On July 26, 2021, the SEC announced the approval of a substituted compliance determination order with respect to security-based swap dealers and major security-based swap participants (SBS Entities) subject to regulation in the French Republic (the French Order). This is the first determination that addresses substituted compliance in connection with the Commission’s capital and margin requirements.

The French Order was approved on July 23, 2021.  It provides that certain SEC-registered French SBS Entities may satisfy certain Securities Exchange Act of 1934 (Exchange Act) requirements by complying with comparable French and European Union (EU) requirements.  In connection with the French Order, the SEC and the French Autorité des Marchés Financiers (AMF) and the Autorité de Contrôle Prudentiel et de Résolution (ACPR) entered into a memorandum of understanding (MOU) to address supervisory and enforcement cooperation and other matters arising under substituted compliance.  Substituted compliance does eliminate the obligation to comply with the U.S. securities laws, but instead provides an alternative method by which French SBS Entities may comply with applicable requirements.  As such, the SEC will retain authority to inspect, examine and supervise the French SBS Entities and take enforcement action as appropriate.

The French Order allows for substituted compliance in connection with Exchange Act requirements regarding capital risk control, recordkeeping and reporting, supervision, and counterparty protection (e.g., fair and accurate disclosures and communications).  However, some Exchange Act requirements will continue to require full, unconditional compliance, including U.S.-based capital requirements.  These capital requirements will likely be one of the more significant changes under the French Order.  U.S.-registered French firms seeking to comply with the French Order will need to ensure that, in addition to the four-tiered French structure, which sets out formulas for calculating four distinct capital requirements (i.e., winding down, operational/legal risk, credit/market risk, and business risk), they also comply with the following U.S.-based capital requirements

  • (1) maintain liquid assets at least $100 million greater than the amount of the firm’s total liabilities before applying the deduction (i.e., risk-weighted assets divided by 12.5), and by at least $20 million after applying the deduction;
  • (2) maintain for at least three years quarterly records demonstrating compliance with the capital condition;
  • (3) immediately notify the SEC if the French firm fails to meet the capital condition; and
  • (4) notify its local supervisor of its intent to rely on substituted compliance.

In addition to full compliance with U.S. capital requirements, the French Order also requires French Firms to:

  • Unconditionally comply with certain trading relationship disclosures for transactions with U.S. counterparties.
  • Report counterparty valuation disputes directly to the SEC.
  • Comply with Exchange Act margin requirements for transactions in non-cleared security-based swaps.
  • Maintain supervisory frameworks that “promote compliance” with the French Order.
  • Provide English translations of the compliance reports provided to the firm’s management pursuant to French and EU law.
  • Treat all counterparties as experienced and/or institutional investors (i.e., “per se professional clients” under French and EU requirements).
  • Reconcile the portfolio containing the relevant security-based swap each business day.
  • Make and preserve accurate books and records and consent to inspection of those records by the SEC.
  • Report periodic unaudited financial and operational information and provide the SEC with the audited financial reports the French firm filed with French authorities.
  • Notify the SEC of any notice the French firm is required to send under comparable French laws.
  • Provide an English translation of any record, report, or notification upon request.

With the French Order and MOU, the U.S. and French securities authorities have created a process though which French SBS Entities can enjoy greater access to U.S. markets and counterparties, while hopefully minimizing the compliance burden for these firms.