Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers

Vol. 77

Friday,

No. 226

November 23, 2012

Part II

Securities and Exchange Commission

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17 CFR Part 240
Capital, Margin, and Segregation Requirements for Security-Based Swap
Dealers and Major Security-Based Swap Participants and Capital
Requirements for Broker-Dealers; Proposed Rule

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–68071; File No. S7–08–12]
RIN 3235–AL12

Capital, Margin, and Segregation
Requirements for Security-Based
Swap Dealers and Major SecurityBased Swap Participants and Capital
Requirements for Broker-Dealers
Securities and Exchange
Commission.
ACTION: Proposed rule.
AGENCY:

In accordance with the DoddFrank Wall Street Reform and Consumer
Protection Act of 2010 (‘‘Dodd-Frank
Act’’), the Securities and Exchange
Commission (‘‘Commission’’), pursuant
to the Securities Exchange Act of 1934
(‘‘Exchange Act’’), is proposing capital
and margin requirements for securitybased swap dealers (‘‘SBSDs’’) and
major security-based swap participants
(‘‘MSBSPs’’), segregation requirements
for SBSDs, and notification
requirements with respect to segregation
for SBSDs and MSBSPs. The
Commission also is proposing to
increase the minimum net capital
requirements for broker-dealers
permitted to use the alternative internal
model-based method for computing net
capital (‘‘ANC broker-dealers’’).
DATES: Comments should be received on
or before January 22, 2013.
ADDRESSES: Comments may be
submitted by any of the following
methods:
SUMMARY:

Electronic Comments
• Use the Commission’s Internet
comment form (http://www.sec.gov/
rules/proposed.shtml); or
• Send an email to [email protected]. Please include File
Number S7–08–12 on the subject line;
or
• Use the Federal eRulemaking Portal
(http://www.regulations.gov). Follow the
instructions for submitting comments.

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Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
All submissions should refer to File
Number S7–08–12. This file number
should be included on the subject line
if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will

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post all comments on the Commission’s
Internet Web site (http://www.sec.gov/
rules/proposed.shtml). Comments also
are available for Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. All comments received
will be posted without change; the
Commission does not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
publicly available.
FOR FURTHER INFORMATION CONTACT:
Michael A. Macchiaroli, Associate
Director, at (202) 551–5525; Thomas K.
McGowan, Deputy Associate Director, at
(202) 551–5521; Randall W. Roy,
Assistant Director, at (202) 551–5522;
Mark M. Attar, Branch Chief, at (202)
551–5889; Sheila Dombal Swartz,
Special Counsel, at (202) 551–5545;
Valentina M. Deng, Attorney, at (202)
551–5778; or Teen I. Sheng, Attorney, at
202–551–5511, Division of Trading and
Markets, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549–7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Proposed Rules and Rule Amendments
A. Capital
1. Introduction
2. Proposed Capital Rules for Nonbank
SBSDs
a. Computing Required Minimum Net
Capital
i. Stand-alone SBSDs Not Using Internal
Models
ii. Broker-Dealer SBSDs Not Using Internal
Models
iii. Stand-alone SBSDs Using Internal
Models
iv. Broker-Dealer SBSDs Using Internal
Models and ANC Broker-Dealers
b. Computing Net Capital
i. The Net Liquid Assets Test
ii. Standardized Haircuts for SecurityBased Swaps
iii. VaR Models
iv. Credit Risk Charges
v. Capital Charge In Lieu of Margin
Collateral
vi. Treatment of Swaps
c. Risk Management
d. Funding Liquidity Stress Test
Requirement
e. Other Rule 15c3–1 Provisions
Incorporated into Rule 18a–1
i. Debt-Equity Ratio Requirements
ii. Capital Withdrawal Requirements
iii. Appendix C
iv. Appendix D
3. Proposed Capital Rules for Nonbank
MSBSPs
B. Margin
1. Introduction

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2. Proposed Margin Requirements for
Nonbank SBSDs and Nonbank MSBSPs
a. Scope of Rule 18a–3
b. Daily Calculations
i. Nonbank SBSDs
ii. Nonbank MSBSPs
c. Account Equity Requirements
i. Nonbank SBSDs
ii. Nonbank MSBSPs
d. $100,000 Minimum Transfer Amount
e. Risk Monitoring and Procedures
3. Specific Request for Comment to Limit
the Use of Collateral
C. Segregation
1. Background
2. Proposed Rule 18a–4
a. Possession and Control of Excess
Securities Collateral
b. Security-Based Swap Customer Reserve
Account
c. Special Provisions for Non-cleared
Security-Based Swap Counterparties
III. General Request for Comment
IV. Paperwork Reduction Act
A. Summary of Collections of Information
Under the Proposed Rules and Rule
Amendments
1. Proposed Rule 18a–1 and Amendments
to Rule 15c3–1
2. Proposed Rule 18a–2
3. Proposed Rule 18a–3
4. Proposed Rule 18a–4
B. Proposed Use of Information
C. Respondents
D. Total Initial and Annual Recordkeeping
and Reporting Burden
1. Proposed Rule 18a–1 and Amendments
to Rule 15c3–1
2. Proposed Rule 18a–2
3. Proposed Rule 18a–3
4. Proposed Rule 18a–4
E. Collection Of Information Is Mandatory
F. Confidentiality
G. Retention Period For Recordkeeping
Requirements
H. Request For Comment
V. Economic Analysis
A. Baseline Of Economic Analysis
1. Overview of the OTC Derivatives
Markets—Baseline for Proposed Rules
18a–1 through 18a–4
2. Baseline for Amendments to Rule 15c3–
1
B. Analysis of the Proposals and
Alternatives
1. Overview—The Proposed Financial
Responsibility Program
a. Nonbank SBSDs
b. Nonbank MSBSPs
2. The Proposed Capital Rules
a. Nonbank SBSDs and ANC Broker-dealers
i. Minimum Capital Requirements
ii. Standardized Haircuts
iii. Capital Charge in Lieu of Margin
Collateral
iv. Credit Risk Charge
v. Funding Liquidity Stress Test
Requirement
vi. Risk Management Procedures
b. Capital Requirements for MSBSPs
c. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
3. The Proposed Margin Rule—Rule 18a–
3

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a. Calculation of Margin Amount
b. Account Equity Requirements
i. Commercial end users
ii. SBSDs—Alternatives A and B
c. Margin Requirements for NonbankMSBSPs
d. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
4. Proposed Segregation Rule—Rule 18a–4
a. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
C. Implementation Considerations
D. General Request for Comment
VI. Regulatory Flexibility Act Certification
VII. Statutory Basis and Text of the Proposed
Amendments

I. Background
On July 21, 2010, President Obama
signed the Dodd-Frank Act into law.1
Title VII of the Dodd-Frank Act (‘‘Title
VII’’) established a new regulatory
framework for OTC derivatives.2 In this
1 See

Public Law 111–203, 124 Stat. 1376 (2010).
to section 701 of the Dodd-Frank Act,
Title VII may be cited as the ‘‘Wall Street
Transparency and Accountability Act of 2010.’’ See
Public Law 111–203 § 701. The Dodd-Frank Act
assigns responsibility for the oversight of the U.S.
OTC derivatives markets to the Commission, the
Commodity Futures Trading Commission (‘‘CFTC’’),
and certain ‘‘prudential regulators,’’ discussed
below. The Commission has oversight authority
with respect to a security-based swap as defined in
section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)), including to implement a registration
and oversight program for a security-based swap
dealer as defined in section 3(a)(71) of the Exchange
Act (15 U.S.C. 78c(a)(71)) and a major securitybased swap participant as defined in section
3(a)(67) of the Exchange Act (15 U.S.C. 78c(a)(67)).
The CFTC has oversight authority with respect to
a swap as defined in section 1(a)(47) of the
Commodity Exchange Act (‘‘CEA’’) (7 U.S.C.
1(a)(47)), including to implement a registration and
oversight program for a swap dealer as defined in
section 1(a)(49) of the CEA (7 U.S.C. 1(a)(49)) and
a major swap participant as defined in section
1(a)(33) of the CEA (7 U.S.C. 1(a)(33)). The
Commission and the CFTC jointly have adopted
rules to further define, among other things, those
terms and the terms swap, security-based swap,
swap dealer, major swap participant, security-based
swap dealer, and major security-based swap
participant. See Further Definition of ‘‘Swap,’’
‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap
Agreement’’; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, Exchange Act Release
No. 64372 (Apr. 29, 2011), 76 FR 29818 (May 23,
2011) (‘‘Product Definitions Proposing Release’’);
Further Definition of ‘‘Swap,’’ ‘‘Security-Based
Swap,’’ and ‘‘Security-Based Swap Agreement’’;
Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, Exchange Act Release No. 67453
(July 18, 2012), 77 FR 48208 (Aug. 13, 2012) (Joint
final rule with the CFTC) (‘‘Product Definitions
Adopting Release’’); Further Definition of ‘‘Swap
Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major
Swap Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant’’,
Exchange Act Release No. 63452 (Dec. 7, 2010), 75
FR 80174 (Dec. 21, 2010) (Joint proposal with the
CFTC) (‘‘Entity Definitions Proposing Release’’); and
Further Definition of ‘‘Swap Dealer,’’ ‘‘SecurityBased Swap Dealer,’’ ‘‘Major Swap Participant,’’
‘‘Major Security-Based Swap Participant’’ and

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regard, Title VII was enacted, among
other reasons, to reduce risk, increase
transparency, and promote market
integrity within the financial system by,
among other things: (i) Providing for the
registration and regulation of SBSDs and
MSBSPs; (ii) imposing clearing and
trade execution requirements on
standardized derivative products; (iii)
creating recordkeeping and real-time
reporting regimes; and (iv) enhancing
the Commission’s rulemaking and
enforcement authorities with respect to
all registered entities and intermediaries
subject to the Commission’s oversight.3
Section 764 of the Dodd-Frank Act
added section 15F to the Exchange Act.4
Section 15F(e)(1)(B) of the Exchange Act
provides that the Commission shall
prescribe capital and margin
requirements for SBSDs and nonbank
MSBSPs that do not have a prudential
regulator (respectively, ‘‘nonbank
SBSDs’’ and ‘‘nonbank MSBSPs’’).5
Section 763 of the Dodd-Frank Act
added section 3E to the Exchange Act.6
Section 3E provides the Commission
with authority to establish segregation
requirements for SBSDs and MSBSPs.7
Section 4s(e)(1)(B) of the CEA
provides that the CFTC shall prescribe
capital and margin requirements for
swap dealers and major swap
participants for which there is not a
prudential regulator (‘‘nonbank swap
dealers’’ and ‘‘nonbank swap
participants’’).8 Section 15F(e)(1)(A) of
‘‘Eligible Contract Participant’’, Exchange Act
Release No. 66868 (Apr. 27, 2012), 77 FR 30596
(May 23, 2012) (Joint final rule with the CFTC)
(‘‘Entity Definitions Adopting Release’’).
3 See Public Law 111–203 §§ 701–774.
4 See id. § 764; 15 U.S.C. 78o–10.
5 See 15 U.S.C. 78o–10(e)(1)(B). Specifically,
section 15F(e)(1)(B) of the Exchange Act provides
that each registered SBSD and MSBSP for which
there is not a prudential regulator shall meet such
minimum capital requirements and minimum
initial and variation margin requirements as the
Commission shall by rule or regulation prescribe.
The term ‘‘prudential regulator’’ is defined in
section 1(a)(39) of the CEA (7 U.S.C. 1(a)(39)) and
that definition is incorporated by reference in
section 3(a)(74) of the Exchange Act (15 U.S.C.
78c(a)(74)). Pursuant to the definition, the Board of
Governors of the Federal Reserve System (‘‘Federal
Reserve’’), the Office of the Comptroller of the
Currency (‘‘OCC’’), the Federal Deposit Insurance
Corporation (‘‘FDIC’’), the Farm Credit
Administration, or the Federal Housing Finance
Agency (collectively, the ‘‘prudential regulators’’) is
the ‘‘prudential regulator’’ of an SBSD, MSBSP,
swap participant, or major swap participant if the
entity is directly supervised by that agency.
6 See Public Law 111–203 § 763; 15 U.S.C. 78c–
5.
7 See 15 U.S.C. 78c–5(a)–(g). Section 3E of the
Exchange Act does not distinguish between bank
and nonbank SBSDs and bank and nonbank
MSBSPs, and, consequently, provides the
Commission with the authority to establish
segregation requirements for SBSDs and MSBSPs,
whether or not they have a prudential regulator. Id.
8 See 7 U.S.C. 6s(e)(1)(B).

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the Exchange Act provides that the
prudential regulators shall prescribe
capital and margin requirements for
bank SBSDs and bank MSBSPs, and
section 4s(e)(1)(A) of the CEA provides
that the prudential regulators shall
prescribe capital and margin
requirements for swap dealers and
major swap participants for which there
is a prudential regulator (‘‘bank swap
dealers’’ and ‘‘bank swap
participants’’).9 The prudential
regulators have proposed capital and
margin requirements for bank swap
dealers, bank SBSDs, bank swap
participants, and bank MSBSPs.10 The
CFTC has proposed capital and margin
requirements for nonbank swap dealers
and nonbank major swap participants.11
The CFTC also has adopted segregation
requirements for cleared swaps and
proposed segregation requirements for
non-cleared swaps.12
Pursuant to sections 763 and 764 of
the Dodd-Frank Act, the Commission is
proposing to amend Rule 15c3–1 and
Rule 15c3–3 and propose new Rules
18a–1 (including appendices to Rule
18a–1), 18a–2, 18a–3, and 18a–4
(including an exhibit to Rule 18a–4).13
The proposed amendments and new
rules would establish capital and
margin requirements for nonbank
SBSDs, including broker-dealers that are
registered as SBSDs (‘‘broker-dealer
SBSDs’’), and nonbank MSBSPs. They
also would establish segregation
requirements for SBSDs and notification
requirements with respect to segregation
for SBSDs and MSBSPs.
Further, the proposals also would
increase the minimum net capital
9 See 15 U.S.C. 78o–10(e)(1)(A); 7 U.S.C.
6s(e)(1)(A).
10 See Margin and Capital Requirements for
Covered Swap Entities, 76 FR 27564 (May 11, 2011)
(‘‘Prudential Regulator Margin and Capital
Proposing Release’’). The prudential regulators, as
part of their proposed margin requirements for noncleared security-based swaps, proposed a
segregation requirement for collateral received as
margin. Id.
11 See Capital Requirements of Swap Dealers and
Major Swap Participants, 76 FR 27802 (May 12,
2011) (‘‘CFTC Capital Proposing Release’’); Margin
Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 76 FR 23732
(Apr. 28, 2011) (‘‘CFTC Margin Proposing Release’’).
The CFTC reopened the comment period for the
CFTC Margin Proposing Release to allow interested
parties to comment on the CFTC proposed rules in
light of the proposals discussed in the international
consultative paper. See Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap
Participants, 77 FR 41109 (July 12, 2012).
12 See Protection of Cleared Swaps Customer
Contracts and Collateral; Conforming Amendments
to the Commodity Broker Bankruptcy Provisions, 77
FR 6336 (Feb. 7, 2012) and Protection of Collateral
of Counterparties to Non-cleared Swaps; Treatment
of Securities in a Portfolio Margining Account in a
Commodity Broker Bankruptcy, 75 FR 75432 (Dec.
3, 2010).
13 See 17 CFR 240.15c3–1; 17 CFR 240.15c3–3.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

requirements and establish liquidity
requirements for ANC broker-dealers.14
An ANC broker-dealer is a broker-dealer
that has been approved by the
Commission to use internal value-at-risk
(‘‘VaR’’) models to determine market
risk charges for proprietary securities
and derivatives positions and to take a
credit risk charge in lieu of a 100%
charge for unsecured receivables related
to OTC derivatives transactions
(hereinafter, collectively ‘‘internal
models’’). The proposed amendments
applicable to ANC broker-dealers are
designed to account for their large size,
the scale of their custodial activities,
and the potential substantial leverage
they may take on if they become more
active in the security-based swap
markets under the Dodd-Frank Act
reforms, which, among other things,
require dealers in security-based swaps
to register with the Commission.15
Finally, some of the proposed
amendments to Rule 15c3–1 would
apply to broker-dealers that are not
registered as SBSDs. These proposed
amendments are designed to maintain a
consistent capital treatment for securitybased swaps and swaps under Rule
15c3–1 and proposed new Rule 18a–1.
As discussed in detail below, the
proposals for capital, margin, and
segregation requirements for SBSDs and
MSBSPs are based in large part on
existing capital, margin, and segregation
requirements for broker-dealers
(‘‘broker-dealer financial responsibility
requirements’’).16 The broker-dealer
financial responsibility requirements
served as the model for the proposals
because the financial markets in which
SBSDs and MSBSPs are expected to
operate are similar to the financial
markets in which broker-dealers
operate. In addition, as discussed below,
the objectives of the broker-dealer
financial responsibility requirements are
similar to the objectives underlying the
proposals. Moreover, the broker-dealer
financial responsibility requirements
have existed for many years and have
facilitated the prudent operation of
broker-dealers.17 Consequently, they
14 See

17 CFR 240.15c3–1(a)(7); 17 CFR 240.15c3–

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1e.
15 See, e.g., 15 U.S.C. 78o–10(a)(1) (‘‘It shall be
unlawful for any person to act as a security-based
swap dealer unless the person is registered as a
security-based swap dealer with the Commission.’’).
16 See infra section II.A.1. of this release
(describing generally the broker-dealer capital
standards); section II.B.1. of this release (describing
generally the broker-dealer margin standards);
section II.C.1. of this release (describing generally
the broker-dealer segregation requirements).
17 For example, one of the objectives of the
broker-dealer financial responsibility requirements
is to protect customers from the consequences of
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provide a reasonable template for
building a financial responsibility
program for SBSDs and MSBSPs.
Furthermore, it is expected that some
nonbank SBSDs also will register as
broker-dealers in order to be able to
offer customers a broader range of
services than a nonbank SBSD not
registered as a broker-dealer (‘‘standalone SBSD’’) would be permitted to
engage in. Therefore, establishing
consistent financial responsibility
requirements would avoid potential
competitive disparities between standalone SBSDs and broker-dealer SBSDs.
However, the Commission recognizes
that there may be other approaches to
establishing financial responsibility
requirements that may be appropriate—
including, for example, applying a
standard based on the international
capital standard for banks (‘‘Basel
Standard’’) 18 in the case of entities that
are part of a bank holding company, as
has been proposed by the CFTC.19 In
general, the bank capital model requires
the holding of specified levels of capital
as a percentage of ‘‘risk weighted
assets.’’ 20 It does not require generally
a full capital deduction for unsecured
receivables, given that banks, as lending
entities, are in the business of extending
credit to a range of counterparties.
This approach could promote a
consistent view and management of
capital within a bank holding company
structure. The Commission is not
proposing this approach, however, both
safeguarding customer securities and funds held by
the broker-dealer. It should be noted that the
Securities Investor Protection Corporation (‘‘SIPC’’),
since its inception in 1971, has initiated customer
protection proceedings for only 324 broker-dealers,
which is less than 1% of the approximately 39,200
broker-dealers that have been members of SIPC
during that timeframe. From 1971 through
December 31, 2011, approximately 1% of the $117.5
billion of cash and securities distributed for
accounts of customers came from the SIPC fund
rather than debtors’ estates. See SIPC, Annual
Report 2011, available at http://www.sipc.org/
Portals/0/PDF/2011_Annual_Report.pdf (‘‘SIPC
2011 Annual Report’’).
18 The Basel Standard was developed by the Basel
Committee on Banking Supervision of the Bank for
International Settlements (‘‘BCBS’’). More
information about the Basel Standard is available at
the Web site of the Bank for International
Settlements (‘‘BIS’’) at http://www.bis.org/bcbs/
index.htm.
19 CFTC Capital Proposing Release, 76 FR 27802.
20 The prudential regulators also have proposed
capital rules that would require a covered swap
entity to comply with the regulatory capital rules
already made applicable to that covered swap entity
as part of its prudential regulatory regime.
Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27568. The prudential regulators
note that they have ‘‘had risk-based capital rules in
place for banks to address over-the-counter
derivatives since 1989 when the banking agencies
implemented their risk-based capital adequacy
standards * * * based on the first Basel Accord.’’
Id.

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because of the distinctions between
bank and nonbank dealer business
models and access to backstop liquidity,
as well as uncertainties as to how a bank
capital standard would in practice affect
valuations and the conduct of business
in a nonbank entity; but the
Commission is specifically seeking
comment on this approach. In addition,
detailed comment is requested below on
alternative financial responsibility
frameworks that could serve as a model
for establishing financial responsibility
requirements for SBSDs and MSBSPs.
The minimum financial and customer
protection requirements proposed
today—like other financial tests that
market participants use in the ordinary
course of business to manage risk or to
comply with applicable regulations—
incorporate many specific numerical
thresholds, limits, deductions, and
ratios.21 The Commission recognizes
that each such quantitative requirement
could be read by some to imply a
definitive conclusion based on
quantitative analysis of that requirement
and its alternatives.
The Commission notes in this regard
that the specific quantitative
requirements included in this proposal
have not been derived directly from
econometric or mathematical models,
nor has the Commission performed a
detailed quantitative analysis of the
likely economic consequences of the
specific quantitative requirements being
included in this proposal. As discussed
in the economic analysis below, there
are a number of challenges presented in
conducting such a quantitative analysis
in a robust fashion. Accordingly, the
selection of a particular quantitative
requirement proposed below reflects a
qualitative assessment by the
Commission regarding the appropriate
financial standard for an identified
issue. In making such assessments and
in turn selecting proposed quantitative
requirements, the Commission has
drawn from its experiences in regulating
broker-dealers and has frequently
looked to comparable quantitative
elements in the existing broker-dealer
financial responsibility regime (e.g., the
current capital charges in the existing
broker-dealer net capital rule) or, where
appropriate, the existing or proposed
regulations of the prudential regulators,
21 For example, the proposed capital
requirements would include in the formula that
determines minimum net capital an amount
generally equal to 8% of the amount of margin that
nonbank SBSDs would be required to collect from
counterparties. Similarly, the capital and margin
proposals, in setting ‘‘haircut’’ requirements to
reflect market risk for certain types of securitybased swaps, propose to use a numerical grid that
establishes specific deductions depending on
spread and tenor, among other factors.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
FINRA, or the CFTC with respect to
similar activities. For example, the
Commission may propose using a
specified haircut percentage (e.g., 15%,
as opposed to a percentage that is higher
or lower) because it believes, based on
its experience regulating markets, that
such percentage should be sufficient to
cover a severe market movement. The
Commission has used these comparable
quantitative requirements as a
reasonable starting point for purposes of
the various proposals because, as noted
above, there are substantial similarities
between the proposed rules and those
other regimes in terms of the relevant
markets, entities, and regulatory
objectives, and because many nonbank
SBSDs may also be subject to the
existing broker-dealer financial
responsibility requirements.
The Commission invites comment,
including relevant data and analysis,
regarding all aspects of the various
quantitative requirements reflected in
the proposed rules. In particular, data
and comment from market participants
and other interested parties regarding
the likely effect of each proposed
quantitative requirement, the effect of
such requirements in the aggregate, and
potential alternative requirements will
be particularly useful to the
Commission in evaluating modifications
to the proposals. Commenters are also
requested to describe in detail any
econometric or mathematical models or
economic analyses of data, to the extent
they exist, that they believe would be
relevant for evaluating or modifying any
quantitative provisions contained in the
proposals.
The Commission staff consulted with
the prudential regulators and the CFTC
in drafting the proposals discussed in
this release.22 In addition, the proposals
of the prudential regulators and the
CFTC were considered in developing
the Commission’s proposed capital,
margin, and segregation requirements
for SBSDs and MSBSPs. The
Commission’s proposals differ in some
respects from proposals of the
prudential regulators and the CFTC, and
such differences are described below in
connection with the relevant proposals.
While some differences are based on
differences in the activities of securities
firms, banks, and commodities firms, or
differences in the products at issue,
other differences may reflect an
alternative approach to balancing the
relevant policy choices and
22 See 15 U.S.C. 78o–10(e)(3)(D)(i) (‘‘The
prudential regulators, the [CFTC], and the
[Commission] shall periodically (but not less
frequently than annually) consult on the minimum
capital requirements and minimum initial and
variation margin requirements.’’).

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considerations. Where these differences
exist, comment is sought on the
advantages and disadvantages of each
proposal and whether a given proposal
is appropriate based on differences in
the business models of the types of
entities that would be subject to the
respective proposal, the risks of these
entities, and any other factors
commenters believe relevant.23
The capital, margin, and segregation
requirements ultimately adopted, like
other requirements established under
the Dodd-Frank Act, could have a
substantial impact on international
commerce and the relative competitive
position of intermediaries operating in
various, or multiple, jurisdictions. In
particular, intermediaries operating in
the U.S. and in other jurisdictions could
be advantaged or disadvantaged if
corresponding requirements are not
established in other jurisdictions or if
the Commission’s rules are substantially
more or less stringent than
corresponding requirements in other
jurisdictions. This could, among other
potential impacts, affect the ability of
intermediaries and other market
participants based in the U.S. to
participate in non-U.S. markets, the
ability of non-U.S.-based intermediaries
and other market participants to
participate in U.S. markets, and whether
and how international firms make use of
global ‘‘booking entities’’ to centralize
risks related to security-based swaps.
These issues have been the focus of
numerous comments to the Commission
and other regulators, Congressional
inquiries, and other public dialogue.24
23 See

15 U.S.C. 78o–10(e)(3)(D)(ii) (providing
that the prudential regulators, the CFTC, and the
Commission ‘‘shall, to the maximum extent
practicable establish and maintain comparable
minimum capital requirements and minimum
initial and variation margin requirements, including
the use of noncash collateral,’’ for SBSDs and swap
dealers).
24 See, e.g., letter from Senator Tim Johnson,
Chairman of the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, and Congressman
Barney Frank, Ranking Member of the U.S. House
Committee on Financial Services, to the CFTC,
Commission, Federal Reserve, and FDIC (Oct. 4,
2011), available at http://www.sec.gov/comments/
s7-25-11/s72511-34.pdf (‘‘Given the global nature of
this market, U.S. regulators should avoid creating
opportunities for international regulatory arbitrage
that could increase systemic risk and reduce the
competitiveness of U.S. firms abroad’’); letter from
Barclays Bank PLC, BNP Paribas S.A., Credit Suisse
AG, Deutsche Bank AG, HSBC, Nomura Securities
International, Inc., Rabobank Nederland, Royal
Bank of Canada, The Royal Bank of Scotland Group
PLC, Societe Generale, The Toronto-Dominion
Bank, and UBS AG, to the CFTC, Commission, and
Federal Reserve (Feb. 17, 2011), available at http://
www.sec.gov/comments/s7-39-10/s73910-25.pdf
(‘‘[T]he home country regulator has the greatest
interest in and is in the best position to protect a
foreign bank swap dealer under its primary
supervision by setting appropriate margin
requirements or functionally equivalent capital

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The potential international
implications of the proposed capital,
margin, and segregation requirements
warrant further consideration. However,
consistent with the Commission’s
general approach with respect to its
other proposals under Title VII, these
implications are recognized here but not
fully addressed. Instead, the
Commission intends to publish a
comprehensive release seeking public
comment on the full spectrum of issues
relating to the application of Title VII to
cross-border security-based swap
transactions and non-U.S. persons that
act in capacities regulated under the
Dodd-Frank Act. This approach will
provide market participants, foreign
regulators, and other interested parties
with an opportunity to consider, as an
integrated whole, the proposed
approach to the cross-border application
of Title VII, including capital, margin,
and segregation requirements.
II. Proposed Rules and Rule
Amendments
A. Capital
1. Introduction
Section 15F(e)(1)(B) of the Exchange
Act requires that the Commission
prescribe capital requirements for
nonbank SBSDs and nonbank
MSBSPs.25 The Commission also has
concurrent authority under section
15(c)(3) of the Exchange Act to prescribe
capital requirements for brokerdealers.26 The existing broker-dealer
capital requirements are contained in
charges for non-cleared swaps’’); letter from Carlos
Tavares, Vice-Chairman of European Securities and
Markets Authority, to the Commission (Jan. 17,
2011), available at http://www.sec.gov/comments/
s7-35-10/s73510-19.pdf (‘‘if the foreign supervision
were not taken into account * * * a foreign [entity
would] be subject to multiple regimes * * * [which
would be] very challenging for regulated entities
and would significantly raise the costs for both the
industry and supervisors’’); BCBS, Board of the
International Organization of Securities
Commissions (‘‘IOCSO’’), Consultative Document,
Margin Requirements for Non-centrally-cleared
Derivatives (July 2012), available at http://www.
iosco.org/library/pubdocs/pdf/IOSCOPD387.pdf
(consultative document seeking comment on
margin requirements for non-centrally-cleared
derivatives).
25 15 U.S.C. 78o–10(e)(1)(B).
26 15 U.S.C. 78o(c)(3). Section 771 of the DoddFrank Act states that unless otherwise provided by
its terms, its provisions relating to the regulation of
the security-based swap markets do not divest any
appropriate Federal banking agency, the
Commission, the CFTC, or any other Federal or
State agency, of any authority derived from any
other provision of applicable law. See Public Law
111–203 § 771. In addition, section 15F(e)(3)(B) of
the Exchange Act provides that nothing in section
15F ‘‘shall limit, or be construed to limit, the
authority’’ of the Commission ‘‘to set financial
responsibility rules for a broker or dealer * * * in
accordance with Section 15(c)(3).’’ 15 U.S.C. 78o–
8(e)(3)(B).

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Rule 15c3–1,27 including seven
appendices to Rule 15c3–1.28 The
minimum capital requirements for
stand-alone SBSDs would be contained
in proposed new Rule 18a–1,29 and the
minimum capital requirements for
broker-dealer SBSDs would be
contained in Rule 15c3–1, as proposed
to be amended. Proposed Rule 18a–1
would be structured similarly to Rule
15c3–1 and would contain many
provisions that correspond to those in
Rule 15c3–1.30
As described above, the capital and
other financial responsibility
requirements for broker-dealers
generally provide a reasonable template
for crafting the corresponding
requirements for nonbank SBSDs. For
example, among other considerations,
the objectives of capital standards for
both types of entities are similar. Rule
15c3–1, described in detail below, is a
net liquid assets test that is designed to
require a broker-dealer to maintain
sufficient liquid assets to meet all
obligations to customers and
counterparties and have adequate
additional resources to wind-down its
business in an orderly manner without
the need for a formal proceeding if it
fails financially.31 In turn, the objective
27 17

CFR 240.15c3–1.
CFR 240.15c3–1a (Options); 17 CFR
240.15c3–1b (Adjustments to net worth and
aggregate indebtedness for certain commodities
transactions); 17 CFR 240.15c3–1c (Consolidated
computations of net capital and aggregate
indebtedness for certain subsidiaries and affiliates);
17 CFR 240.15c3–1d (Satisfactory subordination
agreements); 17 CFR 240.15c3–1e (Deductions for
market and credit risk for certain brokers or
dealers); 17 CFR 240.15c3–1f (Optional market and
credit risk requirements for OTC derivatives
dealers); 17 CFR 240.15c3–1g (Conditions for
ultimate holding companies of certain brokers or
dealers).
29 See proposed new Rule 18a–1.
30 For example, proposed new Rule 18a–1 would
include four appendices: Appendix A (proposed
new Rule 18a–1a); Appendix B (proposed new
Rule18a–1b); Appendix C (proposed new Rule 18a–
1c); and Appendix D (proposed new Rule 18a–1d).
The appendices would correspond to the following
appendices to Rule 15c3–1: Appendix A (Options)
(17 CFR 240.15c3–1a); Appendix B (Adjustments to
net worth and aggregate indebtedness for certain
commodities transactions) (17 CFR 240.15c3–1b);
Appendix C (Consolidated computations of net
capital and aggregate indebtedness for certain
subsidiaries and affiliates) (17 CFR 240.15c3–1c);
and Appendix D (Satisfactory subordination
agreements) (17 CFR 240.15c3–1d).
31 See Net Capital Rule, Exchange Act Release No.
38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12, 1997)
(‘‘Rule 15c3–1 requires registered broker-dealers to
maintain sufficient liquid assets to enable those
firms that fall below the minimum net capital
requirements to liquidate in an orderly fashion
without the need for a formal proceeding.’’). As
indicated, the goal of the rule is to require a brokerdealer to hold sufficient liquid net capital to meet
all obligations to creditors, except for creditors who
agree to subordinate their claims to all other
creditors. As discussed in more detail below, Rule
15c3–1d (Appendix D to Rule 15c3–1) sets forth

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of the proposed capital standards for
nonbank SBSDs is to protect customer
assets and mitigate the consequences of
a firm failure, while allowing these
firms the flexibility in how they conduct
a security-based swaps business.
In addition, the Dodd-Frank Act
divided responsibility for SBSDs by
providing the prudential regulators with
authority to prescribe the capital and
margin requirements for bank SBSDs
and the Commission with authority to
prescribe capital and margin
requirements for nonbank SBSDs.32
This division also suggests it may be
appropriate to model the capital
requirements for nonbank SBSDs on the
capital standards for broker-dealers,
while the capital requirements for bank
SBSDs are modeled on capital standards
for banks (as reflected in the proposal by
the prudential regulators).33 Certain
operational, policy, and legal
differences appear to support this
distinction between nonbank SBSDs
and bank SBSDs. First, based on the
Commission staff’s understanding of the
activities of nonbank dealers in over-the
counter (‘‘OTC’’) derivatives, nonbank
SBSDs are expected to engage in a
securities business with respect to
security-based swaps that is more
similar to the dealer activities of brokerdealers than to the activities of banks;
indeed, some broker-dealers likely will
be registered as nonbank SBSDs.34
Second, existing capital standards for
banks and broker-dealers reflect, in part,
differences in their funding models and
access to certain types of financial
support, and those same differences also
will exist between bank SBSDs and
nonbank SBSDs. For example, banks
obtain funding through customer
deposits and can obtain liquidity
through the Federal Reserve’s discount
window, whereas broker-dealers do
not—and nonbank SBSDs will not—
have access to these sources of funding
and liquidity. Third, Rule 15c3–1
currently contains provisions designed
to address dealing in OTC derivatives by
broker-dealers and, therefore, to some
minimum requirements for a subordinated loan
agreement. See 17 CFR 240.15c3–1d. Typically,
affiliates of the broker-dealer (e.g., the firm’s
holding company) or individual owners of the
broker-dealer make subordinated loans to the
broker-dealer. If the broker-dealer fails financially
and is liquidated, the obligations of the brokerdealer to all other creditors would need to be paid
in full before the obligations of the broker-dealer to
a subordinated lender are paid.
32 See 15 U.S.C. 78o–10, in general; 15 U.S.C.
78o–10(e)(2)(A)–(B), in particular.
33 The prudential regulators have proposed
capital requirements for bank SBSDs and bank swap
dealers that are based on the capital requirements
for banks. See Prudential Regulator Margin and
Capital Proposing Release, 76 FR at 27582.
34 Id.

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extent already can accommodate this
type of activity (although, as discussed
below, proposed amendments to Rule
15c3–1 would be designed to more
specifically address the risks of securitybased swaps and the potential for
increased involvement of broker-dealers
in the security-based swaps markets).35
For these reasons, the proposed
capital standard for nonbank SBSDs is
a net liquid assets test modeled on the
broker-dealer capital standard in Rule
15c3–1.36 However, the Commission
35 See 17 CFR 240.15c3–1f and 17 CFR 240.15c3–
1e. See also Alternative Net Capital Requirements
for Broker-Dealers That Are Part of Consolidated
Supervised Entities, Exchange Act Release No.
49830 (June 8, 2004), 69 FR 34428 (June 21, 2004)
(‘‘Alternative Net Capital Requirements Adopting
Release’’); OTC Derivatives Dealers, Exchange Act
Release No. 40594 (Oct. 23, 1998), 63 FR 59362
(Nov. 3, 1998).
36 As noted above, the prudential regulators
similarly proposed capital standards for bank
SBSDs based on the capital standards for banks. See
Prudential Regulator Margin and Capital Proposing
Release 76 FR 27564. The CFTC has proposed three
different capital standards for nonbank swap
dealers. First, a futures commission merchant
(‘‘FCM’’) that is registered as a swap dealer would
be subject to the CFTC’s net capital rule for FCMs,
which is similar to the Commission’s net capital
rule for broker-dealers in that it imposes a net
liquid assets test. See CFTC Capital Proposing
Release, 76 FR 27802. Second, a swap dealer that
is not an FCM and not affiliated with a U.S. bank
holding company would be subject to a ‘‘tangible
net equity’’ capital standard (the CFTC proposal
defines tangible net equity as equity determined
under U.S. generally accepted accounting
principles (‘‘GAAP’’), and excludes goodwill and
other intangible assets). Third, a swap dealer that
is not an FCM and is affiliated with a U.S. bank
holding company would be subject to the capital
standard that applies to U.S. banking institutions.
Id. The proposed capital standard for nonbank
SBSDs would not make such distinctions and,
therefore, all nonbank SBSDs would be subject to
the net liquid assets test embodied in Rule 15c3–
1 (i.e., regardless of whether they are registered as
broker-dealers or affiliates of U.S. bank holding
companies). The CFTC proposed a tangible net
equity requirement for certain swap dealers to
address the probability that commercial entities
(e.g., entities engaged in agricultural or energy
businesses) may need to register as swap dealers
and that imposing a net liquid assets test could
require them to engage in significant corporate
restructuring and potentially cause undue costs
because their equity is comprised of physical and
other non-current assets. Differences between the
swaps markets and the security-based swaps
markets may make a single capital standard more
workable for nonbank SBSDs. The swaps market is
significantly larger than the security-based swaps
market and has many more active participants that
are commercial entities. See BIS, OTC Derivatives
Market Activity in the Second Half of 2010,
Monetary and Economic Department, (May 2011),
available at http://www.bis.org/publ/otc_hy1105.
pdf. It is expected that financial institutions will
comprise a large segment of the security-based
swaps market as is currently the case and that these
entities are more likely to have affiliates dedicated
to OTC derivatives trading and affiliates that are
broker-dealers registered with the Commission. See
infra section V.A. of this release (providing an
overview of the security-based swaps markets).
Consequently, these affiliates—because their capital
structures are geared towards securities trading or
because they already are broker-dealers—would be

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recognizes that there may be alternative
approaches to financial responsibility
requirements that may be appropriate.37
Accordingly, in the requests for
comment below on the various capital
standards, commenters are encouraged:
(1) To consider alternative approaches
to capital for nonbank SBSDs generally;
(2) for nonbank SBSDs that are brokerdealers, to identify what, if any, specific
amendments to Rule 15c3–1 and its
appendices they believe would not be
appropriate for broker-dealers; and (3)
for stand-alone SBSDs, to identify what,
if any, specific provisions in proposed
new Rule 18a–1 and its appendices
(including those modeled on provisions
in Rule 15c3–1 and its appendices) they
believe would not be appropriate for
stand-alone SBSDs.
The capital standard in Rule 15c3–1—
that serves as a model for the proposed
capital standard for nonbank SBSDs—is
a net liquid assets test. This standard is
designed to promote liquidity; the rule
allows a broker-dealer to engage in
activities that are part of conducting a
securities business (e.g., taking
securities into inventory) but in a
manner that places the firm in the
position of holding at all times more
than one dollar of highly liquid assets
for each dollar of unsubordinated
liabilities (e.g., money owed to
customers, counterparties, and
creditors).38 For example, Rule 15c3–1
able to more readily adhere to a net liquid assets
test. In addition, many broker-dealers currently are
affiliates within bank holding companies.
Consequently, these broker-dealers are subject to
Rule 15c3–1, while their bank affiliates are subject
to bank capital standards.
37 CFTC Capital Proposing Release, 76 FR 27802.
38 See, e.g., Interpretation Guide to Net Capital
Computation for Brokers and Dealers, Exchange Act
Release No. 8024 (Jan. 18, 1967), 32 FR 856 (Jan.
25, 1967) (‘‘Rule 15c3–1 (17 CFR 240.15c3–1) was
adopted to provide safeguards for public investors
by setting standards of financial responsibility to be
met by brokers and dealers. The basic concept of
the rule is liquidity; its object being to require a
broker-dealer to have at all times sufficient liquid
assets to cover his current indebtedness.’’)
(footnotes omitted); Net Capital Treatment of
Securities Positions, Obligations and Transactions
in Suspended Securities, Exchange Act Release No.
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973)
(Commission release of a letter from the Division of
Market Regulation) (‘‘The purpose of the net capital
rule is to require a broker or dealer to have at all
times sufficient liquid assets to cover its current
indebtedness. The need for liquidity has long been
recognized as vital to the public interest and for the
protection of investors and is predicated on the
belief that accounts are not opened and maintained
with broker-dealers in anticipation of relying upon
suit, judgment and execution to collect claims but
rather on a reasonable demand one can liquidate his
cash or securities positions.’’); Net Capital
Requirements for Brokers and Dealers, Exchange
Act Release No. 15426 (Dec. 21, 1978), 44 FR 1754
(Jan. 8, 1979) (‘‘The rule requires brokers or dealers
to have sufficient cash or liquid assets to protect the
cash or securities positions carried in their
customers’ accounts. The thrust of the rule is to

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allows securities positions to count as
allowable net capital, subject to
standardized or internal model-based
haircuts.39 The rule, however, does not
permit most unsecured receivables to
count as allowable net capital.40 This
aspect of the rule severely limits the
ability of broker-dealers to engage in
activities, such as unsecured lending,
that generate unsecured receivables. The
rule also does not permit fixed assets or
other illiquid assets to count as
allowable net capital, which creates
disincentives for broker-dealers to own
real estate and other fixed assets that
cannot be readily converted into cash.
For these reasons, Rule 15c3–1
incentivizes broker-dealers to confine
their business activities and devote
capital to activities such as
underwriting, market making, and
advising on and facilitating customer
securities transactions.
Rule 15c3–1 requires broker-dealers to
maintain a minimum level of net capital
(meaning highly liquid capital) at all
times.41 The rule requires that a brokerdealer perform two calculations: (1) A
computation of the minimum amount of
net capital the broker-dealer must
maintain; 42 and (2) a computation of the
amount of net capital the broker-dealer
is maintaining.43 The minimum net
capital requirement is the greater of a
fixed-dollar amount specified in the rule
and an amount determined by applying
one of two financial ratios: the 15-to-1
aggregate indebtedness to net capital
ratio or the 2% of aggregate debit items
ratio.44
In computing net capital, the brokerdealer must, among other things, make
certain adjustments to net worth such as
deducting illiquid assets and taking
other capital charges and adding
qualifying subordinated loans.45 The
amount remaining after these
deductions is defined as ‘‘tentative net
capital.’’ 46 The final step in computing
insure that a broker or dealer has sufficient liquid
assets to cover current indebtedness.’’); Net Capital
Requirements for Brokers and Dealers, Exchange
Act Release No. 26402 (Dec. 28, 1989), 54 FR 315
(Jan. 5, 1989) (‘‘The rule’s design is that brokerdealers maintain liquid assets in sufficient amounts
to enable them to satisfy promptly their liabilities.
The rule accomplishes this by requiring brokerdealers to maintain liquid assets in excess of their
liabilities to protect against potential market and
credit risks.’’) (footnote omitted).
39 See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR
240.15c3–1e; 17 CFR 240.15c3–1f.
40 See 17 CFR 240.15c3–1(c)(2)(iv).
41 See 17 CFR 240.15c3–1.
42 See 17 CFR 240.15c3–1(a).
43 See 17 CFR 240.15c3–1(c)(2). The computation
of net capital is based on the definition of net
capital in paragraph (c)(2) of Rule 15c3–1. Id.
44 See 17 CFR 240.15c3–1(a).
45 See 17 CFR 240.15c3–1(c)(2)(i)–(xiii).
46 See 17 CFR 240.15c3–1(c)(15).

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net capital is to take prescribed
percentage deductions (‘‘standardized
haircuts’’) from the mark-to-market
value of the proprietary positions (e.g.,
securities, money market instruments,
and commodities) that are included in
its tentative net capital.47 The
standardized haircuts are designed to
account for the market risk inherent in
these positions and to create a buffer of
liquidity to protect against other risks
associated with the securities
business.48 ANC broker-dealers and a
type of limited purpose broker-dealer
that deals solely in OTC derivatives
(‘‘OTC derivative dealers’’) are
permitted, with Commission approval,
to calculate net capital using internal
models as the basis for taking market
risk and credit risk charges in lieu of the
standardized haircuts for classes of
positions for which they have been
approved to use models.49 Rule 15c3–1
imposes substantially higher minimum
capital requirements for ANC brokerdealers and OTC derivatives dealers, as
compared to other types of brokerdealers, because, among other reasons,
the use of internal models to compute
net capital can substantially reduce the
deductions for securities and money
market positions as compared with the
standardized haircuts.50 Consequently,
the higher minimum capital
requirements are designed to account
for risks that may not be addressed by
the internal models. A broker-dealer
must ensure that its net capital exceeds
47 See

17 CFR 240.15c3–1(c)(2)(vi).
e.g., Uniform Net Capital Rule, Exchange
Act Release No. 13635 (June 16, 1977), 42 FR 31778
(June 23, 1977) (‘‘[Haircuts] are intended to enable
net capital computations to reflect the market risk
inherent in the positioning of the particular types
of securities enumerated in [the rule]’’); Net Capital
Rule, Exchange Act Release No. 22532 (Oct. 15,
1985), 50 FR 42961 (Oct. 23, 1985) (‘‘These
percentage deductions, or ‘haircuts’, take into
account elements of market and credit risk that the
broker-dealer is exposed to when holding a
particular position.’’); Net Capital Rule, Exchange
Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996
(Dec. 30, 1997) (‘‘Reducing the value of securities
owned by broker-dealers for net capital purposes
provides a capital cushion against adverse market
movements and other risks faced by the firms,
including liquidity and operational risks.’’)
(footnote omitted).
49 See 17 CFR 240.15c3–1(a)(5) and (a)(7); 17 CFR
240.15c3–1e; 17 CFR 240.15c3–1f. As part of the
application to use internal models, an entity
seeking to become an ANC broker-dealer or an OTC
derivatives dealer must identify the types of
positions it intends to include in its model
calculation. See 17 CFR 240.15c3–3e(a)(1)(iii); 17
CFR 240.15c3–1f(a)(1)(ii). After approval, an ANC
broker-dealer and OTC derivatives dealer must
obtain Commission approval to make a material
change to the model, including a change to the
types of positions included in the model. See 17
CFR 240.15c3–1e(a)(8); 17 CFR 240.15c3-f(a)(3).
50 See 17 CFR 240.15c3–1(a)(5) and (a)(7).
48 See,

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its minimum net capital requirement at
all times.51
A different capital standard than the
net liquid assets test is proposed for
nonbank MSBSPs. As discussed in more
detail below, proposed Rule 18a–2
would require nonbank MSBSPs to
maintain positive tangible net worth.52
The Commission preliminarily believes
that a tangible net worth standard—as
opposed to the net liquid assets test—
is more workable for nonbank MSBSPs
because these entities may engage in a
diverse range of business activities
different from, and broader than, the
securities activities conducted by
broker-dealers or SBSDs (and, to the
extent they did not, they likely would
be required to register as an SBSD and/
or broker-dealer).53 Consequently,
requiring nonbank MSBSPs to adhere to
a capital standard based on a net liquid
assets test could restrict these entities
from engaging in commercial activities
that are part of their core business
models. For example, some of these
entities may engage in manufacturing
and supply activities that generate large
amounts of unsecured receivables and
require substantial fixed assets.54
Accordingly, as discussed below,
proposed Rule 18a–2 is not modeled on
Rule 15c3–1 because of the expected
differences between nonbank SBSDs
and broker-dealers, on the one hand,
and the entities that may register as
nonbank MSBSPs, on the other hand.
Request for Comment
The Commission generally requests
comment on the proposals to impose a
net liquid assets test capital standard for
nonbank SBSDs and a tangible net
worth standard for nonbank MSBSPs. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Will the entities that register as
nonbank SBSDs engage in a securities
business with respect to security-based
51 17

CFR 240.15c3–1(a).
proposed new Rule 18a–2.
53 An entity will need to register with the
Commission as an MSBSP and, consequently, be
subject to proposed new Rule 18a–2 if it falls within
the definition of major security-based swap
participant in section 3(a)(67) of the Exchange Act
(15 U.S.C. 78c(a)(67)) as further defined by the
Commission by rule. See Entity Definitions
Adopting Release, 77 FR 30596.
54 See CFTC Capital Proposing Release, 76 FR at
27807 (proposing a tangible net equity test for major
swap participants that are not part of bank holding
companies noting that although these firms ‘‘may
have significant amounts of balance sheet equity, it
may also be the case that significant portions of
their equity is comprised of physical and other
noncurrent assets, which would preclude the firms
from meeting FCM capital requirements without
engaging in significant corporate restructuring and
incurring potentially undue costs.’’).

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52 See

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swaps that is similar to the securities
business conducted by broker-dealers? If
not, describe how the securities
activities of nonbank SBSDs will differ
from the securities activities of brokerdealers.
2. Will some broker-dealers register as
nonbank SBSDs? If so, which types of
broker-dealers and which types of
activities do these broker-dealers
currently engage in?
3. Should there be different capital
standards for nonbank SBSDs
depending on whether they are
registered as broker-dealers or affiliated
with bank holding companies, or not
registered as broker-dealers and not
affiliated with bank holding companies?
If so, explain why. If not, explain why
not. For example, should stand-alone
SBSDs be subject to a tangible net worth
standard or, if affiliated with a bank
holding company, the bank capital
standard? Would different standards
create competitive advantages? If so,
explain why. If different capital
standards would be appropriate, explain
the appropriate capital standard that
should apply to each of these classes of
nonbank SBSDs.
4. Generally, is there a level of capital
under which counterparties will not
transact with a dealer in OTC
derivatives because the counterparty
credit risk is too great? If so, identify
that level of capital.
5. Will stand-alone SBSDs seek to
effect transactions in securities OTC
derivatives products other than securitybased swaps, such as OTC options, that
would necessitate registration as a
broker-dealer? If so, would registering as
a limited purpose broker-dealer under
the provisions applicable to OTC
derivatives dealers provide a workable
alternative to registering as a full-service
broker-dealer? For example, would there
be conflicts between the proposed
capital, margin, and segregation
requirements for SBSDs and the existing
requirements for OTC derivatives
dealers? If so, identify the conflicts.
6. Should the requirements for OTC
derivatives dealers be amended (by
exemptive relief or otherwise) to
accommodate firms that want to deal in
security-based swaps? If so, explain how
the requirements should be amended
and why.
7. Should the Commission exempt
nonbank SBSDs engaged in activities
with respect to securities OTC
derivatives products other than securitybased swaps from any requirements
applicable to OTC derivatives dealers?
Please identify which requirements and
explain why.
8. As discussed below, the proposed
minimum net capital requirements

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would differ substantially for standalone SBSDs that are approved to use
models in computing net capital (i.e., a
$20 million fixed-dollar minimum net
capital requirement and $100 million
tentative net capital requirement)
compared to broker-dealer SBSDs
approved to use models (i.e., a $1 billion
fixed-dollar minimum net capital
requirement and $5 billion tentative net
capital requirement). In general, because
the definition of ‘‘security-based swap
dealer’’ in the Dodd-Frank Act does not
include acting as a broker or agent in
security-based swaps, entities engaging
in brokerage activities with respect to
security-based swaps could be required
to register as broker-dealers. To the
extent these broker-dealer SBSDs
wanted to use models to compute net
capital, they would be subject to the
higher minimum net capital
requirements. Accordingly, in order to
avoid being subject to higher minimum
net capital requirements applicable to
broker-dealer SBSDs approved to use
models to compute net capital, a standalone SBSD may need to limit the
activity it could conduct on behalf of
customers so that it does not fall within
the definition of a ‘‘broker’’ under the
Exchange Act and, thereby, need to
register as a broker-dealer. Commenters
are requested to address this issue,
including any potential changes to the
proposed capital requirements for standalone SBSDs and broker-dealer SBSDs
discussed below. For example, should
broker-dealer SBSDs approved to use
internal models to compute net capital
and that register as broker-dealers only
in order to conduct brokerage activities
with respect to security-based swaps,
and that do not conduct a general
business in securities with customers,
be subject to the minimum net capital
requirements applicable to stand-alone
SBSDs approved to use internal models?
If so, explain why. If not, explain why
not. If different capital standards would
be appropriate, explain the appropriate
capital standard that should apply to
this class of broker-dealer SBSDs and
whether any limitations should apply,
including with respect to the types of
broker activities in which the nonbank
SBSD may engage in order to qualify for
a particular capital treatment.
Alternatively, or in addition, should the
Commission allow OTC derivatives
dealers (which are subject to a $20
million fixed-dollar minimum net
capital requirement and $100 million
tentative net capital requirement) to be
dually registered as nonbank SBSDs
and/or amend the rules for OTC
derivatives dealers to conduct a broader
range of activities than are currently

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2. Proposed Capital Rules for Nonbank
SBSDs
As discussed in detail below,
proposed new Rule 18a–1 would
prescribe capital requirements for standalone SBSDs and amendments to Rule
15c3–1 would prescribe capital
requirements for broker-dealer SBSDs.
Proposed new Rule 18a–1 would require
a stand-alone SBSD to compute net
capital using standardized haircuts
prescribed in the rule (including
standardized haircuts specifically for
security-based swaps and swaps) or,
alternatively, with Commission

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

i. Stand-alone SBSDs Not Using
Internal Models
A stand-alone SBSD would be subject
to the capital requirements set forth in
proposed new Rule 18a–1. Under this
proposed new rule, a stand-alone SBSD
that is not approved to use internal
models to compute haircuts would be
required to maintain minimum net
capital of not less than the greater of $20
million or 8% of the firm’s risk margin
amount (‘‘8% margin factor’’).57 The
term risk margin amount would be
55 See, e.g., 17 CFR 240.15c3–1(a)(5) and (a)(7); 17
CFR 240.15c3–1e; 17 CFR 240.15c3–1f; 17 CFR
240.15c3–4.
56 See 17 CFR 240.15c3–1(a).

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approval, to use internal models for
positions for which the stand-alone
SBSD has been approved to use internal
models. Under the proposed
amendments to Rule 15c3–1, a brokerdealer SBSD would be required to use
the existing standardized haircuts in the
rule plus proposed new additional
standardized haircuts specifically for
security-based swaps and swaps. A
broker-dealer SBSD that seeks to
compute net capital using internal
models would need to apply to the
Commission for approval to operate as
an ANC broker-dealer. A nonbank SBSD
permitted to use internal models to
compute net capital (whether a standalone SBSD subject to proposed new
Rule 18a–1 or an ANC broker-dealer
subject to Rule 15c3–1, as amended)
would need to comply with additional
requirements as compared to a nonbank
SBSD that is not approved to use
internal models. This would be
consistent with the existing
requirements in Rule 15c3–1, which
impose additional requirements on ANC
broker-dealers and OTC derivatives
dealers as compared with other brokerdealers.55 Finally, the amendments to
Rule 15c3–1 would apply to broker-

Rule 15c3–1 prescribes the minimum
net capital requirement for a brokerdealer as the greater of a fixed-dollar
amount specified in the rule and an
amount determined by applying one of
two financial ratios: the 15-to-1
aggregate indebtedness to net capital
ratio or the 2% of aggregate debit items
ratio.56 The proposed capital
requirements for nonbank SBSDs would
use a similar framework. Under the
proposals, there would be different
minimum net capital requirements for
stand-alone SBSDs that are not
approved to use internal models, brokerdealer SBSDs that are not approved to
use internal models, stand-alone SBSDs
that are approved to use internal
models, and broker-dealer SBSDs that
are approved to use internal models
(i.e., ANC broker-dealers). The following
table provides a summary of the
proposed minimum net capital
requirements, which are discussed in
the following sections.

defined as the sum of: (1) The greater of
the total margin required to be delivered
by the nonbank SBSD with respect to
security-based swap transactions
cleared for security-based swap
customers at a clearing agency or the
amount of the deductions that would
apply to the cleared security-based swap
positions of the security-based swap
customers pursuant to paragraph
(c)(1)(vi) of Rule 18a–1; and (2) the total
margin amount calculated by the standalone SBSD with respect to non-cleared

security-based swaps pursuant to
proposed new Rule 18a–3.58
Accordingly, to determine its minimum
net capital requirement, a stand-alone
SBSD would need to calculate the
amount equal to the 8% margin factor.59
The firm’s minimum net capital
requirement would be the greater of $20
million or the amount equal to the 8%
margin factor.60
The proposed $20 million fixed-dollar
minimum requirement would be the
same as the fixed-dollar minimum

57 See paragraph (a)(1) of proposed new Rule 18a–
1. The rationales for these minimum requirements
are discussed below.
58 See paragraph (c)(6) of proposed new Rule 18a–
1. The components of the risk margin amount are
discussed in detail below.

59 See paragraphs (a)(1) and (c)(6) of proposed
new Rule 18a–1.
60 See paragraph (a)(1) of proposed new Rule 18a–
1.

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dealers that are not registered as SBSDs
to the extent they hold positions in
security-based swaps and swaps.
a. Computing Required Minimum Net
Capital

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permitted? If the Commission took this
action, should it also remove the
exemption for OTC derivatives dealers
from membership in a self-regulatory
organization (‘‘SRO’’)?
9. Describe the types of entities that
may need to register as MSBSPs and
how the activities that these entities
engage in would impact the entity’s
capital position.
10. Should nonbank MSBSPs be
subject to a net liquid assets test capital
standard (in contrast to a tangible net
worth test)? If so, explain why. If not,
explain why not.

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requirement applicable to OTC
derivatives dealers and already familiar
to existing market participants.61 OTC
derivatives dealers are limited purpose
broker-dealers that are authorized to
trade in certain derivatives, including
security-based swaps, and to use
internal models to calculate net capital.
They are required to maintain minimum
tentative net capital of $100 million and
minimum net capital of $20 million.62
These current fixed-dollar minimums
have been the minimum capital
standards for OTC derivative dealers for
over a decade, and are substantially
lower than the fixed-dollar minimums
in Rule 15c3–1 currently applicable to
ANC broker-dealers, which use internal
models to calculate net capital.63 In
addition, available data regarding the
current population of broker-dealers
suggests that these minimums would
not prevent new entrants in the
security-based swap market.64 To date,
there have been no indications that
these minimums are not adequately
meeting the objective of requiring OTC
derivatives dealers to maintain
sufficient levels of regulatory capital to
61 See 17 CFR 240.15c3–1(a)(5). The CFTC
proposed a $20 million fixed-dollar minimum net
capital requirement for FCMs that are registered as
swap dealers, regardless of whether the firm is
approved to use internal models to compute
regulatory capital. See CFTC Capital Proposing
Release, 76 FR 27802.
Further, the CFTC proposed a $20 million fixeddollar ‘‘tangible net equity’’ minimum requirement
for swap dealers and major swap participants that
are not FCMs and are not affiliated with a U.S. bank
holding company. Finally, the CFTC proposed a
$20 million fixed-dollar Tier 1 capital minimum
requirement for swap dealers and major swap
participants that are not FCMs and are affiliated
with a U.S. bank holding company (the term ‘‘Tier
1 capital’’ refers to the regulatory capital
requirement for U.S. banking institutions). Id.
62 See 17 CFR 240.15c3–1(a)(5). When adopting
the capital requirements for OTC derivatives
dealers, the Commission stated ‘‘[t]he minimum
tentative net capital and net capital requirements
are necessary to ensure against excessive leverage
and risks other than credit or market risk, all of
which are now factored into the current haircuts.
Further, while the mathematical assumptions
underlying VaR may be useful in projecting
possible daily trading losses under ‘normal’ market
conditions, VaR may not help firms measure losses
that fall outside of normal conditions, such as
during steep market declines. Accordingly, the
minimum capital requirements provide additional
safeguards to account for possible extraordinary
losses or decreases in liquidity during times of
stress which are not incorporated into VaR
calculations.’’ See OTC Derivatives Dealers, 63 FR
59362.
63 Paragraph (a)(7) of Rule 15c3–1 currently
requires that ANC broker-dealers at all times
maintain tentative net capital of not less than $1
billion and net capital of not less than $500 million.
17 CFR 240.15c3–1(a)(7).
64 See infra section V.B.2.a.i. of this release
(economic analysis discussion based on year-end
2011 data showing that approximately 270 brokerdealers maintain net capital of $20 million or more).

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account for the risks inherent in their
activities.
At the same time, the proposed $20
million fixed-dollar minimum
requirement for stand-alone SBSDs that
do not use internal models to calculate
net capital would be substantially
higher than the fixed-dollar minimums
in Rule 15c3–1 currently applicable to
broker-dealers that do not use internal
models (i.e., that are not ANC brokerdealers or OTC derivatives dealers).65
Under the proposals, stand-alone SBSDs
that do not use models would not be
able to avail themselves of such
minimums and would be subject to the
same $20 million minimum net capital
requirement as OTC derivatives dealers,
even though they would not be using
models like such derivatives dealers. In
other words, the same minimum net
capital requirement will apply to standalone SBSDs regardless of whether or
not they use models.
This level of minimum capital may be
appropriate because of the nature of the
business of a stand-alone SBSD and the
differences from the business of a
broker-dealer or OTC derivatives dealer.
Generally, OTC derivatives, such as
security-based swaps, are contracts
between a dealer and its counterparty.
Consequently, the counterparty’s ability
to collect amounts owed to it under the
contract depends on the financial
wherewithal of the dealer. In contrast,
the returns on financial instruments
held by a broker-dealer for an investor
(other than a derivative issued by the
broker-dealer) are not linked to the
financial wherewithal of the brokerdealer holding the instrument for the
customer. Accordingly, if a stand-alone
SBSD fails, the counterparty may not be
able to liquidate the contract or replace
the contract with a new counterparty
without incurring a loss on the position.
The entities that will register and
operate as nonbank SBSDs should be
sufficiently capitalized to minimize the
risk that they cannot meet their
obligations to counterparties,
particularly given that the
counterparties will not be limited to
other dealers but will include customers
and other counterparties as well.
65 For example, a broker-dealer that carries
customer accounts has a fixed-dollar minimum
requirement of $250,000; a broker-dealer that does
not carry customer accounts but engages in
proprietary securities trading (defined as more than
ten trades a year) has a fixed-dollar minimum
requirement of $100,000; and a broker-dealer that
does not carry accounts for customers or otherwise
does not receive or hold securities and cash for
customers, and does not engage in proprietary
trading activities, has a fixed-dollar minimum
requirement of $5,000. See 17 CFR 240.15c3–
1(a)(2).

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In addition, stand-alone SBSDs will
not be subject to the same limitations
that apply to OTC derivative dealers in
effecting transactions with customers
and engaging in dealing activities.66
Therefore, the failure of a stand-alone
SBSD could have a broader adverse
impact on a larger number of market
participants, including customers and
counterparties.67 The proposed capital
requirements for this group of firms, in
part, are meant to account for this
potential broader impact on market
participants.68
Consequently, stand-alone SBSDs that
do not use internal models would be
subject to the same $20 million fixeddollar minimum net capital requirement
that applies to OTC derivatives dealers.
The same firms would not, however, be
subject to a minimum tentative net
capital requirement, which is applied to
firms that use internal models to
account for risks that may not be fully
captured by the models.69
66 See 17 CFR 240.3b-12; 17 CFR 240.15a–1. Rule
3b–12, defining the term OTC derivatives dealer,
provides, among other things, that an OTC
derivatives dealer’s securities activities must be
limited to: (1) Engaging in dealer activities in
eligible OTC derivative instruments (as defined in
the rule) that are securities; (2) issuing and
reacquiring securities that are issued by the dealer,
including warrants on securities, hybrid securities,
and structured notes; (3) engaging in cash
management securities activities (as defined in Rule
3b–14 (17 CFR 240.3b–14)); (4) engaging in
ancillary portfolio management securities activities
(as defined in the rule); and (5) engaging in such
other securities activities that the Commission
designates by order. See 17 CFR 240.3b–12. Rule
15a–1, governing the securities activities of OTC
derivatives dealers, provides that an OTC
derivatives dealer must effect transactions in OTC
derivatives with most types of counterparties
through an affiliated Commission-registered brokerdealer that is not an OTC derivatives dealer. See 17
CFR 240.15a–1.
67 The proposal is consistent with the CFTC’s
proposed capital requirements for nonbank swap
dealers, which impose $20 million fixed-dollar
minimum requirements regardless of whether the
firm is approved to use internal models to compute
regulatory capital. See CFTC Capital Proposing
Release, 76 FR 27802.
68 As discussed above, stand-alone SBSDs would
be subject to a minimum ratio amount based on the
8% margin factor. OTC derivatives dealers are not
subject to a minimum ratio amount.
69 OTC derivatives dealers are subject to a $100
million minimum tentative net capital requirement.
ANC broker-dealers are currently subject to a $1
billion minimum tentative net capital requirement.
The minimum tentative net capital requirements are
designed to address risks that may not be captured
when using internal models rather than
standardized haircuts to compute net capital. See
OTC Derivatives Dealers, 63 FR at 59384;
Alternative Net Capital Requirements for BrokerDealers That Are Part of Consolidated Supervised
Entities; Proposed Rule, Exchange Act Release No.
48690 (Oct. 24, 2003), 68 FR 62872, 62875 (Nov. 6,
2003) (‘‘We expect that net capital charges will be
reduced for broker-dealers that use the proposed
alternative net capital computation. The present
haircut structure is designed so that firms will have
a sufficient capital base to account for, in addition
to market and credit risk, other types of risk, such

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The proposed 8% margin factor
would be part of determining the standalone SBSD’s minimum net capital
requirement. As noted above, the standalone SBSD would determine this
amount by adding:
• The greater of the total margin
required to be delivered by the standalone SBSD with respect to securitybased swap transactions cleared for
security-based swap customers at a
clearing agency or the amount of the
deductions that would apply to the
cleared security-based swap positions of
the security-based swap customers
pursuant to paragraph (c)(1)(vi) of Rule
18a–1; 70 and
• The total margin amount calculated
by the stand-alone SBSD with respect to
non-cleared security-based swaps
pursuant to paragraph (c)(1)(i)(B) of
proposed new Rule 18a–3.71
as operational risk, leverage risk, and liquidity risk.
Raising the minimum tentative net capital
requirement to $1 billion and net capital
requirement to $500 million is one way to ensure
that firms that use the alternative capital
computation maintain sufficient capital reserves to
account for these other risks. In addition, based on
our experience, firms must have this scale of
operations in order to have developed internal risk
management control systems necessary to support
reliable VaR computations.’’).
70 See paragraph (c)(6) of proposed new Rule 18a–
1. As discussed below in section II.B. of this release,
nonbank SBSDs will be subject to margin
requirements imposed by clearing agencies
pursuant to which nonbank SBSDs will be required
to collect collateral from customers relating to the
customers’ cleared security-based swap
transactions. The amount of collateral required to
be collected as a result of customers’ cleared
security-based swap transactions would be used to
determine the first component of the risk margin
amount. This amount would be added to the second
component of the risk margin amount relating to
non-cleared security-based swaps and that amount
would be multiplied by 8% to determine the 8%
margin factor. However, if the margin requirements
of the clearing agencies require the stand-alone
SBSD to collect total collateral in an amount that
is less than the deductions the firm would apply to
the customers’ cleared security-based swap
positions under proposed new Rule 18a–1, the
stand-alone SBSD would need to add the amount
of the deductions to the second component of the
risk margin amount relating to non-cleared securitybased swaps and multiply that amount by 8% to
determine the 8% margin factor.
71 See paragraph (c)(6) of proposed new Rule 18a–
1. As discussed below in section II.B. of this release,
proposed new Rule 18a–3 would establish margin
requirements for nonbank SBSDs with respect to
non-cleared security-based swaps. See proposed
new Rule 18a–3. The proposed rule would define
the term margin to mean the amount of positive
equity in an account of a counterparty. See
paragraph (b)(5) of proposed new Rule 18a–3.
Under the proposed rule, a nonbank SBSD would
be required to calculate daily a margin amount for
the account of each counterparty to a non-cleared
security-based swap. See paragraph (c)(1)(i)(B) of
proposed new Rule 18a–3. These calculations of
counterparty margin amounts for the purposes of
proposed new Rule 18a–3 would be used to
determine the component of the risk margin
amount relating to non-cleared security-based
swaps. This amount would be added to the first
component relating to cleared security-based swaps,

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The total of these two amounts—i.e.,
the risk margin amount—would be
multiplied by 8% to determine the
amount of the 8% margin factor, which,
if greater than the $20 million fixeddollar amount, would be the stand-alone
SBSD’s minimum net capital
requirement.72 This proposed 8%
margin factor ratio requirement is
similar to an existing requirement in the
CFTC’s net capital rule for FCMs.73
Further, the CFTC has proposed a
similar requirement for swap dealers
and major swap participants registered
as FCMs.74 Under the CFTC’s proposal,
an FCM would be required to maintain
adjusted net capital that is equal to or
greater than 8% of the risk margin
required for customer and non-customer
exchange-traded futures and swaps
positions that are cleared by a
derivatives clearing organization
(‘‘DCO’’).75 The CFTC’s proposed 8% of
margin, or risk-based capital rule, ‘‘is
intended to require FCMs to maintain a
minimum level of capital that is
associated with the level of risk
associated with the customer positions
that the FCM carries.’’ 76 Based on
Commission staff experience with
dually-registered broker-dealer/FCMs,
the Commission preliminarily believes
that the 8% margin factor would serve
as a reasonable measure to ensure that
a firm’s minimum capital requirement
increases or decreases in tandem with
the level of risk arising from customer
futures transactions. Consequently, the
8% margin factor is being proposed to
provide a similar adjustable minimum
net capital requirement for nonbank
and the total amount would be multiplied by 8%
to determine the 8% margin factor.
72 See paragraphs (a)(1) and (c)(6) of proposed
new Rule 18a–1.
73 See 17 CFR 1.17(a)(1)(i)(B). See also Minimum
Financial and Related Reporting Requirements for
Futures Commission Merchants and Introducing
Brokers, 69 FR 49784 (Aug. 12, 2004). The CFTC
proposed the 8% risk margin requirement to
establish a margin-based capital computation
identical to the margin-based minimum net capital
computation that several futures self-regulatory
organizations, including one derivatives clearing
organization, adopted for their respective memberFCMs. Id. at note 16.
74 See CFTC Capital Proposing Release, 76 FR
27802. The 8% risk margin calculation under the
CFTC’s proposal relates to cleared swaps or futures
transactions, whereas the 8% margin factor
proposed in new Rule 18a–1 would be based on
cleared and non-cleared security-based swaps. As
discussed below, the proposed minimum net
capital requirement is based on a nonbank SBSD’s
cleared and non-cleared security-based swap
activity in order to account for the risks of both
types of positions.
75 See CFTC Capital Proposing Release, 76 FR
27802.
76 Id. at 27807.

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SBSDs with respect to their securitybased swap activity.77
Under the proposed rule, nonbank
SBSDs—including stand-alone SBSDs
that are not approved to use internal
models to calculate net capital—would
be subject to a minimum net capital
requirement that increases in tandem
with an increase in the risks associated
with nonbank SBSD’s security-based
swap activities.78 Without the 8%
margin factor, the minimum net capital
requirement for a nonbank SBSD would
be the same (i.e., $20 million) regardless
of the volume, size, and risk of its
outstanding security-based swap
transactions.
The amount computed under the 8%
margin factor generally would increase
as the stand-alone SBSD increased the
volume, size, and risk of its securitybased swap transactions. Specifically,
the proposed definition of the term risk
margin amount is designed to link the
stand-alone SBSD’s minimum net
capital requirement to its cleared and
non-cleared security-based swap
activity. For example, the definition in
proposed new Rule 18a–1 provides that,
for cleared security-based swaps, the
amount is the greater of the margin
required to be collected or the amount
of the deductions that would apply
pursuant to proposed new Rule 18a–1
(i.e., the amount of the deductions using
standardized haircuts).79 The margin
requirement for cleared security-based
swap positions generally should
increase with the volume, size, and risk
of the positions as would the amount of
the standardized haircuts applicable to
the positions. Further, the ‘‘greater of’’
provision is designed to ensure that the
8% margin factor requirement is based
on, at a minimum, the standardized
haircuts as these provide a uniform
approach for all cleared security-based
77 As discussed below in section II.A.2.b.iv. of
this release, an 8% multiplier is used for purposes
of calculating credit risk charges under Appendix
E to Rule 15c3–1. While this is a different
calculation than the proposed 8% margin factor,
using an 8% multiplier for purposes of computing
regulatory capital requirements is an international
standard. See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428, note 42 (describing
the 8% multiplier in Appendix E to Rule 15c3–1
as being ‘‘consistent with the calculation of credit
risk in the OTC derivatives dealers rules and with
the Basel Standard’’ and as being ‘‘designed to
dampen leverage to help ensure that the firm
maintains a safe level of capital.’’).
78 As discussed below in sections II.A.2.a.ii.,
II.A.2.a.iii., and II.A.2.a.iv. of this release, the 8%
margin factor would be used to compute the
minimum net capital requirement for all nonbank
SBSDs.
79 For a stand-alone SBSD approved to use
internal models and an ANC broker-dealer, it would
be the amount of the deductions determined using
a VaR model, except for types of positions for
which the firm has not been approved to use a VaR
model.

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swaps, whereas margin requirements for
cleared security-based swaps will vary
over time and across different clearing
agencies.
As proposed, the 8% margin factor is
determined using the greater of required
margin or standardized haircuts with
respect to cleared security-based swaps
plus the margin amount for non-cleared
security-based swaps calculated under
proposed new Rule 18a–3.80 Thus, the
8% margin factor would be based on a
stand-alone SBSD’s activity in both
cleared and non-cleared security-based
swaps. As noted above, the goal of the
provision is to require the stand-alone
SBSD to increase its net capital in
tandem with an increase in the risk of
its security-based swap transactions.
The proposal does not limit the
computation to only cleared securitybased swaps, as proposed by the CFTC,
because such a limitation would allow
the stand-alone SBSD to increase the
amount of its non-cleared security-based
swaps positions without a
corresponding increase in net capital.
This could create greater risk to the
stand-alone SBSD’s customers
because—as discussed above—their
ability to collect amounts owing on
security-based swaps depends on the
ability of the stand-alone SBSD to meets
its obligations.

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Request for Comment
The Commission generally requests
comment on the proposed minimum net
capital requirements in proposed new
Rule 18a–1 for stand-alone SBSDs that
are not approved to use internal models
to compute net capital. In addition, the
80 Proposed new Rule 18a–3 would require a
nonbank SBSD to calculate daily a margin amount
for the account of each counterparty to a noncleared security-based swap. See paragraph
(c)(1)(i)(B) of proposed new Rule 18a–3. As
discussed below in section II.B. of this release, a
nonbank SBSD would be required to perform this
calculation even though proposed new Rule 18a–3
would not require the nonbank SBSD to collect
collateral from all counterparties to collateralize the
margin amount. For example, the Commission is
proposing that collateral need not be collected from
commercial end users. Nonetheless, the calculation
of the margin amount for purposes of proposed new
Rule 18a–3 would determine the non-cleared
security-based swap component of the risk margin
amount regardless of whether the nonbank SBSD
would be required to collect collateral from the
counterparty to collateralize the margin amount. In
other words, the amount of the risk margin amount
would be based on the calculation required by
proposed new Rule 18a–3 for all counterparties to
non-cleared security-based swaps and not on
whether the stand-alone SBSD would be required
to collect collateral from a counterparty to
collateralize the margin amount. As discussed in
section II.B. of this release, this is designed to
ensure that the risk margin amount is based on all
non-cleared security-based swap activity of the
stand-alone SBSD and not just on security-based
swap activity that would require the firm to collect
collateral.

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Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the proposed $20 million
minimum net capital requirement for
stand-alone SBSDs not using internal
models appropriate? If not, explain why
not. What minimum amount would be
more appropriate? For example, should
the minimum fixed-dollar amount be
greater than $20 million to account for
the broader range of activities that
stand-alone SBSDs will be able to
engage in as compared with OTC
derivatives dealers? If so, explain why.
If it should be a greater amount, how
much greater should it be (e.g., $30
million, $50 million, $100 million, or
some other amount)? Alternatively,
should the minimum fixed-dollar
amount be less than $20 million because
these firms will not be using internal
models to compute net capital? If so,
explain why. If it should be a lower
amount, how much lower (e.g., $15
million, $10 million, $5 million, or
some other amount)? If a greater or
lesser alternative amount is
recommended, explain why it would be
more appropriate for broker-dealer
SBSDs that are not approved to use
internal models.
2. Is the proposed definition of risk
margin amount appropriate? If not,
explain why and suggest modifications
to the definition. For example, are there
modifications that could make the
definition more accurately reflect the
nonbank SBSD’s risk exposure from
dealing in security-based swaps? If so,
describe the modifications and explain
why they would achieve this result.
3. Is the component of the risk margin
amount definition addressing margin
delivered for cleared swaps appropriate?
If not, explain why not. Would the
definition be more appropriate if this
component was dropped so that the first
prong of the definition only
incorporated the haircuts for cleared
security-based swaps?
4. Should the proposed definition of
risk margin amount only address
cleared security-based swaps, consistent
with the CFTC’s proposal? If so, explain
why, including how the risk of noncleared security-based swap activities
could be addressed through other
measures.
5. Is the component of the risk margin
amount definition addressing margin
collected for non-cleared security-based
swaps appropriate? If not, explain why
not.
6. Is the 8% margin factor an
appropriate metric for determining a
nonbank SBSD’s minimum net capital
requirement in terms of increasing a

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nonbank SBSD’s minimum net capital
requirement as the risk of its securitybased swap activities increases? If not,
explain why not. For example, should
the percentage be greater than 8% (e.g.,
10%, 12%, or some other percentage)?
If so, identify the percentage and
explain why it would be preferable.
Should the percentage be less than 8%
(e.g., 6%, 4%, or some other
percentage)? If so, identify the
percentage and explain why it would be
preferable.
7. Should the 8% multiplier be tiered
as the amount of the risk margin amount
increases? If so, explain why. For
example, should the multiplier decrease
from 8% to 6% for the amount of the
risk margin amount that exceeds a
certain threshold, such as $1 billion or
$5 billion? If so, explain why. Should
the amount of the multiplier increase
from 8% to 10% for the amount of the
risk margin amount that exceeds a
certain threshold such as $1 billion or
$5 billion? If so, explain why.
8. Should the 8% margin factor be an
adjustable ratio (e.g., increase to 10% or
decrease to 6%)? For example, should
the multiplier adjust periodically if
certain conditions occur? If so, explain
the conditions under which the 8%
multiplier would adjust upward or
downward and why having an
adjustable ratio would be appropriate.
9. Would the 8% margin factor be a
sufficient minimum net capital
requirement without the $20 million
fixed-dollar minimum? If so, explain
why.
10. Are there metrics other than a
fixed-dollar minimum and the 8%
margin factor for calculating required
minimum capital that would more
appropriately reflect the risk of nonbank
SBSDs? If so, identify them and explain
why they would be preferable. For
example, instead of an absolute fixeddollar minimum, should the minimum
net capital requirement be linked to a
scalable metric such as the size of the
nonbank SBSD or the amount of the
deductions taken by the nonbank SBSD
when computing net capital? For any
scalable minimum net capital
requirements identified, explain how
the computation would work in practice
and how the minimum requirement
would address the same objectives of a
fixed-dollar minimum.
11. Would the 8% margin factor
address the risk of extremely large
nonbank SBSDs? If not, explain why
not. For example, if the customer
margin requirements for cleared and
non-cleared security-based swaps
carried by the nonbank SBSD were low
because the positions were hedged or
otherwise not high risk, the 8% margin

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
factor may not increase in tandem with
the level of the nonbank SBSD’s
security-based swap activity. In this
case, would the 8% margin factor
adequately address the risk of the
nonbank SBSD, particularly if it carried
substantial security-based swap
positions? If not, explain why not.
Would the 8% margin factor be
necessary for small nonbank SBSDs? If
not, explain why not.
12. Would the 8% margin factor
provide an appropriate and workable
restraint on the amount of leverage
incurred by stand-alone SBSDs not
using internal models because the
amount of minimum net capital would
increase as the risk margin amount
increases? If not, explain why not. Is
there another measure that would more
accurately and effectively address the
leverage risk of these firms? If so,
identify the measure and explain why it
would be more accurate and effective.
13. Should the 8% margin factor be
applied to margin related to cleared and
non-cleared swap transactions in
addition to security-based swap
transactions? For example, the provision
could require that 8% of the margin
required for cleared and non-cleared
swaps be added to the 8% of margin
required for cleared and non-cleared
security-based swaps in determining the
minimum net capital requirement.
Would this be a workable approach to
address the fact that the CFTC’s
proposed 8% margin requirement
would not apply to swap dealers that
are not registered as FCMs and, with
respect to dually-registered FCM swap
dealers, it would apply only to cleared
swaps? Including swaps in the 8%
margin factor calculation would provide
for equal treatment of security-based
swaps and swaps in determining a
minimum net capital requirement.
Would this be a workable approach? If
so, explain why. If not, explain why not.
14. Would the 8% margin factor be
practical as applied to a portfolio
margin account that contains securitybased swaps and swaps? If so, explain
why. If not, explain why not.
15. What will be the practical impacts
of the 8% margin factor? For example,
what will be the effect on transaction
costs, liquidity in security-based swaps,
availability of capital to support
security-based swap transactions
generally and/or for non-security-based
swap-related uses, use of security-based
swaps for hedging purposes, risk
management at SBSDs, the costs for
potential new SBSDs to participate in
the security-based swap markets, etc.?
How would these impacts increase or
decrease if the 8% margin factor were
set at a higher or lower percentage?

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ii. Broker-Dealer SBSDs Not Using
Internal Models
A broker-dealer that registers as an
SBSD would continue to be subject to
the capital requirements in Rule 15c3–
1, as proposed to be amended to account
for security-based swap activities.
Proposed amendments to paragraph (a)
of Rule 15c3–1 would establish
minimum net capital requirements for a
broker-dealer SBSD that is not approved
to use internal models to compute net
capital.81 Under these proposed
amendments, the broker-dealer SBSD
would be subject to the same $20
million fixed-dollar minimum net
capital requirement as a stand-alone
SBSD that does not use internal
models.82 As discussed above in section
II.A.2.a.i. of this release, the proposed
$20 million fixed-dollar minimum
would be consistent with the current
fixed-dollar minimum that applies to
OTC derivatives dealers, which has
been used as a minimum capital
standard for OTC derivative dealers for
over a decade.
In addition, a broker-dealer SBSD that
does not use internal models would be
required to use the 8% margin factor to
compute its minimum net capital
amount. As discussed above in section
II.A.2.a.i. of this release, the 8% margin
factor is designed to adjust the brokerdealer SBSD’s minimum net capital
requirement in tandem with the risk
associated with the broker-dealer
SBSD’s security-based swap activity.
Without the 8% margin factor, the
minimum net capital requirement for a
broker-dealer SBSD would be the same
(i.e., $20 million) regardless of the
number, size, and risk of its outstanding
security-based swap transactions.
Consequently, the proposed rule would
include the 8% margin factor in order
to increase the broker-dealer SBSD’s net
capital requirement as the risk of its
security-based swap activities increases.
Moreover, the broker-dealer SBSD—as
a broker-dealer—would be subject to the
existing financial ratio requirements in
Rule 15c3–1 and, therefore, would need
to include the applicable financial ratio
amount when determining the firm’s
minimum net capital requirement.83 A
broker-dealer’s minimum net capital
requirement is the greater of the
applicable fixed-dollar amount and one
of two alternative financial ratios. The
81 See proposed new paragraph (a)(10) of Rule
15c3–1.
82 Id.
83 See 17 CFR 240.15c3–1(a)(1); proposed new
paragraph (a)(10)(i) of Rule 15c3–1. Currently, all
broker-dealers, including the ANC broker-dealers,
are subject either to the aggregate indebtedness
standard or the aggregate debit items (alternative
standard) financial ratio requirements.

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first financial ratio requirement
provides that a broker-dealer must not
permit its aggregate indebtedness to all
other persons to exceed 1500% of its net
capital (i.e., a 15-to-1 aggregate
indebtedness to net capital
requirement).84 This is the default
financial ratio requirement that all
broker-dealers must apply unless they
affirmatively elect to be subject to the
second financial ratio requirement by
notifying their designated examining
authority of the election.85 The second
financial ratio requirement provides that
a broker-dealer must not permit its net
capital to be less than 2% of aggregate
debit items (i.e., customer-related
obligations to the broker-dealer).86
The proposed amendments to Rule
15c3–1 would provide that a brokerdealer SBSD that is not approved to use
internal models would be required to
maintain a minimum net capital level of
not less than the greater of: (1) $20
million or (2) the financial ratio amount
required pursuant to paragraph (a)(1) of
Rule 15c3–1 plus the 8% margin
factor.87 Thus, the proposed minimum
net capital requirement for a brokerdealer SBSD would incorporate the
requirement in Rule 15c3–1 that a
broker-dealer maintain the greater of a
fixed-dollar amount or one of the two
financial ratio amounts, as applicable.88
The financial ratio requirements in Rule
15c3–1 are designed to link the brokerdealer’s minimum net capital
requirement to the level of its securities
activities. For example, the aggregate
debit ratio requirement is designed for
broker-dealers that carry customer
securities and cash.89 This provision
increases the minimum net capital
requirement for these broker-dealers as
they increase their debit items by
engaging in margin lending and
facilitating of customer short-sale
84 See 17 CFR 240.15c3–1(a)(1)(i). Stated another
way, the broker-dealer must maintain, at a
minimum, an amount of net capital equal to 1/15th
(or 6.67%) of its aggregate indebtedness. This
financial ratio generally is used by smaller brokerdealers that do not hold customer securities and
cash.
85 See 17 CFR 240.15c3–1(a)(1)(i)–(ii).
86 See 17 CFR 240.15c3–1(a)(1)(ii). Customer
debit items—computed pursuant to Rule 15c3–3—
consist of, among other things, margin loans to
customers and securities borrowed by the brokerdealer to effectuate deliveries of securities sold
short by customers. See 17 CFR 240.15c3–3; 17 CFR
240.15c3–3a. This ratio generally is used by larger
broker-dealers that hold customer securities and
cash.
87 See proposed new paragraph (a)(10)(i) of Rule
15c3–1.
88 Id.
89 See Net Capital Requirements for Brokers and
Dealers, Exchange Act Release No. 17208 (Oct. 9,
1980), 45 FR 69915 (Oct. 22, 1980).

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

transactions.90 The proposal to combine
the Rule 15c3–1 financial ratios with the
8% margin factor in a broker-dealer
SBSD’s computation of its minimum net
capital requirement is designed to
require the broker-dealer SBSD to
maintain a capital cushion to support its
traditional securities activities (e.g.,
margin lending) and its security-based
swap activities.
Request for Comment
The Commission generally requests
comment on the proposed minimum net
capital requirements for broker-dealer
SBSDs that are not approved to use
internal models. Commenters are
referred to the general questions above
in section II.A.2.a.i. of this release about
the 8% margin factor as applied broadly
to nonbank SBSDs. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the proposed $20 million
minimum net capital requirement
appropriate for broker-dealer SBSDs that
are not approved to use internal
models? If not, explain why not. What
minimum amount would be more
appropriate? For example, should the
minimum fixed-dollar amount be
greater than $20 million to account for
the broader range of activities that
broker-dealer SBSDs will be able to
engage in (e.g., traditional securities
activities such as margin lending), as
compared with stand-alone SBSDs and
OTC derivatives dealers? If it should be
a greater amount, how much greater
should it be (e.g., $30 million, $50
million, $100 million, or some other
amount)? Alternatively, should the
minimum fixed-dollar amount be less
than $20 million because these firms
will not be using internal models to
compute net capital? If it should be a
lower amount, how much lower (e.g.,
$15 million, $10 million, $5 million or
some other amount)? If a greater or
lesser alternative amount is
recommended, explain why it would be
preferable for broker-dealer SBSDs that
are not approved to use internal models.
2. Is combining the 8% margin factor
requirement with the applicable Rule
15c3–1 financial ratio requirement an
appropriate way to determine a
minimum net capital requirement for
broker-dealer SBSDs that are not
approved to use internal models? If not,
explain why not.
3. Would the 8% margin factor
combined with the Rule 15c3–1
financial ratio provide an appropriate
90 See 17 CFR 240.15c3–1(a)(1)(ii); 17 CFR
240.15c3–3a.

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and workable restraint on the amount of
leverage incurred by broker-dealer
SBSDs not using internal models? If not,
explain why not. Is there another
measure that would more accurately
and effectively address the leverage risk
of these firms? If so, identify the
measure and explain why it would be
more accurate and effective.
iii. Stand-Alone SBSDs Using Internal
Models
As discussed above, a stand-alone
SBSD would be subject to the capital
requirements in proposed new Rule
18a–1.91 Rule 18a–1 would permit
stand-alone SBSDs to apply to use
internal models to compute net
capital.92 In terms of minimum capital
requirements, a stand-alone SBSD that
has been approved to use internal
models would be required to maintain:
(1) a minimum tentative net capital
level of not less than $100 million; and
(2) a minimum net capital level of not
less than the greater of $20 million or
the 8% margin factor.93 The proposed
minimum net capital requirement for
stand-alone SBSDs using internal
models (i.e., the greater of $20 million
or the 8% margin factor) is the same as
the proposed minimum net capital
requirement for stand-alone SBSDs and
broker-dealer SBSDs not using internal
models (though the latter would need to
incorporate the Rule 15c3–1 financial
ratio requirement into their minimum
net capital computations).
A stand-alone SBSD approved to use
internal models also would be subject to
a minimum tentative net capital
requirement of $100 million.94 This
proposed minimum tentative net capital
requirement would be consistent with
the current minimum tentative net
capital requirement applicable to OTC
derivatives dealers.95 A minimum
tentative net capital requirement is
designed to operate as a prudential
control on the use of internal models for
regulatory capital purposes.96 Tentative
91 See

proposed new Rule 18a–1.
paragraphs (a)(2) and (d) of proposed new
Rule 18a–1; the discussion below in section
II.A.2.b.iii. of this release.
93 See paragraph (a)(2) of proposed Rule 18a–1.
As discussed above in section II.A.2.a.i. of this
release, the 8% margin factor is designed to adjust
the stand-alone SBSD’s minimum net capital
requirement in tandem with the risk associated
with the broker-dealer firm’s security-based swap
activity.
94 See paragraph (a)(2) of proposed new Rule 18a–
1.
95 Both ANC broker-dealers and OTC derivatives
dealers—entities that use internal models—are
subject to a minimum tentative net capital
requirement. See 17 CFR 240.15c3–1(a)(5) and
(a)(7).
96 OTC Derivatives Dealers, 63 FR at 59384 (‘‘The
final rule contains the minimum requirements of
92 See

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net capital is the amount of net capital
maintained by a broker-dealer before
applying the standardized haircuts or
using internal models to determine
deductions on the mark-to-market value
of proprietary positions to arrive at the
broker-dealer’s amount of net capital.97
OTC derivatives dealers, therefore,
compute tentative net capital before
using internal VaR models to take the
market risk deductions. The minimum
tentative net capital requirement is
designed to account for the fact that VaR
models, while more risk sensitive than
standardized haircuts, tend to
substantially reduce the amount of the
deductions to tentative net capital in
comparison to the standardized haircuts
because the models recognize more
offsets between related positions (i.e.,
positions that show historical
correlations) than the standardized
haircuts.98 In addition, VaR models may
$100 million in tentative net capital and $20
million in net capital. The minimum tentative net
capital and net capital requirements are necessary
to ensure against excessive leverage and risks other
than credit or market risk, all of which are now
factored into the current haircuts. Further, while
the mathematical assumptions underlying VaR may
be useful in projecting possible daily trading losses
under ‘normal’ market conditions, VaR may not
help firms measure losses that fall outside of
normal conditions, such as during steep market
declines. Accordingly, the minimum capital
requirements provide additional safeguards to
account for possible extraordinary losses or
decreases in liquidity during times of stress which
are not incorporated into VaR calculations.’’). See
also Alternative Net Capital Requirements Adopting
Release, 69 FR at 34431 (‘‘The current haircut
structure [use of the standardized haircuts] seeks to
ensure that broker-dealers maintain a sufficient
capital base to account for operational, leverage,
and liquidity risk, in addition to market and credit
risk. We expect that use of the alternative net
capital computation [internal models] will reduce
deductions for market and credit risk substantially
for broker-dealers that use that method. Moreover,
inclusion in net capital of unsecured receivables
and securities that do not have a ready market
under the current net capital rule will reduce the
liquidity standards of Rule 15c3–1. Thus, the
alternative method of computing net capital and, in
particular, its requirements that broker-dealers
using the alternative method of computing [sic]
maintain minimum tentative net capital of at least
$1 billion, maintain net capital of at least $500
million, notify the Commission that same day if
their tentative net capital falls below $5 billion, and
comply with Rule 15c3–4 are intended to provide
broker-dealers with sufficient capital reserves to
account for market, credit, operational, and other
risks.’’) (Text in brackets added).
97 See 17 CFR 240.15c3–1(c)(10).
98 See OTC Derivatives Dealers, 63 FR 53962. See
Net Capital Rule, Exchange Act Release No. 39456
(Dec. 17, 1997), 62 FR 68011 (Dec. 30, 1997)
(concept release considering the extent to which
statistical models should be used in setting the
capital requirements for a broker-dealer’s
proprietary positions) (‘‘For example, the current
method of calculating net capital by deducting fixed
percentages from the market value of securities can
allow only limited types of hedges without
becoming unreasonably complicated. Accordingly,
the net capital rule recognizes only certain specified
hedging activities, and the Rule does not account

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
not capture all risks and, therefore,
having a minimum tentative net capital
requirement (i.e., one that is not derived
using the VaR model) is designed to
require that capital be sufficient to
withstand events that the model may
not take into account (e.g., extraordinary
losses or decreases in liquidity during
times of stress that are not incorporated
into VaR calculations).99 Consequently,
the proposed $100 million minimum
tentative net capital requirement is
designed to provide a sufficient liquid
capital cushion for stand-alone SBSDs
that use models, just as it has done in
practice for entities registered as OTC
derivatives dealers.100
Request for Comment

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

The Commission generally requests
comment on the proposed capital
requirements for stand-alone SBSDs
using internal models. Commenters are
referred to the general questions above
in section II.A.2.a.i. of this release about
the 8% margin factor as applied broadly
to nonbank SBSDs. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the proposed minimum net
capital requirement of $20 million
appropriate for stand-alone SBSDs that
are approved to use internal models, in
comparison to OTC derivatives dealers
which are more limited by the activities
they are permitted to conduct (such as
being prohibited from effecting
transactions with customers)? If not,
explain why not. What minimum
amount would be more appropriate? For
example, should the minimum fixeddollar amount be greater than $20
million to account for the use of internal
models? If it should be a greater amount,
how much greater should it be (e.g., $30
for historical correlations between foreign securities
and U.S. securities or between equity securities and
debt securities. By failing to recognize offsets from
these correlations between and within asset classes,
the fixed percentage haircut method may cause
firms with large, diverse portfolios to reserve capital
that actually overcompensates for market risk.’’ Id.
‘‘The primary advantage of incorporating models
into the net capital rule is that a firm would be able
to recognize, to a greater extent, the correlations and
hedges in its securities portfolio and have a
comparatively smaller capital charge for market
risk.’’).
99 See OTC Derivatives Dealers, 63 FR 59362;
Alternative Net Capital Requirements Adopting
Release, 69 FR 34428. Further, the deductions to
tentative net capital taken by nonbank SBSDs and
broker-dealers are intended to create a pool of new
liquid assets that can be used for any risk assumed
by the firm and not only market risk. A tentative
net capital requirement also serves as a capital
buffer for these other risks to offset the narrower
type of risk intended to be covered by calculating
net capital using internal models.
100 OTC Derivatives Dealers, 63 FR 59362.

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million, $50 million, $100 million, or
some other amount)? Alternatively,
should the minimum fixed-dollar
amount be less than $20 million? If it
should be a lower amount, how much
lower (e.g., $15 million, $10 million, $5
million or some other amount)? If a
greater or lesser alternative amount is
recommended, explain why it would be
more appropriate for stand-alone SBSDs
that are approved to use internal
models.
2. Is it necessary to impose a
minimum tentative net capital
requirement for stand-alone SBSDs
using internal models to capture
additional risks not incorporated into
VaR models (consistent with those
tentative minimum met capital
requirements imposed on OTC
derivatives dealers)? If not, why not?
3. Is the proposed amount of the
minimum tentative net capital level of
$100 million for stand-alone SBSDs
using internal models appropriate? If
not, explain why not. For example,
should the minimum tentative net
capital amount be greater than $100
million to account for the use of internal
models? If it should be a greater amount,
how much greater should it be (e.g.,
$150 million, $200 million, $250
million, or some other amount)? Should
it be a lesser amount (e.g., $75 million,
$50 million, or some other amount)? If
a greater or lesser alternative amount is
recommended, explain why it would be
more appropriate for stand-alone SBSDs
that are approved to use internal
models.
4. Are there metrics other than a
fixed-dollar minimum tentative net
capital requirement that would more
appropriately reflect the risk of nonbank
SBSDs? If so, identify them and explain
why they would be preferable. For
example, instead of an absolute fixeddollar minimum tentative net capital
requirement, should the minimum
tentative net capital requirement be
linked to a scalable metric such as the
size of a nonbank SBSD? For any
scalable minimum tentative net capital
requirements identified, explain how
the computation would work in practice
and how the minimum requirement
would address the same objectives of a
fixed-dollar minimum. Would the 8%
margin factor provide an appropriate
and workable restraint on the amount of
leverage incurred by stand-alone SBSDs
that are approved to use internal
models? Is there another measure that
would more accurately and effectively
address the leverage risk of these firms?
If so, identify the measure and explain
why it would be more accurate and
effective.

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70227

iv. Broker-Dealer SBSDs Using Internal
Models and ANC Broker-Dealers
Under the current requirements of
Rule 15c3–1, a broker-dealer that seeks
to use internal models to compute net
capital must apply to the Commission to
become an ANC broker-dealer.101 If the
application is granted, the ANC brokerdealer is able to take less than 100%
deductions for unsecured receivables
from OTC derivatives counterparties
(non-ANC broker-dealers must deduct
these receivables in full) and can use
VaR models in lieu of the standardized
haircuts to take deductions on their
proprietary positions in securities and
money market instruments to the extent
the firm has been approved to use an
internal model for the type of
position.102 It is expected that some
broker-dealer SBSDs would seek to use
internal models to compute net
capital—as have some broker-dealers—
by applying to become ANC brokerdealers. Broker-dealer SBSDs using
internal models would be subject to the
existing provisions and proposed
amendments to those provisions
currently applicable to ANC brokerdealers.
Under the proposed amendments, the
current net capital requirements for
ANC broker-dealers in Rule 15c3–1
would be enhanced to account for the
firms’ large size, the scale of their
custodial activities, and the potential
that they may become substantially
more active in the security-based swap
markets under the Dodd-Frank Act’s
OTC derivatives reforms. As discussed
in more detail below, the proposed
enhancements would include increasing
the minimum tentative net capital and
minimum net capital requirements;
increasing the ‘‘early warning’’ notice
threshold; narrowing the types of
unsecured receivables for which ANC
broker-dealers may take a credit risk
charge in lieu of a 100% deduction; and
requiring ANC broker-dealers to comply
with a new liquidity requirement.103
Currently, an ANC broker-dealer must
maintain minimum tentative net capital
of at least $1 billion and minimum net
capital of at least $500 million.104 In
addition, an ANC broker-dealer must
provide the Commission with an ‘‘early
warning’’ notice when its tentative net
capital falls below $5 billion.105 These
relatively high minimum capital
requirements (as compared with the
requirements for other types of broker101 See

17 CFR 240.15c3–1e.

102 Id.
103 See proposed amendments to 17 CFR
240.15c3–1; 17 CFR 240.15c3–1e.
104 See 17 CFR 240.15c3–1(a)(7)(i).
105 See 17 CFR 240.15c3–1(a)(7)(ii).

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dealers) reflect the substantial and
diverse range of business activities
engaged in by ANC broker-dealers and
their importance as intermediaries in
the securities markets.106 Further, the
heightened capital requirements reflect
the fact that, as noted above, VaR
models are more risk sensitive but also
may not capture all risks and generally
permit substantially reduced deductions
to tentative net capital as compared to
the standardized haircuts.107
The proposals to strengthen the
requirements for ANC broker-dealers are
made in response to issues that arose
during the 2008 financial crisis,
recognizing the large size of these firms,
and the scale of their custodial
responsibilities. The proposals also are
based on the Commission staff’s
experience supervising the ANC brokerdealers. The financial crisis
demonstrated the risks to financial firms
when market conditions are stressed
and how the failure of a large firm can
accelerate the further deterioration of
market conditions.108 The proposals are
designed to bolster the ANC brokerdealer net capital rules to ensure that
these firms continue to maintain
sufficient capital reserves to account for
market, credit, operational, and other
risks.109 While the rationale for these
enhancements exists irrespective of
whether the ANC broker-dealers
ultimately register as SBSDs, the
proposed increased capital requirements
also are designed to account for
increased security-based swap activities
by these firms. FOCUS Report data and
the Commission staff’s supervision of
the ANC broker-dealers indicate that
these firms currently do not engage in
a substantial business in security-based
swaps.110 It is expected, however, that
106 For example, based on data from broker-dealer
FOCUS Reports, the six ANC broker-dealers
collectively hold in excess of one trillion dollars’
worth of customer securities. Under Rule 17a–5 (17
CFR 240.17a–5), broker-dealers must file periodic
reports on Form X–17A–5 (Financial and
Operational Combined Uniform Single Reports,
‘‘FOCUS Reports’’). Unless an exception applies,
the Commission’s rules deem all reports filed under
Rule 17a–5 confidential. 17 CFR 240.17a–5(a)(3).
The FOCUS Report requires, among other financial
information, a balance sheet, income statement, and
net capital and customer reserve computations. The
FOCUS Report data used in this release is year-end
2011 FOCUS Report data.
107 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
108 See, e.g., World Economic Outlook: Crisis and
Recovery, International Monetary Fund (‘‘IMF’’)
(Apr. 2009), available at http://www.imf.org/
external/pubs/ft/weo/2009/01/pdf/text.pdf.
109 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
110 The ANC broker-dealers are subject to ongoing
Commission staff supervision, which includes
monthly meetings with senior staff of the ANC
broker-dealers. This supervision program provides

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they may increase their security-based
swap activities after the Dodd-Frank
Act’s OTC derivatives reforms are
implemented and become effective
because security-based swap activities
will need to be conducted in regulated
entities.111 Consequently, financial
institutions that currently deal in
security-based swaps will need to
register as an SBSD or register one or
more affiliates as an SBSD. To the extent
they want to offer securities products
and services beyond those related to
security-based swaps, they also will
need to be registered as broker-dealers.
Using an existing broker-dealer—
particularly an ANC broker-dealer that
already is capitalized and has risk
management systems and personnel in
place—could provide efficiencies that
create incentives to register the same
entity as a nonbank SBSD.
Under the proposed amendments to
Rule 15c3–1, ANC broker-dealers would
be required to maintain: (1) Tentative
net capital of not less than $5 billion;
and (2) net capital of not less than the
greater of $1 billion or the financial ratio
amount required pursuant to paragraph
(a)(1) of Rule 15c3–1 plus the 8%
margin factor.112 FOCUS Report data
indicates that the six current ANC
broker-dealers report capital levels in
excess of these proposed increased
minimum requirements. While raising
the tentative net capital requirement
under Rule 15c3–1 from $1 billion to $5
billion would be a significant increase,
the existing ‘‘early warning’’ notice
requirement for ANC broker-dealers is
$5 billion.113 This $5 billion ‘‘early
warning’’ threshold acts as a de facto
minimum tentative net capital
requirement since ANC broker-dealers
seek to maintain sufficient levels of
tentative net capital to avoid the
necessity of providing this regulatory
notice. Accordingly, the objective in
raising the minimum capital
requirements for ANC broker-dealers is
not to require the six existing ANC
broker-dealers to increase their current
capital levels (as they already maintain
tentative net capital in excess of $5
billion).114 Rather, the goal is to
establish new higher minimum
the Commission with information about the current
practices of the ANC broker-dealers.
111 This expectation is based on information
gathered as part of the ANC broker-dealer
supervision program.
112 See proposed amendments to paragraph
(a)(7)(i) of Rule 15c3–1.
113 See 17 CFR 240.15c3–1(a)(7)(i).
114 The ANC broker-dealers report to the
Commission staff, as part of the ANC broker-dealer
supervision program, levels of tentative net capital
that generally are well in excess of $6 billion,
which, as discussed below, is the proposed new
‘‘early warning’’ threshold for ANC broker-dealers.

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requirements designed to ensure that
the ANC broker-dealers continue to
maintain high capital levels and that
any new ANC broker-dealer entrants
maintain capital levels commensurate
with their peers.
As indicated above, the proposed
amendments to Rule 15c3–1 would
require an ANC broker-dealer to
incorporate the 8% margin factor into
its net capital calculation.115
Consequently, an ANC broker-dealer
would be required at all times to
maintain tentative net capital of not less
than $5 billion and net capital of not
less than the greater of $1 billion or the
sum of the ratio requirement under
paragraph (a)(1) of Rule 15c3–1 and
eight percent (8%) of the risk margin
amount for security-based swaps carried
by the ANC broker-dealer.116
Under the proposal, an ANC brokerdealer would be required to provide
early warning notification to the
Commission if its tentative net capital
fell below $6 billion.117 The purpose of
an ‘‘early warning’’ notice requirement
is to require a broker-dealer to provide
notice when its level of regulatory
capital falls to a level that approaches
its required minimum capital
requirement but is sufficiently above the
minimum that the Commission and
SROs can increase their monitoring of
the firm before the minimum is
breached. The proposed increase in the
minimum tentative net capital
requirement to $5 billion necessitates a
corresponding increase in the ‘‘early
warning’’ threshold to an amount above
$5 billion. Existing early warning
thresholds for OTC derivatives dealers
include a requirement to provide notice
when the firm’s tentative net capital
falls below an amount that is 120% of
the firm’s required minimum tentative
net capital amount.118 The proposed
new ‘‘early warning’’ threshold for ANC
broker-dealers of $6 billion in tentative
net capital is modeled on this
requirement and is equal in percentage
terms (120%) to the amount that the
early warning level exceeds the
minimum tentative net capital
115 See proposed amendments to paragraph
(a)(7)(i) of Rule 15c3–1. As discussed above in
section II.A.2.a.i. of this release, the 8% margin
factor is designed to adjust the firm’s minimum net
capital requirement in tandem with the risk
associated with the broker-dealer firm’s securitybased swap activity.
116 See proposed amendments to paragraph
(a)(7)(i) of Rule 15c3–1.
117 See proposed amendments to paragraph
(a)(7)(ii) of Rule 15c3–1. As noted above, the ANC
broker-dealers report to the Commission staff
tentative net capital levels that generally are well
in excess of $6 billion.
118 See 17 CFR 240.17a–11(c)(3).

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requirement for OTC derivatives
dealers.
The rules applicable to ANC brokerdealers provide that the Commission
may impose additional conditions on an
ANC broker-dealer under certain
circumstances.119 In particular,
paragraph (e) of Appendix E to Rule
15c3–1 establishes a non-exclusive list
of circumstances under which the
Commission may restrict the business of
an ANC broker-dealer, including when
the firm’s tentative net capital falls
below the early warning threshold.120 In
this event, the Commission—if it finds
it is necessary or appropriate in the
public interest or for the protection of
investors—may impose additional
conditions on the firm, including
requiring the firm to submit to the
Commission a plan to increase its
tentative net capital (to an amount
above the early warning level).121
Additional restrictions could include
restricting the ANC broker-dealer’s
business on a product-specific, categoryspecific, or general basis; requiring the
firm to file more frequent reports with
the Commission; modifying the firm’s
internal risk management controls or
procedures; requiring the firm to
compute deductions for market and
credit risk using standardized haircuts;
or imposing any other additional
conditions, if the Commission finds that
imposition of other conditions is
necessary or appropriate in the public
interest or for the protection of
investors.122
Request for Comment
The Commission generally requests
comment on the proposed minimum
capital requirements for ANC brokerdealers. Commenters are referred to the
general questions above in section
II.A.2.a.i. of this release about the 8%
margin factor as applied broadly to
nonbank SBSDs. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the proposed increased minimum
net capital requirement from $500
million to $1 billion for ANC brokerdealers appropriate? If not, explain why
not. What minimum amount would be
preferable? For example, should the
minimum fixed-dollar amount be
greater than $1 billion to account for the
large size of these firms and the scale of
their custodial activities? If so, explain
119 See

17 CFR 240.15c3–1e(e)(1).

120 Id.
121 Id. See also Alternative Net Capital
Requirements Adopting Release, 69 FR 34428.
122 See 17 CFR 240.15c3–1e(e).

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why. If it should be a greater amount,
how much greater should it be (e.g., $1.5
billion, $2 billion, $3 billion, or some
other amount)? Alternatively, should
the minimum fixed-dollar amount be
less than $1 billion? If so, explain why.
If it should be a lower amount, how
much lower (e.g., $950 million, $900
million, $850 million, $800 million,
$750 million, or some other amount)? If
a greater or lesser alternative amount is
recommended, explain why it would be
preferable.
2. Is the proposed increase in the
minimum tentative net capital level for
ANC broker-dealers appropriate? If not,
explain why not. For example, should
the minimum tentative net capital
amount be greater than $5 billion to
account for the use of internal models
and the large size of these firms and the
scale of their custodial activities? If it
should be a greater amount, how much
greater should it be (e.g., $6 billion, $8
billion, $10 billion, or some other
amount)? Should it be lesser amount
(e.g., $4 billion, $3 billion, $2 billion or
some other amount)? If a greater or
lesser alternative amount is
recommended, explain why it would be
preferable.
3. Is the proposed increase in the
early warning threshold from $5 billion
to $6 billion for ANC broker-dealers
appropriate? If not, explain why not. For
example, should the minimum tentative
net capital amount be greater than $6
billion, given that the current early
warning threshold ($5 billion) is five
times the current tentative net capital
requirement ($1 billion)? If the early
warning level should be a greater
amount, how much greater should it be
(e.g., $8 billion, $10 billion, $12 billion,
$20 billion, $25 billion, or some other
amount)? Should it be lesser amount
(e.g., $5.8 billion, 5.5 billion, or some
other amount)? If a greater or lesser
alternative amount is recommended,
explain why it would be preferable.
4. Is it appropriate to require brokerdealer SBSDs to become ANC brokerdealers in order to use internal models?
For example, would it be appropriate to
permit broker-dealer SBSDs to use
internal models but subject them to
lesser minimum capital requirements
than the ANC broker-dealers? If so,
explain why. In addition, provide
suggested alternative minimum capital
requirements.
5. Is combining the 8% margin factor
requirement with the applicable Rule
15c3–1 financial ratio requirement an
appropriate way to determine a
minimum net capital requirement for
ANC broker-dealers? If not, explain why
not.

