information.  Regulation SBSR, which was fully implemented in April 2022, governs regulatory and public disclosure of SBS transactions and may well provide enough data to achieve the SEC’s market integrity objectives without the proposed rule’s added requirements that would reveal market participants’ identities and proprietary position information.

We encourage the SEC to defer finalizing any new rules on public disclosure of SBS positions until it conducts, and submits for public comment, a more robust and accurate economic impact analysis using the comprehensive data on SBS transactions to which it gained access under Regulation SBSR.

An alternative approach along these lines is supported by a broad bipartisan coalition in Congress. In a letter last November, fifteen members of the House of Representatives urged the SEC to follow “an approach to implementation that requires confidential reporting for regulatory purposes to give the SEC experience with the data to refine it as necessary to ensure it serves its purpose. Any further stages that would require public dissemination of the data should only be considered following additional economic analysis and public consultation.”

Chair Gensler has repeatedly encouraged Congress to engage with him and the Commission on its regulatory proposals. It is significant that such a large and bipartisan group in Congress has coalesced around a set of ideas to improve a proposed rule. The SEC, and America’s capital markets, would be well served by following these recommendations.

Kyle Brandon is Managing Director, Director of Derivatives Policy at SIFMA.