Large Security-Based Swap Position Reporting

On December 15, 2021, the Securities and Exchange Commission (“SEC”) proposed for comment a new rule under the Securities Exchange Act of 1934 (“Exchange Act”) that would require any person with a security-based swap position exceeding certain thresholds to file a new Schedule 10B disclosing information related to that position.

Proposed Rule 10B-1: Position Reporting of Large Security-Based Swap Positions

The SEC’s stated purpose for proposing the new large security-based swap position rule includes disclosure of concentrated positions, alerting others to the existence of concentrated exposures, and providing advance notice that a person is building up a large credit default swap (“CDS”) position with an incentive to vote against their interests as a debt holder. The SEC does not mention any specific circumstances that are the impetus for the new proposed rule. However, two recent examples of circumstances that may be addressed by the new rule include the default by the investment manager Archegos after accumulating substantial positions using equity swaps and the technical, or “manufactured,” default by an affiliate of Hovnanian that allowed credit default buyers to make claims for payments on their credit default swaps.

Below are the key aspects of the proposed reporting rule:

• The rule applies to “any person” with a security-based swap position exceeding certain thresholds described below.
• A security-based swap position includes security-based swaps on single securities or loans, and narrow-based security indices.¹
• The rule requires position reporting to aggregate the positions of members of a “group” and any entity controlling, controlled by or under common control with such person or group.
• The filing deadline is the end of the 1^st business day following execution of a security-based swap that results in the position exceeding the threshold.
• The reports would be filed on EDGAR, similar to the way that beneficial ownership reports are filed pursuant to Sections 13(d) and (g) of the Exchange Act
• If the security-based swap position exceeds a reporting threshold, then the reporting requirements will require disclosure of the gross position, across all counterparties.
• Position reporting is broken out among (i) credit default swaps, (ii) security-based swaps on debt (excluding CDS), and (iii) security-based swaps on equities, but positions below the relevant threshold may need to be reported as “related” positions.
• The proposed thresholds for reporting are:
  • for CDS:
    • $150 million of notional amount in long CDS net of long positions in the deliverable debt (in other words, if a person (or group) has long positions in deliverable debt equal to or exceeding the notional amount in long CDS, the position would not exceed this long notional reporting threshold);
    • $150 million of notional amount in short CDS; or
    • $300 million of gross notional amounts in long and short CDS (in other words, if a person (or group) has $150 million of notional amount in long CDS, $150 million in long positions in deliverable debt, and $150 million of notional amount in short CDS, such person (or group) would have a filing obligation).
  • For security-based swaps on debt (other than CDS):
    • $300 million of gross notional amounts in such long and short security-based swap.
  • For security-based swaps on equity:
    • $300 million of gross notional amount (which amount shall include (i) the value of the underlying equity securities owned, and (ii) the delta adjusted notional amount of options, futures, and other derivatives once the reporting person or group has in excess of $150 million of gross notional amount in the securities-based swap position); or
    • 5% of a class of equity securities referenced by the securities-based swap (which calculation shall include the number of shares of the underlying equity securities, as well as the shares attributable to any options, futures, and other derivatives owned once the reporting person or group has in excess of 2.5% of a class of equity securities on account of the securities-based swap position).
• Cross-border application – the proposed rule applies if the security-based swap position would be required to be reported pursuant to Rule 908 of Regulation SBSR, or the reporting person holds any amounts of the securities underlying the security-based swap position and either (1) the issuer is organized or has its principal place of business in the US, or (2) such security is part of a class registered under Sec. 12 or 15(d) of the Exchange Act.
• On-going reporting – amendments to a previously filed Schedule 10B must be filed by the end of the 1^st business day following a material change, which includes, without limitation, a material increase or decrease in the position (10% or more), or if the position falls below the reporting threshold.
• Finally, the rule includes an anti-evasion provision.

Businesses that are frequent participants in the total return swap and credit default swap market should review this alert and SEC’s proposed rules.  Persons interested in commenting on the proposed rules must submit those comments to the SEC no later than 45 days following publication of the proposed rule in the Federal Register.

The capital markets and the structured finance and securitization practices at Hunton Andrews Kurth LLP will continue to monitor the development of this rule-making and security-based swap matters.  Please contact us if you have any questions or would like further information regarding the proposed rules or security-based swaps, or require our assistance in submitting written comments on the proposed rules.

¹ Swaps based on a security index that is not a narrow-based security index (i.e., the index is broad-based) is a swap subject to regulation by the Commodity Futures Trading Commission.