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6. Would the 8% margin factor
provide an appropriate and workable
restraint on the amount of leverage
incurred by ANC broker-dealers? If not,
explain why not. Is there another
measure that would more accurately
and effectively address the leverage risk
of these firms? If so, identify the
measure and explain why it would be
more accurate and effective.
Additional Request for Comment on
VaR-Based Capital Charges
On June 7, 2012, the OCC, the FDIC,
and the Federal Reserve (collectively,
the ‘‘Banking Agencies’’) approved a
joint final rule (‘‘Final Rule’’) regarding
market risk capital rules.123 Certain
portions of the Final Rule relate to the
use of financial models for regulatory
capital purposes. Generally, the Banking
Agencies stated that the Final Rule is
designed to ‘‘better capture positions for
which the market risk capital rules are
appropriate; to reduce procyclicality;
enhance the rules’ sensitivity to risks
that are not adequately captured under
current methodologies; and increase
transparency through enhanced
disclosures.’’ The effective date for the
Final Rule is January 1, 2013.
Under the Final Rule, the capital
charge for market risk is the sum of: (1)
Its VaR-based capital requirement; (2) its
stressed VaR-based capital requirement;
(3) any specific risk add-ons; (4) any
incremental risk capital requirement; (5)
any comprehensive risk capital
requirement; and (6) any capital
requirement for de minimis exposures.
Generally, the qualitative and
quantitative requirements for the
Banking Agencies’ VaR-based capital
requirement are similar to the VaRbased capital requirements for ANC
broker-dealers, OTC derivatives dealers,
and, as proposed, for nonbank SBSDs
approved to use internal models.
The Banking Agencies’ stressed VaRbased capital requirement is a new
requirement that banks calculate a VaR
measure with model inputs calibrated to
reflect historical data from a continuous
12-month period that reflects a period of
significant financial stress appropriate
to the bank’s current portfolio. The
stressed VaR requirement is designed to
address concerns that the Banking
Agencies’ existing VaR-based measure,
due to inherent limitations, proved
inadequate in producing capital
requirements appropriate to the level of
losses incurred at many banks during
the financial crisis and to mitigate
123 Risk Based Capital Guidelines: Market Risk,
Federal Reserve, FDIC, OCC, 77 FR 53059 (Aug. 30,
2012).

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procyclicality in the existing market risk
capital requirement for banks.
The Final Rule also specifies
modeling standards for specific risk and
eliminates the current option for a bank
to model some but not all material
aspects of specific risk for an individual
portfolio of debt or equity positions. To
address concerns about the ability to
model specific risk of securitization
products, the Final Rule would require
a bank to calculate an additional capital
charge ‘‘add-on’’ for certain
securitization positions that are not
correlation trading positions.
Further, under the Final Rule, a bank
that measures the specific risk of a
portfolio of debt positions using internal
models is required to calculate an
incremental risk measure for those
positions using an internal model (an
incremental risk model). Generally,
incremental risk consists of the risk of
default and credit migration risk of a
position. Under the Final Rule, an
internal model used to calculate capital
charges for incremental risk must
measure incremental risk over a oneyear time horizon and at a one-tail,
99.9% confidence level, either under
the assumption of a constant level of
risk, or under the assumption of
constant positions.
A bank may measure all material
price risk of one or more portfolios of
correlation trading positions using a
comprehensive risk model. Among the
requirements for using a comprehensive
risk model is that the model measure
comprehensive risk consistent with a
one-year time horizon and at a one-tail,
99.9% confidence level, under the
assumption of either a constant level of
risk or constant positions.
The Commission seeks comment on
whether the Final Rule adopted by the
Banking Agencies for calculating market
risk capital requirements should be
required for ANC broker-dealers, OTC
derivatives dealers, and nonbank SBSDs
that have approval to use internal
models for regulatory capital purposes,
and, if so, which aspects of the
proposed rules of the Banking Agencies
would be appropriate in this context.
b. Computing Net Capital

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i. The Net Liquid Assets Test
The net liquid assets test embodied in
Rule 15c3–1 is being proposed as the
regulatory capital standard for all
nonbank SBSDs (i.e., stand-alone SBSDs
and broker-dealer SBSDs) because these
firms, as previously noted, are expected
to engage in a securities business with
respect to security-based swaps that is
similar to the dealer activities of brokerdealers and because some broker-dealers

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likely will be registered as nonbank
SBSDs. In addition, Rule 15c3–1
currently contains provisions designed
to address dealing in OTC derivatives by
broker-dealers.124 Furthermore, Rule
15c3–1 has been the capital standard for
broker-dealers since 1975 and,
generally, it has promoted the
maintenance of prudent levels of
capital. As discussed in section II.A.1.
of this release, the net liquid assets test
is designed to promote liquidity; the
rule allows a broker-dealer to engage in
activities that are part of conducting a
securities business (e.g., taking
securities into inventory) but in a
manner that places the firm in the
position of holding at all times more
than one dollar of highly liquid assets
for each dollar of unsubordinated
liabilities (e.g., money owed to
customers, counterparties, and
creditors). Consequently, under the
proposed rules, this standard—the net
liquid assets test—would be applied to
all categories of nonbank SBSDs. The
objective is to require the nonbank
SBSD to maintain sufficient liquidity so
that if it fails financially it can meet all
unsubordinated obligations to
customers and counterparties and have
adequate resources to wind-down in an
orderly manner without the need for a
formal proceeding.
The net liquid assets test is imposed
through the mechanics of how a brokerdealer is required to compute net capital
pursuant to Rule 15c3–1. These
requirements are set forth in paragraph
(c)(2) of Rule 15c3–1, which defines the
term ‘‘net capital.’’ 125 The first step is
to compute the broker-dealer’s net
worth under GAAP.126 Next, the brokerdealer must make certain adjustments to
its net worth to calculate net capital.127
These adjustments are designed to leave
the firm in a position where each dollar
of unsubordinated liabilities is matched
by more than a dollar of highly liquid
assets.128 There are thirteen categories
124 See

17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f.
17 CFR 240.15c3–1(c)(2).
126 See id. See also, e.g., Computation of Net
Capital on FOCUS Report Part II, available at
http://sec.gov/about/forms/formx-17a-5_2.pdf. Net
worth is to be computed in accordance with GAAP.
See Interpretation Rule 15c3–1(c)(2)/01 by the
Financial Industry Regulatory Authority (‘‘FINRA’’),
available at http://www.finra.org/web/groups/
industry/@ip/@reg/@rules/documents/
interpretationsfor/p037763.pdf.
127 See 17 CFR 240.15c3–1(c)(2).
128 See, e.g., Net Capital Requirements for Brokers
and Dealers, 54 FR at 315 (‘‘The [net capital] rule’s
design is that broker-dealers maintain liquid assets
in sufficient amounts to enable them to satisfy
promptly their liabilities. The rule accomplishes
this by requiring broker-dealers to maintain liquid
assets in excess of their liabilities to protect against
potential market and credit risks.’’) (footnote
omitted).
125 See

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of net worth adjustments required by
the rule.129 The most significant
adjustments are briefly discussed below.
The first adjustment permits the
broker-dealer to add back to net worth
liabilities that are subordinated to all
other creditors pursuant to a loan
agreement that meets requirements set
forth in Appendix D to the net capital
rule.130 Appendix D prescribes a
number of requirements for a loan to
qualify for the ‘‘add-back’’ treatment.131
For example, the loan agreement must
provide that the broker-dealer cannot repay the loan at term if doing so would
reduce its net capital to certain levels
above the minimum requirement.132
The second adjustment to net worth is
that the broker-dealer must add
unrealized gains and deduct unrealized
losses in the firm’s accounts, mark-tomarket all long and short positions in
listed options, securities, and
commodities as well as add back certain
deferred tax liabilities.133
The third adjustment is that the
broker-dealer must deduct from net
worth any asset that is not readily
convertible into cash.134 This means the
broker-dealer must deduct the following
types of assets (among others): real
estate; furniture and fixtures; exchange
memberships; prepaid rent, insurance
and other expenses; goodwill; and most
unsecured receivables.135 An additional
adjustment is that the broker-dealer
must deduct 100% of the carrying value
of securities for which there is no
‘‘ready market’’ or which cannot be
publicly offered or sold because of
statutory, regulatory, or contractual
arrangements or other restrictions.136
129 See

17 CFR 240.15c3–1(c)(2)(i)–(xiii).
17 CFR 240.15c3–1(c)(2)(ii); 17 CFR
240.15c3–1d.
131 See 17 CFR 240.15c3–1d(b).
132 See 17 CFR 240.15c3–1d(b)(8). The restriction
on repayment, if triggered, makes the subordinated
loan take on the characteristics of permanent capital
in that the loan cannot be repaid until such time
as the conditions preventing repayment no longer
exist. Other requirements for the subordinated loan
include that the agreement shall: (1) Have a term
of at least one year; (2) effectively subordinate any
right of the lender to receive any payment (a
defined term) with respect thereto, together with
accrued interest or compensation, to the prior
payment or provision for payment in full of all
claims of all present and future creditors of the
broker-dealer arising out of any matter occurring
prior to the date on which the related payment
obligation (a defined term) matures; and (3) provide
that the cash proceeds thereof shall be used and
dealt with by the broker-dealer as part of its capital
and shall be subject to the risks of the brokerdealer’s business. 17 CFR 240.15c3–1d(b)(1), (3),
and (4).
133 See 17 CFR 240.15c3–1(c)(2)(i).
134 See 17 CFR 240.15c3–1(c)(2)(iv).
135 Id.
136 See 17 CFR 240.15c3–1(c)(2)(vii). Rule 15c3–
1 defines ready market to include a recognized
established securities market in which there exists
130 See

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After making these and other
adjustments and taking charges required
under Appendix B to Rule 15c3–1,137
the broker-dealer is left with an amount
of adjusted net worth that is defined in
the rule as ‘‘tentative net capital.’’ 138
As discussed in more detail below,
the final step in the process of
computing net capital is to take
deductions from tentative net capital to
account for the market risk inherent in
the proprietary positions of the brokerdealer and to create a buffer of extra
liquidity to protect against other risks
associated with the securities
business.139 Most broker-dealers use the
standardized haircuts prescribed in Rule
15c3–1 to determine the amount of the
deductions they must take from
tentative net capital. ANC brokerdealers and OTC derivatives dealers
may use internal VaR models to
determine the amount of the deductions
for positions for which they have been
approved to use VaR models.140 For all
other types of positions, they must use
standardized haircuts. The standardized
haircuts prescribe deductions in
amounts that are based on the type of
security or money market instrument
independent bona fide offers to buy and sell so that
a price reasonably related to the last sales price or
current bona fide competitive bid and offer
quotations can be determined for a particular
security almost instantaneously and where payment
will be received in settlement of a sale at such price
within a relatively short time conforming to trade
custom. See 17 CFR 240.15c3–1(c)(11). The rule
also provides that a ready market will be deemed
to exist where the securities have been accepted as
collateral for a loan by a bank as defined in section
3(a)(6) of the Exchange Act and where the brokerdealer demonstrates to its designated examining
authority that such securities adequately secure
such loans. Id. The rule further provides that
indebtedness will be deemed to be adequately
secured when the excess of the market value of the
collateral over the amount of the indebtedness is
sufficient to make the loan acceptable as a fully
secured loan to banks regularly making secured
loans to broker-dealers. See 17 CFR 240.15c3–
1(c)(5).
137 17 CFR 240.15c3–1b.
138 See 17 CFR 240.15c3–1(c)(15). Tentative net
capital—net worth after the adjustments—is the
amount by which highly liquid assets plus
subordinated debt of the broker-dealer exceeds total
liabilities. See 17 CFR 240.15c3–1(c)(15). Hence, the
adjustments to net worth required by Rule 15c3–1
impose the net liquid assets test.
139 See, e.g., Uniform Net Capital Rule, 42 FR
31778 (‘‘[Haircuts] are intended to enable net
capital computations to reflect the market risk
inherent in the positioning of the particular types
of securities enumerated in [the rule]’’); Net Capital
Rule, 50 FR 42961 (‘‘These percentage deductions,
or ‘haircuts’, take into account elements of market
and credit risk that the broker-dealer is exposed to
when holding a particular position.’’); Net Capital
Rule, 62 FR 67996 (‘‘Reducing the value of
securities owned by broker-dealers for net capital
purposes provides a capital cushion against adverse
market movements and other risks faced by the
firms, including liquidity and operational risks.’’)
(footnote omitted).
140 See 17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f.

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and, in the case of certain debt
instruments, the time-to-maturity of the
bond.141 Under the VaR model
approach, the amount of the deductions
is based on an estimate of the maximum
potential loss the portfolio of securities
would be expected to incur over a fixed
time period at a certain probability
level.
In order to comply with the proposed
net liquid assets test capital standard for
nonbank SBSDs, broker-dealer SBSDs
would be required to comply with the
existing provisions of Rule 15c3–1 and
proposed amendments to the rule
designed to account for security-based
swap activities. Consequently, a brokerdealer SBSD would compute its net
capital pursuant to the provisions
described above. Stand-alone SBSDs
would be subject to the net liquid assets
test capital standard through application
of proposed new Rule 18a–1.142 The
mechanics of computing net capital in
Rule 18a–1 would be the same as the
existing mechanics for computing net
capital in Rule 15c3–1.143
ii. Standardized Haircuts for SecurityBased Swaps
As discussed above, Rule 15c3–1
provides two alternative approaches for
taking the deductions to tentative net
capital to compute net capital:
standardized haircuts and internal VaR
models.144 ANC broker-dealers and OTC
derivatives dealers are permitted to use
internal VaR models to take deductions
for types of positions for which they
have been approved to use the models.
For all other types of positions, they
must use the standardized haircuts.
Broker-dealers that are not ANC brokerdealers or OTC derivatives dealers must
use the standardized haircuts for all
positions. The same approach is being
proposed for nonbank SBSDs.145 Under
this proposal, a nonbank SBSD would
be required to apply standardized
haircuts to its proprietary positions
unless the Commission approves the
firm to use internal models for those
positions.
Nonbank SBSDs would be required to
apply the standardized haircuts
currently set forth in Rule 15c3–1 for
securities positions for which they have
not been approved to use internal
models.146 The standardized haircuts in
141 See

17 CFR 240.15c3–1(c)(2)(vi).
proposed new Rule 18a–1.
143 Compare 17 CFR 240.15c3–1(c)(2), with
paragraph (c)(1) of proposed new Rule 18a–1.
144 See 17 CFR 240.15c3–1(a)(5), (a)(7), and
(c)(2)(vi). See also 17 CFR 240.15c3–1e; 17 CFR
240.15c3–1f.
145 See section II.A.1. of this release.
146 See 17 CFR 240.15c3–1(c)(2)(vi); paragraph
(c)(1)(vi) of proposed new Rule 18a–1. As proposed,
142 See

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Rule 15c3–1 prescribe differing
deduction amounts for a variety of
classes of securities, including, for
example: securities guaranteed as to
principal or interest by the government
of the United States (‘‘U.S. government
securities’’); 147 certain municipal
securities; 148 Canadian debt
obligations; 149 certain types of mutual
funds; 150 certain types of commercial
paper, bankers acceptances, and
certificates of deposit; 151 certain
nonconvertible debt securities; 152
certain convertible debt securities; 153
paragraph (c)(1)(vi) of proposed new Rule 18a–1
would incorporate by reference the standardized
haircuts in paragraph (c)(2)(vi) of Rule 15c3–1
rather than repeat them in the rule text.
147 See 17 CFR 240.15c3–1(c)(2)(vi)(A).
148 See 17 CFR 240.15c3–1(c)(2)(vi)(B). To qualify
for the deductions under this paragraph, the
municipal security cannot be traded flat or in
default as to principal or interest (a bond is traded
flat if it is sold or traded without accrued interest).
Id. A municipal security that does not meet this
condition would be subject to the deductions
prescribed in the catchall provisions discussed
below in the paragraph accompanying this footnote
or the 100% deduction to net worth for securities
that do not have a ready market discussed above in
section II.A.2.b.i. of this release. See 17 CFR
240.15c3–1(c)(2)(iv), (c)(2)(vi)(J), and (c)(2)(vi)(K).
149 See 17 CFR 240.15c3–1(c)(2)(vi)(C).
150 See 17 CFR 240.15c3–1(c)(2)(vi)(D).
151 See 17 CFR 240.15c3–1(c)(2)(vi)(E). To qualify
for the deductions under this paragraph, the
instrument must have a fixed rate of interest or be
sold at a discount and be rated in one of the three
highest categories by at least two nationally
recognized statistical rating organizations
(‘‘NRSROs’’). Id. If the instrument does not meet
these conditions, it is subject to the deductions
prescribed in the catchall provisions discussed
below in the paragraph accompanying this footnote
or the 100% deduction to net worth for securities
that do not have a ready market discussed above in
section II.A.2.b.i. of this release. See 17 CFR
240.15c3–1(c)(2)(iv), (c)(2)(vi)(J), and (c)(2)(vi)(K).
Pursuant to section 939A of the Dodd-Frank Act,
the Commission has proposed substituting the
NRSRO-rating requirement in this provision and
other provisions of Rule 15c3–1 with a different
standard of creditworthiness. See Public Law 111–
203 § 939A and Removal of Certain References to
Credit Ratings Under the Securities Exchange Act
of 1934, Exchange Act Release No. 64352 (Apr. 27,
2011), 76 FR 26550 (May 6, 2011) (‘‘Reference
Removal Release’’).
152 See 17 CFR 240.15c3–1(c)(2)(vi)(F). To qualify
for the deductions under this paragraph, a
nonconvertible debt security must have a fixed
interest rate and a fixed maturity date, not be traded
flat or in default as to principal or interest, and be
rated in one of the four highest rating categories by
at least two NRSROs. Id. If the nonconvertible debt
security does not meet these conditions it is subject
to the deductions prescribed in the catchall
provisions discussed below in the paragraph
accompanying this footnote or the 100% deduction
to net worth for securities that do not have a ready
market discussed above in section II.A.2.b.i. of this
release. See 17 CFR 240.15c3–1(c)(2)(iv),
(c)(2)(vi)(J), and (c)(2)(vi)(K). Pursuant to section
939A of the Dodd-Frank Act, the Commission has
proposed substituting the NRSRO-rating
requirement in this provision with a different
standard of creditworthiness. See Public Law 111–
203 § 939A; Reference Removal Release, 76 FR
26550.
153 See 17 CFR 240.15c3–1(c)(2)(vi)(G).

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certain cumulative, nonconvertible
preferred stock; 154 and certain
options.155 The rule also contains
catchall provisions to account for
securities that are not included in these
specific classes of securities.156
Generally, the catchall provisions
impose higher deductions than the
deductions in the specifically identified
classes of securities.157 Further, as
discussed above in section II.A.2.b.i. of
this release, if a security does not have
a ‘‘ready market,’’ it is subject to the
100% deduction from net worth.158
Security-based swaps currently are
not an identified class of securities in
Rule 15c3–1.159 The proposed
amendments to Rule 15c3–1 and
proposed new Rule 18a–1 would
establish standardized deductions for
security-based swaps that would apply
to broker-dealers registered as nonbank
SBSDs and broker-dealers that are not
registered as SBSDs (in the case of Rule
15c3–1), and to stand-alone SBSDs (in
the case of Rule 18a–1).160 Some brokerdealers may engage in a de minimis
amount of security-based swap activity,
which would allow them to take
advantage of an exemption from the
definition of ‘‘security-based swap
dealer’’ and not require them to register
as SBSDs.161 Rule 15c3–1 currently
requires broker-dealers to take haircuts
on their proprietary security-based swap
positions as they must for all
154 See 17 CFR 240.15c3–1(c)(2)(vi)(H). To qualify
for the deductions under this paragraph, a
nonconvertible preferred stock must rank prior to
all other classes of stock of the same issuer, be rated
in one of the four highest rating categories by at
least two NRSROs, and not be in arrears as to
dividends. Id. If the nonconvertible preferred stock
does not meet these conditions, it is subject to the
deductions prescribed in the catchall provisions
discussed below in the paragraph accompanying
this footnote or the 100% deduction to net worth
for securities that do not have a ready market
discussed above. See 17 CFR 240.15c3–1(c)(2)(iv),
(c)(2)(vi)(J), and (c)(2)(vi)(K). Pursuant to section
939A of the Dodd-Frank Act, the Commission has
proposed substituting the NRSRO-rating
requirement in this provision with a different
standard of creditworthiness. See Public Law 111–
203 § 939A; Reference Removal Release, 76 FR
26550.
155 See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR
240.15c3–1a.
156 See 17 CFR 240.15c3–1(c)(2)(vi)(J)–(K).
157 Compare 17 CFR 240.15c3–1(c)(2)(vi)(A)–(H),
with 17 CFR 240.15c3–1(c)(2)(vi)(J)–(K).
158 See 17 CFR 240.15c3–1(c)(2)(vii).
159 See 17 CFR 240.15c3–1(c)(2)(vi).
160 See proposed new paragraph (c)(2)(vi)(O) of
Rule 15c3–1; paragraph (c)(1)(vi) of proposed new
Rule 18a–1.
161 See section 3(a)(71) of the Exchange Act (15
U.S.C. 78c(a)(71)) (defining the term security-based
swap dealer); Entity Definitions Adopting Release,
77 FR 30596; Registration of Security-Based Swap
Dealers and Major Security-Based Swap
Participants, Exchange Act Release No. 65543 (Oct.
12, 2011), 76 FR 65784 (Oct. 24, 2011) (‘‘SBSD
Registration Proposing Release’’).

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proprietary positions. Because there are
no specific standardized haircuts for
security-based swaps, a broker-dealer
currently is required to apply a
deduction based on the existing
provisions (e.g., the catchall provisions).
For certain types of OTC derivatives, the
deduction is the notional amount of the
derivative multiplied by the deduction
that would apply to the underlying
instrument referenced by the
derivative.162
The proposals would establish two
separate sets of standardized haircuts
for security-based swaps: one applicable
to security-based swaps that are credit
default swaps and one applicable to
other security-based swaps.163
Credit Default Swaps
The proposed standardized haircuts
for cleared and uncleared security-based
swaps that are credit default swaps
(‘‘CDS security-based swaps’’) are
designed to account for the unique
attributes of these positions.164 A CDS
security-based swap is an instrument in
which the ‘‘protection buyer’’ makes a
series of payments to the ‘‘protection
seller’’ and, in return, the ‘‘protection
seller’’ is obligated to make a payment
to the ‘‘protection buyer’’ if a credit
event occurs with respect to one or more
entities referenced in the contract or
with respect to certain types of
obligations of the entity or entities
referenced in the contract.165 The credit
events that can trigger a payment
obligation of the protection seller on a
CDS security-based swap referencing a
corporate entity typically include the
bankruptcy of the entity or entities
referenced in the contract and the nonpayment of interest and/or principal on
one or more of specified type(s) of
obligations issued by the entity or
entities referenced in the contract.166 In
the case of a CDS security-based swap
that references an asset-backed security,
the credit events may include a
162 See Net Capital Rule, Exchange Act Release
No. 32256 (May 6, 1993), 58 FR 27486, 27490 (May
10, 1993).
163 See proposed new paragraph (c)(2)(vi)(O) of
Rule 15c3–1; paragraph (c)(1)(vi) of proposed new
Rule 18a–1.
164 See section 3(a)(68) of the Exchange Act (15
U.S.C. 78c(a)(68)) (defining the term security-based
swap) and Product Definitions Adopting Release, 77
FR 48207 (Joint Commission and CFTC release
adopting interpretative guidance and rules to,
among other things, further define the types of
credit default swaps that would meet the definition
of security-based swap).
165 See Product Definitions Adopting Release, 77
FR 48207. See also The Credit Default Swap
Market—Report, IOSCO FR05/12 (June 2012)
available at http://www.iosco.org/library/pubdocs/
pdf/IOSCOPD385.pdf.
166 See Product Definitions Adopting Release, 77
FR at 48267.

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principal write-down, a failure to pay
interest, and an interest shortfall.167
CDS security-based swaps referencing
both asset-backed securities and
corporate entities can include other
standardized and customized credit
events.
In addition to the entity or assetbacked security to which they reference,
CDS security-based swaps are defined
by the amount of protection purchased
(the notional amount) and the tenor of
the contract (e.g., 1, 3, 5, 7, or 10 years).
For example, a protection buyer can
enter into a credit default swap
referencing XYZ Company with a
notional amount of $10 million and a
tenor of five years. If XYZ Company
suffers a credit event (as defined in the
contract) during the five-year period
before the contract expires, the
protection seller must pay the
protection buyer $10 million less the
then-current market value of $10
million of obligations issued or
guaranteed by XYZ Company.168 To
receive this protection, the protection
buyer must pay the protection seller
periodic (typically quarterly) payments
over the five-year term of the contract
and possibly an additional upfront
amount. The cumulative amount of
annual payments can be expressed as a
‘‘spread’’ in basis points.169 The spread
at which a CDS security-based swap
trades is based on the market’s
estimation of the risk that XYZ
Company will suffer a credit event (as
defined in the contract) that triggers the
credit seller’s payment obligation as
167 Id.

at 48267, note 682.
most CDS security-based swaps
currently use a standardized ‘‘Auction Settlement’’
mechanism to determine the amount of payment
due from a protection seller to the protection buyer
after the occurrence of a credit event, in some
contracts the protection buyer is required to deliver
obligations issued or guaranteed by the entity
referenced in the contract to the protection seller.
The protection seller can use the value of those
obligations to offset the payment to the protection
buyer.
169 Most CDS security-based swaps currently
trade with contractually standardized fixed rates
(100 basis points or 500 basis points for standard
North American corporate CDS security-based
swaps). Buyers and sellers of protection agree on
upfront payments to adjust the value of the contract
from the contractual fixed rate to the rate which
reflects the credit risks perceived by the market. For
example, if the market spread for a one-year CDS
security-based swap on XYZ Company is 200 basis
points per annum and the notional amount is $10
million, a CDS security-based swap with a
standardized 100-basis points fixed rate would have
quarterly payments of $25,000 (for $100,000 in
annual payments) and an upfront payment of
approximately $100,000. See http://
www.cdsmodel.com/cdsmodel/ for documentation
on the standard model to convert an upfront
payment on a CDS security-based swap to a spread
(or vice-versa) and https://www.theice.com/cds/
Calculator.shtml for an implementation of the
standard model.
168 While

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well as the market’s assessment of the
size of that payment. The greater the
estimated risk that a credit event will
occur (or the greater the expected
payment contingent upon a credit event
occurring), the higher the spread (i.e.,
the cost of buying the protection).
The proposed standardized haircuts
for CDS security-based swaps would be
based on a ‘‘maturity grid’’ approach.170
Rule 15c3–1 currently uses maturity
grids to prescribe standardized haircuts
for various classes of debt
instruments.171 The grids impose a
sliding scale of haircuts with the largest
deductions applying to bonds with the
longest period of time-to-maturity.172
The grids also permit broker-dealers to
completely or partially net long and
short positions in these classes of debt
instruments when the maturities of long
and short positions are in the same
category, subcategory, or, in some cases,
between certain adjacent categories.173
The permitted netting allows the broker170 See proposed new paragraph (c)(2)(vi)(O)(1) of
Rule 15c3–1; paragraph (c)(1)(vi)(A) of proposed
new Rule 18a–1.
171 See 17 CFR 240.15c3–1(c)(2)(vi)(A), (B), (C),
(E), and (G). See also FINRA Rule 4240 (which
prescribes margin requirements for CDS securitybased swaps and includes a maturity-grid
approach), available in the FINRA Manual at http://
www.finra.org; Notice of Filing and Order Granting
Accelerated Approval of Proposed Rule Change, as
Modified by Amendment No. 1, to Implement an
Interim Pilot Program with Respect to Margin
Requirements for Certain Transactions in Credit
Default Swaps, Exchange Act Release No. 59955
(May 22, 2009), 74 FR 25586 (May 28, 2009) (File
No. SR–FINRA 2009–012); Notice of Filing and
Order Granting Accelerated Approval of Proposed
Rule Change to Extend the Implementation of
FINRA Rule 4240 (Margin Requirements for Credit
Default Swaps), Exchange Act Release No. 66528
(Mar. 7, 2012) (File No. SR–FINRA–2012–014)
(extending interim pilot program until July 17,
2012); Notice of Filing and Immediate Effectiveness
of Proposed Rule Change to Extend the
Implementation of FINRA Rule 4240 (Margin
Requirements for Credit Default Swaps), Exchange
Act Release No. 67449 (July 17, 2012) (extending
interim pilot program until July 17, 2013).
172 Id. For example, the grid for certain
nonconvertible debt securities has nine maturity
categories (this class of debt instrument includes
corporate debt and asset-backed securities). See 17
CFR 240.15c3–1(c)(2)(vi)(F)(1). Each category
prescribes a different deduction and the amounts of
the deductions increase as the maturity increases.
Id. The following table shows the maturity
categories and corresponding deductions for these
securities:
Time to Maturity and Deduction
Less than 1 year—2.0%
1 year but less than 2 years—3.0%
2 years but less than 3 years—5.0%
3 years but less than 5 years—6.0%
5 years but less than 10 years—7.0%
10 years but less than 15 years—7.5%
15 years but less than 20 years—8.0%
20 years but less than 25 years—8.5%
25 years or more—9%
173 See 17 CFR 240.15c3–1(c)(2)(vi)(A), (B), (C),
(E), and (G).

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dealer to reduce its required
deductions.174
The proposed grid for CDS securitybased swaps would prescribe the
applicable deduction based on two
variables: the length of time to maturity
of the CDS security-based swap contract
and the amount of the current offered
basis point spread on the CDS securitybased swap.175 As discussed above, the
maturity grids for debt instruments in
Rule 15c3–1 require increased capital
charges as maturity increases. Similarly,
the vertical axis of the proposed grid for
CDS security-based swaps (presented in
the first column of the grid) would
contain nine maturity categories ranging
from 12 months or less (the smallest
deduction) to 121 months and longer
(the largest deduction).176 The
horizontal axis in the proposed maturity
grid (presented in the top row of the
grid) would contain six spread
categories ranging from 100 basis points
or less (the smallest deduction) to 700
basis points and above (the largest
deduction).177 Similar to the current
‘‘haircut’’ grids under Rule 15c3–1, the
proposed grid for CDS security-based
swaps is designed to be risk sensitive by
specifying a range of maturity and
spread buckets.
The number of maturity and spread
categories in the proposed grid for CDS
security-based swaps is based on
Commission staff experience with the
maturity grids for other securities in
Rule 15c3–1 and, in part, on FINRA
Rule 4240.178 While FINRA Rule 4240 is
one reference point, the maturity grid it
specifies does not appear to have been
widely used by market participants, in
part because a significant amount of
business in the current CDS securitybased swap market is conducted by
entities that are not members of
174 Netting would be permitted under the
proposed rule for cleared and non-cleared CDS
because the CDS will have the same underlying
reference obligation and similar time to maturity
and spread factors.
175 See proposed new paragraph (c)(2)(vi)(O)(1)(i)
of Rule 15c3–1; paragraph (c)(1)(vi)(A)(1) of
proposed new Rule 18a–1. The current offered
spread would be the spread on the CDS securitybased swap offered by the market at the time of the
net capital computation and not the spread
specified under the terms of the contract.
176 See proposed new paragraph (c)(2)(vi)(O)(1)(i)
of Rule 15c3–1; paragraph (c)(1)(vi)(A)(1) of
proposed new Rule 18a–1.
177 Id.
178 See Notice of Filing and Order Granting
Accelerated Approval of Proposed Rule Change to
Amend FINRA Rule 4240 (Margin Requirements for
Credit Default Swaps), Exchange Act Release No.
66527 (Mar. 7, 2012) (File No. SR–FINRA–2012–
015) (in which FINRA amended the maturity grid
in Rule 4240 in the interest of regulatory clarity and
efficiency, and based upon FINRA’s experience in
the administration of the rule).

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FINRA.179 Accordingly, the proposed
grid draws largely on Commission staff
experience and reasoned judgments
about the appropriate specifications,
and, as detailed below, the Commission
requests comment and empirical data as
to whether these specifications or others
appropriately reflect the unique
attributes of CDS security-based swaps.
The horizontal ‘‘spread’’ axis is
designed to address the specific credit
risk associated with the obligor or
obligation referenced in the contract. As
noted above, the spread increases as the
protection seller’s estimation of the
likelihood of a credit event occurring
increases. Therefore, the net capital
deduction—which is designed to
address the risk inherent in the
instrument—should increase as the
spread increases. Combining the two
components (maturity and spread) in
the grid results in the smallest
deduction (1% of notional) required for
a short CDS security-based swap with a
maturity of 12 months or less and a
spread of 100 basis points or below and
the largest deduction (50% of notional)
required for a short CDS security-based
swap with a maturity of 121 months or
longer and a spread of 700 basis points
or more. The deduction for an unhedged short position in a CDS securitybased swap (i.e., when the nonbank
SBSD is the seller of protection) would
be the applicable percentage specified
in the grid. The deduction for an unhedged long position in a CDS securitybased swap (i.e., when the nonbank
SBSD is the buyer of protection) would
be 50% of the applicable deduction in
the grid.180
The proposed deduction requirements
for CDS security-based swaps would
permit a nonbank SBSD to net long and
short positions where the credit default
swaps reference the same entity (in the
case of CDS securities-based swaps
referencing a corporate entity) or
179 Broker-dealers historically have not
participated in a significant way in security-based
swap trading, in part, because the Exchange Act has
not previously defined security-based swaps as
‘‘securities’’ and, therefore, they have not been
required to be traded through registered brokerdealers. Existing broker-dealer capital requirements,
however, make it relatively costly to conduct these
activities in broker-dealers, as discussed in section
II.A.2. of this release. As a result, security-based
swap activities, including CDS transactions,
currently are generally concentrated in entities that
are affiliated with the parent companies of brokerdealers, but not in broker-dealers themselves.
180 See proposed new paragraph (c)(2)(vi)(O)(1)(ii)
of Rule 15c3–1; paragraph (c)(1)(vi)(A)(2) of
proposed new Rule 18a–1. The approach of taking
100% of the applicable deduction for short
positions in CDS security-based swaps and 50% for
long positions in CDS security-based swaps is
consistent with FINRA Rule 4240 and is designed
to account for the greater risk inherent in short CDS
security-based swaps.

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obligation (in the case of CDS securitiesbased swaps referencing an asset-backed
security), reference the same credit
events that would trigger payment by
the seller of protection, reference the
same basket of obligations that would
determine the amount of payment by
the seller of protection upon the
occurrence of a credit event, and are in
the same or adjacent maturity and
spread categories (as long as the long
and short positions each have maturities
within three months of the other
maturity category).181 In this case, the
nonbank SBSD would need to take the
specified percentage deduction only on
the notional amount of the excess long
or short position.182
A reduced deduction also could be
taken for long and short CDS securitybased swap positions in the same
maturity and spread categories and that
reference corporate entities in the same
industry sector.183 In this case, the
market risk of the offsetting positions is
mitigated to the extent that
macroeconomic factors similarly impact
companies in a particular industry
sector, because corporate entities in the
same industry sector would likely be
similarly impacted by market events
affecting that specific industry. The
proposed rule would not identify a
specific source for determining industry
sector classifications in order to provide
firms flexibility and to avoid requiring
firms to rely on a specific commercial
entity to comply with the rule. Instead,
a nonbank SBSD would need to use an
industry sector classification system
that is reasonable in terms of grouping
types of companies with similar
business activities and risk
characteristics, and document the
industry sector classification system
used for the purposes of the rule.184 A
181 See proposed new paragraph
(c)(2)(vi)(O)(1)(iii)(A) of Rule 15c3–1; paragraph
(c)(1)(vi)(A)(3)(i) of proposed new Rule 18a–1.
182 Id. For example, assume the nonbank SBSD is
short protection on $10 million in notional CDS
security-based swaps on XYZ Company with a 4.25year (51-month) maturity that trades at a 290 basis
point spread and long protection on $8 million in
notional CDS security-based swaps on XYZ
Company with a 5.25-year (63-month) maturity that
trades at a 310 basis point spread. Rather than take
the deductions on the short protection $10 million
position and the long protection $8 million position
individually, the nonbank SBSD would take a
deduction on the excess short position of $2 million
($10 million short protection position minus the $8
million long protection position) of 5-year maturity
CDS security-based swaps trading at a 290 basis
point spread.
183 Id.
184 See proposed new paragraph
(c)(2)(vi)(O)(1)(iii)(A) of Rule 15c3–1; paragraph
(c)(1)(vi)(A)(3)(i) of proposed new Rule 18a–1. An
example of an industry sector classification system
is: consumer discretionary, consumer staples,
energy, financials, health care, industrials,

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nonbank SBSD could use a third-party’s
classification system or develop its own
classification system, subject to these
limitations. The nonbank SBSD would
need to be able to demonstrate the
reasonableness of the system it uses.
Reduced deductions also would apply
for strategies where the firm is long
(short) a bond or asset-backed security
and long (short) protection through a
CDS security-based swap referencing
the same underlying bond or assetbacked security. In the case where the
nonbank SBSD is long a bond or an
asset-backed security and long
protection through a credit default
swap, the nonbank SBSD would be
required to take 50% of the deduction
required on the bond (i.e., no deduction
would be required with respect to the
CDS security-based swap and a lesser
deduction would apply to the bond than
would be the case if it were not paired
with a CDS security-based swap).185 In
other words, the deduction the nonbank
SBSD would take if it held the bond in
isolation would be reduced by one-half
to account for the protection provided
by the CDS security-based swap
referencing the bond. This reduced
deduction for the long bond position
reflects the risk-reducing effects of the
protection provided by the long CDS
security-based swap position. If the
nonbank SBSD is short a bond or assetbacked security and short protection
through a credit default swap, the
nonbank SBSD would be required to
take the deduction required on the bond
or asset-backed security (i.e., no
deduction would be required with
respect to the CDS security-based
swap).186
Non-Credit Default Swaps
Security-based swaps that are not
credit default swaps (each, a ‘‘non-CDS
security-based swap’’) can be divided
into two broad categories: those that
reference equity securities and those
that reference debt instruments.187 Total
information technology, materials,
telecommunication services, and utilities. See the
Global Industry Classification Standard developed
by MSCI and Standard & Poor’s, available at
http://www.msci.com/resources/pdfs/MK-GICS-DIR3-02.pdf. Another example of an industry sector
classification system is: basic materials, cyclical
consumer, energy, financials, healthcare,
industrials, non-cyclical consumer, technology,
telecommunications, and utilities. See Thompson
Reuters’ business classifications, available at
http://thomsonreuters.com/products_services/
financial/thomson_reuters_indices/trbc/sectors/.
185 See proposed new paragraph
(c)(2)(vi)(O)(1)(iii)(B) of Rule 15c3–1; paragraph
(c)(1)(vi)(A)(3)(ii) of proposed new Rule 18a–1.
186 See proposed new paragraph
(c)(2)(vi)(O)(1)(iii)(C) of Rule 15c3–1; paragraph
(c)(1)(vi)(A)(3)(iii) of proposed new Rule 18a–1.
187 See Product Definitions Adopting Release, 77
FR at 48207.

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return swaps are an example of a nonCDS security-based swap. A total return
swap is an instrument that requires one
of the counterparties (the seller) to make
a payment to the other counterparty (the
buyer) that is based on the price
appreciation of, and income from, the
underlying security referenced by the
security-based swap.188 The buyer in
return makes a payment that is based on
a variable interest rate plus any
depreciation of the underlying security
referenced by the security-based
swap.189 The ‘‘total return’’ consists of
the price appreciation or depreciation
plus any interest or income.190
The proposed standardized haircut for
a non-CDS security-based swap would
be the deduction currently prescribed in
Rule 15c3–1 applicable to the
instrument referenced by the securitybased swap multiplied by the contract’s
notional amount.191 For example, the
standardized haircut for an exchange
traded equity security typically is
15%.192 Consequently, under the
proposal, the standardized haircut for a
non-CDS security-based swap
referencing an exchange traded equity
security would be a deduction equal to
the notional amount of the securitybased swap multiplied by 15%.193 The
same approach would apply to a nonCDS security-based swap referencing a
debt instrument. For example, Rule
15c3–1 prescribes a 7% standardized
haircut for a corporate bond that has a
maturity of five years and is not traded
flat or in default as to principal or
interest and is rated in one of the four
highest rating categories by at least two
NRSROs.194 Under the proposal, a nonCDS security-based swap referencing
such a bond would require a deduction
equal to the contract’s notional amount
multiplied by 7%.195 Linking the
188 See

id. at 48264.

189 Id.
190 Id. The total return swap is designed to put
the buyer in the position of having exposure to the
reference security without actually owning it. Thus,
the seller pays the buyer appreciation (i.e., gains)
and any interest or income on the security and the
buyer pays the seller any depreciation (i.e., loss) on
the reference security plus a variable interest rate.
191 See proposed new paragraph (c)(2)(vi)(O)(2) of
Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed
new Rule 18a–1.
192 See 17 CFR 240.15c3–1(c)(2)(vi)(J).
193 If the notional amount was $5 million, the
standardized haircut would be $750,000 ($5 million
× 0.15 = $750,000). The approach of multiplying the
notional amount by the percentage deduction
applicable to the reference security is consistent
with the CFTC’s proposed capital charges of equity
swaps for nonbank swap dealers that are not using
models and are FCMs. See CFTC Capital Proposing
Release, 76 FR at 27812–27813.
194 See 17 CFR 240.15c3–1(c)(2)(vi)(F)(1)(v).
195 If the notional amount was $5 million, the
standardized haircut would be $350,000 ($5 million
× 0.07 = $350,000).

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
standardized deduction for the non-CDS
security-based swap to the standardized
deduction that would apply to the
instrument referenced by the securitybased swap is based on the rationale
that changes in the market value of the
instrument underlying the securitybased swap will result in corresponding
changes to the market value of the
security-based swap. The proposal also
is consistent with the treatment of
equity security-based swaps under Rule
15c3–1.196 Moreover, the potential
volatility of the changes in the non-CDS
security-based swap is expected to be
similar to the potential volatility in the
instrument underlying the securitybased swap. For example, as discussed
above, the standardized haircut for an
exchange traded equity security is
15%,197 whereas the standardized
haircut is 7% for a corporate bond that
has a maturity of five years and is not
traded flat or in default as to principal
or interest and is rated in one of the four
highest rating categories by at least two
NRSROs.198 The equity security has a
higher deduction amount because it is
expected to have a greater amount of
market risk.199
The examples above reflect the
proposed standardized haircuts for a
single non-CDS security-based swap
treated in isolation. It is expected that
nonbank SBSDs will maintain portfolios
of multiple non-CDS security-based
swaps with offsetting long and short
positions to hedge their risk. Under the
proposed standardized haircuts for nonCDS security-based swaps, nonbank
SBSDs would be able to recognize the
offsets currently permitted under Rule
15c3–1.200 In particular, as discussed
below, nonbank SBSDs would be
permitted to treat a non-CDS securitybased swap that references an equity
security (‘‘equity security-based swap’’)
under the provisions of Appendix A to
Rule 15c3–1, which produces a single
haircut for portfolios of equity options
196 See

Net Capital Rule, 58 FR at 27490.
17 CFR 240.15c3–1(c)(2)(vi)(J).
198 See 17 CFR 240.15c3–1(c)(2)(vi)(F)(1).
199 See, e.g., Net Capital Rule, Exchange Act
Release No. 39456 (Dec. 17, 1997), 62 FR 68011
(Dec. 30, 1997) (‘‘[A] broker-dealer’s haircut for
equity securities is equal to 15 percent of the market
value of the greater of the long or short equity
position plus 15 percent of the market value of the
lesser position, but only to the extent this position
exceeds 25 percent of the greater position. In
contrast to the uniform haircut for equity securities,
the haircuts for several types of interest rate
sensitive securities, such as government securities,
are directly related to the time remaining until the
particular security matures.’’).
200 See proposed new paragraph (c)(2)(vi)(O)(2) of
Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed
new Rule 18a–1.

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197 See

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and related positions.201 Similarly,
nonbank SBSDs would be permitted to
treat a non-CDS security-based swap
that references a debt instrument (‘‘debt
security-based swap’’) in the same
manner as debt instruments are treated
in the Rule 15c3–1 grids in terms of
allowing offsets between long and short
positions where the instruments are in
the same maturity categories,
subcategories, and in some cases,
adjacent categories for the purposes of
computing haircuts for debt securitybased swaps.202
Appendix A to Rule 15c3–1
prescribes a standardized theoretical
pricing model to determine a potential
loss for a portfolio of equity positions
involving the same equity security to
establish a single haircut for the group
of positions (‘‘Appendix A
methodology’’).203 Proposed
amendments to Appendix A to Rule
15c3–1 would permit equity securitybased swaps to be included in portfolios
of equity positions for which the
Appendix A methodology is used to
compute a portfolio haircut.204 Under
201 See 17 CFR 240.15c3–1a; Appendix A to
proposed new Rule 18a–1.
202 See 17 CFR 240.15c3–1(c)(2)(vi).
203 See 17 CFR 240.15c3–1a; Appendix A to
proposed new Rule 18a–1.
204 Specifically, Appendix A to Rule 15c3–1
would be amended to include equity security-based
swaps within the definition of the term ‘‘underlying
instrument’’ in paragraph (a)(4) of Appendix A.
This would allow these positions to be included in
portfolios of equity positions involving the same
equity security for purposes of the Appendix A
methodology. In addition, the proposals would
include security futures on single stocks within the
definition of the term ‘‘underlying instrument,’’
which would permit these positions to be included
in portfolios of positions involving the same
underlying security for purposes of the Appendix
A methodology, subject to a minimum charge. This
proposal is made in response to legislative and
regulatory developments that have occurred since
the Appendix A methodology was adopted in 1997.
See Net Capital Rule, Exchange Act Release No.
38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12, 1997).
When the Appendix A methodology was adopted,
security futures trading was prohibited in the U.S.
This prohibition was repealed by the Commodity
Futures Modernization Act of 2000, which
established a framework for the joint regulation of
security futures products by the Commission and
the CFTC. Public Law 106–554, 114 Stat. 2763
(2000). Because security futures contracts on
individual stocks generally track the price of the
underlying stock, and, at expiration, the price of the
security futures contract equals the price of the
underlying stock, the proposed amendments would
treat a security future on an underlying stock as if
it were the underlying stock. Appendix A to Rule
18a–1 similarly would include equity securitybased swaps and security futures products in the
definition of ‘‘underlying instrument.’’ See
paragraph (a)(4) of proposed new Rule 18a–1a. See
also letter from Michael A. Macchiaroli, Associate
Director, Division of Trading and Markets,
Commission, to Timothy H. Thompson, Senior Vice
President and Chief Regulatory Officer, Chicago
Board Options Exchange, Incorporated (‘‘CBOE’’),
and Grace B. Vogel, Executive Vice President,
Member Regulation, Risk Oversight and Operational

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these proposed amendments, brokerdealer SBSDs and broker-dealers that
are not registered as SBSDs would be
able to include equity security-based
swaps in portfolios of equity positions
for purposes of the Appendix A
methodology. In addition, proposed
new Rule 18a–1 would permit standalone SBSDs to use the Appendix A
methodology as well.205 By permitting
equity security-based swaps to be
included in portfolios of related equity
positions, broker-dealer SBSDs and
broker-dealers that are not registered as
SBSDs would be able to employ a more
sensitive measure of the risk when
computing net capital than would be the
case if the positions were treated in
isolation.
Under the Appendix A methodology
(as proposed to be amended), a nonbank
SBSD could group equity security-based
swaps, options, security futures, long
securities positions, and short securities
positions involving the same underlying
security (e.g., XYZ Company common
stock) and stress the current market
price for each position at ten equidistant
points along a range of positive and
negative potential future market
movements, using an approved
theoretical option pricing model that
satisfies certain conditions specified in
the rule.206 For equity security-based
swaps, the ten stress points for a
portfolio of related positions would
span a range from ¥15% to +15% (i.e.,
¥15%, ¥12%, ¥9%, ¥6%, ¥3%,
+3%, +6%, +9%, +12%, +15%).207 The
gains and losses of each position (e.g.,
a security-based swap, option, and a
security future referencing XYZ
Company and a long position and short
position in XYZ Company stock) in the
portfolio would be allowed to offset
each other to yield a net gain or loss at
each stress point.208 The stress point
Regulation, FINRA (May 4, 2012) (no-action letter
permitting broker-dealers when calculating net
capital using a theoretical pricing model pursuant
to Appendix A to Rule 15c3–1 to group U.S.-listed
security futures contracts on individual stocks with
equity options on, and positions in, the same
underlying instrument under paragraph (b)(1)(ii)(A)
of Appendix A).
205 See proposed new Rule 18a–1a.
206 See 17 CFR 240.15c3–1a(b)(1); paragraph (b)(1)
of proposed new Rule18a–1a. Presently, there is
only one theoretical options pricing model that has
been approved for this purpose.
207 This range of price movements (±) 15% is
consistent with the prescribed 15% haircut for most
equity securities. See 17 CFR 240.15c3–
1(c)(2)(vi)(J).
208 For example, at the ¥6% stress point, XYZ
Company stock long positions would experience a
6% loss, short positions would experience a 6%
gain, and XYZ Company options would experience
gains or losses depending on the features of the
options. These gains and losses are added up
resulting in a net gain or loss at that point.

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that yields the largest potential net loss
for the portfolio would be used to
calculate the aggregate haircut for all the
positions in the portfolio.209 This
method would permit a nonbank SBSD
to compute deductions for a portfolio of
equity security-based swaps in a more
risk sensitive manner by accounting for
the risk of the entire portfolio, rather
than the risk of each position within the
portfolio.
With respect to portfolios of debt
security-based swaps, a nonbank SBSD
could use the offsets permitted in the
debt-maturity grids in Rule 15c3–1.210
The debt-maturity grids permit the
broker-dealer to reduce the amount of
the deductions when long debt security
positions are offset by short debt
security positions. For example, as
discussed above, the maturity grid for
nonconvertible debt securities has nine
maturity categories.211 In each category,
the broker-dealer is required to take the
specified deduction on the greater of the
long or short positions in the
category.212 Consequently, the brokerdealer need not take a deduction on the
gross amount of these positions (i.e., the
broker-dealer need not take a deduction
for the long and short positions). In
addition, the rule permits the brokerdealer to exclude nonconvertible debt
securities from the maturity categories if
they are hedged by other similar
nonconvertible debt securities or
government securities or futures on
government securities.213 The excluded
positions are subject to a separate
maturity grid that imposes lower
deductions.214 The proposed
amendments to Rule 15c3–1 and
proposed new Rule 18a–1 would permit
broker-dealer SBSDs and stand-alone
SBSDs, respectively, to treat debt
209 Because options are part of the portfolio, the
greatest portfolio loss (or gain) would not
necessarily occur at the largest potential market
move stress points (±) 15%. This is because a
portfolio that holds derivative positions that are far
out of the money would potentially realize large
gains at the greatest market move points as these
positions come into the money. Thus, the greatest
net loss for a portfolio conceivably could be at any
market move stress point. In addition, the
Appendix A methodology imposes a minimum
charge based on the number of options contracts in
a portfolio that applies if the minimum charge is
greater than the largest stress point charge. See 17
CFR 240.15c3–1a(b)(1)(v)(C)(2); paragraph
(b)(1)(iv)(C)(2) of proposed new Rule 18a–1a. This
minimum charge is designed to address issues such
as leverage and liquidity risk that may exist even
if the market risk of the portfolio is very low as a
result of closely-correlated hedging.
210 See proposed new paragraph (c)(2)(vi)(O)(2) of
Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed
new Rule 18a–1 (incorporating by reference the
standardized haircuts in Rule 15c3–1).
211 See 17 CFR 240.15c3–1(c)(2)(vi)(F)(1).
212 Id.
213 See 17 CFR 240.15c3–1(c)(2)(vi)(F)(2).
214 See 17 CFR 240.15c3–1(c)(2)(vi)(F)(3).

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security-based swaps in the same
manner as the debt instruments they
reference are treated for the purposes of
determining haircuts. Consequently,
nonbank SBSDs could recognize the
offsets and hedges that those provisions
permit to reduce the deductions on
portfolios of debt security-based swaps.
Request for Comment
The Commission generally requests
comment on the proposed standardized
haircuts for calculating deductions for
security-based swaps. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the proposed maturity/spread
grid approach for CDS security-based
swaps appropriate in terms of
addressing the risk of these positions? If
not, explain why not. How could the
proposed maturity/spread grid approach
be modified to better address the risk of
these positions?
2. Do broker-dealers currently use the
spread/maturity grid in FINRA Rule
4240 to determine capital charges for
credit default swaps? If so, what has
been the experience of broker-dealers in
using the grid? If not, what potential
practical issues does the maturity/
spread grid raise? Are there ways these
practical issues could be addressed
through modifications to the proposed
maturity/spread grid?
3. Is there an alternative maturity/
spread grid approach that would be a
preferable model for the standardized
haircuts? If so, identify the model and
explain why it would be preferable. For
example, should the standardized
haircut for a CDS security-based swap
that references an obligation be based on
the standardized haircut that would
apply to the obligation under paragraph
(c)(2)(vi) of Rule 15c3–1? If so, explain
why. If not, explain why not. How could
a CDS security-based swap that
references an obligor as an entity be
addressed under such a standardized
haircut approach? For example, could
the standardized haircut that would
apply to obligations (e.g., bonds) issued
by the obligor be used as a proxy for the
standardized haircut that would apply
to the CDS security-based swap
referencing the obligor? If so, explain
why.
4. Are the proposed spread categories
for the CDS security-based swap grid
appropriate? If not, explain why not. For
example, should there be more spread
categories? If so, specify the total
number of recommended spread
categories and the basis point ranges
that should be in each category, and
explain why the recommended

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modifications would be preferable.
Should there be fewer spread
categories? If so, specify the total
number of recommended spread
categories and the basis point ranges
that should be in each category, and
explain why the recommended
modifications would be preferable.
5. Would there always be an
observable current offered basis point
spread for purposes of determining the
applicable spread category for a CDS
security-based swap? If it could be the
case that a CDS security-based swap
does not have an observable current
offered spread, how should the spread
category be determined and how should
the rule be modified to require the use
of the determined spread category? For
example, should the rule require that
the nonbank SBSD apply the greatest
percentage deduction applicable to the
CDS security-based swap based on its
maturity (i.e., the deduction prescribed
in ‘‘700 or more’’ basis points spread
category) or another deduction amount?
6. Are the proposed maturity
categories for the CDS security-based
swap grid appropriate? If not, explain
why not. For example, should there be
more maturity categories? If so, specify
the total number of recommended
maturity categories and the time ranges
that should be in each category, and
explain why the recommended
modifications would be preferable.
Should there be fewer maturity
categories? If so, specify the total
number of recommended maturity
categories and the time ranges that
should be in each category, and explain
why the recommended modifications
would be preferable.
7. Are the proposed percentage
deductions in the CDS security-based
swap grid appropriate? If not, explain
why not. For example, should the
percentage deductions be greater? If so,
specify the greater deductions and
explain why they would be preferable.
Should the percentage deductions be
lesser? If so, specify the lesser
deductions and explain why it would be
preferable.
8. Is the proposed 50% reduced
deduction for long CDS security-based
swaps appropriate? If not, explain why
not. For example, should the amount of
the reduced deduction be greater? If so,
specify the amount and explain why it
would be preferable. Should the amount
of the reduced deduction be lesser? If
so, specify the lesser amount and
explain why it would be preferable.
9. Is the proposed offset and
corresponding reduced deduction for
net long and short positions where the
CDS security-based swaps reference the
same obligor or obligation and are in the

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
same maturity and spread categories
appropriate? If not, explain why not.
10. Is the proposed offset and
corresponding reduced deduction for
net long and short positions where the
CDS security-based swaps reference the
same obligor or obligation, are in the
same spread category, and are in an
adjacent maturity category and have
maturities within three months of the
other maturity category appropriate? If
not, explain why not.
11. Is the proposed offset and
corresponding reduced deduction for
long and short CDS security-based swap
positions in the same maturity and
spread categories and that reference
obligors or obligations of obligors in the
same industry sector appropriate? If not,
explain why not.
12. Should the rule specify an
industry sector classification system? If
so, specify the recommended industry
sector classification system and explain
why it would be useful for the purposes
of the standardized haircuts for CDS
security-based swaps.
13. If a nonbank SBSD uses its own
industry sector classification system,
what factors would be relevant in
evaluating whether the system is
reasonable?
14. Should there be a concentration
charge that would apply when the
notional amount of the long and short
CDS security-based swap positions in
the same maturity and spread categories
and that reference obligors or
obligations of obligors in the same
industry sector exceed a certain
threshold to account for the potential
that long and short positions may not
directly offset each other? If so, explain
why. If not, explain why not.
15. Is the proposed deduction for a
position where a nonbank SBDS is long
a bond and long a CDS security-based
swap on the same underlying obligor
appropriate? If not, explain why not. For
example, is the proposed provision that
the reduced deduction would apply
only if the CDS security-based swap
allowed the nonbank SBSD to deliver
the bond to satisfy the firm’s obligation
on the swap appropriate? If not, explain
why not. Additionally, is reducing the
deduction applicable to the bond by
50% an appropriate reduction level?
Should the reduction be less than 50%
(e.g., 25%) or greater than 50% (e.g.,
75%)?
16. Is the proposed reduced deduction
for a position where a nonbank SBDS is
short a bond and short a CDS securitybased swap on the same underlying
bond appropriate? If not, explain why
not.
17. Should the Commission propose
separate grids for CDS security-based

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swaps that reference a single obligor or
obligation and CDS security-based
swaps that reference a narrow based
index? If so, how should the two grids
differ?
18. Are the proposed standardized
haircuts for non-CDS security-based
swaps appropriate? If not, explain why
not. For example, would the risk
characteristics of non-CDS securitybased swaps (e.g., price volatility) be
similar to the instruments they
reference? If not, explain why not.
19. Are there practical issues with
treating equity security-based swaps
under the Appendix A methodology? If
so, describe them. Are there
modifications that could be made to the
Appendix A methodology to address
any practical issues identified? If so,
describe the modifications.
20. Are there provisions in Appendix
A to Rule 15c3–1 not included in
Appendix A to Rule 18a–1 that should
be incorporated into the latter rule? If
so, identify the provisions and explain
why they should be incorporated into
Appendix A to Rule 18a–1. For
example, should the strategy-based
methodology in Appendix A to Rule
15c3–1 be applied to equity securitybased swaps? If so, explain why.
21. Are there practical issues with
treating debt security-based swaps
under the debt maturity grids in Rule
15c3–1? If so, describe them. Are there
modifications that could be made to
address any practical issues identified?
If so, describe the modifications.
iii. VaR Models
The proposed capital requirements for
nonbank SBSDs would permit the use of
internal VaR models to compute
deductions for proprietary securities
positions, including security-based
swap positions, in lieu of the
standardized haircuts. VaR models are
used by financial institutions for
internal risk management purposes.215
In addition, VaR models are used to
compute market risk charges in
international bank capital standards 216
215 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428 (The option to use
VaR models is ‘‘intended to reduce regulatory costs
for broker-dealers by allowing very highly
capitalized firms that have developed robust
internal risk management practices to use those risk
management practices, such as mathematical risk
measurement models, for regulatory purposes’’);
Net Capital Rule, Exchange Act Release No. 39456
(Dec. 17, 1997), 62 FR 68011 (Dec. 30, 1997)
(‘‘Given the increased use and acceptance of VAR
as a risk management tool, the Commission believes
that it warrants consideration as a method of
computing net capital requirements for brokerdealers.’’).
216 See, e.g., Amendment to the capital accord to
incorporate market risks, Basel Committee on
Banking Supervision (Jan. 1996); 12 CFR part 3; 12
CFR parts 208 and 225; 12 CFR part 325.

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and are permitted by the Commission’s
rules for ANC broker-dealers and OTC
derivatives dealers.217 Furthermore, the
prudential regulators and the CFTC
have proposed permitting the use of
VaR models in their capital
requirements for bank SBSDs, bank
swap dealers, and swap dealers.218 The
use of VaR models to calculate market
risk charges for security-based swap
positions would be subject to the
conditions described below.
Broker-dealer SBSDs that are not
already ANC broker-dealers would need
to obtain approval to operate as ANC
broker-dealers to use internal VaR
models to compute net capital. Standalone SBSDs also would need to obtain
Commission approval to use VaR
models for this purpose. The
requirements for a broker-dealer to
apply for approval to operate as an ANC
broker-dealer are contained in
Appendix E to Rule 15c3–1.219 Pursuant
to these requirements, the applicant
must provide the Commission with
various types of information about the
applicant.220 A stand-alone SBSD
applying for approval to use internal
models to compute net capital would be
required to provide similar information
(though a stand-alone SBSD would not
be required to provide certain
information relating to its holding
company or affiliates that is required of
ANC broker-dealer applicants).221
217 See 17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f.
See also Alternative Net Capital Requirements
Adopting Release, 69 FR 34428; OTC Derivatives
Dealers, 63 FR 59362.
218 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564; CFTC Capital
Proposing Release, 76 FR 27802.
219 See 17 CFR 240.15c3–1e. The application
covers both the use of internal VaR models to
compute deductions for proprietary positions and
internal credit risk models to compute charges for
unsecured receivables relating to OTC derivatives.
Id. Specifically, the broker-dealer may apply to the
Commission for authorization to compute
deductions pursuant to Appendix E to Rule 15c3–
1 in lieu of computing deductions pursuant to
paragraph (c)(2)(vi) (the standardized haircuts) and
paragraph (c)(2)(vii) (the 100% deduction for
securities with no ready market) of Rule 15c3–1 and
to compute deductions for credit risk pursuant to
Appendix E for unsecured receivables arising from
transactions in OTC derivatives in lieu of
computing deductions pursuant to paragraph
(c)(2)(iv) of Rule 15c3–1 (the deductions for
unsecured receivables). See 17 CFR 240.15c3–1e(a).
The use of internal credit risk models is discussed
below in section II.A.2.b.iv. of this release.
220 See Alternative Net Capital Requirements
Adopting Release, 69 FR at 34433.
221 See paragraph (d)(1) of proposed new Rule
18a–1. Appendix E to Rule 15c3–1 requires a
broker-dealer applying to become an ANC brokerdealer to provide information about the brokerdealer’s ultimate holding company and affiliates.
See 17 CFR 240.15c3–1e(a)(1)(viii)–(ix) and (a)(2).
Consistent with the requirements for OTC
derivatives dealers, the proposed application
requirements for stand-alone SBSDs seeking

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A broker-dealer applying to become
an ANC broker-dealer is required to
provide the Commission with, among
other things, the following information:
• An executive summary of the
information provided to the
Commission with its application and an
identification of the ultimate holding
company of the ANC broker-dealer; 222
• A comprehensive description of the
internal risk management control
system of the broker-dealer and how
that system satisfies the requirements
set forth in Rule 15c3–4; 223
• A list of the categories of positions
that the ANC broker-dealer holds in its
proprietary accounts and a brief
description of the methods that the ANC
broker-dealer will use to calculate
deductions for market and credit risk on
those categories of positions; 224
• A description of the mathematical
models to be used to price positions and
to compute deductions for market risk,
including those portions of the
deductions attributable to specific risk,
if applicable, and deductions for credit
risk; a description of the creation, use,
and maintenance of the mathematical
models; a description of the ANC
approval to use internal models would not require
the submission of the information about the firm’s
ultimate holding company and affiliates required in
paragraphs (a)(1)(viii)–(ix) and (a)(2)(i)–(xi) of
Appendix E to Rule 15c3–1. Compare 17 CFR
240.15c3–1e(a)(1) and (a)(2), with paragraph (d)(1)
of proposed new Rule 18a–1 and 17 CFR 240.15c3–
1f(a). This additional information may be more
appropriate for a broker-dealer applying to operate
as an ANC broker-dealer because of its ability to
engage in wider ranges of activities than a standalone nonbank SBSD, such as engaging in a general
securities business. The information about the
ultimate holding company and affiliates is designed
to help ensure the Commission can monitor
activities of the holding company and affiliates that
could negatively impact the financial well-being of
the broker-dealer. See Alternative Net Capital
Requirements Adopting Release, 69 FR at 34430.
222 See 17 CFR 240.15c3–1e(a)(1)(i). A stand-alone
SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(A) of proposed new
Rule 18a–1.
223 See 17 CFR 240.15c3–1e(a)(1)(ii). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(B) of proposed new
Rule 18a–1. As discussed below in section II.A.2.c.
of this release, ANC broker-dealers are required to
comply with Rule 15c3–4, and to provide this
information in an application to use internal
models. See 17 CFR 240.15c3–1e(a)(1)(ii), 17 CFR
240.15c3–1(a)(7)(iii) and 17 CFR 240.15c3–4. A
nonbank SBSD that does not use internal models
also would be required to comply with Rule 15c3–
4, but would not have to provide information to the
Commission unless it determined to apply to the
Commission to use internal models. See paragraph
(g) of proposed new Rule 18a–1 and section II.A.2.c.
of this release discussing this requirement.
224 See 17 CFR 240.15c3–1e(a)(1)(iii). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(C) of proposed new
Rule 18a–1.

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broker-dealer’s internal risk
management controls over those
models, including a description of each
category of persons who may input data
into the models; if a mathematical
model incorporates empirical
correlations across risk categories, a
description of the process for measuring
correlations; a description of the
backtesting procedures the ANC brokerdealer will use to backtest the
mathematical model used to calculate
maximum potential exposure; a
description of how each mathematical
model satisfies the applicable
qualitative and quantitative
requirements set forth in paragraph (d)
of Appendix E to Rule 15c3–1; and a
statement describing the extent to which
each mathematical model used to
compute deductions for market and
credit risk will be used as part of the
risk analyses and reports presented to
senior management; 225
• If the ANC broker-dealer is applying
to the Commission for approval to use
scenario analysis to calculate
deductions for market risk for certain
positions, a list of those types of
positions, a description of how those
deductions will be calculated using
scenario analysis, and an explanation of
why each scenario analysis is
appropriate to calculate deductions for
market risk on those types of
positions; 226
• A description of how the ANC
broker-dealer will calculate current
exposure; 227
• A description of how the ANC
broker-dealer will determine internal
credit ratings of counterparties and
internal credit risk weights of
counterparties, if applicable; 228
• For each instance in which a
mathematical model used by the ANC
broker-dealer to calculate a deduction
for market risk or to calculate maximum
225 See 17 CFR 240.15c3–1e(a)(1)(iv). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(D) of proposed new
Rule 18a–1.
226 See 17 CFR 240.15c3–1e(a)(1)(v). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(E) of proposed new
Rule 18a–1. As discussed below, ANC brokerdealers can use scenario analysis in certain cases to
determine deductions for some positions.
227 See 17 CFR 240.15c3–1e(a)(1)(vi). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(F) of proposed new
Rule 18a–1.
228 See 17 CFR 240.15c3–1e(a)(1)(vii). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(G) of proposed new
Rule 18a–1. As discussed below in section
II.A.2.b.iv. of this release, internal credit ratings are
used to compute the credit risk charge.

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potential exposure for a particular
product or counterparty differs from the
mathematical model used by the
ultimate holding company of the ANC
broker-dealer to calculate an allowance
for market risk or to calculate maximum
potential exposure for that same product
or counterparty, a description of the
difference(s) between the mathematical
models; 229 and
• Sample risk reports that are
provided to the persons at the ultimate
holding company who are responsible
for managing group-wide risk and that
will be provided to the Commission
pursuant to Rule 15c3–1g.230
The Commission may request that a
broker-dealer applying to operate as an
ANC broker-dealer supplement its
application (‘‘ANC application’’) with
other information relating to the internal
risk management control system,
mathematical models, and financial
position of the broker-dealer.231 A
broker-dealer’s ANC application and all
submissions in connection with the
ANC application are accorded
confidential treatment, to the extent
permitted by law.232 If any information
in an ANC application is found to be or
becomes inaccurate before the
Commission approves the application,
the broker-dealer must notify the
Commission promptly and provide the
Commission with a description of the
circumstances in which the information
was inaccurate along with updated,
accurate information.233 The
229 See 17 CFR 240.15c3–1e(a)(2)(xi). A standalone SBSD also would be required to provide this
information in an application to use internal
models. See paragraph (d)(1)(i)(H) of proposed new
Rule 18a–1.
230 See 17 CFR 240.15c3–1e(a)(2)(xiii). A standalone SBSD would be required to provide similar
information in an application to use internal
models. See paragraph (d)(1)(i)(I) of proposed new
Rule 18a–1. The proposed requirement for standalone SBSDs to provide this information refers to
sample risk reports that are provided to
‘‘management’’ as opposed to the ‘‘ultimate holding
company.’’ Id. As a practical matter, the two
provisions would achieve the same result; namely,
the submission of sample reports that are provided
to senior levels of the firm. However, because the
stand-alone SBSD application provisions do not
require information about holding companies and
affiliates, the proposed text of the rule refers to
‘‘management.’’
231 See 17 CFR 240.15c3–1e(a)(4). A similar
provision would apply to stand-alone SBSDs
applying to use internal models. See paragraph
(d)(2) of proposed new Rule 18a–1.
232 See 17 CFR 240.15c3–1e(a)(5). See also 5
U.S.C. 552; Alternative Net Capital Requirements
Adopting Release, 69 FR at 34433 (discussing
confidential treatment of ANC applications). A
similar provision would apply to information
submitted by stand-alone SBSDs applying to use
internal models. See paragraph (d)(3) of proposed
new Rule 18a–1.
233 See 17 CFR 240.15c3–1e(a)(6). A similar
provision would apply to stand-alone SBSDs
applying to use internal models. See paragraph
(d)(4) of proposed new Rule 18a–1.

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Commission may approve, in whole or
in part, an ANC application or an
amendment to the application, subject
to any conditions or limitations the
Commission may require if the
Commission finds the approval to be
necessary or appropriate in the public
interest or for the protection of
investors.234
As part of the ANC application
approval process, the Commission staff
reviews the operation of the brokerdealer’s VaR model, including a review
of associated risk management controls
and the use of stress tests, scenario
analyses, and back-testing.235 As part of
this process and on an ongoing basis,
the broker-dealer applicant is required
to demonstrate to the Commission that
the VaR model reliably accounts for the
risks that are specific to the types of
positions the broker-dealer intends to
include in the model computations.
During the review, the Commission
assesses the quality, rigor, and adequacy
of the technical components of the VaR
model and of related model governance
processes. Stand-alone SBSDs applying
for approval to use internal models to
compute net capital would be subject to
similar reviews of their VaR models as
part of the application process.
After an ANC application is approved,
an ANC broker-dealer is required to
amend and submit to the Commission
for approval its ANC application before
materially changing its VaR model or its
internal risk management control
system.236 Further, an ANC brokerdealer is required to notify the
Commission 45 days before it ceases
using a VaR model to compute net
capital.237 Finally, the Commission, by
order, can revoke an ANC brokerdealer’s ability to use a VaR model to
compute net capital if the Commission
finds that the ANC broker-dealer’s use
of the model is no longer necessary or
appropriate in the public interest or for
the protection of investors.238 In this
234 See 17 CFR 240.15c3–1e(a)(7). A similar
provision would apply to applications of standalone SBSDs applying to use internal models. See
paragraph (d)(5) of proposed new Rule 18a–1.
235 The Commission also reviews the brokerdealer’s credit risk model.
236 See 17 CFR 240.15c3–1e(a)(8). This
requirement also applies to material changes to the
ANC broker-dealer’s internal credit risk model. Id.
A similar provision would apply to stand-alone
SBSDs approved to use internal models. See
paragraph (d)(6) of proposed new Rule 18a–1.
237 See 17 CFR 240.15c3–1(a)(10). This
requirement also applies to the ANC broker-dealer’s
internal credit risk model. Id. A similar provision
would apply to stand-alone SBSDs approved to use
internal models. See paragraph (d)(7) of proposed
new Rule 18a–1.
238 See 17 CFR 240.15c3–1e(a)(11). This
requirement also applies to the ANC broker-dealer’s
internal credit risk model. Id. A similar provision

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case, the broker-dealer would need to
revert to using the standardized haircuts
for all positions.
An ANC broker-dealer must comply
with certain qualitative and quantitative
requirements set forth in Appendix E to
Rule 15c3–1.239 A stand-alone SBSD
approved to use a VaR model would be
subject to the same qualitative and
quantitative requirements.240 In this
regard, VaR models estimate the
maximum potential loss a portfolio of
securities and other instruments would
be expected to incur over a fixed time
period at a certain probability level. The
model utilizes historical market data to
generate potential values of a portfolio
of positions taking into consideration
the observed correlations between
different types of assets.
The qualitative requirements in
Appendix E to Rule 15c3–1 specify,
among other things, that: (1) Each VaR
model must be integrated into the ANC
broker-dealer’s daily internal risk
management system; 241 (2) each VaR
model must be reviewed periodically by
the firm’s internal audit staff, and
annually by a registered public
accounting firm, as that term is defined
in section 2(a)(12) of the Sarbanes-Oxley
Act of 2002 (15 U.S.C. 7201 et seq.); 242
and (3) the VaR measure computed by
the model must be multiplied by a
factor of at least three but potentially a
greater amount based on the number of
exceptions to the measure resulting
from quarterly back-testing exercises.243
would apply to stand-alone SBSDs approved to use
internal models. See paragraph (d)(8) of proposed
new Rule 18a–1.
239 See 17 CFR 15c3–1e(d).
240 Compare 17 CFR 15c3–1e(d), with paragraph
(d)(9) of proposed new Rule 18a–1.
241 See 17 CFR 240.15c3–1e(d)(1)(i). A similar
provision would apply to stand-alone SBSDs
approved to use internal models. See paragraph
(d)(9)(i)(A) of proposed new Rule 18a–1.
242 See 17 CFR 240.15c3–1e(d)(1)(ii). The annual
review must be conducted in accordance with
procedures agreed upon by the broker-dealer and
the registered public accounting firm conducting
the review. A similar provision would apply to
stand-alone SBSDs approved to use internal
models. See paragraph (d)(9)(i)(B) of proposed new
Rule 18a–1.
243 See 17 CFR 240.15c3–1e(d)(1)(iii). A backtesting exception occurs when the ANC brokerdealer’s actual one-day loss exceeds the amount
estimated by its VaR model. See, e.g., Supervisory
framework for the use of ‘‘backtesting’’ in
conjunction with the internal models approach to
market risk capital requirements, Basel Committee
on Banking Supervision (Jan. 1996) (‘‘The essence
of all backtesting efforts is the comparison of actual
trading results with model-generated risk measures.
If this comparison is close enough, the backtest
raises no issues regarding the quality of the risk
measurement model. In some cases, however, the
comparison uncovers sufficient differences that
problems almost certainly must exist, either with
the model or with the assumptions of the backtest.
In between these two cases is a grey area where the
test results are, on their own, inconclusive.’’).

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The quantitative requirements specify
that the VaR model of the ANC brokerdealer must, among other things: (1) Use
a 99%, one-tailed confidence level with
price changes equivalent to a tenbusiness-day movement in rates and
prices; 244 (2) use an effective historical
observation period of at least one
year; 245 (3) use historical data sets that
are updated at least monthly and are
reassessed whenever market prices or
volatilities change significantly; 246 and
(4) take into account and incorporate all
significant, identifiable market risk
factors applicable to positions of the
ANC broker-dealer, including risks
arising from non-linear price
characteristics, empirical correlations
within and across risk factors, spread
risk, and specific risk for individual
positions.247
The deduction an ANC broker-dealer
must take to tentative net capital in lieu
of the standardized haircuts is an
amount equal to the sum of four
charges.248 The first is a portfolio
market risk charge for all positions that
are included in the ANC broker-dealer’s
VaR models (i.e., the amount measured
by each VaR model multiplied by a
factor of at least three).249 The second
charge is a specific risk charge for
positions where specific risk was not
captured in the VaR model.250 The third
Depending on the number of back-testing
exceptions, the ANC broker-dealer may need to
increase the market risk multiplier to 3.40, 3.50,
3.65, 3.75, 3.85, or 4.00. Id. Increasing the
multiplier increases the deduction amount, which
in turn is designed to account for a model that is
producing less accurate measures. The same
multiplier provision would apply to stand-alone
SBSDs approved to use internal models. See
paragraph (d)(9)(i)(C) of proposed new Rule 18a–1.
244 See 17 CFR 240.15c3–1e(d)(2)(i). This means
the potential loss measure produced by the model
is a loss that the portfolio could experience if it
were held for ten trading days and that this
potential loss amount would be exceeded only once
every 100 trading days. A similar provision would
apply to stand-alone SBSDs approved to use
internal models. See paragraph (d)(9)(ii)(A) of
proposed new Rule 18a–1.
245 See 17 CFR 240.15c3–1e(d)(2)(iii). A similar
provision would apply to stand-alone SBSDs
approved to use internal models. See paragraph
(d)(9)(ii)(C) of proposed new Rule 18a–1.
246 See 17 CFR 240.15c3–1e(d)(2)(iii). A similar
provision would apply to stand-alone SBSDs
approved to use internal models. See paragraph
(d)(9)(ii)(C) of proposed new Rule 18a–1.
247 See 17 CFR 240.15c3–1e(d)(2)(iv). A similar
provision would apply to stand-alone SBSDs
approved to use internal models. See paragraph
(d)(9)(ii)(D) of proposed new Rule 18a–1.
248 See 17 CFR 240.15c3–1e(b). A similar
provision would apply to stand-alone SBSDs
approved to use internal models. See paragraph
(e)(1) of proposed new Rule 18a–1.
249 See 17 CFR 240.15c3–1e(b)(1). A similar
charge would apply to stand-alone SBSDs in
determining their deduction amount. See paragraph
(e)(1)(i) of proposed new Rule 18a–1.
250 See 17 CFR 240.15c3–1e(b)(2). Specific risk is
the risk that a security price will change for reasons

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charge is for positions not included in
the VaR model where the ANC brokerdealer is approved to determine a charge
using scenario analysis.251 The fourth
charge is determined by applying the
standardized haircuts for all other
positions.252
Finally, ANC broker-dealers are
subject to on-going supervision with
respect to their internal risk
management, including their use of VaR
models.253 In this regard, the
Commission staff meets regularly with
senior risk managers at each ANC
broker-dealer to review the risk
analytics prepared for the firm’s senior
management. These reviews focus on
the performance of the risk
measurement infrastructure, including
statistical models, risk governance
issues such as modifications to and
breaches of risk limits, and the
management of outsized risk exposures.
In addition, Commission staff and
personnel from an ANC broker-dealer
hold regular meetings focused on
financial results, the management of the
firm’s balance sheet, and, in particular,
the liquidity of the balance sheet. The
Commission staff also monitors the
performance of the ANC broker-dealer’s
internal models through regular reports
generated by the firms for their internal
risk management purposes (backtesting,
unrelated to broader market moves. The market risk
charge is designed to address the risk that the value
of a portfolio of trading book assets will decline as
a result of a broad move in market prices or interest
rates. For example, the potential that the S&P 500
index will increase or decrease on the next trading
day creates market risk for a portfolio of equity
securities positions (longs, shorts, options, and OTC
derivatives) and the potential that interest rates will
increase or decrease on the next trading day creates
market risk for a portfolio of fixed-income positions
(longs, shorts, options, and OTC derivatives). The
specific risk charge is designed to address the risk
that the value of an individual position would
decline for reasons unrelated to a broad movement
of market prices or interest rates. For example,
specific risk includes the risk that the value of an
equity security will decrease because the issuer
announces poor earnings for the previous quarter or
the value of a debt security will decrease because
the issuer’s credit rating is lowered. The
Commission is proposing a similar charge that
would apply to stand-alone SBSDs in determining
their deduction amount. See paragraph (e)(1)(ii) of
proposed new Rule 18a–1.
251 See 17 CFR 240.15c3–1e(b)(3). A similar
charge would apply to stand-alone SBSDs in
determining their deduction amount. See paragraph
(e)(1)(iii) of proposed new Rule 18a–1.
252 See 17 CFR 240.15c3–1e(b)(4). A similar
charge would apply to stand-alone SBSDs in
determining their deduction amount. See paragraph
(e)(1)(iv) of proposed new Rule 18a–1.
253 More detailed descriptions of the
Commission’s ANC broker-dealer program are
available on the Commission’s Web site at http://
www.sec.gov/divisions/marketreg/bdriskoffice.htm
and http://www.sec.gov/divisions/marketreg/
bdaltnetcap.htm. The ultimate holding companies
of the ANC broker-dealers also are subject to
monitoring by Commission staff.

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stress test, and other monthly risk
reports) and discussions with firm
personnel (scheduled and ad hoc).254
Material changes to the internal models
are also subject to review and
approval.255 Stand-alone SBSDs
approved to use internal models to
compute net capital would be subject to
similar monitoring and reviews.
Request for Comment
The Commission generally requests
comment on the proposed requirements
for using VaR models to compute net
capital. In addition, the Commission
requests comment, including empirical
data in support of comments, in
response to the following questions:
1. Would VaR models appropriately
account for the risks of security-based
swaps? If not, explain why not. For
example, do the characteristics of
security-based swaps make it more
difficult to measure their market risk
using VaR models than it is to measure
the market risk of other types of
securities using VaR models? If so,
explain why.
2. Are the application requirements in
Appendix E to Rule 15c3–1 an
appropriate model for the application
requirements in proposed new Rule
18a–1? If not, explain why not.
3. Are there provisions in the
application requirements in Appendix E
to Rule 15c3–1 not incorporated into
proposed new Rule 18a–1 that should
be included in the proposed rule, such
as information regarding the ultimate
holding company of the nonbank SBSD?
If so, identify the provisions and explain
why they should be incorporated into
the proposed rule.
4. Is the review process for ANC
applications an appropriate model for
the review process for stand-alone
SBSDs seeking approval to use internal
models to compute net capital? If not,
explain why not.
5. Are there ways to facilitate the
timely review of applications from
nonbank SBSDs to use internal models
if a large number of applications are
filed at the same time? For example,
could a more limited review process be
used if a banking affiliate of a nonbank
SBSD has been approved by a
prudential regulator to use the same
model the nonbank SBSD intends to
use? If so, what conditions should
attach to such approval? Are there other
indicia of the reliability of such models
that could be relied on?
254 In addition to regularly scheduled meetings,
communications with ANC broker-dealers may
increase in frequency, dependent on existing
market conditions, and at times, may involve daily,
weekly or other ad hoc calls or meetings.
255 See 17 CFR 240.15c3–1e(a)(8).

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6. Are the qualitative requirements in
Appendix E to Rule 15c3–1 an
appropriate model for the qualitative
requirements in proposed new Rule
18a–1?
7. More generally, are the qualitative
requirements in Appendix E to Rule
15c3–1 appropriate for VaR models that
will include security-based swaps? If
not, explain why not. For example, are
there additional or alternative
qualitative requirements that should be
required to address the unique risk
characteristics of security-based swaps?
If so, describe them and explain why
they would be appropriate qualitative
requirements.
8. Are the quantitative requirements
in Appendix E to Rule 15c3–1 an
appropriate model for the quantitative
requirements in proposed new Rule
18a–1? If not, explain why not.
9. More generally, are the quantitative
requirements in Appendix E to Rule
15c3–1 appropriate for VaR models that
will include security-based swaps? If
not, explain why not. For example, are
there additional or alternative
quantitative requirements that should be
required to address the unique risk
characteristics of security-based swaps?
If so, describe them and explain why
they would be preferable.
10. Are the components of the
deduction an ANC broker-dealer must
take from tentative net capital under
Appendix E to Rule 15c3–1 an
appropriate model for the components
of the deduction a stand-alone SBSD
approved to use internal models would
be required to take from tentative net
capital under proposed new Rule 18a–
1? If not, explain why not.
11. Should the Commission employ
the same type of on-going monitoring
process used for ANC broker-dealers to
monitor stand-alone SBSDs using
internal models? If not, explain why
not.
iv. Credit Risk Charges
Obtaining collateral is one of the ways
dealers in OTC derivatives manage their
credit risk exposure to OTC derivatives
counterparties.256 Collateral may be
provided to cover the amount of the
256 See, e.g., International Swaps and Derivatives
Association, Inc. (‘‘ISDA’’), Market Review of OTC
Derivative Bilateral Collateralization Practices,
Release 2.0 (Mar. 1, 2010), available at http://www.
isda.org/c_and_a/pdf/Collateral-Market-Review.pdf
(‘‘Market Review of OTC Derivative Bilateral
Collateralization Practices’’); Committee on
Payment and Settlement Systems and the Eurocurrency Standing Committee of the Central Banks
of the Group of Ten countries, OTC Derivatives:
Settlement Procedures And Counterparty Risk
Management, (Sept. 1998), available at http://www.
bis.org/publ/ecsc08.pdf (‘‘OTC Derivatives:
Settlement Procedures And Counterparty Risk
Management’’).

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current exposure of the dealer to the
counterparty.257 In this case, the
collateral is designed to protect the
dealer from losing the positive market
value of the OTC contract if the
counterparty defaults.258 Collateral also
may be provided to cover an amount in
excess of the current exposure
(sometimes referred to as ‘‘residual
exposure’’) of the dealer to the
counterparty.259 In this case, the
collateral is designed to protect the
dealer from potential future credit risk
exposure to the counterparty (‘‘potential
future exposure’’).260 This risk, among
other things, is that the current exposure
may increase in the future and the
counterparty will default on the
obligation to provide additional
collateral to cover the increase or an
increase in the amount of current
exposure will occur after the
counterparty defaults and is no longer
providing collateral.261
As discussed below in section II.B. of
this release, the margin rule for noncleared security-based swaps—proposed
new Rule 18a–3—would require a
nonbank SBSD to collect collateral from
a counterparty to cover current and
potential future exposure to the
counterparty.262 However, under the
rule, a nonbank SBSD would not be
required to collect collateral from a
commercial end user to cover current
and potential future exposure to the
commercial end user.263 This proposed
257 See, e.g., ISDA, Independent Amounts,
Release 2.0 (Mar. 1, 2010) (‘‘Independent
Amounts’’). The current exposure is the amount
that the counterparty would be obligated to pay the
nonbank SBSD if all the OTC derivatives contracts
with the counterparty were terminated (i.e., the net
positive value of the OTC contracts to the nonbank
SBSD and the net negative value of the OTC
contracts to the counterparty). The amount payable
on the OTC derivatives contracts (the positive
value) is determined by marking-to-market the OTC
derivatives contracts and netting contracts with a
positive value against contracts with a negative
value. The market value of an OTC derivatives
contract also is referred to as the replacement value
of the contract as that is the amount the nonbank
SBSD would need to pay to enter into an identical
contract with a different counterparty.
258 Id. at 2 (‘‘The commercial reason for basing the
collateral requirement around the Exposure is that
this represents an approximation of the amount of
credit default loss that would occur between the
parties if one were to default.’’).
259 Id. at 4.
260 Id. at 6 (‘‘The underlying commercial reason
behind Independent Amounts is the desire to create
a ‘‘cushion’’ of additional collateral to protect
against certain risk * * *’’).
261 Id.
262 See proposed new Rule 18a–3.
263 See paragraph (c)(1)(iii)(A) of proposed new
Rule 18a–3. As discussed in section II.B. of this
release, proposed new Rule 18a–3 would contain
three other exceptions to the requirements in the
rule to collect and hold collateral. See paragraphs
(c)(1)(iii)(B), (C), and (D) of proposed new Rule 18a–
3. The proposed alternative credit risk charge

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exception to collecting collateral from
commercial end users is intended to
address concerns that have been
expressed by these entities and others
that the imposition of margin
requirements on commercial companies
that use derivatives to mitigate business
risks could disrupt their ability to enter
into hedging transactions by making it
prohibitively expensive.264 At the same
time, because collecting collateral is an
important means of mitigating risk,
nonbank SBSDs would be required to
take a 100% deduction from net worth
if collateral is not collected from a
commercial end user to cover the
amount of the nonbank SBSD’s
uncollateralized current exposure.265 In
addition, as discussed below in section
II.A.2.b.v. of this release, nonbank
SBSDs would be required to take a
capital charge equal to the amount that
the potential future exposure to the
commercial end user—as measured
under proposed new Rule 18a–3—is
uncollateralized.266 As an alternative to
taking these 100% capital charges for
uncollateralized current and potential
future exposure to a commercial end
user, an ANC broker-dealer and a standalone SBSD using internal models could
take a credit risk charge using a
discussed in this section of the release would not
apply to these other exceptions.
264 See, e.g., letter from the Honorable Debbie
Stabenow, Chairman, Committee on Agriculture,
Nutrition and Forestry, U.S. Senate, the Honorable
Frank D. Lucas, Chairman, Committee on
Agriculture, U.S. House of Representatives, the
Honorable Tim Johnson, Chairman, Committee on
Banking, Housing, and Urban Affairs, U.S. Senate,
and the Honorable Spencer Bachus, Chairman,
Committee on Financial Services, U.S. House of
Representatives to Secretary Timothy Geithner,
Department of Treasury, Chairman Gary Gensler,
CFTC, Chairman Ben Bernanke, Federal Reserve
Board, and Chairman Mary Schapiro, Commission
(Apr. 6, 2011); letter from the Honorable
Christopher Dodd, Chairman, Committee on
Banking, Housing, and Urban Affairs, U.S. Senate,
and the Honorable Blanche Lincoln, Chairman,
Committee on Agriculture, Nutrition, and Forestry,
U.S. Senate, to the Honorable Barney Frank,
Chairman, Financial Services Committee, U.S.
House of Representatives, and the Honorable Collin
Peterson, Chairman, Committee on Agriculture,
U.S. House of Representatives (June 30, 2010); 156
Cong. Rec. S5904 (daily ed. July 15, 2010)
(statement of Sen. Lincoln). See also letter from
Coalition for Derivatives End-Users to David A.
Stawick, Secretary, CFTC (July 11, 2011); letter from
Paul Cicio, President, Industrial Energy Users of
America, to David A. Stawick, Secretary, CFTC
(July 11, 2011); letter from Coalition for Derivatives
End-Users to Elizabeth Murphy, Secretary,
Commission and David A. Stawick, Secretary, CFTC
(Sept. 10, 2010).
265 See 17 CFR 240.15c3–1(c)(2)(iv)(B) (which
requires a broker-dealer—and would require a
broker-dealer SBSD—to deduct unsecured and
partly secured receivables); paragraph (c)(1)(iii)(B)
of proposed new Rule 18a–1 (which would contain
an analogous provision for stand-alone SBSDs).
266 See proposed new paragraph (c)(2)(xiv) of
Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed
Rule 18a–1.

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methodology in Appendix E to Rule
15c3–1.267 This charge would be
designed to balance the concern of
commercial end users that delivering
collateral to nonbank SBSDs could
disrupt their ability to enter into
hedging transactions with the need for
nonbank SBSDs to account for their
credit risk to commercial end users.
ANC broker-dealers currently are
permitted to add back to net worth
uncollateralized receivables from
counterparties arising from OTC
derivatives transactions (i.e., they can
add back the amount of the
uncollateralized current exposure).268
Instead of the 100% deduction that
applies to most unsecured receivables
under Rule 15c3–1, ANC broker-dealers
are permitted to take a credit risk charge
based on the uncollateralized credit
exposure to the counterparty.269 In most
cases, the credit risk charge is
significantly less than a 100%
deduction, since it is a percentage of the
amount of the receivable that otherwise
would be deducted in full. ANC brokerdealers are permitted to use this
approach because they are required to
implement processes for analyzing
credit risk to OTC derivative
counterparties and to develop
mathematical models for estimating
credit exposures arising from OTC
derivatives transactions and
determining risk-based capital charges
for those exposures.270 Under the
current requirements, this approach is
used for uncollateralized OTC
derivatives receivables from all types of
counterparties.271 For the reasons
discussed below, this treatment would
be narrowed under the proposed capital
requirements for ANC broker-dealers
and stand-alone SBSDs using internal
models so that it would apply only to
uncollateralized receivables from
commercial end users arising from
security-based swaps (i.e.,
uncollateralized receivables from other
types of counterparties would be subject
to the 100% deduction from net
worth).272
267 See proposed amendments to paragraph (a)(7)
of Rule 15c3–1; paragraph (a)(2) of proposed new
Rule 18a–1.
268 See 17 CFR 240.15c3–1e(c). OTC derivatives
dealers are permitted to treat such uncollateralized
receivables in a similar manner. See 17 CFR
240.15c3–1f.
269 See 17 CFR 240.15c3–1e(c); 17 CFR 240.15c3–
1(a)(7).
270 Id.
271 Id. While the requirements permit this
treatment for unsecured receivables from all types
of counterparties, the amount of the credit risk
charge—as discussed below—depends on the
creditworthiness of the counterparty. Id.
272 See proposed amendments to paragraphs (a)
and (c) of Rule 15c3–1e.

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The current requirements for
determining risk-based capital charges
for credit exposures are prescribed in
Appendix E to Rule 15c3–1. These
requirements are based on a method of
computing capital charges for credit risk
exposures in the international capital
standards for banking institutions. In
general terms, credit risk is the risk of
loss arising from a borrower or
counterparty’s failure to meet its
obligations in accordance with agreed
terms, including, for example, by failing
to make a payment of cash or delivery
of securities. The considerations that
inform an entity’s assessment of a
counterparty’s credit risk therefore are
broadly similar across the various
relationships that may arise between the
dealer and the counterparty.
Accordingly, the methodology in
Appendix E to Rule 15c3–1 should be
a reasonable model for determining riskbased capital charges for credit
exposures whether the entity in
question is an ANC broker-dealer or a
stand-alone SBSD using models.
Similarly, because credit risk arises
regardless of the number or size of
transactions, the methodology should
apply in a consistent manner whether
an entity deals exclusively in OTC
derivatives, maintains a significant book
of such derivatives, or only engages in
one from time to time.
As discussed above in section
II.A.2.b.i. of this release, the capital
standard in Rule 15c3–1 is a net liquid
assets test. The rule imposes this test by
requiring a broker-dealer to deduct all
illiquid assets, including most
unsecured receivables.273 The goal is to
require the broker-dealer to hold more
than one dollar of highly liquid assets
for each dollar of unsubordinated
liabilities. The rule requires a 100%
deduction for most types of unsecured
receivables because these assets cannot
be readily converted into cash to
provide immediate liquidity to the
broker-dealer.274 FOCUS Report data
and Commission staff experience with
supervising the ANC broker-dealers
indicates that ANC broker-dealers have
not engaged in a large volume of OTC
derivatives transactions since these
rules were adopted in 2004. Therefore,
they have not had significant amounts
of unsecured receivables that could be
subject to the credit risk charge
provisions in Appendix E to Rule 15c3–
1. However, when the Dodd-Frank Act’s
OTC derivatives reforms are
implemented and become effective,
ANC broker-dealers could significantly
273 See

17 CFR 240.15c3–1(c)(2)(iv).
Interpretation Guide to Net Capital
Computation for Brokers and Dealers, 32 FR at 858.
274 See

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increase the amount of the receivables
these firms have relating to OTC
derivatives. This development could
adversely impact the liquidity of the
ANC broker-dealers to the extent
exposures to OTC derivatives are not
collateralized.
For these reasons, ANC broker-dealers
(including broker-dealer SBSDs that are
approved to use internal models) would
be required to treat uncollateralized
receivables from counterparties arising
from security-based swaps like most
other types of unsecured receivables
(i.e., subjecting them to a 100%
deduction from net worth) except when
the counterparty is a commercial end
user. In the case of a commercial end
user, the ANC broker-dealer would be
permitted to continue to take a credit
risk charge in lieu of the 100%
deduction.275 Stand-alone SBSDs that
are approved to use internal models also
would be permitted to take a credit risk
charge for uncollateralized receivables
arising from security-based swaps with
(and only with) commercial end users in
lieu of the 100% deduction.276
Under the proposed capital
requirements for nonbank SBSDs, this
credit risk charge for a commercial end
user could serve as an alternative to the
proposed capital charge in lieu of
collecting collateral to cover potential
future exposure.277 The proposed
capital charge in lieu of margin is
designed to address situations where a
nonbank SBSD does not collect
sufficient (or any) collateral to cover
potential future exposure relating to
cleared and non-cleared security-based
swaps.278 This situation may arise with
respect to counterparties to non-cleared
security-based swaps that are
commercial end users because proposed
new Rule 18a–3 would not require
nonbank SBSDs to collect collateral
from them to cover either current or
potential future exposure.279
The proposed method for calculating
the credit risk charge for commercial
end users would be the same method
ANC broker-dealers currently are
permitted to use for all OTC derivatives
counterparties.280 A stand-alone SBSD
approved to use internal models would
275 See proposed amendments to paragraphs (a)
and (c) of Rule 15c3–1e.
276 See paragraph (e)(2) of proposed new Rule
18a–1.
277 See proposed new paragraph (c)(2)(xiv) of
Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed
Rule 18a–1.
278 Id.
279 See paragraph (c)(1)(iii)(A) of proposed new
Rule 18a–3.
280 See 17 CFR 240.15c3–1e(c); paragraph (e)(2) of
proposed new Rule 18a–1.

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use the same method.281 Under this
method, the credit risk charge is the
sum of three calculated amounts: (1) A
counterparty exposure charge; (2) a
concentration charge if the current
exposure to a single counterparty
exceeds certain thresholds; and (3) a
portfolio concentration charge if
aggregate current exposure to all
counterparties exceeds certain
thresholds.282
The first component of the credit risk
charge is the counterparty exposure
charge.283 An ANC broker-dealer must
determine an exposure charge for each
OTC derivatives counterparty. The first
component of the credit risk charge is
the aggregate of the exposure charges
across all counterparties. The exposure
charge for a counterparty that is
insolvent, in a bankruptcy proceeding,
or in default of an obligation on its
senior debt, is the net replacement value
of the OTC derivatives contracts with
the counterparty (i.e., the net amount of
the uncollateralized current exposure to
the counterparty).284 The counterparty
exposure charge for all other
counterparties is the credit equivalent
amount of the ANC broker-dealer’s
exposure to the counterparty multiplied
by an applicable credit risk weight
factor and then multiplied by 8%.285
The credit equivalent amount is the sum
of the ANC broker-dealer’s: (1)
Maximum potential exposure (‘‘MPE’’)
to the counterparty multiplied by a
back-testing determined factor; and (2)
current exposure to the counterparty.286
281 See paragraph (e)(2) of proposed new Rule
18a–1. While this discussion focuses on the
application of the method in the context of ANC
broker-dealers, the same method would be used by
stand-alone SBSDs for the reasons described above,
in particular the fact that credit risk exposure
should not vary materially depending on whether
an entity is a broker-dealer SBSD or a stand-alone
SBSD.
282 17 CFR 240.15c3–1e(c).
283 17 CFR 240.15c3–1e(c)(1). A stand-alone SBSD
approved to use internal models would be required
to take an identical credit risk charge for this type
of counterparty. See paragraph (e)(2)(i) of proposed
new Rule 18a–1.
284 See 17 CFR 240.15c3–1e(c)(1)(i). In other
words, the uncollateralized receivable is deducted
in full. A stand-alone SBSD approved to use
internal models would take an identical credit risk
charge for this type of counterparty. See paragraph
(e)(2)(i)(A) of proposed new Rule 18a–1.
285 See 17 CFR 240.15c3–1e(c)(1)(ii). A standalone SBSD approved to use internal models would
take an identical credit risk charge for this type of
counterparty. See paragraph (e)(2)(i)(B) of proposed
new Rule 18a–1. The 8% multiplier is consistent
with the calculation of credit risk in the OTC
derivatives dealers rules and with the Basel
Standard, and is designed to dampen leverage to
help ensure that the firm maintains a safe level of
capital. See Alternative Net Capital Requirements
Adopting Release, 69 FR at 34436, note 42.
286 See 17 CFR 240.15c3–1e(c)(4)(i). The amount
of the factor is based on backtesting exceptions. A
stand-alone SBSD approved to use internal models

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The MPE amount is a charge to address
potential future exposure and is
calculated using the ANC brokerdealer’s VaR model as applied to the
counterparty’s positions after giving
effect to a netting agreement with the
counterparty, taking into account
collateral received from the
counterparty, and taking into account
the current replacement value of the
counterparty’s positions.287 The current
exposure amount is the current
replacement value of the counterparty’s
positions after giving effect to a netting
agreement with the counterparty and
taking into account collateral received
from the counterparty.288
A collateral agreement gives the
dealer the right of recourse to an asset
or assets that can be sold or the value
of which can be applied in the event the
counterparty defaults on an obligation
arising from an OTC derivatives contract
between the dealer and the
counterparty.289 Collateral ‘‘ideally’’ is
‘‘an asset of stable and predictable
value, an asset that is not linked to the
value of the transaction in any way and
an asset that can be sold quickly and
easily if the need arises.’’ 290 Appendix
E to Rule 15c3–1 sets forth requirements
for taking account of collateral in
determining the MPE and current
exposure amounts.291 These
requirements are designed to require
collateral that meets the characteristics
noted above. The requirements, among
other things, include that the collateral
is: (1) Marked-to-market each day; (2)
subject to a daily margin maintenance
requirement;292 (3) in the ANC brokerdealer’s possession and control; (4)
liquid and transferable; (5) capable of
being liquidated promptly without
intervention of any other party; (6)
subject to a legally enforceable collateral
agreement; (7) not comprised of
securities issued by the counterparty or
would determine the credit equivalent amount in
the same manner. See paragraph (e)(2)(iv)(A) of
proposed new Rule 18a–1.
287 See 17 CFR 240.15c3–1e(c)(4)(ii). A standalone SBSD approved to use internal models would
compute MPE in the same manner. See paragraph
(e)(2)(iv)(B) of proposed new Rule 18a–1.
288 See 17 CFR 240.15c3–1e(c)(4)(iii). A standalone SBSD approved to use internal models would
compute current exposure in the same manner. See
paragraph (e)(2)(iv)(C) of proposed new Rule 18a–
1.
289 See Market Review of OTC Derivative Bilateral
Collateralization Practices at 5.
290 Id.
291 See 17 CFR 240.15c3–1e(c)(4)(v). A standalone SBSD approved to use internal models would
be subject to the same requirements in order to be
permitted to take into account collateral when
determining the MPE and current exposure
amounts. See paragraph (e)(2)(iv)(E) of proposed
new Rule 18a–1.
292 This refers to an internal maintenance margin
requirement (i.e., not one imposed by regulation).

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a party related to the ANC broker-dealer
or the counterparty; (8) comprised of
instruments that can be included in the
ANC broker-dealer’s VaR model; and (9)
not used in determining the credit rating
of the counterparty.293
Appendix E to Rule 15c3–1 sets forth
certain minimum requirements for
giving effect to netting agreements 294
when determining the MPE and current
exposure amounts.295 Specifically, an
ANC broker-dealer may include the
effect of a netting agreement that allows
the netting of gross receivables from and
gross payables to a counterparty upon
default of the counterparty if:
• The netting agreement is legally
enforceable in each relevant
jurisdiction, including in insolvency
proceedings;
• The gross receivables and gross
payables that are subject to the netting
agreement with a counterparty can be
determined at any time; and
• For internal risk management
purposes, the ANC broker-dealer
monitors and controls its exposure to
the counterparty on a net basis.296
These requirements are designed to
ensure that the netting agreement
between the ANC broker-dealer and the
counterparty permits the ANC brokerdealer to reduce the receivables and
293 See 17 CFR 240.15c3–1e(c)(4)(v)(A)–(H). A
stand-alone SBSD approved to use internal models
would be subject to the same requirements. See
paragraph (e)(2)(iv)(E)(1)–(8) of proposed new Rule
18a–1.
294 Netting agreements are bilateral contracts
between two counterparties that enter into OTC
derivatives contracts with each other. In netting
agreements, the two parties agree that if one
counterparty defaults, the pending OTC derivatives
contracts between the parties will be closed out and
a single net payment obligation will be determined
(as opposed to payment obligations for each
separate OTC derivatives contract between the
parties). The amount of the single net payment
obligation is determined by offsetting OTC
derivatives contracts that have a positive value to
a counterparty with OTC derivatives contracts that
have a negative value to the counterparty. After the
offsets, one counterparty has an amount of positive
value, which to the other counterparty is a negative
value. This is the amount of the single net payment
obligation. If the non-defaulting counterparty is
owed the single net payment amount, it can
liquidate collateral held to secure the obligations of
the defaulting counterparty. However, if the nondefaulting party does not hold collateral, it becomes
a general creditor of the defaulting counterparty
with respect to the amount of the single net
payment obligation.
295 See 17 CFR 240.15c3–1e(c)(4)(iv). A standalone SBSD approved to use internal models would
be subject to the same requirements in order to be
permitted to take into account netting agreements
when determining MPE and current exposure
amounts. See paragraph (e)(2)(iv)(D) of proposed
new Rule 18a–1.
296 See 17 CFR 240.15c3–1e(c)(4)(iv)(A)–(C). A
stand-alone SBSD approved to use internal models
would be subject to the same requirements. See
paragraphs (e)(2)(iv)(D)(1)–(3) of proposed new Rule
18a–1.

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payables between the two entities to a
single net payment obligation.
The counterparty exposure charge is
the sum of the MPE and current
exposure amounts multiplied by an
applicable credit risk weight factor and
then multiplied by 8%.297 Appendix E
to Rule 15c3–1 prescribes three
standardized credit risk weight factors
(20%, 50%, and 150%) and, as an
alternative, permits an ANC brokerdealer with Commission approval to use
internal methodologies to determine
appropriate credit risk weights to apply
to counterparties.298 A higher
percentage credit risk weight factor
results in a larger counterparty exposure
charge amount. Moreover, because the
counterparty exposure charge is
designed to require the ANC brokerdealer to hold capital to address the
firm’s credit risk exposure to the
counterparty, the selection of the
appropriate risk weight factor to use for
a given counterparty is based on an
assessment of the creditworthiness of
the counterparty. ANC broker-dealers
are permitted to use internally derived
credit ratings to select the appropriate
risk weight factor.299
297 See 17 CFR 240.15c3–1e(c)(1)(ii). As noted
above, an 8% multiplier is consistent with the
international bank capital standards and is designed
to dampen leverage to help ensure that the ANC
broker-dealer maintains a safe level of capital. See
Alternative Net Capital Requirements Adopting
Release, 69 FR at 34436.
298 See 17 CFR 240.15c3–1e(c)(4)(vi). A standalone SBSD approved to use internal models would
be subject to the same requirements. See paragraph
(e)(2)(iv)(F) of proposed new Rule 18a–1. The credit
risk weights in Appendix E to Rule 15c3–1 were
based on the international bank capital standards.
See Alternative Net Capital Requirements Adopting
Release, 69 FR at 34436 (‘‘These proposed credit
risk weights were based on the formulas provided
in the Foundation Internal Ratings-Based approach
to credit risk proposed by the Basel Committee and
were derived using a loss given default (the percent
of the amount owed by the counterparty the firm
expects to lose if the counterparty defaults) of
75%.’’) (citations omitted).
299 See 17 CFR 240.15c3–1e(c)(4)(vi)(D). There is
a basic method for ANC broker-dealers to determine
the applicable risk weight factor using external
credit ratings of NRSROs. See 17 CFR 240.15c3–
1e(c)(4)(vi)(A)–(C). Currently, all six ANC brokerdealers are approved to use internally derived
credit ratings. See Reference Removal Release, 76
FR at 26555. Pursuant to section 939A of the DoddFrank Act, the Commission has proposed
eliminating the basic method of using NRSRO
credit ratings and, consequently, if the proposals
are adopted, an ANC broker-dealer would be
required to use internally derived credit ratings. See
Public Law 111–203 § 939A and Reference Removal
Release, 76 FR at 26555–26556. Consistent with
section 939A of the Dodd-Frank Act, there would
not be a basic method for stand-alone SBSDs
approved to use internal models. See paragraph
(e)(2)(iv)(F) of proposed new Rule 18a–1.
Consequently, these nonbank SBSDs would be
required to use internally derived credit ratings to
determine the appropriate risk weight factor to
apply to a counterparty. This does not mean that
an ANC broker-dealer or stand-alone SBSD could

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The second component of an ANC
broker-dealer’s credit risk charge is a
counterparty concentration charge.300
This charge accounts for the additional
risk resulting from a relatively large
exposure to a single counterparty.301
This charge is triggered if the current
exposure of the ANC broker-dealer to a
counterparty exceeds 5% of the
tentative net capital of the ANC brokerdealer.302 In this case, the ANC brokerdealer must take a counterparty
concentration charge equal to: (1) 5% of
the amount by which the current
exposure exceeds 5% of tentative net
capital for a counterparty with a risk
weight factor of 20% or less; (2) 20% of
the amount by which the current
exposure exceeds 5% of tentative net
capital for a counterparty with a risk
weight factor of greater than 20% and
less than 50%; and (3) 50% of the
amount by which the current exposure
exceeds 5% of tentative net capital for
a counterparty with a risk weight factor
of 50% or more.303
The third—and final—component of
the credit risk charge is a portfolio
concentration charge.304 The portfolio
concentration charge is designed to
address the risk of having a relatively
large amount of unsecured receivables
relative to the size of the firm. This
charge is triggered when the aggregate
current exposure of the ANC brokerdealer to all counterparties exceeds 50%
of the firm’s tentative net capital.305 In
this case, the portfolio concentration
charge is equal to 100% of the amount
by which the aggregate current exposure
not include external credit ratings as part of its
internal credit rating methodology. See Reference
Removal Release, 76 FR at 26552–26553
(identifying external credit ratings as one of several
factors a broker-dealer could consider when
assessing credit risk under the Commission’s
proposals to substitute NRSRO credit ratings in the
broker-dealer rules with a different standard of
creditworthiness).
300 See 17 CFR 240.15c3–1e(c)(2). A stand-alone
SBSD approved to use internal models would be
subject to the same counterparty concentration
charge. See paragraph (e)(2)(ii) of proposed new
Rule 18a–1.
301 Concentration charges are intended to provide
a liquidity cushion if a lack of diversification of
positions exposes the firm to additional risk.
302 See 17 CFR 240.15c3–1e(c)(2)(i)–(iii). A standalone SBSD approved to use internal models would
be subject to the same threshold in determining the
counterparty concentration charge. See paragraphs
(e)(2)(ii)(A)–(C) of proposed new Rule 18a–1.
303 See 17 CFR 240.15c3–1e(c)(1)(i)–(iii). A standalone SBSD approved to use internal models would
be subject to the same charges. See paragraphs
(e)(2)(ii)(A)–(C) of proposed new Rule 18a–1.
304 See 17 CFR 240.15c3–1e(c)(3). A stand-alone
SBSD approved to use internal models would be
subject to the same portfolio concentration charge.
See paragraph (e)(2)(iii) of proposed new Rule 18a–
1.
305 17 CFR 240.15c3–1e(c)(3).

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exceeds 50% of the ANC broker-dealer’s
tentative net capital.306
Request for Comment
The Commission generally requests
comment on the proposed credit risk
charges. In addition, the Commission
requests comment, including empirical
data in support of comments, in
response to the following questions:
1. Should ANC broker-dealers and
stand-alone SBSDs using internal
models be required to deduct in full
unsecured receivables from commercial
end users, rather than being permitted
to use the proposed credit risk charge?
If so, explain why. If not, explain why
not. For example, would ANC brokerdealers and stand-alone SBSDs using
internal models have substantial
amounts of receivables from commercial
end users that, if not collateralized,
could adversely impact the liquidity of
these firms? If so, what measures in
addition to the proposed credit risk
charge could be implemented to address
the risk of uncollateralized credit risk
exposure to commercial end users in the
absence of a required 100% deduction?
Commenters should provide data to
support their responses to these
questions.
2. Should ANC broker-dealers and
stand-alone SBSDs using internal
models be required to take a capital
charge in lieu of margin for non-cleared
security-based swaps with commercial
end users? If so, explain why. If not,
explain why not. For example, would
ANC broker-dealers and stand-alone
SBSDs using internal models enter into
substantial amounts of non-cleared
security-based swaps with commercial
end users that could adversely impact
the risk profiles of these firms, if
collateral was not collected to cover
potential future exposure? If so, what
measures in addition to the proposed
credit risk charge could be implemented
to address this risk in the absence of a
required 100% deduction? Commenters
should provide data to support their
responses to these questions.
3. Is the credit risk charge an
appropriate measure to address the risk
to nonbank SBSDs of having
uncollateralized current and potential
future exposure to commercial end
users? If so, explain why. If not, explain
why not. Are there other measures that
could be implemented as an alternative
or in addition to the credit risk charge
to address the risk of this
uncollateralized exposure? If so,
306 See 17 CFR 240.15c3–1e(c)(3). A stand-alone
SBSD approved to use internal models would be
subject to the same charge. See paragraph (e)(2)(iii)
of proposed new Rule 18a–1.

