Substituted Compliance: The Emergence, Challenges, and Evolution of a New Regulatory Paradigm

Over the past few decades, the US Securities and Exchange Commission experimented with a number of different approaches to relaxing Securities and Exchange Commission (SEC) rules to facilitate entry of foreign firms into US capital markets. Initially, the SEC favoured an approach I denominate as modified national treatment, under which foreign firms were allowed exemption from a limited number of specific US requirements that were likely to conflict with, or be redundant with respect to, regulatory requirements in their home jurisdictions. In general, these exemptions were available regardless of the quality of home country oversight. Sometimes those exemptions were available only for transactions with large institutional investors located in the USA. Starting in 2007, the Commission began to comtemplate more far-reaching acceptance of foreign regulatory oversight, most prominently in an approach that came to be known as substituted compliance. A hallmark of substituted compliance was that it was to be selective, and thus available only to those jurisdictions that the Commission determined to be substantially comparable to US regulatory oversight. In the face of the Global Financial Crisis in 2008, the Commission backed away from its initial experiment with substituted compliance, but the exercise still offers an interesting content in which to consider the manner in which the Commission might have determined the comparability of foreign regulatory systems. This essay explores the various analytical options available for making such supervisory assessments. It then concludes with some preliminary thoughts on what might be called ‘second-generation’ substituted compliance, which the SEC and the Commodity Futures Trading Commission have begun to employ in the past few years to limit the extraterritorial application of certain provisions of the Dodd–Frank Act.