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identify the measures and explain why
they would be appropriate alternatives
or supplements to the credit risk charge.
4. What will be the economic impact
of the credit risk charge? For example,
will the additional capital that a
nonbank SBSD would be required to
maintain because of the credit risk
charge result in costs that will be passed
through to end users? Please explain.
5. Should the application of the credit
risk charge be expanded to unsecured
receivables from other types of
counterparties? If so, explain why. If
not, explain why not. How would such
an expansion impact the liquidity of
nonbank SBSDs?
6. Should the application of the credit
risk charge be expanded to the other
exceptions to the margin collateral
requirements in proposed new Rule
18a–3? If so, explain why. If not, explain
why not. How would such an expansion
impact the risk profile of nonbank
SBSDs?
7. The ability to take a credit risk
charge in lieu of a 100% deduction for
an unsecured receivable would apply
only to unsecured receivables from
commercial end users arising from
security-based swap transactions.
Consequently, an ANC broker-dealer
and a nonbank SBSD would need to
take a 100% deduction for unsecured
receivables from commercial end users
arising from swap transactions. Should
the application of the credit risk charge
be expanded to include unsecured
receivables from commercial end users
arising from swap transactions? If so,
explain why. If not, explain why not.
How would such an expansion impact
the liquidity of nonbank SBSDs?
8. Is the overall method of computing
the credit risk charge appropriate for
nonbank SBSDs? If not, explain why
not. For example, are there differences
between ANC broker-dealers and
nonbank SBSDs that would make the
method of computing the credit risk
charge appropriate for the former but
not appropriate for the latter? If so,
identify the differences and explain why
they would make the credit risk charge
not appropriate for nonbank SBSDs.
What modifications should be made to
the method of computing the credit risk
charge for nonbank SBSDs?
9. Are the steps required to compute
the credit risk charge understandable? If
not, identify the steps that require
further explanation.
10. Is the method of computing the
first component of the credit risk
charge—the counterparty exposure
charge—appropriate for nonbank
SBSDs? If not, explain why not. For
example, is the calculation of the credit
equivalent amount for a counterparty

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(i.e., the sum of the MPE and the current
exposure to the counterparty) a
workable requirement for nonbank
SBSDs? If not, explain why not.
11. Are the conditions for taking
collateral into account when calculating
the credit equivalent amount
appropriate for nonbank SBSDs? If not,
explain why not.
12. Are the conditions for taking
netting agreements into account when
calculating the credit equivalent amount
appropriate for nonbank SBSDs? If not,
explain why not.
13. Are the standardized risk weight
factors (20%, 50%, and 150%) proposed
for calculating the credit equivalent
amount appropriate for nonbank
SBSDs? If not, explain why not.
14. Is the method of computing the
second component of the credit risk
charge—the counterparty concentration
charge—appropriate for nonbank
SBSDs? If not, explain why not.
15. Is the method of computing the
third component of the credit risk
charge—portfolio concentration
charge—appropriate for nonbank
SBSDs? If not, explain why not.
v. Capital Charge In Lieu of Margin
Collateral
As discussed above in section II.B. of
this release, collateral is one of the ways
dealers in OTC derivatives manage their
credit risk exposure to OTC derivatives
counterparties.307 Collateral may be
provided to cover the amount of the
current exposure of the dealer to the
counterparty.308 Collateral also may be
provided to cover the potential future
exposure of the dealer to the
counterparty, i.e., margin collateral.309
Clearing agencies will impose margin
collateral requirements on their clearing
members, including nonbank SBSDs, for
cleared security-based swaps.310 In
addition, as discussed below in section
II.B. of this release, proposed new Rule
18a–3 would establish margin collateral
requirements for nonbank SBSDs with
respect to non-cleared security-based
swaps.311 Furthermore, FINRA also
prescribes margin requirements for
security-based swaps.312
Rule 15c3–1 currently requires a
broker-dealer to take a deduction from
net worth for under-margined
accounts.313 Specifically, the brokerdealer is required to deduct from net
307 See Market Review of OTC Derivative Bilateral
Collateralization Practices.
308 See Independent Amounts.
309 Id. at 4.
310 See discussion below in section II.B. of this
release.
311 See proposed new Rule 18a–3.
312 See FINRA Rule 4240.
313 See 17 CFR 240.15c3–1(c)(2)(xii).

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worth the amount of cash required in
each customer’s and noncustomer’s
account to meet a maintenance margin
requirement of the firm’s designated
examining authority after application of
calls for margin, marks to the market, or
other required deposits which are
outstanding five business days or
less.314 These deductions serve the same
purpose as the deductions a brokerdealer is required to take on proprietary
securities positions in that they account
for risk of the positions in the
customer’s account, which the brokerdealer may need to liquidate if the
customer defaults on obligations to the
broker-dealer.
In order to prescribe a similar
requirement for security-based swap
positions, Rule 15c3–1 would be
amended to require broker-dealer SBSDs
to take a deduction from net worth for
the amount of cash required in the
account of each security-based swap
customer to meet the margin
requirements of a clearing agency, selfregulatory organization (‘‘SRO’’), or the
Commission, after application of calls
for margin, marks to the market, or other
required deposits which are outstanding
one business day or less.315 An
analogous provision would be included
in new Rule 18a–1, though it would not
refer to margin requirements of SROs
because stand-alone SBSDs will not be
members of SROs.316 These provisions
would require broker-dealer SBSDs to
take capital charges when their securitybased swap customers do not meet
margin collateral requirements of
clearing agencies, SROs, or the
Commission after one business day from
the date the margin collateral
requirement arises. The capital charge
would be designed to address the risk to
nonbank SBSDs that arises from not
collecting the margin collateral.317
As discussed below in section II.B. of
this release, proposed new Rule 18a–3
would require nonbank SBSDs to collect
collateral to meet account equity
requirements by noon of the next
business day from the day the account
equity requirement arises.318
Consequently, to be consistent with the
proposed requirement to collect
collateral within one day, the undermargined capital charge for securitybased swap accounts would be triggered
within one day of the margin
314 Id.
315 See proposed new paragraph (c)(2)(xii)(B) of
Rule 15c3–1.
316 See paragraph (c)(1)(ix) of proposed new Rule
18a–1.
317 See section II.B.1. of this release for a
discussion of the purpose of margin collateral.
318 See paragraph (c)(1)(ii) of proposed new Rule
18a–3.

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requirement arising, as opposed to the
five-day trigger in Rule 15c3–1.
In addition to the deductions for
under-margined security-based swap
accounts, the proposed rules would
impose capital charges designed to
address situations where the account of
a security-based swap customer is
meeting all applicable margin
requirements but the margin collateral
requirement results in the collection of
an amount of collateral that is
insufficient to address the risk because,
for example, the requirement for cleared
security-based swaps established by a
clearing agency does not result in
sufficient margin collateral to cover the
nonbank SBSD’s exposure or because an
exception to collecting margin collateral
for non-cleared security-based swaps
exists.319 These proposed capital
charges would not apply in the
circumstance, discussed in the
preceding section, involving unsecured
receivables from commercial end users,
which would be separately addressed by
proposed new Rule 18a–1 and proposed
amendments to Rule 15c3–1.320 The
proposed capital charges relating to
margin collateral would be required
deductions from the nonbank SBSD’s
net worth when computing net
capital.321 The proposals are intended to
require a nonbank SBSD to set aside net
capital to address the risks of potential
future exposure that are mitigated
through the collection of margin
collateral. The set aside net capital
would serve as an alternative to
obtaining margin collateral for this
purpose.
With respect to cleared security-based
swaps, for which margin requirements
will not be established by the
Commission, the rules would impose a
capital charge that would apply if a
nonbank SBSD collects margin
collateral from a counterparty in an
amount that is less than the deduction
that would apply to the security-based
swap if it was a proprietary position of
319 See proposed new paragraph (c)(2)(xiv) of
Rule 15c3–1; paragraph (c)(1)(viii) of proposed new
Rule 18a–1. The exceptions to the proposed margin
rule are discussed below.
320 As discussed above in section II.A.2.b.v. of
this release, nonbank SBSDs would be required to
take a 100% deduction to net worth when
calculating net capital equal to their
uncollateralized current exposure to a counterparty
arising from a security-based swap except that an
ANC broker-dealer and a stand-alone SBSD
approved to use internal models could take a credit
risk charge as an alternative to the 100% deduction
if the counterparty was a commercial end user. See
17 CFR 240.15c3–1(c)(2)(iv)(B) (which requires a
broker-dealer—and would require a broker-dealer
SBSD—to deduct unsecured and partly secured
receivables); paragraph (c)(1)(iii)(B) of proposed
new Rule 18a–1 (which would contain an
analogous provision for stand-alone SBSDs).
321 Id.

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the nonbank SBSD (i.e., less than an
amount determined by using the
standardized haircuts in Commission
Rule 15c3–1, as proposed to be
amended, and in proposed new Rule
18a–1 or a VaR model, as applicable).322
This aspect of the proposal is intended
to adequately account for the risk of the
counterparty defaulting by requiring the
nonbank SBSD to maintain capital in
the place of margin collateral in an
amount that is no less than would be
required for a proprietary position.323
This requirement also is intended to
ensure that there is a standard minimum
coverage for exposure to cleared
security-based swap counterparties
apart from the individual clearing
agency margin requirements, which
could vary among clearing agencies and
over time. If the counterparty defaults,
the nonbank SBSD would need to
liquidate the counterparty’s cleared
security-based swaps and other
positions in the account to cover the
counterparty’s obligation to the nonbank
SBSD. Thus, the nonbank SBSD will
become subject to the market risk of
these positions in the event of the
counterparty’s default. If the positions
decrease in value, the nonbank SBSD
may not be able to cover the defaulted
counterparty’s obligations to the
nonbank SBSD through the liquidation
of the positions because the cash
proceeds from the liquidation may yield
less than the obligation.
Margin collateral is designed to
mitigate this risk by serving as a buffer
to account for a decrease in the market
value of the counterparty’s positions
between the time of the default and the
liquidation. If the amount of the margin
collateral is insufficient to make up the
difference, the nonbank SBSD will incur
losses. This proposed capital charge is
designed to require the nonbank SBSD
to hold sufficient net capital, as an
alternative to margin, to enable it to
withstand such losses.
With respect to non-cleared securitybased swaps, the rules would impose
capital charges to address three
exceptions in proposed new Rule 18a–
3 (the nonbank SBSD margin rule).324
322 See proposed paragraph (c)(2)(xiv)(A) of Rule
15c3–1; paragraph (c)(1)(viii)(A) of proposed Rule
18a–1.
323 As discussed in section II.B.2. of this release,
the margin requirements for non-cleared securitybased swaps would be the same as the deductions
to net capital that a nonbank SBSD would take on
the positions under Rule 15c3–1, as proposed to be
amended, and proposed new Rule 18a–1.
324 See paragraphs (c)(1)(iii)(A), (C), and (D) of
proposed new Rule 18a–3. There is a fourth
exception in proposed new Rule 18a–3 under
which a nonbank SBSD would not be required to
collect margin collateral to cover potential future
exposure to another SBSD. See paragraph

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Under these three exceptions, a
nonbank SBSD would not be required to
collect (or, in one case, hold) margin
collateral. As discussed below in section
II.B.2.b. of this release, proposed Rule
18a–3 would require a nonbank SBSD to
perform a daily calculation of a margin
amount for the account of each
counterparty to a non-cleared securitybased swap transaction.325 Proposed
new Rule 18a–3 also would require a
nonbank SBSD to collect and hold
margin collateral (in the form of cash,
securities, and/or money market
instruments) from each counterparty in
an amount at least equal to the
calculated margin amount to the extent
that amount is greater than the amount
of positive equity in the account.326 The
rule would, however, provide
exceptions in certain cases.327
(c)(1)(iii)(B)—Alternative A of proposed new Rule
18a–3. There would not be a capital charge in lieu
of collecting margin collateral from another SBSD
because capital charges could impact the firm’s
liquidity, and each SBSD would be subject to
regulatory capital requirements. A second
alternative (Alternative B) being proposed in new
Rule 18a–3 would require a nonbank SBSD to have
margin collateral posted to an account at a thirdparty custodian in an amount sufficient to cover the
nonbank SBSD’s potential future exposure to the
other SBSD. See paragraph (c)(1)(iii)(B)—
Alternative B—of proposed new Rule 18a–3. These
two alternatives are discussed in more detail in
section II.B.2. of this release.
325 See paragraph (c)(1)(i)(B) of proposed new
Rule 18a–3. The term margin in proposed new Rule
18a–3 would be defined to mean the amount of
positive equity in an account of a counterparty. See
paragraph (b)(5) of proposed new Rule 18a–3.
326 See paragraph (c)(1)(ii) of proposed new Rule
18a–3. See also paragraph (c)(4) of proposed new
Rule 18a–3 (requiring among other things that
collateral be in the physical possession or control
of the nonbank SBSD and that the collateral must
be capable of being liquidated promptly by the
nonbank SBSD). As discussed in section II.B.2. of
this release, the term equity in proposed new Rule
18a–3 would be defined to mean the total current
fair market value of securities positions in an
account of a counterparty (excluding the time value
of an over-the-counter option), plus any credit
balance and less any debit balance in the account
after applying a qualifying netting agreement with
respect to gross derivatives payables and
receivables. See paragraph (b)(4) of proposed new
Rule 18a–3. The term negative equity in proposed
new Rule 18a–3 would be defined to mean equity
of less than $0. See paragraph (b)(6) of proposed
new Rule 18a–3. The term positive equity in
proposed new Rule 18a–3 would be defined to
mean equity of greater than $0. See paragraph (b)(7)
of proposed new Rule 18a–3.
327 See paragraphs (c)(1)(iii)(A), (C), and (D) of
proposed new Rule 18a–3. As noted above and
discussed in more detail in section II.B.2. of this
release, one alternative being considered is to
establish a fourth exception in proposed new Rule
18a–3 under which a nonbank SBSD would not be
required to collect margin collateral to cover
potential future exposure to another SBSD. See
paragraph (c)(1)(iii)(B) of proposed new Rule 18a–
3. Under this alternative, there would not be a
capital charge in lieu of collecting margin collateral
from the other SBSD because capital charges could
impact the firm’s liquidity, and each SBSD would
be subject to regulatory capital requirements. The
other alternative would require nonbank SBSDs to

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Consequently, the three proposed
capital charges discussed below are
designed to serve as an alternative to
margin collateral by requiring the
nonbank SBSD to hold sufficient net
capital to enable it to withstand losses
if the counterparty defaults.
The first proposed capital charge
would apply when a nonbank SBSD not
approved to use internal models does
not collect sufficient margin collateral
from a counterparty to a non-cleared
security-based swap because the
counterparty is a commercial end
user.328 As discussed below in section
II.B.2.c.i. of this release, a nonbank
SBSD would not be required to collect
margin collateral from commercial end
users for non-cleared security-based
swaps.329 The nonbank SBSD would be
required to take a capital charge equal
to the margin amount less any positive
equity in the account of the commercial
end user if the nonbank SBSD did not
collect margin collateral from the
commercial end user pursuant to this
exception.330 As discussed above in
section II.A.2.b.iv. of this release, as an
alternative to this deduction, an ANC
broker-dealer and a stand-alone SBSD
approved to use internal models could
incur a credit risk charge.
The second proposed capital charge
would apply when the nonbank SBSD
does not hold the margin collateral
because the counterparty to the noncleared security-based swap is requiring
the margin collateral to be segregated
pursuant to section 3E(f) of the
Exchange Act.331 Section 3E(f) of the
Exchange Act, among other things,
provides that the segregated account
authorized by that provision must be
carried by an independent third-party
custodian and be designated as a
segregated account for and on behalf of
the counterparty.332 Collateral held in
this manner would not be in the
have margin collateral posted to an account at a
third-party custodian in an amount sufficient to
cover the nonbank SBSD’s potential future exposure
to the other SBSD.
328 See proposed paragraph (c)(2)(xiv)(B)(1) of
Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed
new Rule 18a–1.
329 See paragraph (c)(1)(iii)(A) of proposed new
Rule 18a–3.
330 See proposed new paragraph (c)(2)(xiv)(B)(1)
of Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of
proposed new Rule 18a–1. If collateral is not
collected from a commercial end user, the nonbank
SBSD would be required to take a 100% deduction
for the amount of the uncollateralized current
exposure. As discussed above in section II.A.2.b.iv.
of this release, as alternative to this deduction, an
ANC broker-dealer and a stand-alone SBSD
approved to use internal models could take a credit
risk charge.
331 See proposed new paragraph (c)(2)(xiv)(B)(2)
of Rule 15c3–1; paragraph (c)(1)(viii)(B)(2) of
proposed new Rule 18a–1.
332 See 15 U.S.C. 78c–5(f)(3).

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physical possession or control of the
nonbank SBSD, nor would it would be
capable of being liquidated promptly by
the nonbank SBSD without the
intervention of another party.
Consequently, it would not meet
collateral requirements in proposed new
Rule 18a–3.333 Because collateral
segregated under section 3E(f) of the
Exchange Act would not be under the
control of the nonbank SBSD, consistent
with the existing capital requirements
that apply to broker-dealers, the
Commission is proposing to require the
nonbank SBSD to take a capital charge
equal to the margin amount less any
positive equity in the account of the
counterparty.334
The third proposed capital charge
would apply when a nonbank SBSD
does not collect sufficient margin
collateral from a counterparty to a noncleared security-based swap because the
transaction was entered into prior to the
effective date of proposed new Rule
18a–3 (a ‘‘legacy non-cleared securitybased swap’’).335 The nonbank SBSD
would not be required to collect margin
collateral for accounts holding legacy
non-cleared security-based swaps.336
This proposal is designed to avoid the
difficulties of requiring a nonbank SBSD
to renegotiate security-based swap
contracts in order to come into
compliance with new margin collateral
requirements, which would be a
complex task.337 In lieu of collecting the
margin collateral, the nonbank SBSD
would be required to take a capital

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333 See

paragraphs (c)(4)(i) and (iii) of proposed
new Rule 18a–3.
334 See proposed new paragraph (c)(2)(xiv)(B)(2)
of Rule 15c3–1; paragraph (c)(1)(viii)(B)(2) of
proposed new Rule 18a–1.
335 See proposed new paragraph (c)(2)(xiv)(B)(3)
of Rule 15c3–1; paragraph (c)(1)(viii)(B)(3) of
proposed new Rule 18a–1.
336 See paragraph (c)(1)(iii)(D) of proposed new
Rule 18a–3. A nonbank SBSD would need to take
a 100% deduction for the amount of the
uncollateralized current exposure arising from a
legacy non-cleared security-based swap because (as
discussed above) this amount would be an
unsecured receivable from the counterparty and
subject to a 100% deduction in the computation of
net capital under Rule 15c3–1 and proposed new
Rule 18a–1.
337 The CFTC has proposed a similar exception
for legacy swap transactions. See CFTC Margin
Proposing Release, 76 FR at 23734 (‘‘The
Commission believes that the pricing of existing
swaps reflects the credit arrangements under which
they were executed and that it would be unfair to
the parties and disruptive to the markets to require
that the new margin rules apply to those
positions.’’). The prudential regulators proposed to
permit a covered swap entity to exclude preeffective swaps from initial margin calculations,
while requiring these entities to collect variation
margin, consistent with industry practice.
Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27569.

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charge equal to the margin amount less
any positive equity in the account.338
Request for Comment
The Commission generally requests
comment on the proposed capital in lieu
of margin requirements. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Would the proposed deductions for
under-margined accounts be appropriate
for cleared security-based swap margin
requirements, which would be
established by clearing agencies and
SROs? If not, explain why not. For
example, is the requirement to take the
deduction after one business day
workable in the context of cleared
security-based swaps? If not, explain
why not. In addition, should the margin
requirements of clearing agencies be
included in the deduction for undermargined accounts?
2. Would the proposed deductions for
under-margined accounts be appropriate
for non-cleared security-based swap
margin requirements, which would be
established by proposed new Rule 18a–
3 and, potentially, by SROs? If not,
explain why not. For example, is the
requirement to take the deduction after
one business day workable in the
context of non-cleared security-based
swaps? If not, explain why not.
3. Should there be a deduction for
under-margined swap accounts? If so,
explain why. If not, explain why not.
338 The prudential regulators and CFTC have not
proposed new capital charges for legacy swaps and
legacy security-based swaps; nor have they
proposed specific margin collateral requirements
for such positions. See Prudential Regulator Margin
and Capital Proposing Release, 76 FR 27564; CFTC
Capital Proposing Release, 76 FR 27802; CFTC
Margin Proposing Release, 76 FR 23732. With
respect to banks, the credit risk of holding legacy
security-based swap positions is already taken into
account by existing capital requirements for banks.
The proposed capital charge in lieu of margin for
nonbank SBSDs is based on a concern that, after
SBSD registration requirements take effect, financial
institutions may transfer large volumes of legacy
non-cleared security-based swaps from unregulated
affiliates to newly registered nonbank SBSDs,
including broker-dealer SBSDs. As noted above, the
Commission understands that registered brokerdealers currently do not engage in a high volume
of security-based swap transactions. An influx of
legacy non-cleared security-based swaps into a
newly registered nonbank SBSD could create
substantial risks to the entity. Under the proposed
rule, nonbank SBSDs would be required to hold
sufficient collateral to cover the current exposure
and potential future exposure that arise from these
transactions or, alternatively, to take appropriate
capital charges to address these risks. Entities
holding legacy non-cleared security-based swaps
could either obtain additional capital in order to
register as nonbank SBSDs or legacy non-cleared
security-based swaps could be held and ‘‘wound
down’’ in one entity while a separate entity is used
to conduct new business.

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4. Would the proposed capital charges
in lieu of collecting margin collateral
appropriately address the potential
future exposure risk of nonbank SBSDs
arising from security-based swaps? If
not, explain why not. Are there
alternative means of addressing this
risk? If so, identify and explain them.
5. Is the proposed capital charge in
lieu of margin for cleared security-based
swaps appropriate? If not, explain why
not. In particular, if the amount of
margin collateral required to be
collected for cleared security-based
swaps is less than the capital deduction
that would apply to the positions,
would the margin collateral nonetheless
be sufficient? If so, explain why. In
addition, should SBSDs approved to use
internal models be permitted to use
their VaR models (as opposed to the
standardized haircuts) for purposes of
determining whether this capital charge
applies? If so, explain why.
6. Is the proposed capital charge in
lieu of margin for non-cleared securitybased swaps with counterparties that
are commercial end users appropriate?
If not, explain why not.
7. Should there be an exception for
broker-dealer SBSDs and stand-alone
SBSDs not using internal models from
the requirement to take a capital charge
in lieu of collecting margin collateral
from commercial end users? If so,
explain why such an exception would
not negatively impact the risk profiles of
these nonbank SBSDs and suggest
alternative measures that could be
implemented to address the risk of
uncollateralized potential future
exposure to commercial end users.
8. Should there be a capital charge in
lieu of margin for non-cleared swaps
with counterparties that are commercial
end users? If so, explain why. If not,
explain why not.
9. Is it appropriate to apply the
proposed capital charge in lieu of
margin for non-cleared security-based
swaps with counterparties that require
segregation pursuant to section 3E(f) of
the Exchange Act? If not, explain why
not.
10. Should there be an exception for
counterparties that require segregation
pursuant to section 3E(f) of the
Exchange Act from the requirement to
take a capital charge in lieu of margin
collateral? If so, explain why such an
exception would not negatively impact
the risk profiles of nonbank SBSDs and
suggest alternative measures that could
be implemented to address the risk of
not holding collateral to cover the
potential future exposure.
11. Should there be a capital charge
in lieu of margin for non-cleared swaps
with counterparties that require margin

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collateral with respect to the swaps to
be segregated and held by an
independent third party custodian? If
so, explain why. If not, explain why not.
12. Is the proposed capital charge in
lieu of margin for non-cleared securitybased swaps in accounts that hold
legacy security-based swaps
appropriate, or should there be an
exception from the capital charge for
legacy security-based swaps? Is there an
alternate measure that could be
implemented to address the risk of
uncollateralized potential future
exposure resulting from legacy securitybased swaps? If the proposed capital
charge applies to legacy security-based
swaps, explain how the proposed
capital charge in lieu of margin
collateral would change the economics
of the transactions previously entered
into. How would any such change(s) be
reflected in the cost of maintaining
those, or initiating, new positions?
Would there be any other impacts of the
change in treatment of the legacy
positions?
13. If there is an exception from the
capital charge for legacy security-based
swaps, how would such an exception
impact the risk profiles of nonbank
SBSDs?
14. After the SBSD registration
requirements take effect, would
substantial amounts of legacy securitybased swaps with uncollateralized
potential future exposure be transferred
to broker-dealer SBSDs? Would entities
with substantial amounts of legacy
security-based swaps with
uncollateralized potential future
exposure register as stand-alone SBSDs?
15. Would it be practical for financial
institutions to wind down legacy
security-based swaps in existing entities
rather than transferring them to
nonbank SBSDs? What legal and
operational issues would this approach
raise?
16. Should there be a capital charge
in lieu of margin for non-cleared swap
accounts that hold legacy swaps? If so,
explain why. If not, explain why not.
17. What should be deemed a legacy
security-based swap? For example, if a
nonbank SBSD dealer holds an existing
legacy security-based swap that is
subsequently modified for risk
mitigation purposes, should this be
deemed a new security-based swap
transaction or should it continue to be
treated as a legacy security-based swap?
vi. Treatment of Swaps
CFTC Rule 1.17 prescribes minimum
capital requirements for FCMs.339 The
rule imposes a net liquid assets test
339 See

17 CFR 1.17.

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capital standard.340 Broker-dealers that
are registered as FCMs are subject to
Rule 15c3–1 and CFTC Rule 1.17.341
CFTC Rule 1.17 provides that an FCM
registered as a broker-dealer must
maintain a minimum amount of
adjusted net capital equal to the greater
of, among other amounts, the minimum
amount of net capital required by Rule
15c3–1.342 CFTC Rule 1.17 also
prescribes standardized haircuts for
securities positions by incorporating by
reference the standardized haircuts in
Rule 15c3–1.343 Similarly, Rule 15c3–1,
through Appendix B, prescribes capital
deductions for commodities positions of
a broker-dealer by incorporating by
reference deductions in CFTC Rule 1.17
to the extent Rule 15c3–1 does not
otherwise prescribe a deduction for the
type of commodity position.344
Broker-dealer SBSDs (as brokerdealers) would be subject to Appendix
B to Rule 15c3–1.345 Appendix B to
proposed new Rule 18a–1 would
prescribe capital deductions for
commodities positions of stand-alone
SBSDs and would be modeled on
Appendix B to Rule 15c3–1.346
Consequently, under the provisions of
Rule 15c3–1 and proposed new Rule
18a–1, nonbank SBSDs would be
required to take deductions for
commodity positions when computing
net capital.347
In addition, nonbank SBSDs and
broker-dealers may have proprietary
positions in swaps. Consequently,
Appendix B to Rule 15c3–1 would be
amended to establish standardized
haircuts for proprietary swap positions
and analogous provisions would be
included in Appendix B to proposed
340 Id.
341 See

17 CFR 240.15c3–1; 17 CFR 1.17.
17 CFR 1.17(a)(1)(i)(D).
343 See 17 CFR 1.17(c)(5)(v)–(vii).
344 See 17 CFR 240.15c3–1b(a)(1).
345 17 CFR 240.15c3.–1b.
346 Compare 17 CFR 240.15c3–1b, with Appendix
B to proposed new Rule 18a–1. As discussed above
in section II.A.2.b.ii. of this release, a brokerdealer’s minimum net capital requirement is the
greater of a fixed-dollar amount specified in Rule
15c3–1 and an amount determined by applying one
of two financial ratios: the 15-to-1 aggregate
indebtedness to net capital ratio or the 2% of
customer debit items ratio. The minimum net
capital requirement for a stand-alone SBSD under
proposed Rule 18a–1, however, would not use
either of these financial ratios; rather, its minimum
net capital requirement would be determined by
calculating the 8% margin factor. Appendix B to
Rule 15c3–1 contains provisions that factor into a
broker-dealer’s calculation of the aggregate
indebtedness financial ratio. See 17 CFR 240.15c3–
1b(a)(1) and (a)(2). Those provisions are not
included in Appendix B to proposed new Rule 18a–
1 because stand-alone SBSDs would not use the
aggregate indebtedness financial ratio to determine
their minimum net capital requirement.
347 See 17 CFR 240.15c3–1b; Appendix B to
proposed new Rule 18a–1.
342 See

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new Rule 18a–1.348 This would make
the standardized swap haircuts
applicable to nonbank SBSDs and
broker-dealers.349 An ANC broker-dealer
and a stand-alone SBSD could apply to
include different types of swaps in their
VaR models. If approved, the firm
would not need to apply the
standardized haircuts for the type of
swaps covered by the approved models.
The proposed standardized haircuts
for swaps are similar to the proposed
standardized haircuts for security-based
swaps. Specifically, swaps that are
credit default swaps referencing a broad
based securities index (‘‘Index CDS
swaps’’) would be subject to a maturity
grid similar to the proposed maturity
grid for CDS security-based swaps.350
All other swaps would be subject to a
standardized haircut determined by
multiplying the notional amount of the
swap by the percentage deduction that
would apply to the type of asset or event
referenced by the swap.
Index CDS Swaps
The standardized haircuts proposed
for Index CDS swaps would use the
maturity grid approach proposed for
CDS security-based swaps discussed
above in section II.A.2.b.ii. of this
release. This would provide for a
consistent standardized haircut
approach for Index CDS swaps and CDS
security-based swaps though, as
discussed below, the haircuts would be
lower for the Index CDS security-based
swaps. As with CDS security-based
swaps, the proposed maturity grid for
Index CDS swaps prescribes the
applicable deduction based on two
variables: the length of time to maturity
of the swap and the amount of the
current offered spread on the swap.351
The vertical axis of the proposed grid
would contain nine maturity categories
ranging from 12 months or less (the
smallest deduction) to 121 months and
longer (the largest deduction).352 The
horizontal axis would contain six
spread categories ranging from 100 basis
points or less (the smallest deduction) to
348 See proposed new paragraph (b) of Rule 15c3–
1b; paragraph (b) of proposed new Rule 18a–1b.
349 A nonbank SBSD that is registered as a swap
dealer with the CFTC also would be required to
comply with the CFTC’s capital requirements
applicable to swap dealers as would a broker-dealer
that is registered as a swap dealer (just as a brokerdealer registered as an FCM must comply with Rule
15c3–1 and CFTC Rule 1.17).
350 See proposed new paragraph (b)(1)(i) of Rule
15c3–1b; paragraph (b)(1)(i) of proposed new Rule
18a–1b.
351 See proposed new paragraph (b)(1)(i)(A) of
Rule 15c3–1b; paragraph (b)(1)(i)(A) of proposed
new Rule 18a–1b.
352 Id.

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700 basis points and above (the largest
deduction).353
The haircut percentages in the
proposed maturity grid for Index CDS
swaps would be one-third less than the
haircut percentages in the maturity grid
for CDS security-based swaps to account
for the diversification benefits of an
index.354 For example, the proposed
haircut for an Index CDS swap with a
maturity of 12 months or less and a
spread of 100 basis points or less would
be 0.67% as opposed to a 1% haircut for
a CDS security-based swap in the same
maturity and spread categories. This
one-third reduction in the haircut
percentages is consistent with how
broad-based equity security-indices are
treated in the Appendix A methodology
as compared with single name equity
securities and narrow-based equity
index securities. Specifically, as
discussed above in section II.A.2.b.ii. of
this release, the Appendix A
methodology requires portfolios of
single name equity securities and
narrow-based equity index securities to
be stressed at 10 equidistant valuation
points within a range consisting of a
(+/¥) 15% market move. Portfolios of
broad-based equity index securities are
stressed at 10 equidistant valuation
points within a range consisting of a
(+/¥) 10% market move, which is twothirds of the market move range
applicable to single name equity
securities and narrow-based equity
index securities.
Consistent with the maturity grid
approach for CDS security-based swaps,
the proposed deduction for an unhedged long position in an Index CDS
swap would be 50% of the applicable
haircut in the grid.355 The proposed
deduction requirements for Index CDS
swaps would permit a nonbank SBSD to
net long and short positions where the
credit default swaps reference the same
index, are in the same spread categories,
are in the same maturity categories or in
adjacent maturity categories, and have
maturities within three months of each
other.356 In this case, the nonbank SBSD
would need to take the specified haircut
only on the notional amount of the
excess long or short position.357
Reduced deductions also would apply
for strategies where the firm is long a
basket of securities consisting of the
components of an index and long (buyer
353 Id.
354 Id.
355 See proposed new paragraph (b)(1)(i)(B) of
Rule 15c3–1b; paragraph (b)(1)(i)(B) of proposed
new Rule 18a–1b.
356 See proposed new paragraph (b)(1)(i)(C)(1) of
Rule 15c3–1b; paragraph (b)(1)(i)(C)(1) of proposed
new Rule 18a–1b.
357 Id.

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of protection on) an Index CDS swap on
the index.358 The reduced deduction for
this strategy would apply only if the
credit default swap allowed the
nonbank SBSD to deliver a security in
the basket to satisfy the firm’s obligation
on the swap.359 In this case, the
nonbank SBSD would be required to
take 50% of the deduction required on
the securities in the basket (i.e., no
deduction would be required with
respect to the Index CDS swap and a
lesser deduction would apply to the
securities).360 If the nonbank SBSD is
short (seller of protection) a basket of
securities consisting of the components
of an index and short a credit default
swap that references the index, the
nonbank SBSD would be required only
to take the deduction required on the
securities in the basket (i.e., no
deduction would be required with
respect to the Index CDS swap).361
Interest Rate Swaps
For interest rate swaps, Appendix B to
both Rule 15c3–1 and proposed new
Rule 18a–1 would prescribe a
standardized haircut equal to a
percentage of the notional amount of the
swap that is generally based on the
standardized haircuts in Rule 15c3–1 for
U.S. government securities.362 An
interest rate swap typically involves the
exchange of specified or determinable
cash flows at specified times based
upon a notional amount.363 The
notional amount is not exchanged but is
used to calculate the fixed or floating
rate interest payments under the swap.
Under the proposed rule, each side of
the interest rate swap would be
converted into a synthetic bond position
based on the notional amount of the
swap and the interest rates against
which payments are calculated. These
synthetic bonds would then be placed
into the standardized haircut grid in
Rule 15c3–1 for U.S. government
securities. Any obligation to receive
payments under the swap would be
categorized as a long position; any
obligation to make payments under the
swap would be categorized as a short
position. A position receiving or paying
based on a floating interest rate
generally would be treated as having a
maturity equal to the period until the
358 See proposed new paragraph (b)(1)(i)(C)(2) of
Rule 15c3–1b; paragraph (b)(1)(i)(C)(2) of proposed
new Rule 18a–1b.
359 Id.
360 Id.
361 See proposed new paragraph (b)(1)(i)(C)(3) of
Rule 15c3–1b; paragraph (b)(1)(i)(C)(3) of proposed
new Rule 18a–1b.
362 See 17 CFR 240.15c3–1(c)(2)(vi)(A).
363 See Net Capital Rule, Exchange Act Release
No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec. 30,
1997).

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next interest reset date; a position
receiving or paying based on a fixed rate
would be treated as having a maturity
equal to the residual maturity of the
swap. Synthetic bond equivalents
derived from interest rate swaps, when
offset against one another, would be
subject to a one percent charge based on
the swap’s notional amount. Any
synthetic bond equivalent that would be
subject to a standardized haircut of less
than one percent under the approach
described above would be subject to a
minimum deduction equal to a one
percent charge against the notional
value of the swap.364 This minimum
haircut of one percent is designed to
account for potential differences
between the movement of interest rates
on U.S. government securities and
interest rates upon which swap
payments are based.
All Other Swaps
In the case of a swap that is not an
Index CDS swap or an interest rate
swap, the applicable haircut would be
the amount calculated by multiplying
the notional value of the swap and the
percentage specified in either Rule
15c3–1 or CFTC Rule 1.17 for the asset,
obligation, or event referenced by the
swap.365 For example, a swap
referencing a commodity that is not
covered by an open futures contract or
commodity option would be subject to
a capital deduction applicable to the
commodity as if it were a long or short
inventory position with a market value
equal to the notional value of the swap.
This would typically result in a
deduction equal to 20% of the notional
value of the swap.366 The deduction for
un-hedged currency swaps referencing
certain major foreign currencies,
including the euro, British pounds,
Canadian dollars, Japanese yen, or
Swiss francs, would be 6%.367 This
364 Under Rule 15c3–1, U.S. government
securities with a maturity of less than nine months
are subject to net capital deductions ranging from
three-quarters of 1% to 0%. See 17 CFR 240.15c3–
1(c)(2)(vi)(A)(1)(i)–(iii).
365 See proposed new paragraph (b)(2) of Rule
15c3–1b; paragraph (b)(2) of proposed new Rule
18a–1b.
366 See 17 CFR 240.15c3–1b(a)(3)(ix)(C);
paragraph (a)(2)(ix)(C) of proposed new Rule 18a–
1b.
367 See CFTC Rule 1.17(c)(5)(ii)(E) (imposing a
6% haircut). 17 CFR 1.17(c)(5)(ii)(E). Currency
swaps may involve exchanges of fixed amounts of
currencies. If a nonbank SBSD has a currency swap
in which it receives one foreign currency and pays
out another foreign currency, the broker-dealer
would treat the currency swap as a long position
in a forward of the one foreign currency and an
unrelated short position in the other foreign
currency for capital purposes. See, e.g., Net Capital
Rule, Exchange Act Release No. 32256 (May 4,
1993), 58 FR 27486, 27490 (May 10, 1993).

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deduction could be reduced by an
amount equal to any reduction
recognized for a comparable long or
short position in the referenced
instrument, obligation, or event under
Appendix B to Rule 15c3–1, as
proposed to be amended, and proposed
new Rule 18a–1, or CFTC Rule 1.17. For
example, a commodity swap referencing
an agricultural product that is covered
by an open futures contract or
commodity option in that product
would be subject to a 5% deduction
from the notional value of the swap,
rather than the 20% deduction specified
above.368 Finally, swaps referencing an
equity index could be treated under
Appendix A to Rule 15c3–1 and
proposed new Rule 18a–1.

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Request for Comment
The Commission generally requests
comment on the proposed standardized
haircuts swaps. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Which types of swap activities
would nonbank SBSDs engage in? How
would nonbank SBSDs use swaps?
2. Which types of swap activities
would broker-dealers engage in? How
would broker-dealers use swaps?
3. Do the proposed standardized
haircuts for swaps provide a reasonable
and workable solution for determining
capital charges? Explain why or why
not. Are there preferable alternatives? If
so, describe those alternatives.
4. Are there additional categories of
swaps, other than commodity swaps,
currency swaps, and interest rate swaps,
that the Commission should address in
Rule 15c3–1 and/or proposed Rule
18a–1? If so, describe them.
5. Are the proposed standardized
haircuts for swaps too high or too low?
If so, please explain why and provide
data to support the explanation.
6. Are there capital charges that
should be applied to swaps? If so,
describe them.
7. Do the proposed standardized
haircuts for swaps adequately recognize
offsets in establishing capital
deductions? If not, what offsets should
be recognized, for what type of swap,
and why? Provide data, if applicable,
and identify why that offset would be
appropriate.
8. Do the proposed standardized
haircuts for swaps provide any
incentives or disincentives to effect
swap transactions in a particular type of
368 See 17 CFR 240.15c3–1b(a)(3)(ix)(B);
paragraph (a)(2)(ix)(B) of proposed new Rule 18a–
1b.

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legal entity (e.g., in a stand-alone SBSD
versus a broker-dealer SBSD)? Describe
the incentives and/or disincentives.
9. Do the proposed standardized
haircuts for swaps provide any
competitive advantages or
disadvantages for a particular type of
legal entity? Describe the advantages
and/or disadvantages.
10. How closely do the movements of
interest rates on U.S. government
securities track the movements of
interest rates upon which interest rate
swap payments are based? Is the
proposed 1% minimum percentage
deduction for interest rate swaps
appropriate given that U.S. government
securities with a maturity of less than
nine months have a haircut ranging
from three-quarters of 1% to 0%?
c. Risk Management
Prudent financial institutions
establish and maintain integrated risk
management systems that seek to have
in place management policies and
procedures designed to help ensure an
awareness of, and accountability for, the
risks taken throughout the firm and to
develop tools to address those risks.369
A key objective of a risk management
system is to ensure that the firm does
not ignore any material source of risk.370
Elements of an integrated risk
management system include a dedicated
risk management function, which seeks
to promote integrated and systematic
approaches to risk management and to
develop and encourage the use of a
common set of metrics for risk
throughout the firm.371 This function
generally includes establishing common
firm-wide definitions of risk and
requiring that different business
segments of the firm apply such
definitions consistently for risk
reporting purposes.372 The risk
management function in a financial
institution also typically prepares
background material and data analysis
(risk reports) for senior managers to
review and use to discuss firm-wide
risks.373
Nonbank SBSDs would be required to
comply with Rule 15c3–4, which
requires the establishment of a risk
management control system.374 Rule
15c3–4 was adopted in 1998 as part of
369 See Trends in Risk Integration and
Aggregation, Joint Forum, Bank of International
Settlements (Aug. 2003), available at http://
www.bis.org/publ/joint07.pdf.
370 Id.
371 Id.
372 Id.
373 Id.
374 See proposed new paragraph (a)(10)(ii) of Rule
15c3–1 (17 CFR 240.15c3–1); paragraph (g) of
proposed new Rule 18a–1. See also 17 CFR
240.15c3–4.

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the OTC derivatives dealer oversight
program.375 The rule requires an OTC
derivatives dealer to establish,
document, and maintain a system of
internal risk management controls to
assist in managing the risks associated
with its business activities, including
market, credit, leverage, liquidity, legal,
and operational risks.376 It also requires
OTC derivatives dealers to establish,
document, and maintain procedures
designed to prevent the firm from
engaging in securities activities that are
not permitted of OTC derivatives
dealers pursuant to Rule 15a–1.377 Rule
15c3–4 identifies a number of elements
that must be part of an OTC derivatives
dealer’s internal risk management
control system.378 These include, for
example, that the system have:
• A risk control unit that reports
directly to senior management and is
independent from business trading
units; 379
• Separation of duties between
personnel responsible for entering into
a transaction and those responsible for
recording the transaction in the books
and records of the OTC derivatives
dealer; 380
• Periodic reviews (which may be
performed by internal audit staff) and
annual reviews (which must be
conducted by independent certified
public accountants) of the OTC
derivatives dealer’s risk management
systems; 381 and
• Definitions of risk, risk monitoring,
and risk management.382
Rule 15c3–4 further provides that the
elements of the internal risk
management control system must
include written guidelines, approved by
the OTC derivatives dealer’s governing
body, that cover various topics,
including, for example:
• Quantitative guidelines for
managing the OTC derivatives dealer’s
overall risk exposure; 383
• The type, scope, and frequency of
reporting by management on risk
exposures; 384
• The procedures for and the timing
of the governing body’s periodic review
of the risk monitoring and risk
375 See 17 CFR 240.15c3–4; OTC Derivatives
Dealers, 63 FR 59362.
376 See 17 CFR 240.15c3–4.
377 See 17 CFR 240.15c3–4; 17 CFR 240.15a-1.
378 See 17 CFR 240.15c3–4(c).
379 See 17 CFR 240.15c3–4(c)(1).
380 See 17 CFR 240.15c3–4(c)(2).
381 See 17 CFR 240.15c3–4(c)(3). The annual
review must be conducted in accordance with
procedures agreed to by the firm and the
independent certified public accountant conducting
the review.
382 See 17 CFR 240.15c3–4(c)(4).
383 See 17 CFR 240.15c3–4(c)(5)(iii).
384 See 17 CFR 240.15c3–4(c)(5)(iv).

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
management written guidelines,
systems, and processes; 385
• The process for monitoring risk
independent of the business or trading
units whose activities create the risks
being monitored; 386
• The performance of the risk
management function by persons
independent from or senior to the
business or trading units whose
activities create the risks; 387
• The authority and resources of the
groups or persons performing the risk
monitoring and risk management
functions; 388
• The appropriate response by
management when internal risk
management guidelines have been
exceeded; 389
• The procedures to monitor and
address the risk that an OTC derivatives
transaction contract will be
unenforceable; 390
• The procedures requiring the
documentation of the principal terms of
OTC derivatives transactions and other
relevant information regarding such
transactions; 391 and
• The procedures authorizing
specified employees to commit the OTC
derivatives dealer to particular types of
transactions.392
Rule 15c3–4 also requires
management to periodically review, in
accordance with the written procedures,
the business activities of the OTC
derivatives dealer for consistency with
risk management guidelines.393
In 2004, when adopting the ANC
broker-dealer oversight program, the
Commission included a requirement
that an ANC broker-dealer must comply
with Rule 15c3–4.394 The Commission
explained this requirement:
Participants in the securities markets are
exposed to various risks, including market,
credit, funding, legal, and operational risk.
These risks result, in part, from the diverse
range of financial instruments that brokerdealers now trade. Risk management controls
within a broker-dealer promote the stability
of the firm and, consequently, the stability of
the marketplace. A firm that adopts and
follows appropriate risk management
385 See

17 CFR 240.15c3–4(c)(5)(v).
17 CFR 240.15c3–4(c)(5)(vi).
387 See 17 CFR 240.15c3–4(c)(5)(vii).
388 See 17 CFR 240.15c3–4(c)(5)(viii).
389 See 17 CFR 240.15c3–4(c)(5)(ix).
390 See 17 CFR 240.15c3–4(c)(5)(x).
391 See 17 CFR 240.15c3–4(c)(5)(xi).
392 See 17 CFR 240.15c3–4(c)(5)(xii).
393 See 17 CFR 240.15c3–4(d).
394 See 17 CFR 240.15c3–1(a)(7)(iii); Alternative
Net Capital Requirements Adopting Release, 69 FR
34428. ANC broker-dealers—because they are not
subject to Rule 15a–1—do not need to comply with
the provisions of Rule 15c3–4 relating to Rule 15a–
1. See 17 CFR 240.15c3–1(a)(7)(iii); 17 CFR
240.15c3–4; 17 CFR 240.15a–1.

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386 See

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controls reduces its risk of significant loss,
which also reduces the risk of spreading the
losses to other market participants or
throughout the financial markets as a
whole.395

The Commission is proposing to
require that nonbank SBSDs comply
with Rule 15c3–4 because their
activities will involve risk management
concerns similar to those faced by other
firms subject to the rule.396 In
particular, dealing in OTC derivatives,
including security-based swaps, creates
various types of risk that need to be
carefully managed.397 These risks are
due, in part, to the characteristics of
OTC derivative products and the way
OTC derivative markets have evolved in
comparison to the markets for exchangetraded securities.398 For example,
individually negotiated OTC derivative
products, including security-based
swaps, generally are less liquid than
exchange-traded instruments and
involve a high degree of leverage.
Furthermore, market participants face
risks associated with the financial and
legal ability of counterparties to perform
under the terms of specific transactions.
Consequently, a firm that is active in
dealing in these types of instruments
should have an internal risk
management control system that helps
the firm identify and mitigate the risks
it is facing. Rule 15c3–4 is designed to
require an OTC derivatives dealer and
ANC broker-dealer to take prudent
measures to protect the firm from losses
that can result from failing to account
for and control risk. Requiring nonbank
SBSDs to comply with Rule 15c3–4 is
designed to promote the establishment
of effective risk management control
systems by these firms.399 Moreover,
based on Commission staff experience,
it is expected that many nonbank SBSDs
will be affiliates of firms already subject
to these requirements.
Request for Comment
The Commission generally requests
comment on the proposed risk
management requirements. In addition,
395 Alternative Net Capital Requirements
Adopting Release, 69 FR at 34449.
396 Like ANC broker-dealers, nonbank SBSDs
would not need to comply paragraphs (c)(5)(xiii),
(c)(5)(xiv), (d)(8), and (d)(9) of Rule 15c3–4. These
are the provisions that specifically reference Rule
15a–1. See 17 CFR 240.15c3–4.
397 See OTC Derivatives: Settlement Procedures
And Counterparty Risk Management at 11–15.
398 See OTC Derivatives Dealers, Exchange Act
Release No. 39454 (Dec. 17, 1997), 62 FR 67940
(Dec. 30, 1997).
399 See paragraph (g) of proposed new Rule 18a–
1 (which would apply Rule 15c3–4 to stand-alone
SBSDs); proposed new paragraph (a)(10)(ii) of Rule
15c3–1 (which would apply Rule 15c3–4 to brokerdealer SBSDs); 17 CFR 240.15c3–1(a)(7)(iii) (which
applies Rule 15c3–4 to ANC broker-dealers); 17 CFR
240.15c3–4.

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70251

the Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Are the types of management
controls required by Rule 15c3–4
appropriate for addressing the risks
associated with engaging in a securitybased swap business? If not, explain
why not.
2. Are there types of risk management
controls not identified in Rule 15c3–4
that would be appropriate to prescribe
for nonbank SBSDs? If so, identify the
controls and explain why they would be
appropriate for nonbank SBSDs.
3. Are the factors listed in paragraph
(b) of Rule 15c3–4 appropriate for
nonbank SBSDs? If not, explain why
not.
4. Are there any additional factors
that a nonbank SBSD should consider
when adopting its internal control
system guidelines, policies, and
procedures, in addition to the factors
listed in paragraph (b) of Rule 15c3–4?
If so, identify the factors and explain
why they should be included.
5. Are the elements prescribed in
paragraph (c) of Rule 15c3–4
appropriate for nonbank SBSDs? If not,
explain why not.
6. Are there any additional elements
that a nonbank SBSD should include in
its internal risk management system in
addition to the applicable elements
prescribed in paragraph (c) of Rule
15c3–4? If so, identify the elements and
explain why they should be included.
7. Are there any elements in
paragraph (c) of Rule 15c3–4 that should
not be applicable to nonbank SBSDs
other than elements in paragraphs
(c)(xiii) and (xiv)? If so, identify the
elements and explain why they should
not be applicable.
8. Are the factors management would
need to consider in its periodic review
of the nonbank SBSD’s business
activities for consistency with the risk
management guidelines appropriate for
nonbank SBSDs? If not, explain why
not.
9. Should management consider any
additional factors in its periodic review
of the nonbank SBSD’s business
activities for consistency with the risk
management guidelines other than those
listed in paragraph (d) of Rule 15c3–4?
If so, identify the factors and explain
why they should be included.
10. Are there any factors in paragraph
(d) of Rule 15c3–4 that management
should not consider other than the
factors in paragraphs (d)(8) and (9)? If
so, identify the factors and explain why
they should not be considered.

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d. Funding Liquidity Stress Test
Requirement
The Commission is proposing that
ANC broker-dealers and nonbank SBSDs
approved to use internal models be
subject to liquidity risk management
requirements. Funding liquidity risk has
been defined as the risk that a firm will
not be able to efficiently meet both
expected and unexpected current and
future cash flow and collateral needs
without adversely impacting either the
daily operations or the financial
condition of the firm.400 The
consequences of liquidity funding
strains for financial institutions active
in a securities business include the
inability to continue to issue unsecured
long-term debt to finance illiquid assets
and requirements to deliver additional
collateral to continue to finance liquid
assets on a secured basis.401 The causes
of funding liquidity strain for a financial
institution include firm-specific events
such as credit rating downgrades and
other negative news leading to a loss of
market confidence in the firm.402
Funding liquidity also can come under
stress such as occurred during the
financial crisis.403 Traditionally,
financial institutions have used
liquidity funding stress tests as a means
to measure liquidity risk.404 For
institutions active in securities trading,
liquidity funding stress tests generally
estimate cash and collateral needs over
a period of time and assume that
sources to meet those needs (e.g.,
400 See Joint Forum, Bank of International
Settlements, The management of liquidity risk in
financial groups, (May 2006), at 1, note 1 (‘‘The
management of liquidity risk in financial groups’’).
See also Basel Committee on Banking Supervision,
Principles for Sound Liquidity Risk Management
and Supervision (Sept. 2008), at 1, note 2 (‘‘Funding
liquidity risk is the risk that the firm will not be
able to meet efficiently both expected and
unexpected current and future cash flow and
collateral needs without affecting either daily
operations or the financial condition of the firm.
Market liquidity risk is the risk that a firm cannot
easily offset or eliminate a position at the market
price because of inadequate market depth or market
disruption.’’); Amendments to Financial
Responsibility Rules for Broker-Dealers, Exchange
Act Release No. 55432 (Mar. 9, 2007), 72 FR 12862,
12870, note 72 (Mar. 19, 2007) (‘‘Liquidity risk
includes the risk that a firm will not be able to
unwind or hedge a position or meet cash demands
as they become due.’’); Enhanced Prudential
Standards and Early Remediation Requirements for
Covered Companies, Federal Reserve, 77 FR 594
(Jan. 5, 2012) (proposing a rule to require certain
large financial institutions to conduct liquidity
stress testing at least monthly).
401 See The management of liquidity risk in
financial groups at 10.
402 See id. at 6–8.
403 See Risk Management Lessons from the Global
Bank Crisis of 2008, Senior Supervisors Group
(SSG) (Oct. 21, 2009) (‘‘Risk Management Lessons
from the Global Bank Crisis of 2008’’).
404 The management of liquidity risk in financial
groups at 8–12.

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issuance of long and short unsecured
term debt, secured funding lines, and
lines of credit) will become impaired or
be unavailable.405 To manage funding
liquidity risk, these firms maintain
pools of liquid unencumbered assets
that can be used to raise funds during
a liquidity stress event to meet cash
needs.406 The size of the liquidity pool
is based on the firm’s estimation of how
much funding will be lost from external
sources during a stress event and the
duration of the event.407
The financial crisis demonstrated that
the funding liquidity risk management
practices of certain individual financial
institutions were not sufficient to
handle a liquidity stress event of that
magnitude.408 In particular, it has been
observed that the stress tests utilized by
financial institutions had weaknesses 409
and the amount of contingent liquidity
they maintained to replace external
sources of funding was insufficient to
cover the institutions’ liquidity
needs.410
As discussed above in section II.A.2.c.
of this release, nonbank SBSDs
approved to use internal models would
be subject to Rule 15c3–4, which
currently applies to ANC broker-dealers
and OTC derivatives dealers.411 Rule
15c3–4 requires each firm subject to the
rule to ‘‘establish, document, and
maintain a system of internal risk
management controls to assist it in
managing the risks associated with its
business activities, including market,
credit, leverage, liquidity, legal, and
operational risks.’’ 412 The
Commission’s supervision of ANC
broker-dealers consists of regular
405 Id.

at 10–11.

406 Id.
407 Id.
408 See Risk Management Lessons from the Global
Bank Crisis of 2008.
409 Id. at 14 (‘‘Market conditions and the
deteriorating financial state of firms exposed
weaknesses in firms’ approaches to liquidity stress
testing, particularly with respect to secured
borrowing and contingent funding needs. These
deteriorating conditions underscored the need for
greater consideration of the overlap between
systemic and firm-specific events and longer time
horizons, and the connection between stress tests
and business-as-usual liquidity management.’’).
410 Id. at 15 (‘‘Interviewed firms typically
calculated and maintained a measurable funding
cushion, such as ‘months of coverage,’ which is
conceptually similar to rating agencies’ twelvemonth liquidity alternatives analyses. Some
institutions were required to maintain a liquidity
cushion that could withstand the loss of unsecured
funding for one year. Many institutions found that
this metric did not capture important elements of
stress that the organizations faced, such as the loss
of secured funding and demands for collateral to
support clearing and settlement activity and to
mitigate the risks of accepting novations.’’)
(emphasis in the original).
411 See 17 CFR 240.15c3–4.
412 17 CFR 240.15c3–4.

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meetings with firm personnel to review
each firm’s financial results, the
management of the firm’s balance sheet,
and, in particular, the liquidity of the
firm’s balance sheet.413 Emphasis is
placed on funding and liquidity risk
management plans and liquidity stress
scenarios.414 The Commission staff also
meets regularly with the firm’s financial
controllers to review and discuss price
verification results and other financial
controls, particularly concerning
illiquid or hard-to-value assets or large
asset concentrations.415
Given the large size of ANC brokerdealers and the potentially substantial
role that stand-alone SBSDs approved to
use internal models may play in the
security-based swap markets, these
firms would be required to take steps to
manage funding liquidity risk.416
Specifically, these firms would be
required to perform a liquidity stress
test at least monthly and, based on the
results of that test, maintain liquidity
reserves to address potential funding
needs during a stress event.417
Under the proposal, an ANC brokerdealer and stand-alone SBSD using
internal models would need to perform
a liquidity stress test at least monthly
that takes into account certain assumed
conditions lasting for 30 consecutive
days.418 The results of the liquidity
stress test would need to be provided
within ten business days of the month
end to senior management that has
responsibility to oversee risk
management at the firm. In addition, the
assumptions underlying the liquidity
stress test would need to be reviewed at
least quarterly by senior management
that has responsibility to oversee risk
management at the firm and at least
annually by senior management of the
firm. These provisions are designed to
413 A more detailed description of the
Commission’s ANC broker-dealer program is
available on the Commission’s Web site at http://
www.sec.gov/divisions/marketreg/bdaltnetcap.htm.
414 Id.
415 Id.
416 See proposed new paragraph (f) to Rule 15c3–
1; paragraph (f) of proposed new Rule 18a–1.
417 Id. The requirement to conduct the liquidity
stress test on at least a monthly basis is designed
to ensure that the test is conducted at sufficiently
regular intervals to account for material changes
that could impact the firm’s liquidity profile. In this
regard, the ANC broker-dealers are required to
prepare and file monthly financial reports, which
are designed to allow securities regulators to
monitor their financial condition. See 17 CFR
240.17a–5; compare Enhanced Prudential
Standards and Early Remediation Requirements for
Covered Companies, 77 FR 594 (Jan. 5, 2012)
(Federal Reserve’s proposed rule to require a
‘‘covered company’’ to conduct liquidity stress
testing at least monthly).
418 Based on the Commission staff’s experience,
ANC broker-dealers currently perform regular
liquidity stress tests.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
promote the engagement of senior level
risk managers and managers of the firm
in the implementation of the liquidity
stress test and senior level risk managers
in monitoring the results of the liquidity
stress test.
These required assumed conditions
are designed to be consistent with the
liquidity stress tests performed by the
ANC broker-dealers (based on
Commission staff experience
supervising the firms) and to address
the types of liquidity outflows
experienced by ANC broker-dealers and
other broker-dealers in times of stress.
The required assumed conditions would
be:
• A stress event that includes a
decline in creditworthiness of the firm
severe enough to trigger contractual
credit-related commitment provisions of
counterparty agreements;
• The loss of all existing unsecured
funding at the earlier of its maturity or
put date and an inability to acquire a
material amount of new unsecured
funding, including intercompany
advances and unfunded committed
lines of credit;
• The potential for a material net loss
of secured funding;
• The loss of the ability to procure
repurchase agreement financing for less
liquid assets;
• The illiquidity of collateral required
by and on deposit at clearing agencies
or other entities which is not deducted
from net worth or which is not funded
by customer assets;
• A material increase in collateral
required to be maintained at registered
clearing agencies of which the firm is a
member; and
• The potential for a material loss of
liquidity caused by market participants
exercising contractual rights and/or
refusing to enter into transactions with
respect to the various businesses,
positions, and commitments of the firm,
including those related to customer
businesses of the firm.419
These proposed minimum elements are
designed to ensure that ANC brokerdealers and stand-alone SBSDs using
internal models employ a stress test that
is severe enough to produce an estimate
of a potential funding loss of a
magnitude that might be expected in a
severely stressed market. As discussed
below, the results of the stress test
would be used by the firm to determine
the amount of contingent liquidity to be
maintained. The proposals would
require that the ANC broker-dealer and
stand-alone SBSD itself must maintain
419 See proposed new paragraph (f)(1) to Rule
15c3–1; paragraph (f)(1) of proposed new Rule 18a–
1.

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at all times liquidity reserves based on
the results of the liquidity stress test.420
The liquidity reserves would need to be
comprised of unencumbered cash or
U.S. government securities.421 This
limitation with respect to the assets that
can be used for the liquidity reserves
requirement is designed to ensure that
only the most liquid instruments are
held in the reserves, given that the
market for less liquid instruments is
generally disproportionately volatile
during a time of market stress.
The results of stress tests play a key
role in shaping an entity’s liquidity risk
contingency planning.422 Thus, stress
testing and contingency planning are
closely intertwined.423 Under the
proposals, the ANC broker-dealer and a
stand-alone SBSD using internal models
would be required to establish a written
contingency funding plan.424 The plan
would need to clearly set out the
strategies for addressing liquidity
shortfalls in emergency situations,425
and would need to address the policies,
roles, and responsibilities for meeting
the liquidity needs of the firm and
communicating with the public and
other market participants during a
liquidity stress event.426
420 See proposed new paragraph (f)(3) of Rule
15c3–1; paragraph (f)(3) of proposed new Rule 18a–
1.
421 See proposed new paragraph (f)(3) of Rule
15c3–1; paragraph (f)(3) of proposed new Rule 18a–
1.
422 See, e.g., Federal Reserve, FDIC, OCC, OTS,
and NCUA, Interagency Policy Statement on
Funding and Liquidity Risk Management 7, SR 10–
6 (Mar. 17, 2010).
423 Id.
424 Based on staff experience supervising the ANC
broker-dealers, all of the ANC broker-dealers that
are part of a holding company generally have a
written contingency funding plan, generally at the
holding company level. This proposed rule would
require that each ANC broker-dealer and standalone SBSD using internal models maintain a
written contingency funding plan at the entity level
(in addition to any holding company plan). See also
Enhanced Prudential Standards and Early
Remediation Requirements for Covered Companies,
77 FR at 604. The Federal Reserve stated that the
objectives of the contingency funding plan are to
provide a plan for responding to a liquidity crisis,
to identify alternate liquidity sources that a covered
company can access during liquidity stress events,
and to describe steps that should be taken to ensure
that the covered company’s sources of liquidity are
sufficient to fund its operating costs and meet its
commitments while minimizing additional costs
and disruptions. Id. at 610.
425 See proposed new paragraph (f)(4) of Rule
15c3–1; paragraph (f)(4) of proposed new Rule 18a–
1.
426 See proposed new paragraph (f)(4) of Rule
15c3–1; paragraph (f)(4) of proposed new Rule 18a–
1. To promote the flow of necessary information
during a liquidity stress, the Federal Reserve’s
proposed rule would require the event management
process to include a mechanism that ensures
effective reporting and communication within the
covered company and with outside parties,
including the Federal Reserve and other relevant
supervisors, counterparties, and other stakeholders.

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Request for Comment
The Commission generally requests
comment on the proposed liquidity
stress test requirement. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Are the proposed funding liquidity
requirements appropriate for ANC
broker-dealers and nonbank SBSDs that
use internal models? If not, explain why
not. Are there modifications that would
improve the funding liquidity
provisions? If so, explain them.
2. Should the proposed funding
liquidity requirements apply to a
broader group of broker-dealers (e.g., all
broker-dealers that hold customer
securities and cash or all broker-dealer
with total assets in excess of minimum
threshold)? Explain why or why not.
3. Should the proposed funding
liquidity requirements apply to all
nonbank SBSDs? If so, explain why. If
not, explain why not.
4. Is monthly an appropriate
frequency for the liquidity stress test?
For example, would it be preferable to
require the liquidity stress test on a
more frequent basis such as weekly, or,
alternatively, on a less frequent basis
such as quarterly? If so, explain why.
5. Is the requirement to provide the
results of the liquidity stress test within
ten business days to senior management
that has responsibility to oversee risk
management at the firm appropriate? If
not, explain why not. Should results be
provided in a shorter or longer
timeframe than ten business days? For
example, is ten business days sufficient
time to run the stress tests, generate the
results, and provide them to senior
management? If the time-frame should
be longer or shorter, identify the
different timeframe and explain why it
would be more appropriate than ten
business days.
6. Is the requirement that the
assumptions underlying the liquidity
stress test be reviewed at least quarterly
by senior management that has
responsibility to oversee risk
management at the firm and at least
annually by senior management of firm
appropriate? If not, explain why not.
Should the reviews be more or less
frequent? If so, identify the frequency
and explain why it would be more
appropriate than quarterly and
annually.
7. Are the required assumptions of the
funding liquidity stress test appropriate?
If not, explain why not.
Enhanced Prudential Standards and Early
Remediation Requirements for Covered Companies,
77 FR at 611.

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8. Are there additional or alternative
assumptions that should be required in
the funding liquidity stress test? If so,
identify the additional or alternative
assumptions and explain why they
should be included.
9. Are the required assumptions of the
funding liquidity stress test
understandable? If not, identify the
elements that require further
explanation.
10. Should other types of securities in
addition to U.S. government securities
be permitted for the liquidity pool? If so,
identify the types of securities and
explain why they should be permitted.
11. Are the requirements for the
written contingency funding plan
appropriate? If not, explain why not.
12. Should additional or alternative
requirements for the written
contingency funding plan be required?
If so, identify the additional or
alternative requirements and explain
why they should be required.
e. Other Rule 15c3–1 Provisions
Incorporated into Rule 18a–1
Rule 15c3–1 has four other sets of
provisions that are proposed to be
included in new Rule 18a–1: (1) Debtequity ratio requirements; 427 (2) capital
withdrawal notice requirements; 428 (3)
subsidiary consolidation requirements
(Appendix C); 429 and (4) subordinated
loan agreement requirements (Appendix
D).430
i. Debt-Equity Ratio Requirements
Rule 15c3–1 sets limits on the amount
of a broker-dealer’s outstanding
subordinated loans.431 The limits are
prescribed in terms of debt-to-equity
amounts.432 The debt-to-equity limits
are designed to ensure that a brokerdealer has a base of permanent capital
in addition to any subordinated loans,
which—as discussed above—are
permitted to be added back to net worth
when computing net capital.433
Proposed new Rule 18a–1 would
contain the same debt-to-equity
limits.434 The objective of this parallel
427 See

17 CFR 240.15c3–1(d).
17 CFR 240.15c3–1(e).
429 See 17 CFR 240.15c3–1c.
430 See 17 CFR 240.15c3–1d.
431 See 17 CFR 240.15c3–1(d).
432 Id.
433 See Net Capital Rule, Exchange Act Release
No. 9891 (Dec. 5, 1972), 38 FR 56, 59 (Jan. 3, 1973)
(‘‘The Commission has discovered a large number
of instances in which broker-dealers were able to
comply with the net capital although the firms [sic]
net worth been entirely depleted. Compliance with
the rule was possible only because subordinated
debt is a permissible form of capital. Such
conditions rendered the firm technically insolvent
since its liabilities exceeded its assets.’’).
434 See paragraph (h) of proposed new Rule 18a–
1.

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provision in Rule 18a–1 is to require
nonbank SBSDs to maintain a base of
permanent capital.

Stand-alone SBSDs would be subject
to the same provisions, with one
difference.441 In 2007, the Commission
proposed amendments to Rule 15c3–1
Request for Comment
to eliminate certain of the conditions
The Commission generally requests
required in an order restricting the
comment on the proposal to incorporate
withdrawals or the making of loans or
the debt-equity ratio provisions of Rule
advances to stockholders, insiders, and
15c3–1 into proposed new Rule 18a–1.
affiliates.442 More specifically, under
In addition, the Commission requests
Rule 15c3–1, the Commission can, by
comment, including empirical data in
support of comments, in response to the order, restrict a broker-dealer for a
period up to 20 business days from
following question:
making capital withdrawals, loans, and
1. Are the debt-equity ratio
advances only to the extent the
requirements in Rule 15c3–1
withdrawal, loan, or advance would
appropriate standards for stand-alone
SBSDs? If not, explain why not and
exceed 30% of the broker-dealer’s
suggest an alternative standard.
excess net capital when aggregated with
other such transactions over a 30-day
ii. Capital Withdrawal Requirements
period.443 The current requirement
Rule 15c3–1 requires that a brokerraises a concern, based on Commission
dealer provide notice when it seeks to
staff experience, that to the extent the
withdraw capital in an amount that
books and records of a broker-dealer
exceeds certain thresholds.435 For
that is in financial distress are
example, a broker-dealer must give the
incomplete or inaccurate it can be
Commission a two-day notice before a
difficult for regulators to determine the
withdrawal that would exceed 30% of
the firm’s excess net capital and a notice firm’s actual net capital and excess net
capital amounts.444 An order that limits
within two days after a withdrawal that
436
withdrawals
to a percentage of excess
exceeded 20% of that measure.
The
net capital may be difficult to enforce as
notice provisions are designed to alert
it may not always be clear when that
the Commission and the firm’s
threshold had been reached.445 Given
designated examining authority that
these concerns and consistent with the
capital is being withdrawn to assist in
the monitoring of the financial
proposed amendment to Rule 15c3–1,
condition of the broker-dealer. Rule
the Commission is proposing that its
15c3–1 also restricts capital
ability to restrict withdrawals of capital,
withdrawals that could have certain
loans or advances by stand-alone SBSDs
financial impacts on the firm, including not be limited based on the amount of
withdrawals that reduce net capital
the withdrawal, loan or advance in
below certain numerical levels.437 These relation to the amount of the firms’
restrictions are designed to ensure that
excess net capital.446
the broker-dealer maintains a buffer of
net capital above its minimum required
441 See paragraph (i) of proposed new Rule 18a–
amount. Finally, under the rule, the
1.
442 Amendments to Financial Responsibility Rules
Commission may issue an order
for Broker-Dealers, 72 FR 12862.
temporarily restricting a broker-dealer
443 See 17 CFR 240.15c3–1(e)(3)(i). To issue an
from withdrawing capital or making
order, the Commission must, based on the facts and
loans or advances to stockholders,
information available, conclude that the
insiders, and affiliates under certain
withdrawal, advance or loan may be detrimental to
circumstances.438 This provision and
the financial integrity of the broker-dealer, or may
unduly jeopardize the broker-dealer’s ability to
several of the notice and restriction
repay its customer claims or other liabilities which
provisions were put in place after the
may cause a significant impact on the markets or
failure of the investment bank Drexel
expose the customers or creditors of the brokerBurnham Lambert, Inc. (‘‘Drexel’’).439
dealer to loss without taking into account the
application of the Securities Investor Protection Act
Drexel, prior to its bankruptcy,
of 1970 (‘‘SIPA’’). See 17 CFR 240.15c3–
transferred significant funds from its
1(e)(3)(i)(B). Furthermore, the rule provides that an
broker-dealer subsidiary to the holding
order temporarily prohibiting the withdrawal of
company without notice to the
capital shall be rescinded if the Commission
determines that the restriction on capital
Commission or Drexel’s designated
withdrawal should not remain in effect and that the
examining authority.440
hearing will be held within two business days from
435 See

17 CFR 240.15c3–1(e)(1).
436 See 17 CFR 240.15c3–1(e)(1).
437 See 17 CFR 240.15c3–1(e)(2).
438 See 17 CFR 240.15c3–1(e)(3).
439 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5,
1991).
440 Id. at 9125.

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the date of the request in writing by the brokerdealer. See 17 CFR 240.15c3–1(e)(3)(ii).
444 See Amendments to Financial Responsibility
Rules for Broker-Dealers, 72 FR at 12873.
445 Id.
446 See paragraph (i) of proposed new Rule 18a–
1; Amendments to Financial Responsibility Rules
for Broker-Dealers, 72 FR at 12873.
.

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Request for Comment
The Commission generally requests
comment on the proposal to incorporate
the capital withdrawal provisions of
Rule 15c3–1 into proposed new Rule
18a–1. In addition, the Commission
requests comment, including empirical
data in support of comments, in
response to the following questions:
1. Are the capital withdrawal
requirements in Rule 15c3–1
appropriate standards for stand-alone
SBSDs? If not, explain why and suggest
an alternative standard.
2. Under Rule 15c3–1, a broker-dealer
must give the Commission notice two
days before a withdrawal that would
exceed 30% of the firm’s excess net
capital and two days after a withdrawal
that exceeded 20% of that measure. Are
these thresholds appropriate for standalone SBSDs? If not, explain why not
and suggest alternative thresholds.
3. Rule 15c3–1 also restricts capital
withdrawals that would have certain
financial impacts on a broker-dealer
such as lowering net capital below
certain levels. Are these same
requirements appropriate standards for
stand-alone SBSDs?
4. Under the proposed amendments,
the 30% of excess net capital limitation
currently contained in Rule 15c3–1 with
respect to Commission orders restricting
withdrawals would be eliminated.
However, under the proposed
amendments, the Commission in issuing
an order restricting withdrawals could
impose such terms and conditions as
the Commission deems necessary or
appropriate in the public interest or
consistent with the protection of
investors. Please identify terms and
conditions that the Commission should
consider to be included in such orders.
For example, under certain
circumstances, would it be appropriate
for the current limitation in Rule 15c3–
1 to be included in the order?
Alternatively, should the 30% of excess
net capital limitation currently
contained in Rule 15c3–1 be retained in
proposed new Rule 18a–1? If so, please
explain why.

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iii. Appendix C
Appendix C to Rule 15c3–1 requires
a broker-dealer in computing its net
capital and aggregate indebtedness to
consolidate in a single computation
assets and liabilities of any subsidiary or
affiliate for which it guarantees,
endorses or assumes directly or
indirectly obligations or liabilities.447
The assets and liabilities of a subsidiary
or affiliate whose liabilities and
447 See

17 CFR 240.15c3–1c.

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obligations have not been guaranteed,
endorsed, or assumed directly or
indirectly by the broker-dealer may also
be consolidated.448 By including the
assets and liabilities of a subsidiary in
its net capital computation, a firm may
receive flow-through net capital benefits
because the consolidation may serve to
increase the firm’s net capital and
thereby assist it in meeting the
minimum requirements of Rule 15c3–1.
Appendix C sets forth the requirements
that must be met to consolidate in a
single net capital computation the assets
and liabilities of subsidiaries and
affiliates in order to obtain flow-through
capital benefits for a parent brokerdealer.449 Specifically, the broker-dealer
must possess majority ownership and
control over the consolidated subsidiary
or affiliate and obtain an opinion of
counsel essentially stating that at least
the portion of the subsidiary’s or
affiliate’s net asset value related to the
broker-dealer’s ownership interest
therein may be distributed to the brokerdealer (or a trustee in a SIPA
liquidation) within thirty days, at the
request of the distributee.450 In addition,
subordinated obligations of the
subsidiary or affiliate may not serve to
increase the net worth of the brokerdealer unless the obligations also are
subordinated to the claims of present
and future creditors of the brokerdealer.451 Appendix C also requires that
liabilities and obligations of a subsidiary
or affiliate of the broker-dealer that are
guaranteed, endorsed, or assumed either
directly or indirectly by the brokerdealer must be reflected in the firm’s net
capital computation.452
Based on Commission staff experience
and information from an SRO, very few
broker-dealers consolidate subsidiaries
or affiliates to obtain the flow-through
capital benefits under Appendix C to
Rule 15c3–1. The review and
information from the SRO indicate that
the limited use results from the
448 Id.
449 See

17 CFR 240.15c3–1c.
17 CFR 240.15c3–1c(b). FINRA Rule
4150(a) requires that prior written notice be given
to FINRA whenever a FINRA member guarantees,
endorses or assumes, directly or indirectly, the
obligations or liabilities of another person.
Paragraph (b) of the rule requires that prior written
approval must be obtained from FINRA whenever
any member seeks to receive flow-through capital
benefits in accordance with Appendix C to Rule
15c3–1. This makes compliance with the rule more
stringent because FINRA must pre-approve the
subordinated debt for FINRA member firms who
wish to take advantage of the capital benefits
available under Appendix C of Rule 15c3–1. As of
June 1, 2012, of the 4,711 broker-dealers registered
with the Commission, 4,437 were FINRA member
firms.
451 See 17 CFR 240.15c3–1c(c)(2).
452 See 17 CFR 240.15c3–1c(d).
450 See

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difficulty in obtaining the required
opinion of counsel. Consequently,
Appendix C to proposed new Rule 18a–
1 would contain only the requirement
that a stand-alone SBSD include in its
net capital computation all liabilities or
obligations of a subsidiary or affiliate of
the stand-alone SBSD that the SBSD
guarantees, endorses, or assumes either
directly or indirectly. Thus, stand-alone
SBSDs would not be able to claim flowthrough capital benefits for consolidated
subsidiaries or affiliates. The
Commission does not expect that this
difference in approach between Rule
15c3–1 and proposed new Rule 18a–1
would create any competitive
disadvantage for stand-alone SBSDs visa`-vis broker-dealer SBSDs, given the
limited use of the flow-through benefits
provision under the current rule.
Request for Comment
The Commission generally requests
comment on Appendix C of both Rule
15c3–1 and proposed Rule 18a–1. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Should the flow-through capital
benefit provisions of Appendix C to
Rule 15c3–1 be eliminated? If so,
explain why. Alternatively, should the
flow-through capital benefit provisions
in Appendix C to Rule 15c3–1 be
incorporated into proposed Rule 18a–1?
If so, explain why.
2. Would stand-alone SBSDs be
subject to a competitive disadvantage
vis-a`-vis broker-dealer SBSDs as a result
of the differences between proposed
Appendix C of Rule 18a–1 and
Appendix C of Rule 15c3–1? Would
these differences provide an incentive
for an entity to register a nonbank SBSD
as a broker-dealer SBSD? Please explain.
iv. Appendix D
Appendix D to Rule 15c3–1 sets forth
the minimum and non-exclusive
requirements for satisfactory
subordination agreements.453 A
subordination agreement is a contract
between a broker-dealer and a third
party pursuant to which the third party
lends money or provides a collateralized
note to the broker-dealer. Generally,
broker-dealers use subordination
agreements to borrow from third parties
(typically affiliates) to increase the
broker-dealer’s net capital.454 Nonbank
SBSDs also are expected to use
subordinated debt to obtain financing
for their activities and the proposals
discussed below would prescribe when
453 17

CFR 240.15c3–1d.
17 CFR 240.15c3–1(c)(2)(ii).

454 See

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such loans would receive favorable
capital treatment.
In order to receive beneficial
regulatory capital treatment under Rule
15c3–1, the obligation to the third party
must be subordinated to the claims of
creditors pursuant to a satisfactory
subordination agreement, as defined
under Appendix D.455 Among other
things, a satisfactory subordination
agreement must prohibit, except under
strictly defined limitations,
prepayments or any payment of an
obligation before the expiration of at
least one year from the effective date of
the subordination agreement.456 This
provision was designed to ensure the
adequacy as well as the permanence of
capital in the industry.457
There are two types of subordination
agreements under Appendix D to Rule
15c3–1: (1) a subordinated loan
agreement, which is used when a third
party lends cash to a broker-dealer; 458
and (2) a secured demand note
agreement, which is a promissory note
in which a third party agrees to give
cash to a broker-dealer on demand
during the term of the note and provides
cash or securities to the broker-dealer as
collateral.459
A broker-dealer SBSD would be
subject to the provisions of Appendix D
to Rule 15c3–1 through parallel
provisions in Appendix D to proposed
new Rule 18a–1.460 However, only the
subordinated loan agreement provisions
would be included in Appendix D to
proposed new Rule 18a–1. Thus, stand455 Id.
456 See

17 CFR 240.15c3–1d(b)(1).
Net Capital Requirements for BrokerDealers; Amended Rules, Exchange Act Release No.
18417 (Jan. 13, 1982), 47 FR 3512, 3516 (Jan. 25,
1982).
458 See 17 CFR 240.15c3–1d(a)(2)(ii).
459 See 17 CFR 240.15c3–1d(a)(2)(v)(A). Under a
secured demand note agreement, the third party
cannot sell or otherwise use the collateral unless
the third party substitutes securities of equal value
for the deposited securities. See 17 CFR 240.15c3–
1d(a)(2)(v)(D).
460 Appendix D to Rule 15c3–1d has provisions
that apply if an action (e.g., repayment of the
subordinated loan) would cause the broker-dealer’s
net capital to fall below certain thresholds (e.g.,
120% of the broker-dealer’s minimum net capital
requirement) and a provision that applies if the
broker-dealer’s net capital has fallen below its
minimum net capital requirement. See paragraphs
(b)(7), (b)(8)(i), (b)(10)(ii)(B), (c)(2), and (c)(5)(i)(B)
of 17 CFR 240.15c3–1d. Proposed new Rule 18a–
1 would contain analogous provisions that would
be based on the proposed minimum net capital and
tentative net capital requirements for stand-alone
SBSDs. See paragraphs (b)(6), (b)(7), (b)(9)(ii)(A),
(c)(2), and (c)(4)(i) of proposed new Rule 18a–1d.
In addition, in order to reflect the minimum net
capital requirements that would apply to brokerdealer SBSDs, conforming amendments are being
proposed for Rule 15c3–1d. See proposed
amendments to paragraphs (b)(7), (b)(8)(i),
(b)(10)(ii)(B), (c)(2), and (c)(5)(i)(B) of 17 CFR
240.15c3–1d.

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457 See

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alone SBSDs would not be able to use
secured demand note agreements to
obtain beneficial regulatory capital
treatment under proposed Appendix D
to Rule 18a–1. Based on Commission
staff experience, broker-dealers
infrequently utilize secured demand
notes as a source of capital, and the
amounts of these notes are relatively
small in size. Therefore, this form of
regulatory capital is not being proposed
for stand-alone SBSDs. Accordingly,
Appendix D to proposed new Rule 18a–
1 would refer solely to ‘‘subordinated
loan agreements’’ in the provisions
where Appendix D to Rule 15c3–1 refers
more broadly to ‘‘subordination
agreements.’’ 461
Subordination agreements under
Appendix D to Rule 15c3–1 are
approved by a broker-dealer’s
designated examining authority.462 A
broker-dealer also is required to notify
its designated examining authority upon
the occurrence of certain events under
Appendix D to Rule 15c3–1.463 Because
the term ‘‘designated examining
authority’’ applies only to registered
broker-dealers (i.e., stand-alone SBSDs
would not have a designated examining
authority), the provisions of Appendix
D to Rule 18a–1 refer to the
‘‘Commission’’ instead of the
‘‘designated examining authority.’’
Specifically, under paragraph (c)(5) of
Appendix D to proposed Rule 18a–1, a
stand-alone SBSD would be required to
file two copies of any proposed
subordinated loan agreement (including
nonconforming subordinated loan
agreements) at least 30 days prior to the
proposed execution date of the
agreement with the Commission.464 The
rule would also require an SBSD to file
with the Commission a statement setting
forth the name and address of the
lender, the business relationship of the
lender to the SBSD, and whether the
SBSD carried an account for the lender
effecting transactions in security-based
swaps at or about the time the proposed
agreement was filed.465
Request for Comment
The Commission generally requests
comment on Appendix D to both Rule
15c3–1 and proposed new Rule 18a–1.
461 The term ‘‘subordination agreements’’ as used
in Appendix D to Rule 15c3–1 references both
subordinated loan agreements and secured demand
note agreements.
462 See 17 CFR 240.15c3–1d(c)(6)(i). See also
FINRA Rule 4110(e)(1), which provides that
subordinated loans and secured demand notes must
be approved by FINRA in order to receive beneficial
regulatory capital treatment.
463 See, e.g., 17 CFR 240.15c3–1d(b)(6).
464 See paragraph (c)(5) of proposed new Rule
18a–1d.
465 Id.

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In addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Should the secured demand note
provisions of Appendix D to Rule 15c3–
1 be eliminated? Alternatively, should
the secured demand note provisions be
incorporated into Appendix D to
proposed new Rule 18a–1? If so, explain
why.
2. Would stand-alone SBSDs be
disadvantaged vis-a`-vis broker-dealer
SBSDs as a result of the differences
between proposed Appendix D to
proposed new Rule 18a–1 and
Appendix D to Rule 15c3–1? Would
these differences provide an incentive
for an entity to register a nonbank SBSD
as a broker-dealer SBSD? Please explain.
3. Proposed Capital Rules for Nonbank
MSBSPs
Proposed new Rule 18a–2 would
establish capital requirements for
nonbank MSBSPs. In particular, a
nonbank MSBSP would be required at
all times to have and maintain positive
tangible net worth.466 A tangible net
worth standard is being proposed for
nonbank MSBSPs, rather than the net
liquid assets test in Rule 15c3–1,
because the entities that may need to
register as nonbank MSBSPs may engage
in a diverse range of business activities
different from, and broader than, the
securities activities conducted by
broker-dealers or SBSDs (otherwise they
would be required to register as an
SBSD and/or broker-dealer). For
example, these entities may engage in
commercial activities that require them
to have substantial fixed assets to
support manufacturing and/or result in
them having significant assets
comprised of unsecured receivables.
Requiring them to adhere to a net liquid
assets test could result in their having
to obtain significant additional capital
or engage in costly restructurings.
The term tangible net worth would be
defined to mean the nonbank MSBSP’s
net worth as determined in accordance
with generally accepted accounting
principles in the United States,
excluding goodwill and other intangible
assets.467 In determining net worth, all
long and short positions in securitybased swaps, swaps, and related
positions would need to be marked to
466 See paragraph (a) of proposed new Rule 18a–
2. If a broker-dealer is required to register as a
nonbank MSBSP, it would need to continue to
comply with Rule 15c3–1 in addition to proposed
new Rule 18a–2.
467 See paragraph (b) of proposed new Rule 18a–
2.

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their market value.468 Further, a
nonbank MSBSP would be required to
include in its computation of tangible
net worth all liabilities or obligations of
a subsidiary or affiliate that the
participant guarantees, endorses, or
assumes, either directly or indirectly.469
The proposed definition of tangible net
worth would allow nonbank MSBSPs to
include as regulatory capital assets that
would be deducted from net worth
under Rule 15c3–1, such as property,
plant, equipment, and unsecured
receivables. At the same time, it would
require the deduction of goodwill and
other intangible assets.470
Because nonbank MSBSPs, by
definition, will be entities that engage in
a substantial security-based swap
business, they would be required to
comply with Rule 15c3–4 with respect
to their security-based swap and swap
activities.471 As discussed above in
section II.A.2.c. of this release, Rule
15c3–4 requires OTC derivatives dealers
and ANC broker-dealers to establish,
document, and maintain a system of
internal risk management controls to
assist in managing the risks associated
with their business activities, including
market, credit, leverage, liquidity, legal,
and operational risks.472 The proposal
that nonbank MSBSPs be subject to Rule
15c3–4 is designed to promote sound
risk management practices with respect
to the risks associated with OTC
derivatives.
Finally, the risk that the failure of a
nonbank MSBSP could have a
destabilizing market impact is being
addressed in part by the account equity
requirements in proposed new Rule
18a–3—as discussed below in section
II.B.2.c.ii. of this release—that would
require a nonbank MSBSP to deliver
collateral to counterparties to cover the
counterparty’s current exposure to the
nonbank MSBSP. The proposed
requirement that nonbank MSBSPs
deliver collateral to counterparties is
designed to address a risk that arose
during the 2008 credit crisis (i.e., the
existence of large uncollateralized
exposures of market participants to a
468 Id. This provision is modeled on paragraph
(c)(2)(vi)(B)(1) of Rule 15c3–1. See 17 CFR
240.15c3–1(c)(2)(vi)(B)(1). See also paragraph
(c)(1)(i)(B)(1) of proposed new Rule 18a–1.
469 See paragraph (b) of proposed new Rule 18a–
2.
470 The proposed definition of tangible net worth
is consistent with the CFTC’s proposed definition
of tangible net equity. See CFTC Capital Proposing
Release, 76 FR at 27828 (defining tangible net
equity as ‘‘equity as determined under U.S.
generally accepted accounting principles, and
excludes goodwill and other intangible assets.’’).
471 See paragraph (c) of proposed new Rule 18a–
2.
472 See 17 CFR 240.15c3–4.

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single entity). The proposed
requirements in proposed new Rule
18a–2 that a nonbank MSBSP maintain
positive tangible net worth and establish
risk management controls are designed
to serve as an extra measure of
protection but be flexible enough to
account for the potential range of
business activities of these entities.
Request for Comment
The Commission generally requests
comment on the proposed capital
requirements for nonbank MSBSPs. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Is a tangible net worth test an
appropriate standard for a nonbank
MSBSP? Would a net liquid assets test
capital standard be more appropriate? If
so, describe the rationale for such an
approach.
2. Should nonbank MSBSPs be
permitted to calculate their tangible net
worth using generally accepted
accounting principles in jurisdictions
other than U.S., such as where the
nonbank MSBSP is incorporated,
organized, or has its principal office? If
so, explain why.
3. Can the risks to market stability
presented by nonbank MSBSPs be
largely addressed through margin
requirements?
4. Should proposed new Rule 18a–2
require that a nonbank MSBSP maintain
a minimum fixed-dollar amount of
tangible net equity, for example, equal
to $20,000,000 or some greater or lesser
amount? If so, explain the merits of
imposing a fixed-dollar amount and
identify the recommended fixed-dollar
amount.
5. Should proposed new Rule 18a–2
require that a nonbank MSBSP compute
capital charges for market risk and
credit risk? For example, should such a
requirement be modeled on the CFTC’s
proposed market and credit risk charges
for nonbank swap dealers and nonbank
major swap participants that are not
using internal models and are not
FCMs? 473 If nonbank SBSDs should be
required to take market and credit risk
charges, explain why. If not, explain
why not.
6. Should nonbank MSBSPs be
subject to a leverage test and if so, how
should it be designed? Explain the
rationale for such a test.
7. Should a nonbank MSBSP be
subject to a minimum tangible net worth
requirement that is proportional to the
amount of risk incurred by the MSBSP
473 See CFTC Capital Proposing Release, 76 FR at
27809–27812.

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through its outstanding security-based
swap transactions? More specifically,
should an MSBSP calculate an
‘‘adjusted tangible net worth’’ by
subtracting market risk deductions for
their security-based swaps (either based
on the standardized haircuts or on
approved models) from their tangible
net worth and be required to maintain
sufficient capital such that this adjusted
tangible net worth figure is positive?
B. Margin
1. Introduction
As discussed above in section
II.A.2.b.iv. of this release, dealers in
OTC derivatives manage credit risk to
their OTC derivatives counterparties
through collateral and netting
agreements.474 The two types of credit
exposure arising from OTC derivatives
are current exposure and potential
future exposure. The current exposure is
the amount that the counterparty would
be obligated to pay the dealer if all the
OTC derivatives contracts with the
counterparty were terminated (i.e., it is
the amount of the current receivable
from the counterparty). This form of
credit risk arises from the potential that
the counterparty may default on the
obligation to pay the current receivable.
The potential future exposure is the
amount that the current exposure may
increase in favor of the dealer in the
future. This form of credit risk arises
from the potential that the counterparty
may default before providing the dealer
with additional collateral to cover the
incremental increase in the current
exposure or that the current exposure
will increase after a default when the
counterparty has ceased to provide
additional collateral to cover such
increases and before the dealer can
liquidate the position.
Dealers may require counterparties to
provide collateral to cover their current
and potential future exposures to the
counterparty.475 On the other hand, they
may not require collateral for these
purposes because, for example, the
counterparty is deemed to be of low
474 See Market Review of OTC Derivative Bilateral
Collateralization Practices; OTC Derivatives:
Settlement Procedures and Counterparty Risk
Management.
475 In the Dodd-Frank Act, collateral collected to
cover current exposure is referred to as variation
margin and collateral collected to cover potential
future exposure is referred to as initial margin. See,
e.g., section 15F(e)(2)(B)(i)–(ii) of the Exchange Act
(15 U.S.C. 78o–10(e)(2)(B)(i)–(ii)) and section
4s(e)(1)(A)–(B) of the CEA (7 U.S.C. 6s(e)(1)(A)–(B)),
added by the Dodd-Frank Act. In this release,
collateral collected to cover potential future
exposure is referred to as margin collateral.

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credit risk.476 Alternatively, agreements
between a dealer and its counterparties
could require the counterparties to
begin delivering collateral during the
pendency of the transaction if certain
‘‘trigger events,’’ e.g., a downgrade of
the counterparty’s credit rating, occur.
Prior to the financial crisis, the ability
to enter into OTC derivatives
transactions without having to deliver
collateral allowed counterparties to
enter into OTC derivatives transactions
without the necessity of using capital to
support the transactions.477 So, when
‘‘trigger events’’ occurred during the
financial crisis, counterparties faced
significant liquidity strains in seeking to
meet the requirements to deliver
collateral.478 As a result, some dealers
experienced large uncollateralized
exposures to counterparties
experiencing financial difficulty, which,
in turn, risked exacerbating the already
severe market dislocation.479
The Dodd-Frank Act seeks to address
the risk of uncollateralized credit risk
exposure arising from OTC derivatives
by, among other things, mandating
margin requirements for non-cleared
security-based swaps and swaps. In
particular, section 764 of the DoddFrank Act added new section 15F to the
Exchange Act.480 Section 15F(e)(2)(B) of
the Exchange Act provides that the
Commission shall adopt rules for
nonbank SBSDs and nonbank MSBSPs
imposing ‘‘both initial and variation
margin requirements on all securitybased swaps that are not cleared by a
registered clearing agency.’’ 481 Section
15F(e)(2)(A) of the Exchange Act
provides that the prudential regulators
shall prescribe initial and variation
margin requirements for non-cleared
security-based swap transactions
applicable to bank SBSDs and bank
MSBSPs.482 Section 15F(e)(3)(A) also
476 See, e.g., Orice M. Williams, Director,
Financial Markets and Community Investment,
General Accountability Office (‘‘GAO’’), Systemic
Risk: Regulatory Oversight and Recent Initiatives to
Address Risk Posed by Credit Default Swaps, GAO–
09–397T (Mar. 2009), available at http://
www.gao.gov/new.items/d09397t.pdf (testimony
before the U.S. House Financial Services
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises).
477 Id. at 13.
478 Id. See also GAO, Financial Crisis: Review of
Federal Reserve System Financial Assistance to
American International Group, Inc., GAO–11–616
(Sept. 2011), available at http://www.gao.gov/assets/
590/585560.pdf (‘‘Financial Crisis: Review of
Federal Reserve System Financial Assistance to
American International Group, Inc.’’).
479 See Financial Crisis: Review of Federal
Reserve System Financial Assistance to American
International Group, Inc. at 5–6.
480 See Public Law 111–203 § 764.
481 15 U.S.C. 78o–10(e)(2)(B).
482 See 15 U.S.C. 78o–10(e)(2)(A). The prudential
regulators have proposed margin rules with respect

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provides that ‘‘[t]o offset the greater risk
to the security-based swap dealer or
major security-based swap participant
and the financial system arising from
the use of security-based swaps that are
not cleared,’’ the margin requirements
proposed by the Commission and
prudential regulators shall ‘‘help ensure
the safety and soundness’’ of the SBSDs
and the MSBSPs, and ‘‘be appropriate
for the risk associated with non-cleared
security-based swaps held’’ by an SBSD
or MSBSP.483
Similarly, sections 4s(e)(1)(A) and (B)
of the CEA provide that the prudential
regulators and the CFTC shall prescribe
margin requirements for, respectively,
bank swap dealers and bank major swap
participants, and nonbank swap dealers
and nonbank major swap
participants.484 Further, section
4s(e)(3)(A) of the CEA provides, among
other things, that ‘‘[t]o offset the greater
risk to the swap dealer or major swap
participant and the financial system
arising from the use of swaps that are
not cleared,’’ the margin requirements
adopted by the prudential regulators
and the CFTC shall ‘‘help ensure the
safety and soundness’’ of swap dealers
and major swap participants, and ‘‘be
appropriate for the risk associated with
non-cleared swaps held’’ by these
entities.485
The margin requirements that must be
established with respect to non-cleared
security-based swaps and non-cleared
swaps will operate in tandem with
provisions in the Dodd-Frank Act
requiring that security-based swaps and
swaps must be cleared through a
registered clearing agency or registered
DCO, respectively, unless an exception
to mandatory clearing exists.486 More
to non-cleared swaps and security-based swaps that
would apply to bank swap dealers, bank major
swap participants, bank SBSDs, and bank MSBSPs.
See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564. The prudential
regulators refer to collateral to cover current
exposure as variation margin and collateral to cover
potential future exposure as initial margin. Id.
483 15 U.S.C. 78o–10(e)(3)(A).
484 See 7 U.S.C. 6s(e)(1)(A) and (B). The CFTC has
proposed margin requirements with respect to noncleared swaps that would apply to nonbank swap
dealers and nonbank major swap participants. See
CFTC Margin Proposing Release, 76 FR 23732. The
CFTC refers to collateral to cover current exposure
as variation margin and collateral to cover potential
future exposure as initial margin. Id.
485 7 U.S.C. 6s(e)(3)(A).
486 See Public Law 111–203 § 763 (adding section
3C(a)(1) of the Exchange Act (15 U.S.C. 78c–3(a)(1)
(mandatory clearing of security-based swaps)) and
Public Law 111–203 § 723 (adding section 2(h) of
the CEA (7 U.S.C. 2(h) (mandatory clearing of
swaps)). The mandatory clearing provisions in the
Exchange Act and CEA contain exceptions from the
mandatory clearing requirement for certain types of
entities, security-based swaps, and swaps. See
Process for Submissions for Review of SecurityBased Swaps for Mandatory Clearing and Notice

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specifically, section 3C of the Exchange
Act,487 as added by section 763(a) of the
Dodd-Frank Act, creates, among other
things, a clearing requirement with
respect to certain security-based swaps.
Specifically, this section provides that
‘‘[i]t shall be unlawful for any person to
engage in a security-based swap unless
that person submits such security-based
swap for clearing to a clearing agency
that is registered under this Act or a
clearing agency that is exempt from
registration under this Act if the
security-based swap is required to be
cleared.’’ 488
Clearing agencies and DCOs that
operate as central counterparties
(‘‘CCPs’’) manage credit and other risks
through a range of controls and
methods, including prescribed margin
rules for their members.489 Thus, the
Filing Requirements for Clearing Agencies;
Technical Amendments to Rule 19b–4 and Form
19b–4 Applicable to All Self-Regulatory
Organizations, Exchange Act Release No. 67286
(June 28, 2012), 77 FR 41602 (July 13, 2012)
(explaining exceptions to mandatory clearing for
security-based swaps) (‘‘Process for Submissions of
Security-Based Swaps’’); Process for a Designated
Contract Market or Swap Execution Facility To
Make a Swap Available To Trade, 76 FR 77728
(Dec. 30, 2010) (explaining exceptions to mandatory
clearing for swaps). Security-based swaps and
swaps that are not required to be cleared would be
non-cleared security-based swaps and swaps.
487 15 U.S.C. 78c–3 et seq.
488 15 U.S.C. 78c–3(a)(1) (as added by section
763(a) of the Dodd-Frank Act). The requirement that
a security-based swap must be cleared will stem
from the determination to be made by the
Commission. Such determination may be made in
connection with the review of a clearing agency’s
submission regarding a security-based swap, or any
group, category, type or class of security-based
swap, the clearing agency plans to accept for
clearing. See 15 U.S.C. 78c–3(b)(2)(C)(ii) (as added
by section 763(a) of the Dodd-Frank Act) (‘‘[t]he
Commission shall * * * review each submission
made under subparagraphs (A) and (B), and
determine whether the security-based swap, or
group, category, type, or class of security-based
swaps, described in the submission is required to
be cleared’’.). In addition, section 3C(b)(1) of the
Exchange Act provides that ‘‘[t]he Commission on
an ongoing basis shall review each security-based
swap, or any group, category, type, or class of
security-based swaps to make a determination that
such security-based swap, or group, category, type,
or class of security-based swaps should be required
to be cleared.’’
489 See Clearing Agency Standards for Operation
and Governance, Exchange Act Release No. 64017
(Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011)
(‘‘Clearing Agency Standards for Operation and
Governance’’). A CCP interposes itself between two
counterparties to a transaction. See Process for
Submissions of Security-Based Swaps, 77 FR at
41603. For example, when an OTC derivatives
contract between two counterparties that are
members of a CCP is executed and submitted for
clearing, it is typically replaced by two new
contracts—separate contracts between the CCP and
each of the two original counterparties. At that
point, the original counterparties are no longer
counterparties to each other. Instead, each acquires
the CCP as its counterparty, and the CCP assumes
the counterparty credit risk of each of the original
counterparties that are members of the CCP. To
address the credit risk of acting as a CCP, clearing

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mandatory clearing requirements
established by the Dodd-Frank Act for
security-based swaps and swaps, in
effect, will establish margin
requirements for cleared security-based
swaps and cleared swaps and, thereby,
complement the margin requirements
for non-cleared security-based swaps
and non-cleared swaps established by
the Commission, the prudential
regulators, and the CFTC.490
Pursuant to section 15F(e) of the
Exchange Act, the Commission is
proposing new Rule 18a–3 to establish
margin requirements for nonbank
SBSDs and nonbank MSBSPs with
respect to non-cleared security-based
swaps. The provisions of proposed Rule
18a–3 are based on the margin rules
applicable to broker-dealers (the
‘‘broker-dealer margin rules’’).491 The
goal of modeling proposed new Rule
18a–3 on the broker-dealer margin rules
is to promote consistency with existing
rules and to facilitate the portfolio
margining of security-based swaps with
other types of securities. In the
securities markets, margin rules have
been set by relevant regulatory
authorities (the Federal Reserve and the
SROs) since the 1930s.492 The
agencies and DCOs require their clearing members
to post collateral for proprietary and customer
positions of the member cleared by the clearing
agency or DCO. They also may require their clearing
members to collect collateral from their customers.
In addition, as discussed below, the Federal Reserve
and the broker-dealer SROs prescribe margin rules
requiring broker-dealers to collect margin collateral
from their customers for financed securities
transactions and facilitated short sales of securities.
Id.
490 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27567 (‘‘In the
derivatives clearing process, central counterparties
(CCPs) manage the credit risk through a range of
controls and methods, including a margining
regime that imposes both initial margin and
variation margin requirements on parties to cleared
transactions. Thus, the mandatory clearing
requirement established by the Dodd-Frank Act for
swaps and security-based swaps will effectively
require any party to any transaction subject to the
clearing mandate to post initial and variation
margin to the CCP in connection with that
transaction.’’) (footnote omitted). See also Clearing
Agency Standards for Operation and Governance,
76 FR at 14482 (proposing a requirement that
clearing agencies acting as CCPs must establish,
implement, maintain, and enforce written policies
and procedures reasonably designed to use margin
requirements to limit credit exposures to members
in normal market conditions, use risk-based models
and parameters to set margin requirements, and
review the models and parameters at least
monthly).
491 Broker-dealers are subject to margin
requirements in rules promulgated by the Federal
Reserve (12 CFR 220.1, et seq.), SROs (see, e.g.,
FINRA Rules 4210–4240), and, with respect to
security futures, jointly by the Commission and the
CFTC (17 CFR 242.400–406).
492 The Federal Reserve originally adopted
Regulation T pursuant to section 7 of the Exchange
Act shortly after the enactment of the Exchange Act.
See 1934 Fed. Res. Bull. 675. The purposes of the

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requirement that an SRO file proposed
margin rules with the Commission has
promoted the establishment of
consistent margin levels across the
SROs, which mitigates the risk that
SROs (as well as their member firms)
will compete by implementing lower
margin levels and also helps ensure that
margin levels are set at sufficiently
prudent levels to reduce systemic
risk.493 Basing proposed Rule 18a–3 on
the broker-dealer margin rules is
intended to achieve these same
objectives in the market for securitybased swaps.
Under the broker-dealer margin rules,
an accountholder is required to
maintain a specified level of equity in a
securities account at a broker-dealer
(i.e., the market value of the assets in the
account must exceed the amount of the
accountholder’s obligations to the
broker-dealer by a prescribed
amount).494 This equity serves as a
buffer in the event the accountholder
fails to meet an obligation to the brokerdealer and the broker-dealer must
liquidate the assets in the account to
satisfy the obligation.495 The equity also
provides liquidity to the broker-dealer
with which to fund the credit extended
to the accountholder. The amount of the
equity required to be maintained in the
account depends on the securities
transactions being facilitated through
the resources of the broker-dealer
because the equity requirement
increases as the risk of the securities
purchased with borrowed funds or sold
Federal Reserve’s margin rules include: (1)
Regulation of the amount of credit directed into
securities speculation and away from other uses; (2)
protection of the securities markets from price
fluctuations and disruptions caused by excessive
margin credit; (3) protection of investors against
losses arising from undue leverage in securities
transactions; and (4) protection of broker-dealers
from the financial exposure involved in excessive
margin lending to customers. See Charles F.
Rechlin, Securities Credit Regulation § 1:3 (2d ed.
2008).
493 Pursuant to section 19(b)(1) of the Exchange
Act, each SRO must file with the Commission any
proposed change in, addition to, or deletion from
the rules of the exchange electronically on a Form
19b–4 through the Electronic Form 19b–4 Filing
System, which is a secure Web site operated by the
Commission. 15 U.S.C. 78s(b)(1); 17 CFR 240.19b–
4.
494 See, e.g., 12 CFR 220.2; FINRA Rule
4210(a)(5); 17 CFR 242.401(a)(8). Accountholder
obligations to the broker-dealer generally arise from
the accountholder borrowing funds from the brokerdealer to finance securities purchases and the
accountholder relying on the broker-dealer to
borrow securities or use its own securities to make
delivery on short sales of securities by the
accountholder.
495 The account equity requirement, in effect,
mandates that the account contain sufficient
collateral to cover the broker-dealer’s current
exposure to the accountholder plus a buffer to
address potential future exposure.

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short with borrowed securities
increases.
Proposed new Rule 18a–3 is based on
these same principles and is intended to
form part of an integrated program of
financial responsibility requirements,
along with the proposed capital and
segregation standards. For example,
proposed new Rule 18a–1 would
impose a capital charge in certain cases
for uncollateralized exposures arising
from security-based swaps. The
segregation requirements are intended
to ensure that initial margin collected by
SBSDs is protected from their
proprietary business risks.496
Request for Comment
The Commission generally requests
comment on the proposal to model the
nonbank SBSD margin rule for noncleared security-based swaps on the
broker-dealer margin rules. In addition,
the Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Are there other margin standards
that would more appropriately address
the risks of non-cleared security-based
swaps and/or be more practical
margining programs for non-cleared
security-based swaps? If so, identify
them and explain how they would be
more appropriate and/or practical.
2. What are the current margining
practices of dealers in OTC derivatives
with respect to contracts that likely
would be security-based swaps subject
to proposed new Rule 18a–3? How do
those margining practices differ from
the proposed requirements in proposed
new Rule 18a–3?
3. As a practical matter, would the
structure of proposed new Rule 18a–3
accommodate portfolio margining of
security-based swaps and swaps? If so,
explain why. If not, explain why not.
2. Proposed Margin Requirements for
Nonbank SBSDs and Nonbank MSBSPs
a. Scope of Rule 18a–3
Proposed new Rule 18a–3 would
apply to nonbank SBSDs and nonbank
MSBSPs.497 As discussed in more detail
below, the proposed rule would require
nonbank SBSDs to collect collateral
from their counterparties to non-cleared
security-based swaps to cover both
current exposure and potential future
exposure to the counterparty (i.e., the
rule would require the account to have
prescribed minimum levels of equity);
however, there would be exceptions to
496 See proposed new Rules 18a–1, 18a–3, and
18a–4.
497 See paragraph (a) of proposed new Rule 18a–
3.

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these requirements for certain types of
counterparties and for certain types of
transactions. The collateral collected to
address the potential future exposure
(the margin collateral) would need to be
sufficient to meet the level of account
equity required by the proposed rule.
The required level of account equity
would be based on the risk of the
positions in the account.
Proposed new Rule 18a–3 would
require a nonbank MSBSP to collect
collateral from counterparties to which
the nonbank MSBSP has current
exposure and deliver collateral to
counterparties that have current
exposure to the nonbank MSBSP;
however, there would be exceptions to
these requirements for certain types of
counterparties. These requirements
would apply only to current exposure
(i.e., nonbank MSBSPs and their
counterparties would not be required to
exchange collateral to cover potential
future exposure to each other).
The proposed rule would not identify
the types of instruments that must be
delivered as collateral (e.g., U.S.
government securities). However, it
would place limitations on the collateral
that could be collected by nonbank
SBSDs. First, the rule would require the
nonbank SBSD to take haircuts on the
collateral equal to the amounts of the
deductions required under Rule 15c3–1,
as proposed to be amended, and
proposed new Rule 18a–1, as applicable
to the nonbank SBSD. Second, the rule
would prescribe conditions with respect
to the collateral modeled on the
conditions in Appendix E to Rule 15c3–
1, discussed above in section II.A.2.b.iv.
of this release, that determine when
collateral can be taken into account for
purposes of determining a potential
credit risk charge for exposure to certain
counterparties.498
Finally, the provisions in proposed
new Rule 18a–3 are intended to
establish minimum margin requirements
for non-cleared security-based swaps. A
nonbank SBSD and a nonbank MSBSP
could establish ‘‘house’’ margin
requirements that are more conservative
than those specified in the proposed
new rule.499 For example, a nonbank
SBSD could require that a minimum
level of equity must be maintained in
the accounts of counterparties that
exceed the level of equity required to be
maintained pursuant to the proposed
new rule. In addition, a nonbank SBSD
and a nonbank MSBSP could
498 See

17 CFR 240.15c3–1e(c)(4)(v)(A)–(H).
broker-dealer margin rules, brokerdealers also can establish ‘‘house’’ margin
requirements as long as they are at least as
restrictive as the Federal Reserve and SRO margin
rules. See, e.g., FINRA Rule 4210(d).
499 Under

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specifically identify and thereby limit
the types of instruments they will
accept as collateral.
b. Daily Calculations
i. Nonbank SBSDs
Proposed new Rule 18a–3 would
require nonbank SBSDs to collect
collateral from their counterparties to
non-cleared security-based swaps to
cover both current exposure and
potential future exposure, subject to
certain exceptions discussed below.500
Consequently, proposed new Rule 18a–
3 would require a nonbank SBSD to
perform two calculations as of the close
of each business day with respect to
each account carried by the firm for a
counterparty to a non-cleared securitybased swap transaction.501 A nonbank
SBSD would be required to increase the
frequency of the calculations (i.e.,
perform intra-day calculations) during
periods of extreme volatility and for
accounts with concentrated
positions.502 These more frequent
calculations would be designed to
monitor the nonbank SBSD’s
counterparty risk exposure in situations
where a default by a counterparty or
multiple counterparties would have a
more significant adverse impact on the
financial condition of the nonbank
SBSD than under more normal
circumstances.503 One consequence of
the more frequent calculations could be
that the nonbank SBSD requests that a
counterparty deliver collateral during
the day pursuant to a ‘‘house’’ margin
requirement to account for changes in
the value of the securities and money
market instruments held in the account.
As discussed below in section
II.B.2.c.i. of this release, the daily
calculations would form the basis for
the nonbank SBSD to determine the
amount of collateral the counterparty
would need to deliver to cover any
500 See paragraphs (c)(1)(ii) and (iii) of proposed
new Rule 18a–3.
501 See paragraphs (c)(1)(i)(A) and (B) of proposed
new Rule 18a–3. For purposes of proposed new
Rule 18a–3, the term account would mean an
account carried by a nonbank SBSD or nonbank
MSBSP for a counterparty that holds non-cleared
security-based swaps. See paragraph (b)(1) of
proposed new Rule 18a–3. In addition, the term
counterparty would mean a person with whom the
nonbank SBSD or nonbank MSBSP has entered into
a non-cleared security-based swap transaction. See
paragraph (b)(3) of proposed new Rule 18a–3.
502 See paragraph (c)(7) of proposed new Rule
18a–3.
503 Compare FINRA Rule 4210(d) which states
that procedures shall be established by members to:
‘‘(1) review limits and types of credit extended to
all customers; (2) formulate their own margin
requirements; and (3) review the need for
instituting higher margin requirements, mark-tomarkets and collateral deposits than are required by
this [margin rule] for individual securities or
customer accounts.’’

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current exposure and potential future
exposure the nonbank SBSD has to the
counterparty. The proposed rule would
except certain counterparties from this
requirement. Even if the counterparty is
not required to deliver collateral, the
calculations—by measuring the current
and potential future exposure to the
counterparty—would assist the nonbank
SBSD in managing its credit risk and
understanding the extent of its
uncollateralized credit exposure to the
counterparty and across all
counterparties. In addition, as discussed
above in section II.A.2.a. of this release,
the calculations would be used for
determining the risk margin amount for
purposes of calculating the 8% margin
factor to determine the nonbank SBSD’s
minimum net capital requirement.504
The first calculation would be to
determine the amount of equity in the
account.505 For purposes of the rule, the
term equity would mean the total
current fair market value of securities
positions in an account of a
counterparty (excluding the time value
of an over-the-counter option), plus any
credit balance and less any debit
balance in the account after applying a
qualifying netting agreement with
respect to gross derivatives payables and
receivables.506 Consequently, the first
step in calculating the equity would be
to mark-to-market all of the securities
positions in the account, including noncleared security-based swap positions.
The second step would be to add to that
amount any credit balance in the
account or subtract from that amount
any debit balance in the account. Credit
balances would include payables the
nonbank SBSD owed to the
counterparty. Payables could relate to
cash deposited into the account, the
proceeds of the sales of securities held
in the account, and/or interest and
dividends earned from securities held in
the account. In addition, payables could
relate to derivatives in the account,
including non-cleared security-based
swaps with a net replacement value in
the favor of the counterparty. Debit
balances would be receivables to the
nonbank SBSD owed by the
504 See proposed new paragraph (c)(16) of Rule
15c3–1; paragraph (c)(6) of proposed new Rule 18a–
1.
505 See paragraph (c)(1)(i)(A) of proposed new
Rule 18a–3.
506 See paragraph (b)(4) of proposed new Rule
18a–3. The time value of an OTC option is the
amount that the current market value of the option
exceeds the in-the-money amount of the option. See
also, generally, FINRA Rule 4210(a)(5) (defining
equity to mean the customer’s ownership interest in
the account, computed by adding the current
market value of all securities ‘‘long’’ and the
amount of any credit balance and subtracting the
current market value of all securities ‘‘short’’ and
the amount of any debit balance).

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counterparty, including any net
replacement values in favor of the
nonbank SBSD arising from derivatives
positions and any other amounts owed
to the nonbank SBSD by the
counterparty.
As indicated by the proposed
definition of equity, the nonbank SBSD
could offset payables and receivables
relating to derivatives in the account by
applying a qualifying netting agreement
with the counterparty. To qualify for
this treatment, a netting agreement
would need to meet the minimum
requirements prescribed in Appendix E
to Rule 15c3–1 to qualify for purposes
of the credit risk charge discussed above
in section II.A.2.b.iv. of this release.507
These requirements are designed to
ensure that the netting agreement
between the nonbank SBSD and the
counterparty permits the nonbank SBSD
to reduce the receivables and payables
relating to derivatives between the two
entities to a single net payment
obligation.
The equity is the amount that results
after marking-to-market the securities
positions and adding the credit balance
or subtracting the debit balance
(including giving effect to qualifying
netting agreements). If the value of the
securities positions in the account
exceeds the amount of any debit
balance, the account would have a
positive equity.508 On the other hand, if
the amount of the debit balance is
greater, the account would have a
negative equity.509 The negative equity
in an account would be equal to the
nonbank SBSD’s current exposure to the
counterparty.
The second calculation would be to
determine a margin amount for the
account to address potential future
exposure.510 The proposed rule would
prescribe a standardized method and a
model-based method for calculating the
margin amount.511 The method for
507 See paragraph (c)(5) of proposed new Rule
18a–3; 17 CFR 240.15c3–1e(c)(4)(iv).
508 The proposed rule would define the term
positive equity to mean equity of greater than $0.
See paragraph (b)(7) of proposed new Rule 18a–3.
509 The proposed rule would define the term
negative equity to mean equity of less than $0. See
paragraph (b)(6) of proposed new Rule 18a–3.
510 See paragraph (c)(1)(i)(B) of proposed new
Rule 18a–3.
511 See paragraph (d) of proposed new Rule 18a–
3. Similarly, the prudential regulators have
proposed that bank SBSDs and bank swap dealers
have the option of using internal models to
calculate initial margin requirements for noncleared security-based swaps. See Prudential
Regulator Margin and Capital Proposing Release, 76
FR at 27567–27568 (‘‘With respect to initial margin,
the proposed rule permits a covered swap entity to
select from two alternatives to calculate its initial
margin requirements. A covered swap entity may
calculate its initial margin requirements using a
standardized ‘lookup’ table that specifies the

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determining the margin amount would
be similar to the approach a nonbank
SBSD would need to use to determine
haircuts on proprietary security-based
swap positions when computing net
capital.512 This approach would
maintain consistency between the
proposed margin and capital rules.
Specifically, paragraph (d) of proposed
new Rule 18a–3 would divide securitybased swaps into two classes: CDS
security-based swaps and all other
security-based swaps. Paragraph (d)
would define the standardized
methodology for determining the
margin amount for each class of
security-based swap by reference to the
standardized haircuts that would apply
to the class in proposed new Rule 18a–
1 (if a stand-alone SBSD) or Rule 15c3–
1, as proposed to be amended (if a
broker-dealer SBSD).513 Paragraph (d)
minimum initial margin that must be collected,
expressed as a percentage of the notional amount
of the swap or security-based swap. These
percentages depend on the broad asset class of the
swap or security-based swap. Alternatively, a
covered swap entity may calculate its minimum
initial margin requirements using an internal
margin model that meets certain criteria and that
has been approved by the relevant prudential
regulator.’’) (footnotes omitted). On the other hand,
the CFTC, because of concerns about the resources
necessary to approve the use of internal models for
margining purposes and the fact that nonbank swap
dealers may not have internal models, proposed
that nonbank swap dealers must use either external
models or a standardized approach to determine
initial margin (though the CFTC did propose a
provision under which the CFTC could approve the
use of an internal model should the CFTC obtain
sufficient resources). See CFTC Margin Proposing
Release, 76 FR at 23737. The external models
proposed by the CFTC are: (1) a model currently in
use for margining cleared swaps at a DCO; (2) a
model currently in use for modeling non-cleared
swaps by an entity subject to regular assessment by
a prudential regulator; or (3) a model available for
licensing to any market participant by a vendor. Id.
The use of external models is not being proposed
for nonbank SBSDs because the basis for permitting
firms to use VaR models to compute net capital is
to align their internally developed (i.e., not venderdeveloped) risk management processes with the
process for computing net capital. See Alternative
Net Capital Requirements Adopting Release, 69 FR
at 34428 (the option to use VaR models is ‘‘intended
to reduce regulatory costs for broker-dealers by
allowing very highly capitalized firms that have
developed robust internal risk management
practices to use those risk management practices,
such as mathematical risk measurement models, for
regulatory purposes’’).
512 See paragraph (d) of proposed new Rule 18a–
3; proposed new paragraph (c)(2)(vi)(O) of Rule
15c3–1; paragraph (c)(1)(vi) of proposed new Rule
18a–1.
513 See paragraphs (d)(1)(i) and (ii) of proposed
new Rule 18a–3. As discussed in section II.A.2.b.ii.
of this release, proposed new Rule 18a–1 and Rule
15c3–1, as proposed to be amended, would
prescribe standardized haircuts for security-based
swaps. See proposed new paragraph (c)(2)(vi)(O) of
Rule 15c3–1; paragraph (c)(1)(vi) of proposed new
Rule 18a–1. Consequently, for CDS security-based
swaps, the nonbank SBSD would use the proposed
maturity/spread grid in proposed new paragraph
(c)(2)(vi)(O)(1) of Rule 15c3–1 and paragraph
(c)(1)(vi)(A) of proposed new Rule 18a–1 to

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would provide further that, if the
nonbank SBSD was approved to use
internal models to compute net capital,
the firm could use its internal VaR
model to determine the margin amount
for security-based swaps for which the
firm had been approved to use the
model, except that the margin amount
for equity security-based swaps would
need to be determined exclusively using
the standardized haircuts.514
Consequently, for debt security-based
swaps, a nonbank SBSD approved to use
internal models could calculate the
margin amount using the firm’s VaR
model to the extent the firm is approved
to include these types of positions in the
model for the purposes of computing
net capital. For all other positions, a
nonbank SBSD would need to use the
standardized haircut approach.
Nonbank SBSDs that are not approved
to use internal models to compute net
capital would need to use the
standardized haircuts for all positions to
calculate the margin amount.
As noted above, a nonbank SBSD
(regardless of whether it is approved to
use internal models to compute net
capital) would be required to calculate
the margin amount for equity securitybased swaps using the standardized
haircuts, which includes the ability to
use the methodology in Appendix A to
Rule 15c3–1. This proposal is designed
to establish a margin requirement for
equity security-based swaps that is
consistent with SRO portfolio margin
rules for equity securities, which are
based on the Appendix A
methodology.515 This provision would
determine the margin amount. See paragraph
(d)(1)(i) of proposed new Rule 18a–3. While the
required standardized haircuts would be the same
in Rule 15c3–1, as proposed to be amended, and
proposed new Rule 18a–1, the nonbank SBSD
would refer to Rule 15c3–1 if it is a broker-dealer
SBSD and proposed new Rule 18a–1 if it is a standalone SBSD. For all equity security-based swaps
and debt security-based swaps (other than CDS
security-based swaps), the nonbank SBSD would
use the method of multiplying the notional amount
of the position by the standardized haircut that
would apply to the underlying security as specified
in proposed new paragraph (c)(2)(vi)(O)(2) of Rule
15c3–1 and paragraph (c)(1)(vi)(B) of proposed new
Rule 18a–1. See paragraph (d)(ii) of proposed new
Rule 18a–3. For equity security-based swaps, this
would include being able to use the methodology
in Appendix A to Rule 15c3–1, as proposed to be
amended, and in Appendix A to proposed new Rule
18a–1, as applicable to the nonbank SBSD. For debt
security-based swaps, this would include being able
to use the offsets that are permitted in the debt
maturity grids in paragraph (c)(2)(vi) of Rule 15c3–
1. See 17 CFR 240.15c3–1(c)(2)(vi).
514 See paragraph (d)(2) of proposed new Rule
18a–3.
515 See FINRA Rule 4210(g); CBOE Rule 12.4. See
also FINRA, Portfolio Margin Frequently Asked
Questions, available at www.finra.org. As discussed
in section II.A.2.b.ii. of this release, Appendix A to
Rule 15c3–1 permits a broker-dealer to group

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allow broker-dealer SBSDs to include
equity security-based swaps in the
portfolios of equity securities positions
for which they calculate margin
requirements using the SRO portfolio
margin rules.516 The proposal also
would ensure a consistent portfolio
margin approach for equity security
products across nonbank SBSDs and
broker-dealers that are not SBSDs, and
thereby reduce opportunity for
regulatory arbitrage.

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Request for Comment
The Commission generally requests
comment on the proposed daily
calculation requirements for nonbank
SBSDs in proposed new Rule 18a–3. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Is the proposed definition of equity
appropriate? For example, would the
proposed definition be practical in
terms of determining the net equity in
an account holding non-cleared
security-based swaps? If the proposed
definition is not appropriate, explain
why and provide suggested alternative
definitions.
2. Should the definition of equity
include the time value of an over-thecounter option? If so, explain why.
3. Should the terms current market
value, credit balance, and debit balance
be defined for the purpose of proposed
new Rule 18a–3? For example, would
defining these terms provide greater
clarity to the definition of equity in the
proposed rule? If these terms should be
defined, explain why and provide
suggested definitions.
4. Are the proposed requirements for
netting agreements to qualify for
purposes of determining the amount of
equity in an account appropriate? If not,
explain why not. Are there additional or
alternative provisions that should be
options, futures, long securities positions, and short
securities positions involving the same underlying
security and stress the current market price for each
position at ten equidistant points along a range of
positive and negative potential future market
movements, using an approved theoretical options
pricing model that satisfies certain conditions
specified in the rule. See 17 CFR 240.15c3–1a. The
gains and losses of each position in the portfolio
offset each other to yield a net gain or loss at each
stress point. The stress point that yields the largest
potential net loss for the portfolio would be used
to calculate the aggregate haircut for all the
positions in the portfolio. Id.
516 See, e.g., FINRA Rule 4210(g)(2)(G) (defining
the term ‘‘unlisted derivative’’ for purposes of
inclusion in the Appendix A methodology as used
in the rule to calculate a portfolio margin
requirement to mean ‘‘any equity-based or equity
index-based unlisted option, forward contract, or
security-based swap that can be valued by a
theoretical pricing model approved by the
[Commission].’’) (emphasis added).

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contained in the netting agreement
requirements? If so, identify and explain
them.
5. Is the proposed method for
calculating the margin amount
appropriate? If not, explain why not. For
example, is it appropriate to use the
techniques in Rule 15c3–1, as proposed
to be amended, and proposed new Rule
18a–1 to determine the margin amount?
If not, explain why not. Are there
alternative methods for calculating the
margin amount that would be
preferable? If so, identify them and
explain why they would be preferable.
6. Should proposed new Rule 18a-3
allow an alternative method of
calculating the margin amount that
would permit a nonbank SBSD to
determine the margin amount for a noncleared security-based swap based on
the margin required by a registered
clearing agency for a cleared securitybased swap whose terms and conditions
closely resemble the terms and
conditions of the non-cleared securitybased swap (similar to the CFTC’s
proposal)? Would there be sufficient
similarity between certain cleared and
non-cleared security-based swaps to
make this approach workable? In
addition, if this alternative approach
was permitted, how could the potential
differences in margin requirements
across clearing agencies be addressed?
7. In addition to internal models,
should external models be permitted
such as: (1) a model currently in use for
margining cleared security-based swaps
at a clearing agency; (2) a model
currently in use for modeling noncleared swaps by an entity subject to
regular assessment by a prudential
regulator; or (3) a model available for
licensing to any market participant by a
vendor? What would be the advantages
and disadvantages of permitting
external models?
8. How would the proposed
standardized approaches to determining
the margin amount differ from the
standardized approaches the prudential
regulators proposed for determining the
initial margin amount?
9. The provisions for using VaR
models to compute net capital require
that the model use a 99%, one-tailed
confidence level with price changes
equivalent to a ten-business-day
movement in rates and prices. This
means the VaR model used for the
purpose of determining a counterparty’s
margin amount also would need to use
a 99%, one-tailed confidence level with
price changes equivalent to a tenbusiness-day movement in rates and
prices. The ten-business-day
requirement is designed to account for
market movements that occur over a

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period of time as opposed to a single
day. This is designed to ensure that the
VaR model uses potential market moves
that are large enough to capture multiday moves in rates and prices. Given
this purpose, should the VaR model be
required to use a longer period of time
(e.g., 15, 20, 25, or 30 business days) to
establish a potentially greater margin
collateral requirement for customers
given that they may not be subject to
capital and other prudential
requirements? Would the 3-times
multiplication factor proposed to be
required for VaR models used by
nonbank SBSDs (which, under the
proposal, would need to be increased in
response to back-testing exceptions) be
necessary if the time period were longer
than 10 business days? If not, explain
why not.
ii. Nonbank MSBSPs
Proposed new Rule 18a–3 would
require nonbank MSBSPs to collect
collateral from counterparties to which
the nonbank MSBSP has current
exposure and provide collateral to
counterparties that have current
exposure to the nonbank MSBSP.517
Consequently, a nonbank MSBSP would
be required to calculate as of the close
of business each day the amount of
equity in each account of a
counterparty.518 Consistent with the
proposal for nonbank SBSDs, a nonbank
MSBSP would be required to increase
the frequency of its calculations (i.e.,
perform intra-day calculations) during
periods of extreme volatility and for
accounts with concentrated
positions.519
517 See paragraph (c)(2)(ii) of proposed new Rule
18a-3.
518 See paragraph (c)(2)(i) of proposed new Rule
18a–3. A nonbank MSBSP would apply the
definitions in paragraph (b) of proposed new Rule
18a–3 for the purposes of complying with the
requirements in the rule. See paragraph (b) of
proposed new Rule 18a–3. The term equity would
be defined to mean the total current fair market
value of securities positions in an account of a
counterparty (excluding the time value of an overthe-counter option), plus any credit balance and
less any debit balance in the account after applying
a qualifying netting agreement with respect to gross
derivatives payables and receivables. See paragraph
(b)(4) of proposed new Rule 18a–3. The time value
of an OTC option is the amount that the current
market value of the option exceeds the in-themoney amount of the option. In addition, the term
account is proposed to be defined to mean an
account carried by a nonbank SBSD or nonbank
MSBSP for a counterparty that holds non-cleared
security-based swaps. See paragraph (b)(1) of
proposed new Rule 18a-3. Furthermore, the term
counterparty is proposed to mean a person with
whom the nonbank SBSD or nonbank MSBSP has
entered into a non-cleared security-based swap
transaction. See paragraph (b)(3) of proposed new
Rule 18a–3.
519 See paragraph (c)(7) of proposed new Rule
18a–3. These more frequent calculations would be
designed to monitor the nonbank MSBSP’s

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

As would be the case for a nonbank
SBSD, the first step for a nonbank
MSBSP in calculating the equity in an
account would be to mark-to-market all
of the securities positions in the
account, including non-cleared securitybased swap positions. The second step
would be to add to that amount any
credit balance in the account or subtract
from that amount any debit balance.520
The nonbank MSBSP could offset
payables and receivables relating to
derivatives in the account by applying
a qualifying netting agreement with the
counterparty. To qualify for this
treatment, a netting agreement would
need to meet the minimum
requirements prescribed in Appendix E
to Rule 15c3–1 to qualify for purposes
of the credit risk charge discussed above
in section II.A.2.b.iv. of this release.521
These requirements, set forth in
paragraph (c)(5) of Rule 18a–3, are
designed to ensure that the netting
agreement between the nonbank MSBSP
and the counterparty permits the
nonbank MSBSP to reduce the
receivables and payables between the
two entities to a single net payment
obligation.522
If the value of the securities positions
plus the amount of any cash in the
account exceeds the amount of the debit
balance, the account would have
positive equity.523 This would mean the
counterparty has current exposure to the
nonbank MSBSP. On the other hand, if
the amount of the debit balance is
greater, the account would have
counterparty risk exposure in situations where a
default by a counterparty or multiple counterparties
would have a more significant adverse impact on
the financial condition of the nonbank MSBSP than
under more normal circumstances. One
consequence of the more frequent calculations
could be that the nonbank MSBSP requests that a
counterparty deliver collateral during the day
pursuant to a ‘‘house’’ margin requirement to
account for changes in the value of the securities
and money market instruments held in the account.
520 Credit balances would include payables the
nonbank MSBSP owed to the counterparty.
Payables could relate to cash deposited into the
account, the proceeds of the sales of securities held
in the account, and interest and dividends earned
from securities held in the account. In addition,
payables could relate to derivatives in the account
such as non-cleared security-based swaps with a net
replacement value in the favor of the counterparty.
Debit balances would be receivables to the nonbank
MSBSP owed by the counterparty. Receivables
could relate to derivatives in the account such as
non-cleared security-based swaps with a net
replacement value in the favor of the nonbank
MSBSP.
521 See paragraph (c)(5) of proposed new Rule
18a–3; 17 CFR 240.15c3–1e(c)(4)(iv).
522 See paragraph (c)(5) of proposed new Rule
18a–3.
523 The proposed rule would define the term
positive equity to mean equity of greater than $0.
See paragraph (b)(7) of proposed new Rule 18a–3.

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negative equity.524 This would mean the
nonbank MSBSP has current exposure
to the counterparty.
Nonbank MSBSPs would not be
required to deliver or collect margin
collateral to collateralize potential
future exposure.525 For that reason, Rule
18a–3 would not require nonbank
MSBSPs to calculate a margin amount,
and the rule would not require
counterparties to provide margin
collateral to nonbank MSBSPs to
maintain equity levels above the
nonbank MSBSP’s current exposure.
When a counterparty provides margin
collateral to collateralize potential
future exposure, the counterparty is
exposed to credit risk in the amount that
the collateral provided to the dealer
exceeds the dealer’s current exposure to
the counterparty. With respect to
nonbank SBSDs, collateralizing
potential future exposure is intended to
promote the financial responsibility of
the nonbank SBSD, as the margin
collateral received from the
counterparty protects the nonbank
SBSD from the risks arising from
fluctuations in the value of the
underlying positions before the
collateral can be sold. The counterparty,
in turn, would be protected by the net
liquid assets test standard applicable to
the nonbank SBSD,526 which is
significantly more conservative than the
tangible net worth capital standard
proposed for nonbank MSBSPs.527 The
counterparties also would be protected
by the proposed segregation
requirements with respect to the margin
collateral delivered by
counterparties.528
The proposed margin requirements
for nonbank MSBSPs are designed to
‘‘neutralize’’ the credit risk between a
nonbank MSBSP and a counterparty.
The collection of collateral from
counterparties would strengthen the
liquidity of the nonbank MSBSP by
collateralizing its current exposure to
counterparties. Nonbank MSBSPs, in
contrast to nonbank SBSDs, would be
required to deliver collateral to
counterparties to collateralize their
current exposure to the nonbank
MSBSP, which would lessen the impact
on the counterparties if the nonbank
MSBSP failed, and is intended to
account for the fact that nonbank
524 The proposed rule would define the term
negative equity to mean equity of less than $0. See
paragraph (b)(6) of proposed new Rule 18a–3.
525 See paragraph (c)(2)(i) of proposed new Rule
18a-3 (only requiring calculation of the equity in the
account of each counterparty).
526 See 17 CFR 240.15c3–1; proposed new Rule
18a–1.
527 See proposed new Rule 18a–2.
528 See proposed new Rule 18a–4.

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MSBSPs would be subject to less
stringent capital requirements than
nonbank SBSDs.
In addition, as discussed in section
II.A.3. of the release, the entities that
may need to register as nonbank
MSBSPs could include companies that
engage in commercial activities that are
not necessarily financial in nature (e.g.,
manufacturing, agriculture, and energy)
and for which a net liquid assets test
could be impractical. Finally, because of
these differences in business models,
nonbank MSBSPs may not have the
systems and personnel necessary to
operate daily margin collateral programs
to address potential future exposure.
Request for Comment
The Commission generally requests
comment on the proposed daily
calculation requirements for nonbank
MSBSPs. Commenters are referred to the
questions about the daily calculation
requirements for nonbank SBSDs above
in section II.B.2.b.i. of this release to the
extent those questions address
provisions in proposed new Rule 18a–
3 that also apply to nonbank MSBSPs.
In addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Which types of counterparties
would be expected to transact with
nonbank MSBSPs? Which types of
security-based swap transactions would
these counterparties enter into with
nonbank MSBSPs?
2. Should nonbank MSBSPs be
required to calculate a daily margin
amount for each counterparty? For
example, even if they were not required
to collect collateral to cover potential
future exposure, would the calculation
of the margin amount better enable
them to measure and understand their
counterparty risk?
3. If nonbank MSBSPs should
calculate a daily margin amount, how
should such amount be calculated?
Should a nonbank MSBSP be required
to calculate a margin amount using the
methods prescribed in paragraph (d) of
proposed new Rule 18a–3 or some other
method? For example, should nonbank
MSBSPs be permitted to use external
models to determine a margin amount?
4. Would nonbank MSBSPs have the
systems and personnel necessary to
operate daily margin collateral programs
to calculate a daily margin amount?
c. Account Equity Requirements
i. Nonbank SBSDs
A nonbank SBSD would be required
to calculate as of the close of each
business day: (1) the amount of equity

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

in the account of each counterparty; and
(2) a margin amount for the account of
each counterparty.529 On the next
business day following the calculations,
the nonbank SBSD would be required to
collect cash, securities, and/or money
market instruments from the
counterparty in an amount at least equal
to the negative equity (current exposure)
in the account plus the margin amount
(potential future exposure).530 The
collateral collected would be designed
to ensure that the counterparty
maintains a minimum level of positive
net equity in the account. The proposed
rule would require the nonbank SBSD to
collect collateral for this purpose from
each counterparty, except as discussed
below.
A nonbank SBSD would need to
collect cash, securities, and/or money
market instruments to meet the account
equity requirements in proposed new
Rule 18a–3. Other types of assets would
not be eligible as collateral. In addition,
under proposed new Rule 18a–3, the
fair market value of securities and
money market instruments held in the
account of a counterparty would need to
be reduced by the amount of the
deductions the nonbank SBSD would
apply to the positions pursuant to Rule
15c3–1, as proposed to be amended, or
proposed new Rule 18a–1, as
applicable, for the purpose of
determining whether the level of equity
in the account meets the minimum
requirement.531 Accordingly, securities
and money market instruments with no
‘‘ready market’’ or which cannot be
publicly offered or sold because of
statutory, regulatory, or contractual
arrangements or other restrictions
would be subject to a 100% deduction
and, therefore, these types of securities
and money market instruments would
have no value in terms of meeting the
account equity requirement.532 All other
securities and money market
instruments in the account would be
reduced in value by the amount of the
deductions required in Rule 15c3–1, as
proposed to be amended, and proposed
new Rule 18a–1, as applicable to the
nonbank SBSD.533 The amount of the
deductions would increase for securities
and money market instruments with
greater market risk and, thereby,
529 See paragraph (c)(1)(i) of proposed new Rule
18a–3. See also paragraph (b)(4) of proposed new
Rule 18a–3 (defining the term equity).
530 See paragraph (c)(1)(ii) of proposed new Rule
18a-3.
531 See paragraph (c)(3) of proposed new Rule
18a-3.
532 See 17 CFR 240.15c3–1(c)(2)(vii); paragraph
(c)(1)(iv) of proposed new Rule 18a–1.
533 See 17 CFR 240.15c3–1(c)(2)(vi); paragraphs
(c)(1)(vi)–(vii) of proposed new Rule 18a–1.

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account for the risk that the nonbank
SBSD may not be able to liquidate the
securities and money market
instruments at current market values to
satisfy the obligation of a defaulted
counterparty.534 These deductions
would limit the types of securities and
money market instruments a
counterparty could provide as collateral
and require a counterparty to increase
the amount of collateral delivered to
account for the deductions taken on
securities collateral in the account.535
The prudential regulators and the
CFTC are proposing to specifically
identify the asset classes that would be
eligible collateral for purposes of their
margin rules.536 Proposed new Rule
534 See 17 CFR 240.15c3–1(c)(2)(vi); paragraphs
(c)(1)(vi)–(vii) of proposed new Rule 18a–1.
535 For example, assume an account holds
securities and money market instruments valued at
$50, a credit balance of $10, and a debit balance of
$58. The equity in the account would be $2 ($50
of securities and money market instruments’ value
+ $10 in credits¥$58 in debits = $2). Assume that
the margin amount calculated for the account is
$10. This would mean that the account needs to
have positive equity of at least $10 (it currently has
positive equity of only $2). Assume that the
deduction under Rule 15c3–1 for the $50 of
securities and money market positions held in the
account is $7. This would mean that the
counterparty would need to deliver $15 in cash (i.e.,
not $8) to meet the minimum $10 account equity
requirement ($50 of securities and money market
instruments’ value¥$7 deduction + $10 in
credits¥$58 in debits + $15 cash collateral deposit
= $10). Moreover, if the counterparty delivered
securities and/or money market instruments to meet
the account equity requirement, the fair market
value of the securities and money market
instruments would need to be greater than $15
because their value would be reduced by the
amount of the deduction in Rule 15c3–1 or
proposed new Rule 18a–1, as applicable.
536 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564; CFTC Margin
Proposing Release, 76 FR 23732. The proposal of
the prudential regulators would limit eligible
collateral to cash, foreign currency to the extent the
payment obligation under the security-based swap
or swap is denominated in the currency, obligations
guaranteed by the United States as to principal and
interest, and, with respect to initial margin only, a
senior debt obligation of the Federal National
Mortgage Association, the Federal Home Loan
Mortgage Corporation, the Federal Home Loan
Banks, and the Federal Agricultural Mortgage
Corporation, or any obligation that is an ‘‘insured
obligation,’’ as the term is defined in 12 U.S.C.
2277a(3), of a Farm Credit System bank. See
Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27589. The proposal of the CFTC
would limit eligible collateral for initial margin to
cash, foreign currency to the extent the payment
obligation under the security-based swap or swap
is denominated in the currency, obligations
guaranteed by the United States as to principal and
interest, and a senior debt obligation of the Federal
National Mortgage Association, the Federal Home
Loan Mortgage Corporation, the Federal Home Loan
Banks, and the Federal Agricultural Mortgage
Corporation, or any obligation that is an ‘‘insured
obligation,’’ as the term is defined in 12 U.S.C.
2277a(3), of a Farm Credit System bank. CFTC
Margin Proposing Release, 76 FR at 23747. The
CFTC’s proposal would limit eligible collateral for
variation margin to cash and obligations guaranteed
by the United States as to principal and interest. Id.

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18a-3 would not limit collateral in this
way. However, comment is sought
below in section II.B.3. of this release on
the question of whether to define the
term eligible collateral in a manner that
is similar to the proposals of the
prudential regulators and the CFTC.
The reason for not proposing a
definition of eligible collateral is that
counterparties are expected to engage in
a wide range of trading strategies that
include security-based swaps.
Consequently, the account of a
counterparty may hold, for example, the
security underlying a security-based
swap, as well as a short position, option,
and single stock future on the
underlying security.537 Because of the
relationship between security-based
swaps and these other security
positions, permitting various types of
securities to count as collateral may be
more practical for margin arrangements
involving security-based swaps than for
other types of derivatives. A more
limited definition of eligible collateral
could require a counterparty that has
positive equity in an account equal to or
in excess of the margin amount to
deliver additional collateral to the
extent the positions in the account did
not meet the definition. The
counterparty’s credit exposure to the
nonbank SBSD therefore would be
increased in a way that may not be
necessary to account for the nonbank
SBSD’s potential future exposure to the
counterparty.538
The Commission is proposing certain
additional requirements for eligible
collateral, which are modeled on the
existing collateral requirements in
Appendix E to Rule 15c3–1.539 As
discussed above in section II.A.2.b.iv. of
this release, collateral ‘‘ideally’’ is ‘‘an
asset of stable and predictable value, an
asset that is not linked to the value of
the transaction in any way, and an asset
that can be sold quickly and easily if the
need arises.’’ 540 The requirements in
Appendix E to Rule 15c3–1 are designed
to achieve these objectives.541 The
proposed additional requirements
include:
• The collateral must be subject to the
physical possession or control of the
nonbank SBSD;
537 See, e.g., FINRA Rule 4210(g) (permitting
customer portfolio margining); 17 CFR 240.15c3–1a;
Appendix A to proposed new Rule 18a–1.
538 A counterparty will have credit exposure to a
nonbank SBSD to the extent that collateral held in
the account of the counterparty has a mark-tomarket value in excess of the nonbank SBSD’s
current exposure to the counterparty.
539 See paragraph (c)(4) of proposed new Rule
18a-3.
540 Market Review of OTC Derivative Bilateral
Collateralization Practices at 5.
541 See 17 CFR 240.15c3–1e(c)(4)(v).

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• The collateral must be liquid and
transferable;
• The collateral must be capable of
being liquidated promptly by the
nonbank SBSD without intervention by
any other party;
• The collateral agreement between
the nonbank SBSD and the counterparty
must be legally enforceable by the
nonbank SBSD against the counterparty
and any other parties to the agreement;
• The collateral must not consist of
securities issued by the counterparty or
a party related to the nonbank SBSD, or
to the counterparty; and
• If the Commission has approved the
nonbank SBSD’s use of a VaR model to
compute net capital, the approval
allows the nonbank SBSD to calculate
deductions for market risk for the type
of collateral.542
These proposed collateral
requirements are designed to ensure that
the treatment of collateral requirements
remains consistent between the
proposed capital and margin
requirements. As discussed above in
section II.A.2.b.v. of this release, a
nonbank SBSD would be required to
take a capital charge if a counterparty
does not deliver cash, securities, and/or
money market instruments to the
nonbank SBSD to meet an account
equity requirement within one business
day of the requirement being triggered.
In addition, proposed new Rule 18a–3
would require the nonbank SBSD to
take prompt steps to liquidate securities
and money market instruments in the
account to the extent necessary to
eliminate the account equity
deficiency.543 Under this provision,
which is modeled on a similar
requirement in the broker-dealer margin
rules,544 a nonbank SBSD could need to
liquidate positions in the account to
reduce debits arising from those
transactions. The rule would not require
that the liquidations must be completed
within a specific timeframe.545 Instead,
the rule is designed to give the nonbank
SBSD the flexibility to conduct an
orderly liquidation, taking into account
market conditions and the risk profile of
the account.
542 See paragraphs (c)(4)(i)–(c)(4)(vi) of proposed
new Rule 18a–3.
543 See paragraph (c)(8) of proposed new Rule
18a–3.
544 See 12 CFR 220.4(d) (providing that if a
margin call is not met within the required time, the
broker-dealer must liquidate securities sufficient to
meet the margin call or to eliminate any margin
deficiency existing on the day such liquidation is
required, whichever is less).
545 See paragraph (c)(8) of proposed new Rule
18a–3.

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There would be four exceptions to the
account equity requirements.546 The
first would apply to counterparties that
are commercial end users.547 The
second would apply to counterparties
that are SBSDs.548 The third would
apply to counterparties that are not
commercial end users and that require
their margin collateral to be segregated
pursuant to section 3E(f) of the
Exchange Act.549 The fourth would
apply to accounts of counterparties that
are not commercial end users and that
hold legacy non-cleared security-based
swaps.550 Under these exceptions,
applicable accounts would not need to
meet certain account equity
requirements in proposed new Rule
18a–3 and, therefore, the nonbank SBSD
would be exempted from the
requirements to take prompt steps to
liquidate securities in the account to the
extent necessary to eliminate the
account equity deficiency. However, as
discussed above in section II.A.2.b.v. of
this release, in these cases the nonbank
SBSD would need to take capital
charges in lieu of meeting the account
equity requirements in certain
circumstances.551
Exception for Commercial End Users
Under the first exception to the
account equity requirements, a nonbank
SBSD would not be required to collect
cash, securities, and/or money market
instruments to cover the negative equity
(current exposure) or margin amount
(potential future exposure) in the
account of a counterparty that is a
commercial end user.552 As discussed
546 See paragraphs (c)(1)(iii)(A)–(D) of proposed
new Rule 18a–3.
547 See paragraph (c)(1)(iii)(A) of proposed new
Rule 18a–3.
548 See paragraph (c)(1)(iii)(B)—Alternative A of
proposed new Rule 18a–3. An alternative approach
is being proposed that would not be an exception
to the account equity requirement under which a
nonbank SBSD would need to collect collateral
from another SBSD to cover the negative equity in
the account and the margin amount for the account.
In addition, the collateral collected to cover the
margin amount would need to be held by an
independent third-party custodian. See paragraph
(c)(1)(iii)(B)—Alternative B of proposed new Rule
18a–3.
549 See paragraph (c)(1)(iii)(C) of proposed new
Rule 18a–3.
550 See paragraph (c)(1)(iii)(D) of proposed new
Rule 18a–3.
551 See proposed new paragraph (c)(2)(xiv) of
Rule 15c3–1; paragraph (c)(1)(viii) of proposed Rule
18a–1.
552 See paragraph (c)(1)(iii)(A) of proposed Rule
18a–3. The exception would apply to negative
equity in the account and the margin amount
calculated for the account. However, a nonbank
SBSD would be required to take a 100% deduction
from net worth for the amount of the
uncollateralized negative equity and take the
proposed capital charge in lieu of margin collateral
discussed above in section II.A.2.b.v. of this release.

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above in section II.A.2.b.v. of this
release, this proposed exception to the
requirement to collect collateral is
intended to address concerns that have
been expressed by commercial end
users and others that the imposition of
margin requirements on commercial
companies that use derivatives to
mitigate the risk of business activities
that are not financial in nature could
unduly disrupt their ability to enter into
hedging transactions. The proposed
exception is intended to permit
nonbank SBSDs and commercial end
users to negotiate individual agreements
that would reflect the credit risk of the
commercial end user and the nature and
extent of the non-cleared security-based
swap transactions with the end user,
without creating an undue impediment
to the ability of the commercial end user
to hedge its commercial risks.553
The proposed exception for
commercial end users also is intended
to account for the different risk profiles
of commercial end users as compared
with financial end users.554 When credit
markets are under strain, as in 2008,
financial end users, such as hedge
funds, can face liquidity stress, which
increases their risk of default. Further,
See 17 CFR 240.15c3–1(c)(2)(iv)(B) (deductions for
unsecured receivables); paragraph (c)(1)(iii)(B) of
proposed new Rule 18a–1 (deductions for
unsecured receivables); proposed new paragraph
(c)(2)(xiv) of Rule 15c3–1 (proposed capital charge
in lieu of margin); paragraph (c)(1)(viii) of proposed
Rule 18a–1 (proposed capital charge in lieu of
margin). As an alternative to these capital charges,
ANC broker-dealers and stand-alone SBSDs using
internal models could take the credit risk charge
discussed in section II.A.2.b.iv. of this release. See
amendments to paragraph (a)(7) of Rule 15c3–1;
paragraph (a)(2) of proposed new Rule 18a–1.
553 The margin rule proposed by the prudential
regulators would require the entities subject to the
rule to establish credit exposure limits for each
nonfinancial end user ‘‘under appropriate credit
processes and standards,’’ and to collect collateral
to the extent that individual exposures exceed those
limits. See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27587. The margin rule
proposed by the CFTC would permit entities subject
to the rule and nonfinancial end users ‘‘to set initial
margin and variation margin requirements in their
discretion’’ but each entity subject to the proposed
rule would be required to calculate daily exposure
amounts for nonfinancial end users for risk
management purposes. See CFTC Margin Proposing
Release, 76 FR at 27736.
554 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27571 (‘‘Among end
users, financial end users are considered more risky
than nonfinancial end users because the
profitability and viability of financial end users is
more tightly linked to the health of the financial
system than nonfinancial end users. Because
financial counterparties are more likely to default
during a period of financial stress, they pose greater
systemic risk and risk to the safety and soundness
of the covered swap entity.’’). See also CFTC Margin
Proposing Release, 76 FR at 27735 (‘‘The
Commission believes that financial entities, which
are generally not using swaps to hedge or mitigate
commercial risk, potentially pose greater risk to
CSEs than non-financial entities.’’).

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financial end users as a group, due to
the nature of their business, may engage
in security-based swap transactions in
greater volume than commercial end
users, increasing the risk of substantial
concentration of counterparty exposure
to nonbank SBSDs, and potentially
creating greater systemic risk from the
failure of a single entity.555
For purposes of the rule, the term
commercial end user means any person
(other than a natural person) that: (1)
Engages primarily in commercial
activities that are not financial in nature
and that is not a financial entity as that
term is defined in section 3C(g)(3) of the
Exchange Act; 556 and (2) is using non555 The margin rules proposed by the prudential
regulators and the CFTC would differentiate
collateral requirements based on whether a
financial end user is ‘‘high risk’’ or ‘‘low risk.’’ See
Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27571–27572; CFTC Margin
Proposing Release, 76 FR at 23736–23737. A ‘‘low
risk’’ financial end user is defined in their
proposals as an entity that: (1) is subject to capital
requirements established by a prudential regulator
or a state insurance regulator; (2) predominantly
uses OTC derivatives for hedging purposes; and (3)
does not have significant OTC derivatives exposure.
See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27572; CFTC Margin
Proposing Release, 76 FR at 23735–23736. A low
risk financial end user would not be required to
deliver initial or variation margin if the amounts
required are less than certain prescribed thresholds.
See id. While not all financial end users present the
same degree of counterparty risk, an exception from
the account equity requirements based on the risk
profile of the financial end user is not being
proposed. This is because margin collateral is an
important means of managing credit risk and the
concerns expressed with respect to commercial end
users being required to deliver margin collateral
generally do not apply to financial end users as they
customarily deliver margin collateral. As discussed
in sections II.A.1. and II.A.2.b.i. of this release, the
proposed capital standard for nonbank SBSDs is
based on the net liquid assets test embodied in Rule
15c3–1. Under this test, most unsecured receivables
are deducted in full when computing net capital
because of their illiquidity. Proposed new Rule
18a–3 is designed to complement this treatment of
unsecured receivables by limiting the exceptions to
the requirement to collect collateral from
counterparties to circumstances that provide a
compelling reason for the trade-off between the
risk-mitigating benefits of collateral and practical
impediments to delivering collateral. With respect
to nonbank SBSDs, there does not appear to be a
compelling reason to establish a two-tiered
approach for financial end users. First, financial
end users generally pose more risk than commercial
end users. Second, the different credit risk profiles
of financial end users may not always be clear,
which may make it difficult to differentiate between
high and low risk financial end users. Third, market
participants have told the Commission staff that
financial end users entering into security-based
swap transactions generally already deliver
collateral to dealers to cover current and potential
future exposure.
556 See 15 U.S.C. 78o–3(g)(3). Section 3C(g) of the
Exchange Act defines the term financial entity to
mean: (1) a swap dealer; (2) an SBSD; (3) a major
swap participant; (4) an MSBSP; (5) a commodity
pool as defined in section 1a(10) of the CEA; (6) a
private fund as defined in section 202(a) of the
Investment Advisors Act of 1940; (7) an employee
benefit plan as defined in paragraphs (3) and (32)

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cleared security-based swaps to hedge
or mitigate risk relating to the
commercial activities.557 The proposed
definition of commercial end user is
modeled on the exception to the
mandatory clearing provisions for
security-based swaps in section 3C of
the Exchange Act.558 Among other
things, to qualify for the mandatory
clearing exception, one of the
counterparties to the security-based
swap transaction must not be a financial
entity and must be using security-based
swaps to hedge or mitigate commercial
risk.559
Under the proposed definition, an
individual could not qualify as a
commercial end user. In addition,
because the proposed definition
provides that a commercial end user
must engage primarily in commercial
activities that are not financial in nature
and must not be a financial entity as
defined in section 3C(g)(3) of the
Exchange Act, entities such as banks,
broker-dealers, FCMs, SBSDs, swap
dealers, MSBSPs, swap participants,
mutual funds, private funds, commodity
pools, and employee benefit plans
would not qualify as a commercial end
user.560 Furthermore, the proposed
definition provides that the commercial
end user must be using non-cleared
of section 3 of the Employee Retirement Income and
Security Act of 1974 (29 U.S.C. 1002); or (8) a
person predominantly engaged in activities that are
in the business of banking, or in activities that are
financial in nature as defined in section 4(k) of the
Bank Holding Company Act of 1956.
557 See paragraph (b)(2) of proposed new Rule
18a–3.
558 Compare 15 U.S.C. 78c–3(g)(1), with
paragraph (b)(2) of proposed new Rule 18a–3.
559 See 15 U.S.C. 78c–3(g)(1).
560 See, e.g., 15 U.S.C. 78c–3(g)(3). The prudential
regulators and the CFTC have proposed definitions
of financial end user and financial entity,
respectively, in their non-cleared security-based
swap margin rules in addition to their proposed
definitions of nonfinancial end user. See Prudential
Regulator Margin and Capital Proposing Release, 76
FR at 27571 (defining financial end user), and CFTC
Capital Proposing Release, 76 FR at 23736 (defining
financial entity). As discussed above, the CFTC and
prudential regulators are proposing margin
requirements that would differentiate collateral
requirements based on whether a financial end user
or financial entity is ‘‘high risk’’ or ‘‘low risk.’’ Id.
In other words, their proposals would provide for
potentially different treatment for three classes of
entities: (1) Nonfinancial end users; (2) financial
end users (low risk and high risk); and (3) entities
that are neither a nonfinancial end user nor a
financial end user. Therefore, they need to define
the terms financial end user and financial entity,
respectively. Because proposed new Rule 18a–3
would treat financial end users no differently than
entities that are neither a commercial end user nor
a financial end user, the Commission’s proposed
margin rule does not contain a definition of
financial end user. However, as discussed below,
the proposed rule would provide different
treatment for counterparties that are SBSDs.

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security-based swaps to hedge or
mitigate commercial risk.
The rationale for exempting
commercial end users from the
requirement to deliver collateral to meet
the account equity requirements is that
these end users often do not deliver
collateral by current practice, and
requiring them to do so could adversely
impact their ability to mitigate the risk
of their commercial activities by
entering into hedging transactions. If an
end user is using non-cleared securitybased swaps for purposes other than
hedging (e.g., to take directional
investment positions), the rationale for
exempting the end user from the
account equity requirements would not
apply. An end user that is using noncleared security-based swaps for
investment purposes is not acting like a
commercial end user, and, as such, no
exemption would be available under the
rule.
As discussed below in section II.B.2.e.
of this release, a nonbank SBSD would
be required to establish, maintain, and
document procedures and guidelines for
monitoring the risk of accounts holding
non-cleared security-based swaps.561
Among other things, a nonbank SBSD
would be required to have procedures
and guidelines for determining,
approving, and periodically reviewing
credit limits for each counterparty to a
non-cleared security-based swap.562
Consequently, if a nonbank SBSD does
not collect collateral from a commercial
end user, it would need to establish a
credit limit for the end user and
periodically review the credit limit in
accordance with its risk monitoring
guidelines.563 The rule would not
prohibit a nonbank SBSD from requiring
margin collateral from a commercial end
user.
561 See

paragraph (e) of proposed new Rule 18a–

3.
562 See paragraph (e)(2) of proposed new Rule
18a–3. This is also consistent with the broker-dealer
margin rules. See FINRA Rule 4210(d), which
requires that FINRA member firms establish
procedures to: (1) Review limits and types of credit
extended to all customers; (2) formulate their own
margin requirements; and (3) review the need for
instituting higher margin requirements, mark-tomarkets and collateral deposits than are required by
the Rule for individual securities or customer
accounts. See also FINRA Interpretation 4210(d)/01,
available at http://www.finra.org/web/groups/
industry/@ip/@reg/@rules/documents/industry/
p122203.pdf (noting that FINRA Rule 4210(d)
‘‘requires that members determine the total dollar
amount of credit to be extended to any one
customer or on any one security to limit the
potential loss or exposure to the member. It is
important that specific limits be established to
prevent any one customer or group of customers
from endangering the member’s capital.’’).
563 See id.

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Exception for Counterparties That Are
SBSDs
The second exception to the account
equity requirements in proposed new
Rule 18a–3 would apply to
counterparties that are SBSDs.564 Two
alternatives with respect to SBSD
counterparties are being proposed.
Under the first alternative, a nonbank
SBSD would not need to collect cash,
securities, and/or money instruments to
collateralize the margin amount
(potential future exposure) in the
account of a counterparty that is another
SBSD (‘‘Alternative A’’). This approach
is consistent with the broker-dealer
margin rules, which generally do not
require a broker-dealer to collect margin
collateral from another broker-dealer.
Under the second alternative, a nonbank
SBSD would be required to collect cash,
securities and/or money market
instruments to collateralize both the
negative equity (current exposure) and
the margin amount (potential future
exposure) in the account of a
counterparty that is another SBSD
(‘‘Alternative B’’).565 Moreover, the
cash, securities, and/or money market
instruments would be required to be
segregated in an account at an
independent third-party custodian
pursuant to the requirements of section
3E(f) of the Exchange Act.566 Alternative
B is consistent with the proposals of the
prudential regulators and the CFTC.567
The two alternatives are being
proposed in order to elicit detailed
comment on each approach in terms of
comparing how they would meet the
goals of the Dodd-Frank Act,568 address
systemic issues relating to non-cleared
security-based swaps, raise practical
issues, alter current market practices
564 See paragraph (c)(1)(iii)(B) of proposed new
Rule 18a–3.
565 Alternative B is not an exception to the
account equity requirements in proposed new Rule
18a–3 because it would require collateral to cover
the negative equity and margin amount in an
account of another SBSD. However, its requirement
for how the collateral must be held—at an
independent third-party custodian on behalf of the
counterparty—is different from how the proposed
rule requires that collateral from other types of
counterparties be held (other than counterparties
that elect segregation under section 3E(f) of the
Exchange Act (15 U.S.C. 78c–5(f)).
566 See 15 U.S.C. 78c–5(f).
567 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564; CFTC Margin
Proposing Release, 76 FR 23732.
568 See 15 U.S.C. 78o–10(e)(3)(A) (‘‘[t]o offset the
greater risk to the security-based swap dealer or
major security-based swap participant and the
financial system arising from the use of securitybased swaps that are not cleared,’’ the margin
requirements proposed by the Commission and
prudential regulators shall ‘‘help ensure the safety
and soundness’’ of the SBSD and the MSBSP and
‘‘be appropriate for the risk associated with noncleared security-based swaps held’’ by an SBSD and
MSBSP).

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and conventions, result in benefits and
costs, and impact the security-based
swap markets and the participants in
those markets.
Under Alternative A, a nonbank SBSD
would be required to collect cash,
securities, and/or money market
instruments from another SBSD only to
cover the amount of negative equity (the
current exposure) in the account of the
counterparty.569 Accordingly, under this
approach, the nonbank SBSD would not
be required to collect cash, securities,
and/or money market instruments from
another SBSD to collateralize the
margin amount (the potential future
exposure).570 In other words, a
counterparty that is another SBSD
would not be required to maintain a
minimum level of positive equity in the
counterparty’s account.
Requiring a nonbank SBSD to deliver
collateral to cover potential future
exposure could impact its liquidity. As
discussed above in sections II.A.1. and
II.A.2.b.i. of this release, the proposed
capital requirements for nonbank SBSDs
are based on a net liquid assets test. The
objective of the test is to require the firm
to maintain in excess of a dollar of
highly liquid assets for each dollar of
liabilities in order to facilitate the
liquidation of the firm if necessary and
without the need for a formal
proceeding. When assets are delivered
to another party as margin collateral,
they become unsecured receivables from
the party holding the margin collateral.
Consequently, they no longer are readily
available to be liquidated by the
delivering party. In times of market
stress, a nonbank SBSD may need to
liquidate assets to raise funds and
reduce its leverage. However, if assets
are in the control of another nonbank
SBSD, they would not be available for
this purpose. For this reason, the assets
would need to be deducted from net
worth when the nonbank SBSD
computes net capital under the
proposed capital requirements.571 As a
result, the nonbank SBSD would need to
maintain the required minimum amount
569 See paragraph (c)(1)(iii)(B) of proposed new
Rule 18a–3–Alternative A. To the extent the margin
amount was not collateralized, the nonbank SBSD
would be required to take the proposed capital
charge in lieu of margin collateral discussed above
in section II.A.2.b.v. of this release.
570 Id. Like all counterparties to non-cleared
security-based swaps, counterparties that are SBSDs
would be subject to the risk monitoring
requirements in paragraph (e) of proposed new Rule
18a–3.
571 See 17 CFR 240.15c3–1(c)(2)(iv)(B); paragraph
(c)(1)(iii)(B) of proposed Rule 18a–1. Collateral
provided to another party as margin would be
subject to this 100% deduction.

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of net capital after taking into account
these deductions.
Promoting the liquidity of nonbank
SBSDs is the policy consideration
underlying Alternative A. In addition,
the prudential regulators and the CFTC
have received comments on this issue in
response to their proposals raising
concerns about requiring bank SBSDs
and swap dealers to exchange collateral
to cover potential future exposure and
to have the collateral held by an
independent third-party custodian. For
example, some commenters assert that
imposing segregated initial margin
requirements on trades between swap
entities would result in a tremendous
cost to the financial system in the form
of a massive liquidity drain, and that
swap dealers will lose the ability to
reinvest this collateral to finance other
lending or derivatives transactions,
thereby reducing capital formation and
increasing costs.572 One commenter
stated that, in general, with respect to
non-cleared swaps, charging more
initial margin (as compared to cleared
swaps) could have unintended
consequences, including the inefficient
use of capital by sophisticated market
participants in highly regulated
industries, which could create a drag on
the financial system, slow economic
572 See, e.g., letter from Robert Pickel, Executive
Vice Chairman, ISDA, and Kenneth E. Bentsen, Jr.,
Executive Vice President, Public Policy and
Advocacy, Securities Industry and Financial
Markets Association (‘‘SIFMA’’), to David Stawick,
Secretary, CFTC (July 11, 2011), available at http://
comments.cftc.gov/PublicComments/
ViewComment.aspx?id=47802&SearchText=SIFMA
(‘‘SIFMA/ISDA Comment Letter to the CFTC’’);
letter from Robert Pickel, Executive Vice Chairman,
ISDA, and Kenneth E. Bentsen, Jr., Executive Vice
President, Public Policy and Advocacy, SIFMA, to
Jennifer J. Johnson, Secretary, Federal Reserve, et al.
(July 6, 2011), available at http://www.fdic.gov/
regulations/laws/federal/2011/11c22ad79.PDF
(‘‘SIFMA/ISDA Comment Letter to the Prudential
Regulators’’); letter from the Honorable Darrell Issa,
Chairman, Committee on Oversight and
Government Reform, U.S. House of Representatives,
to Ben Bernanke, Chairman, Federal Reserve et al.
(July 22, 2011), available at http://comments.cftc.
gov/PublicComments/ViewComment.aspx?id=
47943&SearchText=issa, and letter from Mark
Scanlan, Vice President, Agriculture and Rural
Policy, Independent Community Bankers of
America, to the CFTC et al. (July 11, 2011),
available at http://comments.cftc.gov/Public
Comments/ViewComment.aspx?id=47762&Search
Text=scanlan. One commenter noted that there is
no statutory requirement for covered swap entities
to hold initial margin of other covered swap entities
at an independent third party custodian. See letter
from Christine Cochran, President, Commodity
Markets Council, to the OCC et al. (July 11, 2011),
available at http://comments.cftc.gov/Public
Comments/ViewComment.aspx?id=47777&Search
Text=cochran. Here and below, this release refers
to public comments on the margin proposals by the
CFTC and the prudential regulators to more fully
reflect the available views without endorsing those
comments or expressing a view as to the validity
of the comments.

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growth, and diminish customer
choice.573
Another commenter stated that a
combination of daily variation margin,
robust operational procedures, legally
enforceable netting and collateral
agreements, and regulatory capital
requirements provide comprehensive
risk mitigation for collateralized
derivatives, and that any additional
initial margin requirements for swaps
between swap entities would be
unnecessary and unwarranted.574 A
commenter argued that the proposed
initial margin requirements are
inconsistent with proven market
practice, ignore significant differences
in credit quality among swap dealers
and financial entities which justify
different margining treatment, and will
lead to excessive amounts of collateral
being required in comparison to the
actual risks of the underlying swap
transactions and portfolios.575 Finally, a
commenter argued that initial margin
requirements should differentiate based
on credit quality, and that the
prudential regulators’ margin
rulemaking identifies no risk-based
justification for layering zero threshold,
bilateral initial margin requirements for
all swap dealers above and beyond their
existing variation margin
requirements.576
On the other hand, a number of
comments submitted in response to the
proposals of the prudential regulators
and the CFTC supported bilateral
margining and argued that it should be
extended to require SBSDs and swap
dealers to exchange margin collateral
573 See letter from Mark R. Thresher, Executive
Vice President, Chief Financial Officer, Nationwide,
to the OCC (June 24, 2011), available at http://www.
federalreserve.gov/SECRS/2011/June/20110628/R–
1415/R–1415_062311_81363_349039663039_1.pdf.
574 See SIFMA/ISDA Comment Letter to the CFTC;
SIFMA/ISDA Comment Letter to the Prudential
Regulators. This commenter also stated that
precedent exists in the broker-dealer margin rules
for not imposing any initial margin requirements on
trades between swap entities. Id.
575 See letter from Don Thompson, Managing
Director and Associate General Counsel, J.P.
Morgan Chase & Co., to the OCC et al. (June 24,
2011), available at http://www.federalreserve.gov/
SECRS/2011/June/20110627/R–1415/R–1415_
062311_81366_349039350535_1.pdf (‘‘J.P. Morgan
Letter’’). Another commenter pointed out that life
insurers also typically do not post initial margin
and recommended that initial margin requirements
be appropriately sized to reflect the potential
exposure during the close out of a defaulting party.
See letter from Carl B. Wilkerson, Vice President
and Chief Counsel, Securities and Litigation,
American Council of Life Insurers, to the OCC et al.
(July 11, 2011), available at http://www.federal
reserve.gov/SECRS/2011/July/20110728/R–1415/R–
1415_071111_81817_507164831320_1.pdf.
576 See J.P. Morgan Letter. This commenter stated
that initial margin is appropriate in some
circumstances, but it must take into account the
credit quality of counterparties.

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with all counterparties.577 For example,
one commenter stated that the financial
crisis demonstrated that the premise of
one-way margin is flawed.578 This
commenter stated that two-way margin
requirements would aid safety and
soundness by helping a swap dealer and
its counterparty offset their exposures
and prevent them from building up
exposures they cannot fulfill.579
The prudential regulators explained
the reasoning behind their proposal as
follows:
Non-cleared swaps transactions with
counterparties that are themselves swap
entities pose risk to the financial system
because swap entities are large players in
swap and security-based swap markets and
therefore have the potential to generate
systemic risk through their swap activities.
Because of their interconnectedness and large
presence in the market, the failure of a single
swap entity could cause severe stress
throughout the financial system.
Accordingly, it is the preliminary view of the
Agencies that all non-cleared swap
transactions with swap entities should
require margin.580

Alternative B is being proposed in
light of the policy considerations
577 See, e.g., letter from Scott C. Goebel, Senior
Vice President, General Counsel, FMR Co., to John
Walsh, Acting Comptroller of the Currency, OCC
(July 11, 2011); letter from Kevin M. Budd,
Associate General Counsel, and Todd F. Lurie,
Assistant General Counsel, MetLife, to OCC et al.
(July 11, 2011); letter from John R. Gidman, on
behalf of the Association of Institutional Investors,
to Ms. Jennifer Johnson, Secretary, Federal Reserve,
et al. (July 11, 2011); letter from R. Glenn Hubbard,
Co-Chair, John L. Thornton, Co-Chair, and Hal S.
Scott, Director, Committee on Capital Markets
Regulation, to John Walsh, Acting Comptroller,
OCC (July 11, 2011), available at http://www.federal
reserve.gov/SECRS/2011/July/20110719/R–1415/R–
1415_071111_81821_322996697020_1.pdf; letter
from Dennis M. Kelleher, President and Chief
Executive Officer, and Wallace C. Turbeville,
Derivatives Specialist, Better Markets, Inc., to
Jennifer J. Johnson, Secretary, Federal Reserve (July
11, 2011), available at http://www.federalreserve.
gov/SECRS/2011/July/20110728/R–1415/R–1415_
071111_81861_504963784471_1.pdf; letter from
Americans for Financial Reform, to John Walsh,
Acting Comptroller, OCC (July 11, 2011), available
at http://www.federalreserve.gov/SECRS/2011/July/
20110728/R–1415/R–1415_071111_81864_4487
38394756_1.pdf.
578 Letter from Karrie McMillan, General Counsel,
Investment Company Institute, to David Stawick,
Secretary, CFTC (July 11, 2011), available at is
http://www.ici.org/pdf/25344.pdf (‘‘ICI Letter’’).
579 See the ICI Letter.
580 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27570–27571 (footnote
omitted). See also CFTC Margin Proposing Release,
76 FR at 23735 (‘‘It is the nature of the dealer
business that dealers are at the center of the markets
in which they participate. Similarly, a major swap
participant, by its terms, is a significant trader.
Collectively, [swap dealers and major swap
participants] pose greater risk to the markets and
the financial system than other swap market
participants. Accordingly, under the mandate of
Section 4s(e), the Commission believes that they
should be required to collect margin from one
another.’’).

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underlying the proposals of the
prudential regulators and the CFTC.581
Under Alternative B, a nonbank SBSD
would be required to obtain cash,
securities, and/or money market
instruments from another SBSD to cover
the negative equity (current exposure)
and margin amount (potential future
exposure) in the other SBSD’s
account.582 In addition, the cash,
securities, and/or money market
instruments delivered to cover the
margin amount would need to be
carried by an independent third party
custodian pursuant to the requirements
of section 3E(f) of the Exchange Act.583
Therefore, not only would there be no
exception to the account equity
requirement for counterparties that are
SBSDs, but the treatment of the
collateral would be different than for
other types of counterparties in that it
would be required to be held by an
independent third-party custodian.584
Exception for Counterparties That Elect
Segregation Under Section 3E(f)
Under the third exception to the
account equity requirements in
proposed new Rule 18a–3, a nonbank
SBSD would not be required to hold the
cash, securities, and/or money market
instruments delivered by a counterparty
that is not a commercial end user to
cover the margin amount (potential
future exposure), if the counterparty
elects to have the cash, securities, and/
or money market instruments segregated
pursuant to section 3E(f) of the
Exchange Act.585 Section 3E(f) sets forth
provisions under which a counterparty
to a non-cleared security-based swap
with an SBSD can require that collateral
to cover potential future exposure must
be segregated.586 Among other things,
section 3E(f) provides that the collateral
must be segregated in an account carried
by an independent third-party custodian
and designated as a segregated account
for and on behalf of the counterparty.587
As discussed below in section II.C. of
this release, proposed new Rule 18a–3
would establish certain conditions that
581 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564; CFTC Margin
Proposing Release, 76 FR 23744.
582 See paragraph (c)(1)(iii)(B) of proposed Rule
18a–3—Alternative B.
583 Id.
584 Id.
585 See paragraph (c)(1)(iii)(C) of proposed new
Rule 18a–3. This exception would not apply to
negative equity in the counterparty’s account,
which would need to be collateralized by cash,
securities, and/or money market instruments held
by the nonbank SBSD. See 15 U.S.C. 78c–
5(f)(2)(B)(i) (providing that the segregation
provisions in section 3E(f) of the Exchange Act do
not apply to variation margin payments).
586 See 15 U.S.C. 78c–5(f)(1)–(3).
587 See 15 U.S.C. 78c–5(f)(3).

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collateral would need to meet before its
value could be included in the
determination of the amount of equity in
an account.588 Among other conditions,
the collateral would need to be subject
to the physical possession or control of
the nonbank SBSD and capable of being
liquidated promptly by the nonbank
SBSD without intervention by any other
party.589 Margin collateral segregated
pursuant to section 3E(f) of the
Exchange Act would not meet either of
these conditions. First, the collateral
would be in the physical possession or
control of an independent third-party
custodian rather than the nonbank
SBSD. Second, the collateral could not
be liquidated by the nonbank SBSD
without the intervention of the
independent third-party custodian. For
these reasons, the value of the margin
collateral held by the independent
third-party custodian could not be
included when determining the amount
of equity in the account of the
counterparty at the nonbank SBSD.

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Exception for Accounts Holding Legacy
Security-Based Swaps
Under the fourth exception to the
account equity requirements in
proposed new Rule 18a–3, a nonbank
SBSD would not be required to collect
cash, securities, and/or money market
instruments to cover the negative equity
(current exposure) or margin amount
(potential future exposure) in a securitybased swap legacy account.590 Proposed
new Rule 18a–3 would define securitybased swap legacy account to mean an
account that holds no security-based
swaps entered into after the effective
date of the rule and that is used to hold
only security-based swaps entered into
prior to the effective date of the rule, as
well as collateral for those securitybased swaps.591 As discussed above in
section II.A.2.b.v. of this release, this
exception would be designed to address
the impracticality of renegotiating
contracts governing security-based swap
588 See paragraph (c)(4) of proposed new Rule
18a–3.
589 See paragraphs (c)(4)(i)–(iii) of proposed new
Rule 18a–3.
590 See paragraph (c)(1)(iii)(D) of proposed new
Rule 18a–3. While this exception would apply to
negative equity in the account and the margin
amount calculated for the account, a nonbank SBSD
would be required to take a 100% deduction from
net worth for the amount of the uncollateralized
current exposure and take the proposed capital
charge in lieu of margin collateral discussed above
in section II.A.2.b.v. of this release. See proposed
new paragraph (c)(2)(xiv) of Rule 15c3–1; paragraph
(c)(1)(viii) of proposed new Rule 18a–1. In addition,
like all counterparties to non-cleared security-based
swaps, these counterparties would be subject to the
risk monitoring requirements in paragraph (e) of
proposed new Rule 18a–3.
591 See paragraph (b)(9) of proposed new Rule
18a–3.

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transactions that predate the
effectiveness of proposed new Rule 18a–
3 in order to come into compliance with
the account equity requirements in the
rule.592
Request for Comment
The Commission generally requests
comment on the proposed account
equity requirements for counterparties
of nonbank SBSDs in proposed new
Rule 18a–3.593 In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Would it be appropriate to limit the
assets that could be used to collateralize
the negative equity and margin amounts
in an account to cash, securities, and
money market instruments? Are there
other types of assets that should be
permitted to meet the account equity
requirements in proposed new Rule
18a–3? If so, identify the other asset
types and compare their liquidity to
cash, securities, and money market
instruments.
2. Is the proposed requirement to take
deductions on securities and money
market instruments in calculating the
amount of equity in an account
appropriate? If not, explain why not.
Are there other measures that a nonbank
SBSD could be required to take to
address the risk that securities and
money market instruments may not be
able to be liquidated at current market
values to cover the obligations of a
defaulted counterparty? If so, explain
how the other measures would be an
adequate substitute to deductions.
3. Are the proposed conditions
(modeled on the Appendix E
conditions) for taking into account
collateral in determining the amount of
equity in an account appropriate for
proposed new Rule 18a–3? If not,
explain why not. Should any individual
condition be eliminated? If so, explain
why. Are there additional conditions
that should be added? If so, identify
them and explain how they would
promote the goal of ensuring that
collateral can be promptly liquidated to
592 As noted above in section II.A.2.b.v. of this
release, the CFTC has proposed a similar exception
for legacy swaps. See CFTC Margin Proposing
Release, 76 FR at 23734. The prudential regulators
proposed to permit a covered swap entity to
exclude pre-effective swaps from initial margin
calculations, while requiring these entities to
collect variation margin, consistent with industry
practice. See Prudential Regulator Margin and
Capital Proposing Release, 76 FR at 27569.
593 As discussed earlier, the Commission is
soliciting comment below in section II.B.3. of this
release on whether to define the term eligible
collateral in a manner similar to the prudential
regulators and the CFTC.

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cover the obligation of a defaulted
counterparty.
4. Is the proposed requirement that a
nonbank SBSD take prompt steps to
liquidate securities in an account to the
extent necessary to eliminate an account
equity deficiency appropriate? For
example, should there be a specific
time-frame (e.g., 1, 2, 3, 4, 5, or some
other number of business days) in
which the nonbank SBSD is required to
liquidate securities in the account? If so,
explain why a specific time-frame
would be preferable to requiring the
nonbank SBSD to act promptly.
5. Is the proposed exception to the
account equity requirements for
commercial end users appropriate? If
not, explain why not. Should
commercial end users be required to
collateralize negative equity and the
margin amount in their accounts?
Explain why or why not. Should the
exception apply only to the margin
amount (i.e., should commercial end
users be required to collateralize the
negative equity in their accounts)?
Explain why or why not.
6. Is the proposed definition of
commercial end user appropriate? If not,
explain why not. For example, would
the proposed definition of commercial
end user be too broad, or too narrow, in
terms of capturing types of
counterparties for which the exception
would not be appropriate? If so, explain
why and suggest how the definition
could be modified to address this issue.
7. Should the rule contain a proposed
definition of financial end user? If so,
explain why. For example, would a
definition of financial end user similar
to the definitions of the prudential
regulators and CFTC provide needed
clarity to the definition of commercial
end user (i.e., by specifying certain
entities that are not commercial end
users)?
8. Do commercial end users use
security-based swaps to hedge
commercial risk? If so, identify the type
of commercial risk they hedge with
security-based swaps and explain how
security-based swaps are used to hedge
this risk.
9. Should proposed new Rule 18a–3
define the term commercial risk for the
purpose of providing greater clarity as to
the meaning of the term commercial end
user? If so, how should the term
commercial risk be defined?
10. Should there be a two-tiered
approach with respect to the account
equity requirements for financial end
users based on whether they are low
risk or high risk, similar to the proposed
approach of the prudential regulators
and the CFTC? If so, explain why.

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11. How do non-commercial end
users presently use security-based
swaps? For example, do they use them
to hedge commercial risk? If so, identify
the type of commercial risk they hedge
with security-based swaps.
12. With respect to counterparties that
are SBSDs, how would Alternatives A
and B compare in terms of promoting
the goals of the Dodd-Frank Act,
including limiting the risks posed by
non-cleared security-based swaps? How
would each address or fail to address
systemic issues relating to non-cleared
security-based swaps?
13. What would be the impact of
Alternatives A and B on the efficient use
of capital?
14. What would be the practical
effects of Alternatives A and B on the
capital and liquidity positions, or the
financial health generally, of nonbank
SBSDs? How would each alter current
market practices and conventions with
respect to collateralizing credit
exposures arising from non-cleared
security-based swaps? Are there
practical issues with respect to
Alternatives A and B? If so, identify and
explain them.
15. How would the benefits of
Alternatives A and B compare? How
would the costs compare?
16. How would Alternatives A and B
impact the market for security-based
swaps? How would they impact
participants in those markets?
17. How would Alternatives A and B
promote the clearing of security-based
swaps? For example, would Alternative
B—because of the requirement to fund
margin collateral requirements—
incentivize nonbank SBSDs to transact
in cleared security-based swaps? If so,
explain why.
18. What would be the potential
impact if the Commission adopted
Alternative A and the prudential
regulators and the CFTC adopted rules
similar to Alternative B? Consider and
explain the impact competitively and
practically.
19. Would the proposed exception to
the account equity requirements for
counterparties that elect segregation
under section 3E(f) of the Exchange Act
be appropriate? If not, explain why not.
20. Would the proposed exception to
the account equity requirements for
accounts that elect to hold legacy
security-based swaps be appropriate? If
not, explain why not.
21. Would it be appropriate to permit
legacy security-based swaps to be held
in an entity that is not an SBSD? If so,
why, and what conditions should be
imposed on such an entity?
22. Should counterparties be required
to post variation margin with respect to

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legacy swaps? Is this consistent with
current market practice?
23. Should there be an exception from
the account equity requirements for
small banks, savings associations, farm
credit system institutions, and credit
unions from the account equity
requirements (e.g., for entities with
assets of $10 billion or less)? 594 Explain
why or why not.
24. Should there be an exception from
the account equity requirements for
affiliates of the nonbank SBSD? For
example, do affiliates present less credit
risk than non-affiliates? If there should
be an exception for affiliates, should it
be limited to certain affiliates? For
example, should the exception only
apply to affiliates that are subject to
capital and other regulatory
requirements? Please explain.
25. Should there be an exception for
foreign governmental entities? Explain
why or why not. Should types of foreign
governmental entities be distinguished
for purposes of an exception? For
example, are there objective benchmarks
based on creditworthiness that could be
used to distinguish between foreign
governmental entities for which the
exception to the account equity
requirements would and would not be
appropriate? If so, identify the
benchmarks and explain how they
could be incorporated into the rule.
26. Do dealers in OTC derivatives
currently collect collateral from foreign
governmental entities for their OTC
derivatives transactions? If so, from
which types of foreign governmental
entities?
27. Do national foreign governments
typically guarantee the obligations of
political subdivisions and agencies? If
so, identify the types of political
subdivisions and agencies that are
guaranteed and are not guaranteed.
ii. Nonbank MSBSPs
A nonbank MSBSP would be required
to calculate as of the close of each
business day the amount of equity in the
account of each counterparty to a noncleared security-based swap.595 On the
next business day following the
calculation, the nonbank MSBSP would
be required to either collect or deliver
594 See, e.g., 15 U.S.C. 78c–3(g)(3)(B) (requiring
the Commission to consider whether to exempt
small banks, savings associations, farm credit
system institutions and credit unions from the
definition of ‘‘financial entity’’ contained in
Exchange Act section 3C(g)(3)(A) for the purposes
of mandatory clearing of security-based swaps). See
also End-User Exception to Mandatory Clearing of
Security-Based Swaps, Exchange Act Release No.
63556 (Dec. 15, 2010), 75 FR 79992, 80000–80002
(Dec. 21, 2010).
595 See paragraph (c)(2)(i) of proposed new Rule
18a–3.

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cash, securities, and/or money market
instruments to the counterparty
depending on whether there was
negative or positive equity in the
account of the counterparty.596
Specifically, if the account has negative
equity as calculated on the previous
business day, the nonbank MSBSP
would be required to collect cash,
securities, and/or money market
instruments in an amount equal to the
negative equity.597 Conversely, if the
account has positive equity as calculated
on the previous business day, the
nonbank MSBSP would be required to
deliver cash, securities, and/or money
market instruments to the counterparty
in an amount equal to the positive
equity.598
Nonbank MSBSPs may not maintain
two-sided markets or otherwise engage
in activities that would require them to
register as an SBSD.599 They will,
however, by definition, maintain
substantial positions in particular
categories of security-based swaps.600
These positions could create significant
risk to counterparties to the extent the
counterparties have uncollateralized
current exposure to the nonbank
MSBSP. In addition, they could pose
significant risk to the nonbank MSBSP
to the extent it has uncollateralized
current exposure to its counterparties.
The proposed account equity
requirements for nonbank MSBSPs are
designed to address these risks by
imposing a requirement that nonbank
MSBSPs on a daily basis must
‘‘neutralize’’ the credit risk between the
nonbank MSBSP and the counterparty
either by collecting or delivering cash,
securities, and/or money market
instruments in an amount equal to the
positive or negative equity in the
account.
Unlike nonbank SBSDs, nonbank
MSBSPs would not be required to
reduce the fair market value of
securities and money market
instruments held in the account of a
counterparty (or delivered to a
counterparty) for purposes of
determining whether the level of equity
in the account meets the minimum
596 See paragraph (c)(2)(ii) of proposed new Rule
18a–3. As indicated, the nonbank MSBSP would
need to deliver cash, securities, and/or money
market instruments and, consequently, other types
of assets would not be eligible as collateral.
597 See paragraph (c)(2)(ii)(A) of proposed new
Rule 18a–3. In this case, the nonbank MSBSP
would have current exposure to the counterparty in
an amount equal to the negative equity.
598 See paragraph (c)(2)(ii)(B) of proposed new
Rule 18a–3.
599 See Entity Definitions Adopting Release, 77 FR
30596.
600 See 15 U.S.C. 78c(a)(67); Entity Definitions
Adopting Release, 77 FR 30596.

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requirement. As discussed above in
section II.B.2.c.i. of this release, the
reductions taken by a nonbank SBSD
would be based on the deductions that
would apply to the positions pursuant
to Rule 15c3–1, as proposed to be
amended, and proposed new Rule 18a–
1, as applicable.601 Nonbank MSBSPs
would not be subject to these rules and,
consequently, would not be required to
comply with them for purposes of
proposed new Rule 18a–3.
Like nonbank SBSDs, nonbank
MSBSPs would be subject to the
requirements in paragraph (c)(4) of
proposed new Rule 18a–3, which are
modeled on the existing collateral
requirements in Appendix E to Rule
15c3–1.602 As discussed above in
section II.A.2.b.iv of this release, these
requirements are designed to ensure that
the collateral is an asset of stable and
predictable value, an asset that is not
linked to the value of the transaction in
any way, and an asset that can be sold
quickly and easily if the need arises.
Nonbank MSBSPs would be required
to take prompt steps to liquidate
securities and money market
instruments in the account to the extent
necessary to eliminate an account equity
deficiency.603 These steps could include
liquidating non-cleared security-based
swap positions in the account to reduce
debits arising from those transactions.
The rule would not require that the
liquidations must be completed within
a specific timeframe in order to provide
the nonbank MSBSP flexibility to
conduct an orderly liquidation, taking
into account market conditions and the
risk profile of the account.
There would be three exceptions to
the account equity requirements for
nonbank MSBSPs.604 The first exception
would apply to counterparties that are
commercial end users.605 Under this
exception, the nonbank MSBSP would
not be required to collect collateral from
a commercial end user when the
account of the end user has negative
equity.606 This exception would be
consistent with the proposed exception
from the account equity requirements
for accounts of commercial end users at
nonbank SBSDs. However, nonbank
MSBSPs would not be required to take
601 See paragraph (c)(3) of proposed new Rule
18a–3.
602 See paragraph (c)(4) of proposed new Rule
18a–3; 17 CFR 240.15c3–1e(c)(4)(v).
603 See paragraph (c)(8) of proposed new Rule
18a–3.
604 See paragraph (c)(2)(iii) of proposed new Rule
18a–3. MSBSPs could choose to collect collateral in
these cases.
605 See paragraph (c)(2)(iii)(A) of proposed new
Rule 18a–3.
606 Id.

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a credit risk charge or capital charge
relating to the amount of the
uncollected margin.607 The reason for
this proposed exception is the concern
that requiring commercial end users to
deliver collateral could impair their
ability to manage commercial risks
through hedging transactions. A
nonbank MSBSP would be required to
deliver cash, securities, and/or money
market instruments to a commercial end
user as necessary to collateralize the end
user’s current exposure to the nonbank
MSBSP.
Under the second exception, a
nonbank MSBSP would not be required
to collect cash, securities, and/or money
market instruments from an SBSD to
collateralize the amount of the negative
equity in the account of the SBSD.
Under the account equity requirements
in proposed new Rule 18a–3, a nonbank
SBSD would be required to collect
collateral from a nonbank MSBSP to
cover the negative equity and margin
amount in the account of the nonbank
MSBSP carried by the nonbank
SBSD.608 Once a nonbank SBSD
collected these amounts, a nonbank
MSBSP would have current exposure to
the nonbank SBSD, at a minimum, equal
to the amount of the positive equity
required to be maintained in the
nonbank MSBSP’s account at the
nonbank SBSD. A regulatory
requirement that the nonbank MSBSP
must collect collateral from the nonbank
SBSD to collateralize the amount of the
positive equity in the account at the
nonbank SBSD could defeat the purpose
of proposed new Rule 18a–3; namely,
that nonbank SBSDs collect cash,
securities, and/or money market
instruments to collateralize their
potential future exposure to the
counterparties, including nonbank
MSBSPs.609 In essence, the proposed
607 Compare paragraph (c)(1)(iii)(A) of proposed
new Rule 18a–3, with paragraph (c)(2)(iii)(A) of
proposed Rule new 18a–3.
608 See paragraph (c)(1)(ii) of proposed Rule 18a–
3. As discussed above, MSBSPs would not be
included in the definition of commercial end user.
Consequently, an MSBSP would be required to
deliver cash, securities, and/or money market
instruments to collateralize the negative equity and
the margin amount in its security-based swap
account at a nonbank SBSD.
609 For example, assume a nonbank SBSD
calculates that the account of a nonbank MSBSP has
a negative equity of $20 (current exposure) and a
margin amount of $50 (potential future exposure)
pursuant to paragraph (c)(1)(i) of proposed new
Rule 18a–3. On the next business day, the nonbank
SBSD would need to collect cash, securities, and/
or money market instruments to collateralize these
amounts pursuant to paragraph (c)(1)(ii) of
proposed new Rule 18a–3. Assume the nonbank
MSBSP delivers cash as collateral. It would need to
deliver $70 in cash, of which $50 (as collateral for
the margin amount) would be a receivable from the
nonbank SBSD to the nonbank MSBSP. In other

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requirements reflect a general
preference in favor of requiring
counterparties to nonbank SBSDs to
fully collateralize their obligations to
the nonbank SBSDs.
The third exception would apply to a
security-based swap legacy account.610
Under this exception, consistent with
the proposed corresponding exception
applying to accounts with nonbank
SBSDs, a nonbank MSBSP would not be
required to collect cash, securities, and/
or money market instruments to
collateralize the negative equity in a
security-based swap legacy account. In
addition, the MSBSP would not be
required to deliver collateral to cover
the positive equity in the account. This
exception would be designed to address
the impracticality of renegotiating
contracts governing security-based swap
transactions that predate the
effectiveness of proposed new Rule 18a–
3 in order to come into compliance with
the account equity requirements in the
rule.
Request for Comment
The Commission generally requests
comment on the proposed account
equity requirements for counterparties
of nonbank MSBSPs in proposed Rule
18a–3. Commenters are referred to the
questions about the account equity
requirements for nonbank SBSDs above
in section II.B.2.c.i. of this release to the
extent those questions address
provisions in proposed new Rule 18a–
3 that also apply to nonbank MSBSPs.
In addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Are the proposed account equity
requirements for nonbank MSBSPs
appropriate? If not, explain why not.
2. Should nonbank MSBSPs be
required to reduce the fair market value
of securities and money market
instruments for purposes of determining
whether the level of equity in the
account meets the minimum
requirement? What would be the impact
of not requiring nonbank MSBSPs to
reduce the fair market value of
words, the $50 (as a receivable from the nonbank
SBSD) would be the nonbank MSBSP’s current
exposure to the nonbank SBSD. If the nonbank
MSBSP was required to collect collateral from the
nonbank SBSD to cover this amount, the account
of the nonbank MSBSP at the nonbank SBSD would
not meet the minimum equity requirement of $50.
610 See paragraph (c)(2)(iii)(C) of proposed new
Rule 18a–3. The term security-based swap legacy
account would be defined to mean an account that
holds no security-based swaps entered into after the
effective date of the rule and that is used only to
hold security-based swaps entered into prior to the
effective date of the rule and collateral for those
security-based swaps. See paragraph (b)(9) of
proposed new Rule 18a–3.

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securities and money market
instruments for purposes of determining
whether the level of equity in the
account meets the minimum
requirement?
3. Should nonbank MSBSPs be
required to collect or deliver cash,
securities, and/or money market
instruments to collateralize a margin
amount (potential future exposure) in
addition to the negative equity amount
(current exposure)? Should they be
required to deliver cash, securities, and/
or money market instruments to a
commercial end user to collateralize a
margin amount? Please explain.
4. Is the proposed exception to the
account equity requirements for credit
exposures to commercial end users
appropriate? If not, explain why not. For
example, because nonbank MSBSPs
would not be required to take a credit
risk charge or capital charge relating to
the amount of uncollected margin
collateral, would nonbank MSBSPs be
subject to additional risks not applicable
to nonbank SBSDs? If so, explain why.
If not, explain why not.
5. Is the proposed exception to the
account equity requirements for credit
exposures to SBSDs appropriate? If not,
explain why not.
6. Is the proposed exception to the
account equity requirements for credit
exposures in security-based swap legacy
accounts appropriate? If not, explain
why not.
d. $100,000 Minimum Transfer Amount
Proposed new Rule 18a–3 would
establish a minimum transfer amount of
$100,000 with respect to a particular
counterparty.611 Under this provision, a
nonbank SBSD and a nonbank MSBSP
would not be required to collect or
deliver collateral to meet an account
equity requirement if the amount
required to be collected or delivered is
equal to or less than $100,000. If the
minimum transfer amount is exceeded,
the entire account equity requirement
would need to be collateralized, not just
the amount of the requirement that
exceeds $100,000.
The proposed minimum transfer
provision is designed to establish a
threshold so that the degree of risk
reduction achieved by requiring account
equity requirements to be collateralized
is sufficiently small that the costs of
delivering collateral may not be
justified. The proposed $100,000
threshold is based on the proposals of
the prudential regulators and the
CFTC.612
611 See

paragraph (c)(6) of proposed Rule 18a–3.
Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27575; CFTC Margin
612 See

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Request for Comment
The Commission generally requests
comment on the minimum transfer
amount in proposed new Rule 18a–3. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Is it appropriate to have a minimum
transfer amount? If not, explain why
not. For example, should an account
equity requirement be collateralized
regardless of the amount of cash,
securities, and/or money market
instruments that would need to be
transferred to meet the requirement?
2. Is $100,000 an appropriate
minimum transfer amount? Should the
amount be greater than $100,000 (e.g.,
$150,000, $200,000, $500,000, or some
other amount)? If so, identify the
amount and explain why it would be a
better threshold. Should the amount be
less than $100,000 (e.g., $75,000,
$50,000, $25,000, or some other
amount)? If so, identify the amount and
explain why it would be a better
threshold.
e. Risk Monitoring and Procedures
A nonbank SBSD would be required
to monitor the risk of each account of
a counterparty to a non-cleared securitybased swap and establish, maintain, and
document procedures and guidelines for
monitoring the risk of such accounts.613
Proposing Release, 76 FR at 23735 (‘‘In order to
reduce transaction costs, proposed § 23.150 would
establish a ‘minimum transfer amount’ of $100,000.
Initial and variation margin payments would not be
required to be made if below that amount. This
amount was selected in consultation with the
prudential regulators. It represents an amount
sufficiently small that the level of risk reduction
might not be worth the transaction costs of moving
the money. It only affects the timing of collection;
it does not change the amount of margin that must
be collected once the $100,000 level is exceeded.’’).
Some commenters to the CFTC and Prudential
Regulators proposed margin rules, while generally
supporting the use of minimum transfer amounts,
stated that they should have the flexibility to set
higher minimum transfer amounts and that
minimum transfer amounts up to $250,000 were
more consistent with prevailing industry practice.
See letter from the Coalition for Derivatives EndUsers, to David A. Stawick, Secretary, CFTC (July
11, 2011), available at http://comments.cftc.gov/
PublicComments/ViewComment.aspx?id=47804;
letter from Carl B. Wilkerson, Vice President &
Chief Counsel, Securities & Litigation, American
Council of Life Insurers, to the Prudential
Regulators and David A. Stawick, Secretary, CFTC
(July 11, 2011), available at http://
comments.cftc.gov/PublicComments/
ViewComment.aspx?id=47742; letter from Lisa M.
Ledbetter, Vice President and Deputy General
Counsel, Legislative and Regulatory Affairs, Freddie
Mac, to David A. Stawick, Secretary, CFTC (July 11,
2011), available at http://comments.cftc.gov/
PublicComments/ViewComment.aspx?id=47771.
613 See paragraph (e) of proposed new Rule 18a–
3. Paragraph (e) of proposed new Rule 18a–3 would
not apply to nonbank MSBSPs. As discussed below,
the proposed risk monitoring procedures are

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The nonbank SBSD also would be
required to review, in accordance with
written procedures, and at reasonable
periodic intervals, its non-cleared
security-based swap activities for
consistency with the risk monitoring
procedures and guidelines.614 The risk
monitoring procedures and guidelines
would need to include, at a minimum,
procedures and guidelines for:
• Obtaining and reviewing the
account documentation and financial
information necessary for assessing the
amount of current and potential future
exposure to a given counterparty
permitted by the nonbank SBSD;
• Determining, approving, and
periodically reviewing credit limits for
each counterparty, and across all
counterparties;
• Monitoring credit risk exposure to
the security-based swap dealer from
non-cleared security-based swaps,
including the type, scope, and
frequency of reporting to senior
management;
• Using stress tests to monitor
potential future exposure to a single
counterparty and across all
counterparties over a specified range of
possible market movements over a
specified time period;
• Managing the impact of credit
exposure related to non-cleared
security-based swaps on the nonbank
SBSD’s overall risk exposure;
• Determining the need to collect
collateral from a particular
counterparty, including whether that
determination was based upon the
creditworthiness of the counterparty
and/or the risk of the specific noncleared security-based swap contracts
with the counterparty;
• Monitoring the credit exposure
resulting from concentrated positions
with a single counterparty and across all
counterparties, and during periods of
extreme volatility; and
• Maintaining sufficient equity in the
account of each counterparty to protect
against the largest individual potential
future exposure of a non-cleared
security-based swap carried in the
account of the counterparty as measured
by computing the largest maximum
possible loss that could result from the
exposure.
designed to address the risk that results from
dealing in non-cleared security-based swaps (i.e.,
the type of activity that would require a nonbank
MSBSP to register as an SBSD). See 15 U.S.C. 78o–
10(a)(1); Entity Definitions Proposing Release, 75 FR
at 80174. As discussed above in section II.A.3 of
this release, a nonbank MSBSP would be required
to comply with Rule 15c3–4, which requires an
entity subject to its provisions to establish a risk
management control system.
614 See paragraph (e) of proposed new Rule 18a–
3.

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These proposed requirements are
modeled on similar requirements in
FINRA Rule 4240, which establishes an
interim pilot program imposing margin
requirements for transactions in credit
default swaps executed by a FINRA
member.615 As discussed above in
section II.A.2.c. of this release, nonbank
SBSDs would be required to comply
with Rule 15c3–4.616 Rule 15c3–4
requires an OTC derivatives dealer to
establish, document, and maintain a
system of internal risk management
controls to assist in managing the risks
associated with its business activities,
including market, credit, leverage,
liquidity, legal, and operational risks.617
Risk management systems are designed
to help ensure an awareness of, and
accountability for, the risks taken
throughout a firm and to develop tools
to address those risks.618 A key
objective of a risk management system
is to ensure that a firm does not ignore
any material source of risk.619
The procedures and guidelines that a
nonbank SBSD would establish
pursuant to proposed new Rule 18a–3
would be a part of the broader system
of risk management controls the
nonbank SBSD would establish
pursuant to Rule 15c3–4.620 The
requirement in proposed new Rule 18a–
3 is designed to require specific risk
management procedures and guidelines
with respect to the risks of acting as a
dealer in non-cleared security-based
swaps, which could result in a nonbank
SBSD carrying accounts for significant
numbers of counterparties and effecting
numerous transactions for
counterparties on a daily basis. For
example, the nonbank SBSD would be
required to have procedures and
guidelines for determining, approving,
and periodically reviewing credit limits
for each counterparty, and across all
counterparties.621 In addition, the
nonbank SBSD would be required to
have procedures and guidelines for
determining the need to collect
collateral from a particular
counterparty, including whether that
determination was based upon the
creditworthiness of the counterparty
615 See FINRA Rule 4240. The risk monitoring
requirements in FINRA Rule 4240 were, in turn,
modeled on risk monitoring requirement in SRO
portfolio margining rules. See FINRA Rule 4210(g);
Rules 12.4 and 15.8A of the CBOE.
616 17 CFR 240.15c3–4.
617 Id.
618 See Joint Forum, Bank of International
Settlements, Trends in Risk Integration and
Aggregation, (Aug. 2003), available at http://
www.bis.org/publ/joint07.pdf.
619 Id.
620 17 CFR 240.15c3–4.
621 See paragraph (e)(2) of proposed new Rule
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and/or the risk of the specific noncleared security-based swap contracts
with the counterparty.622 As discussed
above in section II.B.2.c.i. of this
release, nonbank SBSDs would not be
required to collect collateral from a
commercial end user to meet the
account equity requirements in
proposed new Rule 18a–3.623 However,
the firm would be required to determine
credit limits for the end user and
analyze the need for collecting collateral
from the end user. These risk
monitoring procedures and guidelines
are designed to prevent the nonbank
SBSD from allowing its credit exposure
to the end user to reach a level that
creates a substantial risk that the default
of the end user could have a material
adverse impact on the nonbank SBSD.
Request for Comment
The Commission generally requests
comment on the requirements in
proposed new Rule 18a–3 to monitor
risk and to have risk monitoring
procedures and guidelines. In addition,
the Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Are the required elements of the
risk monitoring procedures and
guidelines appropriate? If not, explain
why not. Should there be additional or
alternative required elements to the risk
monitoring procedures and guidelines?
If so, identify them and explain why
they should be included.
2. Are the descriptions of the required
elements of the risk monitoring
procedures and guidelines in
paragraphs (e)(1) through (8) of
proposed new Rule 18a–3 sufficiently
clear in terms of what is proposed to be
required of nonbank SBSDs? If not,
explain why not and suggest changes to
make the elements more clear.
3. Is it appropriate to require that the
risk monitoring procedures and
guidelines be a part of the system of risk
management control prescribed in Rule
15c3–4? If not, explain why not.
4. What are the current practices of
dealers in OTC derivatives in terms of
monitoring the risk of counterparties?
Are the requirements in proposed new
Rule 18a–3 consistent with current
practices? Are they more limited or are
they broader than current practices?
5. Should nonbank MSBSPs be
subject to the requirements of paragraph
(e) of proposed new Rule 18a–3? If so,
explain why. If not, explain why not.
622 See paragraph (e)(6) of proposed new Rule
18a–3.
623 See paragraph (c)(1)(iii)(A) of proposed new
Rule 18a–3.

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3. Specific Request for Comment To
Limit the Use of Collateral
Proposed new Rule 18a–3 does not
specifically identify classes of assets
that could be used to meet the account
equity requirements in the rule. The
Commission, however, is considering
whether it would be appropriate to
adopt limits on eligible collateral
similar to those the prudential
regulators and the CFTC proposed.624
Specifically, comment is sought on
whether proposed new Rule 18a–3
should define the term eligible collateral
in order to narrowly prescribe the
classes of assets that would qualify as
collateral to meet the account equity
requirements. For example, one
approach would be to limit eligible
collateral to cash and U.S. government
securities.
Limiting eligible collateral to cash and
U.S. government securities could be a
way to ensure that a nonbank SBSD will
be able to liquidate the collateral
promptly and at current market prices if
necessary to cover the obligations of a
defaulting counterparty. During a period
of market stress, the value of collateral
other than cash pledged as margin also
may come under stress through rapid
market declines and systemic
liquidations and deleveraging by
financial institutions. Generally, U.S.
government securities are substantially
less susceptible to this risk than other
types of securities and, in fact, may
become the investment of choice during
a period of market stress as investors
seek the relative safety of these
securities.625
Another approach would be to adopt
the definition of eligible collateral
proposed by the prudential regulators or
to adopt the ‘‘forms of margin’’
proposed by the CFTC.626 Both of these
proposed approaches would extend
eligible collateral beyond cash and U.S.
government securities but would not
permit the use of certain securities (e.g.,
listed equities that would be permitted
by proposed Rule 18a–3).
The Commission also seeks comment
in response to the following questions,
including empirical data in support of
comments:
1. Should the types of assets that
could be used to meet the nonbank
624 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27578; CFTC Margin
Proposing Release, 76 FR at 23738–23739.
625 See IMF, Global Financial Stability Report,
The Quest for Lasting Stability (Apr. 2012),
available at http://www.imf.org/external/pubs/ft/
gfsr/2012/01/pdf/text.pdf.
626 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27578; CFTC Margin
Proposing Release, 76 FR at 23738–23739
(proposing that only certain types of financial
instruments be eligible collateral).

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SBSD account equity requirements in
proposed new Rule 18a–3 be more
limited? Explain why or why not. For
example, are the proposed provisions
that would require a nonbank SBSD to
mark-to-market the value of the
collateral, apply haircuts to the
collateral, and adhere to the collateral
requirements incorporated from
Appendix E to Rule 15c3–1 sufficient to
ensure that collateral is able to serve the
purpose of protecting the nonbank
SBSD from the credit exposure of a
counterparty to a non-cleared securitybased swap? If so, explain why. If not,
explain why not.
2. Explain the risk to nonbank SBSDs
if they are permitted to accept a broader
range of securities and money market
instruments (as proposed in new Rule
18a–3) to meet the account equity
requirements.
3. Should the types of assets that
could be used to meet the nonbank
MSBSP account equity requirements in
proposed new Rule 18a–3 be more
limited? Explain why or why not. Since
nonbank MSBSPs would not be required
to apply haircuts to the collateral or
adhere to the collateral requirements
incorporated from Appendix E to Rule
15c3–1, should the types of collateral
they are allowed to accept be more
limited? Explain why or why not.
4. Explain the risk to nonbank
MSBSPs if they are permitted to accept
a broader range of securities and money
market instruments (as proposed in new
Rule 18a–3) to meet the account equity
requirements.
5. If the term eligible collateral is
defined for purposes of proposed new
Rule 18a–3, should the definition
include securities of governmentsponsored entities? If so, identify the
government-sponsored entities and
explain why the securities of the
identified entity would be appropriate
collateral. Alternatively, explain why
securities of government-sponsored
entities generally or individually should
not be included in a potential definition
of eligible collateral.
6. If the term eligible collateral is
defined for purposes of proposed new
Rule 18a–3, should the definition
include immediately-available cash
funds denominated in a foreign
currency when the currency is the same
currency in which payment obligations
under the security-based swap are
required to be settled? If so, should
eligible collateral be limited to specific
foreign currencies? If so, identify the
currencies and explain why the
identified currencies would be
appropriate collateral. Alternatively,
explain why foreign currencies
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included in a potential definition of
eligible collateral.
7. If the term eligible collateral is
defined for purposes of proposed new
Rule 18a–3, should the definition
include immediately-available cash
funds denominated in foreign currency
even in cases where the currency is not
the same currency in which payment
obligations under the security-based
swap are required to be settled? If so,
should eligible collateral be limited to
specific foreign currencies? If so,
identify the currencies and explain why
the identified currencies would be
appropriate collateral in this
circumstance. Alternatively, explain
why foreign currencies in this
circumstance should not be included in
a potential definition of eligible
collateral.
8. If the term eligible collateral is
defined for purposes of proposed new
Rule 18a–3, should the definition
include securities of foreign sovereign
governments? If so, identify the foreign
sovereign governments and explain why
the securities of the identified foreign
sovereign governments would be
appropriate collateral. Alternatively,
explain why securities of foreign
sovereign governments should not be
included in the definition of eligible
collateral.
9. If the term eligible collateral is
defined for purposes of proposed new
Rule 18a–3, should the definition
include a fully paid margin equity
security, as that term is defined in 12
CFR 220.2,627 in the case where a noncleared equity security-based swap
references the margin equity security? If
so, explain why margin equity securities
would be appropriate collateral in this
circumstance. Alternatively, explain
why margin equity securities in this
circumstance should not be included in
the definition of eligible collateral.
10. Should there be separate eligible
collateral requirements for
collateralizing negative equity and the
margin amount? For example, should
the assets permitted to collateralize
negative equity be limited to cash and
U.S. government securities, while the
assets permitted to collateralize the
margin amount encompass a broader
range of securities?
C. Segregation
1. Background
The U.S. Bankruptcy Code provides
special protections for customers of
stockbrokers (the ‘‘stockbroker
627 Regulation T defines margin equity security as
a margin security that is an equity security (as
defined in section 3(a)(11) of the Exchange Act). See
12 CFR 220.2.

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liquidation provisions’’).628 Among
other protections, customers share
ratably with other customers ahead of
all other creditors in the customer
property held by the failed
stockbroker.629 Segregation
requirements are designed to identify
customer property as distinct from the
proprietary assets of the firm and to
protect customer property by, for
example, preventing the firm from using
it to make proprietary investments. The
goal of segregation is to facilitate the
prompt return of customer property to
customers either before or during a
liquidation proceeding if the firm
fails.630
The Dodd-Frank Act contains
provisions designed to ensure that cash
and securities held by an SBSD relating
to security-based swaps will be deemed
customer property under the
stockbroker liquidation provisions.631 In
particular, section 3E(g) of the Exchange
Act provides, among other things, that
a security-based swap shall be
considered to be a security as such term
is ‘‘used in section 101(53A)(B) and
subchapter III of title 11, United States
Code’’ 632 and in the stockbroker
liquidation provisions.633 Section 3E(g)
also provides that an account that holds
a security-based swap shall be
considered to be a securities account as
that term is ‘‘defined’’ in the stockbroker
liquidation provisions.634 In addition,
section 3E(g) provides that the terms
purchase and sale as defined in sections
3(a)(13) and (14) of the Exchange Act,
respectively, shall be applied to the
terms purchase and sale as used in the
628 See 11 U.S.C. 741–753. SIPA provides similar
protections for ‘‘customers’’ of registered brokerdealers. See 15 U.S.C. 78aaa et seq. However, SIPA
also provides additional protections such as the
right for each customer to receive an advance of up
to $500,000 to facilitate the prompt satisfaction of
a claim for securities and cash ($250,000 of the
$500,000 may be used to satisfy the cash portion
of a claim).
629 See 11 U.S.C. 752.
630 See Michael P. Jamroz, The Customer
Protection Rule, 57 Bus. Law. 1069 (May 2002).
631 See Public Law 111–203 § 763(d) adding
section 3E(g) to the Exchange Act (15 U.S.C. 78c–
5(g)).
632 See 15 U.S.C. 78c–5(g); 11 U.S.C. 101(53A)(B).
Section 101(53A)(B) defines a stockbroker to mean
a person—(1) with respect to which there is a
customer, as defined in section 741, subchapter III,
title 11, United States Code (the definition section
of the stockbroker liquidation provisions); and (2)
that is engaged in the business of effecting
transactions in securities—(i) for the account of
others; or (ii) with members of the general public,
from or for such person’s own account. 11 U.S.C.
101(53A)(B).
633 See 15 U.S.C. 78c–5(g); 11 U.S.C. 741–753.
634 See 15 U.S.C. 78c–5(g); 11 U.S.C. 741. There
is no definition of securities account in 11 U.S.C.
741. The term securities account is used in 11
U.S.C. 741(2) and (4) in defining the terms customer
and customer property.

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stockbroker liquidation provisions.635
Finally, section 3E(g) provides that the
term customer as defined in the
stockbroker liquidation provisions
excludes any person to the extent the
person has a claim based on a noncleared security-based swap transaction
except to the extent of any margin
delivered to or by the customer with
respect to which there is a customer
protection requirement under section
15(c)(3) of the Exchange Act or a
segregation requirement.636
The provisions of section 3E(g) of the
Exchange Act apply the customer
protection elements of the stockbroker
liquidation provisions to cleared
security-based swaps, including related
collateral, and, if subject to segregation
requirements, to collateral delivered as
margin for non-cleared security-based
swaps.637 The Dodd-Frank Act
established segregation requirements for
cleared and non-cleared security-based
swaps and provided the Commission
with the authority to adopt rules with
respect to segregation. In particular,
section 763 of the Dodd-Frank Act
amended the Exchange Act to add new
section 3E.638 Section 3E sets forth
requirements applicable to SBSDs and
MSBSPs with respect to the segregation
of cleared and non-cleared securitybased swap collateral and provides the
Commission with rulemaking authority
in this area.639 The Commission also has
concurrent authority under section
15(c)(3) of the Exchange Act to prescribe
segregation requirements for brokerdealers.640
635 See 15 U.S.C. 78c–5(g); 11 U.S.C. 741–753.
Section 3(a)(13) of the Exchange Act, as amended
by the Dodd-Frank Act (Pub. L. 111–203 § 761(a)),
defines the term purchase to mean, in the case of
security-based swaps, the execution, termination
(prior to its scheduled maturity date), assignment,
exchange, or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a
security-based swap, as the context may require. 15
U.S.C. 78c(a)(13). Section 3(a)(14) of the Exchange
Act, as amended by the Dodd-Frank Act (Pub. L.
111–203 § 761(a)), defines the term sale to mean, in
the case of security-based swaps, the execution,
termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or
conveyance of, or extinguishing of rights or
obligations under, a security-based swap, as the
context may require. See 15 U.S.C. 78c(a)(14).
636 See 15 U.S.C. 78c–5(g); 11 U.S.C. 741(2).
637 See 15 U.S.C. 78c–5(g); 11 U.S.C. 741–753.
638 See Public Law 111–203 § 763; 15 U.S.C. 78c–
5.
639 See 15 U.S.C. 78c–5. Unlike the grants of
capital and margin rulemaking authority in the
Dodd-Frank Act, section 3E does not divide
rulemaking authority for segregation requirements
for SBSDs and MSBSPs between the Commission
and the prudential regulators. Compare 15 U.S.C.
78o–10(e)(1), with 15 U.S.C. 78c–5. Consequently,
the Commission’s rulemaking authority in this area
extends to bank SBSDs and bank MSBSPs. 15
U.S.C. 78c–5.
640 See 15 U.S.C. 78o(c)(3). See also Public Law
111–203 § 771 (codified at 15 U.S.C. 78o–

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Section 3E(b)(1) of the Exchange Act
provides that a broker, dealer, or SBSD
shall treat and deal with all money,
securities, and property of any securitybased swap customer received to
margin, guarantee, or secure a cleared
security-based swap transaction as
belonging to the customer.641 Section
3E(b)(2) provides that the money,
securities, and property shall be
separately accounted for and shall not
be commingled with the funds of the
broker, dealer, or SBSD or used to
margin, secure, or guarantee any trades
or contracts of any security-based swap
customer or person other than the
person for whom the money, securities,
or property are held.642
Section 3E(c)(1) of the Exchange Act
provides that, notwithstanding section
3E(b), money, securities, and property of
cleared security-based swap customers
of a broker, dealer, or SBSD may, for
convenience, be commingled and
deposited in the same one or more
accounts with any bank, trust company,
or clearing agency.643 Section 3E(c)(2)
further provides that the Commission
may by rule, regulation, or order
prescribe terms and conditions under
which money, securities, and property
of a customer with respect to cleared
security-based swaps may be
commingled and deposited with any
other money, securities, and property
received by the broker, dealer, or SBSD
and required by the Commission to be
separately accounted for and treated and
dealt with as belonging to the securitybased swap customer of the broker,
dealer, or SBSD.644
With respect to non-cleared securitybased swaps, section 3E(f)(1)(A) of the
Exchange Act provides that an SBSD
and an MSBSP shall be required to
notify a counterparty of the SBSD or
MSBSP at the beginning of a noncleared security-based swap transaction
10(e)(3)(B)). Section 771 of the Dodd-Frank Act
states that unless otherwise provided by its terms,
its provisions relating to the regulation of the
security-based swap markets do not divest any
appropriate Federal banking agency, the
Commission, the CFTC, or any other Federal or
State agency, of any authority derived from any
other provision of applicable law. See Public Law
111–203 § 771. In addition, section 15F(e)(3)(B) of
the Exchange Act provides that nothing in section
15F ‘‘shall limit, or be construed to limit, the
authority’’ of the Commission ‘‘to set financial
responsibility rules for a broker or dealer * * * in
accordance with Section 15(c)(3).’’ 15 U.S.C. 78o–
8(e)(3)(B).
641 See section 3E(b)(1) of the Exchange Act (15
U.S.C. 78c–5(b)(1)). As indicated, the provisions of
section 3E(b) do not apply to MSBSPs.
642 See section 3E(b)(2) of the Exchange Act (15
U.S.C. 78c–5(b)(2)).
643 See section 3E(c)(1) of the Exchange Act (15
U.S.C. 78c–5(c)(1)).
644 See section 3E(c)(2) of the Exchange Act (15
U.S.C. 78c–5(c)(2)).

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that the counterparty has the right to
require the segregation of the funds or
other property supplied to margin,
guarantee, or secure the obligations of
the counterparty.645 Section 3E(f)(1)(B)
provides that, if requested by the
counterparty, the SBSD or MSBSP shall
segregate the funds or other property for
the benefit of the counterparty and, in
accordance with such rules and
regulations as the Commission may
promulgate, maintain the funds or other
property in a segregated account
separate from the assets and other
interests of the SBSD or MSBSP.646
Section 3E(f)(3) provides that the
segregated account shall be carried by
an independent third-party custodian
and be designated as a segregated
account for and on behalf of the
counterparty (‘‘individual
segregation’’).647 In the case of noncleared security-based swaps, therefore,
each counterparty has the right to
require its collateral to be isolated in an
account at an independent custodian
that identifies the counterparty by
name, rather than commingled with
collateral of other counterparties.
The objective of individual
segregation is for the funds and other
property of the counterparty to be
carried in a manner that will keep these
assets separate from the bankruptcy
estate of the SBSD or MSBSP if it fails
financially and becomes subject to a
liquidation proceeding. Having these
assets carried in a bankruptcy-remote
manner protects the counterparty from
the costs of retrieving assets through a
bankruptcy proceeding caused, for
example, because another counterparty
of the SBSD or MSBSP defaults on its
obligations to the SBSD or MSBSP.
Section 3E(f)(2)(B)(i) of the Exchange
Act provides that the segregation
requirements for non-cleared securitybased swaps do not apply to variation
margin payments, so that the right of a
counterparty to require individual
account segregation applies only to
initial and not variation margin.648 It
also provides that the segregation
requirements shall not preclude any
commercial arrangement regarding the
investment of segregated funds or other
property that may only be invested in
such investments as the Commission
may permit by rule or regulation, and
the related allocation of gains and losses
645 See 15 U.S.C. 78c–5(f)(1)(A). See also section
3E(f)(2)(A) of the Exchange Act, which provides
that the provisions of section 3E(f)(1) apply only to
a security-based swap between a counterparty and
SBSD or MSBSP that is not submitted for clearing
to a clearing agency. See 15 U.S.C. 78c–5(f)(2)(A).
646 See 15 U.S.C. 78c–5(f)(1)(B).
647 See 15 U.S.C. 78c–5(f)(3).
648 See 15 U.S.C. 78c–5(f)(2)(B)(i).

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resulting from any investment of the
segregated funds or other property.649
Finally, section 3E(f)(4) provides that if
the counterparty does not choose to
require segregation of funds or other
property, the SBSD or MSBSP shall
send a quarterly report to the
counterparty that the firm’s back office
procedures relating to margin and
collateral requirements are in
compliance with the agreement of the
counterparties.650
Pursuant, in part, to the grants of
rulemaking authority in sections 3E and
15(c)(3) of the Exchange Act, the
Commission is proposing new Rule
18a–4 to establish segregation
requirements for SBSDs with respect to
cleared and non-cleared security-based
swaps that would supplement the
requirements in section 3E.651 Proposed
new Rule 18a–4 would apply to all
types of SBSDs (i.e., it would apply to
bank SBSDs, stand-alone SBSDs, and
broker-dealer SBSDs).652 As discussed
in more detail below, proposed new
Rule 18a–4 would prescribe detailed
requirements for how cash, securities,
and money market instruments of a
customer with cleared security-based
swaps must be segregated when an
SBSD commingles those assets with the
cash and securities of other customers
(‘‘omnibus segregation’’) pursuant to
section 3E(c)(1) of the Exchange Act.653
In addition, the proposed rule would
require that cash, securities, and money
market instruments of a customer with
respect to non-cleared security-based
swaps must be treated in the same
manner as cash, securities, and money
market instruments of a customer with
respect to cleared security-based swaps
in cases where the counterparty does
not elect individual segregation 654 and
does not affirmatively waive segregation
altogether.655 In other words, proposed
new Rule 18a–4 would establish an
alternative omnibus, or ‘‘commingled’’,
segregation approach for non-cleared
security-based swaps. This approach
would be the default requirement under
which an SBSD would be required to
segregate securities and funds relating to
649 See 15 U.S.C. 78c–5(f)(2)(B)(ii). No
requirements are being proposed at this time
pursuant to the authority in section 3E(f)(1)(B)(ii) of
the Exchange Act.
650 See section 3E(f)(4) of the Exchange Act (15
U.S.C. 78c–5(f)(4)).
651 See 15 U.S.C. 78c–5; 15 U.S.C. 78o(c)(3).
652 Unlike section 15F of the Exchange Act that
divides responsibility for capital and margin rules
between the Commission and the prudential
regulators, section 3E of the Exchange Act provides
authority solely to the Commission. Compare 15
U.S.C. 78o–10, with 15 U.S.C. 78c–5.
653 See 15 U.S.C. 78c–5(c)(1).
654 See 15 U.S.C. 78c–5(f)(1)–(3).
655 See 15 U.S.C. 78c–5(f)(4).

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non-cleared security-based swaps and,
therefore, apply in the absence of a
counterparty electing individual
segregation or affirmatively waiving
segregation.656
The omnibus segregation
requirements in Rule 18a–4 would not
apply to MSBSPs.657 Consequently, if an
MSBSP holds collateral from a
counterparty with respect to noncleared security-based swaps, it would
be subject only to the segregation
requirements in section 3E of the
Exchange Act with respect to the
collateral, and would not be required to
segregate the collateral unless the
counterparty required individual
segregation under section 3E.658 The
omnibus segregation requirements in
Rule 18a–4 may not be practical for
MSBSPs for the same reasons discussed
in sections II.A.3. and II.B.2. of this
release with respect to the proposed
capital and margin requirements for
MSBSPs (i.e., the potentially wide range
of business models under which
nonbank MSBSPs may operate under
the proposed rule, and the uncertain
impact that requirements designed for
broker-dealers could have on these
entities). MSBSPs will instead be
subject to the provisions in section 3E(f)
of the Exchange Act, which provide
certain baseline segregation
requirements for non-cleared securitybased swaps.659 In addition,
counterparties would be able to
negotiate customized segregation
agreements with MSBSPs, subject to
these provisions.660
As discussed in more detail below,
the omnibus segregation requirements of
Rule 18a–4 are modeled on the
provisions of the broker-dealer
segregation rule—Rule 15c3–3.661 Rule
15c3–3 is designed ‘‘to give more
specific protection to customer funds
and securities, in effect forbidding
656 As discussed below in section II.C.2.c. of this
release, an SBSD would be required to obtain a
subordination agreement from a counterparty that
waives segregation. By entering into the
subordination agreement, the counterparty would
affirmatively waive segregation. The absence of a
subordination agreement would mean that the
counterparty is presumed not to have waived
segregation and the SBSD would need to treat the
counterparty’s cash, securities, and/or money
market instruments pursuant to the omnibus
segregation requirements of proposed new Rule
18a–4.
657 As discussed in more detail below, MSBSPs
would be subject to a notification requirement. See
paragraph (d)(1) of proposed new Rule 18a–4.
658 The provisions of section 3E of the Exchange
Act governing cleared security-based swaps do not
apply to nonbank MSBSPs. See 15 U.S.C. 78c–5(b)
(referring specifically to a ‘‘broker, dealer, or
security-based swap dealer’’ and not to an MSBSP.).
659 See 15 U.S.C. 78c–5(f).
660 Id.
661 See 17 CFR 240.15c3–3.

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brokers and dealers from using customer
assets to finance any part of their
businesses unrelated to servicing
securities customers; e.g., a firm is
virtually precluded from using customer
funds to buy securities for its own
account.’’ 662 To meet this objective,
Rule 15c3–3 requires a broker-dealer
that maintains custody of customer
securities and cash (a ‘‘carrying brokerdealer’’) to take two primary steps to
safeguard these assets. The steps are
designed to protect customers by
segregating their securities and cash
from the broker-dealer’s proprietary
business activities. If the broker-dealer
fails financially, the securities and cash
should be readily available to be
returned to the customers. In addition,
if the failed broker-dealer is liquidated
in a formal proceeding under SIPA, the
securities and cash should be isolated
and readily identifiable as ‘‘customer
property’’ and, consequently, available
to be distributed to customers ahead of
other creditors.663
The first step required by Rule 15c3–
3 is that a carrying broker-dealer must
maintain physical possession or control
over customers’ fully paid and excess
margin securities.664 Physical
possession or control means the brokerdealer must hold these securities in one
of several locations specified in Rule
15c3–3 and free of liens or any other
662 See Net Capital Requirements for Brokers and
Dealers, Exchange Act Release No. 21651 (Jan. 11,
1985), 50 FR 2690, 2690 (Jan. 18, 1985). See also
Broker-Dealers; Maintenance of Certain Basic
Reserves, Exchange Act Release No. 9856 (Nov. 10,
1972), 37 FR 25224, 25224 (Nov. 29, 1972).
663 See 15 U.S.C. 78aaa et seq.
664 See 17 CFR 240.15c3–3(d). The term fully paid
securities includes all securities carried for the
account of a customer in a special cash account as
defined in Regulation T promulgated by the Board
of Governors of the Federal Reserve System, as well
as margin equity securities within the meaning of
Regulation T which are carried for the account of
a customer in a general account or any special
account under Regulation T during any period
when section 8 of Regulation T (12 CFR 220.8)
specifies that margin equity securities shall have no
loan value in a general account or special
convertible debt security account, and all such
margin equity securities in such account if they are
fully paid: provided, however, that the term ‘‘fully
paid securities’’ shall not apply to any securities
which are purchased in transactions for which the
customer has not made full payment. 17 CFR
240.15c3–3(a)(3). The term margin securities means
those securities carried for the account of a
customer in a general account as defined in
Regulation T, as well as securities carried in any
special account other than the securities referred to
in paragraph (a)(3) of Rule 15c3–3. 17 CFR
240.15c3–3(a)(4). The term excess margin securities
means those securities referred to in paragraph
(a)(4) of Rule 15c3–3 carried for the account of a
customer having a market value in excess of 140
percent of the total of the debit balances in the
customer’s account or accounts encompassed by
paragraph (a)(4) of Rule 15c3–3 which the brokerdealer identifies as not constituting margin
securities. 17 CFR 240.15c3–3(a)(5).

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interest that could be exercised by a
third-party to secure an obligation of the
broker-dealer.665 Permissible locations
include a bank, as defined in section
3(a)(6) of the Exchange Act, and a
clearing agency.666
The second step is that a carrying
broker-dealer must maintain a reserve of
funds or qualified securities in an
account at a bank that is at least equal
in value to the net cash owed to
customers.667 The account must be
titled ‘‘Special Account for the
Exclusive Benefit of Customers of the
Broker-Dealer’’ (‘‘customer reserve
account’’).668 The amount of net cash
owed to customers is computed
pursuant to a formula set forth in
Exhibit A to Rule 15c3–3 (‘‘Exhibit A
formula’’).669 Under the Exhibit A
formula, the broker-dealer adds up
customer credit items (e.g., cash in
customer securities accounts) and then
subtracts from that amount customer
debit items (e.g., margin loans).670 If
credit items exceed debit items, the net
amount must be on deposit in the
customer reserve account in the form of
cash and/or qualified securities.671 A
broker-dealer cannot make a withdrawal
from the customer reserve account until
the next computation and even then
only if the computation shows that the
665 See 17 CFR 240.15c3–3(c). Customer securities
held by the carrying broker-dealer are not assets of
the firm. Rather, the carrying broker-dealer holds
them in a custodial capacity and the possession and
control requirement is designed to ensure that the
carrying broker-dealer treats them in a manner that
allows for their prompt return.
666 Id.
667 17 CFR 240.15c3–3(e). The term ‘‘qualified
security’’ is defined in Rule 15c3–3 to mean a
security issued by the United States or a security
in respect of which the principal and interest are
guaranteed by the United States (‘‘U.S. government
security’’). See 17 CFR 240.15c3–3(a)(6).
668 See 17 CFR 240.15c3–3(e)(1). The purpose of
giving the account this title is to alert the bank and
creditors of the broker-dealer that this reserve fund
is to be used to meet the broker-dealer’s obligations
to customers (and not the claims of general
creditors) in the event the broker-dealer must be
liquidated in a formal proceeding.
669 17 CFR 240.15c3–3a.
670 See id.
671 17 CFR 240.15c3–3(e). Customer cash is a
balance sheet item of the carrying broker-dealer
(i.e., the amount of cash received from a customer
increases the amount of the carrying broker-dealer’s
assets and creates a corresponding liability to the
customer). The reserve formula is designed to
isolate these broker-dealer assets so that an amount
equal to the net liabilities to customers is held as
a reserve in the form of cash or U.S. government
securities. The requirement to establish this reserve
is designed to effectively prevent the carrying
broker-dealer from using customer funds for
proprietary business activities such as investing in
securities. The goal is to put the carrying brokerdealer in a position to be able to readily meet its
cash obligations to customers by requiring the firm
to make deposits of cash and/or U.S. government
securities into the customer reserve account in the
amount of the net cash owed to customers.

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reserve requirement has decreased.672
The broker-dealer must make a deposit
into the customer reserve account if the
computation shows an increase in the
reserve requirement.
In addition, the Exhibit A formula
permits the broker-dealer to offset
customer credit items only with
customer debit items.673 This means the
broker-dealer can use customer cash to
facilitate customer transactions such as
financing customer margin loans and
borrowing securities to make deliveries
of securities customers have sold
short.674 As discussed above in section
II.B. of this release, the broker-dealer
margin rules require securities
customers to maintain a minimum level
of equity in their securities accounts. In
addition to protecting the broker-dealer
from the consequences of a customer
default, this equity serves to overcollateralize the customers’ obligations
to the broker-dealer. This buffer protects
the customers whose cash was used to
facilitate the broker-dealer’s financing of
securities purchases and short-sales by
customers. For example, if the brokerdealer fails, the customer debits,
because they generally are overcollateralized, should be attractive
assets for another broker-dealer to
purchase or, if not purchased by another
broker-dealer, they should be able to be
liquidated to a net positive equity.675
The proceeds of the debits sale or
liquidation can be used to repay the
customer cash used to finance the
customer obligations. This cash plus the
funds and/or U.S. government securities
held in the customer reserve account
should equal or exceed the total amount
of customer credit items (i.e., the total
amount owed by the broker-dealer to its
customers).676
672 See

17 CFR 240.15c3–3(e).
17 CFR 240.15c3–3a.
674 For example, if a broker-dealer holds $100 for
customer A, the broker-dealer can use that $100 to
finance a security purchase of customer B. The $100
the broker-dealer owes customer A is a credit in the
formula and the $100 customer B owes the brokerdealer is a debit in the formula. Therefore, under
the Exhibit A formula there would be no
requirement to maintain cash and/or U.S.
government securities in the customer reserve
account. However, if the broker-dealer did not use
the $100 held in customer A’s account for this
purpose, there would be no offsetting debit and,
consequently, the broker-dealer would need to have
on deposit in the customer reserve account cash
and/or U.S. government securities in an amount at
least equal to $100.
675 The attractiveness of the over-collateralized
debits facilitates the bulk transfer of customer
accounts from a failing or failed broker-dealer to
another broker-dealer.
676 See Net Capital Requirements for BrokerDealers; Amended Rules, Exchange Act Release No.
18417 (Jan. 13, 1982), 47 FR 3512, 3513 (Jan. 25,
1982) (‘‘The alternative approach is founded on the
concept that, if the debit items in the Reserve
Formula can be liquidated at or near their contract
673 See

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Proposed new Rule 18a–4 would
contain certain provisions that are
modeled on corresponding provisions of
Rule 15c3–3.677 Paragraph (a) of the
proposed rule would define key terms
used in the rule.678 Paragraph (b) would
require an SBSD to promptly obtain and
thereafter maintain physical possession
or control of all excess securities
collateral (a term defined in paragraph
(a)) and specify certain locations where
excess securities collateral could be
held and would be deemed to be in the
SBSD’s control.679 Paragraph (c) would
require an SBSD to maintain a special
account for the exclusive benefit of
security-based swap customers and have
on deposit in that account at all times
an amount of cash and/or qualified
securities (a term defined in paragraph
(a)) determined through a computation
using the formula in Exhibit A to
proposed new Rule 18a–4.680 A brokerdealer SBSD would need to treat
security-based swap accounts separately
from other securities accounts and,
consequently, would need to perform
separate possession and control and
reserve account computations for
security-based swap accounts and other
securities accounts. The former would
be subject to the possession and control
and reserve account requirements in
proposed new Rule 18a–4 and the latter
would continue to be subject to the
analogous requirements in Rule 15c3–3.
This would keep separate the segregated
customer property related to securitybased swaps from customer property
related to other securities, including
property of retail securities customers.
Paragraph (d) of Rule 18a–4 would
contain certain additional provisions
that do not have analogues in Rule
15c3–3. First, it would require an SBSD
and an MSBSP to provide the notice
required by section 3E(f)(1)(A) of the
Exchange Act prior to the execution of
the first non-cleared security-based
swap transaction with the
counterparty.681 Second, it would
require the SBSD to obtain
subordination agreements from
counterparties that opt out of the
segregation requirements in proposed
value, these assets along with any cash required to
be on deposit under the [customer protection] rule,
will be sufficient to satisfy all liabilities to
customers (which are represented as credit items in
the Reserve Formula).’’).
677 Compare 17 CFR 240.15c3–3, with proposed
new Rule 18a–4.
678 Compare 17 CFR 240.15c3–3(a), with
paragraph (a) of proposed new Rule 18a–4.
679 Compare 17 CFR 240.15c3–3(b)–(d), with
paragraph (b) of proposed new Rule 18a–4.
680 Compare 17 CFR 240.15c3–3(e), with
paragraph (c) of proposed new Rule 18a–4.
681 See 15 U.S.C. 78c–5(f)(1)(A); paragraph (d)(1)
of proposed new Rule 18a–4.

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new Rule 18a–4 because they either
elect individual segregation pursuant to
the provisions of section 3E(f) of the
Exchange Act 682 or agree that the SBSD
need not segregate their assets at all.683
As discussed in more detail below,
the omnibus segregation requirements
in proposed new Rule 18a–4 are
designed to accommodate the
operational aspects of an SBSD
collecting cash, securities, and/or
money market instruments from
security-based swap customers to
margin cleared security-based swaps
and delivering cash, securities, and/or
money market instruments to registered
clearing agencies to meet margin
requirements of the clearing agencies
with respect to the customers’
transactions. Similarly, the omnibus
segregation requirements are designed
to accommodate the current practice of
dealers in OTC derivatives to collect
cash, securities, and/or money market
instruments from a counterparty to
cover current and potential future
exposure arising from an OTC
derivatives transaction with the
counterparty and concurrently deliver
cash, securities, and/or money market
instruments to another dealer as
collateral for an OTC derivatives
transaction that hedges (takes the
opposite side of) the OTC derivatives
transaction with the counterparty. At
the same time, the omnibus segregation
requirements are designed to isolate,
identify, and protect cash, securities,
and/or money market instruments
received by the SBSD as collateral for
cleared and non-cleared security-based
swaps, whether the collateral is held by
the SBSD, a registered clearing agency,
or another SBSD.
Finally, the Commission is proposing
a conforming amendment to add new
paragraph (p) to Rule 15c3–3 to state
that a broker-dealer that is registered as
an SBSD pursuant to section 15F of the
Exchange Act must also comply with
the provisions of Rule 18a–4.684 This
proposed amendment would clarify that
a broker-dealer SBSD must comply with
both Rule 15c3–3 and Rule 18a–4.
Request for Comment
The Commission generally requests
comment on the approach of proposed
new Rule 18a–4. In addition, the
Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Should there be rules under section
3E(f)(1)(B)(i) of the Exchange Act with
682 See

15 U.S.C. 78c–5(f)(1)–(3).
15 U.S.C. 78c–5(f)(4).
684 See proposed paragraph (p) of Rule 15c3–3.
683 See

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respect to how an SBSD and an MSBSP
must segregate funds and other property
relating to non-cleared security-based
swaps to supplement the individual
segregation provisions in section 3E(f)?
If so, describe the types of requirements
the rules should impose.
2. Should there be rules under section
3E(f)(2)(B)(ii)(I) of the Exchange Act
with respect to how an SBSD and an
MSBSP may invest funds or other
property relating to non-cleared
security-based swaps to supplement the
individual segregation provisions in
section 3E(f)? If so, describe the types of
requirements the rules should impose.
For example, should the rules require
that the funds may be invested only in
U.S. government securities or in
qualified securities as that term is
defined in paragraph (a)(5) of proposed
new Rule 18a–4? Explain why or why
not.
3. Is it appropriate to model the
segregation provisions for securitybased swap customers on the provisions
of Rule 15c3–3? If not, explain why and
identify another segregation model.
4. Should MSBSPs be required to
comply with all the omnibus
segregation requirements of proposed
new Rule 18a–4? If so, explain why. If
not, explain why not.
5. Should the omnibus segregation
requirements accommodate the ability
to hold swaps in security-based swap
customer accounts to facilitate a
portfolio margin treatment for related or
offsetting positions in the account?
What practical or legal impediments
may exist to doing so? If swaps could be
held in the account along with securitybased swaps, how would the existence
of differing bankruptcy regimes for
securities and commodities instruments
impact the ability to unwind positions
or distribute assets to customers in the
event of insolvency of the SBSD?
2. Proposed Rule 18a–4
a. Possession and Control of Excess
Securities Collateral
Paragraph (b)(1) of Rule 18a–4 would
require an SBSD to promptly obtain and
thereafter maintain physical possession
or control of all excess securities
collateral carried for the accounts of
security-based swap customers.685
Physical possession or control as used
in Rule 15c3–3 means a broker-dealer
cannot lend or hypothecate securities
subject to the requirement and must
hold them itself or, as is more common,
685 This paragraph is modeled on paragraph (b)(1)
of Rule 15c3–1. Compare 17 CFR 240.15c3–1(b)(1),
with paragraph (b)(1) of proposed new Rule 18a–4.

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in a satisfactory control location.686 As
discussed below, physical possession or
control is intended to have the same
meaning in proposed new Rule 18a–4.
The term security-based swap
customer would be defined to mean any
person from whom or on whose behalf
the SBSD has received or acquired or
holds funds or other property for the
account of the person with respect to a
cleared or non-cleared security-based
swap transaction.687 The definition
would exclude a person to the extent
that person has a claim for funds or
other property which by contract,
agreement or understanding, or by
operation of law, is part of the capital
of the SBSD or is subordinated to all
claims of security-based swap customers
of the SBSD.688 This proposed
definition of security-based swap
customer is modeled on the current
definition of customer in Rule 15c3–
3.689 As discussed above, an SBSD
would be required to obtain
subordination agreements from
counterparties that elect individual
segregation pursuant to the selfexecuting provisions of section 3E(f) of
the Exchange Act 690 or that waive
segregation.691 Because these
counterparties would enter into
subordination agreements, they would
not meet the definition of security-based
swap customer and, consequently, the
omnibus segregation requirements of
proposed new Rule 18a–4 would not
apply to their funds and other
property.692
686 See Amendments to Financial Responsibility
Rules for Broker-Dealers, 72 FR 12862.
687 See paragraph (a)(6) of proposed new Rule
18a–4. Paragraph (a)(1) of proposed Rule 18a–4
would define the term cleared security-based swap
to mean a security-based swap that is, directly or
indirectly, submitted to and cleared by a clearing
agency registered with the Commission pursuant to
section 17A of the Exchange Act (15 U.S.C. 78q–
1). Any other security-based swap would be a noncleared security-based swap.
688 See paragraph (a)(6) of proposed new Rule
18a–4.
689 Compare 17 CFR 240.15c3–3(a)(1), with
paragraph (a)(6) of proposed new Rule 18a–4. The
proposed definition also is based on the definitions
of ‘‘customer’’ in 11 U.S.C. 741(2) and 15 U.S.C.
78lll(2), which, respectively, apply to liquidations
of stockbrokers under the stockbroker liquidation
provisions and broker-dealers under the SIPA. As
discussed above in section II.C.1 of this release,
under these liquidation provisions, customers
receive special protections such as priority claims
to customer property over general creditors. See 11
U.S.C. 101 et seq.; 15 U.S.C. 78aaa et seq.
690 See 15 U.S.C. 78c–5(f)(1)–(3).
691 See 15 U.S.C. 78c–5(f)(4).
692 Counterparties that elect individual
segregation would not need the protections of the
omnibus segregation requirements because their
funds and other property would be held by an
independent third-party custodian and, therefore,
the third-party custodian—rather than the SBSD—
would owe the securities and funds to the
counterparty. Counterparties that waive segregation,

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
Proposed new Rule 18a–4 would
define the term excess securities
collateral to mean securities and money
market instruments carried for the
account of a security-based swap
customer that have a market value in
excess of the current exposure of the
SBSD to the customer, excluding: (1)
Securities and money market
instruments held in a qualified clearing
agency account but only to the extent
the securities and money market
instruments are being used to meet a
margin requirement of the clearing
agency resulting from a security-based
swap transaction of the customer; and
(2) securities and money market
instruments held in a qualified
registered security-based swap dealer
account but only to the extent the
securities and money market
instruments are being used to meet a
margin requirement of the other SBSD
resulting from the SBSD entering into a
non-cleared security-based swap
transaction with the other SBSD to
offset the risk of a non-cleared securitybased swap transaction between the
SBSD and the customer. The proposed
definition of excess securities collateral
is based on the provisions of Rule 15c3–
3 requiring a broker-dealer to maintain
physical possession or control of fully
paid and excess margin securities (i.e.,
securities that are not being used to
secure the obligations of the customer to
the broker-dealer).693 Under the
proposed definition of excess securities
collateral, securities and money market
instruments of a security-based swap
customer of the SBSD that are not being
used to collateralize the SBSD’s current
exposure to the customer would need to
be in the physical possession or control
of the SBSD unless one of the two
exceptions in the definition applies to
the securities and money market
instruments.
The first exception in the definition
refers to securities and money market
instruments held in a qualified clearing
agency account but only to the extent
the securities and money market
instruments are being used to meet a
margin requirement of the clearing
agency resulting from a security-based
swap transaction of the customer. This
exception is designed to accommodate
the margin requirements of clearing
agencies, which will require SBSDs to
in effect, have agreed that their funds and other
property can be used by the SBSD for its proprietary
business purposes. Therefore, they have agreed to
forego the benefits of segregation.
693 See 17 CFR 240.15c3–3(d); 17 CFR 240.15c3–
3(a)(3) (defining the term fully paid securities); 17
CFR 240.15c3–3(a)(4) (defining the term margin
securities); 17 CFR 240.15c3–3(a)(5) (defining the
term excess margin securities).

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deliver margin collateral to the clearing
agency to cover exposures arising from
cleared security-based swaps of the
SBSD’s security-based swap
customers.694 Customer securities and
money market instruments provided to
the clearing agency for this purpose
would not meet the definition of excess
securities collateral and, therefore,
would not be subject to the physical
possession or control requirement.695
This exception would allow the clearing
agency to hold the securities as
collateral against obligations of the
SBSD’s customers arising from their
cleared security-based swaps.
The term qualified clearing agency
account would be defined to mean an
account of an SBSD at a clearing agency
established to hold funds and other
property in order to purchase, margin,
guarantee, secure, adjust, or settle
cleared security-based swaps of the
SBSD’s security-based swap customers
that meets the following conditions:
• The account is designated ‘‘Special
Clearing Account for the Exclusive
Benefit of the Cleared Security-Based
Swap Customers of [name of the
SBSD]’’; 696
• The clearing agency has
acknowledged in a written notice
provided to and retained by the SBSD
that the funds and other property in the
account are being held by the clearing
agency for the exclusive benefit of the
security-based swap customers of the
SBSD in accordance with the
regulations of the Commission and are
being kept separate from any other
accounts maintained by the SBSD with
the clearing agency; 697 and
• The account is subject to a written
contract between the SBSD and the
clearing agency which provides that the
funds and other property in the account
shall be subject to no right, charge,
security interest, lien, or claim of any
694 As discussed above, security-based swap
clearing agencies will require SBSDs to deliver
margin collateral for the security-based swap
transactions of the SBSD’s customers that are
cleared by the clearing agency.
695 While the Commission is proposing this
exemption, these customer securities and money
market instruments would still be required to be
included in the SBSD’s reserve formula calculation
under proposed new Rule 18a–4a.
696 See paragraph (a)(3)(i) of proposed new Rule
18a–4. This provision is modeled on paragraph
(e)(1) of Rule 15c3–3, which requires a brokerdealer to maintain a ‘‘Special Reserve Bank Account
for the Exclusive Benefit of Customers.’’ Compare
17 CFR 240.15c3–3(e), with paragraph (a)(3)(i) of
proposed new Rule 18a–4.
697 See paragraph (a)(3)(ii) of proposed new Rule
18a–4. This provision is modeled on paragraph (f)
of Rule 15c3–3, which requires a broker-dealer to
obtain a written notification from a bank where it
maintains a customer reserve account. Compare 17
CFR 240.15c3–3(f), with paragraph (a)(3)(iii) of
proposed new Rule 18a–4.

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70279

kind in favor of the clearing agency or
any person claiming through the
clearing agency, except a right, charge,
security interest, lien, or claim resulting
from a cleared security-based swap
transaction effected in the account.698
These provisions are designed to
ensure that securities and money market
instruments of security-based swap
customers related to cleared securitybased swaps provided to a clearing
agency are isolated from the proprietary
assets of the SBSD and identified as
property of the security-based swap
customers.
The second exception in the
definition of excess securities collateral
is for securities and money market
instruments held in a qualified
registered security-based swap dealer
account but only to the extent the
securities and money market
instruments are being used to meet a
margin requirement of the other SBSD
resulting from the SBSD entering into a
non-cleared security-based swap
transaction with the other SBSD to
offset the risk of a non-cleared securitybased swap transaction between the
SBSD and the customer. This exception
is designed to accommodate the practice
of dealers in OTC derivatives
transactions maintaining ‘‘matched
books’’ of transactions in which an OTC
derivatives transaction with a
counterparty is hedged with an
offsetting transaction with another
dealer. SBSDs, as dealers in securitybased swaps, are expected to actively
manage the risk of their non-cleared
security-based swap positions by
entering into offsetting transactions with
other SBSDs.699 These other SBSDs may
require margin collateral from the
SBSD.700 Customer securities and
698 See paragraph (a)(3)(iii) of proposed new Rule
18a–4. This provision is modeled on paragraph (f)
of Rule 15c3–3, which requires a broker-dealer to
obtain a contract from a bank where it maintains
a ‘‘Special Reserve Bank Account for the Exclusive
Benefit of Customers.’’ Compare 17 CFR 240.15c3–
3(f), with paragraph (a)(3)(ii) of proposed new Rule
18a–4.
699 For example, assume an SBSD and a
counterparty enter into a CDS security-based swap
on XYZ Company with a notional amount of $10
million and term of five years and in which the
SBSD is the seller of protection and counterparty
is the buyer of protection. The SBSD could enter
into a matching transaction (a CDS security-based
swap on XYZ Company with a notional amount of
$10 million and term of five years) with another
SBSD in which the SBSD is the buyer of protection
and the other SBSD is the seller of protection. This
would match the transaction with the counterparty
with the transaction with the other SBSD and hedge
the SBSD’s risk resulting from the transaction with
the customer.
700 As discussed above in section II.B.2.c.i. of this
release, an SBSD would not be required to collect
collateral equal to the margin amount if the
counterparty was another SBSD under the

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money market instruments provided to
another SBSD for this purpose would be
excepted from the definition of excess
securities collateral and, therefore,
would not be subject to the physical
possession or control requirement.
Thus, this provision would allow an
SBSD to finance customer transactions
in non-cleared security-based swaps by
using customer collateral to secure
offsetting transactions with another
SBSD, provided that the collateral is
held in an account with the other SBSD
that meets certain requirements.
The term qualified registered securitybased swap dealer account (‘‘qualified
SBSD account’’) would be defined to
mean an account at another SBSD
registered with the Commission
pursuant to section 15F of the Exchange
Act that is not an affiliate of the SBSD
and that meets the following conditions:
• The account is designated ‘‘Special
Account for the Exclusive Benefit of the
Security-Based Swap Customers of
[name of the SBSD]’’; 701
• The account is subject to a written
acknowledgement by the other SBSD
provided to and retained by the SBSD
that the funds and other property held
in the account are being held by the
other SBSD for the exclusive benefit of
the security-based swap customers of
the SBSD in accordance with the
regulations of the Commission and are
being kept separate from any other
accounts maintained by the SBSD with
the other SBSD; 702
Alternative A account equity requirement in
proposed new Rule 18a–3. See paragraph
(c)(1)(iii)(B)—Alternative A of proposed new Rule
18a–3. Consequently, an SBSD would not be
required to maintain a minimum level of positive
equity in its account at another SBSD with respect
to non-cleared security-based swaps. This would
mean that the SBSD may not need to provide
collateral to the other SBSD other than an amount
necessary to cover the current exposure of the other
SBSD, which, in turn could reduce the need to use
securities and money market instruments of
security-based swap customers to collateralize
hedging transactions. However, under the
Alternative B account equity requirement, an SBSD
would be required to provide collateral equal to the
margin amount to the other SBSD. See paragraph
(c)(1)(iii)(B)—Alternative B of proposed new Rule
18a–3. This could increase the need to use
securities and money market instruments of
security-based swap customers to collateralize
hedging transactions.
701 See paragraph (a)(4)(i) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account, this provision is
modeled on paragraph (e)(1) of Rule 15c3–3, which
requires a broker-dealer to maintain a ‘‘Special
Reserve Bank Account for the Exclusive Benefit of
Customers.’’ Compare 17 CFR 240.15c3–3(e), with
paragraph (a)(4)(i) of proposed new Rule 18a–4.
702 See paragraph (a)(4)(ii) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account, this provision is
modeled on paragraph (f) of Rule 15c3–3, which
requires a broker-dealer to obtain a written
notification from a bank where it maintains a
‘‘Special Reserve Bank Account for the Exclusive

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• The account is subject to a written
contract between the SBSD and the
other SBSD which provides that the
funds and other property in the account
shall be subject to no right, charge,
security interest, lien, or claim of any
kind in favor of the other SBSD or any
person claiming through the SBSD,
except a right, charge, security interest,
lien, or claim resulting from a noncleared security-based swap transaction
effected in the account; 703 and
• The account and the assets in the
account are not subject to any type of
subordination agreement.704
These conditions are largely identical to
the conditions for a qualified clearing
agency account and are similarly
designed to ensure that securities and
money market instruments of securitybased swap customers relating to noncleared security-based swaps provided
to another SBSD are isolated from the
proprietary assets of the SBSD and are
identified as property of the securitybased swap customers. Further, the
account and the assets in the account
could not be subject to any type of
subordination agreement. This
condition is designed to ensure that if
the other SBSD holding the qualified
SBSD account fails, the SBSD
accountholder will be treated as a
security-based swap customer in a
liquidation proceeding and, therefore,
could make a pro rata claim for
customer property with other customers
ahead of all other creditors.705
Paragraph (b)(2) of proposed new Rule
18a–4 would identify five satisfactory
control locations for excess securities
collateral.706 Rule 15c3–3 identifies the
same locations as satisfactory control
locations.707 Proposed new Rule 18a–4
Benefit of Customers.’’ Compare 17 CFR 240.15c3–
3(f), with paragraph (a)(4)(ii) of proposed new Rule
18a–4.
703 See paragraph (a)(4)(iii) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account, this provision is
modeled on paragraph (f) of Rule 15c3–3, which
requires a broker-dealer to obtain a contract from a
bank where it maintains a ‘‘Special Reserve Bank
Account for the Exclusive Benefit of Customers.’’
Compare 17 CFR 240.15c3–3(f), with paragraph
(a)(4)(iii) of proposed new Rule 18a–4.
704 See paragraph (a)(4)(iv) of proposed new Rule
18a–4.
705 See paragraph (a)(6) of proposed new Rule
18a–4 (excluding persons who subordinate their
claims against the SBSD to all other creditors from
the definition of security-based swap customer).
706 See paragraph (b)(2) of proposed new Rule
18a–4.
707 Compare 17 CFR 240.15c3–3(c), with
paragraph (b)(2) of proposed new Rule 18a–4. Rule
15c3–3 identifies two control locations that the
Commission is not proposing be identified in
proposed new Rule 18a–4. First, paragraph (c)(2) of
Rule 15c3–3 identifies as a control location ‘‘a
special omnibus account in the name of such broker
or dealer with another broker or dealer in

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would provide that an SBSD has control
of excess securities collateral only if the
securities and money market
instruments:
• Are represented by one or more
certificates in the custody or control of
a clearing corporation or other
subsidiary organization of either
national securities exchanges, or of a
custodian bank in accordance with a
system for the central handling of
securities complying with the
provisions of Exchange Act Rule 8c–1(g)
and Exchange Act Rule 15c2–1(g) the
delivery of which certificates to the
SBSD does not require the payment of
money or value, and if the books or
records of the SBSD identify the
security-based swap customers entitled
to receive specified quantities or units
of the securities so held for such
security-based swap customers
collectively; 708
• Are the subject of bona fide items
of transfer; provided that securities and
money market instruments shall be
deemed not to be the subject of bona
fide items of transfer if, within 40
calendar days after they have been
transmitted for transfer by the SBSD to
the issuer or its transfer agent, new
certificates conforming to the
instructions of the SBSD have not been
received by the SBSD, the SBSD has not
compliance with the requirements of section 4(b) of
Regulation T under the Act (12 CFR 220.4(b)), such
securities being deemed to be under the control of
such broker or dealer to the extent that he has
instructed such carrying broker or dealer to
maintain physical possession or control of them
free of any charge, lien, or claim of any kind in
favor of such carrying broker or dealer or any
persons claiming through such carrying broker or
dealer.’’ See 17 CFR 240.15c3–3(c)(2). Stand-alone
SBSDs are not expected to maintain such accounts.
Second, Rule 15c3–3 identifies as a control location
‘‘a foreign depository, foreign clearing agency or
foreign custodian bank which the Commission
upon application from a broker or dealer, a
registered national securities exchange or a
registered national securities association, or upon
its own motion shall designate as a satisfactory
control location for securities.’’ See 17 CFR
240.15c3–3(c)(4). See also Interpretative Release:
Guidelines for Control Locations for Foreign
Securities, Exchange Act Release No. 10429 (Oct.
12, 1973), 38 FR 29217, 29217 (Oct. 23, 1973). As
discussed below, the last control location identified
in Rule 15c3–3 and proposed to be identified in
new Rule 18a–4 is such other location ‘‘as the
Commission shall upon application from a broker
or dealer find and designate to be adequate for the
protection of customer securities.’’ See 17 CFR
240.15c3–3(c)(7) and paragraph (b)(2)(v) of
proposed new Rule 18a–4. Under the Commission’s
proposal, SBSDs seeking to have a foreign
depository, foreign clearing agency, or foreign
custodian bank identified as a satisfactory control
location would need to apply to the Commission
under paragraph (b)(2)(v) of proposed new Rule
18a–4.
708 See paragraph (b)(2)(i) of proposed new Rule
18a–4. This provision is modeled on paragraph
(c)(1) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(c)(1), with paragraph (b)(2)(i) of proposed new
Rule 18a–4.

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received a written statement by the
issuer or its transfer agent
acknowledging the transfer instructions
and the possession of the securities and
money market instruments, or the
security-based swap dealer has not
obtained a revalidation of a window
ticket from a transfer agent with respect
to the certificate delivered for
transfer; 709
• Are in the custody or control of a
bank as defined in section 3(a)(6) of the
Act, the delivery of which securities and
money market instruments to the SBSD
does not require the payment of money
or value and the bank having
acknowledged in writing that the
securities and money market
instruments in its custody or control are
not subject to any right, charge, security
interest, lien or claim of any kind in
favor of a bank or any person claiming
through the bank; 710
• Are held in or are in transit between
offices of the SBSD; or are held by a
corporate subsidiary if the SBSD owns
and exercises a majority of the voting
rights of all of the voting securities of
such subsidiary, assumes or guarantees
all of the subsidiary’s obligations and
liabilities, operates the subsidiary as a
branch office of the SBSD, and assumes
full responsibility for compliance by the
subsidiary and all of its associated
persons with the provisions of the
Federal securities laws as well as for all
of the other acts of the subsidiary and
such associated persons; 711 or
• Are held in such other locations as
the Commission shall upon application
from an SBSD find and designate to be
adequate for the protection of customer
securities.712
709 See paragraph (b)(2)(ii) of proposed new Rule
18a–4. This provision is modeled on paragraph
(c)(3) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(c)(3), with paragraph (b)(2)(ii) of proposed new
Rule 18a–4.
710 See paragraph (b)(2)(iii) of proposed new Rule
18a–4. This provision is modeled on paragraph
(c)(5) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(c)(5), with paragraph (b)(2)(iii) of proposed new
Rule 18a–4.
711 See paragraph (b)(2)(iv) of proposed new Rule
18a–4. This provision is modeled on paragraph
(c)(6) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(c)(6), with paragraph (b)(2)(iv) of proposed new
Rule 18a–4.
712 See paragraph (b)(2)(v) of proposed new Rule
18a–4. This provision is modeled on paragraph
(c)(7) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(c)(7), with paragraph (b)(2)(v) of proposed new
Rule 18a–4. See Guidelines for Control Locations for
Foreign Securities, Exchange Act Release No. 10429
(Oct. 12, 1973, 38 FR 29217 (Oct. 23, 1973)
(prescribing the process under Rule 15c3–3 for a
broker-dealer to apply to the Commission to utilize
a foreign control location). Among other things,
certain conditions must be met for the foreign
control location to be deemed satisfactory. A
broker-dealer must represent in an application to
the Commission that the conditions are satisfied.
An application submitted shall be considered

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The identification of these locations as
satisfactory control locations is designed
to limit where the SBSD can hold excess
securities collateral. The identified
locations are places from which the
securities and money market
instruments can promptly be retrieved
and returned to the security-based swap
customers.
Paragraph (b)(3) of Rule 18a–4 would
require that each business day the SBSD
must determine from its books and
records the quantity of excess securities
collateral that the firm had in
possession and control as of the close of
the previous business day and the
quantity of excess securities collateral
the firm did not have in possession or
control on that day.713 The paragraph
would provide further that the SBSD
must take steps to retrieve excess
securities collateral from certain
specifically identified non-control
locations if securities and money market
instruments of the same issue and class
are at these locations.714 Specifically,
paragraph (b)(3) would provide that if
securities or money market instruments
of the same issue and class are:
• Subject to a lien securing an
obligation of the SBSD, then the SBSD,
not later than the next business day on
which the determination is made, must
issue instructions for the release of the
securities or money market instruments
from the lien and must obtain physical
possession or control of the securities
and money market instruments within
two business days following the date of
the instructions; 715
• Held in a qualified clearing agency
account, then the SBSD, not later than
the next business day on which the
determination is made, must issue
instructions for the release of the
securities or money market instruments
by the clearing agency and must obtain
physical possession or control of the
securities or money market instruments
within two business days following the
date of the instructions; 716
accepted unless the Commission rejects the
application within 90 days of receipt by the
Commission. Id.
713 See paragraph (b)(3) of proposed new Rule
18a–4. The provisions in this paragraph are
modeled on the provisions in paragraph (d) of Rule
15c3–3. Compare 17 CFR 240.15c3–3(d), with
paragraph (b)(3) of proposed new Rule 18a–4.
714 See paragraph (b)(3) of proposed new Rule
18a–4.
715 See paragraph (b)(3)(i) of proposed new Rule
18a–4. This provision is modeled on paragraph
(d)(1) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(d)(1), with paragraph (b)(3)(i) of proposed new
Rule 18a–4.
716 See paragraph (b)(3)(ii) of proposed new Rule
18a–4. As discussed above, securities held in a
qualified clearing agency account are not excess
securities collateral, but only to the extent the
securities are being used to meet a margin

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• Held in a qualified SBSD account
maintained by another SBSD, then the
SBSD, not later than the next business
day on which the determination is
made, must issue instructions for the
release of the securities and money
market instruments by the other SBSD
and must obtain physical possession or
control of the securities or money
market instruments within two business
days following the date of the
instructions; 717
• Loaned by the SBSD, then the
SBSD, not later than the next business
day on which the determination is
made, must issue instructions for the
return of the loaned securities and
money market instruments and must
obtain physical possession or control of
the securities or money market
instruments within five business days
following the date of the
instructions; 718
• Failed to receive more than 30
calendar days, then the SBSD, not later
than the next business day on which the
determination is made, must take
prompt steps to obtain physical
possession or control of the securities or
money market instruments through a
buy-in procedure or otherwise; 719
• Receivable by the SBSD as a
security dividend, stock split or similar
distribution for more than 45 calendar
days, then the SBSD, not later than the
next business day on which the
determination is made, must take
requirement of the clearing agency resulting from a
security-based swap transaction of the customer.
See paragraph (a)(2)(i) of proposed new Rule 18a–
4. Consequently, if securities held in a qualified
clearing agency account are not necessary to meet
a margin requirement of the clearing agency, they
would be excess securities collateral and the SBSD
would need to move them to a satisfactory control
location.
717 See paragraph (b)(3)(iii) of proposed new Rule
18a–4. As discussed above, securities held in a
qualified SBSD account are not excess securities
collateral but only to the extent the securities are
being used to meet a margin requirement of the
other SBSD resulting from the SBSD entering into
a non-cleared security-based swap transaction with
the other SBSD to offset the risk of a non-cleared
security-based swap transaction between the SBSD
and the customer. See paragraph (a)(2)(ii) of
proposed new Rule 18a–4. Consequently, if
securities held in a qualified clearing agency
account are not necessary to meet a margin
requirement of the other SBSD and/or are not
collateralizing a transaction that offsets the risk of
n non-cleared security-based swap with the
customer, they would be excess securities collateral
and the SBSD would need to move them to a
satisfactory control location.
718 See paragraph (b)(3)(iv) of proposed new Rule
18a–4. This provision is modeled on paragraph
(d)(1) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(d)(1), with paragraph (b)(3)(iv) of proposed new
Rule 18a–4.
719 See paragraph (b)(3)(v) of proposed new Rule
18a–4. This provision is modeled on paragraph
(d)(2) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(d)(2), with paragraph (b)(3)(v) of proposed new
Rule 18a–4.

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prompt steps to obtain physical
possession or control of the securities or
money market instruments through a
buy-in procedure or otherwise; 720 or
• Included on the books or records of
the SBSD as a proprietary short position
or as a short position for another person
more than 10 business days (or more
than 30 calendar days if the SBSD is a
market maker in the securities), then the
SBSD must, not later than the business
day following the day on which the
determination is made, take prompt
steps to obtain physical possession or
control of such securities or money
market instruments.721

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Request for Comment
The Commission generally requests
comment on the proposed physical
possession and control requirements in
proposed new Rule 18a–4. In addition,
the Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Are possession and control
requirements modeled on Rule 15c3–3
appropriate for security-based swaps? If
not, explain why not.
2. Is the proposed definition of
security-based swap customer
appropriate? If not, explain why not and
suggest modifications to the definition.
3. Is the proposed definition of excess
securities collateral appropriate? If not,
explain why not and suggest
modifications to the definition.
4. Is the proposed exception in the
definition of excess securities collateral
for securities and money market
instruments held in a qualified clearing
agency account appropriate? If not,
explain why not. Would this proposed
exception raise practical or legal issues?
If so, explain why.
5. Is the proposed definition of
qualified clearing agency account
appropriate? If not, explain why not and
suggest modifications to the definition.
6. Is the proposed exception in the
definition of excess securities collateral
for securities and money market
instruments held in a qualified
registered security-based swap dealer
account appropriate? If not, explain
720 See paragraph (b)(3)(vi) of proposed new Rule
18a–4. This provision is modeled on paragraph
(d)(3) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(d)(3), with paragraph (b)(3)(vi) of proposed new
Rule 18a–4.
721 See paragraph (b)(3)(vii) of proposed new Rule
18a–4. This provision is modeled on a proposed
amendment to Rule 15c3–3 that is still pending. See
Amendments to Financial Responsibility Rules for
Broker-Dealers, 72 FR at 12895. The provisions of
paragraph (b)(3)(vii) of proposed new Rule 18a–4
are intended to achieve the same objectives of the
proposed amendments to Rule 15c3–3. See id. at
12865–66 (explaining the basis for the proposed
amendment to Rule 15c3–3).

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why not. Would this proposed
exception raise practical or legal issues?
If so, explain why.
7. Is the proposed definition of
qualified registered security-based swap
dealer account appropriate? For
example, is the condition that the
qualified registered security-based swap
dealer account not be held by an
affiliate of the SBSD appropriate? If the
definition is not appropriate, explain
why not and suggest modifications to
the definition.
8. How do dealers in OTC derivatives
that will be security-based swaps use
offsetting transactions to hedge the risk
of these positions? Would the proposed
possession and control requirements for
non-cleared security-based swaps
adversely affect the ability of SBSDs to
enter into hedging transactions? If so,
explain why and suggest modifications
to the requirements that could address
this issue.
9. Are the control locations identified
in proposed new Rule 18a–4
appropriate for security-based swaps? If
not, explain why not. Should the two
additional control locations in
paragraphs (c)(2) and (c)(4) of Rule
15c3–3 that are not being incorporated
into proposed new Rule 18a–4 be
included in the rule? If so, explain why.
10. Should the process for applying to
the Commission to have a location
designated to be adequate for the
protection of customer securities and
money market instruments under
paragraph (b)(2)(v) of proposed new
Rule 18a–4 be similar to the current
process for a broker-dealer to utilize a
foreign control location under Rule
15c3–3 (i.e., a process in which the
SBSD must submit an application
representing that certain conditions are
met and in which an application is
deemed accepted if not specifically
rejected by the Commission within 90
days)? Alternatively, should the
Commission be required to formally act
on each application through the
issuance of an order?
11. Are the steps in paragraph (b)(3)
of proposed new Rule 18a–4 that an
SBSD would be required to take to move
securities and money market
instruments from non-control locations
to control locations appropriate for
security-based swaps? If not, explain
why not.
12. Are there any possession and
control provisions in Rule 15c3–3 that
are not being incorporated in proposed
new Rule 18a–4 that should be included
in the rule? If so, identify them and
explain why they should be
incorporated into proposed new Rule
18a–4.

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b. Security-Based Swap Customer
Reserve Account
Paragraph (c)(1) of Rule 18a–4 would
require an SBSD, among other things, to
maintain a special account for the
exclusive benefit of security-based swap
customers separate from any other bank
account of the SBSD.722 The term
special account for the exclusive benefit
of security-based swap customers (‘‘Rule
18a–4 Customer Reserve Account’’)
would be defined to mean an account at
a bank that is not the SBSD or an
affiliate of the SBSD and that meets the
following conditions:
• The account is designated ‘‘Special
Account for the Exclusive Benefit of the
Security-Based Swap Customers of
[name of the SBSD]’’; 723
• The account is subject to a written
acknowledgement by the bank provided
to and retained by the SBSD that the
funds and other property held in the
account are being held by the bank for
the exclusive benefit of the securitybased swap customers of the SBSD in
accordance with the regulations of the
Commission and are being kept separate
from any other accounts maintained by
the SBSD with the bank; 724 and
• The account is subject to a written
contract between the SBSD and the bank
which provides that the funds and other
property in the account shall at no time
be used directly or indirectly as security
for a loan or other extension of credit to
the SBSD by the bank and, shall be
subject to no right, charge, security
interest, lien, or claim of any kind in
favor of the bank or any person claiming
through the bank.725
722 See paragraph (c) of proposed new Rule 18a–
4. The provisions of paragraph (c) of proposed new
Rule 18a–4 are modeled on paragraph (e) of Rule
15c3–3. Compare 17 CFR 240.15c3–3(e), with
paragraph (c) of proposed new Rule 18a–4.
723 See paragraph (a)(7)(i) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account and a qualified
SBSD account, this provision is modeled on
paragraph (e)(1) of Rule 15c3–3, which requires a
broker-dealer to maintain a ‘‘Special Reserve Bank
Account for the Exclusive Benefit of Customers’’
(the ‘‘Rule 15c3–3 Customer Reserve Account’’).
Compare 17 CFR 240.15c3–3(e), with paragraph
(a)(7)(i) of proposed new Rule 18a–4.
724 See paragraph (a)(7)(ii) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account and a qualified
SBSD account, this provision is modeled on
paragraph (f) of Rule 15c3–3, which requires a
broker-dealer to obtain a written notification from
a bank where it maintains a Rule 15c3–3 Customer
Reserve Account. Compare 17 CFR 240.15c3–3(f),
with paragraph (a)(7)(ii) of proposed new Rule
18a–4.
725 See paragraph (a)(7)(iii) of proposed new Rule
18a–4. Similar to the proposed conditions for a
qualified clearing agency account and a qualified
SBSD account, this provision is modeled on
paragraph (f) of Rule 15c3–3, which requires a
broker-dealer to obtain a written contract from a
bank where it maintains a ‘‘Special Reserve Bank

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These conditions are largely identical to
the conditions for a qualified clearing
agency account and qualified SBSD
account and are similarly designed to
ensure that cash and qualified securities
deposited into the special bank account
(as discussed below) are isolated from
the proprietary assets of the SBSD and
identified as property of the securitybased swap customers.
Paragraph (c)(1) of proposed new Rule
18a–4 would provide that the SBSD
must at all times maintain in a Rule
18a–4 Customer Reserve Account,
through deposits into the account, cash
and/or qualified securities in amounts
computed in accordance with the
formula set forth in Exhibit A to Rule
18a–4.726 The formula in Exhibit A to
proposed new Rule 18a–4 is modeled on
the formula in Exhibit A to Rule 15c3–
1, which requires a broker-dealer to add
up various credit items and debit
items.727 The credit items include credit
balances in customer accounts and
funds obtained through the use of
customer securities.728 The debit items
include money owed by customers (e.g.,
from margin lending), securities
borrowed by the broker-dealer to
effectuate customer short sales, and
required margin posted to certain
clearing agencies as a consequence of
customer securities transactions.729 If,
Account for the Exclusive Benefit of Customers.’’
Compare 17 CFR 240.15c3–3(f), with paragraph
(a)(7)(iii) of proposed new Rule 18a–4.
726 See paragraph (c)(1) of proposed new Rule
18a–4; Exhibit A to proposed new Rule 18a–4.
727 Compare 17 CFR 240.15c3–3a, with Exhibit A
to proposed new Rule 18a–4.
728 See 17 CFR 240.15c3–3a, Items 1–9. Brokerdealers are permitted to use customer margin
securities to, for example, obtain bank loans to
finance the funds used to lend to customers to
purchase the securities. The amount of the bank
loan is a credit in the formula because this is the
amount that the broker-dealer would need to pay
the bank to retrieve the securities. Similarly, brokerdealers may use customer margin securities to make
stock loans to other broker-dealers in which the
lending broker-dealer typically receives cash in
return. The amount payable to the other brokerdealer on the stock loan is a credit in the formula
because this is the amount the broker-dealer would
need to pay the other broker-dealer to retrieve the
securities.
729 See 17 CFR 240.15c3–3a, Items 10–14. Item 13
identifies as a debit item margin required and on
deposit with the Options Clearing Corporation for
all option contracts written or purchased in
accounts of securities customers. See 17 CFR
240.15c3–3a, Item 13. Similarly, Item 14 identifies
as a debit item margin related to security futures
products written, purchased, or sold in accounts
carried for security-based swap customers required
and on deposit with a clearing agency registered
with the Commission under section 17A of the
Exchange Act (15 U.S.C. 78q–1) or a DCO registered
with the CFTC under section 5b of the CEA (7
U.S.C. 78q–1). These debits reflect the fact that
customer options and security futures transactions
that are cleared generate margin requirements in
which the broker-dealer must deliver collateral to
the Options Clearing Corporation in the case of

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under the formula, customer credit
items exceed customer debit items, the
broker-dealer must maintain cash and/
or qualified securities in that net
amount in a Rule 15c3–3 Customer
Reserve Account.
The formula in Exhibit A for
determining the amount to be
maintained in a Rule 18a–4 Customer
Reserve Account similarly would
require an SBSD to add up credit items
and debit items.730 If, under the
formula, the credit items exceed the
debit items, the SBSD would be
required to maintain cash and/or
qualified securities in that net amount
in a Rule 18a–4 Customer Reserve
Account.731 The credit and debit items
identified in Exhibit A to proposed new
Rule 18a–4 are the same as the credit
and debit items in Exhibit A to Rule
15c3–1, though Exhibit A to proposed
new Rule 18a–4 would identify two
additional debit items.732 As discussed
above, SBSDs will be required to deliver
collateral to meet margin requirements
of clearing agencies arising from cleared
security-based swap transactions of
their customers. In addition, SBSDs may
deliver collateral to other SBSDs to meet
margin requirements under proposed
new Rule 18a–3 and, possibly, to meet
‘‘house’’ margin requirements of the
other SBSD with respect to non-cleared
security-based swaps the SBSD is using
to hedge the risk of customer noncleared security-based swaps.
Consequently, Exhibit A to proposed
new Rule 18a–4 would identify the
following debit items that are not
identified in Exhibit A to Rule 15c3–3:
• Margin related to cleared securitybased swap transactions in accounts
carried for security-based swap
customers required and on deposit at a
clearing agency registered with the
Commission pursuant to section 17A of
the Exchange Act (15 U.S.C. 78q–1); and
• Margin related to non-cleared
security-based swap transactions in
options or a clearing agency or DCO in the case of
security futures products. Identifying the collateral
delivered to the Options Clearing Corporation, a
clearing agency, or a DCO as a debit item permits
the broker-dealer to use customer cash or securities
to meet margin requirements generated by customer
transactions.
730 See proposed new Rule 18a–4a. Exhibit A to
Rule 15c3–3 has a number of ‘‘Notes’’ that provide
further explanation of the credit and debit items.
See 17 CFR 240.15c3–3a, Notes A–G. Exhibit A to
proposed new Rule 18a–4 would have substantially
similar notes. See Notes A–G to Exhibit A to
proposed new Rule 18a–4.
731 As discussed above, the account would need
to be at a bank that is not the SBSD or an affiliate
of the SBSD and that meets certain additional
conditions. See paragraph (a)(7) of proposed new
Rule 18a–4.
732 Compare 17 CFR 240.15c3–3a, with Exhibit A
to proposed new Rule 18a–4.

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accounts carried for security-based swap
customers held in a qualified registered
SBSD account at another SBSD.
These debit items would serve the same
purpose as the debit items in Exhibit A
to Rule 15c3–3 that identify margin
required and on deposit at the Options
Clearing Corporation, a registered
clearing agency, and a DCO.733
If the total credits exceed the total
debits, an SBSD would need to maintain
that amount on deposit in a Rule 18a–
4 Customer Reserve Account in the form
of funds and/or qualified securities.734
An SBSD would be permitted under the
proposed rule to use qualified securities
to meet this account deposit
requirement to implement section 3E(d)
of the Exchange Act.735 Section 3E(d)
provides that money of security-based
swap customers received by an SBSD to
margin, guarantee, or secure a cleared
security-based swap may be invested in
obligations of the United States,
obligations fully guaranteed as to
principal and interest by the United
States, general obligations of a State or
any subdivision of a State (‘‘municipal
securities’’), and in any other
investment that the Commission may by
rule or regulation prescribe.736 Section
3E(d) further provides that such
investments shall be made in
accordance with such rules and
regulations and subject to such
conditions as the Commission may
prescribe.737
The term qualified security as used in
proposed new Rule 18a–4 would be
defined to mean: (1) Obligations of the
United States; (2) obligations fully
guaranteed as to principal and interest
by the United States; and (3) general
obligations of any State or subdivision
of a State that are not traded flat or are
not in default, were part of an initial
offering of $500 million or greater, and
were issued by an issuer that has
published audited financial statements
within 120 days of its most recent fiscal
year-end.738 Rule 15c3–3 contains a
similar definition of qualified security,
except the definition does not include
municipal securities.739
While section 3E(d) of the Exchange
Act permits the use of municipal
733 See
734 See

17 CFR 240.15c3–3a, Items 13–14.
paragraph (c)(1) of proposed new Rule

18a–4.
735 15 U.S.C. 78c–5(d).
736 Id.
737 Id.
738 See paragraph (a)(5) of proposed new Rule
18a–4.
739 See 17 CFR 240.15c3–3(a)(6) (defining the
term qualified security to mean a security issued by
the United States or a security in respect of which
the principal and interest are guaranteed by the
United States).

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securities, the rule imposes conditions
on their use designed to ensure that
only municipal securities with the most
reliable valuations—and therefore
greater safety and liquidity—are
permitted to meet the Rule 18a–4
Customer Reserve Account funding
requirement in paragraph (c)(1) of
proposed new Rule 18a–4 (consistent
with the objective of the current
definition of ‘‘qualified security’’ in
Rule 15c3–3).740 Because of the
diversity and breadth of the municipal
market, the availability of issuer
information and the related ability to
value and trade a particular municipal
security can vary considerably.741 The
objective of segregation requirements is
to isolate customer assets from a firm’s
proprietary business and, therefore,
enable the firm to quickly return the
assets to the customers if the firm fails.
Rule 15c3–3 limits the definition of
qualified securities to U.S. government
securities to ensure that securities
deposited in a customer reserve account
can be liquidated quickly at current
market values even in stressed market
conditions. The proposed conditions for
depositing municipal securities into the
SBSD’s Rule 18a–4 Customer Reserve
Account are designed to help ensure
that only securities that are likely to
have significant issuer information
available and that can be valued and
liquidated quickly at current market
values are permitted to meet the
740 See paragraphs (a)(5)(iii)(A)–(C) of proposed
new Rule 18a–4.
741 Despite its size and importance, the municipal
securities market has not been subject to the same
level of regulation as other sectors of the U.S.
capital markets. See Commission, Report on the
Municipal Securities Market (July 31, 2012)
(‘‘Municipal Securities Report’’), available at
http://www.sec.gov/news/studies/2012/
munireport073112.pdf. The Municipal Securities
Report notes concerns about access to issuer
information; the presentation and comparability of
information; and the existence/adequacy of
disclosure controls and procedures. Id. at iv, 108–
09. For example, the Municipal Securities Report
notes that studies have shown that disclosure of
audited annual financial statements by many
municipal issuers is particularly slow. Id. at 76. By
the time annual financial statements are filed or
otherwise publicly available, many municipal
market analysts and investors believe that the
financial information has diminished usefulness or
has lost relevance in assessing the current financial
position of a municipal issuer. Id. Correspondingly,
weaker or more distressed entities are more likely
to have later audit completion times. Id. In
addition, the Municipal Securities Report notes that
although there have been improvements in the
availability of pricing information about completed
trades (i.e., post-trade information), the secondary
market for municipal securities remains opaque.
Investors have very limited access to information
regarding which market participants would be
interested in buying or selling a municipal security,
and at which prices (i.e., pre-trade information). Id.
at vi, 115.

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minimum account deposit
requirement.742
The first proposed condition for
municipal securities is that they must be
general obligation bonds. General
obligation bonds are backed by the full
faith and credit and/or taxing authority
of the issuer.743 They normally are
issued to finance non-revenue
producing public works projects (e.g.,
schools and roads) and generally are
paid off with funds from taxes or fees.
Issuers typically have the ability to raise
taxes in order to service the debt
obligations of these municipal
securities. In contrast, revenue bonds
are issued to fund projects that will
eventually generate revenue (e.g., a toll
road). The anticipated revenue is used
to make payments of principal and
interest owing on the bonds. Revenue
bonds generally do not permit the
bondholders to compel taxation or
legislative appropriation of funds not
pledged for the purpose of servicing the
debt obligations of these municipal
securities.744 Consequently, the
creditworthiness of revenue bonds
depends on the success of the project
being financed, whereas the
creditworthiness of general obligation
bonds ultimately depends on the taxing
authority of the issuer. Therefore,
general obligation bonds tend to have
lower rates of default than other types
of municipal securities.745 In order to
limit the use of municipal securities in
the Rule 18a–4 Customer Reserve
Account to the most creditworthy
instruments,746 the proposed definition
742 See Municipal Securities Report at 113–115
(recognizing the municipal securities market’s
‘‘relatively low liquidity’’ and the ‘‘relatively
opaque’’ pre-trade information about municipal
securities’ prices).
743 See Municipal Securities Report at 7.
744 Id.
745 See, e.g., Moody’s Investor Services
(‘‘Moody’s’’), Special Comment: U.S. Municipal
Bonds Defaults and Recoveries, 1970–2011, at 1
(Mar. 7, 2012), available at http://
www.moodys.com/research
documentcontentpage.aspx?docid=PBC_140114.
See also Municipal Securities Report, at 7 (noting
reports indicate that a majority of defaults in the
municipal securities market are in conduit revenue
bonds issued for nongovernmental purposes, such
as multi-family housing, healthcare (hospitals and
nursing homes), and industrial development bonds
(for economic development and manufacturing
purposes).
746 See Fitch Ratings (‘‘Fitch’’), Default Risk and
Recovery Rates on U.S. Municipal Bonds, note 116,
at 1 (Jan. 9, 2007), available at http://www.cdfa.net/
cdfa/cdfaweb.nsf/ordredirect.html?open&
id=fitchdefaultreport.html Fitch is not aware of any
state or local municipality of size that has
experienced a permanent or extended default on its
general obligation bonds since the Great
Depression, so that in one of its studies, Fitch
assumed a 100% recovery rate on general obligation
bonds). Id. See also Moody’s, Special Comment:
Moody’s US Municipal Bond Rating Scale, 11 (Nov.
2002), available at http://www.moodys.com/sites/

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of qualified security would limit the use
of municipal securities to general
obligation bonds.
The second proposed condition for
the use of municipal securities is that
they must be part of an initial offering
of $500 million or greater. The size of
the initial offering is an indication of the
size of the market for a particular
issuer’s municipal securities.
Additionally, the secondary market for
a municipal security is generally smaller
than for the initial offering.747 The $500
million threshold is designed to be large
enough to ensure that the market for a
particular issuer’s securities is large
enough that the securities can be
liquidated quickly and at their current
market price in order to raise cash to
return to an SBSD’s customers.
The third proposed condition for the
use of municipal securities is that they
must be issued by an issuer that has
published audited financial statements
within 120 days of its most recent fiscal
year-end.748 Prices for municipal
securities issued by issuers that have
published relatively current information
about their financial condition may tend
to be more transparent than prices for
municipal securities issued by issuers
for which such financial information is
not available, because investors and
analysts have more current information
to assess the creditworthiness of the
issuer and to inform pricing
decisions.749
products/DefaultResearch/2001700000407258.pdf.
Similarly, Moody’s acknowledged the ‘‘anticipated
near 100% recovery rate on any defaulted general
obligation bond,’’ because there have been no
defaults among Moody’s-rated issuers of general
obligation bonds since at least 1970. Id.
747 While almost all municipal bonds trade in the
first month following the initial offering, only 15%
trade in the second month, and even fewer trade in
subsequent months. Municipal Securities Report at
113–14 (citing Richard C. Green, Burton Hollifield
and Normal Schu¨rhoff, Financial Intermediation
and the Costs of Trading in an Opaque Market, 20
Rev. Fin. Stud. 275, 282 (2007)).
748 See, e.g., Notice of Filing of Amendment No.
2 and Order Granting Accelerated Approval of
Proposed Rule Change, as Modified by Amendment
Nos. 1 and 2 Thereto, Relating to Additional
Voluntary Submissions by Issuers to the MSRB’s
Electronic Municipal Market Access System
(‘‘EMMA®’’), Exchange Act Release No. 62183 (May
26, 2010), 75 FR 30876 (June 2, 2010) (‘‘MSRB Rule
Filing’’). The MSRB stated that, ‘‘issuers that seek
to make their financial information available under
the voluntary annual filing undertaking also would
be bringing the timing of their disclosures into
closer conformity with the timeframes that
investors in the registered securities market have
come to rely upon.’’ Id. at 30882.
749 See MSRB Notice 2010–15 (June 2, 2010),
available at http://www.msrb.org/Rules-andInterpretations/Regulatory-Notices/2010/2010–
15.aspx?n=1 (requesting voluntary submissions of
audited financial statements within 120 calendar
days of the fiscal year-end, or as a transitional
alternative available through December 31, 2013,
within 150 calendar days of the fiscal year-end).
Timely financial reporting ‘‘is critical to the

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

As discussed above, an SBSD would
be required to add up credit items and
debit items pursuant to the formula in
Exhibit A to proposed new Rule 18a–1.
If, under the formula, the credit items
exceed the debit items, the SBSD would
be required to maintain cash and/or
qualified securities in that net amount
in the Rule 18a–4 Customer Reserve
Account. Paragraph (c)(1) of proposed
new Rule 18a–4 would require an SBSD
to take certain deductions for purposes
of this requirement.750 The amount of
cash and/or qualified securities in the
Rule 18a–4 Customer Reserve Account
would need to equal or exceed the
amount required pursuant to the
formula in Exhibit A to proposed new
Rule 18a–1after applying the
deductions.
First, the SBSD would need to deduct
the percentage of the value of municipal
securities specified in paragraph
(c)(2)(vi) of Rule 15c3–1.751 Paragraph
(c)(2)(vi) of Rule 15c3–1 prescribes the
standardized haircuts a broker-dealer
must apply to municipal securities
when computing net capital. For the
purposes of proposed new Rule 18a–4,
the SBSD would need to apply the
standardized haircuts to municipal
securities held in the Rule 18a–4
Customer Reserve Account even if the
firm is approved to use VaR models for
purposes of computing its net capital
under Appendix E to Rule 15c3–1, as
proposed to be amended, or proposed
new Rule 18a–1. The purpose of these
deductions would be to account for
potential market losses that may be
incurred when municipal securities
held in a Rule 18a–4 Customer Reserve
Account are liquidated to return funds
to security-based swap customers.
Second, the SBSD would need to
deduct the aggregate value of the
municipal securities of a single issuer to
the extent the value exceeds 2% of the
amount required to be maintained in the
Rule 18a–4 Customer Reserve Account.
The Commission preliminarily believes
that this deduction would serve as a
reasonable benchmark designed to avoid
the potential that the SBSD might use
customer funds to establish a
concentrated position in municipal
securities of a single issuer. A
concentrated position could be more
functioning of an efficient trading market,’’
especially since bond ratings are only updated
when a significant change is about to occur, and
credit reports represent a costly alternative.
Municipal Securities Report at 74 (citing Jeff L.
Payne and Kevin L. Jensen, An Examination of
Municipal Audit Delay, J. Acc. & Pub. Pol’y, Vol.
21, Issue 1, 3 (2002)).
750 See paragraph (c)(1) of proposed new Rule
18a–4.
751 See 17 CFR 240.15c3–1(c)(2)(vi)(B).

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difficult to liquidate at current market
values.
Third, the SBSD would need to
deduct the aggregate value of all
municipal securities to the extent the
amount of the securities exceeds 10% of
the amount required to be maintained in
the Rule 18a–4 Customer Reserve
Account. The Commission preliminarily
believes that this deduction would serve
as a reasonable benchmark designed to
limit the amount of customer funds an
SBSD could invest in municipal
securities.752 As noted above, the
segregation provisions are designed to
prevent an SBSD from using customer
property for proprietary business
purposes such as paying expenses. The
purpose of the deposits into the Rule
18a–4 Customer Reserve Account is to
create a reserve to protect the funds of
security-based swap customers. The
deposits are not intended as a means for
the SBSD to earn investment returns by,
for example, establishing positions in
higher yielding municipal securities.
The 10% threshold is designed to limit
the ability of the SBSD to use the Rule
18a–4 Customer Reserve Account
deposit requirement to invest in
municipal securities, for the purpose of
obtaining higher yields than U.S.
government securities.
Fourth, the SBSD would be required
to deduct the amount of funds held in
a Rule 18a–4 Customer Reserve Account
at a single bank to the extent the amount
exceeds 10% of the equity capital of the
bank as reported by the bank in its most
recent Consolidated Report of Condition
and Income (‘‘Call Report’’).753 This
provision is consistent with a pending
proposed amendment to Rule 15c3–3.754
752 Compare to Rule 15c3–1(c)(2)(vi)(M)(1)
(imposing undue concentration charges on certain
securities in the proprietary account of a brokerdealer whose market value exceeds more than 10%
of the ‘‘net capital’’ of a broker-dealer before
application of haircuts).
753 With the passage of the Dodd-Frank Act, the
supervision of savings associations was transferred
from the Office of Thrift Supervision to the OCC for
federal savings associations and to the FDIC for
state savings associations on the ‘‘transfer date,’’
which is defined as one year after enactment of the
Dodd-Frank Act, subject to an additional six month
extension. See section Public Law 111–203 §§ 300–
378. See also List of OTS Regulations to be Enforced
by the OCC and the FDIC Pursuant to the DoddFrank Act, OCC, FDIC, 76 FR 39246 (July 6, 2011).
Supervision of savings and loan holding companies
and their subsidiaries (other than depository
institutions) was transferred from the OTS to the
Federal Reserve. Therefore, in February 2011, the
OTS, the OCC, and the FDIC proposed to require,
‘‘savings associations currently filing the Thrift
Financial Report to convert to filing the
Consolidated Reports of Condition and Income or
Call Reports beginning with the reporting period
ending on March 31, 2012.’’ Proposed Agency
Information Collection Activities; Comment
Request, 76 FR 7082, 7082 (Feb. 8, 2011).
754 Amendments to Financial Responsibility Rules
for Broker-Dealers, 72 FR at 12864.

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As the Commission stated when
proposing the amendment to Rule 15c3–
3:
Broker-dealers must deposit cash or
‘‘qualified securities’’ into the customer
reserve account maintained at a ‘‘bank’’
under Rule 15c3–3(e). Rule 15c3–3(f) further
requires the broker-dealer to obtain a written
contract from the bank in which the bank
agrees not to re-lend or hypothecate
securities deposited into the reserve account.
Consequently, the securities should be
readily available to the broker-dealer. Cash
deposits, however, are fungible with other
deposits carried by the bank and may be
freely used in the course of the bank’s
commercial lending activities. Therefore, to
the extent a broker-dealer deposits cash in a
reserve bank account, there is a risk the cash
could be lost or inaccessible for a period if
the bank experiences financial difficulties.
This could adversely impact the brokerdealer and its customers if the balance of the
reserve deposit is concentrated at one bank
in the form of cash.755

The deduction in proposed new Rule
18a–4 is designed to address the same
risk to SBSDs that the Commission
identified with respect to concentrating
in a single bank cash deposits in a
customer reserve account maintained
under Rule 15c3–1.
Paragraph (c)(2) of proposed new Rule
18a–4 would provide that it is unlawful
for an SBSD to accept or use credits
identified in the items of the formula set
forth in Exhibit A to proposed new Rule
18a–4 except to establish debits for the
specified purposes in the items of the
formula.756 This provision would
prohibit the SBSD from using customer
cash and cash realized from the use of
customer securities for purposes other
than those identified in the debit items
in Exhibit A to proposed new Rule 18a–
4. Thus, the SBSD would be prohibited
from using customer cash to, for
example, pay expenses.
Paragraph (c)(3) of proposed new Rule
18a–4 would provide that the
computations necessary to determine
the amount required to be maintained in
the Rule 18a–4 Customer Reserve
Account must be made daily as of the
close of the previous business day and
any deposit required to be made into the
account must be made on the next
business day following the computation
no later than one hour after the opening
of the bank that maintains the
account.757 Paragraph (c)(3) also would
provide that the SBSD may make a
755 Id.
756 See paragraph (c)(2) of proposed new Rule
18a–4. This provision is modeled on paragraph
(e)(2) of Rule 15c3–3. Compare 17 CFR 240.15c3–
3(e)(2), with paragraph (c)(2) of proposed new Rule
18a–4.
757 See paragraph (c)(3) of proposed new Rule
18a–4.

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withdrawal from the Rule 18a–4
Customer Reserve Account only if the
amount remaining in the account after
the withdrawal is equal to or exceeds
the amount required to be maintained in
the account.758
Proposed new Rule 18a–4 would
require a daily computation as opposed
to the weekly computation that is
required by Rule 15c3–3. The margin
requirements of clearing agencies and
other SBSDs for security-based swaps
are expected generally to be determined
on a daily basis, which will require
SBSDs to deliver collateral to, and
receive the return of collateral from,
clearing agencies and other SBSDs on a
daily basis.759 If the Rule 18a–4
Customer Reserve Account computation
were performed on a weekly basis, the
SBSD might need to fund margin
requirements relating to customer
security-based swaps using its own
funds for up to a week because the
customer cash necessary to meet the
requirement is ‘‘locked up’’ in the Rule
18a–4 Customer Reserve Account and
cannot be withdrawn for a number of
days, which could cause liquidity
strains on the SBSD.
Finally, paragraph (c)(4) of proposed
new Rule 18a–4 would require an SBSD
to promptly deposit funds or qualified
securities into a Rule 18a–4 Customer
Reserve Account of the SBSD if the
amount of funds and/or qualified
securities held in one or more Rule 18a–
4 Customer Reserve Accounts falls
below the amount required to be
maintained pursuant to the rule.760 This
proposal is designed to require an SBSD
to use its own resources to fund the
deposit requirement if there is a
shortfall in the amount of cash or
qualified securities maintained in its
Rule 18a–4 Customer Reserve Account.
Request for Comment

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

The Commission generally requests
comment on the requirements for the
Rule 18a–4 Customer Reserve Account
in proposed new Rule 18a–4. In
addition, the Commission requests
comment, including empirical data in
support of comments, in response to the
following questions:
1. Are Rule 18a–4 Customer Reserve
Account requirements modeled on Rule
758 Id.
759 As discussed above in section II.B.2.b.i. of this
release, proposed new Rule 18a–3 would require a
nonbank SBSD to calculate the equity in the
account of each counterparty on a daily basis and
to collect collateral needed to collateralize an
account equity requirement on the next business
day. See paragraphs (c)(1)(i)–(ii) of proposed new
Rule 18a–3.
760 See paragraph (c)(4) of proposed new Rule
18a–4.

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15c3–3 appropriate for security-based
swaps? If not, explain why not.
2. Is the proposed definition of special
account for the exclusive benefit of
security-based swap customers
appropriate? If not, explain why not and
suggest modifications to the definition.
3. Are the proposed credit and debit
items in Exhibit A to proposed new
Rule 18a–4 appropriate? If not, explain
why not. Are there alternative or
additional credit and debit items that
should be included in the formula? If so,
describe them and explain why they
should be included in the formula.
4. How would the formula
computation for a broker-dealer SBSD
differ from the formula computation for
a stand-alone SBSD? For example, the
debit items relating to financing
securities transactions would not apply
to stand-alone SBSDs as financing
securities transactions would need to be
conducted in a broker-dealer.
Consequently, should there be a
separate Exhibit A formula for standalone SBSDs?
5. Are the two additional debit items
in Exhibit A to proposed new Rule 18a–
4 relating to margin collateral required
and on deposit at clearing agencies,
DCOs, and other SBSDs appropriate? If
not, explain why not.
6. Note G to Exhibit A to proposed
new Rule 18a–4 is analogous to Note G
to Exhibit A to Rule 15c3–3. Note G to
Exhibit A to Rule 15c3–3 prescribes
(and Note G to Exhibit A to proposed
new Rule 18a–1 would prescribe) the
conditions for when a clearing agency or
DCO can qualify for purposes of
including debits in the reserve formula
under Item 14 (margin related to
security futures products). Should these
conditions apply to when a clearing
agency would qualify for purposes of
including debits in the Rule 18a–4
Customer Reserve Account formula
under Item 15? If so, explain why. If not,
explain why not. For example, could the
Note G conditions, if applied to Item 15,
be used instead of the proposed
definition of qualified clearing agency
account in proposed new Rule 18a–4?
Would the Note G conditions be a
workable alternative to the proposed
definition? Would the Note G
conditions achieve the same customer
protection objectives as the proposed
definition?
7. Is the proposed definition of
qualified security appropriate? If not,
explain why not and suggest
modifications to the definition. For
example, should additional types of
securities be included in the definition?
If so, identify the types of securities and
explain why they should be included in
the definition and how their inclusion

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would meet the objective of segregation
that customer cash is not used to make
proprietary investments.
8. Is the proposed condition to the
definition of qualified security that
municipal securities be general
obligation bonds in the definition
appropriate? If not, explain why not.
Identify other types of municipal
securities that should be included and
explain how their inclusion would be
consistent with the objective that only
the most highly liquid securities (i.e.,
securities capable of being liquidated at
market value even during times of
market stress) be permitted to meet the
Rule 18a–4 Customer Reserve Account
deposit requirement.
9. It is expected that the proposed
condition that municipal securities be
part of an initial offering of $500 million
or greater in the definition of qualified
security would limit qualifying
securities to a very small percentage of
general obligation municipal security
issuances.761 Would the $500 million
threshold be appropriate? If not, explain
why not. For example, should this
threshold be a greater amount (e.g., $750
million, $1 billion, or some other
amount) or a lesser amount (e.g., $250
million, $100 million, or some other
amount)? If so, indicate the
recommended threshold and explain
why it would be preferable.
10. Is the proposed condition that
municipal securities must be issued by
an issuer that has published audited
financial statements within 120 days of
its most recent fiscal year-end in the
definition of qualified security
appropriate? If not, explain why not.
11. The MSRB Rule Filing
contemplates those issuers who are
engaged in the voluntary annual filing
undertaking will be able to provide the
information to the MSRB’s Electronic
Muni Market Access System within 150
calendar days after the end of the
applicable fiscal year prior to January 1,
2014. The 150 calendar day time frame
is an interim measure and would no
longer be available after January 1, 2014.
Should municipal securities that
otherwise meet the definition of
qualified securities be permitted if the
issuer submits financial information
within 150 calendar days after the end
of the applicable fiscal year during this
transitional period that would end on
January 1, 2014?
12. Is the proposed deduction for
municipal securities held in a Rule 18a–
4 Customer Reserve Account equal to
the percentage specified in paragraph
761 Data source: Mergent’s Municipal Bond
Securities Database.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
(c)(2)(vi) of Rule 15c3–1 appropriate? If
not, explain why not.
13. Is the proposed deduction for
municipal securities of a single issuer
held in a Rule 18a–4 Customer Reserve
Account in excess of 2% of the amount
required to be maintained in the
account appropriate? If not, explain why
not. For example, should the threshold
be greater (e.g., 3%, 5%, 7%, 10%, or
some other amount) or lesser (e.g., 1.5%,
1%, 0.5%, or some other amount)? If so,
identify the recommended threshold
and explain why it would be preferable.
14. Is the proposed deduction for
municipal securities held in a Rule 18a–
4 Customer Reserve Account in excess
of 10% of the amount required to be
maintained in the account appropriate?
If not, explain why not. For example,
should the threshold be greater (e.g.,
15%, 20%, 25%, 30%, or some other
amount) or lesser (e.g., 7%, 5%, 3%, or
some other amount)? If so, identify the
recommended threshold and explain
why it would be preferable.
15. Is the proposed deduction for the
amount that funds held in a Rule 18a–
4 Customer Reserve Account at a single
bank exceed 10% of the equity capital
of the bank as reported by the bank in
its most recent Call Report appropriate?
If not, explain why not. For example,
should the threshold be greater (e.g.,
15%, 20%, 25%, 30%, or some other
amount) or lesser (e.g., 7%, 5%, 3%, or
some other amount)? If so, identify the
recommended threshold and explain
why it would be preferable.
16. Is it appropriate to require that the
computations to determine the amount
required to be maintained in the Rule
18a–4 Customer Reserve Account must
be made daily as of the close of the
previous business day and any deposit
required to be made into the account
must be made on the next business day
following the computation? If not,
explain why not. For example, should
the computations be required on a
weekly basis consistent with Rule 15c3–
3? If so, explain why.
17. Are there any customer reserve
account provisions in Rule 15c3–1 that
are not being incorporated in proposed
new Rule 18a–4 that should be included
in the rule? If so, identify them and
explain why they should be
incorporated into proposed new Rule
18a–4.
18. More generally, are there any
provisions in Rule 15c3–1 that are not
being incorporated in proposed new
Rule 18a–4 that should be included in
the rule? If so, identify them and
explain why they should be
incorporated into proposed new Rule
18a–4.

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c. Special Provisions for Non-Cleared
Security-Based Swap Counterparties
Paragraph (d) of proposed new Rule
18a–4 would require an SBSD and an
MSBSP to provide the notice required
by section 3E(f)(1)(A) of the Exchange
Act prior to the execution of the first
non-cleared security-based swap with
the counterparty.762 Paragraph (d) also
would require an SBSD to obtain
subordination agreements from
counterparties that opt out of the
omnibus segregation requirements in
proposed new Rule 18a–4 because they
either elect individual segregation
pursuant to the self-executing
provisions of section 3E(f) of the
Exchange Act 763 or agree that the SBSD
need not segregate their assets at all.764

70287

therefore, would give the counterparty
an opportunity to determine whether to
elect individual segregation, waive
segregation, or, by not electing
individual segregation or waiving
segregation, to have the collateral
segregated pursuant to the omnibus
segregation provisions of proposed new
Rule 18a–4.

Subordination Agreements
Paragraph (d)(2) of proposed new
Rule 18a–4 would require an SBSD to
obtain agreements from counterparties
that either elect individual segregation
or waive segregation altogether that
such counterparties subordinate all of
their claims against the SBSD to the
claims of security-based swap
customers.768 By entering into
subordination agreements, these
Notice Requirement
counterparties would not meet the
The provisions in section 3E(f) of the
definition of security-based swap
Exchange Act allow a program by which customer in proposed new Rule 18a–
a counterparty to non-cleared security4.769 They also would not be entitled to
based swaps with an SBSD or an
share ratably with security-based swap
MSBSP can choose individual
customers in the fund of customer
segregation.765 These provisions provide property held by the SBSD if it is
a framework of baseline requirements
liquidated. This provision would be
that can be supplemented by
consistent with text in Rule 15c3–3
commercial arrangements between
concerning the exclusion of persons
counterparties and SBSDs and MSBSPs. whose interests are subordinated from
Proposed new Rule 18a–4 would
the definition of ‘‘customer.’’ 770
augment these provisions by prescribing
As discussed in section II.C.1. of this
when the notice specified in section
release, segregation requirements are
3E(f)(1)(A) must be provided to the
designed to identify customer property
counterparty by the SBSD or MSBSP.
as distinct from the proprietary assets of
Section 3E(f)(1)(A) provides that an
the firm and to protect the customer
SBSD and an MSBSP shall be required
property by, for example, preventing the
to notify the counterparty at the
firm from using it to make proprietary
‘‘beginning’’ of a non-cleared securityinvestments. The goal of segregation is
based swap transaction about the right
to facilitate the prompt return of
to require segregation of the funds or
customer property to customers either
other property supplied to margin,
before or during a liquidation
guarantee, or secure the obligations of
proceeding if the firm fails. However, if
the counterparty.766 To provide greater
a counterparty’s property is held by a
clarity as to the meaning of ‘‘beginning’’ third-party custodian because the
as used in the statute, paragraph (d)(1)
counterparty elects individual
of proposed new Rule 18a–4 would
segregation or if the counterparty waives
require an SBSD or MSBSP to provide
segregation, there is no need to isolate
the notice in writing to a counterparty
the counterparty’s property since it is
prior to the execution of the first nonwith the third-party custodian in the
cleared security-based swap transaction former case or the counterparty has
with the counterparty occurring after
agreed that the SBSD can use it for
the effective date of the rule.767
proprietary purposes in the latter case.
Consequently, the notice would need to The subordination provisions in
be given in writing to the counterparty
proposed new Rule 18a–4 are designed
prior to the execution of a transaction
to clarify the rights of counterparties
and, therefore, before the counterparty
768 See paragraph (d)(2) of proposed new Rule
is required to deliver margin collateral
18a–4.
to the SBSD or MSBSP. The notice,
762 See

15 U.S.C. 78c–5(f)(1)(A); paragraph (d)(1)
of proposed new Rule 18a–4.
763 See 15 U.S.C. 78c–5(f)(1)–(3).
764 See 15 U.S.C. 78c–5(f)(4).
765 See 15 U.S.C. 78c–5(f)(1)–(3).
766 See 15 U.S.C. 78c–5(f)(4).
767 See paragraph (c)(1) of proposed new Rule
18a–4.

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769 See paragraph (a)(6) of proposed new Rule
18a–4.
770 See paragraph (a)(1) of Rule 15c3–3 defining
‘‘customer’’ for purposes of Rule 15c3–3 to
specifically exclude ‘‘any other person to the extent
that person has a claim for property or funds which
by contract, agreement or understanding, or by
operation of law, is part of the capital of the brokerdealer or is subordinated to the claims of creditors
of the broker-dealer. 17 CFR 240.15c3–3(a)(1).

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that have their property held by the
SBSD and elect segregation and the
rights of counterparties that either elect
to have their property held by a thirdparty custodian or waive segregation.
An SBSD would need to obtain a
conditional subordination agreement
from a counterparty that elects
individual segregation.771 The
agreement would be conditional
because the subordination agreement
required under the proposed rule would
not be effective in a case where the
counterparty’s assets are included in the
bankruptcy estate of the SBSD.
Specifically, the proposed rule would
provide that the counterparty would
need to subordinate claims but only to
the extent that funds or other property
provided by the counterparty to the
independent third-party custodian are
not treated as customer property under
the stockbroker liquidation provisions
in a liquidation of the security-based
swap dealer.772 Counterparties that
choose individual segregation are opting
to have their funds and other property
held in a manner that makes the
counterparty’s property bankruptcy
remote from the SBSD. If the
arrangement is effective, the
counterparties should not have any
customer claims to cash, securities, or
money market instruments used to
margin their non-cleared security-based
swap transactions in a liquidation of the
SBSD, as their property will be held by
the independent third party custodian.
However, because there is a possibility
that an individual segregation
arrangement would not be effective, the
subordination agreement of a
counterparty that chooses individual
segregation would be conditioned on
the funds and other property of the
counterparty not being included in the
bankruptcy estate of the SBSD. If a
counterparty elects individual
segregation but the election is not
effective in keeping the counterparty’s
assets bankruptcy remote, then the
counterparty should be treated as a
security-based swap customer with a
pro rata priority claim to customer
property.
An SBSD also would need to obtain
an unconditional subordination
agreement from a counterparty that
waives segregation altogether.773 By
opting out of segregation, the
counterparty agrees that cash, securities,
and money market instruments
delivered to the SBSD can be used by
771 See paragraph (d)(2)(i) of proposed new Rule
18a–4.
772 Id.
773 See paragraph (d)(2)(ii) of proposed new Rule
18a–4.

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the SBSD for proprietary purposes and
need not be isolated from the
proprietary assets of the SBSD.
Therefore, these counterparties are
foregoing the protections of segregation,
which include the right to share ratably
with other customers in customer
property held by the SBSD. If these
counterparties were deemed securitybased swap customers, they could have
a pro rata priority claim on customer
property. This result could disadvantage
the security-based swap customers that
did not waive segregation by
diminishing the amount of customer
property available to be distributed to
customers.

property are individually segregated at a
third party custodian.
4. Is it appropriate to require
counterparties who waive all right to
segregation to subordinate their claims
to security-based swap customers? If
not, explain why not and describe other
measures that could be taken to ensure
that security-based swap customers
whose cash, securities, and money
market instruments are subject to the
omnibus segregation requirements have
a first priority claim to these assets over
counterparties who waive all right to
segregation.

Request for Comment
The Commission generally requests
comment on the special provisions for
non-cleared security-based swaps in
proposed new Rule 18a–4. In addition,
the Commission requests comment,
including empirical data in support of
comments, in response to the following
questions:
1. Is the requirement to have notice be
given in writing prior to the execution
of the first non-cleared security-based
swap transaction with the counterparty
occurring after the effective date of the
rule appropriate? If not, explain why
not. Should the notice be required on a
periodic basis such as monthly or
annually? If so, explain why. If not,
explain why not. Should the notice be
required before every transaction? If so,
explain why. If not, explain why not.
2. Describe the current practices and
arrangements for individual segregation.
For example, are these arrangements
based on tri-party agreements between
the SBSD, counterparty, and
independent third-party custodian? If
so, describe the terms of the these thirdparty agreements. Under these
agreements, how would the SBSD
perfect its security interest in the funds
and other property held by the thirdparty custodian? What terms would the
counterparty require that are designed
to ensure that funds or property held by
the independent third-party custodian
at the time of a liquidation proceeding
of the SBSD are not included in the
bankruptcy estate of the SBSD?
3. Is it appropriate to require
counterparties electing individual
segregation to subordinate their claims
to security-based swap customers? If
not, explain why not and describe other
measures that could be taken to ensure
that security-based swap customers
whose cash, securities, and money
market instruments are subject to the
omnibus segregation requirements have
a first priority claim to these assets over
counterparties whose funds and other

In responding to the specific requests
for comment above, interested persons
are encouraged to provide supporting
data and analysis and, when
appropriate, suggest modifications to
proposed rule text. Responses that are
supported by data and analysis provide
great assistance to the Commission in
considering the practicality and
effectiveness of proposed new
requirements as well as weighing the
benefits and costs of proposed
requirements. In addition, commenters
are encouraged to identify in their
responses a specific request for
comment by indicating the section
number of the release.
The Commission also seeks comment
on the proposals as a whole. In this
regard, the Commission seeks comment,
including empirical data in support of
comments, on the following:
1. Are there financial responsibility
programs other than the broker-dealer
financial responsibility program that
could serve as a better model for
establishing financial responsibility
requirements for SBSDs and MSBSPs? If
so, identify the program and explain
how it would be a better model for
implementing the provisions of the
Dodd-Frank Act mandating capital and
margin requirements for nonbank
SBSDs and nonbank MSBSPs.
2. Should any of the proposed
quantitative requirements (e.g.,
minimum capital thresholds, margin
risk factor, standardized haircuts) be
modified? If so, how? Are there new
quantitative requirements that should be
used? What would be the financial or
other consequences for individual firms
and the financial markets of such
modified or new quantitative
requirements and how would such
consequences differ from the proposed
requirements? Please provide detailed
data regarding such consequences and
describe in detail any econometric or
other mathematical models, or
economic analyses of data, that would

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be relevant for evaluating or modifying
any quantitative requirements.
3. How would the proposals integrate
with provisions in other titles and
subtitles of the Dodd-Frank Act and any
regulations or proposed regulations
under those other titles and subtitles?
4. How would the proposals integrate
with other proposals applicable to
SBSDs or MSBSPs in the Exchange Act
and any applicable regulations adopted
under authority in the Exchange Act?
5. As discussed throughout this
release, many of the proposed
amendments are based on dollar
amounts that are prescribed in existing
requirements. Should any of these
proposed dollar amounts be adjusted to
account for inflation?
6. What should the implementation
timeframe be for the proposed
amendments and new rules? For
example, should the compliance date be
90, 120, 150, 180, or some other number
of days after publication? Should the
proposed requirements have different
time frames before their compliance
dates are triggered? For example, would
it take longer to come into compliance
with certain of these proposals than
others? If so, rank the requirements in
terms of the length of time it would take
to come into compliance with them and
propose a schedule of compliance dates.
IV. Paperwork Reduction Act
Certain provisions of the proposed
rule amendments and proposed new
rules would contain a new ‘‘collection
of information’’ within the meaning of
the Paperwork Reduction Act of 1995
(‘‘PRA’’).774 The Commission is
submitting the proposed rule
amendments and proposed new rules to
the Office of Management and Budget
(‘‘OMB’’) for review in accordance with
the PRA. An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a currently valid OMB
control number. The titles for the
collections of information are:
(1) Rule 18a–1 and related
appendices, Net capital requirements for
security-based swap dealers for which
there is not a prudential regulator (a
proposed new collection of
information);
(2) Rule 18a–2, Capital requirements
for major security-based swap
participants for which there is not a
prudential regulator (a proposed new
collection of information);
(3) Rule 18a–3, Non-cleared securitybased swap margin requirements for
security-based swap dealers and major
security-based swap participants for
774 44

U.S.C. 3501 et seq.; 5 CFR 1320.11.

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which there is not a prudential regulator
(a proposed new collection of
information);
(4) Rule 18a–4, Segregation
requirements for security-based swap
dealers and major security-based swap
participants (a proposed new collection
of information); and
(5) Rule 15c3–1 Net capital
requirements for brokers or dealers
(OMB Control Number 3235–0200).
The burden estimates contained in this
section do not include any other
possible costs or economic effects
beyond the burdens required to be
calculated for PRA purposes.
A. Summary of Collections of
Information Under the Proposed Rules
and Rule Amendments
1. Proposed Rule 18a–1 and
Amendments to Rule 15c3–1
Section 764 of the Dodd-Frank Act
added section 15F to the Exchange
Act.775 Section 15F(e)(1)(B) of the
Exchange Act provides that the
Commission shall prescribe capital and
margin requirements for nonbank
SBSDs and nonbank MSBSPs. Proposed
new Rule 18a–1 776 would establish
minimum capital requirements for
stand-alone SBSDs and the amendments
to Rule 15c3–1 777 would augment the
current capital requirements for brokerdealers to address broker-dealers that
register as SBSDs and to enhance the
provisions applicable to ANC brokerdealers (all of which the Commission
preliminarily estimates would register
as SBSDs). The proposed new rule and
amendments would establish a number
of new collection of information
requirements.
First, under proposed Rule 18a–1, a
stand-alone SBSD would need to apply
to the Commission to be authorized to
use internal models to compute net
capital.778 As part of the application
process, a stand-alone SBSD would be
required to provide the Commission
staff with, among other things: (1) A
comprehensive description of the firm’s
internal risk management control
system; (2) a description of the VaR
models the firm will use to price
positions and compute deductions for
market risk; (3) a description of the
firm’s internal risk management controls
775 See

Public Law 111–203 § 764; 15 U.S.C. 78o–

10.
776 See proposed new Rule 18a–1. See also
section II.A. of this release.
777 See proposed amendments to Rule 15c3–1.
See also section II.A. of this release.
778 See paragraphs (a)(2) and (d) of proposed new
Rule 18a–1. This collection of information
requirement already exists in Rule 15c3–1 and
applies to broker-dealers seeking to become ANC
broker-dealers.

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over the VaR models, including a
description of each category of person
who may input data into the models;
and (4) a description of the back-testing
procedures that that firm will use to
review the accuracy of the VaR
models.779 In addition, under proposed
Rule 18a–1, a stand-alone SBSD
authorized to use internal models would
review and update the models it uses to
compute market and credit risk, as well
as backtest the models.
Second, under proposed Rule 18a–1
and amendments to Rule 15c3–1,
nonbank SBSDs that are approved to use
models to compute deductions for
market and credit risk under Rule 18a–
1 and ANC broker-dealers would be
required to perform a liquidity stress
test at least monthly and, based on the
results of that test, maintain liquidity
reserves to address funding needs.780
The result of the test must be provided
within 10 business days to senior
management that has the responsibility
to oversee risk management of the
nonbank SBSD or ANC broker-dealer.
The assumptions underlying the
liquidity stress test must be reviewed at
least quarterly by senior management
that has responsibility to oversee risk
management at the nonbank SBSD and
at least annually by senior management
of the nonbank SBSD.781 In addition, if
such a nonbank SBSD or ANC brokerdealer is part of a consolidated entity
using liquidity stress tests, the nonbank
SBSD or ANC broker-dealer would need
to justify and document any differences
in the assumptions used in their
liquidity stress tests from those used in
the liquidity stress tests of the
consolidated entity.782 Furthermore, the
nonbank SBSDs and ANC broker-dealers
would be required to establish a written
contingency funding plan.783 The plan
would need to address the policies and
roles and responsibilities of relevant
personnel for meeting the liquidity
needs of the firm and communications
with the public and other market
participants during a liquidity stress
event.784
Third, nonbank SBSDs, including
broker-dealer SBSDs, would be required
to comply with certain requirements of
779 See

paragraph (d) of proposed new Rule 18a–

1.
780 See proposed new paragraph (f) to Rule 15c3–
1; paragraph (f) of proposed new Rule 18a–1.
781 See proposed new paragraph (f)(1) to Rule
15c3–1; paragraph (f)(1) of proposed new Rule 18a–
1.
782 See proposed new paragraph (f)(2) of Rule
15c3–1; paragraph (f)(2) of proposed new Rule 18a–
1.
783 See proposed new paragraph (f)(4) of Rule
15c3–1; paragraph (f)(3) of proposed new Rule 18a–
1.
784 Id.

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Rule 15c3–4.785 Rule 15c3–4 requires
OTC derivatives dealers and firms
subject to its provisions, to establish,
document, and maintain a system of
internal risk management controls to
assist the firm in managing the risks
associated with business activities,
including market, credit, leverage,
liquidity, legal, and operational risks.786
Fourth, under paragraph
(c)(2)(vi)(O)(1)(iii) of Rule 15c3–1 and
paragraph (c)(1)(vi)(A)(3)(i) of proposed
new Rule 18a–1, broker-dealers, brokerdealers registered as SBSDs, and standalone SBSDs not using models would be
required to use an industry sector
classification system that is documented
and reasonable in terms of grouping
types of companies with similar
business activities and risk
characteristics, used for credit default
swap reference names for purposes of
calculating ‘‘haircuts’’ on security-based
swaps under the applicable net capital
rules.787 These firms could use a
classification system of a third-party or
develop their own classification system,
subject to these limitations, and would
need to be able to demonstrate the
reasonableness of the system they
use.788
Fifth, under paragraph (i) of proposed
Rule 18a–1, stand-alone SBSDs would
be required to provide the Commission
with certain written notices with respect
to equity withdrawals.789
Finally, under paragraph (c)(5) of
Appendix D to proposed Rule 18a–1, a
stand-alone SBSD would be required to
file with the Commission two copies of
any proposed subordinated loan
agreement (including nonconforming
subordinated loan agreements) at least
30 days prior to the proposed execution
date of the agreement.790 The rule
would also require an SBSD to file with
the Commission a statement setting
forth the name and address of the
lender, the business relationship of the
lender to the SBSD, and whether the
SBSD carried an account for the lender
effecting transactions in security-based
swaps at or about the time the proposed
agreement was filed.791
785 See 17 CFR 240.18a–1(g); 15c3–1(a)(10)(ii).
See also 17 CFR 240.15c3–4.
786 Id.
787 See paragraph (c)(2)(vi)(O)(1)(iii) of Rule 15c3–
1; paragraph (c)(1)(vi)(A)(3)(i) of proposed new Rule
18a–1.
788 See proposed new paragraph
(c)(2)(vi)(O)(1)(iii)(A) of Rule 15c3–1; paragraph
(c)(1)(vii)(A)(3)(i) of proposed new Rule 18a–1.
789 See paragraph (i) of proposed new Rule 18a–
1.
790 See paragraph (c)(5) of proposed new Rule
18a–1d.
791 Id.

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2. Proposed Rule 18a–2
Proposed new Rule 18a–2 would
establish capital requirements for
nonbank MSBSPs.792 In particular, a
nonbank MSBSP would be required at
all times to have and maintain positive
tangible net worth.793 The proposed
definition of tangible net worth would
allow nonbank MSBSPs to include as
regulatory capital assets that would be
deducted from net worth under Rule
15c3–1, such as property, plants,
equipment, and unsecured receivables.
At the same time, it would require the
deduction of goodwill and other
intangible assets.794
Because MSBSPs, by definition, will
be entities that engage in a substantial
security-based swap business, the
Commission is proposing that they be
required to comply with Rule 15c3–4,795
which requires OTC derivatives dealers
and other firms subject to its provisions
to establish, document, and maintain a
system of internal risk management
controls to assist the firm in managing
the risks associated with their business
activities, including market, credit,
leverage, liquidity, legal, and
operational risks.796
3. Proposed Rule 18a–3
Proposed new Rule 18a–3 would
establish minimum margin
requirements for non-cleared securitybased swap transactions entered into by
nonbank SBSDs and nonbank
MSBSPs.797 Proposed Rule 18a–3 would
prescribe the requirements for nonbank
SBSDs or nonbank MSBSPs to collect or
post collateral with regard to noncleared security-based swap
transactions. The provisions of
proposed Rule 18a–3 contain a
collection of information requirement
for nonbank SBSDs. Specifically,
paragraph (e) of proposed Rule 18a–3
would require a nonbank SBSD to
monitor the risk of each account and
establish, maintain, and document
procedures and guidelines for
monitoring the risk of accounts as part
792 See proposed new Rule 18a–2. See also
section II.A.3 of this release.
793 See paragraph (a) of proposed new Rule
18a–2.
794 The proposed definition of tangible net worth
under proposed new Rule 18a–2 is consistent with
the CFTC’s proposed definition of tangible net
equity. See CFTC Capital Proposing Release, 76 FR
at 27828 (Defining tangible net equity as ‘‘equity as
determined under U.S. generally accepted
accounting principles, and excludes goodwill and
other intangible assets.’’).
795 See paragraph (c) of proposed new Rule
18a–2.
796 See 17 CFR 240.15c3–4.
797 See proposed new Rule 18a–3. See also
section II.B. of this release for a more detailed
description of the proposed rule.

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of the risk management control system
required by Rule 15c3–4.798 In addition,
the rule would require a nonbank SBSD
to review, in accordance with written
procedures and at reasonable periodic
intervals, its non-cleared security-based
swap activities for consistency with the
risk monitoring procedures and
guidelines required by paragraph (e) of
Rule 18a–3. The nonbank SBSD would
also be required to determine whether
information and data necessary to apply
the risk monitoring procedures and
guidelines required by paragraph (e) of
Rule 18a–3 are accessible on a timely
basis and whether information systems
are available to adequately capture,
monitor, analyze, and report relevant
data and information. Finally, the rule
would require that the risk monitoring
procedures and guidelines must
include, at a minimum, procedures and
guidelines for:
• Obtaining and reviewing account
documentation and financial
information necessary for assessing the
amount of current and potential future
exposure to a given counterparty
permitted by the SBSD;
• Determining, approving, and
periodically reviewing credit limits for
each counterparty, and across all
counterparties;
• Monitoring credit risk exposure to
the SBSD from non-cleared securitybased swaps, including the type, scope,
and frequency of reporting to senior
management;
• Using stress tests to monitor
potential future exposure to a single
counterparty and across all
counterparties over a specified range of
possible market movements over a
specified time period;
• Managing the impact of credit
exposure related to non-cleared
security-based swaps on the SBSD’s
overall risk exposure;
• Determining the need to collect
collateral from a particular
counterparty, including whether that
determination was based upon the
creditworthiness of the counterparty
and/or the risk of the specific noncleared security-based swap contracts
with the counterparty;
• Monitoring the credit exposure
resulting from concentrated positions
with a single counterparty and across all
counterparties, and during periods of
extreme volatility; and
• Maintaining sufficient equity in the
account of each counterparty to protect
against the largest individual potential
future exposure of a non-cleared
security-based swap carried in the
798 See paragraph (e) to proposed new Rule
18a–3.

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account of the counterparty as measured
by computing the largest maximum
possible loss that could result from the
exposure.
4. Proposed Rule 18a–4
Proposed new Rule 18a–4 would
establish segregation requirements for
cleared and non-cleared security-based
swap transactions, which would apply
to all types of SBSDs (i.e., they would
apply to bank SBSDs, nonbank standalone SBSDs, and broker-dealer SBSDs),
as well as notification requirements for
SBSDs and MSBSPs.799 The provisions
of proposed Rule 18a–4 are modeled on
Rule 15c3–3, the broker-dealer
segregation rule.800 Paragraph (a) of the
proposed new rule would define key
terms used in the rule.801 Paragraph (b)
would require an SBSD to promptly
obtain and thereafter maintain physical
possession or control of all excess
securities collateral (a term defined in
paragraph (a)) and specify certain
locations where excess securities
collateral could be held and deemed in
the SBSD’s control.802 Paragraph (c)
would require an SBSD to maintain a
special account for the exclusive benefit
of security-based swap customers and
have on deposit in that account at all
times an amount of cash and/or
qualified securities (a term defined in
paragraph (a)) determined through a
computation using the formula in
Exhibit A to proposed new Rule 18a–
4.803
Paragraph (d) of proposed new Rule
18a–4 would contain provisions that are
not modeled specifically on Rule 15c3–
1. First, it would require an SBSD and
an MSBSP to provide the notice
required by section 3E(f)(1)(A) of the
Exchange Act to a counterparty in
writing prior to the execution of the first
non-cleared security-based swap
transaction with the counterparty.804
Second, it would require the SBSD to
obtain subordination agreements from
counterparties that opt out of the
segregation requirements in proposed
new Rule 18a–4 because they either
elect individual segregation pursuant to
the self-executing provisions of section
3E(f) of the Exchange Act 805 or agree

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799 See

proposed new Rule 18a–4. See also
section II.C. of this release for a more detailed
description of the proposal.
800 17 CFR 240.15c3–3.
801 Compare 17 CFR 240.15c3–3(a), with
paragraph (a) of proposed new Rule 18a–4.
802 Compare 17 CFR 240.15c3–3(b)–(d), with
paragraph (b) of proposed new Rule 18a–4.
803 Compare 17 CFR 240.15c3–3(e), with
paragraph (c) of proposed new Rule 18a–4.
804 See 15 U.S.C. 78c–5(f)(1)(A); proposed
paragraph (d)(1) of proposed new Rule 18a–4.
805 See 15 U.S.C. 78c–5(f)(1)–(3).

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that the SBSD need not segregate their
assets at all.806
Additionally, paragraph (a)(3) of
proposed new Rule 18a–4 would define
qualified clearing agency account to
mean an account of an SBSD at a
clearing agency established to hold
funds and other property in order to
purchase, margin, guarantee, secure,
adjust, or settle cleared security-based
swaps of the SBSD’s security-based
swap customers that meets the
following conditions (which would
contain collection of information
requirements):
• The account is designated ‘‘Special
Clearing Account for the Exclusive
Benefit of the Cleared Security-Based
Swap Customers of [name of the
SBSD]’’; 807
• The clearing agency has
acknowledged in a written notice
provided to and retained by the SBSD
that the funds and other property in the
account are being held by the clearing
agency for the exclusive benefit of the
cleared security-based swap customers
of the SBSD in accordance with the
regulations of the Commission and are
being kept separate from any other
accounts maintained by the SBSD with
the clearing agency; 808 and
• The account is subject to a written
contract between the SBSD and the
clearing agency which provides that the
funds and other property in the account
shall be subject to no right, charge,
security interest, lien, or claim of any
kind in favor of the clearing agency or
any person claiming through the
clearing agency, except a right, charge,
security interest, lien, or claim resulting
from a cleared security-based swap
transaction effected in the account.809
Under paragraph (a)(4) of proposed
new Rule 18a–4, a qualified SBSD
account would be defined to mean an
account at another SBSD registered with
the Commission pursuant to section 15F
806 See

15 U.S.C. 78c–5(f)(4).
paragraph (a)(3)(i) of proposed new Rule
18a–4. This provision is modeled on paragraph
(e)(1) of Rule 15c3–3, which requires a brokerdealer to maintain a ‘‘Special Reserve Bank Account
for the Exclusive Benefit of Customers.’’ Compare
17 CFR 240.15c3–3(e), with paragraph (a)(3)(i) of
proposed new Rule 18a–4.
808 See paragraph (a)(3)(ii) of proposed new Rule
18a–4. This provision is modeled on paragraph (f)
of Rule 15c3–3, which requires a broker-dealer to
obtain a written notification from a bank where it
maintains a customer reserve account. Compare 17
CFR 240.15c3–3(f), with paragraph (a)(3)(ii) of
proposed new Rule 18a–4.
809 See paragraph (a)(3)(iii) of proposed new Rule
18a–4. This provision is modeled on paragraph (f)
of Rule 15c3–3, which requires a broker-dealer to
obtain a contract from a bank where it maintains
a ‘‘Special Reserve Bank Account for the Exclusive
Benefit of Customers.’’ Compare 17 CFR 240.15c3–
3(f), with paragraph (a)(3)(ii) of proposed new Rule
18a–4.
807 See

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of the Exchange Act that is not an
affiliate of the SBSD and that meets
conditions that are largely identical to
the conditions for a qualified clearing
agency account. Finally, paragraph
(c)(1) of proposed new Rule 18a–4
would require an SBSD, among other
things, to maintain a special account for
the exclusive benefit of security-based
swap customers separate from any other
bank account of the SBSD.810 The term
special account for the exclusive benefit
of security-based swap customers would
be defined under paragraph (a)(7) of
proposed new Rule 18a–4 to mean an
account at a bank that is not an affiliate
of the SBSD and that meets conditions
that are largely identical to the
conditions for a qualified clearing
agency account and qualified SBSD
account.811
Paragraph (c)(1) of proposed new Rule
18a–4 would provide that the SBSD
must at all times maintain in a Rule
18a–4 Customer Reserve Account,
through deposits into the account, cash
and/or qualified securities in amounts
computed in accordance with the
formula set forth in Exhibit A to Rule
18a–4.812 The formula in Exhibit A to
proposed new Rule 18a–4 is modeled on
the formula in Exhibit A to Rule 15c3–
3.813 Paragraph (c)(3) of proposed new
Rule 18a–4 would provide that the
computations necessary to determine
the amount required to be maintained in
the special bank account must be made
daily as of the close of the previous
business day and any deposit required
to be made into the account must be
made on the next business day
following the computation no later than
1 hour after the opening of the bank that
maintains the account.814
B. Proposed Use of Information
As discussed more fully above, the
Commission and SROs, as applicable,
would use the information collected
under new Rules 18a–1, 18a–2, 18a–3
and 18a–4, as well as the amendments
to Rule 15c3–1 to determine whether an
SBSD, MSBSP, or ANC broker-dealer, as
applicable, is in compliance with each
applicable rule and to help fulfill their
oversight responsibilities. The
810 See paragraph (c) of proposed new Rule 18a–
4. The provisions of paragraph (c) of proposed new
Rule 18a–1 are modeled on paragraph (e) of Rule
15c3–3. Compare 17 CFR 240.15c3–3(e), with
paragraph (c) of proposed new Rule 18a–4.
811 See paragraph (a)(7) of proposed new Rule
18a–4. See also Section II.C.1. of this release for a
more detailed description of the proposed
requirements.
812 See paragraph (c)(1) of proposed new Rule
18a–4; Exhibit A to proposed new Rule 18a–4.
813 See 17 CFR 240.15c3–3a.
814 See paragraph (c)(3) of proposed new rule
18a–4.

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collections of information would also
help to ensure that SBSD, MSBSPs and
broker-dealers are meeting their
obligations under the proposed rules
and rule amendments and have the
required policies and procedures in
place.
Proposed new Rules 18a–1 and 18a–
2, as well as the proposed amendments
to Rule 15c3–1 would be integral parts
of the Commission’s financial
responsibility program for SBSDs and
MSBSPs, and ANC broker-dealers,
respectively. Proposed Rule 18a–1 and
Rule 15c3–1 are designed to ensure that
nonbank SBSDs and broker-dealers
(including broker-dealer SBSDs),
respectively, have sufficient liquidity to
meet all unsubordinated obligations to
customers and counterparties and,
consequently, if the SBSD or brokerdealer fails, sufficient resources to
wind-down in an orderly manner
without the need for a formal
proceeding. The collections of
information in proposed new Rule 18a–
1, Rule 18a–2 and the amendments to
Rule 15c3–1 would facilitate the
monitoring of the financial condition of
nonbank SBSDs, nonbank MSBSPs and
broker-dealers by the Commission.
Proposed new Rule 18a–3 would
prescribe, among other things,
requirements for nonbank SBSDs to
collect collateral with regard to noncleared security-based swap
transactions. Under proposed Rule 18a–
3, a nonbank SBSD would be required
to establish and implement risk
monitoring procedures with respect to
counterparty accounts.815 The purpose
of the proposed rule is to limit risks to
individual firms and systemic risk
arising from non-cleared security-based
swaps. The collections of information in
proposed Rule 18a–3 would assist
examiners in determining whether
SBSDs are in compliance with
requirements in the rule.
Proposed new Rule 18a–4 would
establish segregation requirements for
cleared and non-cleared security-based
swap transactions, which would apply
to all types of SBSDs (i.e., they would
apply to bank SBSDs, nonbank standalone SBSDs, and broker-dealer SBSDs),
as well as establish notice requirements
for SBSDs and MSBSPs. Proposed new
Rule 18a–4 would be an integral part of
the Commission’s financial
responsibility program for SBSDs. Its
purpose is to protect the rights of
security-based swap customers and their
ability to promptly obtain their property
from an SBSD. The collection of
information requirements in the
815 See

paragraph (e) of proposed new Rule 18a–

3.

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proposed new rule would facilitate the
process by which the Commission
monitors how SBSDs are fulfilling their
custodial responsibilities to SBSD
customers. Proposed Rule 18a–4 also
would require that an SBSD provide
certain notices to counterparties.816
These notices would alert
counterparties to the alternatives
available to them with respect to
segregation of non-cleared securitybased swaps. The Commission staff
would use this new collection of
information in its examination and
oversight program.
C. Respondents
Consistent with the Entity Definitions
Adopting Release, the Commission staff
estimates that 50 or fewer entities
ultimately may have to register with the
Commission as SBSDs.817 In addition,
consistent with the Entity Definitions
Adopting Release, based on available
data regarding the single-name credit
default swap market—which the
Commission believes will comprise the
majority of security-based swaps—the
Commission staff estimates that the
number of MSBSPs likely will be five or
fewer and, in actuality, may be zero.818
Therefore, to capture the likely number
of MSBSPs that may be subject to the
collections of information for purposes
of this PRA, the Commission staff
estimates for purposes of this PRA that
5 entities will register with the
Commission as MSBSPs. Accordingly,
for the purposes of calculating PRA
reporting burdens, the Commission staff
estimates there are 50 SBSDs and 5
MSBSPs respondents.
816 See paragraphs (a) and (c) of proposed new
Rule 18a–4.
817 Entity Definitions Adopting Release, 77 FR at
30725. This estimate—which potentially overstates
the number of potential entities that ultimately have
to register with the Commission as SBSDs—is
consistent with the data regarding activities and
positions of participants in the single-name credit
default swap market summarized in a memorandum
of the Commission staff. See Memorandum (Mar.
15, 2012), available at http://www.sec.gov/
comments/s7-39-10/s73910-154.pdf (‘‘CDS Data
Analysis’’). Depending on the final capital
requirements as well as other requirements for
SBSDs and how businesses choose to respond to
such requirements, the actual number of SBSDs
may be significantly fewer. See Business Conduct
Standards for Security-Based Swap Dealers and
Major-Security Based Swap Participants, Exchange
Act Release No. 64766 (June 29, 2011), 76 FR 42396,
42442 (July 18, 2011) (‘‘Business Conduct Release’’).
See also SBSD Registration Proposing Release, 76
FR at 65808.
818 Entity Definitions Adopting Release, 77 FR at
30727, 30729. The number of MSBSPs likely will
depend on the final capital requirements and other
requirements for MSBSPs and how businesses
choose to respond to such requirements. See
Business Conduct Release, 76 FR at 42442. See also
SBSD Registration Proposing Release, 76 FR at
65808.

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The Commission previously estimated
that 16 broker-dealers would likely seek
to register as SBSDs.819 The
Commission is retaining this estimate
for purposes of this release.820
Accordingly, for the purposes of
calculating PRA reporting burdens, the
Commission staff estimates there are 16
broker-dealer SBSDs.
Because proposed Rules 18a–1 and
18a–3 would apply only to nonbank
SBSDs, including nonbank subsidiaries
of bank holding companies the Federal
Reserve regulates, the number of
respondents subject to these proposed
rules would be less than the 50 entities
expected to register with the
Commission as an SBSD, as many of the
dealers that currently engage in OTC
derivative activities are banks, and
would therefore be ‘‘bank SBSDs.’’ 821
Because the Commission staff estimates
that 16 broker-dealers would likely
register as SBSDs, there would be an
estimated maximum of 34 bank
SBSDs.822 However, because of business
planning purposes, risk management
purposes, potential regulatory
requirements, or other reasons, some of
these entities would likely register with
the Commission as nonbank stand-alone
SBSDs. Therefore, as stated above,
because many of the dealers that
currently engage in OTC derivatives
activities are banks, the Commission
staff estimates that approximately 75%
of the maximum estimated bank SBSDs
will register as bank SBSDs, and the
remainder (approximately 25%) will
register as stand-alone nonbank SBSDs.
As a result, for purposes of the reporting
burdens, the Commission staff estimates
that approximately 9 entities will
register as stand-alone SBSDs.823
Therefore, for purposes of the reporting
burdens, the Commission staff estimates
819 See SBSD Registration Proposing Release, 76
FR at 65808. No comments were received on this
estimate.
820 Id.
821 See, e.g., ISDA Margin Survey 2012 (May
2012), at Appendix 1, available at http://
www2.isda.org/functional-areas/research/surveys/
margin-surveys/ (‘‘ISDA Margin Survey 2012’’).
ISDA is a global trade association for OTC
derivatives. The ISDA margin survey is conducted
annually to examine the state of collateral use and
management among derivatives dealers and endusers. See id.; ISDA Margin Survey 2011, available
at http://www2.isda.org/functional-areas/research/
surveys/margin-surveys/ (‘‘ISDA Margin Survey
2011’’). Appendix 1 to the survey lists firms that
responded to the survey including the largest dealer
banks. See ISDA Margin Survey 2012 at Appendix
1; ISDA Margin Survey 2011 at Appendix 1. See
also Economic Analysis in section V.A. of this
release (discussing overview of OTC derivatives
market).
822 50 SBSDs¥16 broker-dealer SBSDs = 34
maximum estimated bank SBSDs.
823 34 maximum estimated bank SBSDs × 25% =
8.5, rounded to 9 stand-alone nonbank SBSDs.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
that approximately 25 nonbank SBSDs
would be subject to Rules 18a–1 and
18a–3.824
Of the 9 stand-alone SBSDs, the
Commission staff estimates that, based
on its experience with ANC brokerdealers and OTC derivatives dealers, the
majority of stand-alone SBSDs would
apply to use internal models.825
Consequently, the Commission is
estimating that 6 of the 9 stand-alone
SBSDs would apply to use internal
models under Rule 18a–1. Because the
Commission staff estimates that 6 standalone SBSDs would apply to the
Commission to use internal models, the
Commission staff estimates that three
stand-alone SBSDs would not use
models.826 For purposes of estimating
the number of respondents with respect
to the proposed amendments to Rule
15c3–1, the Commission staff estimates
that there would be 10 respondents
currently subject to the collection of
information as it relates to Appendix E
to Rule 15c3–1.827 Finally, because the
Commission staff estimates that 10 of
the broker-dealers registered as SBSDs
would be ANC broker-dealers, the
Commission staff estimates that 6
broker-dealers registered as SBSDs
would not use internal models.828
Type of respondent

Number of
respondents

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SBSDs ....................................
Bank SBSDs ...........................
Nonbank SBSDs .....................
Broker-Dealer SBSDs .............
Stand-Alone SBSD .................
ANC Broker-Dealer SBSDs ....
Broker-Dealer SBSDs (Not
Using Models) .....................
Stand-Alone SBSDs (Using
Models) ...............................
Stand-Alone SBSDs (Not
Using Models) .....................
Nonbank MSBSPs ..................

50
25
25
16
9
10
6
6
3
5

824 16 broker-dealer SBSDs + 9 stand-alone SBSDs
= 25 nonbank SBSDs.
825 See section II.A.2.a.iii. of this release
(discussing minimum capital requirements for
stand-alone SBSDs); section II.A.2.b.iii. of this
release (discussing the use of VaR models). VaR
models, while more risk sensitive than standardized
haircuts, tend to substantially reduce the amount of
the deductions to tentative net capital in
comparison to the standardized haircuts because
the models recognize more offsets between related
positions than the standardized haircuts. Therefore,
the Commission expects that stand-alone SBSDs
that have the capability to use internal models to
calculate net capital would chose to do so.
826 9 stand-alone SBSDs¥6 stand-alone SBSDs
using internal models = 3 stand-alone SBSDs not
using models.
827 These 10 broker-dealer respondents likely
would also register as SBSDs because these entities
are expected to engage in a broad range of activities.
828 16 broker-dealers registered as SBSDs¥10
ANC broker-dealer SBSDs = 6 broker-dealer SBSDs
not using internal models.

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The Commission generally requests
comment on all aspects of these
estimates of the number of respondents.
Commenters should provide specific
data and analysis to support any
comments they submit with respect to
the number of respondents, including
identifying any sources of industry
information that could be used to
estimate the number of respondents.
D. Total Initial and Annual
Recordkeeping and Reporting Burden
1. Proposed Rule 18a–1 and
Amendments to Rule 15c3–1
Proposed Rule 18a–1 and the
proposed amendments to Rule 15c3–1
would have collection of information
requirements that result in one-time and
annual hour burdens for nonbank
SBSDs and ANC broker-dealers. The
estimates in this section are based in
part on the Commission’s experience
with burden estimates for similar
collections of information requirements,
including the current collection of
information requirements for Rule
15c3–1.829
First, under paragraph (a)(2) of
proposed Rule 18a–1, the Commission
is proposing that a stand-alone SBSD be
required to file an application for
authorization to compute net capital
using internal models.830 The
requirements for the application would
be set forth in paragraph (d) of proposed
Rule 18a–1, which is modeled on the
application requirements of Appendix E
to Rule 15c3–1.831 ANC brokerdealers—the number of which would
include broker-dealer SBSDs that seek
to use internal models—currently are
subject to this application requirement.
Consequently, the Commission staff
estimates that the proposed
requirements of paragraph (d) of Rule
18a–1 would result in one-time and
annual hour burdens for stand-alone
SBSDs.832
Based on its experience with ANC
broker-dealers and OTC derivatives
dealers, the Commission expects that
stand-alone SBSDs that apply to the
Commission to use internal models to
829 17

CFR 240.15c3–1.
broker-dealer SBSD seeking Commission
authorization to use internal models to compute
market and credit risk charges would apply under
the existing provisions of Appendix E to Rule 15c3–
1, which apply to ANC broker-dealers. See 17 CFR
240.15c3–1e.
831 See 17 CFR 240.15c3–1e(a) and paragraph (d)
of proposed Rule 18a–1. Consequently, the
Commission is using the current collection of
information for Appendix E to Rule 15c3–1 as a
basis for this new collection of information.
832 The requirements that would be imposed on
paragraphs (d) and (e) of proposed Rule 18a–1 are
consistent with the requirements of Appendix E to
Rule 15c3–1.
830 A

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70293

calculate net capital will already have
developed models to calculate market
and credit risk and will already have
developed internal risk management
control systems. On the other hand, the
Commission notes that proposed Rule
18a–1 contains additional requirements
that stand-alone SBSDs may not yet
have incorporated into their models and
control systems.833 Therefore, standalone SBSDs would incur one-time hour
burdens and start-up costs in order to
develop their VaR models in accordance
with the requirements of proposed Rule
18a–1, as well as to submit such models
along with its application under
paragraph (d) of proposed Rule 18a–1 to
the Commission for approval.
These estimates are based on
currently approved PRA estimates for
the ANC firms and OTC derivatives
dealers.834 While these estimates are
averages, the burdens may vary
depending on the size and complexity
of each stand-alone SBSD.
The Commission staff estimates that
each of the 6 stand-alone nonbank
SBSDs that apply to use the internal
models would spend approximately
1,000 hours to develop and submit its
VaR model and the description of its
risk management control system to the
Commission as well as to create and
compile the various documents to be
included with the application and to
work with the Commission staff through
the application process.835 This
includes approximately 100 hours for an
in-house attorney to complete a review
of the application.836 Consequently, the
Commission staff estimates that the total
burden associated with the application
process for the stand-alone SBSDs
would result in an industry-wide onetime hour burden of approximately
6,000 hours.837 In addition, the
Commission staff allocated 75% (4,500
hours) of these one-time burden
hours 838 to internal burden and the
833 See sections II.A.2.b.iii., II.A.2.c., and II.A.2.d.
of this release (describing requirements for VaR
models and other requirements under proposed
Rule 18a–1 for stand-alone SBSDs).
834 See OTC Derivatives Dealers, 62 FR 67940;
OTC Derivatives Dealers, 63 FR 59362; Alternative
Net Capital Requirements Adopting Release, 69 FR
at 34452.
835 This estimate is based on the current hour
burdens under Appendix E to Rule 15c3–1.
836 Id. See also OTC Derivatives Dealers, 62 FR
67940; Alternative Net Capital Requirements
Adopting Release, 69 FR at 34452.
837 6 stand-alone SBSDs × 1,000 hours = 6,000
hours.
838 The internal hours likely would be performed
by an in-house attorney (1,500 hours), a risk
management specialist (1,500 hours), and
compliance manager (1,500 hours). Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: ((in-house attorney for

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remaining 25% (1,500 hours) to external
burden to hire outside professionals to
assist in preparing and reviewing the
stand-alone SBSD’s application for
submission to the Commission.839 The
Commission staff estimates $400 per
hour for external costs for retaining
outside consultants, resulting in a onetime industry-wide external cost of
$600,000.840
The Commission staff estimates that a
stand-alone SBSD approved to use
internal models would spend
approximately 5,600 hours per year to
review and update the models and
approximately 160 hours each quarter,
or approximately 640 hours per year, to
backtest the models.841 Consequently,
the Commission staff estimates that the
total burden associated with reviewing
and back-testing the models for the 6
stand-alone SBSDs would result in an
industry-wide annual hour burden of
approximately 37,440 hours per year.842
In addition, the Commission staff has
allocated 75% (28,080) 843 of these
burden hours to internal burden and the
remaining 25% (9,360) to external
burden to hire outside professionals to
assist in reviewing, updating and
backtesting the models.844 The
1,500 hours at $378 per hour) + (risk management
specialist for 1,500 hours at $259 per hour) +
(compliance manager for 1,500 hours at $279 per
hour)) = $1,374,000. The hourly rates use for
internal professionals used throughout this section
IV. of the release are taken from SIFMA’s
Management & Professional Earnings in the
Securities Industry 2011, modified to account for an
1800-hour work-year and multiplied by 5.35 to
account for bonuses, firm size, employee benefits
and overhead.
839 6,000 hours × .75 = 4,500 hours; 6,000 hours
× .25 = 1,500 hours. This allocation is based on the
Commission’s experience in implementing the ANC
rules for broker-dealers. Larger firms tend to
perform these tasks in-house due to the proprietary
nature of these models as well as the high fixedcosts in hiring an outside consultant. However,
smaller firms may need to hire an outside
consultant to perform certain of these tasks.
840 1,500 hours × $400 per hour = $600,000. See
PRA Analysis in Product Definitions Adopting
Release, 77 FR at 48334 (providing an estimate of
$400 an hour to engage an outside attorney). See
also Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 64514
(May 18, 2011) 76 FR 33430, 33504 (June 8, 2012)
(providing estimate of $400 per hour to engage
outside attorneys and outside professionals).
841 These hour burdens are consistent with the
current hour burdens under Appendix E to Rule
15c3–1 for ANC broker-dealers.
842 6 Stand-alone SBSDs × [5,600 hours + 640
hours] = 37,440 hours.
843 These functions likely would be performed by
a risk management specialist (14,040 hours) and a
senior compliance examiner (14,040 hours).
Therefore, the estimated internal costs for this hour
burden would be calculated as follows: ((risk
management specialist for 14,040 hours at $259 per
hour) + (senior compliance examiner for 14,040
hours at $230 per hour)) = $6,865,560.
844 37,440 hours × .75 = 28,080; 37,440 hours ×
.25 = 9,360 hours. This allocation is based on the
Commission’s experience in implementing the ANC

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Commission staff estimates $400 per
hour for external costs for retaining
outside professionals, resulting in an
industry-wide external cost of $3.7
million annually.845
Stand-alone SBSDs electing to file an
application with the Commission to use
a VaR model will incur start-up costs
including information technology costs
to comply with proposed Rule 18a–1.
Because each stand-alone SBSD’s
information technology systems may be
in varying stages of readiness to enable
these firms to meet the requirements of
the proposed rules, the cost of
modifying their information technology
systems could vary significantly. Based
on the estimates for the ANC brokerdealers,846 it is expected that a standalone SBSD would incur an average of
approximately $8.0 million to modify its
information technology systems to meet
the VaR requirements of the proposed
new Rule 18a–1, for a total one-time
industry-wide cost of $48 million.847
Second, under paragraph (f) of
proposed Rule 18a–1 and proposed new
paragraph (f) of Rule 15c3–1, standalone SBSDs that are approved to use
models to compute deductions for
market and credit risk under Rule 18a–
1 and ANC broker-dealers would be
subject to liquidity stress test
requirements. The Commission staff
estimates that the proposed
requirements resulting from these
provisions would result in a one-time
burden to applicable stand-alone SBSDs
and ANC broker-dealers as they would
need to develop models for the liquidity
stress test, document the results of the
test to provide to senior management,
document differences in the
assumptions used in the liquidity stress
test of the firm from those used in a
consolidated entity of which the firm is
a part, and develop a written
contingency funding plan.848 Based on
experience supervising ANC brokerrules for broker-dealers. Larger firms tend to
perform these tasks in-house due to the proprietary
nature of these models as well as the high fixedcosts in hiring an outside consultant. However,
smaller firms may need to hire an outside
consultant to perform these tasks.
845 9,360 hours × $400 per hour = $3,744,000. See
PRA Analysis in Product Definitions Adopting
Release, 77 FR 48334 (providing an estimate of
$400 an hour to engage an outside attorney). See
also Nationally Recognized Statistical Rating
Organizations, 76 FR at 33504 (providing estimate
of $400 per hour to engage outside attorneys and
outside professionals).
846 Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
847 6 stand-alone SBSDs × $8 million = $48
million.
848 See section II.A.2.d. of this release (discussing
liquidity stress test and written contingency
funding plan).

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dealers,849 the Commission staff
estimates that each of the 6 stand-alone
SBSDs and 10 ANC broker-dealers
would spend an average of
approximately 200 hours to comply
with these requirements, resulting in an
average industry-wide one-time internal
hour burden of approximately 3,200
hours.850
In terms of annual hour burden, the
Commission staff estimates that a standalone SBSD or ANC broker-dealer
would spend an average of
approximately 50 hours 851 per month
testing and documenting the results of
its liquidity stress test and reviewing its
contingency funding plan, resulting in a
total industry-wide annual hour burden
of approximately 9,600 hours.852
Third, under paragraph (g) of
proposed new Rule 18a–1, a stand-alone
SBSD would be required to comply with
Rule 15c3–4 (except for certain
provisions of that rule) as if it were an
OTC derivatives dealer.853 ANC brokerdealers currently are required to comply
with Rule 15c3–4.854 Nonbank SBSDs
would be required to comply with Rule
15c3–4, which requires the
establishment of a risk management
849 Based on Commission staff experience
supervising the ANC broker-dealers, all of the ANC
broker-dealers that are part of a holding company
generally have a written contingency funding plan,
generally at the holding company level. This
proposed rule would require that each ANC brokerdealer and stand-alone SBSD using internal models
maintain a written contingency funding plan at the
entity level (in addition to any holding company
plan). Therefore, the proposed hour burdens are
averages for all firms, including the ANC brokerdealers, which may already conduct these activities
within their organizations, and smaller firms,
including stand-alone broker-dealers which may
not currently undertake these proposed activities.
850 [10 ANC broker-dealers + 6 stand-alone
SBSDs] × 200 hours = 3,200 hours. Based on
Commission staff experience supervising the ANC
broker-dealers, the Commission staff expects that
these functions would likely be performed
internally by an in-house attorney (1,600 hours) and
a risk management specialist (1,600). Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: ((in-house attorney for
1,600 hours at $378 per hour) + (risk management
specialist for 1,600 hours at $259 per hour)) =
$1,019,200.
851 This PRA estimate is based, in part, on the 160
hours per quarter it would take an ANC brokerdealer to review and backtest its models under the
current collection of information in Rule 15c3–1.
See Alternative Net Capital Requirements Adopting
Release, 69 FR at 34452.
852 [6 Stand-alone SBSDs + 10 ANC brokerdealers] × 50 hours × 12 months = 9,600 hours.
These functions would be performed by a senior
compliance examiner (4,800 hours) and a risk
management specialist (4,800 hours). Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: ((senior compliance
examiner for 4,800 hours at $230 per hour) + (risk
management specialist for 4,800 hours at $259 per
hour)) = $2,347,200.
853 See paragraph (g) to proposed new Rule 18a–
1.
854 17 CFR 240.15c3–1(a)(7)(iii).

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control system.855 The Commission
adopted Rule 15c3–4 in 1998 as part of
the OTC derivatives dealer oversight
program.856 The rule requires an OTC
derivatives dealer to establish,
document, and maintain a system of
internal risk management controls to
assist in managing the risks associated
with its business activities, including
market, credit, leverage, liquidity, legal,
and operational risks.857 It also requires
OTC derivatives dealers to establish,
document, and maintain procedures
designed to prevent the firm from
engaging in securities activities that are
not permitted by OTC derivatives
dealers pursuant to Rule 15a–1.858 Rule
15c3–4 identifies a number of elements
that must be part of an OTC derivatives
dealer’s internal risk management
control system.859 These include, for
example, that the system have:
• A risk control unit that reports
directly to senior management and is
independent from business trading
units; 860
• Separation of duties between
personnel responsible for entering into
a transaction and those responsible for
recording the transaction in the books
and records of the OTC derivatives
dealer; 861
• Periodic reviews (which may be
performed by internal audit staff) and
annual reviews (which must be
conducted by independent certified
public accountants) of the OTC
derivatives dealer’s risk management
systems; 862 and
• Definitions of risk, risk monitoring,
and risk management.863
Rule 15c3–4 further provides that the
elements of the internal risk
management control system must
include written guidelines, approved by
the OTC derivatives dealer’s governing
body, that discuss a number of matters,
including for example:
• Quantitative guidelines for
managing the OTC derivatives dealer’s
overall risk exposure; 864
• The type, scope, and frequency of
reporting by management on risk
exposures; 865
855 See proposed new paragraph (a)(10)(ii) of Rule
15c3–1 (17 CFR 240.15c3–1); paragraph (g) of
proposed new Rule 18a–1. See also 17 CFR
240.15c3–4.
856 See 17 CFR 240.15c3–4; OTC Derivatives
Dealers, 63 FR 59362.
857 See 17 CFR 240.15c3–4.
858 See 17 CFR 240.15c3–4; 17 CFR 240.15a–1.
859 See 17 CFR 240.15c3–4(c).
860 See 17 CFR 240.15c3–4(c)(1).
861 See 17 CFR 240.15c3–4(c)(2).
862 See 17 CFR 240.15c3–4(c)(3).
863 See 17 CFR 240.15c3–4(c)(4).
864 See 17 CFR 240.15c3–4(c)(5)(iii).
865 See 17 CFR 240.15c3–4(c)(5)(iv).

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• The procedures for and the timing
of the governing body’s periodic review
of the risk monitoring and risk
management written guidelines,
systems, and processes; 866
• The process for monitoring risk
independent of the business or trading
units whose activities create the risks
being monitored; 867
• The performance of the risk
management function by persons
independent from or senior to the
business or trading units whose
activities create the risks; 868
• The authority and resources of the
groups or persons performing the risk
monitoring and risk management
functions; 869
• The appropriate response by
management when internal risk
management guidelines have been
exceeded; 870
• The procedures to monitor and
address the risk that an OTC derivatives
transaction contract will be
unenforceable; 871
• The procedures requiring the
documentation of the principal terms of
OTC derivatives transactions and other
relevant information regarding such
transactions; 872 and
• The procedures authorizing
specified employees to commit the OTC
derivatives dealer to particular types of
transactions.873
Rule 15c3–4 also requires management
to periodically review, in accordance
with the written procedures, the
business activities of the OTC
derivatives dealer for consistency with
risk management guidelines.874
Based on the nature of the written
guidelines described above, the
Commission staff estimates that the
requirement to comply with Rule 15c3–
4 would result in one-time and annual
hour burdens to nonbank SBSDs. The
Commission staff estimates that the
average amount of time a firm would
spend implementing its risk
management control system would be
2,000 hours,875 resulting in an industrywide one-time hour burden of 30,000
866 See

17 CFR 240.15c3–4(c)(5)(v).
17 CFR 240.15c3–4(c)(5)(vi).
868 See 17 CFR 240.15c3–4(c)(5)(vii).
869 See 17 CFR 240.15c3–4(c)(5)(viii).
870 See 17 CFR 240.15c3–4(c)(5)(ix).
871 See 17 CFR 240.15c3–4(c)(5)(x).
872 See 17 CFR 240.15c3–4(c)(5)(xi).
873 See 17 CFR 240.15c3–4(c)(5)(xii).
874 See 17 CFR 240.15c3–4(d).
875 This estimates is based on the one-time
burden estimated for an OTC derivatives dealer to
implement is controls under Rule 15c3–1. See OTC
Derivatives Dealers, 62 FR 67940. This also is
included in the current PRA estimate for Rule
15c3–4.
867 See

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hours across the 15 nonbank SBSDs not
already subject to Rule 15c3–4.876
The proposed rule would require a
nonbank SBSD to consider a number of
issues affecting its business
environment when creating its risk
management control system. For
example, a nonbank SBSD would need
to consider, among other things, the
sophistication and experience of
relevant trading, risk management, and
internal audit personnel, as well as the
separation of duties among these
personnel, when designing and
implementing its internal control
system’s guidelines, policies, and
procedures. This would help to ensure
that the control system that is
implemented would adequately address
the risks posed by the firm’s business
and the environment in which it is
being conducted. In addition, this
would enable a nonbank SBSD
derivatives dealer to implement specific
policies and procedures unique to its
circumstances.
In implementing its policies and
procedures, a nonbank SBSD would be
required to document and record its
system of internal risk management
controls. In particular, a nonbank SBSD
would be required to document its
consideration of certain issues affecting
its business when designing its internal
controls. A nonbank SBSD would also
be required to prepare and maintain
written guidelines that discuss its
internal control system, including
procedures for determining the scope of
authorized activities. The Commission
staff estimates that each of these 15
nonbank SBSDs 877 would spend
approximately 250 hours per year
reviewing and updating their risk
management control systems to comply
with Rule 15c3–4, resulting in an
industry-wide annual hour burden of
approximately 3,750 hours.878
876 25 nonbank SBSDs—10 ANC broker-dealer
SBSDs = 15 nonbank SBSDs. 15 nonbank SBSDs ×
2,000 hours = 30,000 hours. This number is
incremental to the current collection of information
for Rule 15c3–1 with regard to complying with the
provisions of Rule 15c3–4 and, therefore, excludes
the 10 respondents included in the collection of
information for that rule. These hours would likely
be performed by a combination of an in-house
attorney (10,000 hours), a risk management
specialist (10,000 hours), and an operations
specialist (10,000 hours). Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: ((in-house attorney for 10,000
hours at $378 per hour) + (risk management
specialist for 10,000 hours at $259 per hour) +
(operations specialist for 10,000 hours at $117 per
hour)) = $7,540,000.
877 25 nonbank SBSDs¥10 ANC broker-dealer/
SBSDs = 15 nonbank SBSDs.
878 15 nonbank SBSDs × 250 hours = 3,750 hours.
These hour burden estimates are consistent with
similar collections of information under Appendix

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Nonbank SBSDs may incur start-up
costs to comply with the provisions of
Rule 15c3–4 incorporated into proposed
Rule 18a–1, including information
technology costs. The information
technology systems of nonbank SBSDs
may be in varying stages of readiness to
enable these firms to meet the
requirements of the proposed rules so
the cost of modifying their information
technology systems could vary
significantly. Based on the estimates for
similar collections of information,879 it
is expected that a nonbank SBSDs
would incur an average of
approximately $16,000 for initial
hardware and software expenses, while
the average ongoing cost would be
approximately $20,500 per nonbank
SBSD to meet the requirements of the
proposed new Rule 18a–1, for a total
industry-wide initial cost of $240,000
and ongoing cost of $307,500 per
year.880
Fourth, proposed paragraph
(c)(2)(vi)(O)(1)(iii) of Rule 15c3–1 and
paragraph (c)(1)(vi)(A)(3)(i) of proposed
new Rule 18a–1, broker-dealer SBSDs
and stand-alone SBSDs not using
models would be required to use an
industry sector classification system
that is documented and reasonable in
terms of grouping types of companies
with similar business activities and risk
characteristics used for credit default
swap reference obligors for purposes of
calculating ‘‘haircuts’’ on security-based
swaps under applicable net capital
rules.
As discussed above, the Commission
staff estimates that 6 broker-dealer
SBSDs and 3 nonbank SBSDs not using
models would utilize the credit default
swap haircut provisions under the
proposed amendments to Rule 15c3–1
and proposed new Rule 18a–1,
respectively. Consequently, these firms
would use an industry sector
classification system that is documented
for the credit default swap reference
obligors. The Commission expects that
these firms would utilize external
classifications systems because of
reduced costs and ease of use as a result
of the common usage of several of these
classification systems in the financial
services industry. The Commission staff
estimates that nonbank SBSDs not using
E to Rule 15c3–1. These hours likely would be
performed by a risk management specialist.
Therefore, the estimated internal costs for this hour
burden would be calculated as follows: Risk
management specialist for 3,750 hours at $259 per
hour = $971,250.
879 Risk Management Controls for Brokers or
Dealers with Market Access, Exchange Act Release
No. 63421 (Nov. 3, 2010), 75 FR 69792, 69814 (Nov.
15, 2010).
880 15 nonbank SBSDs × $16,000 = $240,000; 15
nonbank SBSDs × $20,500 =$307,500.

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models would spend approximately 1
hour per year documenting these
industry sectors, for a total annual hour
burden of 9 hours.881
Fifth, under paragraph (i) of proposed
new Rule 18a–1, a nonbank SBSD
would be required to file certain notices
with the Commission relating to the
withdrawal of equity capital.882 Brokerdealers—which would include brokerdealer SBSDs—currently are required to
file these notices under paragraph (e) of
Rule 15c3–1.883 The Commission staff
estimates that the notice requirements
would result in annual hour burdens to
stand-alone SBSDs. The Commission
staff estimates that each of the 9 standalone SBSDs would file approximately 2
notices annually with the
Commission.884 In addition, the
Commission staff estimates that it
would take a stand-alone SBSD
approximately 30 minutes to file these
notices, resulting in an industry-wide
annual hour burden of 4.5 hours.885
Finally, under Appendix D to
proposed new Rule 18a–1, a nonbank
SBSD would be required to file a
proposed subordinated loan agreement
with the Commission (including
nonconforming subordinated loan
agreements).886 Broker-dealers—which
would include broker-dealer SBSDs—
currently are subject to such a
requirement. The Commission staff
estimates this proposed requirement
would result in one-time and annual
hour burdens for stand-alone SBSDs.
Based on staff experience with Rule
15c3–1, the Commission staff estimates
that each of the 9 stand-alone SBSDs
would spend approximately 20 hours of
internal employee resources drafting or
updating its subordinated loan
agreement template to comply with the
881 (3 nonbank SBSDs not using models × 1 hour)
+ (6 broker-dealer SBSDs × 1 hour) = 9 hours. This
function would likely be performed by an internal
compliance attorney. Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: Internal compliance attorney
for 9 hours at $322 per hour = $2,898.
882 See proposed new Rule 18a–1(i).
883 17 CFR 240.15c3–1(e).
884 This estimate is based on the number of
notices currently filed by broker-dealers under the
current collection of information under Rule 15c3–
1.
885 [9 stand-alone SBSDs × 2 notices] × 30
minutes = 4.5 hours. This estimate is based on the
30 minutes it is estimated to take a broker-dealer
to file a similar notice under Rule 15c3–1. The
Commission believes the stand-alone SBSDs would
likely perform these functions internally using an
internal compliance attorney. Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: Internal compliance
attorney for 4.5 hours at $322 per hour = $1,449.
886 See proposed new paragraph (c)(5) to
proposed Rule 18a–1. Broker-dealer SBSDs would
be subject to the provisions of Appendix D to Rule
15c3–1. 17 CFR 240.15c3–1d.

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proposed requirement, resulting in an
industry-wide one-time hour burden of
approximately 180 hours.887 In
addition, based on staff experience with
Rule 15c3–1, the Commission staff
estimates that each stand-alone SBSD
would file 1 proposed subordinated
loan agreement with the Commission
per year and that it would take a firm
approximately 10 hours to prepare and
file the agreement, resulting in an
industry-wide annual hour burden of
approximately 90 hours.888
2. Proposed Rule 18a–2
Proposed new Rule 18a–2 would
establish capital requirements for
nonbank MSBSPs.889 In particular, a
nonbank MSBSP would be required at
all times to have and maintain positive
tangible net worth.890 Because MSBSPs,
by definition, will be entities that
engage in a substantial security-based
swap business, under the proposed
rules, they would be required to comply
with Rule 15c3–4,891 which requires
OTC derivatives dealers and ANC
broker-dealers to establish, document,
and maintain a system of internal risk
management controls to assist in
managing the risks associated with their
business activities, including market,
credit, leverage, liquidity, legal, and
operational risks.892 The Commission
staff estimates that the requirement to
comply with Rule 15c3–4 would result
in one-time and annual hour burdens to
nonbank MSBSPs. The Commission
staff estimates that the average amount
of time a firm would spend
implementing its risk management
control system would be 2,000 hours,893
resulting in an industry-wide one-time
hour burden of 10,000 hours.894
887 9 stand-alone SBSDs × 20 hours = 180 hours.
This function would likely be performed by an inhouse attorney. Therefore, the estimated internal
costs for this hour burden would be calculated as
follows: in-house attorney for 180 hours at $378 per
hour = $68,040.
888 9 stand-alone SBSDs × 1 loan agreement × 10
hours = 90 hours. This function would likely be
performed by an in-house attorney. Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: In-house attorney for 90
hours at $378 per hour = $34,020.
889 See proposed new Rule 18a–2.
890 See paragraph (a) of proposed new Rule 18a–
2.
891 See paragraph (c) of proposed new Rule 18a–
2.
892 See 17 CFR 240.15c3–4.
893 This estimate is based on the one-time burden
estimated for an OTC derivatives dealer to
implement is controls under Rule 15c3–1. OTC
Derivatives Dealers, 62 FR 67940. This also is
included in the current PRA estimate for Rule
15c3–4.
894 5 MSBSPs × 2,000 hours = 10,000 hours.
These hours would likely be performed by a
combination of an internal compliance attorney
(3,333.33 hours), a risk management specialist
(3,333.33 hours), and an operations specialist

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The proposed rule would require a
nonbank MSBSP to consider a number
of issues affecting its business
environment when creating its risk
management control system. For
example, a nonbank MSBSP would need
to consider, among other things, the
sophistication and experience of
relevant trading, risk management, and
internal audit personnel, as well as the
separation of duties among these
personnel, when designing and
implementing its internal control
system’s guidelines, policies, and
procedures. This would help to ensure
that the control system that is
implemented would adequately address
the risks posed by the firm’s business
and the environment in which it is
being conducted. In addition, this
would enable a nonbank MSBSP to
implement specific policies and
procedures unique to its circumstances.
In implementing its policies and
procedures, a nonbank MSBSP would
be required to document and record its
system of internal risk management
controls. In particular, a nonbank
MSBSP would be required to document
its consideration of certain issues
affecting its business when designing its
internal controls. A nonbank MSBSP
would also be required to prepare and
maintain written guidelines that discuss
its internal control system, including
procedures for determining the scope of
authorized activities. The Commission
staff estimates that each of the 5
MSBSPs would spend approximately
250 hours per year reviewing and
updating their risk management control
systems to comply with Rule 15c3–4,
resulting in an industry-wide annual
hour burden of approximately 1,250
hours.895
Because nonbank MSBSPs may not
initially have the systems or expertise
internally to meet the risk management
requirements of proposed new Rule
18a–2, these firms would likely hire an
outside risk management consultant to
assist them in implementing their risk
management systems. The Commission
staff estimates that a nonbank MSBSP
may hire an outside management
(3,333.33 hours). Therefore, the estimated internal
costs for this hour burden would be calculated as
follows: ((internal compliance attorney for 3,333.33
hours at $322 per hour) + (risk management
specialist for 3,333.33 hours at $259 per hour) +
(operations specialist for 3,333.33 hours at $117 per
hour)) = $2,326,664.34.
895 5 MSBSPs × 250 hours = 1,250 hours. These
hour burden estimates are consistent with similar
collections of information under Appendix E to
Rule 15c3–1. These hours would likely be
performed by a risk management specialist.
Therefore, the estimated internal cost for this hour
burden would be calculated as follows: Risk
management specialist for 1,250 hours at $259 per
hour = $323,750.

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consultant for approximately 200 hours
to assist the firm for a total start-up cost
to the nonbank MSBSP of $80,000 per
MSBSP, or a total of $400,000 for all
nonbank MSBSPs.896
Nonbank MSBSPs may incur start-up
costs to comply with proposed Rule
18a–2, including information
technology costs. The information
technology systems of a nonbank
MSBSP may be in varying stages of
readiness to enable these firms to meet
the requirements of the proposed rules
so the cost of modifying their
information technology systems could
vary significantly. Based on the
estimates for similar collections of
information,897 the Commission staff
expects that a nonbank MSBSP would
incur an average of approximately
$16,000 for initial hardware and
software expenses, while the average
ongoing cost would be approximately
$20,500 per nonbank MSBSP to meet
the requirements of the proposed new
Rule 18a–2, for a total industry-wide
initial cost of $80,000 and ongoing cost
of $102,500.898
3. Proposed Rule 18a–3
Proposed paragraph (e) of new Rule
18a–3 would require a nonbank SBSD to
establish and implement risk
monitoring procedures with respect to
counterparty accounts.899 Therefore,
paragraph (e) to proposed Rule 18a–3
would result in one-time and annual
hour burdens for nonbank SBSDs. In
this regard, nonbank SBSDs would need
to develop a comprehensive written risk
analysis methodology for assessing the
potential risk to the firm over a
specified range of possible market
movements over a specified time period
that would meet the requirements of the
rule.
Because these firms would already be
required to comply with Rule 15c3–4,900
the Commission staff estimates that each
of the 25 nonbank SBSDs would spend
an average of approximately 210 hours
establishing the written risk analysis
methodology, resulting in an industrywide one-time hour burden of
896 5 nonbank MSBSPs × $80,000 = $400,000. See
also PRA Analysis in Product Definitions Adopting
Release, 77 FR at 48344 (providing an estimate of
$400 an hour to engage an outside attorney);
Nationally Recognized Statistical Rating
Organizations, 76 FR at 33504 (providing estimate
of $400 per hour to engage outside attorneys and
outside professionals).
897 Risk Management Controls for Brokers or
Dealers with Market Access, 75 FR at 69814.
898 5 nonbank MSBSPs × $16,000 = $80,000; 5
nonbank MSBSPs × $20,500 = $102,500.
899 See paragraph (e) of proposed new Rule 18a–
3.
900 See section II.A.2.c. of this release (describing
risk management provisions of Rule 15c3–4).

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approximately 5,250 hours.901 In
addition, based on staff experience, the
Commission staff estimates that a
nonbank SBSD would spend an average
of approximately 60 hours per year
reviewing the written risk analysis
methodology and updating it as
necessary, resulting in an average
industry-wide annual hour burden of
approximately 1,500 hours.902
The 25 respondents subject to the
collection of information may incur
start-up costs in order to comply with
this collection of information. These
costs may vary depending on the size
and complexity of the nonbank SBSD.
In addition, the start-up costs may be
less for the 16 nonbank SBSD
respondents also registered as brokerdealers because these firms may already
be subject to similar requirements with
respect to other margin rules.903 For the
remaining 9 nonbank SBSDs, because
these written procedures may be novel
undertakings for these firms, the
Commission staff assumes these
nonbank SBSDs would have their
written risk analysis methodology
reviewed by outside counsel. As a
result, the Commission staff estimates
that these nonbank SBSDs would likely
incur $2,000 in legal costs, or $18,000
in the aggregate initial burden to review
and comment on these materials.904
4. Proposed Rule 18a–4
Under proposed new Rule 18a–4,
SBSDs would be required to establish
special accounts with banks and obtain
written acknowledgements from, and
901 25 nonbank SBSDs × 210 hours = 5,250 hours.
See generally Clearing Agency Standards for
Operation and Governance, 76 FR at 14510
(estimating 210 one-time burden hours and 60
annual hours to implement policies and procedures
reasonably designed to use margin requirements to
limit a clearing agency’s credit exposures to
participants in normal market conditions and use
risk-based models and parameters to set and review
margin requirements.). These hours would likely be
performed internally by an assistant general counsel
(1,750 hours), a compliance attorney (1,750 hours),
and a risk management specialist (1,750 hours).
Therefore, the estimated internal cost for this hour
burden would be calculated as follows: ((assistant
general counsel for 1,750 hours at $407 per hour)
+ (risk management specialist for 1,750 hours at
$259 per hour) + (compliance attorney for 1,750
hours at $322 per hour)) = $1,729,000.
902 25 stand-alone SBSDs × 60 hours = 1,500
hours. These hours would likely be performed by
a compliance attorney. Therefore, the estimated
internal cost for this hour burden would be
calculated as follows: Compliance attorney for
1,500 hours at $322 per hour = $483,000.
903 See, e.g., FINRA Rule 4210 and 4240. See also
Business Conduct Release, 76 FR at 42445 (noting
burden for paragraph (g) of proposed Rule 15Fh–3
is based on existing FINRA rules).
904 The Commission staff estimates the review of
the written risk analysis methodology would
require 5 hours of outside counsel time at a cost of
$400 per hour. See also Business Conduct Release,
76 FR at 42445.

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enter into written contracts with, the
banks. These special accounts would
include: (1) The qualified clearing
agency account under paragraph (a)(3);
(2) the qualified SDSD account under
paragraph (a)(4); and the special account
for the exclusive benefit of securitybased swap customers under paragraph
(a)(7) of proposed new Rule 18a–4,
(collectively, the ‘‘special accounts’’).
Based on staff experience with Rule
15c3–3, the Commission staff estimates
that each of the 50 SBSDs would
establish six special accounts at banks
(two for each type of special account).
Further, based on staff experience with
Rule 15c3–3, the Commission staff
estimates that each SBSD would spend
approximately 30 hours to draft and
obtain the written acknowledgement
and agreement for each account,
resulting in an industry-wide one-time
hour burden of approximately 9,000
hours.905 The Commission staff
estimates that 25% 906 of the 50 SBSDs
or approximately 13 would establish a
new special account each year because,
for example, they change their banking
relationship, for each type of special
account. Therefore, the Commission
staff estimates an industry-wide annual
hour burden of approximately 1,170
hours.907
Paragraph (c)(1) of proposed new Rule
18a–4 would provide that the SBSD
must at all times maintain in a special
account, through deposits into the
account, cash and/or qualified securities
in amounts computed in accordance
with the formula set forth in Exhibit A
to Rule 18a–4,908 modeled on the
formula in Appendix A to Rule 15c3–3.
Paragraph (c)(3) of proposed new Rule
18a–4 would provide that the
computations necessary to determine
the amount required to be maintained in
the special bank account must be made
on a daily basis. Variation in size and
complexity between these SBSDs would
make it very difficult to develop a
meaningful figure for the amount of
time required to calculate each reserve
computation. Based on experience with
the Rule 15c3–3 reserve computation
905 50 SBSDs × 6 special accounts × 30 hours =
9,000 hours. A compliance attorney would likely
perform this function. Therefore, the estimated
internal cost for this hour burden would be
calculated as follows: Compliance attorney for
9,000 hours at $322 per hour = $2,898,000.
906 This number is based on the currently
approved PRA collection for Rule 15c3–3.
907 13 SBSDs × 3 types of special accounts × 30
hours = 1,170 hours. A compliance attorney would
likely perform this function. Therefore, the
estimated internal cost for this hour burden would
be calculated as follows: Compliance attorney for
1,170 hours at $322 per hour = $376,740.
908 See paragraph (c)(1) of proposed new Rule
18a–4 and Exhibit A to proposed new Rule 18a–4.

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PRA burden hours and with the OTC
derivatives industry, the Commission
staff estimates that it would take
between one and five hours to compute
each reserve computation, and that the
average time spent across all the SBSDs
would be approximately 2.5 hours.
Accordingly, the Commission staff
estimates that the resulting annual hour
burden for paragraph (c)(3) of proposed
new Rule 18a–3 would be
approximately 31,250 hours.909
Under paragraph (d)(1) of proposed
new Rule 18a–4, an SBSD or an MSBSP
would be required to provide a notice to
a counterparty pursuant to section 3E(f)
of the Exchange Act prior to the
execution of the first non-cleared
security-based swap transaction with
the counterparty occurring after the
effective date of the proposed rule.910
All 50 SBSDs and 5 MSBSPs would be
required to provide these notices to
their counterparties. The Commission
staff estimates that these 55 entities
would engage outside counsel to draft
and review the notice at a cost of $400
per hour for an average of 10 hours per
respondent, resulting in a one-time cost
burden of $220,000 for all of these 55
entities.911
The number of notices sent in the first
year the rule is effective would depend
on the number of counterparties with
which each SBSD and MSBSP engages
in security-based swap transactions. The
number of counterparties an SBSD and
MSBSP would have would vary
depending on the size and complexity
of the firm and its operations. The
Commission staff estimates that each of
the 50 SBSDs and 5 MSBSPs would
have approximately 1,000
counterparties at any given time.912
909 50 SBSDs × 250 business days × 2.5 hours/day
= 31,250 hours. This task would likely be
performed by a financial reporting manager.
Therefore, the estimated internal cost for this hour
burden would be calculated as follows: Financial
reporting manager for 31,250 hours at $309 per hour
= $9,656,250.
910 See paragraph (d)(1) of proposed new Rule
18a–4.
911 [50 SBSDs + 5 MSBSPs] × $400 per hour × 10
hours = $220,000. The Commission expects that
these functions would likely be performed by
outside counsel with an expertise in financial
services law to help ensure that counterparties are
receiving the proper notice under the statutory
requirement.
912 The Commission previously estimated that
there are approximately 8,500 market participants
in security-based swap transactions. See Business
Conduct Release, 76 FR at 42443. Based on the
8,500 market participants and Commission staff
experience relative to the securities and OTC
derivatives industry, the Commission staff estimates
that each SBSD and MSBSP would have 1,000
counterparties at any given time. The number of
counterparties may widely vary depending on the
size of the SBSD or MSBSP. A large firm may have
thousands or counterparties at one time, while a
smaller firm may have substantially less than 1,000.

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Therefore, the Commission staff
estimates that approximately 55,000
notices would be sent in the first year
the rule is effective.913 The Commission
staff estimates that the each of the 50
SBSDs and 5 MSBSPs would spend
approximately 10 minutes sending out
the notice, resulting in an industry-wide
one-time hour burden of approximately
9,167 hours.914 The Commission staff
further estimates that the 50 SBSDs and
5 MSBSPs would establish account
relationships with 200 new
counterparties per year. Therefore, the
Commission staff estimates that
approximately 11,000 notices would be
sent annually,915 resulting in an
industry-wide annual hour burden of
approximately 1,833 hours.916
Under proposed new Rule 18a–
4(d)(2), an SBSD would be required to
obtain agreements from counterparties
that do not choose to require segregation
of funds or other property pursuant to
Section 3E(f) of the Exchange Act or
paragraph (c)(3) of Rule 18a–4 in which
the counterparty agrees to subordinate
all of its claims against the SBSD to the
claims of security-based swap customers
of the SBSD.917 The Commission staff
estimates that an SBSD would spend, on
average, approximately 200 hours to
draft and prepare standard
subordination agreements, resulting in
an industry-wide one-time hour burden
of 10,000 hours.918 Because the SBSD
would enter into these agreements with
The Commission staff also estimates, based on staff
experience, that these entities would establish
account relationships with approximately 200 new
counterparties a year, or approximately 20% of a
firm’s existing counterparties.
913 [50 SBSDs + 5 MSBSPs] × 1,000 counterparties
= 55,000 notices.
914 (55,000 notices × 10 minutes)/60 minutes =
9,167 hours. A compliance clerk would likely send
these notices. Therefore, the estimated internal cost
for this hour burden would be calculated as follows:
Compliance clerk for 9,167 hours at $60 per hour
= $550,020. The hourly rates use for internal office
employees used throughout this section are taken
from SIFMA’s Office Salaries in the Securities
Industry 2011, modified by the Commission staff to
account for an 1800-hour work-year and multiplied
by 2.93 to account for bonuses, firm size, employee
benefits and overhead.
915 [50 SBSDs + 5 MSBSPs] × 200 counterparties
= 11,000 notices.
916 (11,000 notices × 10 minutes)/60 minutes =
1,833 hours. A compliance clerk would likely send
these notices. Therefore, the estimated internal cost
for this hour burden would be calculated as follows:
compliance clerk for 1,833 hours at $60 per hour
= $109,980.
917 See paragraph (d)(2) of proposed new Rule
18a–4.
918 200 hours × 50 SBSDs = 10,000 hours. An inhouse attorney would likely draft these agreements
because the Commission staff expects that drafting
contracts would be one of the typical job functions
of an in-house attorney. Therefore, the estimated
internal cost for this hour burden would be
calculated as follows: In-house attorney for 10,000
hours at $378 per hour = $3,780,000.

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security-based swap customers, after the
SBSD prepares a standard subordination
agreement in-house, the Commission
staff also estimates that an SBSD would
have outside counsel a review the
standard subordination agreements and
that the review would take
approximately 20 hours at a cost of
approximately $400 per hour. As a
result, the Commission staff estimates
that each SBSD would incur one-time
costs of approximately $8,000,919
resulting in an industry-wide one-time
cost of approximately $400,000.920
As discussed above, the Commission
staff estimates that each of the 50 SBSDs
would have approximately 1,000
counterparties at any given time. The
Commission staff further estimates that
approximately 50% of these
counterparties would either elect
individual segregation or waive
segregation altogether.921 The
Commission staff estimates that an
SBSD would spend 20 hours per
counterparty to enter into a written
subordination agreement, resulting in an
industry-wide one-time hour burden of
approximately 500,000 hours.922
Further, as discussed the Commission
staff estimates that each of the 50 SBSDs
would establish account relationships
with 200 new counterparties per year.
The Commission staff further estimates
that 50% or 100 of these counterparties
would either elect individual
segregation or waive segregation
altogether. Therefore, the Commission
staff estimates an industry-wide annual
hour burden of approximately 100,000
hours.923
× 20 hours = $8,000.
× 50 = $400,000.
921 Based on discussions with market
participants, the Commission staff understands that
many large buy-side financial end users currently
ask for individual segregation and the Commission
staff assumes that many of these end users will
continue to do so. However, Commission staff
believes that some smaller end users may not
choose to incur additional cost that may come with
individual segregation. Therefore, the Commission
staff estimates that approximately 50% of
counterparties will either elect individual
segregation or waiver segregation altogether.
922 50 SBSDs × 500 counterparties × 20 hours =
500,000 hours. These functions would likely be
performed by a compliance attorney (250,000
hours) and a compliance clerk (250,000 hours).
Therefore, the estimated internal cost for this hour
burden would be calculated as follows:
((compliance attorney for 250,000 hours at $322 per
hour) + (compliance clerk for 250,000 hours at $60
per hour)) = $95,500,000.
923 50 SBSDs × 100 counterparties × 20 hours =
100,000 hours. These functions would likely be
performed by a compliance attorney (50,000 hours)
and a compliance clerk 50,000 hours). Therefore,
the estimated internal cost for this hour burden
would be calculated as follows: ((compliance
attorney for 50,000 hours at $322 per hour) +
(compliance clerk for 50,000 hours at $60 per hour))
= $19,100,000.
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E. Collection of Information Is
Mandatory
The collections of information
pursuant to the proposed amendments
and new rules are mandatory, as
applicable, for ANC broker-dealers,
SBSDs, and MSBSPs.
F. Confidentiality
The Commission expects to receive
confidential information in connection
with the proposed collections of
information. To the extent that the
Commission receives confidential
information pursuant to these
collections of information, the
Commission is committed to protecting
the confidentiality of such information
to the extent permitted by law.924
G. Retention Period for Recordkeeping
Requirements
ANC broker-dealers are required to
preserve for a period of not less than
three years, the first two years in an
easily accessible place, certain records
required under Rule 15c3–4 and certain
records under Appendix E to Rule
15c3–1.925 Rule 17a–4 specifies the
required retention periods for a brokerdealer.926 Many of a broker-dealer’s
records must be retained for three years;
certain other records must be retained
for longer periods.927
As noted above, the recordkeeping
burdens with respect to some
requirements in proposed new Rules
18a–1 through 18a–4 will be addressed
in the SBSD and MSBSP recordkeeping
requirements, which will the subject of
a separate release.
H. Request for Comment
Pursuant to 44 U.S.C. 3306(c)(2)(B),
the Commission requests comment on
the proposed collections of information
in order to:
• Evaluate whether the proposed
collections of information are necessary
for the proper performance of the
functions of the Commission, including
924 See, e.g., 15 U.S.C. 78 × (governing the public
availability of information obtained by the
Commission); 5 U.S.C. 552 et seq. (Freedom of
Information Act—‘‘FOIA’’). See also paragraph
(d)(1) of proposed new Rule 18a–1(d). FOIA
provides at least two pertinent exemptions under
which the Commission has authority to withhold
certain information. FOIA Exemption 4 provides an
exemption for ‘‘trade secrets and commercial or
financial information obtained from a person and
privileged or confidential.’’ 5 U.S.C. 552(b)(4). FOIA
Exemption 8 provides an exemption for matters that
are ‘‘contained in or related to examination,
operating, or condition reports prepared by, on
behalf of, or for the use of an agency responsible
for the regulation or supervision of financial
institutions.’’ 5 U.S.C. 552(b)(8).
925 See 17 CFR 17a–4(b)(9), (10), and (12).
926 17 CFR 240.17a–4.
927 Id.

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whether the information would have
practical utility;
• Evaluate the accuracy of the
Commission’s estimates of the burden of
the proposed collections of information;
• Determine whether there are ways
to enhance the quality, utility, and
clarity of the information to be
collected; and
• Evaluate whether there are ways to
minimize the burden of the collection of
information on those who respond,
including through the use of automated
collection techniques or other forms of
information technology.
Persons submitting comments on the
collection of information requirements
should direct their comments to the
Office of Management and Budget,
Attention: Desk Officer for the
Securities and Exchange Commission,
Office of Information and Regulatory
Affairs, Washington, DC 20503, and
should also send a copy of their
comments to Elizabeth M. Murphy,
Secretary, Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549–1090, and refer
to File No. S7–08–12. OMB is required
to make a decision concerning the
collections of information between 30
and 60 days after publication of this
document in the Federal Register;
therefore, comments to OMB are best
assured of having full effect if OMB
receives them within 30 days of this
publication. Requests for the materials
submitted to OMB by the Commission
with regard to these collections of
information should be in writing, refer
to File No. S7–08–12, and be submitted
to the Securities and Exchange
Commission, Records Management,
Office of Filings and Information
Services, 100 F Street NE., Washington,
DC 20549.
V. Economic Analysis
The Commission is sensitive to the
costs and benefits of its rules. Some of
these costs and benefits stem from
statutory mandates, while others are
affected by the discretion exercised in
implementing the mandates. The
following economic analysis seeks to
identify and consider the benefits and
costs—including the effects on
efficiency, competition, and capital
formation—that would result from the
proposed capital, margin, and
segregation rules for SBSDs and
MSBSPs and from the proposed
amendments to Rule 15c3–1. The costs
and benefits considered in proposing
these new rules and amendments are
discussed below and have informed the
policy choices described throughout
this release.

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The Commission discusses below a
baseline against which the rules may be
evaluated. For the purposes of this
economic analysis, the baseline is the
OTC derivatives markets as they exist
today prior to the effectiveness of the
statutory and regulatory provisions that
will govern these markets in the future
pursuant to the Dodd-Frank Act. With
respect to the proposed amendments to
Rule 15c3–1, the baseline for purposes
of this economic analysis is the current
capital regime for broker-dealers under
Rule 15c3–1.928
While the Commission does not have
comprehensive information on the U.S.
OTC derivatives markets, the
Commission is using the limited data
currently available in considering in
this economic analysis the effects of the
proposals, including their intended
benefits and anticipated possible
costs.929 Additionally, the Commission
requests that commenters identify
sources of data and information as well
as provide data and information to assist
the Commission in analyzing the
economic consequences of the proposed
rules. More generally, the Commission
requests comment on all aspects of this
initial economic analysis, including on
whether the analysis has: (1) Identified
all benefits and costs, including all
effects on efficiency, competition, and
capital formation; (2) given due
consideration to each benefit and cost,
including each effect on efficiency,
competition, and capital formation; and
(3) identified and considered reasonable
alternatives to the proposed new rules
and rule amendments.
If these proposed rules and rule
amendments are adopted, their benefits
and costs would affect competition,
efficiency, and capital formation in the
security-based swap market broadly,
with the impact not being limited to
SBSDs and MSBSPs. Section 3(f) of the
Exchange Act provides that whenever
the Commission engages in rulemaking
under the Exchange Act and is required
to consider or determine whether an
action is necessary or appropriate in the
public interest, the Commission shall
also consider, in addition to the
protection of investors, whether the
action will promote efficiency,
competition, and capital formation.930
In addition, section 23(a)(2) of the
Exchange Act requires the Commission,
when adopting rules under the
928 17

CFR 240.15c3–1.
that is available for the purposes
of this economic analysis includes an analysis of
the market for single-name credit default swaps
performed by the Commission’s Division of Risk,
Strategy, and Financial Innovation. See CDS Data
Analysis.
930 15 U.S.C. 78c(f).

Exchange Act, to consider the effect
such rules would have on
competition.931 Section 23(a)(2) of the
Exchange Act also prohibits the
Commission from adopting any rule that
would impose a burden on competition
not necessary or appropriate in
furtherance of the purposes of the
Exchange Act.932
As discussed more fully in section II.
above, the Commission is proposing: (1)
Rules 18a–1 and 18a–2, and
amendments to Rule 15c3–1, to
establish capital requirements for
nonbank SBSDs and nonbank MSBSPs;
(2) Rule 18a–3 to establish customer
margin requirements applicable to
nonbank SBSDs and nonbank MSBSPs
for non-cleared security-based swaps;
and (3) Rule 18a–4 to establish
segregation requirements for SBSDs and
notification requirements with respect
to segregation for SBSDs and
MSBSPs.933 Some of the proposed
amendments to Rule 15c3–1 would
apply to broker-dealers that are not
registered as SBSDs or MSBSPs to the
extent that they hold positions in
security-based swaps and swaps. The
Commission also is proposing to amend
Rule 15c3–1 to increase the minimum
capital requirements for ANC brokerdealers. Finally, the Commission is
proposing a liquidity requirement for
ANC broker-dealers and for nonbank
stand-alone SBSDs that use internal
models to compute net capital.
The sections below present an
overview of the OTC derivatives
markets, a discussion of the general
costs and benefits of the proposed
financial responsibility requirements,
and a discussion of the costs and
benefits of each proposed amendment
and new rule. The sections that follow
also incorporate a consideration of the
potential effects of the proposed
amendments and new rules on
competition, efficiency, and capital
formation.
A. Baseline of Economic Analysis
1. Overview of the OTC Derivatives
Markets—Baseline for Proposed Rules
18a–1 Through 18a–4
As stated above, to assess the costs
and benefits of these rules, a baseline
must be established against which the
rules may be evaluated. For the
purposes of this economic analysis, the
baseline is the OTC derivatives

929 Information

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931 15

U.S.C. 78w(a)(2).

932 Id.
933 The Commission is also proposing a
conforming amendment to Rule 15c3–3 to clarify
that broker-dealer SBSDs must comply with Rule
15c3–3 and Rule 18a–4, as applicable.

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markets 934 as they exist today prior to
the effectiveness of the statutory and
regulatory provisions that will govern
these markets in the future pursuant to
the Dodd-Frank Act.935 The markets as
they exist today are dominated, both
globally and domestically, by a small
number of firms, generally entities
affiliated with or within large
commercial banks.936
The OTC derivatives markets have
been described as opaque because, for
example, transaction-level data about
OTC derivatives trading generally is not
publicly available.937 This economic
analysis is supported, where possible,
by data currently available to the
Commission from The Depository Trust
& Clearing Corporation Trade
Information Warehouse (‘‘DTCC–TIW’’).
This evaluation takes into account data
regarding the security-based swap
market and especially data regarding the
activity—including activity that may be
suggestive of dealing behavior—of
participants in the single-name credit
default swap market.938 While a large
segment of the security-based swap
market is comprised of single-name
credit default swaps, these derivatives
do not comprise the entire securitybased swap market.939 Moreover, credit
934 OTC derivatives may include forwards, swaps
and options on foreign exchange, and interest rate,
equity and commodity derivatives.
935 The baseline, however, for amendments to
Rule 15c3–1 is the current financial responsibility
regime for broker-dealers under this rule.
936 See, e.g., ISDA Margin Survey 2012.
937 See Orice M. Williams, GAO, Systemic Risk:
Regulatory Oversight and Recent Initiatives to
Address Risk Posed by Credit Default Swaps at 2,
5, 27. See also Robert E. Litan, The Brookings
Institution, The Derivatives Dealers’ Club and
Derivatives Market Reform: A Guide for Policy
Makers, Citizens and Other Interested Parties 15–
20 (Apr. 7, 2010), available at http://
www.brookings.edu/∼/media/research/files/papers/
2010/4/07%20derivatives%20litan/
0407_derivatives_litan.pdf; Security-Based Swap
Data Repository Registration, Duties, and Core
Principles, Exchange Act Release No. 63347 (Nov.
19, 2010), 75 FR 77306, 77354 (Dec. 10, 2010);
IOSCO, The Credit Default Swap Market, Report
FR05/12, (June 2012), available at http://
www.iosco.org/library/pubdocs/pdf/
IOSCOPD385.pdf (stating although the amount of
public information on CDS has increased over
recent years, the CDS market is still quite opaque).
938 The CDS Data Analysis provides reasonably
comprehensive information regarding the credit
default swap activities and positions of U.S. market
participants, but the Commission notes that the data
does not encompass those credit default swaps that
both: (i) Do not involve U.S. counterparties; and (ii)
are based on non-U.S. reference entities. Reliance
on this data should not be interpreted to indicate
our views as to the nature or extent of the
application of Title VII to non-U.S. persons; instead,
it is anticipated that issues regarding the
extraterritorial application of Title VII will be
addressed in a separate release.
939 In addition, it is reasonable to believe that the
implementation of Title VII itself will change the
security-based swap market, and, with the full
implementation of Title VII—which in part is

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default swaps are a small percentage of
the overall OTC derivatives market,
which, in addition to security-based
swaps, includes foreign currency swaps
and interest rate swaps.
Available information about the
global OTC derivatives markets suggests
that swap transactions, in contrast to
security-based swap transactions,
dominate trading activities, notional
amounts, and market values.940 For
example, the BIS estimates that the total
notional amounts outstanding and gross
market value of global OTC derivatives
were over $648 trillion and $27.2
trillion, respectively, as of the end of
2011.941 Of these totals, the BIS
estimates that foreign exchange
contracts, interest rate contracts, and
commodity contracts comprised
approximately 88% of the total notional
amount and 84% of the gross market
value.942 Credit default swaps,
including index credit default swaps,
comprised approximately 4.4% of the
total notional amount and 5.8% of the
gross market value. Equity-linked
contracts, including forwards, swaps
and options, comprised approximately
an additional 1.0% of the total notional
amount and 2.5% of the gross market
value.943
Because the financial responsibility
program for SBSDs and MSBSPs would
apply to dealers and participants in the
security-based swap markets, they are
expected to affect a substantially smaller
portion of the U.S. OTC derivatives
conditioned on the implementation of the proposed
financial responsibility program—more information
will be available for this analysis.
940 See BIS, Statistical Release: OTC derivatives
statistics at end-December 2011, 5 (May 2012),
available at http://www.bis.org/publ/otc_hy1205.pdf
(reflecting data reported by central banks in 14
countries: Belgium, Canada, France, Germany,
England, Italy, Japan, the Netherlands, Sweden,
Switzerland, the United Kingdom, the United
States, Australia, and Spain).
941 Id. at 12 (‘‘Nominal or notional amounts
outstanding are defined as the gross nominal or
notional value of all deals concluded and not yet
settled on the reporting date * * * Gross market
values are defined as the sums of the absolute
values of all open contracts with either positive or
negative replacement values evaluated at market
prices prevailing on the reporting date * * * gross
market values supply information about the
potential scale of market risk in derivatives
transactions. Furthermore, gross market value at
current market prices provides a measure of
economic significance that is readily comparable
across markets and products.’’).
942 Id.
943 Id. Similarly, the OCC has found that interest
rate products comprised 81% of the total notional
amount of OTC derivatives held by bank dealers
whereas credit derivative contracts comprised 6.4%
and equity contracts comprised 1% of that notional
amount. See OCC, Quarterly Report on Bank
Trading and Derivatives Activities, Fourth Quarter
2011, available at http://www.occ.gov/topics/
capital-markets/financial-markets/trading/
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markets than the proposed financial
responsibility rules for swap dealers and
major swap participants proposed by
the CFTC and prudential regulators.944
In addition, though the proposed
capital, segregation and margin rules
apply to all security-based swaps, not
just single-name credit default swaps,
the data on single-name credit default
swaps are currently sufficiently
representative of the market to help
inform this economic analysis because
currently an estimated 95% of all
security-based swap transactions appear
likely to be single-name credit default
swaps.945 The majority of these singlename credit default swaps, both in
terms of aggregate total notional amount
and total volume by product type, are
based on corporate and sovereign
reference entities.946
While the number of transactions is
larger in single-name credit default
swaps than in index credit default
swaps, the aggregate total notional
amount of the latter exceeds that of
single-name credit default swaps.947 For
example, the total aggregate notional
amount for single-name credit default
swaps was $6.2 trillion, while the
aggregate total notional amount for
index credit default swaps was $16.8
trillion over the sample period of
January 1, 2011 to December 31, 2011.
For the same sample period, however,
single-name credit default swaps totaled
69% of transactional volume, while
index credit default swaps comprised
31% of the total transactional
volume.948 The majority of trades in
both notional amount and volume for
both single-name and index credit
default swaps over the 2011 sample
period were new trades in contrast to
assignments, increases, terminations or
exits.949 The analysis of the 2011 data
further shows that by total notional
amount and total volume the majority of
single-name and index credit default
contracts have a tenor of 5 years.950 In
addition, the data from the sample
period indicates that the geographical
distribution of counterparties’ parent
944 See CFTC Margin Proposing Release, 76 FR
27802; Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564.
945 See Entity Definitions Adopting Release, 77 FR
at 30636. See also Product Definitions Adopting
Release, 77 FR 48205 (defining the term securitybased swap).
946 Data compiled by the Commission’s Division
of Risk, Strategy, and Financial Innovation on credit
default transactions from the DTCC–TIW between
January 1, 2011 and December 31, 2011.
947 Id. This data also shows the average mean and
median single-name and index credit default swap
notional transaction size in millions is 6.47 and
4.12, and 39.22 and 14.25, respectively.
948 Id.
949 Id.
950 Id.

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country domiciles in single name
contracts are concentrated in the United
States, United Kingdom, and
Switzerland.951
As described more fully in the CDS
Data Analysis,952 based on 2011
transaction data, Commission staff
identified entities currently transacting
in the credit default swap market that
may register as SBSDs by analyzing
various criteria of their dealing activity.
The results suggest that there is
currently a high degree of concentration
of potential dealing activity in the
single-name credit default swap market.
For example, using the criterion that
dealers are likely to transact with many
counterparties who themselves are not
dealers, the analysis of the 2011 data
show that only 28 out of 1,084 market
participants have three or more
counterparties that themselves are not
recognized as dealers by ISDA.953 In
addition, the analysis suggests that
dealers appear, based on the percentage
of trades between buyer and seller
principals, in the majority of all trades
on either one or both sides in singlename and index credit default swaps.954
This concentration to a large extent
appears to reflect the fact that those
larger entities are well-capitalized and
therefore possess competitive
advantages in engaging in OTC securitybased swap dealing activities by
providing potential counterparties with
adequate assurances of financial
performance.955 As such, it is
951 Id.
952 See

CDS Data Analysis.
at Table 3c. The analysis of this transaction
data is imperfect as a tool for identifying dealing
activity, given that the presence or absence of
dealing activity ultimately turns upon the relevant
facts and circumstances of an entity’s securitybased swap transactions, as informed by the dealertrader distinction. Criteria based on the number of
an entity’s counterparties that are not recognized as
dealers nonetheless appear to be useful for
identifying apparent dealing activity in the absence
of full analysis of the relevant facts and
circumstances, given that engaging in securitybased swap transactions with non-dealers would be
consistent with the conduct of seeking to profit by
providing liquidity to others, as anticipated by the
dealer-trader distinction.
954 Data compiled by the Commission’s Division
of Risk, Strategy, and Financial Innovation on credit
default transactions from the DTCC–TIW between
January 1, 2011 and December 31, 2011.
Additionally, according to the OCC, at the end of
the first quarter of 2012, derivatives activity in the
U.S. banking system continues to be dominated by
a small group of large financial institutions. Four
large commercial banks represent 93% of the total
banking industry notional amounts and 81% of
industry net current credit exposure. See OCC,
Quarterly Report on Bank Trading and Derivatives
Activities, First Quarter 2012, available at http://
www.occ.gov/topics/capital-markets/financialmarkets/trading/derivatives/dq112.pdf.
955 See, e.g., Craig Pirrong, Rocket Science,
Default Risk and The Organization of Derivatives
953 Id.

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reasonable to conclude that currently
there likely are high barriers to entry in
terms of capitalization in connection
with security-based swap dealing
activity.956
Other than OTC derivatives dealers,
which are subject to significant
limitations on their activities, brokerdealers historically have not
participated in a significant way in
security-based swap trading for at least
two reasons. First, because the Exchange
Act has not previously defined securitybased swaps as ‘‘securities,’’ they have
not been required to be traded through
registered broker-dealers.957 And
second, a broker-dealer engaging in
security-based swap activities is
currently subject to existing regulatory
requirements with respect to those
activities, including capital, margin,
segregation, and recordkeeping
requirements. Specifically, the existing
broker-dealer capital requirements make
it relatively costly to conduct these
activities in broker-dealers, as discussed
in section II.A.2. of this release. As a
result, security-based swap activities are
currently mostly concentrated in
entities that are affiliated with the
parent companies of broker-dealers, but
not in broker-dealers themselves.958
End users enter into OTC derivatives
transactions to take investment
positions or to hedge commercial and
financial risk. These non-dealer end
users of OTC derivatives are, for
example, commercial companies,
governmental entities, financial
institutions, investment vehicles, and
individuals. Available data suggests that
the largest end users of credit default
swaps are, in descending order, hedge
funds, asset managers, and banks, which
may have a commercial need to hedge
their credit exposures to a wide variety
of entities or may take an active view on
credit risk.959 Based on the available
Markets, Working Paper 17–18 (2006), available at
http://www.cba.uh.edu/spirrong/Derivorg1.pdf
(noting that counterparties seek to reduce risk of
default by engaging in credit derivative transactions
with well-capitalized firms). See also Entity
Definitions Adopting Release, 77 FR at 30739–
30742.
956 See id. at 18–19 (noting lack of success among
new entrants into derivatives dealing market due to
perception that AAA rating for subsidiary is less
desirable than a slightly lower rating for a larger
entity, and suggesting that there are ‘‘economies of
scale in bearing default risk’’ that may induce
‘‘substantial concentration in dealer activities’’). See
also Entity Definitions Adopting Release, 77 FR at
30739–30742.
957 See definition of ‘‘security’’ in section 3(a)(10)
of the Exchange Act and ‘‘security-based swap’’ in
section 3(a)(68) of the Exchange Act.
958 See ISDA Margin Survey 2012.
959 This information is based on available market
data from DTCC–TIW compiled by the
Commission’s Division of Risk, Strategy, and
Financial Innovation. For example, data compiled

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data, the Commission further estimates
that commercial end users currently
participate in the security-based swap
markets on a very limited basis.960
Finally, this baseline for proposed
new Rules 18a–1 through 18a–4 will be
further discussed in the applicable
sections of the release below.
Request for Comment
The Commission generally requests
comment about its preliminary
estimates of the scale and composition
of the OTC derivatives market,
including the relative size of the
security-based swap segment of that
market. In addition, the Commission
requests that commenters provide data
and sources of data to quantify:
1. The average daily and annual
volume of OTC derivatives transactions;
2. The volume of transactions in each
class of OTC derivatives (e.g., interest
rate swaps, index credit default swaps,
single-name credit default swaps,
currency swaps, commodity swaps, and
equity-based swaps);
3. The total notional amount of all
pending swap transactions;
4. The total current exposure of all
pending swap transactions;
5. The total notional amount of all
pending security-based swap
transactions;
6. The total current exposure of all
pending security-based swap
transactions;
7. The types and numbers of dealers
in OTC derivatives (e.g., banks, brokerdealers, unregulated entities);
8. The capital levels of dealers,
particularly those not subject to
regulatory capital requirements;
9. The types and numbers of dealers
in OTC derivatives dealers that engage
in both a swap and security-based swap
business;
10. The types and numbers of dealers
in OTC derivatives that engage only in
a swap business;
11. The types and numbers of dealers
in OTC derivatives that engage only in
a security-based swaps business;
by the Commission’s Division of Risk, Strategy, and
Financial Innovation on credit default transactions
from the DTCC–TIW between January 1, 2011 and
December 31, 2011 suggests that for single-name
credit default swap transactions, dealer to dealer
transactions composed 68.26% of trades between
buyer and seller principals over the sample period.
960 For example, data compiled by the
Commission’s Division of Risk, Strategy, and
Financial Innovation on credit default transactions
from the DTCC–TIW between January 1, 2011 and
December 31, 2011 suggest that the total percentage
of trades between buyer and seller principals over
the sample period for single-name credit default
swaps was only 0.03% of the total trade
counterparty distribution for non-financial end
users, which are composed of non-financial
companies and family trusts.

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12. The classes of end users (e.g.,
commercial end users, financial end
users, and others) and the number of
end users in each class;
13. The types of OTC derivatives
transactions that each class of end user
commonly engages in;
14. The amount of assets posted for
OTC derivatives to collateralize current
exposure;
15. The amount of assets posted for
OTC derivatives to collateralize
potential future exposure;
16. The type of assets used as
collateral; and
17. The amount of assets that are held
under the different types of collateral
arrangements (e.g., held by the dealer
but not segregated, held by the dealer in
omnibus segregation, held by a thirdparty custodian).
2. Baseline for Amendments to Rule
15c3–1
As discussed in more detail above, the
Commission is proposing amendments
to Rule 15c3–1.961 These amendments
would establish minimum net capital
requirements for broker-dealers that
register as SBSDs, increase the
minimum net capital requirements for
ANC broker-dealers, narrow the current
treatment of credit risk charges for ANC
broker-dealers to apply only to
uncollateralized receivables from
commercial end users arising from
security-based swaps, and establish
liquidity requirements for ANC brokerdealers and nonbank SBSDs using
internal models. Some of those
proposed amendments to Rule 15c3–1
would also apply to broker-dealers not
registering as SBSDs or MSBSPs to the
extent they hold security-based swap
positions or non-security-based swap
positions.
As discussed in section II.A.1. of this
release, the existing broker-dealer
capital requirements are contained in
Rule 15c3–1 962 and seven appendices to
Rule 15c3–1.963 The baseline for this
economic analysis with respect to the
proposed amendments to Rule 15c3–1 is
961 See

section II.B. of this release.
CFR 240.15c3–1.
963 17 CFR 240.15c3–1a (Options); 17 CFR
240.15c3–1b (Adjustments to net worth and
aggregate indebtedness for certain commodities
transactions); 17 CFR 240.15c3–1c (Consolidated
computations of net capital and aggregate
indebtedness for certain subsidiaries and affiliates;
17 CFR 240.15c3–1d (Satisfactory subordination
agreements); 17 CFR 240.15c3–1e (Deductions for
market and credit risk for certain brokers or
dealers); 17 CFR 240.15c3–1f (Optional market and
credit risk requirements for OTC derivatives
dealers); 17 CFR 240.15c3–1g (Conditions for
ultimate holding companies of certain brokers or
dealers).
962 17

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the broker-dealer capital regime as it
exists today.
Specifically, current Rule 15c3–1
requires broker-dealers to maintain a
minimum level of net capital (meaning
highly liquid capital) at all times.964 The
rule requires that a broker-dealer
perform two calculations: (1) A
computation of the minimum amount of
net capital the broker-dealer must
maintain; 965 and (2) a computation of
the amount of net capital the brokerdealer is maintaining.966 The minimum
net capital requirement is the greater of
a fixed-dollar amount specified in the
rule and an amount determined by
applying one of two financial ratios: the
15-to-1 aggregate indebtedness to net
capital ratio or the 2% of aggregate debit
items ratio.967
In computing net capital, the brokerdealer must, among other things, make
certain adjustments to net worth such as
deducting illiquid assets and taking
other capital charges and adding
qualifying subordinated loans.968
‘‘Tentative net capital’’ is defined as the
amount remaining after these
deductions.969 The final step in
computing net capital is to deduct from
the mark-to-market values of the
proprietary positions (e.g. in securities,
money market instruments, and
commodities) that are included in its
tentative net capital prescribed
percentages (‘‘standardized
haircuts’’).970 The standardized haircuts
are designed to account for the market
risk inherent in these proprietary
positions and to create a buffer of
liquidity to protect against other risks
associated with the securities
business.971 With Commission approval,
ANC broker-dealers and OTC derivative
dealers are permitted to calculate
deductions for market risk and credit
risk from tentative net capital using
internal models in lieu of the
standardized haircuts.972 Because the
964 See

17 CFR 240.15c3–1.
17 CFR 240.15c3–1(a).
966 See 17 CFR 240.15c3–1(c)(2). The computation
of net capital is based on the definition of ‘‘net
capital’’ in paragraph (c)(2) of Rule 15c3–1. Id.
967 See 17 CFR 240.15c3–1(a).
968 See 17 CFR 240.15c3–1(c)(2)(i)–(xiii).
969 See 17 CFR 240.15c3–1(c)(15).
970 See 17 CFR 240.15c3–1(c)(2)(vi).
971 See, e.g., Uniform Net Capital Rule, 42 FR
31778 (‘‘[Haircuts] are intended to enable net
capital computations to reflect the market risk
inherent in the positioning of the particular types
of securities enumerated in [the rule]’’).
972 See 17 CFR 240.15c3–1(a)(5) and (a)(7); 17
CFR 240.15c3–1e; 17 CFR 240.15c3–1f. As part of
the application to use internal models, an entity
seeking to become an ANC broker-dealer or an OTC
derivatives dealer must identify the types of
positions it intends to include in its model
calculation. See 17 CFR 240.15c3–3e(a)(1)(iii); 17
CFR 240.15c3–1f(a)(1)(ii). After approval, the ANC

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use of internal models to compute net
capital generally can substantially
reduce the deductions for proprietary
positions compared to standardized
haircuts and only certain risks are
addressed by these internal models,
current Rule 15c3–1 imposes
substantially higher minimum capital
requirements for ANC broker-dealers
and OTC derivatives dealers as
compared to other types of brokerdealers.973 For example, under current
Rule 15c3–1, ANC broker-dealers are
required to at all times maintain
tentative net capital of not less than $1
billion and net capital of not less than
$500,000,974 and they are required to
provide notice to the Commission if
their tentative net capital falls below $5
billion.975 The current rule requires that
a broker-dealer must ensure that its net
capital exceeds its minimum net capital
requirement at all times.976
Finally, the baseline of the current
capital regime will be further discussed
in the applicable sections of the release
below.
B. Analysis of the Proposals and
Alternatives
1. Overview—The Proposed Financial
Responsibility Program
Generally, the financial responsibility
requirements the Commission is
proposing today are intended to
enhance the financial integrity of SBSDs
and MSBSPs. As discussed more fully
below, in proposing these requirements,
the Commission is seeking to
appropriately consider both the
potential benefits of minimizing the risk
that the failure of one firm will cause
financial distress to other firms and
disrupt financial markets and the U.S.
financial system and the potential costs
to that firm, the financial markets, and
the U.S. financial system if SBSDs and
MSBPs are required to comply with
overly restrictive capital, margin and
segregation requirements. This
introductory section reviews at a general
level certain considerations regarding
the economic analysis of the proposed
rules that is set forth in greater detail
below.
As discussed in section I. of the
release, the current broker-dealer
financial responsibility requirements
serve as the template for the proposals
for several reasons. First, the financial
broker-dealer or OTC derivatives dealer must obtain
Commission approval to make a material change to
the model, including a change to the types of
positions included in the model. See 17 CFR
240.15c3–1e(a)(8); 17 CFR 240.15c3–f(a)(3).
973 See 17 CFR 240.15c3–1(a)(5) and (a)(7).
974 17 CFR 240.15c3–1(a)(7)(i).
975 17 CFR 240.15c3–1(a)(7)(ii).
976 17 CFR 240.15c3–1(a).

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markets in which SBSDs and MSBSPs
are expected to operate are similar to the
financial markets in which brokerdealers operate in the sense that they are
driven in significant part by dealers that
buy and sell on a regular basis and that
take principal risk. Second, like
nonbank dealers in securities but unlike
bank SBSDs, nonbank SBSDs will not be
able to rely on a backstop provider of
liquidity but rather need to be able to
liquidate assets quickly in the event of
a counterparty default. Third, the
broker-dealer financial responsibility
requirements have existed for many
years and have facilitated the prudent
operation of broker-dealers.977 Fourth,
some broker-dealers likely will be
registered as nonbank SBSDs so as to be
able to offer customers a broader range
of services than would be permitted as
a stand-alone SBSD. Therefore,
establishing consistent financial
responsibility requirements would
avoid potential competitive disparities
between stand-alone SBSDs and brokerdealer SBSDs. And fifth, by placing an
emphasis on maintaining liquid assets
and requiring the segregation of
customer funds, the current brokerdealer financial responsibility
requirements have generally been
successful in limiting losses to
customers due to broker-dealer
defaults.978 Consequently, the current
broker-dealer financial responsibility
requirements provide a reasonable
template for building a financial
responsibility program for SBSDs and
MSBSPs.
However, the Commission recognizes
that there may be other appropriate
977 For example, one of the objectives of the
broker-dealer financial responsibility requirements
is to protect customers from the consequences of
the financial failure of a broker-dealer in terms of
safeguarding customer securities and funds held by
the broker-dealer. In this regard, SIPC, since its
inception in 1971, has initiated customer protection
proceedings for only 324 broker-dealers, which is
less than 1% of the approximately 39,200 brokerdealers that have been members of SIPC during that
timeframe. During the same period, only $1.1
billion of the $117.5 billion of cash and securities
distributed for accounts of customers came from the
SIPC fund rather than debtors’ estates. See SIPC
2011 Annual Report.
978 For example, of the more than 625,200 claims
satisfied in completed or substantially completed
cases since SIPC’s inception in 1971, as of
December 31, 2011, a total of 351 were for cash and
securities whose value was greater than the limits
of protection afforded by SIPA. The 351 claims,
unchanged during 2011, represent less than onetenth of one percent of all claims satisfied. The
unsatisfied portion of claims, $47.2 million, is
unchanged in 2011. These remaining claims
approximate three-tenths of one percent of the total
value of securities and cash distributed for accounts
of customers in those cases. See SIPC 2011 Annual
Report. These figures do not include the SIPA
liquidations of Bernard L. Madoff Investment
Securities LLC and Lehman Brothers Inc., which are
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approaches to establishing financial
responsibility requirements—including,
for example, requirements based on the
Basel Standard in the case of entities
that are part of a bank holding company,
as has been proposed by the CFTC.979
Generally, the bank capital model
requires the holding of specified levels
of capital as a percentage of ‘‘risk
weighted assets.’’ 980 In general, it does
not require a full capital deduction for
unsecured receivables, given that banks,
as lending entities, are in the business
of extending credit to a range of
counterparties.
This approach could promote a
consistent view and management of
capital within a bank holding company
structure. However, it would not be a
net liquid assets standard. In addition,
applying capital rules designed for
banks to a non-bank entity would raise
various practical and policy issues that
are not directly implicated by the
proposed approach. First, it would need
to be clear whether a regulator with
primary responsibility for the non-bank
entity would defer to bank regulators
with respect to the interpretation of
Basel standards as applied to the entity,
or instead develop its own
interpretation of those standards.
Further, it would need to be clear how
trading and other risks of the non-bank
entity and its bank affiliate or affiliates
would be expected to be managed,
whether such risks would be managed
holistically at the holding company
level or separately at the entity level,
and what limitations, if any, would
apply to transfers of risks from a bank
to its non-bank entity affiliate, or vice
versa. In addition, to the extent that
bank capital standards would permit the
non-bank entity to hold more illiquid
assets as regulatory capital, an
additional liquidity standard might be
required at the entity level in order to
assure that the entity maintained
sufficient liquidity to support its trading
activity. Similarly, if the non-bank
entity were an SBSD that held assets for
customers, the impact of any reduced
liquidity associated with the application
of bank capital standards on the ability
of the entity to quickly wind down
979 CFTC

Capital Proposing Release, 76 FR 27802.
prudential regulators also have proposed
capital rules that would require a covered swap
entity to comply with the regulatory capital rules
already made applicable to that covered swap entity
as part of its prudential regulatory regime.
Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27568. The prudential regulators
note that they have ‘‘had risk-based capital rules in
place for banks to address over-the-counter
derivatives since 1989 when the banking agencies
implemented their risk-based capital adequacy
standards * * * based on the first Basel Accord.’’
Id.

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operations and distribute assets to
customers would need to be considered.
The Commission specifically seeks
comment as to whether to adapt Basel
capital standards to non-bank affiliates
of banks, and how such a regime would
work in practice—including how it
would address the issues described
above and similar challenges.
The Commission also recognizes that
in determining appropriate financial
responsibility requirements—whether
based on current broker-dealer rules or
other alternative approaches described
above—it must assess and consider a
number of different costs and benefits,
and the determinations it ultimately
makes can have a variety of economic
consequences for the relevant firms,
markets, and the financial system as a
whole. On the one hand, the capital and
margin requirements in particular are
broadly intended to work in tandem to
strengthen the financial system by
reducing the potential for default to an
acceptable level and limiting the
amount of leverage that can be
employed by SBSDs and other market
participants. Requiring particular firms
to hold more capital or exchange more
margin may reduce the risk of default by
one or more market participants and
reduce the amount of leverage employed
in the system generally, which in turn
may have a number of important
benefits. The failure of an SBSD could
result in immediate financial loss to its
counterparties or customers,
particularly those that are not able to
avoid losses by liquidating collateral or
those that have delivered assets for
custody by the SBSD. Since the primary
benefit of the capital and margin
requirements is to reduce the
probability of a SBSD failure, potential
counterparties may be more willing to
transact when they have greater
assurance that they will be paid
following a credit event. Depending on
the size of the SBSD and its
interconnectedness with other market
participants, such a default also could
have adverse spillover or contagion
effects that could create instability for
the financial markets more generally,
such as limiting the willingness of
healthy market participants to extend
credit to each other, and thus
substantially reduce liquidity and
valuations for particular types of
financial instruments.981 Further, to the
extent that market participants generally

perceive that the prudential
requirements are sufficient to protect
them from losses due to a counterparty’s
default, the security-based swap market
may experience increased trading
activity, reduced transaction costs,
improved liquidity, enhanced capital
formation, and an improved ability to
manage risk.
On the other hand, as described
below, higher financial responsibility
requirements for individual firms also
give rise to direct costs for the firms
involved and potentially significant
collective costs for the markets and the
financial system as a whole. For
example, overly restrictive requirements
that increase the cost of trading by
individual firms could reduce their
willingness to engage in such trading,
adversely affecting liquidity in the
security-based swaps markets and
increasing transaction costs for market
participants. Similarly, capital
requirements that are set high enough to
limit or restrict the willingness or ability
of new firms to enter the market may
impair or reduce competition in the
markets, which in turn could also
adversely affect liquidity and price
discovery and increase transaction
costs. Any such reduction in liquidity or
price discovery, or increase in
transaction costs, could adversely affect
efficiency and impose direct costs on
those market participants who rely on
security-based swaps to manage or
hedge the risks arising from their
business activities that may support or
promote capital formation. Even if the
cost of overly restrictive financial
responsibility requirements were
shouldered only by those market
participants that are subject to them, the
excess amount of capital or margin tied
up as a result of those requirements
would not be available for potentially
more efficient uses, which thereby
could impair effective capital allocation
and formation.
Although, in establishing appropriate
financial responsibility requirements
that are neither insufficient nor
excessive, the Commission must seek to
consider these and other potential
benefits and costs, the Commission
notes that it is difficult to quantify such
benefits and costs. For example,
although the adverse spillover effects of
defaults on liquidity and valuations
were evident during the financial
crisis,982 it is difficult to quantify the

981 See, e.g., Markus K. Brunnermeier and Lasse
Heje Pedersen, Market Liquidity and Funding
Liquidity, Review of Financial Studies, 22 Review
of Financial Studies 2201 (2009); Denis Gromb and
Dimitri Vayanos, A Model of Financial Market
Liquidity Based on Intermediary Capital, 8 Journal
of the European Economic Association 456 (2010).

982 See aggregate derivatives claims on Lehman
Brothers Special Finance initially filed by the top
30 financial institution counterparties was
estimated to be approximately $22 billion, available
at http://chapter11.epiqsystems.com/LBH/
document/
GetDocument.aspx?DocumentId=1386611 and

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
effects of measures intended to reduce
the default probability of the individual
intermediary, the ensuing prevention of
contagion, and the adverse effects on
liquidity and valuation. More broadly, it
is difficult to quantify the costs and
benefits that may be associated with
steps to mitigate or avoid a future
financial crisis. Similarly, although
capital, margin, or segregation
requirements may, among other things,
affect liquidity and transaction costs in
the security-based swap markets, and
result in a different allocation of capital
than may otherwise occur, it is difficult
to quantify the extent of these effects, or
the resulting effect on the financial
system more generally.
These difficulties are further
aggravated by the fact that only limited
public data related to the security-based
swap market, in general, and to securitybased swap market participants in
particular, exist, all of which could
assist in quantifying certain benefits and
costs. It also is difficult to demonstrate
empirically that the customer
protections associated with the
proposed financial responsibility
requirements would alter the likelihood
that any specific market participant
would suffer injury, or the degree to
which the participant would suffer
injury, from participating in an underor over-regulated security-based swap
market.
In light of these challenges, much of
the discussion of the proposed rules in
this economic analysis will remain
qualitative in nature, although where
possible the economic analysis attempts
to quantify these benefits and costs. The
inability to quantify these benefits and
costs, however, does not mean that the
benefits and costs of the proposals are
any less significant. In addition, as
noted above, the proposed rules include
a number of specific quantitative
requirements—such as numerical
thresholds, limits, deductions and
ratios. The Commission recognizes that
the specificity of each such quantitative
requirement could be read by some to
imply a definitive conclusion based on
quantitative analysis of that requirement
and its alternatives. These quantitative
requirements have not been derived
directly from econometric or
mathematical models. Instead, they
reflect a preliminary assessment by the
Commission, based on qualitative
analysis, regarding the appropriate
financial standard for an identified
issue, drawing (as noted above) from the
Commission’s long-term experience in
administering its existing broker-dealer
http://chapter11.epiqsystems.com/LBH/document/
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financial responsibility regime as well
as its general experience in regulating
broker-dealers and markets and from
comparable quantitative requirements in
its own rules and those of other
regulators. Accordingly, the discussion
generally describes in a qualitative way
the primary costs, benefits and other
economic effects that the Commission
has identified and taken into account in
developing these specific quantitative
requirements. The Commission
emphasizes that it invites comment,
including relevant data and analysis,
regarding all aspects of the various
quantitative requirements reflected in
the proposed rules.
Finally, the Commission notes that
the proposals ultimately adopted, like
other requirements under the DoddFrank Act, could have a substantial
impact on international commerce and
the relative competitive position of
intermediaries operating in various, or
multiple, jurisdictions. U.S. or foreign
firms could be advantaged or
disadvantaged depending on how the
rules ultimately adopted by the
Commission compare with
corresponding requirements in other
jurisdictions. Such differences could in
turn affect cross-border capital flows
and the ability of global firms to most
efficiently allocate capital among legal
entities to meet the demands of their
counterparties. The Commission intends
to address the potential international
implications of the proposed capital,
margin and segregation requirements,
together with the full spectrum of other
issues relating to the application of Title
VII to cross-border security-based swap
transactions, in a separate proposal.
a. Nonbank SBSDs
In addition to fulfilling a statutory
requirement, it is expected that the
proposed capital, margin and
segregation rules should be beneficial to
market participants by advancing
market transparency, risk reduction and
counterparty protection as Title VII of
the Dodd-Frank Act intended.983 It can
be further expected that these benefits
manifest themselves over the long-term
and benefit the market as a whole. To
the extent that the proposed rules
increase the safety and soundness of
entities that register as nonbank SBSDs
and not just codify current practice, the
proposals should specifically reduce the
likelihood of default by an intermediary
with substantial positions in securitybased swaps and possible negative
spillover effects. This would further
imply that without the proposed rules
in place, such an event could result in
983 See

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significant losses to counterparties
whose exposures to the defaulting
dealer are not sufficiently secured,
which, depending on the size of
individual counterparty exposures,
could lead to defaults of those
counterparties. Such events could then
deter intermediaries from entering into
financing transactions,984 even with
creditworthy counterparties, which
could ultimately adversely affect
valuation and liquidity in the broader
financial markets.985
Apart from the positive impact on the
safety and soundness of the securitybased swap market, the proposed new
rules and rule amendments could create
the potential for regulatory arbitrage to
the extent that they differ from
corresponding rules other regulators
adopt. As noted above in section I. of
this release, the Commission is
proposing capital and margin
requirements for nonbank SBSDs that
differ in some respects from the
prudential regulators’ proposed capital
and margin requirements for bank
SBSDs.986 Depending on the final rules
the Commission adopts, the financial
responsibility requirements could make
it more or less costly to conduct
security-based swaps trading in banks as
compared to nonbank SBSDs. For
example, if the application of the
proposed 8% margin risk factor
substantially increases capital
requirements for nonbank SBSDs
compared to the risk-based capital
requirements imposed by the prudential
regulators on the same activity, bank
holding companies could be
incentivized to conduct these activities
in their bank affiliates.987 On the other
hand, if the Commission does not
require nonbank SBSDs to collect initial
margin in their transactions with each
other, as is generally current market
practice,988 while the prudential
regulators require the collection of
initial margin for the same trades as
their proposed rules suggest,
intermediaries could have an incentive
984 See, e.g., Markus K. Brunnermeier and Lasse
Heje Pedersen, Market Liquidity and Funding
Liquidity, Review of Financial Studies at 22; Denis
Gromb and Dimitri Vayanos, A Model of Financial
Market Liquidity Based on Intermediary Capital at
8.
985 See aggregate derivatives claims on Lehman
Brothers Special Finance initially filed by the top
30 financial institution counterparties was
estimated to be approximately $22 billion, available
at http://chapter11.epiqsystems.com/LBH/
document/
GetDocument.aspx?DocumentId=1386611 and
http://chapter11.epiqsystems.com/LBH/document/
GetDocument.aspx?DocumentId=1430484.
986 See section I. of this release.
987 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564.
988 See generally ISDA Margin Survey 2011.

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to conduct business through nonbank
entities.989 These differences could
create competitive inequalities and
affect the allocation of trading activities
within a holding company structure.
The proposed financial responsibility
requirements for SBSDs would also
result in costs to individual market
participants and may affect the amount
of capital available to support securitybased swap transactions generally.990 As
described in section V.B.1 immediately
above, if SBSDs are required to maintain
an excessive amount of capital, that
amount may result in certain costs for
the markets and the financial system,
including the potential for the reduced
availability of security-based swaps for
market participants who would
otherwise use such transactions to
hedge the risks of their business, or
engage in other activities that would
promote capital formation. In addition,
in some cases, these costs may include
costs to financial conglomerates to
restructure their security-based swap
activities or move them into affiliates
that register as SBSDs.991 Nonbank
SBSDs as well as other market
participants would also incur costs to
hire compliance personnel and to
establish internal systems, procedures
and controls designed to ensure
compliance with the new requirements.
Some of these costs were discussed in
the PRA analysis in section IV of this
release. Finally, the full cost impact of
the proposed financial responsibility
requirements will depend to some
extent on other rules related to SBSDs
(e.g., registration) that the Commission
has not yet adopted.992
Costs related to specific sections of
the proposed new rules and rule
amendments are discussed below. Some
of these costs may be largely fixed in
nature; other costs (such as minimum
capital requirements and margin costs)
may be variable as they reflect the level
of the nonbank SBSD’s security-based
swap activity. End users also may incur
increased transaction costs in
connection with the proposals as SBSDs
are likely to pass on the financial
burden of any increased capital, margin
or segregation requirements to
customers.993
This economic analysis considers the
overall benefits and costs of the
989 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564.
990 See section II. of this release.
991 See SBSD Registration Proposing Release, 76
FR 65784.
992 Id.
993 If the rules succeed in improving competition
among dealers in the security-based swap market
rules this pass-through behavior should be less of
a concern.

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proposed new rules and amendments,
keeping in mind that the benefits may
be distributed across market
participants, accrue over the long-term,
and are difficult to quantify or to
measure as easily as certain costs.
Request for Comment
The Commission generally requests
comment about its analysis of the
general costs and benefits of the
proposed rules. The Commission
requests data to quantify and estimates
of the costs and the value of the benefits
of the proposals described above. The
Commission also requests data to
quantify the impact of the proposals
against the baseline. In addition, the
Commission requests comment in
response to the following questions:
1. In general terms, how effectively
would the proposed rules limit systemic
risk arising from security-based swap
transactions? Please explain.
2. In general, how would the
proposed rules and rule amendments
impact the capital of entities that would
need to register as nonbank SBSDs? For
example, would they require these
entities to hold more capital? If so, what
would be the impact of the availability
of sources of funding to these entities?
3. How important is parity of
treatment between nonbank SBSDs and
bank SBSDs in terms of regulatory
requirements, and how should parity be
understood? For example, should
nonbank SBSDs and bank SBSDs be
required to hold the same amounts of
capital to support a certain level of
security-based swaps business?
4. To what extent would the proposed
regulatory requirements impact the
amount of liquidity provided for or
required by security-based swap market
participants, and to what extent will
that affect the funding cost for the
financial sector in particular and the
economy in general? Please quantify.
b. Nonbank MSBSPs
As with their application to nonbank
SBSDs, in addition to fulfilling a
statutory requirement, it is expected that
the proposed capital, margin and
notification requirements under the
segregation rules for MSBSPs will
advance market transparency, risk
reduction and counterparty protection
as Title VII of the Dodd-Frank Act
intended.994 However, in contrast to
capital and margin requirements for
nonbank SBSDs, the proposed rules for
nonbank MSBSPs are intended to limit
the impact on counterparties of a
potential default by a nonbank MSBSP,
rather than to create prudential
994 See

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standards that would render the
possibility of its failure more remote.
Capital standards of the type that would
apply to SBSDs 995 may not be practical
for nonbank MSBSPs, depending on
their individual business models and
whether they are subject to any other
prudential requirements. Accordingly,
the proposals are intended to ensure
that nonbank MSBSPs meet a minimum
capital standard by maintaining a
positive tangible net worth,996
collateralize their current exposures to
end users, and post collateral to
counterparties that covers at least the
amount of the current exposure of those
counterparties to them.997
These proposed requirements are
expected to have a relatively smaller
aggregate effect than the proposed
financial responsibility requirements for
nonbank SBSDs because they are likely
to affect relatively fewer entities. The
Commission expects that only 5 or
fewer entities will register as nonbank
MSBSPs with the Commission.998
Another approach, discussed further
below, would subject MSBSPs to a
capital regime similar to that proposed
for nonbank SBSDs.
The proposed financial responsibility
requirements for MSBSPs would also
result in costs to individual market
participants and may affect the amount
of capital available to support securitybased swap transactions overall and the
financial markets generally. To the
extent that the proposed capital and
margin requirements are too restrictive,
it could limit capital formation and the
use of security-based swaps to hedge
risks associated with the MSBSP’s
business activities.999
The proposed requirements may also
impose more limited compliance
burdens on MSBSPs. For example,
nonbank MSBSPs as well as other
market participants would also incur
costs to hire compliance personnel and
to establish internal systems, procedures
and controls designed to ensure
compliance with the new
requirements.1000 Some of these costs
are discussed in the PRA analysis in
section IV. of this release. Finally, the
full cost impact of the proposed
financial responsibility requirements
will depend to some extent on other
rules related to MSBSPs (e.g.,
registration) that the Commission has
not yet adopted.1001
995 See

proposed new Rule 18a–1.
proposed new Rule 18a–2.
997 See proposed new Rule 18a–3.
998 See section IV.C. of this release.
999 See section II. of this release.
1000 See section V.C. of this release.
1001 See SBSD Registration Proposing Release, 76
FR 65784.
996 See

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
Costs related to specific sections of
the proposed new rules and rule
amendments are discussed below. Some
of these costs may be largely fixed in
nature; other costs (such as minimum
capital requirements and margin costs)
may be variable as they reflect the level
of the nonbank MSBSP’s security-based
swap activity.
Request for Comment
The Commission generally requests
comment about its analysis of the
general costs and benefits of the
proposed rules on MSBSPs. The
Commission requests data to quantify
and estimates of the costs and the value
of the benefits of the proposals for
MSBSPs described above.

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

2. The Proposed Capital Rules
a. Nonbank SBSDs and ANC BrokerDealers
As discussed above in section II.A. of
this release, proposed new Rule 18a–1
would prescribe capital requirements
for stand-alone SBSDs, and proposed
amendments to Rule 15c3–1 would
prescribe capital requirements for
broker-dealer SBSDs and increase
existing capital requirements for ANC
broker-dealers.1002 The proposed
amendments to Rule 15c3–1 would
apply to broker-dealers that are not
registered as SBSDs to the extent they
hold positions in security-based swaps
and swaps. In addition, the Commission
is proposing liquidity requirements for
ANC broker-dealers and stand-alone
SBSDs that use internal models to
compute net capital.1003 Finally, the
Commission is proposing to require that
all nonbank SBSDs comply with Rule
15c3–4, which requires the
establishment of a risk management
control system.1004
As described above, the capital and
other financial responsibility
requirements for broker-dealers
generally provide a reasonable template
for crafting the corresponding
requirements for nonbank SBSDs. For
example, among other considerations,
the objectives of capital standards for
both types of entities are similar. Rule
15c3–1 is a net liquid assets test that is
designed to require a broker-dealer to
maintain sufficient liquid assets to meet
all obligations to customers and
counterparties and have adequate
additional resources to wind-down its
business in an orderly manner without
1002 See

proposed new Rule 18a–1.
proposed paragraph (f) to Rule 15c3–1;
paragraph (f) of proposed new Rule 18a–1.
1004 See proposed new paragraph (a)(10)(ii) of
Rule 15c3–1; paragraph (g) of proposed new Rule
18a–1. See also 17 CFR 240.15c3–4.
1003 See

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the need for a formal proceeding if it
fails financially. The objective of the
proposed capital standards for nonbank
SBSDs is the same.
In addition, as discussed in section
II.A.1. above, the Dodd-Frank Act
divided responsibility for SBSDs and
MSBSPs by providing the prudential
regulators with authority to prescribe
the capital and margin requirements for
bank SBSDs and the Commission with
authority to prescribe capital and
margin requirements for nonbank
SBSDs.1005 This division also suggests it
may be appropriate to model the capital
requirements for nonbank SBSDs on the
capital standards for broker-dealers,
while the capital requirements for bank
SBSDs are modeled on capital standards
for banks (as reflected in the proposal by
the prudential regulators).1006
As discussed in section II.A.1. above,
certain differences in the activities of
securities firms, banks, and
commodities firms, differences in the
products at issue, or the balancing of
relevant policy choices and
considerations, appear to support this
distinction between nonbank SBSDs
and bank SBSDs. First, based on the
Commission staff’s understanding of the
activities of nonbank dealers in OTC
derivatives, nonbank SBSDs are
expected to engage in a securities
business with respect to security-based
swaps that is more similar to the dealer
activities of broker-dealers than to the
activities of banks; indeed, some brokerdealers likely will be registered as
nonbank SBSDs.1007 Second, existing
capital standards for banks and brokerdealers reflect, in part, differences in
their funding models and access to
certain types of financial support, and
those same differences also will exist
between bank SBSDs and nonbank
SBSDs. For example, banks obtain
funding through customer deposits and
can obtain liquidity through the Federal
Reserve’s discount window; whereas
broker-dealers do not—and nonbank
SBSDs will not—have access to these
sources of funding and liquidity. Third,
Rule 15c3–1 currently contains
provisions designed to address dealing
in OTC derivatives by broker-dealers
and, therefore, to some extent already
can accommodate this type of activity
(although, as discussed below, proposed
amendments to Rule 15c3–1 would be
designed to more specifically address

the risks of security-based swaps and
the potential for increased involvement
of broker-dealers in the security-based
swaps markets).1008 For these reasons,
the proposed capital standard for
nonbank SBSDs is a net liquid assets
test modeled on the broker-dealer
capital standard in Rule 15c3–1.
The net liquid assets test is designed
to allow a broker-dealer to engage in
activities that are part of conducting a
securities business (e.g., taking
securities into inventory) but in a
manner that places the firm in the
position of holding at all times more
than one dollar of highly liquid assets
for each dollar of unsubordinated
liabilities (e.g., money owed to
customers, counterparties, and
creditors). For example, Rule 15c3–1
allows securities positions to count as
allowable net capital, subject to
standardized or internal model-based
haircuts.1009 The rule, however, does
not permit most unsecured receivables
to count as allowable net capital.1010
This aspect of the rule severely limits
the ability of broker-dealers to engage in
activities, such as unsecured lending,
that generate unsecured receivables. The
rule also does not permit fixed assets or
other illiquid assets to count as
allowable net capital, which creates
disincentives for broker-dealers to own
real estate and other fixed assets that
cannot be readily converted into cash.
For these reasons, Rule 15c3–1
incentivizes broker-dealers to confine
their business activities and devote
capital to activities such as
underwriting, market making, and
advising on and facilitating customer
securities transactions.
Proposed new Rule 18a–1 and the
proposed amendments to Rule 15c3–1
would provide a number of benefits, as
well as impose certain costs on nonbank
SBSDs, broker-dealer SBSDs, and
broker-dealers, which are described
below. In considering costs, in cases
where the Commission is proposing
amendments to Rule 15c3–1, the
baseline is the current broker-dealer
capital regime under Rule 15c3–1.1011
The proposed rule also will have
possible effects on competition,
efficiency, and capital formation, which
will be discussed further below.

1005 See 15 U.S.C. 78o–10, in general; 15 U.S.C.
78o–10(e)(2)(A)–(B), in particular.
1006 The prudential regulators have proposed
capital requirements for bank SBSDs and bank swap
dealers that are based on the capital requirements
for banks. See Prudential Regulator Margin and
Capital Proposing Release, 76 FR at 27582.
1007 Id.

1008 See 17 CFR 240.15c3–1f and 17 CFR
240.15c3–1e. See also Alternative Net Capital
Requirements Adopting Release, 69 FR 34428; OTC
Derivatives Dealers, 63 FR 59362.
1009 See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR
240.15c3–1e; 17 CFR 240.15c3–1f.
1010 See 17 CFR 240.15c3–1(c)(2)(iv).
1011 17 CFR 240.15c3–1.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

i. Minimum Capital Requirements

capital requirements under the
proposed new Rule 18a–1 and proposed
amendments to Rule 15c3–1:

The following table provides a
summary of the proposed minimum

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Stand-alone SBSDs and broker-dealer
SBSDs that are not approved to use
internal models, that is, are neither ANC
broker-dealers nor OTC derivatives
dealers, would be required to maintain
net capital of the larger of $20 million
or 8% of the firm’s margin factor. The
proposed $20 million fixed-dollar
minimum requirement would be
consistent with the fixed-dollar
minimum requirement applicable to
OTC derivatives dealers and already
familiar to existing market
participants.1012 OTC derivatives
dealers are limited purpose brokerdealers that are authorized to trade in
certain derivatives, including securitybased swaps, use internal models to
calculate net capital, and they are
required to maintain minimum tentative
net capital of $100 million and
minimum net capital of $20 million.1013
These current fixed-dollar minimums
have been the minimum capital
standards for OTC derivative dealers for
over a decade and to date, there have
been no indications that these
minimums are not adequately meeting
the objective of requiring OTC
derivatives dealers to maintain
sufficient levels of regulatory capital to
1012 See 17 CFR 240.15c3–1(a)(5). The CFTC
proposed a $20 million fixed-dollar minimum net
capital requirement for FCMs that are registered as
swap dealers, regardless of whether the firm is
approved to use internal models to compute
regulatory capital. See CFTC Capital Proposing
Release, 76 FR 27802. Further, the CFTC proposed
a $20 million fixed-dollar ‘‘tangible net equity’’
minimum requirement for swap dealers and major
swap participants that are not FCMs and are not
affiliated with a U.S. bank holding company.
Finally, the CFTC proposed a $20 million fixeddollar Tier 1 capital minimum requirement for
swap dealers and major swap participants that are
not FCMs and are affiliated with a U.S. bank
holding company (the term ‘‘Tier 1 capital’’ refers
to the regulatory capital requirement for U.S.
banking institutions). Id.
1013 See 17 CFR 240.15c3–1(a)(5).

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account for the risks inherent in their
activities.
However, the proposed $20 million
fixed-dollar minimum requirement for
stand-alone SBSDs not using internal
models to calculate net capital would be
substantially higher than the fixeddollar minimums in Rule 15c3–1
currently applicable to broker-dealers
that do not use internal models.1014 The
proposed more stringent minimum
capital requirement of $20 million for
stand-alone SBSDs not approved to use
models reflects the facts that these
firms: (1) Unlike broker-dealers, will be
able to deal in security-based swaps,
which, in general, pose risks that are
different from, and in some respects
greater than, those arising from dealing
in securities; but (2) unlike OTC
derivative dealers have direct customer
relationships and have custody of
customer funds.1015 Therefore, without
the increased requirements, a failure of
a stand-alone SBSD would, ceteris
paribus, be more likely than a failure of
an OTC derivatives dealer and, as a
consequence of the relationships with
customers, would have a broader
adverse impact on a larger number of
market participants, including
customers and counterparties.1016
1014 For example, a broker-dealer that carries
customer accounts has a fixed-dollar minimum
requirement of $250,000; a broker-dealer that does
not carry customer accounts but engages in
proprietary securities trading (defined as more than
ten trades a year) has a fixed-dollar minimum
requirement of $100,000; and a broker-dealer that
does not carry accounts for customers or otherwise
receive or hold securities and cash for customers,
and does not engage in proprietary trading
activities, has a fixed-dollar minimum requirement
of $5,000. See 17 CFR 240.15c3–1(a)(2).
1015 See 17 CFR 240.3b–12; 17 CFR 240.15a–1.
1016 The proposal is consistent with the CFTC’s
proposed capital requirements for nonbank swap
dealers, which impose $20 million fixed-dollar
minimum requirements regardless of whether the

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Consequently, these heightened
requirements should enhance the safety
and soundness of the nonbank SBSDs,
and thereby reduce systemic risk, as
well as increase market participants’
confidence in the security-based swap
markets. Stand-alone SBSDs not
approved to use internal models would
not, however, be subject to a minimum
tentative net capital requirement, which
is applied to only firms that use internal
models to account for risks not fully
captured by the models.1017
Stand-alone SBSDs using models
would be required to maintain
minimum net capital of the higher of
$20 million or the 8% margin factor, as
well as a minimum tentative net capital
of $100 million, a requirement that also
applies to OTC derivatives dealers.
Models to calculate deductions from
tentative net capital for proprietary
positions take only market and credit
risk into account and therefore generally
lead to lower deductions and higher
levels of net capital.1018 The minimum
firm is approved to use internal models to compute
regulatory capital. See CFTC Capital Proposing
Release, 76 FR 27802.
1017 OTC derivatives dealers are subject to a $100
million minimum tentative net capital requirement.
ANC broker-dealers are currently subject to a $1
billion minimum tentative net capital requirement.
The minimum tentative net capital requirements are
designed to address risks that may not be captured
when using internal models rather than
standardized haircuts to compute net capital. See
OTC Derivatives Dealers, 63 FR at 59384;
Alternative Net Capital Requirements for BrokerDealers That Are Part of Consolidated Supervised
Entities; Proposed Rule, Exchange Act Release No.
48690 (Oct. 24, 2003), 68 FR 62872, 62875 (Nov. 6,
2003).
1018 See, e.g., Alternative Net Capital
Requirements Adopting Release, 69 FR at 34455
(describing benefits of alternative net capital
requirements for broker-dealers using models
stating a ‘‘major benefit for the broker-dealer will
be lower deductions from net capital for market and
credit risk that we expect will result from the use
of the alternative method.’’). Therefore, it is likely

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
tentative net capital requirement for
firms using models is intended to
provide an additional assurance of
adequate capital to reflect this concern.
However, because the tentative net
capital calculation does not take
account of market risk deductions, the
minimum $100 million tentative net
capital requirement might be a less
effective standard in cases where a
dealer maintains a substantial amount of
less liquid positions that require
relatively large deductions for market
risk. As an alternative, the Commission
could impose a minimum requirement
that increases according to the nature
and size of the positions held, for
example, 25% of the market risk
deductions that are required to be taken
in determining actual net capital. This
approach could better scale the tentative
net capital requirement according to the
risk of the proprietary positions held by
an SBSD. On the other hand, a variable
tentative net capital test would not serve
as an accurate measure of risk if the
model did not appropriately capture all
material risks of the positions or the
assumptions underlying the use of the
model were no longer appropriate. The
variable tentative net capital test also
could increase the tentative net capital
requirement in some cases to a level that
could limit or discourage the entry of
firms that do not presently compete in
the security-based swap markets.
Further, as noted above, the minimum
net capital requirement in each case
would increase in accordance with an
increase in the amount of business
conducted as a result of the 8% margin
factor. The Commission is specifically
seeking comment on this alternative in
section II.A.1. of this release.
Under the proposed amendments to
Rule 15c3–1, ANC broker-dealers would
be required to maintain: (1) Tentative
net capital of not less than $5 billion;
and (2) net capital of not less than the
greater of $1 billion or the financial ratio
amount required pursuant to paragraph
(a)(1) of Rule 15c3–1 plus the 8%
margin factor.1019 These relatively high
minimum capital requirements for ANC
dealers (as compared with the
requirements for other types of brokerdealers) reflect the substantial and
diverse range of business activities
engaged in by ANC broker-dealers and
their importance as intermediaries in
that for new entrants to capture substantial volume
in security-based swaps they will need to use VaR
models. See also OTC Derivatives Dealer Release,
63 FR 59362 (discussing benefits of minimum
capital requirements as an additional measure of
protection).
1019 See proposed amendments to paragraph
(a)(7)(i) of Rule 15c3–1.

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the securities markets.1020 Further, the
heightened capital requirements reflect
the fact that, as noted above, VaR
models are more risk sensitive but also
generally permit substantially reduced
deductions to tentative net capital as
compared to the standardized haircuts
as well as the fact that VaR models may
not capture all risks.1021
Based on financial information
reported by the ANC broker-dealers in
their monthly FOCUS Reports filed with
the Commission, the six current ANC
broker-dealers maintain capital levels in
excess of these proposed increased
minimum requirements. For example, at
the end of 2011, the interquartile range
of net capital and tentative net capital
levels among the six ANC broker-dealers
were from $1.11 billion to $7.77 billion
and from $1.32 billion to $9.69 billion,
respectively. Further, ANC brokerdealers are currently required to notify
the Commission if their tentative net
capital falls below $5 billion.1022 This
notification provision is used by the
Commission to trigger increased
supervision of the firm’s operations and
to take any necessary corrective action
and is similar to corollary ‘‘early
warning’’ requirements for OTC
derivatives dealers.1023 Consequently,
this $5 billion ‘‘early warning’’ level
currently acts as the de facto minimum
tentative net capital requirement since
the ANC broker-dealers seek to avoid
providing this regulatory notice that
their tentative net capital has fallen
below the early warning level.1024
Although increases to minimum
tentative and minimum net capital
requirements are being proposed, the
proposals may not present a material
cost to the current ANC broker-dealers,
because they already hold more than the
proposed minimum requirements in the
amendments to Rule 15c3–1. The more
relevant number is the proposed
increase in the early warning
notification threshold from $5 billion to
$6 billion. The existing early warning
requirement for OTC derivatives dealers
triggers a notice when the firm’s
tentative net capital falls below an
1020 As noted above, the six ANC broker-dealers
collectively hold in excess of one trillion dollars’
worth of customer securities.
1021 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
1022 17 CFR 240.15c3–1(a)(ii).
1023 OTC derivatives dealers are required to
provide notification promptly (but within 24 hours)
if their tentative net capital falls below 120% of the
firm’s required minimum tentative net capital
amount. See 17 CFR 240.17a–11(c)(3). Rule 17a–11
also requires ANC broker-dealers and OTC
derivatives dealers to provide same day notification
if their tentative net capital falls below required
minimums. See 17 CFR 240.17a–11(b)(2).
1024 See 17 CFR 240.15c3–1(a)(7)(i).

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amount that is 120% of the firm’s
required minimum tentative net capital
amount of $100 million ($120 million =
1.2 × $100 million).1025 The proposed
new ‘‘early warning’’ threshold for ANC
broker-dealers of $6 billion (= 1.2 × $5
billion) in tentative net capital is
modeled on this requirement. In
general, because the amount of actual
net capital is subject to volatility
commensurate with market volatility in
proprietary instruments, the
Commission expects ANC brokerdealers to maintain a reasonable
cushion in excess of the minimum.
Since, based on the Commission staff’s
supervision of the ANC broker-dealers,
the current ANC broker-dealers report
tentative net capital levels generally
well in excess of $6 billion, the costs to
the ANC broker-dealers to comply with
this new requirement are not expected
to be material.1026 However, these costs
may be prohibitive to new entrants that
wish to register as broker-dealer SBSDs
using internal models if they currently
do not, or cannot, maintain these
proposed capital levels. As noted below,
such barriers to entry may prevent or
reduce competition among SBSDs,
which in turn can lead to higher
transaction costs and less liquidity than
would otherwise exist.
In addition to the proposed minimum
fixed tentative and minimum net capital
requirements, the proposed 8% margin
factor would be part of determining a
nonbank SBSD’s minimum net capital
requirement.1027 The 8% margin factor
is intended to establish a minimum
capital requirement that scales with the
level of a nonbank SBSD’s securitybased swap activity and to limit the
amount of leverage a nonbank SBSD can
employ by requiring an increase in
capital commensurate with the amount
of leverage extended.
The 8% margin factor ratio
requirement also is similar to an
existing requirement in the CFTC’s net
capital rule for FCMs,1028 and the CFTC
has proposed a similar requirement for
swap dealers and major swap
participants registered as FCMs.1029
1025 See

17 CFR 240.17a–11(c)(3).

1026 Id.
1027 Since the 8% margin factor would be additive
to the minimum capital requirements for ANC
broker-dealers conducting a security-based swap
business, the cost impact to an ANC broker-dealer
using its current minimum capital requirements
under Rule 15c3–1 and 15c3–1e as a baseline,
would at minimum, increase by the 8% margin
factor.
1028 See 17 CFR 1.17(a)(1)(i)(B).
1029 See CFTC Capital Proposing Release, 76 FR
27802. The 8% calculation under the CFTC’s
proposal relates to cleared swaps or futures
transactions, whereas the 8% margin factor

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Under the CFTC’s proposal, an FCM
would be required to maintain adjusted
net capital 1030 that is equal to or greater
than 8% of the risk margin required for
customer and non-customer exchangetraded futures and swaps positions that
are cleared by a DCO.1031 Because
exchange-traded futures, however, are
generally more liquid and give rise to
lower margins than non-cleared
security-based swaps with the same
notional amount, the proposed 8%
margin factor (which includes margin
for both cleared and non-cleared swaps)
would require allocating substantially
more capital to support a non-cleared
security-based swap contract compared
to a futures contract. Requiring such
additional capital could impose the
types of costs on these firms and the
markets more generally that are
described above in section V.B.1. of this
release. On the other hand, applying the
8% margin factor to non-cleared
security-based swaps (rather than just
cleared security-based swaps) would
permit the nonbank SBSD’s minimum
capital requirement to vary based on
this aspect of its business, which can
entail similar leverage and present
proposed in new Rule 18a–1 would be based on
cleared and non-cleared security-based swaps.
1030 The CFTC has proposed that swap dealers
and major swap participants that are also FCMs
would be required to meet the existing FCM
requirement to hold minimum levels of adjusted net
capital, and also would be required to calculate the
required minimum level as the greatest of the
following: (1) A fixed dollar amount which under
the CFTC’s proposed rules would be $20 million;
(2) the amount required for FCMs that also act as
retail foreign exchange dealers; (3) 8% of the
proposed risk margin; (4) the amount required by
a registered futures association of which the FCM
is a member; or (4) for an FCM, that is also a brokerdealer, the amount required by Commission rules.
See CFTC Capital Proposing Release, 76 FR 27802.
1031 See CFTC Capital Proposing Release, 76 FR
27802. The CFTC’s proposed 8% margin
requirement is intended to establish a minimum
capital requirement that corresponds to the level of
risk arising from the FCM’s swap activity. Id. at
27807. One commenter objected to the inclusion of
the 8% test in the CFTC’s capital proposal, noting
that margin and capital are complementary
concepts in that both incorporate counterparty risk,
and accordingly, the higher the initial margin
requirement for a particular swap, the less
regulatory capital a swap dealer should need to
carry the client’s position. The commenter believed
that the CFTC’s 8% charge would lead to
allocations of dealer and client funding and capital
to client portfolios in amounts disproportionately
large in comparison to the risks of the relevant
transactions. This commenter recommended to the
CFTC that the CFTC defer incorporating swaps into
the 8% margin multiplier for capital until after
margin and capital requirements are finalized and
the CFTC and market participants have had an
opportunity to evaluate margin levels and the
interrelationship between swap margin and capital.
Letter from John M. Damgard, President, Futures
Industry Association, Robert G. Pickel, Chief
Executive Officer, ISDA and Kenneth E. Bentsen,
Jr., Executive Vice President, Public Policy and
Advocacy, SIFMA, to the CFTC (July 7, 2011)
(‘‘FIA/ISDA/SIFMA Comment Letter to the CFTC’’).

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greater credit risk than cleared securitybased swaps. This would have the
benefit of further promoting the goals of
the financial responsibility rules
described above in section V.B.1. of this
release.
Based on FOCUS Report information
as of year-end 2011, approximately ten
broker-dealers, including the current
ANC broker-dealers, maintain tentative
net capital in excess of $5 billion,1032
approximately 31 broker-dealers
maintain net capital in excess of $1
billion, approximately 145 brokerdealers maintain tentative net capital in
excess of $100 million, and
approximately 270 broker-dealers
maintain net capital in excess of $20
million.
Although the proposed increase in
minimum capital and early warning
requirements for ANC broker-dealers
will not affect firms that already have
this classification, it would reduce the
number of additional firms (from 31 to
4, according to FOCUS Report data) that
would currently qualify for this
designation and hence represents a
significant potential cost for additional
registrants. As noted above, these costs
may be prohibitive to new entrants that
wish to register as ANC broker-dealer
SBSDs using internal models. If these
additional costs were not imposed or
were lower, there might be greater
opportunities for more competition in
the security-based swap markets, which
in turn could lower transaction costs
and increase liquidity in these markets.
However, setting capital levels that
allow new entrants that do not have
sufficient capital to engage in the
diverse business of ANC broker dealers
could be disruptive to the market. In
addition, to the extent that potential
new entrants are able to operate
effectively in these markets as standalone SBSDs (i.e., swap dealers that are
not registered as broker-dealers), they
would be eligible for lower minimum
capital requirements and competition
could further increase without
compromising the heightened
requirements for ANC broker-dealers.
With respect to the derivatives
markets in particular, it is difficult to
quantify the impact of the proposed
capital requirements against the
baseline of the OTC derivatives markets
as they exist today because prior to the
adoption of Title VII, swaps and
security-based swaps were by and large
unregulated.1033 As discussed above in
1032 These 10 broker-dealers also maintain
tentative net capital in excess of $6.0 billion based
on FOCUS Report information as of year-end 2011.
1033 See Product Definitions Adopting Release, 77
FR 48207.

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section V.A. of this release, however,
most trading in security-based swaps
and other derivatives is currently
conducted by large banks and their
affiliates. Among these entities are the
current ANC broker-dealers. Other
broker-dealers affiliated with firms
presently conducting business in
security-based swaps may be among the
270 broker-dealers that maintain net
capital in excess of $20 million.
Consequently, broker-dealers presently
trading in security-based swaps may not
need to raise significant new amounts of
capital in order to register as nonbank
SBSDs. At the same time, the proposed
minimum capital requirements could
discourage entry by entities other than
the approximately 270 broker-dealers
that already have capital in excess of the
required minimums.
As discussed above in section II.A.1.
of this release, the Commission is
seeking comment on possible
modifications to the capital
requirements in ways that may lessen
potential compliance costs. First, to the
extent that a nonbank SBSD that is
approved to use models may be required
to register as a broker-dealer solely to
conduct certain brokerage activity, e.g.,
sending customer orders for execution
to a security-based swap execution
facility, the Commission could modify
the capital requirements by setting
lower minimum capital requirements
for such firms than apply to ANC
broker-dealers. Further, the
requirements for OTC derivatives
dealers could be amended to allow these
firms to conduct a broader range of
activities. This modification could
increase the ability of firms that are not
capitalized at minimum capital
requirements proposed for the ANC
firms to use models and compete for
business in security-based swaps.
The Commission also could consider
modifications that would increase the
flexibility for a broader group of firms
to conduct a derivatives business that
extends beyond security-based swaps.
For example, the Commission could
determine to allow a firm to register
jointly as an OTC derivatives dealer and
SBSD. This modification could allow
the registrant to conduct a broader range
of derivatives activities than dealing
only in security-based swaps, and to be
able to use internal models for capital
purposes without being subject to much
higher capital requirements that apply
to ANC broker-dealers. On the other
hand, there could be practical
difficulties in merging the registration
regimes. For example, because OTC
derivatives dealers are prohibited from
having custody of customers’ assets,
while nonbank SBSDs would be

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
permitted to do so, subject to
compliance with new Rule 18a–4, dual
registrants could be required to
maintain separate sets of compliance
processes and procedures, based on
product type.
Alternatively, the Commission could
provide conditional relief on a case-bycase basis to allow a firm that is
registered as an SBSD to conduct
dealing activity in derivatives other than
security-based swaps. This also could
provide a means for an entity to do
business in a broad set of derivative
instruments, subject to the basic capital
standards that would apply to SBSDs.
This approach also could allow the
Commission to fashion exemptive relief
on a case-by-case basis, pending further
consideration of how and whether to
reconcile the SBSD and OTC derivatives
dealer regimes. On the other hand,
allowing SBSDs to deal in products that
OTC derivatives dealers can deal in,
without the restrictions that apply to
their activities, could undermine the
purpose for the restrictions. The
Commission is specifically soliciting
comment on these potential approaches
above in section II.A.1.

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ii. Standardized Haircuts
As discussed in section II.A.2.b.ii. of
this release, under proposed new Rule
18a–1 and the amendments to Rule
15c3–1, a nonbank SBSD would be
required to apply standardized haircuts
to its proprietary positions, unless the
Commission approved it to use internal
models for specific positions. In general,
all haircut regimes are intended to be
conservative estimates of risk as they
tend to overcompensate for the actual
risks and hence generally impose higher
costs in terms of capital compared to
VaR models.1034
As discussed in section II.A.2.b.ii. of
this release, for positions that are not
security-based swaps, broker-dealer
SBSDs and stand-alone SBSDs also
would be required to apply the
standardized haircuts currently set forth
in Rule 15c3–1.1035 Standardized
‘‘haircuts’’ for credit default swaps
would be based on a maturity grid
1034 Commenters to the proposed CFTC capital
rule for swap dealers stated that they believe that
model-based approaches are generally superior to
grid-based approaches. One commenter argued that
grid-based approaches are generally insufficiently
risk sensitive, are not part of integrated risk
management systems, and are hard to keep up-todate to include innovative product and trading
strategies. FIA/ISDA/SIFMA Comment Letter to the
CFTC. Grid-based approaches, however, provide
alternatives to firms that are unable to or chose not
to use models.
1035 See 17 CFR 240.15c3–1(c)(2)(vi); paragraph
(c)(1)(vii) of proposed new Rule 18a–1. See also
section II.A.2.b.vi. of this release (discussing the
treatment of swaps).

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approach. Modeled after similar
‘‘haircut’’ approaches currently
employed under Rule 15c3–1, the
proposed approach for credit default
swaps is designed to be more risksensitive than a haircut approach that
determines market deductions based on
the type of each position without
recognizing offsets among securities
with similar risk characteristics (the
proposed rules also permit firms to
reduce the required haircut for certain
netted positions). The number of
maturity and spread categories in the
proposed grid for credit default swaps is
based on staff experience with the
maturity grids for other securities in
Rule 15c3–1 and, in part, on FINRA
Rule 4240.1036 While the haircut grid
design takes into account that positions
in credit defaults swaps with larger
spreads or longer tenors are riskier and
hence should be supported by larger
haircuts, the Commission is specifically
seeking comment on the design of the
grid and particularly whether the
haircuts appropriately reflect the risk
inherent in long and short positions of
credit defaults swaps across the spread
and tenor spectrum.
Security-based swaps that are not
credit default swaps can be divided into
two broad categories: Those that
reference equity securities and those
that reference debt instruments. Since
each type of security-based swap can be
viewed as being equivalent to a highlylevered synthetic position in the
referenced instrument and therefore has
the same price volatility as the
referenced instrument, the standardized
haircut for these categories of securitybased swaps would be the deduction
currently prescribed in Rule 15c3–1
applicable to the instrument referenced
by the security-based swap multiplied
by the contract’s notional amount.1037 It
1036 See Notice of Filing and Order Granting
Accelerated Approval of Proposed Rule Change to
Amend FINRA Rule 4240 (Margin Requirements for
Credit Default Swaps), Exchange Act Release No.
66527 (Mar. 7, 2012) (File No. SR–FINRA–2012–
015) (in which FINRA amended the maturity grid
in Rule 4240 in the interest of regulatory clarity and
efficiency, and based upon FINRA’s experience in
the administration of the rule). While FINRA Rule
4240 is one reference point, the maturity grid it
specifies does not appear to have been widely used
by market participants, in part because a significant
amount of business in the current credit default
swap market is conducted by entities that are not
members of FINRA.
1037 See proposed new paragraph (c)(2)(vi)(O)(2)
of Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed
new Rule 18a–1. For example, if a dealer
maintained a position in a security-based swap with
a notional amount of $1 million that provided the
dealer with long exposure to a nonconvertible debt
security maturing in 21⁄2 years (assuming no
offsetting short positions), the dealer would look to
Rule 15c3–1(c)(2)(vi)(F) to find the applicable
haircut percentage (5%) and the firm would be
required to take a capital deduction of $50,000.

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70311

is likely that a nonbank SBSD that
maintains substantial positions in such
instruments would maintain portfolios
of multiple instruments in such
categories with offsetting long and short
positions to hedge its risk.
Under the Commission’s proposed
standardized haircuts for these
categories of security-based swaps,
nonbank SBSDs would also be able to
recognize the offsets currently permitted
under Rule 15c3–1.1038 In particular, as
discussed below, nonbank SBSDs would
be permitted to treat equity securitybased swaps under the provisions of
Appendix A to Rule 15c3–1, which
produces a single haircut for portfolios
of equity options and related
positions.1039 This method would
permit a nonbank SBSD to compute
deductions for a portfolio of equity
security-based swaps using a
comprehensive risk perspective by
accounting for the risk of the entire
portfolio, rather than the risk of each
position within the portfolio.1040
Appendix A provides a relatively less
costly mechanism for a nonbank SBSD
to calculate haircuts (in contrast to the
standardized haircuts) since it is used
for other equity derivatives and
generally may reduce haircuts for a
nonbank SBSD by allowing a swap
referencing an equity security to be
considered as part of a related portfolio.
This, in turn, may permit a nonbank
SBSD to more efficiently deploy this
capital savings in other areas of its
operations, as well as enhance
operational efficiencies.
Similarly, nonbank SBSDs would be
permitted to treat a debt security-based
swap in the same manner as debt
instruments are treated in the Rule
15c3–1 grids in terms of allowing offsets
between long and short positions where
the instruments are in the same maturity
categories, subcategories, and in some
cases, adjacent categories.1041
Consequently, nonbank SBSDs could
recognize the offsets and hedges that
those provisions permit to reduce the
deductions on portfolios of debt
security-based swaps, and thereby
reduce their capital costs. This, in turn,
may permit a nonbank SBSD to more
efficiently deploy this capital savings in
other areas of its operations.
The proposed approaches, like other
types of standardized haircuts, likely
will require a higher amount of capital
to conduct security-based swaps
1038 See proposed new paragraph (c)(2)(vi)(O)(2)
of Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed
new Rule 18a–1.
1039 See 17 CFR 240.15c3–1a; Appendix A to
proposed new Rule 18a–1.
1040 See section II.A.2.b.ii. of this release.
1041 See 17 CFR 240.15c3–1(c)(2)(vi).

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business, in contrast to a VaR model.
While the standardized haircuts and
proposed CDS grid recognize certain
offsets, standardized haircuts generally
result in higher costs of capital because
the standardized approaches do not
recognize other ways in which a
nonbank SBSD may mitigate its
exposures, including unwinding
unprofitable trades, entering into certain
hedges that would not be recognized
under the proposed capital rules, and
portfolio diversification. The higher
amounts that may result from using the
standardized haircut and a grid-based
approach 1042 may be acceptable for
nonbank SBSDs that occasionally trade
in security-based swaps but not in a
substantial enough volume to justify the
initial and ongoing systems and
personnel costs to develop, implement,
and monitor the performance of internal
models. On the other hand, firms that
conduct a substantial business in
securities-based swaps in general will
need to use the more cost-efficient
models to measure and manage the risks
of their positions over time.
The benefit of the standardized
haircut approach of measuring market
risk, besides its inherent simplicity, is
that it may reduce the likelihood of
default or failure by nonbank SBSDs
that have not demonstrated that they
have the risk management capabilities,
of which VaR models are an integral
part, or capital levels to support the use
of VaR models. Therefore, the
standardized haircut approach, in turn,
may improve customer protections and
reduce systemic risk. In addition, a
standardized haircut approach may
reduce costs for the nonbank SBSD
related to the risk of failing to observe
or correct a problem with the use of VaR
models that could adversely impact the
firm’s financial condition, because the
use of VaR models would require the
allocation by the nonbank SBSD of
additional firm resources and personnel.
Conversely, if the proposed
standardized haircuts are too
conservative, they could make the
conduct of security-based swaps
business too costly, preventing or
impairing the ability of firms to engage
in security-based swaps, increasing
transaction costs, reducing liquidity,
and reducing the availability of securitybased swaps for risk mitigation by end
users.
iii. Capital Charge in Lieu of Margin
Collateral
As discussed in section II.A.2.b.v. of
this release, the Commission is
proposing certain capital charges in lieu
1042 See

section II.A.2.b.2. of this release.

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of margin. Generally, margin collateral
is designed to serve as a buffer to
account for a decrease in the market
value of the counterparty’s positions
between the time of default and
liquidation. If the amount of the margin
collateral is insufficient to make up the
difference, the nonbank SBSD will incur
losses. The proposal requires the
nonbank SBSD to hold sufficient net
capital to enable it to, first, withstand
such losses and to cover counterparty
exposures that are not sufficiently
secured with liquid collateral, and,
second, to create a strong incentive for
dealers to collateralize these exposures.
Consequently, this proposed capital
charge may serve as an alternative to
margin collateral, enhance the financial
soundness of the nonbank SBSD and, in
turn, ultimately reduce systemic risk.
With respect to cleared security-based
swaps, the rules would impose a capital
charge if a nonbank SBSD collects
margin collateral from a counterparty in
an amount that is less than the
deduction that would apply to the
security-based swap if it were a
proprietary position of the nonbank
SBSD (i.e., less than an amount
determined by using the standardized
haircuts in Rule 15c3–1, as proposed to
be amended, and in proposed new Rule
18a–1 or a VaR model, as
applicable).1043 As discussed in section
II.A.2.b.v. of this release, the proposed
capital charge, therefore, is designed to
protect the nonbank SBSDs against this
risk, and thereby, serves to increase the
safety and soundness of the nonbank
SBSD.
This proposed charge, however, could
impose additional capital costs on
cleared transactions where the amount
of the additional costs would depend on
the differences between amounts
required under Rule 18a–1 and margin
amounts the clearing agency sets. It is
difficult to estimate the cost impact of
this proposal because there is currently
a lack of trading for customers in
cleared security-based swaps that could
be used for comparative purposes.1044 In
1043 See proposed paragraph (c)(2)(xiv)(A) of Rule
15c3–1; paragraph (c)(1)(viii)(A) of proposed Rule
18a–1.
1044 See Process for Submissions of SecurityBased Swaps, 77 FR 41602 (although the volume of
interdealer CDS cleared to date is quite large, many
security-based swap transactions are still ineligible
for central clearing, and many transactions in
security-based swaps eligible for clearing at a CCP
continue to settle bilaterally. Voluntary clearing of
security-based swaps in the U.S. is currently
limited to CDS products. Central clearing of
security-based swaps began in March 2009 for
index CDS products, in December 2009 for singlename corporate CDS products, and in November
2011 for single-name sovereign CDS products. At
present, there is no central clearing in the U.S. for

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addition, requiring nonbank SBSDs to
take a capital charge equal to the
difference between the haircut amount
and the clearing agency margin could
reduce incentives to use cleared
security-based swap contracts, which
would be inconsistent with the goal of
reducing systemic risk. However,
incentives to clear security-based swaps
will be substantially affected by a
variety of other factors, including the
amount of margin required for noncleared contracts, and clearing volume
will also be affected by mandatory
clearing determinations by the
Commission under Section 763(a) of the
Dodd-Frank Act. In general, it is unclear
whether the additional costs to conduct
business on a cleared basis would
materially affect the volume of business
that SBSDs conduct on an uncleared
basis when they have the choice to do
so.
As discussed in section II.A.2.b.v. of
the release, with respect to non-cleared
security-based swaps, the Commission
is proposing capital charges to address
three exceptions in proposed new Rule
18a–3 (nonbank SBSD margin rule),
including margin not collected from
commercial end users, margin collateral
collected but segregated pursuant to
section 3E(f) of the Exchange Act, and
margin that has not been collected for a
legacy swap.1045 The rule is designed to
reduce systemic risk by requiring capital
to cover counterparty exposures,
because the capital levels will serve in
lieu of margin as a buffer in case of
counterparty defaults. If the nonbank
SBSD did not hold capital in lieu of
margin, a counterparty default could
lead to the default of the nonbank SBSD
itself. This capital charge should have
the benefit of reducing the likelihood of
default of the nonbank SBSD due to
under-margined counterparty exposure.
Conversely it will increase the cost of
capital for nonbank SBSDs that engage
in non-cleared security-based swaps
because they must use their own capital
to support the counterparty’s
transaction, which in turn could reduce
the liquidity of such security-based
swaps. However, the proposed rule
imposes a charge only if a firm fails to
collect margin under Rule 18a–3, and
thus no additional costs would be
imposed on a nonbank SBSDs that
security-based swaps that are not CDS products,
such as those based on equity securities.). Id.
1045 This proposed rule also provides the nonbank
SBSDs certain flexibility in determining whether to
collect margin from certain counterparties exempt
from certain requirements of proposed Rule 18a–3
and thus attempts to appropriately consider both
the concerns of commercial end users and other
entities/transactions exempt from proposed new
Rule 18a–3 and the need to enhance the financial
soundness of the nonbank SBSD.

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
collects margin. Therefore, the proposed
rule is designed to create a strong
incentive for nonbank SBSDs to collect
margin and collateralize counterparty
exposures.
The charge for collateral segregated in
individual accounts under Section 3E(f)
of the Exchange Act reflects the
potential that collateral collected by an
SBSD but held in a third-party
custodian account may not be readily
liquidated immediately following a
counterparty’s default. Accordingly, this
aspect of the rule would create an
additional capital cost to SBSDs that
hold collateral in independent thirdparty accounts.1046 If these costs are
passed on to counterparties electing an
independent segregation option, they
could deter counterparties from electing
the option and reduce their flexibility in
determining the optimal way to hold
their collateral.
The third proposed capital charge
would apply to margin not collected in
the case of legacy non-cleared securitybased swaps. This proposal should
benefit nonbank SBSDs and their
counterparties in that it is designed to
avoid the difficulties of requiring a
nonbank SBSD to renegotiate securitybased swap contracts to come into
compliance with the new margin
collateral requirements, which would be
a complex and costly task. Based on
discussions with market participants,
this proposal, however, may impose
substantial costs in the form of capital
charges on firms that have legacy
contracts.1047 Because broker-dealers,
however, currently do not conduct
significant business in security-based
swaps, and any newly-registered SBSDs
may not enter into security-based swap
transactions before the effectiveness of
these proposed rules and, therefore, not
have any legacy security-based swaps,
this cost of capital may be immaterial.
However, the costs could be significant
if legacy security-based swaps are
assigned to a security-based swap
dealer.
iv. Credit Risk Charge

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As discussed in section II.A.2.b.iv. of
this release, consistent with existing
1046 See discussion above in section II.A.2.b.v. of
this release. See also discussion above in section
V.B.1. of this release (discussing quantification of
costs).
1047 As discussed above in section II.B.2. of this
release, this exception would be designed to
address the impracticality of renegotiating contracts
governing security-based swap transactions that
predate the effectiveness of proposed new Rule
18a–3 in order to come into compliance with the
account equity requirements in the rule. See
discussion above in section V.A.1. of this release
(discussing quantification of costs).

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rules affecting broker-dealers,1048
proposed Rule 18a–1 and the
amendments to Rule 15c3–1 rule would
require firms to take a 100% charge for
the amount of any unsecured receivable,
including any uncollateralized
receivable currently owed under a
security-based swap. As an alternative
to taking this capital charge in lieu of
margin to a commercial end user, as
discussed in section II.A.2.b.iv. of the
release, ANC broker-dealers and standalone SBSDs using internal models
would be permitted instead to take a
credit risk charge using a methodology
in Appendix E to Rule 15c3–1 for
uncollateralized receivables arising from
security-based swaps with (and only
with) commercial end users in lieu of
the 100% deduction otherwise required
by the rules.1049
The proposed rule is designed to
provide an alternative, less costly way
(in lieu of the 100% deduction
otherwise required by the rules) to
recognize credit exposure incurred in
transactions with commercial end users
for those nonbank SBSDs approved to
use internal models. Nonbank SBSDs
would be permitted to use this approach
because they are required to implement
processes for analyzing credit risk to
OTC derivative counterparties and to
develop mathematical models for
estimating credit exposures arising from
OTC derivatives transactions and
determining risk-based capital charges
for those exposures.1050
The rule, however, will increase
costs 1051 for nonbank SBSDs that do
substantial trading with commercial end
users and do not collect margin for
transactions in non-cleared securitybased swaps from them. Available data
suggests that commercial end users
presently do not conduct substantial
trading in non-cleared security-based
swaps.1052 Therefore, the proposed
1048 See 17 CFR 240.15c3–1(c)(2)(iv)(B)–(D);
proposed new Rule 18a–1(c)(1)(iii)(B)–(D).
1049 See paragraph (e)(2) of proposed new Rule
18a–1. Paragraph (c)(1) of Appendix E to Rule
15c3–1 requires an ANC broker-dealer to take a
counterparty exposure charge in an amount equal
to: (i) The net replacement value in the account of
each counterparty that is insolvent, or in
bankruptcy, or that has senior unsecured long-term
debt in default; and (ii) for a counterparty not
otherwise described in paragraph (c)(1)(i) of
Appendix E, the credit equivalent amount of the
broker’s or dealer’s exposure to the counterparty, as
defined in paragraph (c)(4)(i) of this Appendix E,
multiplied by the credit risk weight of the
counterparty, as defined in paragraph (c)(4)(vi) of
Appendix E, multiplied by 8%. 17 CFR 240.15c3–
1e(c)(1).
1050 See Appendix E to Rule 15c3–1 and proposed
new Rule 18a–1.
1051 See section V.B.1. of this release (discussing
quantification of costs).
1052 See generally CDS Data Analysis; ISDA
Margin Survey 2012.

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credit risk charge may not have an
immediate cost impact on nonbank
SBSDs when compared to the baseline
of the OTC derivatives markets as they
exist today. However, costs, in terms of
higher capital charges and opportunity
costs, could become significant if
commercial end users begin to trade
security-based swaps in greater volume
and exposures to the nonbank SBSDs
remain uncollateralized.
To the extent that commercial end
users do trade in security-based swaps,
the ability of a nonbank SBSD to use
internal models likely would give it a
significant cost advantage over nonbank
SBSDs not using models once the initial
infrastructure investment to use the
models has been made. In addition,
ANC broker-dealers currently are
permitted to add back to net worth
uncollateralized receivables from
counterparties arising from OTC
derivatives transactions (i.e., they can
add back the amount of the
uncollateralized current exposure).1053
This treatment would be narrowed
under the proposed capital
requirements for nonbank SBSDs as
well as for ANC broker-dealers to the
extent that it would apply only to
uncollateralized receivables from
commercial end users arising from
security-based swaps. In contrast,
uncollateralized receivables from other
types of counterparties would be subject
to a 100% deduction from net worth to
limit the potential that the rules would
permit a substantial amount of
unsecured exposures for ANC brokerdealers and nonbank SBSDs.1054
According to FOCUS Reports and staff
experience supervising the ANC brokerdealers, ANC broker-dealers have not
engaged in a large volume of OTC
derivatives transactions since the rules
were adopted in 2004. Therefore, they
have not had significant amounts of
unsecured receivables that would be
subject to the credit risk charge
provisions in Appendix E to Rule 15c3–
1. However, when the Dodd-Frank OTC
derivatives reforms are implemented,
ANC broker-dealers could significantly
increase their holdings of OTC
derivatives. An increase in derivatives
exposure that is uncollateralized would
increase the exposure of the ANC
broker-dealers to their derivatives
counterparties. In turn, however, this
proposed amendment should strengthen
the capital position of the ANC broker1053 See 17 CFR 240.15c3–1e(c). OTC derivatives
dealers are permitted to treat such uncollateralized
receivables in a similar manner. See 17 CFR
240.15c3–1f.
1054 See proposed amendments to paragraphs (a)
and (c) of Rule 15c3–1e. See section II.A.2.b.iv. of
this release (discussing credit risk charges).

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dealers, and thereby reduce the
likelihood of default of one of these
entities. Because ANC broker-dealers
currently do not trade in significant
amounts of OTC derivatives, and
therefore, do not currently have
significant amounts of unsecured
receivables related to OTC derivatives
transactions, the cost impact as
compared to the baseline of the current
capital regime for broker-dealers should
not be material for these firms.
v. Funding Liquidity Stress Test
Requirement

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As discussed in section II.A.2.d. of
this release, the Commission is
proposing a funding liquidity stress
requirement 1055 to be conducted by the
ANC broker-dealers and stand-alone
SBSDs that use internal models at least
monthly that takes into account certain
assumed conditions lasting for 30
consecutive days. These required
assumed conditions would be:
• A stress event that includes a
decline in creditworthiness of the firm
severe enough to trigger contractual
credit-related commitment provisions of
counterparty agreements; 1056
• The loss of all existing unsecured
funding at the earlier of its maturity or
put date and an inability to acquire a
material amount of new unsecured
funding, including intercompany
advances and unfunded committed
lines of credit;
• The potential for a material net loss
of secured funding;
• The loss of the ability to procure
repurchase agreement financing for less
liquid assets;
• The illiquidity of collateral required
by and on deposit at clearing agencies
or other entities which is not deducted
from net worth or which is not funded
by customer assets;
• A material increase in collateral
required to be maintained at registered
clearing agencies of which the firm is a
member; and
• The potential for a material loss of
liquidity caused by market participants
exercising contractual rights and/or
refusing to enter into transactions with
respect to the various businesses,
positions, and commitments of the firm,
1055 Compare BCBS, Basel III: International
framework for liquidity risk measurement,
standards and monitoring (Dec. 2010), available at
http://www.bis.org/publ/bcbs188.pdf.
1056 See Federal Reserve Enhanced Prudential
Standards and Early Remediation Requirements for
Covered Companies, 77 FR 594, 608 (Jan. 5, 2012)
(noting that effective liquidity stress testing should
be conducted over a variety of time horizons to
adequately capture rapidly developing events, and
other conditions and outcomes that may materialize
in the near or long term).

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including those related to customer
businesses of the firm.1057
These proposed minimum elements are
designed to ensure that ANC brokerdealers and stand-alone SBSDs using
internal models employ a stress test that
is severe enough to produce an estimate
of a potential funding loss of a
magnitude that might be expected in a
severely stressed market.
The benefit of the proposed liquidity
stress test requirement is an additional
level of protection against disruptions in
the ability to obtain funding for a firm
with significant proprietary positions in
securities or derivatives.1058 The
proposed liquidity requirement is
intended to increase the likelihood that
a firm could withstand a general loss of
confidence in the firm itself, or the
markets more generally and stay solvent
for up to 30 days, during which time it
could either regain the ability to obtain
funding in the ordinary course or else
better position itself for resolution, with
less collateral impact on other market
participants and the financial system.
As such, this proposal may reduce the
likelihood and severity of a fire sale
and, therefore, mitigate spillover effects
and lower systemic risk.1059 This, in
turn, may increase confidence in the
security-based swap markets and may
lead to an increase in trading in this
market.
This proposal, however, would
impose additional opportunity costs of
capital, and other costs on ANC brokerdealers and nonbank SBSDs directly
related to the amount of the required
liquidity reserve because a nonbank
SBSD would be unable to deploy the
assets that are maintained for the
1057 See proposed new paragraph (f)(1) to Rule
15c3–1 and paragraph (f)(1) of proposed new Rule
18a–1.
1058 See letter from Christopher Cox, Chairman,
Commission, to Dr. Nout Wellink, Chairman, BCBS
(Mar. 20, 2008), available at http://www.sec.gov/
news/press/2008/2008–48_letter.pdf (highlighting
importance of liquidity management in meeting
obligations during stressful market conditions). See
also Enhanced Prudential Standards and Early
Remediation Requirements for Covered Companies,
77 FR 594, 608 (Jan. 5, 2012) (proposing that
liquidity stress testing must be tailored to reflect a
covered company’s capital structure, risk profile,
complexity, activities, size and other appropriate
risk-related factors stating that stress testing will be
directly tied to the covered company’s business
profile and the regulatory environment in which it
operates.). The minimum factors described above
are intended to specifically address factors relevant
to the regulatory environment in which ANC
broker-dealers and stand-alone SBSD using internal
models operate.
1059 See Andrei Shleifer and Robert Vishny, Fire
Sales in Finance and Macroeconomics, 25 Journal
of Economic Perspectives 29–48 (Winter 2011)
(surveying literature on fire sales, which implies
that if financial institutions are not liquidity
restraints during fire sales, price and liquidity
spirals should less likely occur).

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liquidity reserve in other, potentially
more efficient ways.
In addition, smaller firms may incur
more implementation costs, because, in
general, large firms already run stress
tests and maintain a liquidity reserve
based on those tests.1060 In addition, the
required assumed conditions are
designed to be consistent with the
liquidity stress tests performed by ANC
broker-dealers (based on staff
experience in supervising the ANC
broker-dealers) and to address the types
of outflows experienced by ANC brokerdealers and other broker-dealers in
times of stress. Therefore, while the
opportunity cost of the liquidity
requirements might be substantial, they
are not expected to impose liquidity
standards that are materially different
from what is observed now among the
ANC broker-dealers and thus should not
represent an undue burden at this time.
Finally, under the proposals, an ANC
broker-dealer and a stand-alone SBSD
using internal models would be
required to establish a written
contingency funding plan. The plan
would need to clearly set out the
strategies for addressing liquidity
shortfalls in emergency situations,1061
and would need to address the policies,
roles, and responsibilities for meeting
the liquidity needs of the firm and
communicating with the public and
other market participants during a
liquidity stress event.1062
This proposal may reduce the
likelihood of default of a nonbank SBSD
that uses internal models or an ANC
broker-dealer, and thus, in turn, reduce
systemic risk. Based on staff experience
supervising ANC broker-dealers and
monitoring the ultimate holding
companies of these firms, most of these
entities have a written contingency
funding plan, generally, at the holding
company level. To the extent that these
firms are required to implement a
written contingency funding plan at the
nonbank SBSD level or ANC level, these
firms may incur personnel, technology
or other operational costs to develop
and implement such a plan.1063
vi. Risk Management Procedures
As discussed in section II.A.2.c.
above, nonbank SBSDs would be
required to comply with the risk
management provisions of Rule 15c3–4,
as if they were OTC derivatives dealers,
because the risks of trading by nonbank
SBSDs in security-based swaps,
1060 See

17 CFR 240.15c3–4.
proposed new paragraph (f)(4) of Rule
15c3–1; paragraph (f)(4) of proposed Rule 18a–1.
1062 See proposed new paragraph (f)(4) of Rule
15c3–1; paragraph (f)(4) of proposed Rule 18a–1.
1063 See section V.C. of this release.
1061 See

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
including market, credit, operational,
and legal risks, are similar to the risks
faced by OTC derivatives dealers in
trading other types of OTC
derivatives.1064 These requirements may
reduce the risk of significant losses by
nonbank SBSDs. The internal risk
management control system
requirements also should reduce the
risk that the problems of one firm will
spread because each nonbank SBSD
should have a better understanding of
the nonbank’s exposures and the risks of
those exposures. The nonbank SBSDs
may incur costs in better modifying
documents and their information
technology systems to meet these
requirements, but these costs could vary
significantly among nonbank SBSDs
depending on the degree to which their
risk management systems are
documented and on size of each firm
and the types of business it engages
in.1065
b. Capital Requirements for MSBSPs

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As discussed in section II.A.3. of the
release, proposed new Rule 18a–2
would require nonbank MSBSPs to have
and maintain positive tangible net
worth at all times.1066 Entities that may
need to register as MSBSPs may engage
in a diverse range of business activities
very different from, and broader than,
the securities activities conducted by
broker-dealers (otherwise they would be
required to register as an SBSD and/or
broker-dealer). Because nonbank
MSBSPs, by definition, will be entities
that have substantial exposure to
security-based swaps, they would also
be required to comply with Rule 15c3–
4,1067 which requires OTC derivatives
dealers and ANC broker-dealers to
establish, document, and maintain a
system of internal risk management.1068
This proposal is designed to promote
sound risk management practices with
respect to the risks associated with
trading in OTC derivatives. Nonbank
MSBSPs may incur implementation
costs, such as technology costs to
comply with the risk management
1064 For example, individually negotiated OTC
derivative products, including security-based
swaps, generally are not very liquid. Market
participants face risks associated with the financial
and legal ability of counterparties to perform under
the terms of specific transactions. The additional
exposure to credit risk, liquidity risk, and other
risks makes it necessary for OTC derivatives market
participants to implement a risk management
control system.
1065 See section V.C. of this release.
1066 See paragraph (a) of proposed new Rule 18a–
2.
1067 See paragraph (c) of proposed new Rule 18a–
2.
1068 See 17 CFR 240.15c3–4.

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practices proposed by the rule. These
are discussed in section V.C. below.
Risk management controls at nonbank
MSBSPs may promote the stability of
these firms and, consequently, the
stability of the entire financial system.
This, in turn, may protect the financial
industry from systemic risk.
The Commission could instead
impose capital requirements that are the
same as, or modeled on, those that are
being proposed for nonbank SBSDs,
which could more effectively reduce the
risk of failure of MSBSPs and thereby
reduce systemic risk. In general,
nonbank SBSDs and MSBSPs can be
expected to differ in terms of the range
and types of their counterparty
relationships and, by definition,
MSBSPs will not maintain two-sided
exposure to a range of instruments that
is characteristic of dealer activity. The
systemic impact of the failure of an
MSBSP will depend on various factors,
including the ability of its
counterparties to readily liquidate assets
posted by the MSBSP as collateral,
without suffering a loss. Although the
Commission is proposing to require
MSBSPs to post collateral to eliminate
their current exposure to counterparties
in security-based swaps, the collateral
may not be sufficient to avoid losses
during a period of market volatility. At
the same time, imposing a capital
regime on MSBSPs that is based on a net
liquid assets test could impact the
ability of an MSBSP to pursue business
activities and strategies unrelated to its
activities involving financial
instruments. For example, these entities
may engage in commercial activities
that require them to have substantial
fixed assets to support manufacturing
and/or result in them having significant
assets comprised of unsecured
receivables. Requiring them to adhere to
a net liquid assets test could result in
their having to obtain significant
additional capital or engage in costly
restructurings. The Commission is
specifically seeking comment on this
approach in section II.A.3. of this
release.
As stated above, at present, entities
that may be required to be registered as
MSBSPs are expected to be companies
that engage in a diverse range of
business. For these reasons, it would be
difficult to quantify how much
additional capital, if any, or costs the
capital requirements under proposed
new Rule 18a–3 would require these
entities to maintain or incur and
compare these amounts against the
current baseline of the OTC derivatives
market as it exists today.1069 Given that

proposed new Rule 18a–2 would only
require that a nonbank MSBSP maintain
a positive tangible net worth at all
times, and 5 or fewer entities are
expected to register as nonbank
MSBSPs,1070 these costs are not
expected to be material because it is not
expected that these firms would have to
alter their existing business practice in
any substantial way to comply with the
proposed positive tangible net worth
test.
c. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The proposed financial responsibility
requirements should reduce the risk of
a failure of any major market participant
in the security-based swap market,
which in turn reduces the possibility of
a general market failure, and thus
promotes confidence for market
participants to transact in security-based
swaps for investment and hedging
purposes. The proposed capital
requirements are designed to promote
confidence in nonbank SBSDs among
customers, counterparties, and the
entities that provide financing to
nonbank SBSDs and, thereby, lessen the
potential that these market participants
may seek to rapidly withdraw assets and
financing from SBSDs during a time of
market stress. This heightened
confidence is expected to increase
trading activity and promote
competition among dealers. The
proposed financial responsibility
requirements, in significant part, will
affect efficiency and capital formation
through their impact on
competition.1071 Specifically, markets
that are competitive can, ceteris paribus,
be expected to promote a more efficient
allocation of capital.
Any new entrant will increase the
number of competing entities, and the
extent to which competition increases
will depend on the number of
additional entrants and their success in
attracting business from established
market participants. As discussed in
section IV. of this release, the
Commission expects up to 50 entities to
register as SBSDs. The number of
registered firms will depend, among
other factors, on whether potential new
entrants determine that the cost impact
of the proposed financial responsibility
requirements would allow them to
compete effectively for business. To the
extent that costs associated with the
proposed rules are high however, they
1070 See

section IV. of this release.
also Entity Definitions Adopting Release,
77 FR at 30742.
1071 See

1069 See

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may negatively affect competition
within the security-based swap markets.
This may, for example, lead smaller
dealers or entities for whom dealing is
not a core business to exit the market
because compliance with the proposed
minimum capital requirements is not
feasible because of cost considerations.
The same costs might also deter the
entry of new SBSDs or MSBSPs into the
market, and if sufficiently high, increase
concentration among nonbank SBSDs.
The possibility of using VaR to
calculate haircuts may permit a
nonbank SBSD to more efficiently
deploy capital in other parts of its
operations (because VaR models could
reduce capital charges and thereby
could make additional capital
available), which should be a factor in
the decision to enter the security-based
swap markets in general and through
which type of registrant in particular.
Because of the reduced charges for
market and credit risk, a nonbank SBSD
may be able to reallocate capital from
the nonbank SBSD to affiliates that may
receive a higher return than the
nonbank SBSD.1072 Therefore, the
success of new entrants in competing
for security-based swap business also
will likely depend on the extent to
which they obtain the Commission’s
approval to use a VaR model.1073 Hence,
the Commission expects a positive
impact on competition especially among
SBSDs that use internal models,
whether they are stand-alone SBSDs or
ANC broker-dealers.
However, some of the entities that
presently compete in the market may
opt to conduct these activities in
registered broker-dealer affiliates; this
development would not increase the
number of competitors. But other firms
that currently do not deal in securitybased swaps or do not do so in any
significant degree, may choose to
compete either as a stand-alone SBSD or
as a broker-dealer SBSD. This may
increase the number of competing firms.
The proposals ultimately adopted,
like other requirements established
under the Dodd-Frank Act, could have
a substantial impact on international
1072 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
1073 See, e.g., Alternative Net Capital
Requirements Adopting Release, 69 FR at 34455
(describing benefits of alternative net capital
requirements for broker-dealers using models
stating a ‘‘major benefit for the broker-dealer will
be lower deductions from net capital for market and
credit risk that we expect will result from the use
of the alternative method.’’) Therefore, it is likely
that for new entrants to capture substantial volume
in security-based swaps they will need to use VaR
models. See also OTC Derivatives Dealer Release,
63 FR 59362 (discussing benefits of minimum
capital requirements as an additional measure of
protection).

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commerce and the relative competitive
position of intermediaries operating in
various, or multiple, jurisdictions. In
particular, intermediaries operating in
the U.S. and in other jurisdictions could
be advantaged or disadvantaged if
corresponding requirements are not
established in other jurisdictions or if
the Commission’s rules are substantially
more or less stringent than
corresponding requirements in other
jurisdictions. This could, among other
potential impacts, affect the ability of
intermediaries and other market
participants based in the U.S. to
participate in non-U.S. markets, the
ability of non-U.S.-based intermediaries
and other market participants to
participate in U.S. markets, and whether
and how international firms make use of
global ‘‘booking entities’’ to centralize
risks related to security-based swaps. As
discussed in section I. of this release,
these issues have been the focus of
numerous comments to the Commission
and other regulators, Congressional
inquiries, and other public dialogue.
Accordingly, substantial differences
between the U.S. and foreign
jurisdictions in the costs of complying
with the financial responsibility
requirements for security-based swaps
between U.S. and foreign jurisdictions
could reduce cross-border capital flows
and hinder the ability of global firms to
most efficiently allocate capital among
legal entities to meet the demands of
their counterparties. As discussed in
section I. of this release, the potential
international implications of the
proposed capital, margin, and
segregation requirements warrant
further consideration.1074 The
Commission intends to publish a
comprehensive release seeking public
comment on the full spectrum of issues
relating to the application of Title VII to
cross-border security-based swap
transactions and non-U.S. persons that
act in capacities regulated under the
Dodd-Frank Act.
The willingness of end users to trade
with a nonbank SBSD dealer will
depend on their evaluation of the risks
of trading with that particular firm
compared to more established firms,
and their ability to negotiate favorable
price and other terms. As discussed in
section V.A. of this release, end users of
security-based swaps are mostly
comprised of hedge funds and other
asset management and financial firms.
Many of these entities are sophisticated
1074 See BCBS, IOSCO, Margin Requirements for
Non-centrally-cleared Derivatives (July 2012),
available at http://www.iosco.org/library/pubdocs/
pdf/IOSCOPD387.pdf (consultative document
seeking comment on a paper on margin
requirements for non-centrally-cleared derivatives).

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participants that trade in substantial
volume and generally post collateral for
their security-based swap positions.1075
These end users are relatively wellpositioned to negotiate price and other
terms with competing dealers and to
take advantage of greater choice of
nonbank SBSD counterparties. These
same participants, when transacting in
the securities markets, often trade with
a variety of competing dealers,
including through prime brokerage
relationships. To the extent that the
proposals result in increased
competition, participants in the
security-based swap markets should be
able to take advantage of this increased
competition and negotiate improved
terms, resulting generally in narrower
spreads and better prices.
In addition, benefits may be expected
to also arise from the ability of nonbank
SBSDs, which now conduct substantial
business in security-based swaps, to
consolidate those operations within
their affiliated U.S. broker-dealers. This
flexibility may yield efficiencies for
clients conducting business in securities
and security-based swaps, including
netting benefits,1076 a reduction in the
number of account relationships
required with affiliated entities, and a
reduction in the number of governing
agreements. These potential benefits are
at some tension with benefits from an
increase in the number of competitors,
to the extent that netting benefits will be
maximized by holding a large portfolio
of positions at the same entity,1077
rather than trading with a variety of
competing dealers. Further, because the
proposals would permit the conduct of
a security-based swap business in an
entity jointly registered as a brokerdealer SBSD,1078 they would facilitate
the potential for those firms to offer
portfolio margin for a variety of
positions. From the standpoint of a
holding company with multiple
financial affiliates, aggregating securitybased swaps business in a single entity,
1075 See,

e.g., Independent Amounts at 6.
e.g., paragraph (c)(5) of proposed new
Rule 18a–3(c)(5). See letter from Stuart J. Kaswell,
Executive Vice President, Managing Director and
General Counsel, Managed Funds Association, to
David A. Stawick, Secretary of the CFTC (July 11,
2011) (‘‘Effective netting agreements lower systemic
risk by reducing both the aggregate requirement to
deliver margin and trading costs for market
participants.’’).
1077 See Darrell Duffie and Haoxiang Zhu, Does a
Central Clearing Party Reduce Counterparty Risk,
Stanford University Working Paper (Mar. 6, 2010)
(showing that netting in the context of CCPs results
in significant reductions in counterparty
exposures).
1078 See, e.g., amendments to Rule 15c3–1
(proposing minimum net capital requirements for
broker-dealers engaging in a security-based swap
business).
1076 See,

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
such as a broker-dealer SBSD, could
help to simplify and streamline risk
management, allow more efficient use of
capital, as well as operational
efficiencies, and avoid the need for
multiple netting and other agreements.
While these arguments generally
suggest the possibility of positive effects
of the proposed rules on competition,
efficiency and capital formation,
financial responsibility requirements
that impose too many competitive
burdens pose the risk of imposing
excessive regulatory costs that could
deter the efficient allocation of capital.
Such rules also may be expected to
reduce the capital formation benefits
that otherwise would be associated with
security-based swaps. Specifically,
financial responsibility requirements
that are overly stringent may prevent
entries in the security-based swap
markets and thereby may either increase
spreads and trading costs or even reduce
the availability of security-based swaps.
In both instances, end users would face
higher cost to meet their business needs.
Apart from their impact on the extent
of dealer competition and efficiencies
for end users, the proposed new rules
and rule amendments could create the
potential for regulatory arbitrage to the
extent that they differ from
corresponding rules other regulators
adopt. As noted above in section I. of
this release, the proposals of the
prudential regulators and the CFTC
were considered in developing the
Commission’s proposed capital, margin,
and segregation requirements for SBSDs
and MSBSPs. The Commission’s
proposals differ in some respects from
proposals of the prudential regulators
and the CFTC. While some differences
are based on differences in the activities
of securities firms, banks, and
commodities firms, or differences in the
products at issue, other differences may
reflect an alternative approach to
balancing the relevant policy choices
and considerations. Depending on the
final rules the Commission adopts, the
financial responsibility requirements
could make it more or less costly to
conduct security-based swaps trading in
banks as compared to nonbank SBSDs.
For example, high capital requirements
may discourage certain entities from
participating in the security-based swap
markets, particularly if the regulatory
costs for nonbank SBSDs are high.
Likewise, if the application of the
proposed 8% margin risk factor
substantially increases capital
requirements for nonbank SBSDs
compared to risk-based capital
requirements imposed by the prudential
regulators on the same activity, bank
holding companies could be

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incentivized to conduct these activities
in their bank affiliates.1079 These
differences could create competitive
inequalities and affect the allocation of
trading activities within a holding
company structure.
Finally, in significant part, the effect
of the proposals for nonbank MSBSPs
on efficiency and capital formation will
also be linked to the effect of these
requirements on competition,1080 as
competitive markets, ceteris paribus,
can be expected to promote a more
efficient allocation of capital.
Conversely, if the proposals for
MSBSPs are accompanied by too many
competitive burdens, the proposals risk
the imposition of excessive regulatory
costs that could deter the efficient
allocation of capital. Such rules also
may be expected to reduce the capital
formation benefits that otherwise would
be associated with security-based
swaps. Requirements for nonbank
MSBSPs that are overly stringent may
prevent entries in the security-based
swap markets and thereby may reduce
the availability of security-based swaps,
forcing end users to use less effective
financial instruments to meet their
business needs.
Request for Comment
The Commission generally requests
comment about its analysis of the
general costs and benefits of the
proposed capital rules for SBSDs and
MSBSPs. In addition, the Commission
requests comment in response to the
following questions:
1. Would the minimum capital
requirements represent a barrier to entry
to firms that may otherwise seek to trade
security-based swaps as SBSDs? If so,
which types of firms would be
foreclosed?
2. Is it correct to assume that firms
that have the risk management
capability to act as a dealer in securitybased swaps generally would also meet
or be readily able to meet the proposed
capital minimums?
3. To what extent will firms that
receive approval to use VaR models be
able to dominate trading in securitybased swaps, whether because of costs
to other firms in applying a haircut
methodology to security-based swaps or
for other reasons?
4. What would be the impact of
market concentration on reduction in
systemic risk? For example, would
concentration of positions in a relatively
few firms exacerbate systemic risk by
1079 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564.
1080 See also Entity Definitions Adopting Release,
77 FR at 30742.

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70317

exaggerating the impact of the failure of
a single firm? Conversely, would high
capital requirements better protect
against systemic risk by reducing the
risk of failure of a nonbank SBSD?
5. Do the proposed capital
requirements for nonbank SBSDs
proportionately reflect the increased
risk associated with the use of internal
models and trading in a portfolio of
instruments, including securities,
security-based swaps, and other
derivatives?
6. The Commission requests comment
on how much additional capital would
be required, if any, as a result of the
proposed 8% margin factor based on a
sample portfolio of security-based
swaps and how the result compares to
the amount these firms currently hold
against the same risk.
7. Under the proposed 8% margin
factor, the relation between exposure
and capital is linear. Is this type of
formal approach appropriate for risks
associated with security-based swaps?
Should the risk margin factor be
increased at higher levels of exposure,
or should it increase on some other
basis?
8. How would firms’ current risk
management practices for calculating
their exposures to counterparties
compare to the proposed 8% margin
factor, if nonbank SBSDs were only
required to comply with a fixed
minimum net capital standard?
9. From a systemic risk perspective,
should the proposed capital rules for
nonbank SBSDs encourage the conduct
of security-based swaps trading outside
of broker-dealer affiliates?
10. From a systemic risk perspective,
are the proposed increases in the
minimum net capital (from $500 million
to $1 billion) and minimum tentative
net capital ($1 billion to $5 billion)
requirements for ANC broker-dealers
adequate? From a systematic risk
perspective, is the proposed increase in
the ‘‘early warning’’ level from $5
billion to $6 billion for ANC brokerdealers adequate?
11. Would the proposed CDS grid
impose any additional costs on nonbank
SBSDs in comparison to the current
haircut charges for similar debt
securities under Rule 15c3–1?
12. Would a nonbank SBSD incur
additional costs resulting from the
proposed liquidity stress test based on
current practice? The Commission
requests that commenters quantify the
extent of the additional cost the
proposed stress test would yield based
on hypothetical firm portfolios, and
provide the Commission with such data.
13. Are the factors proposed in the
liquidity funding stress test adequate? If

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not, are there other factors that should
be included?
14. How would proposed new Rule
18a–2 impact entities that may be
required to register as MSBSPs?
15. Would proposed new Rule 18a–2
require nonbank MSBSPs to hold
additional capital, in comparison to
current capital levels maintained at
these firms? If yes, please quantify the
amount.
16. What additional costs, if any,
would a nonbank MSBSP incur in
making adjustments to risk management
practices to conform to the specific
provisions of Rule 15c3–4?
17. If stand-alone SBSDs would not be
able to claim flow-through capital
benefits for consolidated subsidiaries or
affiliates under Rule 18a–1c, in contrast
to Appendix C of existing Rule 15c3–1,
would stand-alone SBSDs be
competitively disadvantaged? If yes,
please explain.
18. Would the Commission’s
proposals lead to greater competition
among intermediaries for security-based
swaps business, greater concentration,
or neither? How important are the goals
of reduction in systemic risk versus
promotion of competition in crafting
rules in this area, and to what extent are
they competing goals? If they are not
competing goals, how should the
achievement of both goals inform the
Commission’s overall approach?
19. Will the Commission’s proposals
affect the competitive position of U.S.
firms in the global security-based swaps
market? How in general would they
impact global trading in these products?
How could the Commission best address
any anti-competitive effects? For
example, should the Commission permit
U.S. firms trading with off-shore
counterparties to collect margin based
on the rules of the jurisdiction where
the counterparty is located, provided
the Commission determines that those
rules are comparable to the U.S. regime?
How would comparability be
determined?
20. The Commission specifically
requests comment on the potential
impact of interagency differences in
specific aspects of capital and margin
requirements. Which specific aspects of
the proposed rules could have the most
impact in determining the type of legal
entity in which trading is conducted?
What would be the market or economic
effects?
3. The Proposed Margin Rule—Rule
18a–3
As discussed in section II.B. of this
release, pursuant to section 15F(e) of the
Exchange Act, proposed new Rule 18a–
3 would establish margin requirements

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for nonbank SBSDs and nonbank
MSBSPs with respect to transactions
with counterparties in non-cleared
security-based swaps.1081 As discussed
in more detail below, the proposed rule
would require nonbank SBSDs to collect
collateral from their counterparties to
non-cleared security-based swaps to
cover both current exposure and
potential future exposure to the
counterparty (i.e., the rule would
require the account to have prescribed
minimum levels of equity); however,
there would be exceptions to these
requirements for certain types of
counterparties. Proposed new Rule 18a–
3 would have a number of benefits as
well as impose certain costs on nonbank
SBSDs, nonbank MSBSPs, as well as
other market participants, including
commercial end users. The proposed
rule also would have possible effects on
competition, efficiency, and capital
formation, which will be discussed
further below.
The two types of credit exposure
arising from OTC derivatives are current
exposure and potential future exposure.
The current exposure is the amount that
the counterparty would be obligated to
pay the dealer if all the OTC derivatives
contracts with the counterparty were
terminated (i.e., it is the amount of the
current receivable from the
counterparty). This form of credit risk
arises from the potential that the
counterparty may default on the
obligation to pay the current receivable.
The potential future exposure is the
amount that the current exposure may
increase in the favor of the dealer in the
future. This form of credit risk arises
from the potential that the counterparty
may default before providing the dealer
with additional collateral to cover the
incremental increase in the current
exposure or the current exposure will
increase after a default when the
counterparty has ceased to provide
additional collateral to cover such
increases and before the dealer can
liquidate the position.
Rule 18a–3 is intended to support a
goal of the Dodd-Frank Act by
promoting centralized clearing of
sufficiently standardized products,1082
1081 See

proposed new Rule 18a–3.
Dodd-Frank Act seeks to ensure that,
wherever possible and appropriate, derivatives
contracts formerly traded exclusively in the OTC
market be cleared. See, e.g., Senate Committee on
Banking, Housing, and Urban Affairs, The Restoring
American Financial Stability Act of 2010, S. Rep.
No. 111–176, 34 (stating that ‘‘[s]ome parts of the
OTC market may not be suitable for clearing and
exchange trading due to individual business needs
of certain users. Those users should retain the
ability to engage in customized, non-cleared
contracts while bringing in as much of the OTC
market under the centrally cleared and exchangetraded framework as possible.’’).
1082 The

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which, in turn, may help to mitigate
credit risk.1083 Specifically, Rule 18a–3,
by creating stringent margin
requirements for non-cleared contracts,
is meant to create incentives for
participants to clear security-based
swaps, where available and appropriate
for their needs.1084 Central clearing can
provide systemic benefits by limiting
systemic leverage and aggregating and
managing risks by a central
counterparty.1085 At the same time,
realization of these benefits assumes
that central counterparties are
appropriately capitalized and
sufficiently collateralize their exposures
to their clearing members. Under the
proposed rule, the market will benefit
from the required collateralization of
non-cleared security-based swaps.
Specifically, the required
collateralization should improve
counterparty risk management, reduce
the risk of contagion from a defaulting
counterparty, and ultimately reduce
systemic risk.
While available data suggests that
clearing of security-based swaps has
been increasing, significant segments of
the security-based swap markets remain
uncleared, even where a CCP is
available to clear the product in
question on a voluntary basis.1086 The
mandatory clearing determinations
made pursuant to Exchange Act section
3C(a)(1) will alter current clearing
practices at the time such
determinations are made. The
Commission has not yet made any
mandatory clearing determinations
under the authority of section 3C(a)(1)
of the Exchange Act and cannot estimate
1083 For example, when an OTC derivatives
contract between two counterparties that are
members of a CCP is executed and submitted for
clearing, it is typically replaced by two new
contracts—separate contracts between the CCP and
each of the two original counterparties. At that
point, the original counterparties are no longer
counterparties to each other. Instead, each acquires
the CCP as its counterparty, and the CCP assumes
the counterparty credit risk of each of the original
counterparties that are members of the CCP. See
Stephen Cecchetti, Jacob Gyntelberg, and Mark
Hollanders, Central counterparties for over-thecounter derivatives, BIS Quarterly Review (Sept.
2009), available at http://www.bis.org/publ/qtrpdf/
r_qt0909f.pdf. Structured and operated
appropriately, CCPs may improve the management
of counterparty risk and may provide additional
benefits such as multilateral netting of trades. See
also Process for Submissions of Security-Based
Swaps, 77 FR at 41603.
1084 See Daniel Heller and Nicholas Vause,
Expansion of Central Clearing, BIS Quarterly
Review (June 2011) (arguing expansion of central
clearing within or across segments of the
derivatives markets could economize both on
margin and non-margin resources).
1085 See Process for Submissions of SecurityBased Swaps, 77 FR 41602.
1086 See Process for Submissions of SecurityBased Swaps, 77 FR 41602.

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at this time how much of the securitybased swap markets may ultimately be
subject to such determinations.
Other costs resulting from proposed
new Rule 18a–3 may result from
reducing the availability of liquid assets
for purposes other than posting
collateral. Data available to the
Commission suggests that existing
collateral practices vary widely by type
of market participant and
counterparty.1087 For example, the ISDA
Margin Survey 2012, which provides
global estimates regarding the use of
collateral in the OTC derivatives
business based on a survey of ISDA
members as of the end of 2011,1088
stated that 71% of all OTC derivatives
transactions were subject to collateral
agreements; the average percentage was
96% for the largest dealers responding
to the survey.1089 The percent of trades
subject to collateral agreements was
higher, however, for credit derivatives
(93.4% of all trades) and about the same
as the general average for equity
derivatives (72.7%).1090
The ISDA Margin Survey 2011
reported on the extent of
collateralization (percentage of net
exposures) by type of counterparty.1091
The amount reported for all
counterparties and all OTC derivatives
was 73.1%.1092 The ISDA Margin
Survey 2011 also indicates that the
collateralization levels by large dealers
of their net exposures to their bank and
broker-dealer dealer counterparties was
88.6%.1093 For hedge funds, the average
collateralization levels were 178%,

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1087 See,

e.g., ISDA Margin Survey 2012. Proposed
new Rule 18a–3 would distinguish by counterparty
type in that the rule would provide specific
exemptions from the rule for certain counterparties,
such as commercial end users. See section II.B. of
this release.
1088 ISDA Margin Survey 2012. The ISDA Margin
Survey 2012 also states that the estimated amount
of collateral in circulation in the non-cleared OTC
derivatives market at the end of 2011 was
approximately $3.6 trillion, which is up 24% from
last year’s estimated amount of $2.9 trillion.
1089 Id. The threshold for classification as a
‘‘large’’ program under the ISDA survey is more
than 3,000 agreements. Overall, 84% of all OTC
derivatives transactions executed by the largest
dealers were subject to collateral agreements. Hedge
fund exposures tend to be the most highly
collateralized of all types of counterparty exposures
with average collateralization levels exceeding
100% of net exposures, a figure that reflects
‘‘Independent Amounts’’ (initial margin) posted by
such firms. ISDA Margin Survey 2011 at Table 3.3.
1090 ISDA Margin Survey 2012 at Table 3.2. The
fourteen largest reporting firms reported an average
96.1% of credit derivatives trades were subject to
collateral arrangements during 2011, and 85.5% of
equity derivatives trades were subject to collateral
agreements. Id.
1091 See ISDA Margin Survey 2011. This
information was not reported in the ISDA Margin
Survey 2012.
1092 Id.
1093 Id.

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reflecting a greater tendency to collect
initial margin from those
participants.1094 Finally, exposures to
non-financial corporations (37.3%) and
sovereign governments (17.6%) had
much lower levels of coverage.1095
The data from the ISDA Margin
Survey 2011 and the ISDA Margin
Survey 2012 support the premises that
margin practices widely vary, that larger
dealers tend to collateralize their net
exposures, that exposures to financial
end users tend to be collateralized with
both variation (current exposure) and
initial margin (potential future
exposure), and that much of the
exposure to non-financial end users
generally is not collateralized.1096
Rule 18a–3 is generally modeled on
the broker-dealer margin rules in terms
of establishing an account equity
requirement; requiring nonbank SBSDs
to collect collateral to meet the
requirement; and, subject to haircuts,
allowing a range of securities for which
there is a ready market to be used as
collateral.1097 The goals of modeling
proposed new Rule 18a–3 on the brokerdealer margin rules are to create a
framework that will limit counterparty
exposure of nonbank SBSDs while
promoting consistency with existing
rules. This consistency may also
facilitate the ability to provide portfolio
margining of security-based swaps with
other types of securities, and in
particular single name credit default
swaps along with bonds that serve as
reference obligations for the credit
default swaps.
In the securities markets, margin rules
have been set by relevant regulatory
authorities (the Federal Reserve and the
SROs) since the 1930s.1098 The
1094 Id.
1095 Id.
1096 See generally ISDA Margin Survey 2011;
ISDA Margin Survey 2012. The results of the
survey, however, could be substantially different if
limited only to U.S. participants, because the data
contained in the ISDA Margin Survey 2011 and
ISDA Margin Survey 2012 is global. Id. For
example, 47% of the institutions responding to the
ISDA Margin Survey 2012 were based in Europe,
the Middle East, or Africa, and 31% were based in
the Americas. ISDA Margin Survey 2012 at Chart
1.1.
1097 Broker-dealers are subject to margin
requirements in Regulation T promulgated by the
Federal Reserve (12 CFR 220.1, et seq.), in rules
promulgated by the SROs (see, e.g., FINRA Rules
4210–4240), and with respect to security futures, in
rules jointly promulgated by the Commission and
the CFTC (17 CFR 242.400–406).
1098 The Federal Reserve originally adopted
Regulation T pursuant to section 7 of the Exchange
Act shortly after the enactment of the Exchange Act.
See 1934 Fed. Res. Bull. 675. The purposes of the
Federal Reserve’s margin rules include: (1)
Regulation of the amount of credit directed into
securities speculation and away from other uses; (2)
protection of the securities markets from price
fluctuations and disruptions caused by excessive

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70319

requirement that an SRO file proposed
margin rules with the Commission has
promoted the establishment of
consistent margin levels across the
SROs, which mitigates the risk that
SROs (as well as their member firms)
will compete by implementing lower
margin levels and helps ensure that
margin levels are set at sufficiently
prudent levels to reduce systemic
risk.1099 Basing proposed Rule 18a–3 on
the broker-dealer margin rules is
intended to achieve these same
objectives in the market for securitybased swaps. This consistency between
margin requirements for securities and
security-based swaps should ultimately
benefit participants in the securities
markets, reduce the potential for
regulatory arbitrage, and lead to
consistent interpretation and
enforcement of applicable regulatory
requirements across U.S. securities
markets.
The discussion below focuses on the
impact of specific provisions of
proposed new Rule 18a–3 and their
potential benefits and costs. With
respect to certain provisions, the
Commission has identified alternatives
to the proposed approach and is seeking
comment on the relative costs and
benefits of adopting the alternatives, in
comparison to the proposed approach.
As to whether nonbank SBSDs should
be required to collect initial margin in
transactions with each other, the
Commission is expressly proposing
alternative formulations of the rule.
a. Calculation of Margin Amount
Proposed new Rule 18a–3 would
require a nonbank SBSD to perform two
calculations (and a nonbank MSBSP to
perform one calculation) as of the close
of each business day with respect to
each account carried by the firm for a
counterparty to a non-cleared securitybased swap transaction.1100 Even if the
counterparty is not required to deliver
collateral, the calculation(s) would
assist the nonbank SBSD or the nonbank
MSBSPs in managing its credit risk (and
determining how much needs to be
margin credit; (3) protection of investors against
losses arising from undue leverage in securities
transactions; and (4) protection of broker-dealers
from the financial exposure involved in excessive
margin lending to customers. See Charles F.
Rechlin, Securities Credit Regulation § 1:3 (2d ed.
2008).
1099 Pursuant to Section 19(b)(1) of the Exchange
Act, each SRO must file with the Commission any
proposed change in, addition to, or deletion from
the rules of the exchange electronically on a Form
19b–4 through the Electronic Form 19b–4 Filing
System, which is a secure Web site operated by the
Commission. 15 U.S.C. 78s(b)(1) and 17 CFR
240.19b–4.
1100 See paragraphs (c)(1)(i)(A), (B), and (c)(2)(i) of
proposed new Rule 18a–3.

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collateralized) and understanding the
extent of its uncollateralized credit
exposure to the counterparty and across
all counterparties. These required
calculations also would provide
examiners with enhanced information
about non-cleared security-based swaps,
allowing the Commission and other
appropriate regulators to gain
‘‘snapshot’’ information at a point in
time for examination purposes.
As described in section II.B. of the
release, paragraph (d) of proposed new
Rule 18a–3 would prescribe a
standardized method for calculating the
margin amount as well as a model-based
method if the non-bank SBSD is
approved to use internal models.1101
The benefits of consistent treatment of
the standardized haircut and internal
models as between the proposed capital
rules and proposed new Rule 18a–3 may
increase operational efficiencies and
reduce costs at the nonbank SBSD by
permitting the use of congruent systems
and processes to comply with both
capital and margin requirements.1102
As is the case with the impact of
standardized haircuts on regulatory
capital, as described in section II.B. of
the release, nonbank SBSDs required to
use standardized haircuts under Rule
18a–3(d) to determine the margin
amount generally will be required to
collect higher margin amounts from
counterparties for non-cleared securitybased swap transactions than nonbank
SBSDs that are approved to use internal
models will need to collect, because
VaR models generally result in lower
charges than the standardized haircut
provisions.1103
In addition, this proposed
requirement would impose additional
operational and technology costs to
install or upgrade systems needed to
perform daily calculations under
proposed new Rule 18a–3. These costs
may vary because broker-dealers
registering as nonbank SBSDs may
already have systems in place, as
current margin rules 1104 for securities
require daily margin calculations for
customer accounts, while new entrants
may incur higher operational or other
systems costs to comply with this
requirement. Finally, secondary costs
(such as reduced profits) could arise if
commercial end users or other
1101 See paragraph (d) of proposed new Rule 18a–
3. ‘‘Margin amount’’ is generally initial margin or
potential future exposure. These terms may be used
interchangeably throughout this section.
1102 See proposed new Rule 18a–1; proposed new
Rule 18a–3; proposed amendments to Rule 15c3–1.
1103 See Alternative Net Capital Requirements
Adopting Release, 69 FR 34428.
1104 See, e.g., FINRA Rule 4220 (Daily Record of
Required Margin); 12 CFR 220.4.

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counterparties reduce trading in noncleared security-based swaps because of
the increased collateral requirements
required by Rule 18a–3, or if these
entities determine to trade instead with
non-U.S. entities.
b. Account Equity Requirements
As described in section II.B. to this
release, a nonbank SBSD and nonbank
MSBSP generally would need to collect
cash and/or securities to meet the
account equity requirements in
proposed new Rule 18a–3.1105 This
proposal recognizes that counterparties
may engage in a wide range of trading
strategies that include security-based
swaps. Because of the relation between
security-based swaps and other
securities positions, permitting various
types of securities to count as collateral
may be more practical for margin
arrangements involving security-based
swaps than for other types of
derivatives. This flexibility to accept a
broad range of securities, along with
consistency with existing margin
requirements,1106 takes advantage of
efficiencies that result from correlations
between securities and security-based
swaps.1107 However, it may increase the
risk that SBSDs will incur a shortfall if,
as a result, they hold less liquid
collateral that cannot be quickly sold for
an amount that covers the nonbank
SBSD’s exposure to the
counterparty.1108 This risk may be
mitigated by the collateral haircut and
other requirements regarding the
liquidity of collateral under the
proposed rule.1109
As an alternative, the Commission
could limit eligible collateral to the
most highly liquid categories, as
proposed by the prudential regulators
1105 By requiring most counterparties to deliver
collateral, the proposed margin requirements are
intended to prevent counterparties from employing
undue leverage in their portfolios of security-based
swaps, which can exacerbate the magnitude of
losses in relation to the financial resources of the
counterparty in the case of default.
1106 See the Federal Reserve’s Regulation T, 12
CFR 220.1, et seq. and SRO margin rules, such as
FINRA Rule 4210 and CBOE Rule 12.3. The
consideration in adopting final rules will be
informed by the comments received.
1107 The ISDA Margin Survey 2012 states with
regard to the types of assets used as collateral, that
the use of cash and government securities as
collateral remains predominant, constituting 90.4%
of collateral received and 96.8% of collateral
delivered. ISDA Margin Survey 2012 at 8, Table 2.1.
1108 Gary Gorton and Guillermo Ordon
˜ ez,
Collateral Crises, Yale University Working Paper
(Mar. 2012) (arguing that during normal times
collateral values are less precise, but during volatile
times are reassessed). This reassessment can
possibly lead to large negative shocks in their
values, which by deduction can lead to market
disruptions if collateral needs to be liquidated.
1109 See paragraphs (c)(3)–(c)(4) of proposed new
Rule 18a–3.

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and the CFTC and described in section
II.B.2.c. of this release.1110 This
alternative could limit the potential that
an SBSD would incur a loss following
default of a counterparty based on
changes in market values of less liquid
collateral that occur before the SBSD is
able to sell the collateral, and therefore
could limit the potential for a default by
the SBSD to other counterparties. On
the other hand, if Rule 18a–3 required
a counterparty to deliver additional
collateral beyond assets already held in
the counterparty’s account because the
existing assets did not qualify as eligible
collateral, the rule could have the effect
of increasing the counterparty’s
exposure to the SBSD and draining
liquidity from the counterparty in a way
that may not be necessary to account for
the nonbank SBSD’s potential future
exposure to the counterparty, and may
increase costs for both the nonbank
SBSD and its counterparties.1111 Also,
granting counterparties the flexibility to
post a variety of collateral types to meet
margin requirements may result in
reduced costs for end users and could
encourage increased trading of securitybased swaps, thereby increasing
competition. The extent of increased
trading of non-cleared security-based
swaps, however, may depend on the
extent to which portfolio margin
treatment would materially increase the
amount of net equity that counterparties
would have available to serve as
collateral, compared to the amount that
would result if they were limited to very
highly liquid securities, such as U.S.
Treasury securities.
i. Commercial End Users
As discussed in section II.B.2.c.i. of
this release, under proposed new Rule
18a–3, a nonbank SBSD would not be
required to collect cash or securities to
cover the negative equity (current
exposure) or margin amount (potential
future exposure) in the account of a
counterparty that is a commercial end
user.1112
1110 Commenters argued that the scope of eligible
collateral should be significantly expanded by
arguing that there are other assets that are highly
liquid and suitable for credit support if a
counterparty fails and if eligible collateral remains
narrowly defined, the liquidity of eligible assets
could be highly affected and sourcing of adequate
margin could become difficult. See, e.g., CFTC
SIFMA/ISDA Letter.
1111 This alternative may also increase demand
for highly liquid collateral and potentially cause
shortages in the supply of cash and government
bonds. See IMF, Global Financial Stability Report:
The Quest for Lasting Stability 96 and 120 (Apr.
2012), available at http://www.imf.org/External/
Pubs/FT/GFSR/2012/01/pdf/text.pdf.
1112 See paragraph (b)(2) of proposed new Rule
18a–3 (defining the term commercial end user).

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As discussed above in section
II.A.2.b.v. of this release, this proposed
exception to the requirement to collect
collateral is intended to benefit
commercial end users in order to
address concerns that have been
expressed by them and others that the
imposition of margin requirements on
commercial companies that use
derivatives to mitigate the risk of
business activities that are not financial
in nature could unduly disrupt their
ability to enter into such hedging
transactions. The proposed exception
for commercial end users also is
intended to account for the different risk
profiles of commercial end users as
compared with financial end users.1113
This exception may increase efficiencies
by allowing such end users to more cost
efficiently manage business risks and
thereby better compete in their
respective industries.
At the same time, to the extent of any
dealer exposure to commercial end
users, the proposed exception for
commercial end users could lead to
uncollateralized exposure by nonbank
SBSDs to commercial end users. To
address this concern and because
collecting collateral is an important
means of mitigating risk, Rule 18a–1
would require nonbank SBSDs not
approved to use internal models to take
a capital charge equal to the margin
amount calculated for the commercial
end user to the extent the firm does not
collect cash or securities equal to that
amount.1114 Requiring a firm to hold
capital in lieu of margin 1115 in these
cases is designed to reflect both the
needs of commercial end users and
concerns that permitting nonbank
SBSDs to assume credit exposure
without the protection of margin could
lead to the assumption of inappropriate
risks. In this way the proposal is
intended to ensure the safety and
soundness of nonbank SBSDs and be
proportionate to the amount of
1113 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27571 (‘‘Among end
users, financial end users are considered more risky
than nonfinancial end users because the
profitability and viability of financial end users is
more tightly linked to the health of the financial
system than nonfinancial end users. Because
financial counterparties are more likely to default
during a period of financial stress, they pose greater
systemic risk and risk to the safety and soundness
of the covered swap entity.’’). See also CFTC Margin
Proposing Release, 76 FR at 27735 (‘‘The
Commission believes that financial entities, which
are generally not using swaps to hedge or mitigate
commercial risk, potentially pose greater risk to
CSEs than non-financial entities.’’).
1114 See proposed paragraph (c)(2)(xiv) of Rule
15c3–1; paragraph (c)(1)(xiv) of proposed Rule 18a–
1.
1115 See section II.A.2.b.v. of this release
(discussing proposed charge capital in lieu of
margin collateral).

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uncollateralized exposures to
commercial end users.1116
The extent of the impact of the
intended benefit to commercial end
users, however, would depend on
whether nonbank SBSDs choose to trade
with commercial end user
counterparties on an uncollateralized
basis, notwithstanding the capital
charges under Rule 18a–1. In addition,
nonbank SBSDs subject to this capital
charge are expected to, at least partially,
pass the increased cost of capital
through to commercial end users in the
form of increased transaction
pricing.1117 Accordingly, any potential
economic benefit associated with an
exception from Rule 18a–3 for
commercial end users in non-cleared
security-based swaps may be offset to
the extent that nonbank SBSDs
determine to pass on any costs incurred
as a result of the additional capital
charges.1118 In summary, the
Commission does not expect those costs
will be material, unless commercial end
users begin to account for meaningful
volume in non-cleared security-based
swap trading.
As an alternative, the Commission
could limit this proposed exception for
commercial end users and require
nonbank SBSDs to collect collateral
from commercial end users with regard
to their transactions in non-cleared
security-based swaps. This alternative
would protect the nonbank SBSDs by
requiring that transactions with
commercial end users be collateralized.
However, in contrast to the
Commission’s proposal, this alternative
would limit the flexibility of nonbank
SBSDs and commercial end users to
negotiate the terms of their non-cleared
1116 As discussed above in section II.A. of this
release, nonbank SBSDs that have been approved to
use internal models for credit risk would take a
much smaller capital charge, i.e., 8% of net
replacement value multiplied by the counterparty
factor. These firms also would be permitted to take
a smaller charge with respect to the unsecured
receivables from commercial end user
counterparties, which may provide a competitive
advantage for nonbank SBSDs that are capable of
and have received approval to model credit risk.
1117 Even under these conditions, a nonbank
SBSD still retains the option to collect margin from
its counterparties.
1118 See Antonio S. Mello and John E. Parsons,
Margins, Liquidity and the Cost of Hedging, MIT
Center for Energy and Environmental Policy
Research Working Paper 2012–005 (May 2012)
(presenting a replication argument to show that a
non-margined swap is equivalent to a package of (1)
a margined swap, plus (2) a contingent line of
credit). The paper concludes that a mandate to clear
and therefore to margin derivatives trades forces
dealers to market these two components separately,
but otherwise makes no additional demand on nonfinancial corporations, and therefore, a clearing and
margin mandate does not add any real costs to a
non-financial corporation seeking to hedge its
commercial risk). Id.

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security-based swap transactions. In
considering this approach, the
Commission would need to consider the
benefit of any additional protections to
SBSDs against losses in transactions
with commercial end users in light of
increased costs to such end users or less
accessibility to them of hedging
instruments.
ii. SBSDs—Alternatives A and B
As described in section II.B. to the
release, the Commission is proposing
specific alternative margin requirements
with respect to counterparties that are
nonbank SBSDs. Under Alternative A,
which would create an exception from
proposed new Rule 18a–3, a nonbank
SBSD would need collateral only to
cover the current exposure (negative
equity) in the account of a counterparty
that is another SBSD. Under Alternative
B, a nonbank SBSD would be required
to collect collateral to cover both the
current exposure (negative equity) and
the potential future exposure (margin
amount) in the account of a
counterparty that is another SBSD 1119
and further segregate the margin amount
in an account carried by an independent
third-party custodian pursuant to the
requirements of Section 3E(f) of the
Exchange Act.1120 Alternative B is
consistent with the proposals of the
prudential regulators and the CFTC.1121
As discussed in section V.A. above,
the baseline of this economic analysis is
the OTC derivatives markets as they
exist today. The CDS Data Analysis
suggests there is currently a high degree
of concentration of potential dealing
activity in the single-name credit default
swap market. Based on discussions with
market participants, the Commission
staff understands that dealers in
security-based swaps presently collect
variation margin covering current
exposure but generally do not collect
initial margin covering potential future
exposure from other dealers.1122
Accordingly, relative to the existing
market for security-based swaps,
Alternative A would not create
additional costs for dealers resulting
from transactions with other dealers in
security-based swaps. Alternative B
would impose substantially greater costs
1119 Alternative B is not an exception to the
account equity requirements in proposed new Rule
18a–3 because it would require the nonbank SBSD
to collect collateral to cover the negative equity and
margin amount in an account of another SBSD.
1120 See 15 U.S.C. 78c–5(f).
1121 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564; CFTC Margin
Proposing Release, 76 FR 23732.
1122 See generally ISDA Margin Survey 2011;
ISDA Margin Survey 2012.

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to inter-dealer transactions compared to
the baseline.
Alternatives A and B would both
require the exchange of variation
margin; the difference between the
alternatives therefore is, first and
foremost, whether to require nonbank
SBSD counterparties to exchange initial
margin. The cost impact would depend
on how significant initial margin is in
relation to variation margin, which will
vary by type of contract, extent of
market volatility, and other factors. The
goal for either alternative is to reduce
systemic risk without imposing undue
additional cost to the extent that the
ability of counterparties to trade
security-based swaps is severely
compromised. However, the benefit of
collecting the margin amount under
Alternative B would be the further
protection of a nonbank SBSD from
market exposure during the period of
unwinding a position from a defaulting
counterparty when that counterparty, by
definition, would not be able to post
additional variation margin.
Requiring a nonbank SBSD to post
initial margin, however, could
significantly impact its liquidity and
therefore limit the ability of the
nonbank SBSD to trade in securitybased swaps. Permitting a firm to retain
a pool of liquid assets that would not
otherwise be used to post initial margin
could permit the nonbank SBSD to use
this capital more efficiently, for example
by increasing its investment in
information technology or increasing its
investments that offer a higher rate of
return. The potential benefit of
Alternative B is that it would limit the
aggregate amount of leverage in the
financial system associated with
security-based swaps. A principal
purpose of Title VII of the Dodd-Frank
Act, including those provisions that
apply to capital and margin
requirements for dealers, is to reduce
systemic risk, particularly risks
associated with relatively opaque
bilateral, non-cleared derivative
transactions. Requiring dealers to
collateralize their potential future
exposure to each other by exchanging
both initial and variation margin may
further reduce systemic risk by reducing
leverage and the potential that a default
by a single large dealer could translate
to defaults of counterparty dealers with
potential ripple effects throughout the
system.
On the other hand, the requirement to
exchange initial margin would not only
impose costs to the extent that it would
result in substantially less capital
available to support the security-based
swap business or other dealer activity,
but also it could contribute to the

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instability of a nonbank SBSD. The
instability stems from the possibility
that assets posted to the custodian
account might in the case of a
counterparty default not be immediately
returned to a nonbank SBSD to absorb
losses or meet other liquidity demands.
In this regard, the ability of a dealer
counterparty to demand and obtain the
return of initial margin held by a thirdparty custodian could be subject to
various uncertainties, including the
potential for counterparty disputes that
might be subject to court resolution.
During periods of general market
instability or loss of confidence, even a
brief delay in being able to access liquid
assets could prove decisive.1123
The prudential regulators and the
CFTC have received comment letters
regarding the liquidity impact of their
proposed rules, as well as public
research reports attempting to estimate
the liquidity impact.1124 Each of these
commenters used different methods,
data and assumptions to arrive at a
liquidity impact estimate and respond
to the amount of initial margin required
by the prudential regulators’ and CFTC’s
proposed margin rules. Overall, each of
these commenters concluded that the
liquidity impact of the proposed initial
margin rules proposed by the CFTC and
the prudential regulators was
significant.1125 One such estimate,
however, noted that the numbers should
be viewed as an ‘‘order of magnitude
estimate’’ and that ‘‘[o]ne cannot predict
which entities will use derivatives in
1123 See Manmohan Singh, Velocity of Pledged
Collateral: Analysis and Implications, IMF Working
Paper, WP/11/256 (Nov. 2011) (stating that the
decline in leverage and re-use of collateral may be
viewed positively from a financial stability
perspective, but from a monetary policy
perspective, however, the lubrication in the global
financial markets is now lower as the velocity of
money-type instruments has declined.). Singh
argues that the ‘‘velocity of collateral,’’ analogous to
the concept of the ‘‘velocity of money’’ indicates the
liquidity impact of collateral. A security that is
owned by an economic agent and can be pledged
as re-usable collateral leads to chains. Therefore,
Singh argues that a shortage of acceptable collateral
would have a negative cascading impact on lending
similar to the impact on the money supply of a
reduction in the monetary base. Id. at 16. See also
Manmohan Singh and James Aitken, The (sizable)
Role of Rehypothecation in the Shadow Banking
System, IMF Working Paper WP/10/172 (July 2010).
1124 See OCC Economics Department, Unfunded
Mandates Reform Act—Impact Analysis for Swaps
Margin and Capital Rule, (Apr. 15, 2011) (‘‘OCC
Unfunded Mandates Report’’); SIFMA/ISDA
Comment Letter to the Prudential Regulators; J.P.
Morgan Letter; Bank of America-Merrill Lynch, No
Margin for Error, Part 3: Dodd-Frank Implements
QE3, Credit Derivatives Strategist (Nov. 5, 2011)
(‘‘BAML Report’’).
1125 See Manmohan Singh, Collateral, Netting and
Systemic Risk in the OTC Derivatives Market, IMF
Working Paper WP 10/99 (1999) (a study by the IMF
arguing that moving OTC derivatives to centralized
clearing would require between $170 and $220
billion in initial margin collateral).

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the future nor the amounts and types of
products that will be used.’’ 1126
Consequently, while it is difficult to
estimate the costs imposed by requiring
dealers to post initial margin,
commenters to the CFTC and prudential
regulators’ proposed margin rules and
others have estimated that the cost
would be significant. These estimates
are discussed in detail below.1127
One commenter to the prudential
regulators’ proposed margin rule stated
that imposing segregated initial margin
requirements on trades between swap
entities would result in a tremendous
cost to the financial system in the form
of a massive liquidity drain.1128 This
commenter estimated that the effect of
the proposed rule would result in a cost
of $428 billion in initial margin for
swap dealers.1129 Another commenter
predicted that the initial margin
requirements will result in a huge drain
of liquid assets from the U.S. economy
because they would require very large
amounts of collateral to be posted as
initial margin and placed in segregated
custodial accounts.1130 This commenter
attempted to quantify this amount by
calculating the amounts of initial
margin that the firm would have to
collect from 34 of its largest professional
dealer counterparties by reference to the
‘‘Lookup Table’’ percentages of notional
approach set forth in Appendix A to the
prudential regulators’ margin
rulemaking.1131 Application of this
approach to the commenter’s existing
portfolio with those 34 counterparties
yielded an estimated amount of initial
margin that the firm would have to
collect equal to $1.4 trillion.1132 The
commenter noted that since the
interdealer initial margin requirements
are reciprocal, it would also be obligated
to post $1.4 trillion.1133
1126 SIFMA/ISDA Comment Letter to the
Prudential Regulators at 38.
1127 See BCBS, IOSCO, Margin Requirements for
Non-centrally-cleared Derivatives. The Working
Group on Margin Requirements is conducting a
Quantitative Impact Study to better quantify the
impact of the proposed margin requirements set
forth in the consultative paper. See id. at Part C.
1128 SIFMA/ISDA Comment Letter to the
Prudential Regulators.
1129 Id. at 36.
1130 J.P. Morgan Letter.
1131 J.P. Morgan Letter; Prudential Regulator
Margin and Capital Proposing Release, 76 FR at
27592.
1132 J.P. Morgan Letter at 5.
1133 Id. In the J.P. Morgan Letter, however, it was
noted that it is likely that most swap dealers would
use the model based approach, and not the ‘‘lookup
table’’, to calculate initial margin which would
likely produce smaller initial margin amounts. In
the letter, it was argued that there is substantial
uncertainty about the model approval process and
timing and accordingly the large amounts resulting
from application of the lookup table are relevant.
Id.

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In addition, the OCC Unfunded
Mandates Report estimated that the
initial margin collected under the
prudential regulators’ proposed margin
rule in one year could total $2.56
trillion.1134 The report pointed out,
however, that several factors are likely
to reduce the impact of the proposed
rule, including a move to central
clearing and the fact that dealers are
likely to use internal models that permit
netting. The report estimated that
currently roughly 20% of swap
contracts trade through clearing
houses.1135 Assuming that the
proportion of cleared to non-cleared
swaps will at a minimum remain at one
in five, the report further estimated the
required funds to cover the initial
margin requirement under the proposed
rule to be $2.05 trillion (0.80 × $2.56
trillion).1136
Finally, the BAML Report stated that
its calculations suggested that the
regulatory changes may eventually
result in initial margin requirements of
$200 billion to $600 billion for US
banks, as current derivatives portfolios
turn over.1137
In summary, as stated above,
commenters concluded that the
liquidity impact of the initial margin
rules proposed by the CFTC and the
prudential regulators was
significant.1138 However, one
commenter acknowledged that the
numbers should be viewed as an ‘‘order
of magnitude estimate’’ and that ‘‘[o]ne
cannot predict which entities will use
derivatives in the future nor the
amounts and types of products that will
be used.’’ 1139 The Commission seeks
comment on the liquidity impact of its
proposals below and in section II.B. of
this release.

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

c. Margin Requirements for NonbankMSBSPs
As described in section II.B. of this
release, a nonbank MSBSP would be
required to calculate as of the close of
1134 OCC Unfunded Mandates Report at 5. The
report also used the ‘‘lookup table’’ to estimate the
initial margin impact of the prudential regulators’
proposed margin rule, and noted the proposed rule
would apply to any swap that is a national bank,
a federally chartered branch or agency of a foreign
bank, or a federal savings association. Id. at 2.
1135 OCC Unfunded Mandates Report at 5.
1136 Id. The report also estimated that the actual
cost of the initial margin requirement is the
opportunity cost of collateral that under the
prudential regulators’ rule must be segregated into
a custodial account with a presumably lower rate
of return.
1137 BAML Report at 5.
1138 See also Manmohan Singh, Collateral,
Netting and Systemic Risk in the OTC Derivatives
Market.
1139 SIFMA/ISDA Comment Letter to the CFTC at
38.

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each business day the amount of equity
in the account of each counterparty to
a non-cleared security-based swap.1140
On the next business day following the
calculation, the nonbank MSBSP would
be required to either collect or deliver
cash, securities, and/or money
instruments to the counterparty
depending on whether there was
negative or positive equity in the
account of the counterparty.1141
Specifically, if the account had negative
equity on the previous business day, the
nonbank MSBSP would be required to
collect cash, securities, and or money
market instruments in an amount equal
to the negative equity.1142 Conversely, if
the account had positive equity on the
previous business day, the nonbank
MSBSP would be required to deliver
cash, securities, and/or money market
instruments to the counterparty in an
amount equal to the positive equity.1143
Nonbank MSBSPs are not expected to
maintain two-sided markets or
otherwise engage in activities that
would require them to register as an
SBSD.1144 They will, however, by
definition, maintain substantial
positions in particular categories of
security-based swaps.1145 These
positions could create significant risk to
counterparties to the extent the
counterparties have uncollateralized
current exposure to the nonbank SBSD.
In addition, they could pose significant
risk to the nonbank MSBSP to the extent
it has uncollateralized current exposure
to its counterparties. The proposed
account equity requirements for
nonbank MSBSPs seek to address these
risks by imposing a requirement that
nonbank MSBSPs on a daily basis must
‘‘neutralize’’ the credit risk between the
nonbank MSBSP and the counterparty
either by collecting or delivering cash,
securities, and/or money market
instruments in an amount equal to the
positive or negative equity in the
account.
The collection of collateral from
counterparties would strengthen the
liquidity of the nonbank MSBSP by
1140 See paragraph (c)(2)(i) of proposed new Rule
18a–3.
1141 See paragraph (c)(2)(ii) of proposed new Rule
18a–3. As indicated, the nonbank MSBSP would
need to deliver cash, securities, and/or money
market instruments and, consequently, other types
of assets would not be eligible as collateral.
1142 See paragraph (c)(2)(ii)(A) of proposed new
Rule 18a–3. In this case, the nonbank MSBSP
would have current exposure to the counterparty in
an amount equal to the negative equity.
1143 See paragraph (c)(2)(ii)(B) of proposed new
Rule 18a–3.
1144 See Entity Definitions Adopting Release, 77
FR 30596.
1145 See 15 U.S.C. 78c(a)(67); Entity Definitions
Adopting Release, 77 FR 30596.

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collateralizing its current exposure to
counterparties. The delivery of
collateral to counterparties to
collateralize their current exposure to
the nonbank MSBSP would lessen the
impact on the counterparties if the
nonbank MSBSP failed.
The requirement for nonbank MSBSPs
to post current exposure to certain
counterparties under proposed new
Rule 18a–3 would impose an
incremental opportunity cost for these
nonbank MSBSPs only to the extent that
they do not currently post collateral to
cover current exposure. The
requirement that nonbank MSBSPs
collect variation margin from certain
counterparties also would represent an
incremental cost to those counterparties
users to the extent they do not currently
post such margin.
As stated above, proposed new Rule
18a–3 contains an exception for trades
between nonbank MSBSPs and
commercial end users, so those end
users would not face additional costs
because of this exception.
Instead of the proposed approach, the
Commission could adopt margin
requirements for nonbank MSBSPs that
are consistent with those proposed for
nonbank SBSDs, by requiring them to
collect initial margin from all nondealer counterparties. This approach
could better protect the MSBSP from
loss in the event of a counterparty
default, and thereby lessen the
possibility of a default by the MSBSP.
On the other hand, such a requirement
would increase the credit exposure of
counterparties to the MSBSP by the
amount of the initial margin that they
provide to the MSBSP and could
increase their risk of loss if the MSBSP
were to fail and they were unsuccessful
in obtaining the return of amounts owed
to them. The Commission is seeking
comment on this alternative.
d. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The proposed margin requirements to
collect collateral from their
counterparties to non-cleared securitybased swaps to cover both current
exposure and potential future exposure
are designed to insulate security-based
swap market participants from the
negative fallout of a defaulting
counterparty. Basing proposed Rule
18a–3 on the broker-dealer margin rules
is intended to achieve those objectives
in the market for security-based swaps.
Moreover, the consistency between
margin requirements for securities and
security-based swaps should ultimately
promote efficiency in the securities

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markets, and in turn, enhance
competition in the security-based swap
markets.
The proposed rule offers built-in
flexibilities that should enhance the
efficiency in the application of the rule.
For example, granting counterparties the
flexibility to post a variety of collateral
types to meet margin requirements may
result in increased efficiencies for end
users, and could encourage increased
trading of security-based swaps and
thereby increase competition.
Furthermore, the proposed exception for
commercial end users is intended to
account for the different risk profiles of
commercial end users as compared with
financial end users.1146 This exception
may increase efficiencies by allowing
SBSDs to optimally choose to collect
collateral or take a capital charge, which
in turn might allow end users to more
cost efficiently manage business risks
and thereby better compete in their
respective industries.
However, the flexibility to use models
to calculate margins instead of applying
the standard haircuts could have an
adverse impact on competition if the
differences in these margin amounts are
sufficiently large. If this was the case, a
nonbank SBSD not approved to use
models will find it difficult to compete
with an SBSD approved to use models.
However, it is conceivable that SBSDs
not approved to use models would tend
to do business only in cleared securitybased swaps and SBSDs that use models
would compete in both cleared and noncleared security-based swaps. This
separation could have a negative impact
on competition in non-cleared securitybased swaps. If, however, SBSDs that
are approved to use models manage
counterparty risk more efficiently, the
market for non-cleared security-based
swaps might be systemically less risky
than it would be if SBSDs not using
models participated actively in that
market. It is unclear whether the benefit
from the reduction in systemic risk
would outweigh the potential cost of the
reduced competition.
There also is a trade-off between
Alternatives A and B for SBSDs. Under
1146 See Prudential Regulator Margin and Capital
Proposing Release, 76 FR at 27571 (‘‘Among end
users, financial end users are considered more risky
than nonfinancial end users because the
profitability and viability of financial end users is
more tightly linked to the health of the financial
system than nonfinancial end users. Because
financial counterparties are more likely to default
during a period of financial stress, they pose greater
systemic risk and risk to the safety and soundness
of the covered swap entity.’’). See also CFTC Margin
Proposing Release, 76 FR at 27735 (‘‘The
Commission believes that financial entities, which
are generally not using swaps to hedge or mitigate
commercial risk, potentially pose greater risk to
CSEs than non-financial entities.’’).

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Alternative A the reduced demand on
posting and collecting collateral should
lead to more efficient allocation of
capital and hence improve competition,
but it comes at the cost of being less
resilient to counterparty defaults and
hence might overall increase systemic
risk. In addition, if the Commission
does not require nonbank SBSDs to
collect initial margin in their
transactions with each other, as is
generally current market practice,1147
while the prudential regulators require
the collection of initial margin for the
same trades as their proposed rules
suggest, intermediaries could have an
incentive to conduct business through
nonbank entities.1148 Under Alternative
B, the requirement to exchange initial
margin would impose costs on the
nonbank SBSD in the form of a capital
charge to the extent the nonbank SBSD
must post initial margin. This could
result in substantially less liquidity
available to the nonbank SBSD to
support its security-based swap
business or other dealer activity, but to
the extent it limits the amount of
uncleared SBSD transactions among
nonbank SBSDs as a whole, it could
lead to lower systemic risk. Moreover, if
this requirement results in a significant
increase in costs because of the required
capital charge, nonbank SBSDs could be
motivated to conduct trading either in
bank SBSDs or offshore because they
would not need to take the capital
charge. Especially in the latter case, this
may not only adversely affect domestic
competition if the only dealers able to
absorb the increased expenses are the
ones currently participating in the
market, it also could increase systemic
risk worldwide if the regulatory
environment in foreign jurisdictions are
less stringent.
Request for Comment
The Commission generally requests
comment about its analysis of the costs
and benefits of proposed Rule 18a–3. In
addition, the Commission requests
comment in response to the following
questions:
1. In many respects, the proposed
rules reflect an interplay between
capital and margin requirements. How
should each set of rules take account of
the other? For example, does the
proposed alternative capital charge in
lieu of collecting margin from
commercial end users appropriately
account for the increased exposure to
the dealer? Does it over-state the
exposure?
1147 See

generally ISDA Margin Survey 2011.
Prudential Regulator Margin and Capital
Proposing Release, 76 FR 27564.
1148 See

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2. What would be the general market
impact of requiring that dealers post
both variation and initial margin in
transactions with each other?
Commenters are asked to supply data on
the volume of interdealer transactions in
security-based swaps and the aggregate
dollar impact of this proposal. How
does the impact of requiring dealers to
exchange both variation and initial
margin compare with the aggregate
dollar impact of requiring that nonbank
SBSDs collect only variation margin?
3. With regard to Alternatives A and
B regarding interdealer margin, the
Commission requests that commenters
provide the following data points to the
Commission:
• The relative amounts of variation
and initial margin for sample dealer
portfolios of security-based swaps;
• The industry dollar impact and
liquidity impact of requiring lock up of
initial margin for dealer portfolios; and
• How the amount of initial margin
would compare to overall dealer capital.
4. The Commission also requests
comment on the potential legal
limitations involved in obtaining a
return of collateral that has been posted
to a third party custodian, the costs
involved, and whether there are ways to
overcome these limitations.
5. The Commission requests comment
on the costs and benefits, if the
Commission, as an alternative to
proposed new Rule 18a–3, permitted
nonbank SBSDs to apply to the
Commission to use internal models
solely to compute the margin amount in
paragraph (d) to Rule 18a–3 (without
seeking approval to use internal models
for capital purposes). Would this
alternative impact the Commission’s
oversight responsibility of nonbank
SBSDs?
6. What is the cost impact, if any, of
permitting nonbank SBSDs to accept
securities as collateral that may be less
liquid than Treasury securities in the
case of severe market disruptions?
Would this cost be mitigated by the
haircut and collateral requirements in
proposed Rule 18a–3?
7. What would be the costs and
benefits of an initial margin requirement
between nonbank SBSDs counterparties
dependent on the firm’s minimum net
capital requirement (e.g., based on firm
size)?
8. Proposed Rule 18a–3(d) would
require that firms approved to use VaR
models calculate margin amount using
a 99%, 10 business-day period. How
would this proposal affect sample
portfolios of security-based swaps based
on existing internal firm models and
current market practices, including
margin practices at registered clearing

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
agencies? The Commission requests data
from market participants to assist it in
evaluating this proposal.
9. Would the margin requirements
under proposed new Rule 18a–3
incentivize counterparties to trade in
cleared security-based swaps? If certain
security-based swaps cannot be cleared,
would the proposed margin
requirements render the use of these
non-cleared contracts inefficient?
10. Will nonbank MSBSPs incur
operational, technology or other costs to
calculate the amount of equity in the
account of a counterparty, as required
under paragraph (c)(2)(i) of proposed
new Rule 18a–3?

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

4. Proposed Segregation Rule—Rule
18a–4
Proposed new Rule 18a–4 would
establish segregation requirements for
cleared and non-cleared security-based
swap transactions, which would apply
to bank SBSDs, nonbank stand-alone
SBSDs, and broker-dealer SBSDs.1149
The goal of proposed new Rule 18a–4 is
to protect customer assets by ensuring
that cash and securities that SBSDs hold
for security-based swap customers are
isolated from the proprietary assets of
the SBSD and identified as property of
such customers.1150 This approach
would facilitate the prompt return of
customer property to customers either
before or during liquidation proceedings
if the firm fails,1151 and is therefore
expected to provide market participants
who enter into security-based swap
transactions with an SBSD the
confidence that their accounts will
remain separate from the SBSD in the
event of bankruptcy.1152 As such,
proposed new Rule 18a–4 will have a
number of benefits as well as impose
certain costs on SBSDs and MSBSPs, as
well as other market participants. The
proposed rules are expected to have
possible effects on competition,
efficiency, and capital formation, which
are discussed below.
As discussed earlier in this release,
Rule 18a–4 is in substantial part
modeled on provisions of Rule 15c3–3
that require a carrying broker-dealer to
take two primary steps to safeguard
these assets. The first step required by
Rule 15c3–3 is that a carrying broker1149 See proposed new Rule 18a–4. See also
section II.C. of this release for a more detailed
description of the proposal. The provisions of
proposed new Rule 18a–4 are modeled on the
broker-dealer segregation rule, Rule 15c3–3. 17 CFR
240.15c3–3.
1150 See proposed new Rule 18a–4.
1151 See generally Michael P. Jamroz, The
Customer Protection Rule, 57 Bus. Law. 1069 (May
2002). See also section II.C. of this release for a
more detailed description of the proposal.
1152 See 15 U.S.C. 78c–5.

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dealer must maintain physical
possession or control over customers’
fully paid and excess margin
securities.1153 The second step is that a
carrying broker-dealer must maintain a
reserve of funds or qualified securities
in a customer reserve account at a bank
that is equal in value to the net cash
owed to customers, computed in
accordance with the Exhibit A
formula.1154 The corollary provisions of
Rule 18a–4 are likewise intended to
require that customer funds are
adequately protected from loss in the
event of the SBSD’s failure. Further, this
protection would be provided to
customers who have not affirmatively
elected to require individual account
segregation of their assets under section
3E(f) of the Exchange Act.
Paragraph (a) of the proposed new
rule would define key terms used in the
rule.1155 Paragraph (b) would require an
SBSD to promptly obtain and thereafter
maintain physical possession or control
of all excess securities collateral (a term
defined in paragraph (a)) and specify
certain locations where excess securities
collateral could be held and deemed in
the SBSD’s control.1156 Paragraph (c)
would require an SBSD to maintain a
special account for the exclusive benefit
of security-based swap customers and
have on deposit in that account at all
times an amount of cash and/or
qualified securities (a term defined in
paragraph (a)) determined through a
computation using the formula in
Exhibit A to proposed new Rule 18a–
4.1157
Paragraph (d) of proposed new Rule
18a–4 would contain provisions that are
designed to implement the individual
account segregation requirements of
section 3E(f) of the Exchange Act, and
therefore, are not modeled specifically
on Rule 15c3–3. First, it would require
an SBSD and an MSBSP to provide the
notice required by section 3E(f)(1)(A) of
the Exchange Act prior to the execution
of the first non-cleared security-based
swap transaction with the
counterparty.1158 Second, it would
require the SBSD to obtain
subordination agreements from
1153 See

17 CFR 240.15c3–3(d).
CFR 240.15c3–3(e). The term ‘‘qualified
security’’ is defined in Rule 15c3–3 to mean a
security issued by the United States or a security
in respect of which the principal and interest are
guaranteed by the United States. See 17 CFR
240.15c3–3(a)(6).
1155 Compare 17 CFR 240.15c3–3(a), with
paragraph (a) of proposed new Rule 18a–4.
1156 Compare 17 CFR 240.15c3–3(b)–(d), with
paragraph (b) of proposed new Rule 18a–4.
1157 Compare 17 CFR 240.15c3–3(e), with
paragraph (e) of proposed new Rule 18a–4.
1158 See 15 U.S.C. 78c–5(f)(1)(A); paragraph (d)(1)
of proposed new Rule 18a–4.
1154 17

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counterparties that opt out of the
segregation requirements in proposed
new Rule 18a–4 because they either
elect individual segregation pursuant to
the self-executing provisions of section
3E(f) of the Exchange Act 1159 or agree
that the SBSD need not segregate their
assets at all.1160
Available information suggests that
customer assets related to OTC
derivatives are currently not
consistently segregated from dealer
proprietary assets. With respect to noncleared derivatives, available
information suggests that there is no
uniform segregation practice but that
collateral for most accounts is not
segregated.1161 According to the ISDA
Margin Survey 2012, where independent
amounts (initial margin) is collected,
ISDA members reported that most
(approximately 72.2%) was commingled
with variation margin and not
segregated, and only 4.8% of the
amount received was segregated with a
third party custodian.1162
In the absence of a segregation
requirement, the likelihood that
security-based swap customers would
suffer losses upon a dealer default may
substantially increase. The proposed
segregation requirements would limit
for security-based swap customers these
potential losses if an SBSD fails.1163 The
extent to which assets are in fact
protected by proposed Rule 18a–4
would depend on how effective they are
in practice in allowing assets to be
readily returned to customers.
It is difficult to measure these benefits
against the current baseline of the OTC
derivatives market as it exists today, as
discussed in section V.A.1. of this
release. Rule 15c3–3, on which
proposed Rule 18a–4 is modeled,
however, may generally provide a
reasonable template for crafting the
corresponding requirements for
nonbank SBSDs.1164 Furthermore, the
ensuing increased confidence of market
participants when transacting in
1159 See

15 U.S.C. 78c–5(f)(1)–(3).
15 U.S.C. 78c–5(f)(4).
1161 See generally ISDA Margin Survey 2012.
1162 ISDA Margin Survey 2012. The survey also
notes that while the holding of the independent
amounts and variation margin together continues to
be the industry standard both contractually and
operationally, it is interesting to note that the ability
to segregate has been made increasingly available to
counterparties over the past three years on a
voluntary basis, and has led to adoption of 26% of
independent amount received and 27.8% of
independent amount delivered being segregated in
some respects. Id. at 10. See also Independent
Amounts.
1163 CFTC and Commission, Statement on MF
Global about the deficiencies in customer futures
segregated accounts held at the firm (Oct. 31, 2011).
1164 See 17 CFR 240.15c3–3. See SIPC 2011
Annual Report.
1160 See

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security-based swaps, as compared to
the OTC derivatives market as it exists
today, should enhance liquidity and
generally benefit market participants.
Further, modeling the provisions of
Rule 18a–4 on existing Rule 15c3–3 will
generally promote consistent treatment
of collateral in circumstances where a
broker-dealer SBSD conducts business
in securities and security-based swaps
with the same counterparty, and in
these cases it will facilitate the ability of
firms to offer portfolio margin treatment.
In addition, ‘‘omnibus segregation’’
requirements of proposed Rule 18a–4
are intended to reduce costs for SBSDs
and their customers by providing a less
expensive segregation alternative to
individual account segregation.1165
Currently, because of a lack of trading
in cleared security-based swaps for
customers,1166 there is no definitive
baseline against which to measure the
various costs associated with
segregation requirements for those
trades. Further, overall costs of
segregating collateral for cleared
security-based swaps will be heavily
affected by the clearing agency rules,
which will govern how margin required
by, and held at, a clearing agency with
respect to customer positions must be
segregated.1167
As stated above, proposed new Rule
18a–4 also is intended to provide SBSDs
and their counterparties a less
expensive segregation alternative to
individual account segregation. Higher
costs for individual segregation derive
from, among other things, higher fees
charged by custodians to monitor
individual account assets and to
account for potentially greater legal
risks and liabilities of custodians to
account beneficiaries or dealers, as well
as higher operational costs to account
for collateral on an individual customer
basis. A commenter to the CFTC raised
concerns with the length of time and the
costs to comply with an individual
segregation mandate. Specifically, the
commenter raised concerns regarding
the number of collateral arrangements
that would be required. The commenter
estimated, based on discussion with its
members, that ‘‘a rough estimate of the
time it would take to establish the
necessary collateral arrangements is 1
year and eleven months, with an
associated cost of $141.8 million, per
covered swap entity.’’ 1168 To account
for these higher costs, SBSDs likely may
1165 See

section 3E(f)(1)(B) of the Exchange Act.
Process for Submissions of SecurityBased Swaps, 77 FR 41602.
1167 See Clearing Agency Standards for Operation
and Governance, 76 FR 14472.
1168 SIFMA/ISDA Comment Letter to the
Prudential Regulators.
1166 See

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increase fees for customers that choose
individual rather than omnibus
segregation. If higher fees make it
prohibitively expensive for some
counterparties to elect individual
segregation, the proposed omnibus
segregation scheme under Rule 18a–4
could be a more cost-effective solution.
Rule 18a–4 will impose on SBSDs
operational costs, as well as costs
related to the use of customer funds,
compared to the baseline, given that
dealers in general do not presently
segregate customer collateral for
security-based swaps, and to the extent
collateral is segregated, it is not done so
on the terms that would be required by
proposed new Rule 18a–4. The
operational costs include costs to
establish qualifying bank accounts and
to perform the calculations required to
determine the amount that is required at
any one time to be maintained in the
reserve account.1169 In cases where an
SBSD is jointly registered as a brokerdealer, the costs of adapting existing
systems to account for security-based
swap transactions may not be material
in light of the similarities between the
systems and procedures required by
Rule 15c3–3 and those that would be
required by proposed new Rule 18a–4.
A further cost would be imposed on
SBSDs to the extent that collateral they
hold that could otherwise be
rehypothecated would no longer be
eligible for this purpose.1170 An SBSD
would incur a cost of funds equal to the
borrowing cost of the dealer if the dealer
was unable to use customer collateral to
finance its business activities. The
extent of this cost would depend on
how much collateral associated with
security-based swaps and held by
dealers today consists of initial margin
that they can rehypothecate, i.e., that is
not now segregated as would be
required under Rule 18a–4 (the rule
would not require the segregation of
variation margin).1171

1169 See proposed new Rule 18a–4. See section
V.C. of this release for a discussion of
implementation costs. See also section V.B. of this
release.
1170 See SIFMA/ISDA Comment Letter to the
Prudential Regulators (‘‘First, because the collateral
cannot be rehypothecated, and because the
collateral amounts will be very large, CSEs will be
limited to investing very large amounts of eligible
collateral in assets that generate low returns.’’).
1171 See Manmohan Singh, Velocity of Pledged
Collateral: Analysis and Implications; Manmohan
Singh and James Aitken, The (sizable) Role of
Rehypothecation in the Shadow Banking System.

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a. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The proposed segregation
requirements for SBSDs are designed to
protect and preserve counterparty
collateral held at SBSDs. More
specifically, the goal of proposed new
Rule 18a–4 is to protect customer assets
by ensuring that cash and securities that
SBSDs hold for security-based swap
customers are isolated from the
proprietary assets of the SBSD and
identified as property of such
customers.1172 These protections may
provide market participants who enter
into security-based swap transactions
with an SBSD the assurance that their
accounts will remain separate from the
SBSD in the event of bankruptcy.1173
These proposed protections could
reduce the risk of loss of collateral to
individual counterparties and, thereby,
promote participation in the securitybased swap markets. This may result in
enhanced competition and more
efficient price discovery.
Therefore, proposed segregation rules
that promote, or do not unduly restrict,
competition may be accompanied by
regulatory benefits that minimize the
risk of market failure and thus promote
efficiency within the market. Such
competitive markets would increase the
efficiency with which market
participants could transact in securitybased swaps for speculative, trading,
hedging and other purposes.
Conversely, increased costs associated
with the proposed segregation rules
could result in high barriers to entry and
negatively affect competition for SBSDs
in the security-based swap markets.
Further, modeling the provisions of
Rule 18a–4 on existing Rule 15c3–3 will
generally promote consistent treatment
of collateral in circumstances where a
broker-dealer SBSD conducts business
in securities and security-based swaps
with the same counterparty, increasing
efficiencies for counterparties. Finally,
the proposed ‘‘omnibus segregation’’
requirements of proposed Rule 18a–4
are intended to provide a less expensive
segregation alternative to individual
account segregation.1174 This proposed
requirement could also result in
increased efficiencies, and, in turn,
facilitate capital formation through the
availability of additional capital for
counterparties as a result of decreased
costs.
1172 See

proposed new Rule 18a–4.
15 U.S.C. 78c–5.
1174 See 15 U.S.C. 78c(f)(1)(B).
1173 See

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Request for Comment
The Commission generally requests
comment about its analysis of the costs
and benefits of the proposed segregation
rules. In addition, the Commission
requests comment in response to the
following questions:
1. To what extent do counterparties
presently require that their assets
associated with security-based swaps be
independently segregated?
2. What would be the overall market
impact of a right by customers to
demand individual segregation? How
would costs to end users be impacted?
Would those costs differ depending on
the type of end user or size of its
positions with the SBSD?
3. How would the existence of
omnibus versus independent accounts
factor into the ability easily to resolve a
defaulting SBSD?
4. Would the proposed segregation
requirements prove to be difficult to
implement for existing contracts?

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C. Implementation Considerations
As discussed above, proposed Rules
18a–1 through 18a–4, as well as the
proposed amendments to Rule 15c3–1,
would impose certain costs on SBSDs
and MSBSPs. The Commission expects
that the highest economic cost impact as
a result of the proposed new rules and
rule amendments would likely result
from the additional capital nonbank
SBSDs and nonbank SBSDs may have to
hold as a result of the proposed capital
rules, and the additional margin that
SBSDs, MSBSPs, and other market
participants may have to post and/or
collect as a result of proposed margin
requirements.
The proposed new rules and rule
amendments, however, as discussed
above, would impose certain
implementation burdens and related
costs on SBSDs, MSBSPs and other
market participants. These costs may
include start-up costs, including
personnel and other costs, such as
technology costs, to comply with the
proposed new rules and rule
amendments. As discussed in section
IV.D. of this release, the Commission
has estimated the burdens and related
costs of these implementation
requirements for SBSDs and
MDBSPs.1175 These costs are
summarized below.
A stand-alone SBSD that applies to
use internal models would be required
under proposed new Rule 18a–1 to
create and compile various documents
1175 See section IV.D. of this release (discussing
total initial and annual recordkeeping and reporting
burden of the proposed rules and rule
amendments).

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to be included with the application,
including documents related to the
development of its VaR models, and to
provide additional documentation to,
and respond to questions from,
Commission staff throughout the
application process.1176 These firms
also would be required to review and
backtest these models annually. The
requirements are estimated to impose
one-time and annual costs in the
aggregate of approximately $1.97
million 1177 and $10.6 million,
respectively.1178 These firms would also
incur technology costs of $48.0 million
in the aggregate.1179
Stand-alone SBSDs that use internal
models and ANC broker-dealers would
be required to develop a liquidity stress
test and a written contingency plan
under proposed new Rule 18a–1 and
proposed amendments to Rule 15c3–1,
and periodically review them.1180 These
requirements would impose one-time
and annual costs in the aggregate of
approximately $1.0 million 1181 and $2.3
million,1182 respectively.
Rule 18a–1 also would require standalone SBSDs to establish, document,
and maintain a system of internal risk
management controls required under
Rule 15c3–4, as well as to review and
update these controls.1183 This
requirement would impose one-time
and annual costs in the aggregate of $7.5
million 1184 and $971,000,
respectively.1185 These firms also may
incur aggregate initial and ongoing
information technology costs of
$240,000 and $307,500,
respectively.1186
Finally, nonbank SBSDs and brokerdealers, as applicable, may incur onetime and ongoing costs related to filing
notices and subordination agreements
and documenting industry sector
classifications under proposed new Rule
18a–1, and amendments to Rule 15c3–
1.1187 These requirements would
impose one-time and annual costs in the
1176 See

section IV.A.1. of this release.
consists of external costs of $600,000,
plus internal costs of $1.37 million. See section
IV.D.1. of this release.
1178 This consists of external costs of $3.7 million,
plus internal costs of $6.9 million. See section
IV.D.1. of this release.
1179 See section IV.D.1. of this release.
1180 See section IV.A.1. of this release.
1181 See section IV.D.1. of this release.
1182 Id.
1183 See section IV.A.1. of this release.
1184 See section IV.D.1. of this release.
1185 Id.
1186 Id.
1187 See section IV.A.1. of this release.
1177 This

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70327

aggregate of $68,040 1188 and $38,367,
respectively.1189
Rule 18a–2 also would require
nonbank MSBSPs to establish,
document, and maintain a system of
internal risk management controls
required under Rule 15c3–4, as well as
to review and update these controls.1190
This requirement would impose onetime and annual costs in the aggregate
of $2.7 million 1191 and $324,000 1192 for
nonbank MSBSPs, respectively. These
nonbank MSBSPs also may incur initial
and ongoing information technology
costs of $80,000 and $102,500,
respectively.1193
Rule 18a–3 would require nonbank
SBSDs to establish a written risk
analysis methodology, which would
need to be reviewed and updated.1194
This requirement would impose onetime and annual costs in the aggregate
of $1.7 million 1195 and $483,000,
respectively.1196
Finally, SBSDs and MSBSPs would
incur various one-time and ongoing
costs in the aggregate in order to comply
with the segregation and notification
requirements of proposed new Rule
18a–4.1197 Each SBSD would incur onetime and annual costs in establishing
special bank accounts required by the
rule. This requirement would impose
one-time and annual costs of $2.9
million 1198 and $377,000 1199 in the
aggregate on SBSDs, respectively. In
addition, SBSDs would be required to
perform a reserve computation required
by Appendix A to proposed new Rule
18a–4, which would impose on these
firms annual costs in the aggregate of
$9.7 million.1200
In addition, both SBSDs and MSBSPs
would be required to prepare and send
to their counterparties segregationrelated notices pursuant to section 3E(f)
1188 See section IV.D.1 of this release (one-time
cost to draft subordinated loan agreement template
under Appendix D to proposed new Rule 18a–1).
1189 Id. (annual costs of $2,898, $1,449 and
$34,020 related to documenting industry sector
classifications for credit default swap haircuts
under Rule 18a–1, equity withdrawal notices under
paragraph (i) under Rule 18a–1, and preparing and
filing proposed subordinated loan agreements with
the Commission under Appendix D to Rule 18a–1).
1190 See section IV.A.2. of this release.
1191 This consists of external costs of $400,000,
plus internal costs of $2.3 million. See section
IV.D.2. of this release.
1192 See section IV.D.2. of this release.
1193 Id.
1194 See section IV.A.3. of this release.
1195 See section IV.D.3. of this release. This
consists of external costs of $18,000, plus internal
costs of $1.7 million.
1196 Id.
1197 See section IV.A.4. of this release.
1198 See section IV.D.4. of this release.
1199 Id.
1200 Id.

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of the Exchange Act.1201 This
requirement would impose one-time
and annual costs in the aggregate to
SBSDs and MSBSPs of $770,000 1202
and $110,000, respectively.1203
Finally, proposed new Rule 18a–4
would require each SBSD to draft,
prepare, and enter into subordination
agreements with certain
counterparties.1204 This requirement
would impose on these firms one-time
and annual costs in the aggregate of
$99.7 million 1205 and $19.1 million,1206
respectively.
D. General Request for Comment
The Commission requests data to
quantify, and estimates of, the costs and
the value of the benefits of the proposed
rules described above. Commenters
should provide estimates of these costs
and benefits, as well as any costs and
benefits not already defined, that may
result from the adoption of the proposed
rules. Commenters should provide
analysis and empirical data to support
their views on the costs and benefits
associated with the proposals. The
Commission requests comment on any
effect the proposed new rules and rule
amendments may have on efficiency,
competition, and capital formation,
including the competitive or
anticompetitive effects the proposals
may have on market participants. In
addition, the Commission requests
comment on whether other provisions
of the Dodd-Frank Act for which
Commission rulemaking is required are
likely to have an effect on the costs and
benefits of the proposed rules.
Commenters should provide analysis
and empirical data to support their
views on the costs and benefits
associated with the proposed rules.
VI. Regulatory Flexibility Act
Certification
The Regulatory Flexibility Act
(‘‘RFA’’) 1207 requires Federal agencies,
in promulgating rules, to consider the
impact of those rules on small entities.
Section 603(a) 1208 of the Administrative
Procedure Act,1209 as amended by the
RFA, generally requires the Commission
to undertake a regulatory flexibility
analysis of all proposed rules, or
1201 See

section IV.A.4. of this release.
section IV.D.4. of this release. This
consists of external costs of $220,000, plus internal
costs of $550,020.
1203 Id.
1204 See section IV.A.4. of this release.
1205 See section IV.D.4. of this release. This
consists of external costs of $400,000, plus internal
costs of $3,780,000 and $95,580,000.
1206 Id.
1207 5 U.S.C. 601 et seq.
1208 5 U.S.C. 603(a).
1209 5 U.S.C. 551 et seq.

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1202 See

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proposed rule amendments, to
determine the impact of such
rulemaking on ‘‘small entities.’’ 1210
Section 605(b) of the RFA states that
this requirement shall not apply to any
proposed rule or proposed rule
amendment, which, if adopted, would
not have a significant economic impact
on a substantial number of small
entities.1211
For purposes of Commission
rulemaking in connection with the RFA,
a small entity includes: (1) When used
with reference to an ‘‘issuer’’ or a
‘‘person,’’ other than an investment
company, an ‘‘issuer’’ or ‘‘person’’ that,
on the last day of its most recent fiscal
year, had total assets of $5 million or
less,1212 or (2) a broker-dealer with total
capital (net worth plus subordinated
liabilities) of less than $500,000 on the
date in the prior fiscal year as of which
its audited financial statements were
prepared pursuant to Rule 17a–5(d)
under the Exchange Act,1213 or, if not
required to file such statements, a
broker-dealer with total capital (net
worth plus subordinated liabilities) of
less than $500,000 on the last day of the
preceding fiscal year (or in the time that
it has been in business, if shorter); and
is not affiliated with any person (other
than a natural person) that is not a small
business or small organization.1214
Under the standards adopted by the
Small Business Administration, small
entities in the finance and insurance
industry include the following: (1) For
entities in credit intermediation and
related activities,1215 firms with $175
million or less in assets; (2) for nondepository credit intermediation and
certain other activities,1216 firms with
$7 million or less in annual receipts; (3)
for entities in financial investments and
1210 Although section 601(b) of the RFA defines
the term ‘‘small entity,’’ the statute permits agencies
to formulate their own definitions. The Commission
has adopted definitions for the term ‘‘small entity’’
for the purposes of Commission rulemaking in
accordance with the RFA. Those definitions, as
relevant to this proposed rulemaking, are set forth
in Rule 0–10, 17 CFR 240.0–10. See Statement of
Management on Internal Accounting Control,
Exchange Act Release No. 18451 (Jan. 28, 1982), 47
FR 5215 (Feb. 4, 1982).
1211 See 5 U.S.C. 605(b).
1212 See 17 CFR 240.0–10(a).
1213 See 17 CFR 240.17a–5(d).
1214 See 17 CFR 240.0–10(c).
1215 Including commercial banks, savings
institutions, credit unions, firms involved in other
depository credit intermediation, credit card
issuing, sales financing, consumer lending, real
estate credit, and international trade financing.
1216 Including firms involved in secondary market
financing, all other non-depository credit
intermediation, mortgage and nonmortgage loan
brokers, financial transactions processing, reserve
and clearing house activities, and other activities
related to credit intermediation.

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related activities,1217 firms with $7
million or less in annual receipts; (4) for
insurance carriers and entities in related
activities,1218 firms with $7 million or
less in annual receipts; and (5) for
funds, trusts, and other financial
vehicles,1219 firms with $7 million or
less in annual receipts.1220
Based on available information about
the security-based swap market,1221 the
market, while broad in scope, is largely
dominated by entities such as those that
would be covered by the SBSD and
MSBSP definitions. Subject to certain
exceptions, section 3(a)(71)(A) of the
Exchange Act defines security-based
swap dealer to mean any person who:
(1) Holds itself out as a dealer in
security-based swaps; (2) makes a
market in security-based swaps; (3)
regularly enters into security-based
swaps with counterparties as an
ordinary course of business for its own
account; or (4) engages in any activity
causing it to be commonly known in the
trade as a dealer or market maker in
security-based swaps. Section
3(a)(67)(A) of the Exchange Act defines
major security-based swap participant
to be any person: (1) Who is not an
SBSD; and (2) who maintains a
substantial position in security-based
swaps for any of the major securitybased swap categories, as such
categories are determined by the
Commission, excluding both positions
held for hedging or mitigating
commercial risk and positions
maintained by any employee benefit
plan (or any contract held by such a
plan) as defined in paragraphs (3) and
(32) of section 3 of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002) for the primary purpose
of hedging or mitigating any risk
directly associated with the operation of
the plan; whose outstanding securitybased swaps create substantial
1217 Including firms involved in investment
banking and securities dealing, securities brokerage,
commodity contracts dealing, commodity contracts
brokerage, securities and commodity exchanges,
miscellaneous intermediation, portfolio
management, providing investment advice, trust,
fiduciary and custody activities, and miscellaneous
financial investment activities.
1218 Including direct life insurance carriers, direct
health and medical insurance carriers, direct
property and casualty insurance carriers, direct title
insurance carriers, other direct insurance (except
life, health and medical) carriers, reinsurance
carriers, insurance agencies and brokerages, claims
adjusting, third party administration of insurance
and pension funds, and all other insurance related
activities.
1219 Including pension funds, health and welfare
funds, other insurance funds, open-end investment
funds, trusts, estates, and agency accounts, real
estate investment trusts, and other financial
vehicles.
1220 See 13 CFR 121.201 (Jan. 1, 2010).
1221 See CDS Data Analysis.

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counterparty exposure that could have
serious adverse effects on the financial
stability of the United States banking
system or financial markets; or that is a
financial entity that is highly leveraged
relative to the amount of capital such
entity holds and that is not subject to
capital requirements established by an
appropriate Federal banking regulator;
and maintains a substantial position in
outstanding security-based swaps in any
major security-based swap category, as
such categories are determined by the
Commission.1222
Based on feedback from industry
participants about the security-based
swap markets, entities that will qualify
as SBSDs and MSBSPs, whether
registered broker-dealers or not, will
likely exceed the thresholds defining
‘‘small entities’’ set out above. Thus, it
is unlikely that proposed Rules 18a–1 to
18a–4 and the amendments to Rule
15c3–1 would have a significant
economic impact on any small entity.
The Commission estimates that there
are approximately 808 broker-dealers
that were ‘‘small’’ for the purposes Rule
0–10. The amendments to Rule 15c3–1
relating to the standardized haircuts for
swaps and security-based swaps, as well
as the proposed CDS maturity grid
would apply to all broker-dealers with
such proprietary positions. These
proposed amendments, therefore, would
apply to all ‘‘small’’ broker-dealers in
that they would be subject to the
requirements in the proposed
amendments. It is likely, however, that
these proposed amendments would
have no, or little, impact on ‘‘small’’
broker-dealers, since most, if not all, of
these firms generally would not hold
these types of positions.
For the foregoing reasons, the
Commission certifies that the proposed
new Rules 18a–1 through 18a–4,
amendments to Rule 15c3–1, and
amendments to Rule 15c3–3 would not
have a significant economic impact on
any small entity for purposes of the
RFA.
The Commission encourages written
comments regarding this certification.
1222 See also Entity Definitions Adopting Release,
77 FR 30596 (‘‘The SEC continues to believe that
the types of entities that would engage in more than
a de minimis amount of dealing activity involving
security-based swaps—which generally would be
major banks—would not be ‘small entities’ for
purposes of the RFA. Similarly, the SEC continues
to believe that the types of entities that may have
security-based swap positions above the level
required to be a ‘major security-based swap
participant’ would not be a ‘small entity’ for
purposes of the RFA. Accordingly, the SEC certifies
that the final rules defining ‘security-based swap
dealer’ or ‘major security-based swap participant’
would not have a significant economic impact on
a substantial number of small entities for purposes
of the RFA.’’). Id. at 30743.

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The Commission requests that
commenters describe the nature of any
impact on small entities and provide
empirical data to illustrate the extent of
the impact.
VII. Statutory Basis and Text of the
Proposed Amendments
Pursuant to the Exchange Act, 15
U.S.C. 78a et seq., and particularly,
sections 3(b), 3E, 15, 15F, 23(a), and 36
(15 U.S.C. 78c(b), 78c–5, 78o, 78o–10,
78w(a), and 78mm), thereof, the
Commission is proposing to amend
§§ 240.15c3–1, 240.15c3–1a, 240.15c3–
1b, 240.15c3–1d, 240.15c3–1e, and
240.15c3–3, and proposing §§ 240.18a–
1, 240.18a–1a, 240.18a–1b, 240.18a–1c,
240.18a–1d, 240.18a–2, 240.18a–3,
240.18a–4, and 240.18a–4a under the
Exchange Act.
List of Subjects in 17 CFR Parts 240
Brokers, Fraud, Reporting and
recordkeeping requirements, Securities.
Text of Amendment
In accordance with the foregoing,
Title 17, Chapter II of the Code of
Federal Regulations is proposed to be
amended as follows:
PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934
1. The general authority citation for
part 240 is revised, the sectional
authorities for §§ 240.15c3–1 and
240.15c3–3 are revised, add sectional
authorities for §§ 240.15c3–1a,
240.15c3–1e, 240.15c3–3, 240.18a–1,
240.18a–1a, 240.18a–1b, 240.18a–1c,
240.18a–1d, 240–18a–2, 240.18a–3 and
240.18a–4 in numerical order to read as
follows.
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f,
78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m,
78n, 78n–1, 78o, 78o–10 78o–4, 78p, 78q,
78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–20,
80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 80b–
11, and 7201 et seq.; 12 U.S.C. 5221(e)(3), 15
U.S.C. 8302, and 18 U.S.C. 1350, unless
otherwise noted.

*

*

*

*

*

Section 240.15c3–1 is also issued under 15
U.S.C. 78o(c)(3), 78o–10(d), and 78o–10(e).
Section 240.15c3–3 is also issued under 15
U.S.C. 78c–5, 78o(c)(2), 78(c)(3), 78q(a),
78w(a); sec. 6(c), 84 Stat. 1652; 15 U.S.C.
78fff.

*

*

*

*

*

Sections 240.18a–1, 240.18a–1a, 240.18a–
1b, 240.18a–1c, 240.18a–1d, 240.18a–2, and
240.18a–3 are also issued under 15 U.S.C.
78o–10(d) and 78o–10(e).
Section 240.18a–4 is also issued under 15
U.S.C. 78c–5(f).

*

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*

*

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*

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*

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70329

2. Section 240.15c3–1 is amended by:
a. Revising the center heading above
paragraph (a)(7);
b. In paragraph (a)(7) removing the
phrase ‘‘and using the credit risk
standards of Appendix E to compute a
deduction for credit risk on certain
credit exposures arising from
transactions in derivatives instruments,
instead of the provisions of paragraph
(c)(2)(iv) of this section’’ and in its place
adding the phrase ‘‘and using the credit
risk standards of Appendix E to
compute a deduction for credit risk for
security-based swap transactions with
commercial end users as defined in
§ 240.18a–3(b)(2), instead of the
provisions of paragraphs (c)(2)(iv) and
(c)(2)(xiv)(B)(1) of this section’’;
c. Revising paragraph (a)(7)(i);
d. In paragraph (a)(7)(ii), remove ‘‘$5
billion’’ and in its place add ‘‘$6
billion’’;
e. Adding a center heading and
paragraph (a)(10);
f. Adding paragraph (c)(2)(vi)(O);
g. Re-designating paragraph (c)(2)(xii)
as paragraph (c)(2)(xii)(A) and adding
new paragraph (c)(2)(xii)(B);
h. Adding paragraph (c)(2)(xiv);
i. Adding paragraph (c)(16); and
j. Adding paragraph (f).
The revisions and additions read as
follows:
§ 240.15c3–1 Net capital requirements for
brokers or dealers.

*

*
*
(a) * * *

*

*

Alternative Net Capital Computation
For Broker-Dealers Authorized To Use
Models
(7) * * *
(i) At all times maintain tentative net
capital of not less than $5 billion and
net capital of not less than the greater
of $1 billion or the sum of the ratio
requirement under paragraph (a)(1) of
this section and eight percent (8%) of
the risk margin amount;
*
*
*
*
*
Broker-Dealers Registered as SecurityBased Swap Dealers
(10) A broker or dealer registered with
the Commission as a security-based
swap dealer, other than a broker or
dealer subject to the provisions of (a)(7)
of this section, must:
(i) At all times maintain net capital of
not less than the greater of $20 million
or the sum of the ratio requirement
under paragraph (a)(1) of this section
and eight percent (8%) of the risk
margin amount; and
(ii) Comply with § 240.15c3–4 as
though it were an OTC derivatives
dealer with respect to all of its business

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

activities, except that paragraphs
(c)(5)(xiii), (c)(5)(xiv), (d)(8), and (d)(9)
of § 240.15c3–4 shall not apply.
*
*
*
*
*
(c) * * *

(2) * * *
(vi)(O) Security-based swaps. (1)
Credit default swaps. (i) Short positions
(selling protection). In the case of a
security-based swap that is a short
credit default swap, deducting the

percentage of the notional amount based
upon the current basis point spread of
the credit default swap and the maturity
of the credit default swap in accordance
with the following table:

Basis point spread
Length of time to maturity of
CDS contract

100 or less
(%)

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

12 months or less ....................................
13 months to 24 months ..........................
25 months to 36 months ..........................
37 months to 48 months ..........................
49 months to 60 months ..........................
61 months to 72 months ..........................
73 months to 84 months ..........................
85 months to 120 months ........................
121 months and longer ............................

1.00
1.50
2.00
3.00
4.00
5.50
7.00
8.50
10.00

(ii) Long positions (purchasing
protection). In the case of a securitybased swap that is a long credit default
swap, deducting 50% of the deduction
that would be required by paragraph
(c)(2)(vi)(O)(1)(i) of this section if the
security-based swap was a short credit
default swap.
(iii) Long and short positions. (A)
Long and short credit default swaps. In
the case of security-based swaps that are
long and short credit default swaps
referencing the same entity (in the case
of credit default swap securities-based
swaps referencing a corporate entity) or
obligation (in the case of credit default
swap securities-based swaps referencing
an asset-backed security), that have the
same credit events which would trigger
payment by the seller of protection, that
have the same basket of obligations
which would determine the amount of
payment by the seller of protection
upon the occurrence of a credit event,
that are in the same or adjacent spread
category, and that are in the same or
adjacent maturity category and have a
maturity date within three months of
the other maturity category, deducting
the percentage of the notional amount
specified in the higher maturity category
under paragraph (c)(2)(vi)(O)(1)(i) or (ii)
on the excess of the long or short
position. In the case of security-based
swaps that are long and short credit
default swaps referencing corporate
entities in the same industry sector and
the same spread and maturity categories
prescribed in paragraph
(c)(2)(vi)(O)(1)(i) of this section,
deducting 50% of the amount required
by paragraph (c)(2)(vi)(O)(1)(i) of this
section on the short position plus the
deduction required by paragraph
(c)(2)(vi)(O)(1)(ii) of this section on the
excess long position, if any. For the
purposes of this section, the broker or

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101–300

301–400

2.00
3.50
5.00
6.00
7.00
8.50
10.00
15.00
20.00

5.00
7.50
10.00
12.50
15.00
17.50
20.00
22.50
25.00

dealer must use an industry sector
classification system that is reasonable
in terms of grouping types of companies
with similar business activities and risk
characteristics and the broker-dealer
must document the industry sector
classification system used pursuant to
this section.
(B) Long security and long credit
default swap. In the case of a securitybased swap that is a long credit default
swap referencing a debt security and the
broker or dealer is long the same debt
security, deducting 50% of the amount
specified in paragraph (c)(2)(vi) or (vii)
of this section for the bond, provided
that the broker or dealer can deliver the
debt security to satisfy the obligation of
the broker or dealer on the credit default
swap.
(C) Short security and short credit
default swap. In the case of a securitybased swap that is a short credit default
swap referencing a bond or a corporate
entity, and the broker or dealer is short
the bond or a bond issued by the
corporate entity, deducting the amount
specified in paragraph (c)(2)(vi) or (vii)
of this section for the bond. In the case
of a security-based swap that is a short
credit default swap referencing an assetbacked security and the broker or dealer
is short the asset-backed security,
deducting the amount specified in
paragraph (c)(2)(vi) or (vii) of this
section for the asset-backed security.
(2) Security-based swaps that are not
credit default swaps. In the case of any
security-based swap that is not a credit
default swap, deducting the amount
calculated by multiplying the notional
amount of the security-based swap and
the percentage specified in paragraph
(c)(2)(vi) of this section applicable to the
reference security. A broker or dealer
may reduce the deduction under this
paragraph (c)(2)(vi)(O)(2) by an amount

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401–500
7.50
10.00
12.50
15.00
17.50
20.00
22.50
25.00
27.50

501–699
10.00
12.50
15.00
17.50
20.00
22.50
25.00
27.50
30.00

700 or more
15.00
17.50
20.00
22.50
25.00
27.50
30.00
40.00
50.00

equal to any reduction recognized for a
comparable long or short position in the
reference security under paragraph
(c)(2)(vi) of this section and, in the case
of a security-based swap referencing an
equity security, the method specified in
§ 240.15c3–1a.
*
*
*
*
*
(xii) * * *
(B) Deducting the amount of cash
required in the account of each securitybased swap customer to meet the margin
requirements of a clearing agency,
Examining Authority, or the
Commission, after application of calls
for margin, marks to the market, or other
required deposits which are outstanding
one business day or less.
*
*
*
*
*
(xiv) Deduction from net worth in lieu
of collecting margin amounts for
security-based swaps. (A) Cleared
security-based swap transactions.
Deducting the amount of the margin
difference for each account carried by
the broker or dealer for another person
that holds cleared security-based swap
transactions. The margin difference is
the amount of the deductions that the
positions in the account would incur
pursuant to paragraph (c)(2)(vi)(O) of
this section if owned by the broker or
dealer less the margin value of collateral
held in the account.
(B) Non-cleared security-based swap
transactions. (1) Commercial end users.
Deducting, with respect to a
counterparty that is a commercial end
user as that term is defined in
§ 240.18a–3(b)(2), the margin amount
calculated pursuant to § 240.18a–
3(c)(1)(i)(B) for the account of the
counterparty at the broker or dealer less
any positive equity in that account as
that term is defined in § 240.18a–3(b)(7).
(2) Margin collateral held by thirdparty custodian. Deducting, with

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
respect to a counterparty that is not a
commercial end user as that term is
defined in § 240.18a–3(b)(2) and that
elects to have collateral segregated in an
account at an independent third-party
custodian pursuant to section 3E(f) of
the Act (15 U.S.C. 78c–5(f)), the margin
amount calculated pursuant to
§ 240.18a–3(c)(1)(i)(B) for the account of
the counterparty less any positive equity
in the account as that term is defined in
§ 240.18a–3(b)(7).
(3) Security-based swap legacy
accounts. Deducting, with respect to a
security-based swap legacy account as
that term is defined in § 240.18a–3(b)(9)
of a counterparty that is not a
commercial end user as that term is
defined in § 240.18a–3(b)(2), the margin
amount calculated pursuant § 240.18a–
3(c)(1)(i)(B) for the account less any
positive equity in the account as that
term is defined in § 240.18a–3(b)(7).
*
*
*
*
*
(16) The term risk margin amount
means the sum of:
(i) The greater of the total margin
required to be delivered by the broker or
dealer with respect to security-based
swap transactions cleared for securitybased swap customers at a clearing
agency or the amount of the deductions
that would apply to the cleared securitybased swap positions of the securitybased swap customers pursuant to
paragraph (c)(2)(vi)(O) of this section;
and
(ii) The total margin amount
calculated by the broker or dealer with
respect to non-cleared security-based
swaps pursuant to § 240.18a–
3(c)(1)(i)(B).
*
*
*
*
*
(f) Liquidity requirements. (1)
Liquidity stress test. A broker or dealer
whose application, including
amendments, has been approved, in
whole or in part, to calculate net capital
under Appendix E of this section must
run a liquidity stress test at least
monthly, the results of which must be
provided within ten business days to
senior management that has
responsibility to oversee risk
management at the broker or dealer. The
assumptions underlying the liquidity
stress test must be reviewed at least
quarterly by senior management that has
responsibility to oversee risk
management at the broker or dealer and
at least annually by senior management
of the broker or dealer. The liquidity
stress test must include, at a minimum,
the following assumed conditions
lasting for 30 consecutive days:
(i) A stress event that includes a
decline in creditworthiness of the
broker or dealer severe enough to trigger

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Jkt 229001

contractual credit-related commitment
provisions of counterparty agreements;
(ii) The loss of all existing unsecured
funding at the earlier of its maturity or
put date and an inability to acquire a
material amount of new unsecured
funding, including intercompany
advances and unfunded committed
lines of credit;
(iii) The potential for a material net
loss of secured funding;
(iv) The loss of the ability to procure
repurchase agreement financing for less
liquid assets;
(v) The illiquidity of collateral
required by and on deposit at registered
clearing agencies or other entities which
is not deducted from net worth or which
is not funded by customer assets;
(vi) A material increase in collateral
required to be maintained at registered
clearing agencies of which it is a
member; and
(vii) The potential for a material loss
of liquidity caused by market
participants exercising contractual
rights and/or refusing to enter into
transactions with respect to the various
businesses, positions, and commitments
of the broker or dealer, including those
related to customer businesses of the
broker or dealer.
(2) Stress test of consolidated entity.
The broker or dealer must justify and
document any differences in the
assumptions used in the liquidity stress
test of the broker or dealer from those
used in the liquidity stress test of the
consolidated entity of which the broker
or dealer is a part.
(3) Liquidity reserves. The broker or
dealer must maintain at all times
liquidity reserves based on the results of
the liquidity stress test. The liquidity
reserves used to satisfy the liquidity
stress test must be:
(i) Cash, obligations of the United
States, or obligations fully guaranteed as
to principal and interest by the United
States; and
(ii) Unencumbered and free of any
liens at all times. Securities in the
liquidity reserve can be used to meet
delivery requirements as long as cash or
other acceptable securities of equal or
greater value are moved into the
liquidity pool contemporaneously.
(4) Contingency funding plan. The
broker or dealer must have a written
contingency funding plan that addresses
the broker’s or dealer’s policies and the
roles and responsibilities of relevant
personnel for meeting the liquidity
needs of the broker or dealer and
communications with the public and
other market participants during a
liquidity stress event.
*
*
*
*
*

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70331

3. Section 240.15c3–1a is amended
by:
a. In paragraph (a)(4), revising the first
and last sentences; and
b. Adding paragraph (b)(1)(v)(C)(5).
The addition to read as follows:
§ 240.15c3–1a Options (Appendix A to 17
CFR 240.15c3–1).

(a) * * *
(4) The term underlying instrument
refers to long and short positions, as
appropriate, covering the same foreign
currency, the same security, security
future, or security-based swap, or a
security which is exchangeable for or
convertible into the underlying security
within a period of 90 days. * * * The
term underlying instrument shall not be
deemed to include securities options,
futures contracts, options on futures
contracts, qualified stock baskets, or
unlisted instruments (other than
security-based swaps).
*
*
*
*
*
(b) * * *
(1) * * *
(v) * * *
(C) * * *
(5) In the case of portfolio types
involving security futures and equity
options on the same underlying
instrument and positions in that
underlying instrument, there will be a
minimum charge of 25% times the
multiplier for each security-future and
equity option.
*
*
*
*
*
4. Section 240.15c3–1b is amended by
adding a paragraph (b) to read as
follows:
§ 240.15c3–1b Adjustments to net worth
and aggregate indebtedness for certain
commodities transactions (Appendix B to
17 CFR 240.15c3–1).

*

*
*
*
*
(b) Every broker or dealer in
computing net capital pursuant to
§ 240.15c3–1 must comply with the
following:
(1) Swaps. In the case of any swap for
which the deductions in Appendix E of
this section do not apply:
(i) Credit default swaps referencing
broad-based securities indices. (A) Short
positions (selling protection). In the case
of a swap that is a short credit default
swap referencing a broad-based
securities index, deducting the
percentage of the notional amount based
upon the current basis point spread of
the credit default swap and the maturity
of the credit default swap in accordance
with the following table:

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
Basis point spread

Length of time to maturity of
CDS contract

100 or less
(%)

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12 months or less ....................................
13 months to 24 months ..........................
25 months to 36 months ..........................
37 months to 48 months ..........................
49 months to 60 months ..........................
61 months to 72 months ..........................
73 months to 84 months ..........................
85 months to 120 months ........................
121 months and longer ............................

0.67
1.00
1.33
2.00
2.67
3.67
4.67
5.67
6.67

(B) Long positions (purchasing
protection). In the case of a swap that is
a long credit default swap referencing a
broad-based securities index, deducting
50% of the deduction that would be
required by paragraph (b)(1)(i)(A) of this
Appendix B if the swap was a short
credit default swap.
(C) Long and short positions. (1) Long
and short credit default swaps. In the
case of swaps that are long and short
credit default swaps referencing the
same broad-based security index, have
the same credit events which would
trigger payment by the seller of
protection, have the same basket of
obligations which would determine the
amount of payment by the seller of
protection upon the occurrence of a
credit event, that are in the same or
adjacent spread category, and that are in
the same or adjacent maturity category
and have a maturity date within three
months of the other maturity category,
deducting the percentage of the notional
amount specified in the higher maturity
category under paragraph (b)(1)(i)(A) or
(b)(1)(i)(B) of this Appendix B on the
excess of the long or short position.
(2) Long basket of obligors and long
credit default swap. In the case of a
swap that is a long credit default swap
referencing a broad-based securities
index and the broker or dealer is long
a basket of debt securities comprising all
of the components of the securities
index, deducting 50% of the amount
specified in § 240.15c3–1(c)(2)(vi) for
the component securities, provided the
broker or dealer can deliver the
component securities to satisfy the
obligation of the broker or dealer on the
credit default swap.
(3) Short basket of obligors and short
credit default swap. In the case of a
swap that is a short credit default swap
referencing a broad-based securities
index and the broker or dealer is short
a basket of debt securities comprising all
of the components of the securities
index, deducting the amount specified
in § 240.15c3–1(c)(2)(vi) for the
component securities.

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Jkt 229001

101–300
(%)

301–400
(%)

1.33
2.33
3.33
4.00
4.67
5.67
6.67
10.00
13.33

3.33
5.00
6.67
8.33
10.00
11.67
13.33
15.00
16.67

(2) All other swaps. (i) In the case of
any swap that is not a credit default
swap, deducting the amount calculated
by multiplying the notional value of the
swap by the percentage specified in:
(A) Section 240.15c3–1 applicable to
the reference asset if § 240.15c3–1
specifies a percentage deduction for the
type of asset;
(B) 17 CFR 1.17 applicable to the
reference asset if 17 CFR 1.17 specifies
a percentage deduction for the type of
asset and § 240.15c3–1 does not specify
a percentage deduction for the type of
asset; or
(C) In the case of an interest rate
swap, § 240.15c3–1(c)(2)(vi)(A) based on
the maturity of the swap, provided that
the percentage deduction must be no
less than 0.5%.
(ii) A security-based swap dealer may
reduce the deduction under this
paragraph (b)(2)(ii) by an amount equal
to any reduction recognized for a
comparable long or short position in the
reference asset or interest rate under
§ 240.15c3–1 or 17 CFR 1.17.
§ 240.15c3–1d

[Amended]

5. Section 240.15c3–1d is amended
by:
a. Adding to the end of the second
sentence of paragraph (b)(7) the phrase
‘‘, or if, in the case of a broker or dealer
operating pursuant to paragraph (a)(10)
of § 240.15c3–1, its net capital would be
less than either $24 million or 10% of
the risk margin amount under
§ 240.15c3–1’’;
b. In the first sentence of paragraph
(b)(8)(i), adding after the phrase ‘‘if
greater, or’’ the phrase ‘‘, in the case of
a broker or dealer operating pursuant to
paragraph (a)(10) of § 240.15c3–1, its net
capital would be less than either $24
million or 10% of the risk margin
amount under § 240.15c3–1, or’’;
c. In paragraph (b)(10)(ii)(B), adding
after the phrase ‘‘if greater,’’ the phrase
‘‘or, in the case of a broker or dealer
operating pursuant to paragraph (a)(10)
of § 240.15c3–1, its net capital is less
than either $20 million or 8% of the risk
margin amount under § 240.15c3–1,’’;

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401–500
(%)
5.00
6.67
8.33
10.00
11.67
13.33
15.00
16.67
18.33

501–699
(%)

700 or more
(%)

6.67
8.33
10.00
11.67
13.33
15.00
16.67
18.33
20.00

10.00
11.67
13.33
15.00
16.67
18.33
20.00
26.67
33.33

d. In paragraph (c)(2), adding at the
end of the sentence the phrase ‘‘, or, in
the case of a broker or dealer operating
pursuant to paragraph (a)(10) of
§ 240.15c3–1, its net capital would be
less than either $24 million or 10% of
the risk margin amount under
§ 240.15c3–1’’; and
e. In paragraph (c)(5)(i)(B), adding
after the phrase ‘‘if greater, or less than
120 percent of the minimum dollar
amount required by paragraph (a)(1)(ii)
of this section,’’ the phrase ‘‘, or, in the
case of a broker or dealer operating
pursuant to paragraph (a)(10) of
§ 240.15c3–1, its net capital would be
less than either $24 million or 10% of
the risk margin amount under
§ 240.15c3–1,’’.
§ 240.15c3–1e

[Amended]

6. Section 240.15c3–1e is amended
by:
a. In the first sentence of paragraph (a)
before the first ‘‘:’’, removing the phrase
‘‘transactions in derivatives
instruments’’ and adding in its place the
phrase ‘‘security-based swap
transactions with commercial end users
as defined in § 240.18a–3(b)(2)’’;
b. In the first sentence of paragraph (c)
before the first ‘‘:’’, removing the phrase
‘‘transactions in derivatives
instruments’’ and adding in its place the
phrase ‘‘security-based swap
transactions with commercial end users
as defined in § 240.18a–3(b)(2)’’;
c. In paragraph (c)(2)(ii), removing the
phrase ‘‘$5 billion’’ and adding in its
place the phrase ‘‘$6 billion’’; and
d. In paragraph (e)(1), removing the
phrase ‘‘$5 billion’’ and adding in its
place the phrase ‘‘$6 billion’’.
7. Section 240.15c3–3 is amended by
adding new paragraph (p) to read as
follows:
§ 240.15c3–3 Customer protection—
reserves and custody of securities.

*

*
*
*
*
(p) Security-based swaps. A broker or
dealer that is registered as a securitybased swap dealer pursuant to section
15F of the Act (15 U.S.C. 78o-8) must

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
also comply with the provisions of
§ 240.18a–4.
8. Section 240.18a–1 is added to read
as follows:
§ 240.18a–1 Net capital requirements for
security-based swap dealers for which
there is not a prudential regulator.

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Note to § 240.18a–1: Rule 18a–1 and its
appendices do not apply to a security-based
swap dealer that has a prudential regulator as
such a security-based swap dealer is subject
to the capital requirement of the prudential
regulator. In addition, Rule 18a–1 and its
appendices do not apply to a security-based
swap dealer that also is registered as a broker
or dealer pursuant to section 15(b) of the Act
(15 U.S.C. 78o(b)) as such a security-based
swap dealer is subject to the net capital
requirements in § 240.15c3–1 and its
appendices.

(a) Minimum requirements. Every
registered security-based swap dealer
must at all times have and maintain net
capital no less than the greater of the
highest minimum requirements
applicable to its business under
paragraphs (a)(1) or (2) of this section,
and tentative net capital no less than the
minimum requirement under paragraph
(a)(2) of this section.
(1) A security-based swap dealer must
at all times maintain net capital of not
less than the greater of $20 million or
eight percent (8%) of the risk margin
amount.
(2) In accordance with paragraph (d)
of this section, the Commission may
approve, in whole or in part, an
application or an amendment to an
application by a security-based swap
dealer to calculate net capital using the
market risk standards of paragraph (d) to
compute a deduction for market risk on
some or all of its positions, instead of
the provisions of paragraphs (c)(1)(iv),
(vi), and (vii) of this section, and using
the credit risk standards of paragraph
(d) to compute a deduction for credit
risk for security-based swap transactions
with commercial end users as defined in
§ 240.18a–3(b)(2), instead of the
provisions of paragraphs (c)(1)(iii) and
(c)(1)(viii)(B)(1) of this section, subject
to any conditions or limitations on the
security-based swap dealer the
Commission may require as necessary or
appropriate in the public interest or for
the protection of investors. A securitybased swap dealer that has been
approved to calculate its net capital
under paragraph (d) of this section must
at all times maintain tentative net
capital of not less than $100 million and
net capital of not less than the greater
of $20 million or eight percent (8%) of
the risk margin amount; and
(b) A security-based swap dealer must
at all times maintain net capital in

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addition to the amounts required under
paragraph (a)(1) or (2) of this section, as
applicable, in an amount equal to 10
percent of:
(1) The excess of the market value of
United States Treasury Bills, Bonds and
Notes subject to reverse repurchase
agreements with any one party over 105
percent of the contract prices (including
accrued interest) for reverse repurchase
agreements with that party;
(2) The excess of the market value of
securities issued or guaranteed as to
principal or interest by an agency of the
United States or mortgage related
securities as defined in section 3(a)(41)
of the Act subject to reverse repurchase
agreements with any one party over 110
percent of the contract prices (including
accrued interest) for reverse repurchase
agreements with that party; and
(3) The excess of the market value of
other securities subject to reverse
repurchase agreements with any one
party over 120 percent of the contract
prices (including accrued interest) for
reverse repurchase agreements with that
party.
(c) Definitions. For purpose of this
section:
(1) The term net capital shall be
deemed to mean the net worth of a
security-based swap dealer, adjusted by:
(i) Adjustments to net worth related to
unrealized profit or loss and deferred
tax provisions. (A) Adding unrealized
profits (or deducting unrealized losses)
in the accounts of the security-based
swap dealer;
(B)(1) In determining net worth, all
long and all short positions in listed
options shall be marked to their market
value and all long and all short
securities and commodities positions
shall be marked to their market value.
(2) In determining net worth, the
value attributed to any unlisted option
shall be the difference between the
option’s exercise value and the market
value of the underlying security. In the
case of an unlisted call, if the market
value of the underlying security is less
than the exercise value of such call it
shall be given no value and in the case
of an unlisted put if the market value of
the underlying security is more than the
exercise value of the unlisted put it
shall be given no value.
(C) Adding to net worth the lesser of
any deferred income tax liability related
to the items in paragraphs (c)(1)(i)(C)(1),
(2), and (3) of this section, or the sum
of paragraphs (c)(1)(i)(C)(1), (2), and (3)
of this section;
(1) The aggregate amount resulting
from applying to the amount of the
deductions computed in accordance
with paragraphs (c)(1)(vii) and (viii) of
this section and Appendices A and B,

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70333

§ 240.18a–1a and § 240.18a–1b, the
appropriate Federal and State tax rate(s)
applicable to any unrealized gain on the
asset on which the deduction was
computed.
(2) Any deferred tax liability related
to income accrued which is directly
related to an asset otherwise deducted
pursuant to this section;
(3) Any deferred tax liability related
to unrealized appreciation in value of
any asset(s) which has been otherwise
deducted from net worth in accordance
with the provisions of this section; and
(D) Adding, in the case of future
income tax benefits arising as a result of
unrealized losses, the amount of such
benefits not to exceed the amount of
income tax liabilities accrued on the
books and records of the security-based
swap dealer, but only to the extent such
benefits could have been applied to
reduce accrued tax liabilities on the date
of the capital computation, had the
related unrealized losses been realized
on that date.
(E) Adding to net worth any actual tax
liability related to income accrued
which is directly related to an asset
otherwise deducted pursuant to this
section.
(ii) Subordinated liabilities. Excluding
liabilities of the security-based swap
dealer that are subordinated to the
claims of creditors pursuant to a
satisfactory subordinated loan
agreement, as defined in Appendix D
(§ 240.18a–1d).
(iii) Assets not readily convertible into
cash. Deducting fixed assets and assets
which cannot be readily converted into
cash, including, among other things:
(A) Fixed assets and prepaid items.
Real estate; furniture and fixtures;
exchange memberships; prepaid rent,
insurance and other expenses; goodwill,
organization expenses;
(B) Certain unsecured and partly
secured receivables. All unsecured
advances and loans; deficits in
customers’ and non-customers’
unsecured and partly secured notes;
deficits in customers’ and noncustomers’ unsecured and partly
secured accounts after application of
calls for margin, marks to the market or
other required deposits that are
outstanding for more than one business
day; and the market value of stock
loaned in excess of the value of any
collateral received therefore.
(C) Insurance claims. Insurance
claims that, after seven (7) business days
from the date the loss giving rise to the
claim is discovered, are not covered by
an opinion of outside counsel that the
claim is valid and is covered by
insurance policies presently in effect;
insurance claims that after twenty (20)

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

70334

Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

business days from the date the loss
giving rise to the claim is discovered
and that are not accompanied by an
opinion of outside counsel described
above, have not been acknowledged in
writing by the insurance carrier as due
and payable; and insurance claims
acknowledged in writing by the carrier
as due and payable outstanding longer
than twenty (20) business days from the
date they are so acknowledged by the
carrier; and
(D) Other deductions. All other
unsecured receivables; all assets
doubtful of collection less any reserves
established therefore; the amount by
which the market value of securities
failed to receive outstanding thirty (30)
calendar days exceeds the contract
value of such fails to receive, and the
funds on deposit in a ‘‘segregated trust
account’’ in accordance with 17 CFR
270.27d–1 under the Investment
Company Act of 1940, but only to the
extent that the amount on deposit in
such segregated trust account exceeds
the amount of liability reserves
established and maintained for refunds
of charges required by sections 27(d)
and 27(f) of the Investment Company
Act of 1940; Provided, That any amount
deposited in the ‘‘special account for the
exclusive benefit of security-based swap
customers’’ established pursuant to
§ 240.18a–4 and clearing deposits shall
not be so deducted.
(E)(1) For purposes of this paragraph:
(i) The term reverse repurchase
agreement deficit shall mean the
difference between the contract price for
resale of the securities under a reverse
repurchase agreement and the market
value of those securities (if less than the
contract price).
(ii) The term repurchase agreement
deficit shall mean the difference
between the market value of securities
subject to the repurchase agreement and
the contract price for repurchase of the
securities (if less than the market value
of the securities).
(iii) As used in paragraph
(c)(1)(iii)(E)(1) of this section, the term
contract price shall include accrued
interest.
(iv) Reverse repurchase agreement
deficits and the repurchase agreement
deficits where the counterparty is the
Federal Reserve Bank of New York shall
be disregarded.
(2)(i) In the case of a reverse
repurchase agreement, the deduction
shall be equal to the reverse repurchase
agreement deficit.
(ii) In determining the required
deductions under paragraph
(c)(1)(iii)(E)(2)(i) of this section, the
security-based swap dealer may reduce

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the reverse repurchase agreement deficit
by:
(A) Any margin or other deposits held
by the security-based swap dealer on
account of the reverse repurchase
agreement;
(B) Any excess market value of the
securities over the contract price for
resale of those securities under any
other reverse repurchase agreement with
the same party;
(C) The difference between the
contract price for resale and the market
value of securities subject to repurchase
agreements with the same party (if the
market value of those securities is less
than the contract price); and
(D) Calls for margin, marks to the
market, or other required deposits that
are outstanding one business day or
less.
(3)(i) In the case of repurchase
agreements, the deduction shall be:
(A) The excess of the repurchase
agreement deficit over 5 percent of the
contract price for resale of United States
Treasury Bills, Notes and Bonds, 10
percent of the contract price for the
resale of securities issued or guaranteed
as to principal or interest by an agency
of the United States or mortgage related
securities as defined in section 3(a)(41)
of the Act and 20 percent of the contract
price for the resale of other securities;
and
(B) The excess of the aggregate
repurchase agreement deficits with any
one party over 25 percent of the
security-based swap dealer’s net capital
before the application of paragraphs
(c)(1)(vii) and (viii) of this section (less
any deduction taken with respect to
repurchase agreements with that party
under paragraph (c)(1)(iii)(E)(3)(i)(A) of
this section) or, if greater;
(C) The excess of the aggregate
repurchase agreement deficits over 300
percent of the security-based swap
dealer’s net capital before the
application of paragraphs (c)(1)(vii) and
(viii) of this section.
(ii) In determining the required
deduction under paragraph
(c)(1)(iii)(E)(3)(i) of this section, the
security-based swap dealer may reduce
a repurchase agreement by:
(A) Any margin or other deposits held
by the security-based swap dealer on
account of a reverse repurchase
agreement with the same party to the
extent not otherwise used to reduce a
reverse repurchase agreement deficit;
(B) The difference between the
contract price and the market value of
securities subject to other repurchase
agreements with the same party (if the
market value of those securities is less
than the contract price) not otherwise

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used to reduce a reverse repurchase
agreement deficit; and
(C) Calls for margin, marks to the
market, or other required deposits that
are outstanding one business day or less
to the extent not otherwise used to
reduce a reverse repurchase agreement
deficit.
(F) Securities borrowed. One percent
of the market value of securities
borrowed collateralized by an
irrevocable letter of credit.
(G) Any receivable from an affiliate of
the security-based swap dealer (not
otherwise deducted from net worth) and
the market value of any collateral given
to an affiliate (not otherwise deducted
from net worth) to secure a liability over
the amount of the liability of the
security-based swap dealer unless the
books and records of the affiliate are
made available for examination when
requested by the representatives of the
Commission in order to demonstrate the
validity of the receivable or payable.
The provisions of this subsection shall
not apply where the affiliate is a
registered security-based swap dealer,
registered broker or dealer, registered
government securities broker or dealer,
bank as defined in section 3(a)(6) of the
Act, insurance company as defined in
section 3(a)(19) of the Act, investment
company registered under the
Investment Company Act of 1940,
federally insured savings and loan
association, or futures commission
merchant or swap dealer registered
pursuant to the Commodity Exchange
Act.
(iv) Non-marketable securities.
Deducting 100 percent of the carrying
value in the case of securities or
evidence of indebtedness in the
proprietary or other accounts of the
security-based swap dealer, for which
there is no ready market, as defined in
paragraph (c)(4) of this section, and
securities, in the proprietary or other
accounts of the security-based swap
dealer, that cannot be publicly offered
or sold because of statutory, regulatory
or contractual arrangements or other
restrictions.
(v) Deducting from the contract value
of each failed to deliver contract that is
outstanding five business days or longer
(21 business days or longer in the case
of municipal securities) the percentages
of the market value of the underlying
security that would be required by
application of the deduction required by
paragraph (c)(1)(vii) of this section.
Such deduction, however, shall be
increased by any excess of the contract
price of the failed to deliver contract
over the market value of the underlying
security or reduced by any excess of the
market value of the underlying security

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
over the contract value of the failed to
deliver contract, but not to exceed the
amount of such deduction. The
Commission may, upon application of
the security-based swap dealer, extend
for a period up to 5 business days, any
period herein specified when it is
satisfied that the extension is warranted.
The Commission upon expiration of the
extension may extend for one additional

period of up to 5 business days, any
period herein specified when it is
satisfied that the extension is warranted.
(vi) Security-based swaps. Deducting
the percentages specified in paragraphs
(c)(1)(vi)(A) and (B) of this section (or
the deductions prescribed in § 240.18a–
1a) of the notional amount of any
security-based swaps in the proprietary
account of the security-based swap
dealer.

70335

(A) Credit default swaps. (1) Short
positions (selling protection). In the case
of a security-based swap that is a short
credit default swap, deducting the
percentage of the notional amount based
upon the current basis point spread of
the credit default swap and the maturity
of the credit default swap in accordance
with the following table:

Basis point spread
Length of time to maturity of
CDS contract

100 or less
(%)

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

12 months or less ....................................
13 months to 24 months ..........................
25 months to 36 months ..........................
37 months to 48 months ..........................
49 months to 60 months ..........................
61 months to 72 months ..........................
73 months to 84 months ..........................
85 months to 120 months ........................
121 months and longer ............................

1.00
1.50
2.00
3.00
4.00
5.50
7.00
8.50
10.00

(2) Long positions (purchasing
protection). In the case of a securitybased swap that is a long credit default
swap, deducting 50% of the deduction
that would be required by paragraph
(c)(1)(vi)(A)(1) of this section if the
security-based swap was a short credit
default swap.
(3) Long and short positions. (i) Long
and short credit default swaps. In the
case of security-based swaps that are
long and short credit default swaps
referencing the same obligor or
obligation, that are in the same spread
category, and that are in the same
maturity category or are in the next
maturity category and have a maturity
date within three months of the other
maturity category, deducting the
percentage of the notional amount
specified in the higher maturity category
under paragraphs (c)(1)(vi)(A)(1) or (2)
on the excess of the long or short
position. In the case of security-based
swaps that are long and short credit
default swaps referencing obligors or
obligations of obligors in the same
industry sector and the same spread and
maturity categories prescribed in
paragraph (c)(1)(vi)(A)(1) of this section,
deducting 50% of the amount required
by paragraph (c)(1)(vi)(A)(1) of this
section on the short position plus the
deduction required by paragraph
(c)(1)(vi)(A)(2) of this section on the
excess long position, if any. For the
purposes of this section, the securitybased swap dealer must use an industry
sector classification system that is
reasonable in terms of grouping types of
companies with similar business
activities and risk characteristics and

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101–300
(%)

301–400
(%)

2.00
3.50
5.00
6.00
7.00
8.50
10.00
15.00
20.00

5.00
7.50
10.00
12.50
15.00
17.50
20.00
22.50
25.00

document the industry sector
classification system used pursuant to
this section.
(ii) Long security and long credit
default swap. In the case of a securitybased swap that is a long credit default
swap referencing a debt security and the
security-based swap dealer is long the
same debt security, deducting 50% of
the amount specified in § 240.15c3–
1(c)(2)(vi) or (vii) for the bond, provided
that the security-based swap dealer can
deliver the bond to satisfy the obligation
of the security-based swap dealer on the
credit default swap.
(iii) Short security and short credit
default swap. In the case of a securitybased swap that is a short credit default
swap referencing a bond or a corporate
entity and the security-based swap
dealer is short the bond or a bond issued
by the corporate entity, deducting the
amount specified in § 240.15c3–
1(c)(2)(vi) or (vii) for the bond. In the
case of a security-based swap that is a
short credit default swap referencing an
asset-backed security and the securitybased swap dealer is short the assetbacked security, deducting the amount
specified in § 240.15c3–1(c)(2)(vi) or
(vii) for the asset-backed security.
(B) All other security-based swaps. In
the case of any security-based swap that
is not a credit default swap, deducting
the amount calculated by multiplying
the notional amount of the securitybased swap and the percentage specified
in § 240.15c3–1(c)(2)(vi) applicable to
the reference security. A security-based
swap dealer may reduce the deduction
under this paragraph (c)(1)(vi)(B) by an
amount equal to any reduction

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401–500
(%)
7.50
10.00
12.50
15.00
17.50
20.00
22.50
25.00
27.50

501–699
(%)
10.00
12.50
15.00
17.50
20.00
22.50
25.00
27.50
30.00

700 or more
(%)
15.00
17.50
20.00
22.50
25.00
27.50
30.00
40.00
50.00

recognized for a comparable long or
short position in the reference security
under § 240.15c3–1(c)(2)(vi) and, in the
case of a security-based swap
referencing an equity security, the
method specified in § 240.18a–1a.
(vii) All other securities, money
market instruments or options.
Deducting the percentages specified in
§ 240.15c3–1(c)(2)(vi) of the market
value of all securities, money market
instruments, and options in the
proprietary accounts of the securitybased swap dealer.
(viii) Deduction from net worth in lieu
of collecting margin amounts for
security-based swaps. (A) Cleared
security-based swap transactions.
Deducting the amount of the margin
difference for each account carried by
the security-based swap dealer for
another person that holds cleared
security-based swap transactions. The
margin difference is the amount of the
deductions that the positions in the
account would incur pursuant to
paragraph (c)(1)(vi) of this section if
owned by the security-based swap
dealer less the margin value of collateral
held in the account.
(B) Non-cleared security-based swap
transactions. (1) Commercial end users.
Deducting, with respect to a
counterparty that is a commercial end
user as that term is defined in
§ 240.18a–3(b)(2), the margin amount
calculated pursuant to § 240.18a–
3(c)(1)(i)(B) for the account of the
counterparty less any positive equity in
the account as that term is defined in
§ 240.18a–3(b)(7).

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(2) Margin collateral held by thirdparty custodian. Deducting, with
respect to a counterparty that is not a
commercial end user as that term is
defined in § 240.18a–3(b)(2) and that
elects to have collateral segregated in an
account at an independent third-party
custodian pursuant to section 3E(f) of
the Act (15 U.S.C. 78c–5(f)), the margin
amount calculated pursuant to
§ 240.18a–3(c)(1)(i)(B) for the account of
the counterparty at the security-based
swap dealer less any positive equity in
that account as that term is defined in
§ 240.18a–3(b)(7).
(3) Security-based swap legacy
accounts. Deducting, with respect to a
security-based swap legacy account as
that term is defined in § 240.18a–3(b)(9)
of a counterparty that is not a
commercial end user as that term is
defined in § 240.18a–3(b)(2), the margin
amount calculated pursuant § 240.18a–
3(c)(1)(i)(B) for the account less any
positive equity in the account as that
term is defined in § 240.18a–3(b)(7).
(ix) Deduction from net worth for
certain undermargined accounts.
Deducting the amount of cash required
in the account of each security-based
swap customer to meet the margin
requirements of a clearing agency or the
Commission, after application of calls
for margin, marks to the market, or other
required deposits which are outstanding
one business day or less.
(2) The term exempted securities shall
mean those securities deemed exempted
securities by section 3(a)(12) of the
Securities Exchange Act of 1934 and the
rules thereunder.
(3) Customer. The term customer shall
mean any person from whom, or on
whose behalf, a security-based swap
dealer has received, acquired or holds
funds or securities for the account of
such person, but shall not include a
security-based swap dealer, a broker or
dealer, a registered municipal securities
dealer, or a general, special or limited
partner or director or officer of the
security-based swap dealer, or any
person to the extent that such person
has a claim for property or funds which
by contract, agreement, or
understanding, or by operation of law,
is part of the capital of the securitybased swap dealer.
(4) Ready market. The term ready
market shall include a recognized
established securities market in which
there exists independent bona fide
offers to buy and sell so that a price
reasonably related to the last sales price
or current bona fide competitive bid and
offer quotations can be determined for a
particular security almost
instantaneously and where payment
will be received in settlement of a sale

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at such price within a relatively short
time conforming to trade custom.
(5) The term tentative net capital
means the net capital of the securitybased swap dealer before deductions for
market and credit risk computed
pursuant to this section and increased
by the balance sheet value (including
counterparty net exposure) resulting
from transactions in derivative
instruments which would otherwise be
deducted. Tentative net capital shall
include securities for which there is no
ready market, as defined in paragraph
(c)(4) of this section, if the use of
mathematical models has been
approved for purposes of calculating
deductions from net capital for those
securities pursuant to paragraph (d) of
this section.
(6) The term risk margin amount
means the sum of:
(i) The greater of the total margin
required to be delivered by the securitybased swap dealer with respect to
security-based swap transactions
cleared for security-based swap
customers at a clearing agency or the
amount of the deductions that would
apply to the cleared security-based swap
positions of the security-based swap
customers pursuant to paragraph
(c)(1)(vi) of this section; and
(ii) The total margin amount
calculated by the security-based swap
dealer with respect to non-cleared
security-based swaps pursuant to
§ 240.18a–3(c)(1)(i)(B).
(d) Application to use models to
compute deductions for market and
credit risk. (1) A security-based swap
dealer may apply to the Commission for
authorization to compute deductions for
market risk under this paragraph (d) in
lieu of computing deductions pursuant
to paragraphs (c)(1)(iv), (vi), and (vii) of
this section and to compute deductions
for credit risk pursuant to this paragraph
(d) on credit exposures arising from
transactions in derivatives instruments
(if this paragraph (d) is used to calculate
deductions for market risk on these
instruments) in lieu of computing
deductions pursuant to paragraph
(c)(1)(iii) of this section.
(i) A security-based swap dealer shall
submit the following information to the
Commission with its application:
(A) An executive summary of the
information provided to the
Commission with its application and an
identification of the ultimate holding
company of the security-based swap
dealer;
(B) A comprehensive description of
the internal risk management control
system of the security-based swap
dealer and how that system satisfies the
requirements set forth in § 240.15c3–4;

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(C) A list of the categories of positions
that the security-based swap dealer
holds in its proprietary accounts and a
brief description of the methods that the
security-based swap dealer will use to
calculate deductions for market and
credit risk on those categories of
positions;
(D) A description of the mathematical
models to be used to price positions and
to compute deductions for market risk,
including those portions of the
deductions attributable to specific risk,
if applicable, and deductions for credit
risk; a description of the creation, use,
and maintenance of the mathematical
models; a description of the securitybased swap dealer’s internal risk
management controls over those
models, including a description of each
category of persons who may input data
into the models; if a mathematical
model incorporates empirical
correlations across risk categories, a
description of the process for measuring
correlations; a description of the
backtesting procedures the securitybased swap dealer will use to backtest
the mathematical models used to
calculate maximum potential exposure;
a description of how each mathematical
model satisfies the applicable
qualitative and quantitative
requirements set forth in this paragraph
(d); and a statement describing the
extent to which each mathematical
model used to compute deductions for
market risk and credit risk will be used
as part of the risk analyses and reports
presented to senior management;
(E) If the security-based swap dealer
is applying to the Commission for
approval to use scenario analysis to
calculate deductions for market risk for
certain positions, a list of those types of
positions, a description of how those
deductions will be calculated using
scenario analysis, and an explanation of
why each scenario analysis is
appropriate to calculate deductions for
market risk on those types of positions;
(F) A description of how the securitybased swap dealer will calculate current
exposure;
(G) A description of how the securitybased swap dealer will determine
internal credit ratings of counterparties
and internal credit risk weights of
counterparties, if applicable;
(H) For each instance in which a
mathematical model to be used by the
security-based swap dealer to calculate
a deduction for market risk or to
calculate maximum potential exposure
for a particular product or counterparty
differs from the mathematical model
used by the ultimate holding company
to calculate an allowance for market risk
or to calculate maximum potential

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exposure for that same product or
counterparty, a description of the
difference(s) between the mathematical
models; and
(I) Sample risk reports that are
provided to management at the securitybased swap dealer who are responsible
for managing the security-based swap
dealer’s risk.
(ii) [Reserved].
(2) The application of the securitybased swap dealer shall be
supplemented by other information
relating to the internal risk management
control system, mathematical models,
and financial position of the securitybased swap dealer that the Commission
may request to complete its review of
the application;
(3) The application shall be
considered filed when received at the
Commission’s principal office in
Washington, DC A person who files an
application pursuant to this section for
which it seeks confidential treatment
may clearly mark each page or
segregable portion of each page with the
words ‘‘Confidential Treatment
Requested.’’ All information submitted
in connection with the application will
be accorded confidential treatment, to
the extent permitted by law;
(4) If any of the information filed with
the Commission as part of the
application of the security-based swap
dealer is found to be or becomes
inaccurate before the Commission
approves the application, the securitybased swap dealer must notify the
Commission promptly and provide the
Commission with a description of the
circumstances in which the information
was found to be or has become
inaccurate along with updated, accurate
information;
(5) The Commission may approve the
application or an amendment to the
application, in whole or in part, subject
to any conditions or limitations the
Commission may require if the
Commission finds the approval to be
necessary or appropriate in the public
interest or for the protection of
investors, after determining, among
other things, whether the security-based
swap dealer has met the requirements of
this paragraph (d) and is in compliance
with other applicable rules promulgated
under the Act;
(6) A security-based swap dealer shall
amend its application to calculate
certain deductions for market and credit
risk under this paragraph (d) and submit
the amendment to the Commission for
approval before it may change
materially a mathematical model used
to calculate market or credit risk or
before it may change materially its

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internal risk management control
system;
(7) As a condition for the securitybased swap dealer to compute
deductions for market and credit risk
under this paragraph (d), the securitybased swap dealer agrees that:
(i) It will notify the Commission 45
days before it ceases to compute
deductions for market and credit risk
under this paragraph (d); and
(ii) The Commission may determine
by order that the notice will become
effective after a shorter or longer period
of time if the security-based swap dealer
consents or if the Commission
determines that a shorter or longer
period of time is necessary or
appropriate in the public interest or for
the protection of investors; and
(8) Notwithstanding paragraph (d)(7)
of this section, the Commission, by
order, may revoke a security-based swap
dealer’s exemption that allows it to use
the market risk standards of this
paragraph (d) to calculate deductions for
market risk, and the exemption to use
the credit risk standards of this
paragraph (d) to calculate deductions for
credit risk on certain credit exposures
arising from transactions in derivatives
instruments if the Commission finds
that such exemption is no longer
necessary or appropriate in the public
interest or for the protection of
investors. In making its finding, the
Commission will consider the
compliance history of the security-based
swap dealer related to its use of models,
the financial and operational strength of
the security-based swap dealer and its
ultimate holding company, and the
security-based swap dealer’s
compliance with its internal risk
management controls.
(9) VaR models. To be approved, each
value-at-risk (‘‘VaR’’) model must meet
the following minimum qualitative and
quantitative requirements:
(i) Qualitative requirements. (A) The
VaR model used to calculate market or
credit risk for a position must be
integrated into the daily internal risk
management system of the securitybased swap dealer;
(B) The VaR model must be reviewed
both periodically and annually. The
periodic review may be conducted by
the security-based swap dealer’s
internal audit staff, but the annual
review must be conducted by a
registered public accounting firm, as
that term is defined in section 2(a)(12)
of the Sarbanes-Oxley Act of 2002 (15
U.S.C. 7201 et seq.); and
(C) For purposes of computing market
risk, the security-based swap dealer
must determine the appropriate
multiplication factor as follows:

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(1) Beginning three months after the
security-based swap dealer begins using
the VaR model to calculate market risk,
the security-based swap dealer must
conduct backtesting of the model by
comparing its actual daily net trading
profit or loss with the corresponding
VaR measure generated by the VaR
model, using a 99 percent, one-tailed
confidence level with price changes
equivalent to a one business-day
movement in rates and prices, for each
of the past 250 business days, or other
period as may be appropriate for the
first year of its use;
(2) On the last business day of each
quarter, the security-based swap dealer
must identify the number of backtesting
exceptions of the VaR model using clean
profit and loss, that is, the number of
business days in the past 250 business
days, or other period as may be
appropriate for the first year of its use,
for which the actual net trading loss, if
any, exceeds the corresponding VaR
measure; and
(3) The security-based swap dealer
must use the multiplication factor
indicated in Table 1 of this paragraph
(d) in determining its market risk until
it obtains the next quarter’s backtesting
results;

TABLE 1—MULTIPLICATION FACTOR
BASED ON THE NUMBER OF
BACKTESTING EXCEPTIONS OF THE
VAR MODEL
Number of
exceptions
4 or fewer .........................
5 ........................................
6 ........................................
7 ........................................
8 ........................................
9 ........................................
10 or more ........................

Multiplication
factor
3.00
3.40
3.50
3.65
3.75
3.85
4.00

(4) For purposes of incorporating
specific risk into a VaR model, a
security-based swap dealer must
demonstrate that it has methodologies
in place to capture liquidity, event, and
default risk adequately for each
position. Furthermore, the models used
to calculate deductions for specific risk
must:
(i) Explain the historical price
variation in the portfolio;
(ii) Capture concentration (magnitude
and changes in composition);
(iii) Be robust to an adverse
environment;
(iv) Capture name-related basis risk;
(v) Capture event risk; and
(vi) Be validated through backtesting.
(5) For purposes of computing the
credit equivalent amount of the
security-based swap dealer’s exposures

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to a counterparty, the security-based
swap dealer must determine the
appropriate multiplication factor as
follows:
(i) Beginning three months after it
begins using the VaR model to calculate
maximum potential exposure, the
security-based swap dealer must
conduct backtesting of the model by
comparing, for at least 80 counterparties
with widely varying types and sizes of
positions with the firm, the ten business
day change in its current exposure to
the counterparty based on its positions
held at the beginning of the ten-business
day period with the corresponding tenbusiness day maximum potential
exposure for the counterparty generated
by the VaR model;
(ii) As of the last business day of each
quarter, the security-based swap dealer
must identify the number of backtesting
exceptions of the VaR model, that is, the
number of ten-business day periods in
the past 250 business days, or other
period as may be appropriate for the
first year of its use, for which the change
in current exposure to a counterparty
exceeds the corresponding maximum
potential exposure; and
(iii) The security-based swap dealer
will propose, as part of its application,
a schedule of multiplication factors,
which must be approved by the
Commission based on the number of
backtesting exceptions of the VaR
model. The security-based swap dealer
must use the multiplication factor
indicated in the approved schedule in
determining the credit equivalent
amount of its exposures to a
counterparty until it obtains the next
quarter’s backtesting results, unless the
Commission determines, based on,
among other relevant factors, a review of
the security-based swap dealer’s
internal risk management control
system, including a review of the VaR
model, that a different adjustment or
other action is appropriate.
(ii) Quantitative requirements.
(A) For purposes of determining
market risk, the VaR model must use a
99 percent, one-tailed confidence level
with price changes equivalent to a ten
business-day movement in rates and
prices;
(B) For purposes of determining
maximum potential exposure, the VaR
model must use a 99 percent, one-tailed
confidence level with price changes
equivalent to a one-year movement in
rates and prices; or based on a review
of the security-based swap dealer’s
procedures for managing collateral and
if the collateral is marked to market
daily and the security-based swap
dealer has the ability to call for
additional collateral daily, the

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Commission may approve a time
horizon of not less than ten business
days;
(C) The VaR model must use an
effective historical observation period of
at least one year. The security-based
swap dealer must consider the effects of
market stress in its construction of the
model. Historical data sets must be
updated at least monthly and reassessed
whenever market prices or volatilities
change significantly; and
(D) The VaR model must take into
account and incorporate all significant,
identifiable market risk factors
applicable to positions in the accounts
of the security-based swap dealer,
including:
(1) Risks arising from the non-linear
price characteristics of derivatives and
the sensitivity of the market value of
those positions to changes in the
volatility of the derivatives’ underlying
rates and prices;
(2) Empirical correlations with and
across risk factors or, alternatively, risk
factors sufficient to cover all the market
risk inherent in the positions in the
proprietary or other trading accounts of
the security-based swap dealer,
including interest rate risk, equity price
risk, foreign exchange risk, and
commodity price risk;
(3) Spread risk, where applicable, and
segments of the yield curve sufficient to
capture differences in volatility and
imperfect correlation of rates along the
yield curve for securities and
derivatives that are sensitive to different
interest rates; and
(4) Specific risk for individual
positions.
(iii) Additional conditions. (A) As a
condition for the security-based swap
dealer to use this paragraph (d) to
calculate certain of its capital charges,
the Commission may impose additional
conditions on the security-based swap
dealer, which may include, but are not
limited to restricting the security-based
swap dealer’s business on a productspecific, category-specific, or general
basis; submitting to the Commission a
plan to increase the security-based swap
dealer’s net capital or tentative net
capital; filing more frequent reports
with the Commission; modifying the
security-based swap dealer’s internal
risk management control procedures; or
computing the security-based swap
dealer’s deductions for market and
credit risk in accordance with
paragraphs (c)(1) (iii), (iv), (vii), or (viii)
as appropriate. If the Commission finds
it is necessary or appropriate in the
public interest or for the protection of
investors, the Commission may impose
additional conditions on the securitybased swap dealer, if:

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(1) The security-based swap dealer is
required by § 240.18a–8 to provide
notice to the Commission that the
security-based swap dealer’s tentative
net capital is less than $100 million;
(2) The security-based swap dealer
fails to meet the reporting requirements
set forth in § 240.18a–8;
(3) Any event specified in § 240.18a–
8 occurs;
(4) There is a material deficiency in
the internal risk management control
system or in the mathematical models
used to price securities or to calculate
deductions for market and credit risk or
allowances for market and credit risk, as
applicable, of the security-based swap
dealer;
(5) The security-based swap dealer
fails to comply with this paragraph (d);
or
(6) The Commission finds that
imposition of other conditions is
necessary or appropriate in the public
interest or for the protection of
investors.
(e) Models to compute deductions for
market risk and credit risk. (1) Market
risk. A security-based swap dealer
whose application, including
amendments, has been approved under
paragraph (d) of this section, shall
compute a deduction for market risk in
an amount equal to the sum of the
following:
(i) For positions for which the
Commission has approved the securitybased swap dealer’s use of VaR models,
the VaR of the positions multiplied by
the appropriate multiplication factor
determined according to paragraph (d)
of this section, except that the initial
multiplication factor shall be three,
unless the Commission determines,
based on a review of the security-based
swap dealer’s application or an
amendment to the application under
paragraph (d) of this section, including
a review of its internal risk management
control system and practices and VaR
models, that another multiplication
factor is appropriate;
(ii) For positions for which the VaR
model does not incorporate specific
risk, a deduction for specific risk to be
determined by the Commission based
on a review of the security-based swap
dealer’s application or an amendment to
the application under paragraph (d) of
this section and the positions involved;
(iii) For positions for which the
Commission has approved the securitybased swap dealer’s application to use
scenario analysis, the greatest loss
resulting from a range of adverse
movements in relevant risk factors,
prices, or spreads designed to represent
a negative movement greater than, or
equal to, the worst ten-day movement of

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the four years preceding calculation of
the greatest loss, or some multiple of the
greatest loss based on the liquidity of
the positions subject to scenario
analysis. If historical data is insufficient,
the deduction shall be the largest loss
within a three standard deviation
movement in those risk factors, prices,
or spreads over a ten-day period,
multiplied by an appropriate liquidity
adjustment factor. Irrespective of the
deduction otherwise indicated under
scenario analysis, the resulting
deduction for market risk must be at
least $25 per 100 share equivalent
contract for equity positions, or one-half
of one percent of the face value of the
contract for all other types of contracts,
even if the scenario analysis indicates a
lower amount. A qualifying scenario
must include the following:
(A) A set of pricing equations for the
positions based on, for example,
arbitrage relations, statistical analysis,
historic relationships, merger
evaluations, or fundamental valuation of
an offering of securities;
(B) Auxiliary relationships mapping
risk factors to prices; and
(C) Data demonstrating the
effectiveness of the scenario in
capturing market risk, including specific
risk; and
(iv) For all remaining positions, the
deductions specified in § 240.15c3–
1(c)(2)(vi), § 240.15c3–1(c)(2)(vii), and
applicable appendices to § 240.15c3–1.
(2) Credit risk. A security-based swap
dealer whose application, including
amendments, has been approved under
paragraph (d) of this section with
respect to positions in security-based
swaps may compute a deduction for
credit risk on security-based swap
transactions with commercial end users
as defined in § 240.18a–3(b)(2) in an
amount equal to the sum of the
following:
(i) A counterparty exposure charge in
an amount equal to the sum of the
following:
(A) The net replacement value in the
account of each counterparty that is
insolvent, or in bankruptcy, or that has
senior unsecured long-term debt in
default; and
(B) For a counterparty not otherwise
described in paragraph (e)(2)(i)(A) of
this section, the credit equivalent
amount of the security-based swap
dealer’s exposure to the counterparty, as
defined in paragraph (e)(2)(iv)(A) of this
section, multiplied by the credit risk
weight of the counterparty, as
determined in accordance with
paragraph (e)(2)(iv)(F) of this section,
multiplied by 8%;

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(ii) A concentration charge by
counterparty in an amount equal to the
sum of the following:
(A) For each counterparty with a
credit risk weight of 20% or less, 5% of
the amount of the current exposure to
the counterparty in excess of 5% of the
tentative net capital of the securitybased swap dealer;
(B) For each counterparty with a
credit risk weight of greater than 20%
but less than 50%, 20% of the amount
of the current exposure to the
counterparty in excess of 5% of the
tentative net capital of the securitybased swap dealer; and
(C) For each counterparty with a
credit risk weight of greater than 50%,
50% of the amount of the current
exposure to the counterparty in excess
of 5% of the tentative net capital of the
security-based swap dealer; and
(iii) A portfolio concentration charge
of 100% of the amount of the securitybased swap dealer’s aggregate current
exposure for all counterparties in excess
of 50% of the tentative net capital of the
security-based swap dealer.
(iv) Terms. (A) The credit equivalent
amount of the security-based swap
dealer’s exposure to a counterparty is
the sum of the security-based swap
dealer’s maximum potential exposure to
the counterparty, as defined in
paragraph (e)(2)(iv)(B) of this section,
multiplied by the appropriate
multiplication factor, and the securitybased swap dealer’s current exposure to
the counterparty, as defined in
paragraph (e)(2)(iv)(C) of this section.
The security-based swap dealer must
use the multiplication factor determined
according to paragraph (d)(9)(i)(C)(5) of
this section, except that the initial
multiplication factor shall be one,
unless the Commission determines,
based on a review of the security-based
swap dealer’s application or an
amendment to the application approved
under paragraph (d) of this section,
including a review of its internal risk
management control system and
practices and VaR models, that another
multiplication factor is appropriate;
(B) The maximum potential exposure
is the VaR of the counterparty’s
positions with the security-based swap
dealer, after applying netting
agreements with the counterparty
meeting the requirements of paragraph
(e)(2)(iv)(D) of this section, taking into
account the value of collateral from the
counterparty held by the security-based
swap dealer in accordance with
paragraph (e)(2)(iv)(E) of this section,
and taking into account the current
replacement value of the counterparty’s
positions with the security-based swap
dealer;

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(C) The current exposure of the
security-based swap dealer to a
counterparty is the current replacement
value of the counterparty’s positions
with the security-based swap dealer,
after applying netting agreements with
the counterparty meeting the
requirements of paragraph (e)(2)(iv)(D)
of this section and taking into account
the value of collateral from the
counterparty held by the security-based
swap dealer in accordance with
paragraph (e)(2)(iv)(E) of this section;
(D) Netting agreements. A securitybased swap dealer may include the
effect of a netting agreement that allows
the security-based swap dealer to net
gross receivables from and gross
payables to a counterparty upon default
of the counterparty if:
(1) The netting agreement is legally
enforceable in each relevant
jurisdiction, including in insolvency
proceedings;
(2) The gross receivables and gross
payables that are subject to the netting
agreement with a counterparty can be
determined at any time; and
(3) For internal risk management
purposes, the security-based swap
dealer monitors and controls its
exposure to the counterparty on a net
basis.
(E) Collateral. When calculating
maximum potential exposure and
current exposure to a counterparty, the
fair market value of collateral pledged
and held may be taken into account
provided:
(1) The collateral is marked to market
each day and is subject to a daily margin
maintenance requirement;
(2) The security-based swap dealer
maintains physical possession or sole
control of the collateral;
(3) The collateral is liquid and
transferable;
(4) The collateral may be liquidated
promptly by the firm without
intervention by any other party;
(5) The collateral agreement is legally
enforceable by the security-based swap
dealer against the counterparty and any
other parties to the agreement;
(6) The collateral does not consist of
securities issued by the counterparty or
a party related to the security-based
swap dealer or to the counterparty;
(7) The Commission has approved the
security-based swap dealer’s use of a
VaR model to calculate deductions for
market risk for the type of collateral in
accordance with paragraph (d) of this
section; and
(8) The collateral is not used in
determining the credit rating of the
counterparty.
(F) Credit risk weights of
counterparties. A security-based swap

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dealer that computes its deductions for
credit risk pursuant to paragraph (e)(2)
of this section shall apply a credit risk
weight for transactions with a
counterparty of either 20%, 50%, or
150% based on an internal credit rating
the security-based swap dealer
determines for the counterparty.
(1) As part of its initial application or
in an amendment, the security-based
swap dealer may request Commission
approval to apply a credit risk weight of
either 20%, 50%, or 150% based on
internal calculations of credit ratings,
including internal estimates of the
maturity adjustment. Based on the
strength of the security-based swap
dealer’s internal credit risk management
system, the Commission may approve
the application. The security-based
swap dealer must make and keep
current a record of the basis for the
credit risk weight of each counterparty;
(2) As part of its initial application or
in an amendment, the security-based
swap dealer may request Commission
approval to determine credit risk
weights based on internal calculations,
including internal estimates of the
maturity adjustment. Based on the
strength of the security-based swap
dealer’s internal credit risk management
system, the Commission may approve
the application. The security-based
swap dealer must make and keep
current a record of the basis for the
credit risk weight of each counterparty;
and
(3) As part of its initial application or
in an amendment, the security-based
swap dealer may request Commission
approval to reduce deductions for credit
risk through the use of credit
derivatives.
(f) Liquidity requirements. (1)
Liquidity stress test. A security-based
swap dealer that computes net capital
under paragraph (a)(2) of this Rule 18a–
1 must perform a liquidity stress test at
least monthly, the results of which must
be provided within ten business days to
senior management that has
responsibility to oversee risk
management at the security-based swap
dealer. The assumptions underlying the
liquidity stress test must be reviewed at
least quarterly by senior management
that has responsibility to oversee risk
management at the security-based swap
dealer and at least annually by senior
management of the security-based swap
dealer. The liquidity stress test must
include, at a minimum, the following
assumed conditions lasting for 30
consecutive days:
(i) A stress event includes a decline in
creditworthiness of the broker or dealer
severe enough to trigger contractual

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credit-related commitment provisions of
counterparty agreements;
(ii) The loss of all existing unsecured
funding at the earlier of its maturity or
put date and an inability to acquire a
material amount of new unsecured
funding, including intercompany
advances and unfunded committed
lines of credit;
(iii) The potential for a material net
loss of secured funding;
(iv) The loss of the ability to procure
repurchase agreement financing for less
liquid assets;
(v) The illiquidity of collateral
required by and on deposit at clearing
agencies or other entities which is not
deducted from net worth or which is not
funded by customer assets;
(vi) A material increase in collateral
required to be maintained at registered
clearing agencies of which it is a
member; and
(vii) The potential for a material loss
of liquidity caused by market
participants exercising contractual
rights and/or refusing to enter into
transactions with respect to the various
businesses, positions, and commitments
of the security-based swap dealer,
including those related to customer
businesses of the security-based swap
dealer.
(2) Stress test of consolidated entity.
The security-based swap dealer must
justify and document any differences in
the assumptions used in the liquidity
stress test of the security-based swap
dealer from those used in the liquidity
stress test of the consolidated entity of
which the security-based swap dealer is
a part.
(3) Liquidity reserves. The securitybased swap dealer must maintain at all
times liquidity reserves based on the
results of the liquidity stress test. The
liquidity reserves used to satisfy the
liquidity stress test must be:
(i) Cash, obligations of the United
States, or obligations fully guaranteed as
to principal and interest by the United
States; and
(ii) Unencumbered and free of any
liens at all times.
Securities in the liquidity reserve can
be used to meet delivery requirements
as long as cash or other acceptable
securities of equal or greater value are
moved into the liquidity pool
contemporaneously.
(4) Contingency funding plan. The
security-based swap dealer must have a
written contingency funding plan that
addresses the security-based swap
dealer’s policies and the roles and
responsibilities of relevant personnel for
meeting the liquidity needs of the
security-based swap dealer and
communications with the public and

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other market participants during a
liquidity stress event.
(g) Internal risk management control
systems. A security-based swap dealer
must comply with § 240.15c3–4 as if it
were an OTC derivatives dealer with
respect to all of its business activities,
except that paragraphs (c)(5)(xiii) and
(xiv) and (d)(8) and (9) of § 240.15c3–4
shall not apply.
(h) Debt-equity requirements. No
security-based swap dealer shall permit
the total of outstanding principal
amounts of its satisfactory
subordination agreements (other than
such agreements which qualify under
this paragraph (h) as equity capital) to
exceed 70 percent of its debt-equity
total, as hereinafter defined, for a period
in excess of 90 days or for such longer
period which the Commission may,
upon application of the security-based
swap dealer, grant in the public interest
or for the protection of investors. In the
case of a corporation, the debt-equity
total shall be the sum of its outstanding
principal amounts of satisfactory
subordination agreements, par or stated
value of capital stock, paid in capital in
excess of par, retained earnings,
unrealized profit and loss or other
capital accounts. In the case of a
partnership, the debt-equity total shall
be the sum of its outstanding principal
amounts of satisfactory subordination
agreements, capital accounts of partners
(exclusive of such partners’ securities
accounts) subject to the provisions of
paragraph (i) of this section, and
unrealized profit and loss. Provided,
however, that a satisfactory
subordinated loan agreement entered
into by a partner or stockholder which
has an initial term of at least three years
and has a remaining term of not less
than 12 months shall be considered
equity for the purposes of this paragraph
(h) if:
(1) It does not have any of the
provisions for accelerated maturity
provided for by paragraphs (b)(8)(i),
(9)(i), or (9)(ii) of Appendix D of this
section and is maintained as capital
subject to the provisions restricting the
withdrawal thereof required by
paragraph (i) of this section; or
(2) The partnership agreement
provides that capital contributed
pursuant to a satisfactory subordination
agreement as defined in Appendix D of
this section shall in all respects be
partnership capital subject to the
provisions restricting the withdrawal
thereof required by paragraph (i) of this
section.
(i) Notice provisions relating to
limitations on the withdrawal of equity
capital. (1) No equity capital of the
security-based swap dealer or a

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subsidiary or affiliate consolidated
pursuant to Appendix C of this section
may be withdrawn by action of a
stockholder or a partner or by
redemption or repurchase of shares of
stock by any of the consolidated entities
or through the payment of dividends or
any similar distribution, nor may any
unsecured advance or loan be made to
a stockholder, partner, employee or
affiliate without written notice given in
accordance with paragraph (i)(1)(iv) of
this section:
(i) Two business days prior to any
withdrawals, advances or loans if those
withdrawals, advances or loans on a net
basis exceed in the aggregate in any 30
calendar day period, 30 percent of the
security-based swap dealer’s excess net
capital. A security-based swap dealer, in
an emergency situation, may make
withdrawals, advances or loans that on
a net basis exceed 30 percent of the
security-based swap dealer’s excess net
capital in any 30 calendar day period
without giving the advance notice
required by this paragraph, with the
prior approval of the Commission.
Where a security-based swap dealer
makes a withdrawal with the consent of
the Commission, it shall in any event
comply with paragraph (i)(1)(ii) of this
section; or
(ii) Two business days after any
withdrawals, advances or loans if those
withdrawals, advances or loans on a net
basis exceed in the aggregate in any 30
calendar day period, 20 percent of the
security-based swap dealer’s excess net
capital.
(iii) This paragraph (i)(1) does not
apply to:
(A) Securities or commodities
transactions in the ordinary course of
business between a security-based swap
dealer and an affiliate where the
security-based swap dealer makes
payment to or on behalf of such affiliate
for such transaction and then receives
payment from such affiliate for the
securities or commodities transaction
within two business days from the date
of the transaction; or
(B) Withdrawals, advances or loans
which in the aggregate in any thirty
calendar day period, on a net basis,
equal $500,000 or less.
(iv) Each required notice shall be
effective when received by the
Commission in Washington, DC, the
regional office of the Commission for
the region in which the security-based
swap dealer has its principal place of
business, and the Commodity Futures
Trading Commission if such securitybased swap dealer is registered with that
Commission.
(2) Limitations on withdrawal of
equity capital. No equity capital of the

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security-based swap dealer or a
subsidiary or affiliate consolidated
pursuant to Appendix C of this section
may be withdrawn by action of a
stockholder or a partner or by
redemption or repurchase of shares of
stock by any of the consolidated entities
or through the payment of dividends or
any similar distribution, nor may any
unsecured advance or loan be made to
a stockholder, partner, employee or
affiliate, if after giving effect thereto and
to any other such withdrawals,
advances or loans and any Payments of
Payments Obligations (as defined in
Appendix D of this section) under
satisfactory subordinated loan
agreements which are scheduled to
occur within 180 days following such
withdrawal, advance or loan if:
(i) The security-based swap dealer’s
net capital would be less than 120
percent of the minimum dollar amount
required by paragraph (a) of this section;
and
(ii) The total outstanding principal
amounts of satisfactory subordinated
loan agreements of the security-based
swap dealer and any subsidiaries or
affiliates consolidated pursuant to
Appendix C of this section (other than
such agreements which qualify as equity
under paragraph (h) of this section)
would exceed 70% of the debt-equity
total as defined in paragraph (h) of this
section.
(3) Temporary restrictions on
withdrawal of net capital. (i) The
Commission may by order restrict, for a
period up to twenty business days, any
withdrawal by the security-based swap
dealer of equity capital or unsecured
loan or advance to a stockholder,
partner, member, employee or affiliate
under such terms and conditions as the
Commission deems necessary or
appropriate in the public interest or
consistent with the protection of
investors if the Commission, based on
the information available, concludes
that such withdrawal, advance or loan
may be detrimental to the financial
integrity of the security-based swap
dealer, or may unduly jeopardize the
security-based swap dealer’s ability to
repay its customer claims or other
liabilities which may cause a significant
impact on the markets or expose the
customers or creditors of the securitybased swap dealer to loss.
(ii) An order temporarily prohibiting
the withdrawal of capital shall be
rescinded if the Commission determines
that the restriction on capital
withdrawal should not remain in effect.
A hearing on an order temporarily
prohibiting withdrawal of capital will
be held within two business days from

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the date of the request in writing by the
security-based swap dealer.
(4) Miscellaneous provisions. (i)
Excess net capital is that amount in
excess of the amount required under
paragraph (a) of this section. For the
purposes of paragraphs (i)(1) and (2) of
this section, a security-based swap
dealer may use the amount of excess net
capital and deductions required under
paragraphs (c)(1)(vii) and (viii) and
Appendix A of this section reported in
its most recently required filed Form X–
18A–7 for the purposes of calculating
the effect of a projected withdrawal,
advance or loan relative to excess net
capital or deductions. The securitybased swap dealer must assure itself
that the excess net capital or the
deductions reported on the most
recently required filed Form X–18A–7
have not materially changed since the
time such report was filed.
(ii) The term equity capital includes
capital contributions by partners, par or
stated value of capital stock, paid-in
capital in excess of par, retained
earnings or other capital accounts. The
term equity capital does not include
securities in the securities accounts of
partners and balances in limited
partners’ capital accounts in excess of
their stated capital contributions.
(iii) Paragraphs (i)(1) and (2) of this
section shall not preclude a securitybased swap dealer from making required
tax payments or preclude the payment
to partners of reasonable compensation,
and such payments shall not be
included in the calculation of
withdrawals, advances, or loans for
purposes of paragraphs (i)(1) and (2) of
this section.
(iv) For the purpose of this paragraph
(i), any transactions between a securitybased swap dealer and a stockholder,
partner, employee or affiliate that
results in a diminution of the securitybased swap dealer’s net capital shall be
deemed to be an advance or loan of net
capital.
9. Section 240.18a–1a is added to read
as follows:
§ 240.18a–1a Options (Appendix A to 17
CFR 240.18a–1).

(a)(1) Definitions. The term unlisted
option means any option not included
in the definition of listed option
provided in § 240.15c3–1(c)(2)(x).
(2) The term option series refers to
listed option contracts of the same type
(either a call or a put) and exercise style,
covering the same underlying security
with the same exercise price, expiration
date, and number of underlying units.
(3) The term related instrument
within an option class or product group
refers to futures contracts and options

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on futures contracts covering the same
underlying instrument. In relation to
options on foreign currencies, a related
instrument within an option class also
shall include forward contracts on the
same underlying currency.
(4) The term underlying instrument
refers to long and short positions, as
appropriate, covering the same foreign
currency, the same security, security
future, or security-based swap, or a
security which is exchangeable for or
convertible into the underlying security
within a period of 90 days. If the
exchange or conversion requires the
payment of money or results in a loss
upon conversion at the time when the
security is deemed an underlying
instrument for purposes of this
Appendix A, the security-based swap
dealer will deduct from net worth the
full amount of the conversion loss. The
term underlying instrument shall not be
deemed to include securities options,
futures contracts, options on futures
contracts, qualified stock baskets, or
unlisted instruments (other than
security-based swaps).
(5) The term options class refers to all
options contracts covering the same
underlying instrument.
(6) The term product group refers to
two or more option classes, related
instruments, underlying instruments,
and qualified stock baskets in the same
portfolio type (see paragraph (b)(1)(ii) of
this section) for which it has been
determined that a percentage of
offsetting profits may be applied to
losses at the same valuation point.
(b) The deduction under this
Appendix A must equal the sum of the
deductions specified in paragraph
(b)(1)(iv)(C) of this section.
Theoretical Pricing Charges
(1)(i) Definitions. (A) The terms
theoretical gains and losses mean the
gain and loss in the value of individual
option series, the value of underlying
instruments, related instruments, and
qualified stock baskets within that
option’s class, at 10 equidistant
intervals (valuation points) ranging from
an assumed movement (both up and
down) in the current market value of the
underlying instrument equal to the
percentage corresponding to the
deductions otherwise required under
§ 240.15c3–1 for the underlying
instrument (see paragraph (b)(1)(iii) of
this section). Theoretical gains and
losses shall be calculated using a
theoretical options pricing model that
satisfies the criteria set forth in
paragraph (b)(1)(i)(B) of this section.
(B) The term theoretical options
pricing model means any mathematical
model, other than a security-based swap

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dealer’s proprietary model, the use of
which has been approved by the
Commission. Any such model shall
calculate theoretical gains and losses as
described in paragraph (b)(1)(i)(A) of
this section for all series and issues of
equity, index and foreign currency
options and related instruments, and
shall be made available equally and on
the same terms to all security-based
swap dealers. Its procedures shall
include the arrangement of the vendor
to supply accurate and timely data to
each security-based swap dealer with
respect to its services, and the fees for
distribution of the services. The data
provided to security-based swap dealers
shall also contain the minimum
requirements set forth in paragraphs
(b)(1)(iv)(C) of this section and the
product group offsets set forth in
paragraphs (b)(1)(iv)(B) of this section.
At a minimum, the model shall consider
the following factors in pricing the
option:
(1) The current spot price of the
underlying asset;
(2) The exercise price of the option;
(3) The remaining time until the
option’s expiration;
(4) The volatility of the underlying
asset;
(5) Any cash flows associated with
ownership of the underlying asset that
can reasonably be expected to occur
during the remaining life of the option;
and
(6) The current term structure of
interest rates.
(C) The term major market foreign
currency means the currency of a
sovereign nation for which there is a
substantial inter-bank forward currency
market.
(D) The term qualified stock basket
means a set or basket of stock positions
which represents no less than 50% of
the capitalization for a highcapitalization or non-high-capitalization
diversified market index, or, in the case
of a narrow-based index, no less than
95% of the capitalization for such
narrow-based index.
(ii) With respect to positions
involving listed option positions in its
proprietary or other account, the
security-based swap dealer shall group
long and short positions into the
following portfolio types:
(A) Equity options on the same
underlying instrument and positions in
that underlying instrument;
(B) Options on the same major market
foreign currency, positions in that major
market foreign currency, and related
instruments within those options’
classes;
(C) High-capitalization diversified
market index options, related

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instruments within the option’s class,
and qualified stock baskets in the same
index;
(D) Non-high-capitalization
diversified index options, related
instruments within the index option’s
class, and qualified stock baskets in the
same index; and
(E) Narrow-based index options,
related instruments within the index
option’s class, and qualified stock
baskets in the same index.
(iii) Before making the computation,
each security-based swap dealer shall
obtain the theoretical gains and losses
for each option series and for the related
and underlying instruments within
those options’ class in the proprietary or
other accounts of that security-based
swap dealer. For each option series, the
theoretical options pricing model shall
calculate theoretical prices at 10
equidistant valuation points within a
range consisting of an increase or a
decrease of the following percentages of
the daily market price of the underlying
instrument:
(A) +(¥)15% for equity securities
with a ready market, narrow-based
indexes, and non-high-capitalization
diversified indexes;
(B) +(¥)6% for major market foreign
currencies;
(C) +(¥)20% for all other currencies;
and
(D) +(¥)10% for high-capitalization
diversified indexes.
(iv)(A) The security-based swap
dealer shall multiply the corresponding
theoretical gains and losses at each of
the 10 equidistant valuation points by
the number of positions held in a
particular option series, the related
instruments and qualified stock baskets
within the option’s class, and the
positions in the same underlying
instrument.
(B) In determining the aggregate profit
or loss for each portfolio type, the
security-based swap dealer will be
allowed the following offsets in the
following order, provided, that in the
case of qualified stock baskets, the
security-based swap dealer may elect to
net individual stocks between qualified
stock baskets and take the appropriate
deduction on the remaining, if any,
securities:
(1) First, a security-based swap dealer
is allowed the following offsets within
an option’s class:
(i) Between options on the same
underlying instrument, positions
covering the same underlying
instrument, and related instruments
within the option’s class, 100% of a
position’s gain shall offset another
position’s loss at the same valuation
point;

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(ii) Between index options, related
instruments within the option’s class,
and qualified stock baskets on the same
index, 95%, or such other amount as
designated by the Commission, of gains
shall offset losses at the same valuation
point;
(2) Second, a security-based swap
dealer is allowed the following offsets
within an index product group:
(i) Among positions involving
different high-capitalization diversified
index option classes within the same
product group, 90% of the gain in a
high-capitalization diversified market
index option, related instruments, and
qualified stock baskets within that index
option’s class shall offset the loss at the
same valuation point in a different highcapitalization diversified market index
option, related instruments, and
qualified stock baskets within that index
option’s class;
(ii) Among positions involving
different non-high-capitalization
diversified index option classes within
the same product group, 75% of the gain
in a non-high-capitalization diversified
market index option, related
instruments, and qualified stock baskets
within that index option’s class shall
offset the loss at the same valuation
point in another non-high-capitalization
diversified market index option, related
instruments, and qualified stock baskets
within that index option’s class or
product group;
(iii) Among positions involving
different narrow-based index option
classes within the same product group,
90% of the gain in a narrow-based
market index option, related
instruments, and qualified stock baskets
within that index option’s class shall
offset the loss at the same valuation
point in another narrow-based market
index option, related instruments, and
qualified stock baskets within that index
option’s class or product group;
(iv) No qualified stock basket should
offset another qualified stock basket;
and
(3) Third, a security-based swap
dealer is allowed the following offsets
between product groups: Among
positions involving different diversified
index product groups within the same
market group, 50% of the gain in a
diversified market index option, a
related instrument, or a qualified stock
basket within that index option’s
product group shall offset the loss at the
same valuation point in another product
group;
(C) For each portfolio type, the total
deduction shall be the larger of:
(1) The amount for any of the 10
equidistant valuation points
representing the largest theoretical loss

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after applying the offsets provided in
paragraph (b)(1)(iv)(B) if this section; or
(2) A minimum charge equal to 25%
times the multiplier for each equity and
index option contract and each related
instrument within the option’s class or
product group, or $25 for each option on
a major market foreign currency with
the minimum charge for futures
contracts and options on futures
contracts adjusted for contract size
differentials, not to exceed market value
in the case of long positions in options
and options on futures contracts; plus
(3) In the case of portfolio types
involving index options and related
instruments offset by a qualified stock
basket, there will be a minimum charge
of 5% of the market value of the
qualified stock basket for highcapitalization diversified and narrowbased indexes; and
(4) In the case of portfolio types
involving index options and related
instruments offset by a qualified stock
basket, there will be a minimum charge
of 71⁄2% of the market value of the
qualified stock basket for non-highcapitalization diversified indexes.
(5) In the case of portfolio types
involving security futures and equity
options on the same underlying
instrument and positions in that
underlying instrument, there will be a
minimum charge of 25% times the
multiplier for each security-future and
equity option.
10. Section 240.18a–1b is added to
read as follows:
§ 240.18a–1b Adjustments to net worth for
certain commodities transactions
(Appendix B to 17 CFR 240.18a–1).

(a) Every registered security-based
swap dealer in computing net capital
pursuant to § 240.18a–1 shall comply
with the following:
(1) Where a security-based swap
dealer has an asset or liability which is
treated or defined in paragraph
§ 240.18a–1, the inclusion or exclusion
of all or part of such asset or liability for
net capital shall be in accordance with
§ 240.18a–1, except as specifically
provided otherwise in this Appendix B.
Where a commodity related asset or
liability is specifically treated or defined
in 17 CFR 1.17 and is not generally or
specifically treated or defined in
§ 240.18a–1 or this Appendix B, the
inclusion or exclusion of all or part of
such asset or liability for net capital
shall be in accordance with 17 CFR
1.17.
(2) In computing net capital as
defined in paragraph (c)(1) of § 240.18a–
1, the net worth of a security-based
swap dealer shall be adjusted as follows

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with respect to commodity-related
transactions:
(i) Unrealized profit or loss for certain
commodities transactions. (A)
Unrealized profits shall be added and
unrealized losses shall be deducted in
the commodities accounts of the
security-based swap dealer, including
unrealized profits and losses on fixed
price commitments and forward
contracts; and
(B) The value attributed to any
commodity option which is not traded
on a contract market shall be the
difference between the option’s strike
price and the market value for the
physical or futures contract which is the
subject of the option. In the case of a
long call commodity option, if the
market value for the physical or futures
contract which is the subject of the
option is less than the strike price of the
option, it shall be given no value. In the
case of a long put commodity option, if
the market value for the physical
commodity or futures contract which is
the subject of the option is more than
the striking price of the option, it shall
be given no value.
(ii) Deduct any unsecured commodity
futures or option account containing a
ledger balance and open trades, the
combination of which liquidates to a
deficit or containing a debit ledger
balance only: Provided, however,
Deficits or debit ledger balances in
unsecured customers’, non-customers’
and proprietary accounts, which are the
subject of calls for margin or other
required deposits need not be deducted
until the close of business on the
business day following the date on
which such deficit or debit ledger
balance originated;
(iii) Deduct all unsecured receivables,
advances and loans except for:
(A) Management fees receivable from
commodity pools outstanding no longer
than thirty (30) days from the date they
are due;
(B) Receivables from foreign clearing
organizations;
(C) Receivables from registered
futures commission merchants or
brokers, resulting from commodity
futures or option transactions, except
those specifically excluded under
paragraph (a)(2)(ii) of this Appendix B.
(iv) Deduct all inventories (including
work in process, finished goods, raw
materials and inventories held for
resale) except for readily marketable
spot commodities; or spot commodities
which adequately collateralize
indebtedness under 17 CFR 1.17(c)(7);
(v) Guarantee deposits with
commodities clearing organizations are
not required to be deducted from net
worth;

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules

(vi) Stock in commodities clearing
organizations to the extent of its margin
value is not required to be deducted
from net worth;
(vii) Deduct from net worth the
amount by which any advances paid by
the security-based swap dealer on cash
commodity contracts and used in
computing net capital exceeds 95
percent of the market value of the
commodities covered by such contracts.
(viii) Do not include equity in the
commodity accounts of partners in net
worth.
(ix) In the case of all inventory, fixed
price commitments and forward
contracts, except for inventory and
forward contracts in the inter-bank
market in those foreign currencies
which are purchased or sold for further
delivery on or subject to the rules of a
contract market and covered by an open
futures contract for which there will be
no charge, deduct the applicable
percentage of the net position specified
below:
(A) Inventory which is currently
registered as deliverable on a contract
market and covered by an open futures
contract or by a commodity option on a
physical—No charge.
(B) Inventory which is covered by an
open futures contract or commodity
option—5% of the market value.
(C) Inventory which is not covered—
20% of the market value.
(D) Fixed price commitments (open
purchases and sales) and forward
contracts which are covered by an open
futures contract or commodity option—
10% of the market value.
(E) Fixed price commitments (open
purchases and sales) and forward
contracts which are not covered by an
open futures contract or commodity
option—20% of the market value.
(x) Deduct for undermargined
customer commodity futures accounts
the amount of funds required in each
such account to meet maintenance
margin requirements of the applicable
board of trade or, if there are no such
maintenance margin requirements,
clearing organization margin
requirements applicable to such
positions, after application of calls for
margin, or other required deposits
which are outstanding three business
days or less. If there are no such
maintenance margin requirements or
clearing organization margin
requirements on such accounts, then
deduct the amount of funds required to
provide margin equal to the amount
necessary after application of calls for
margin, or other required deposits
outstanding three days or less to restore
original margin when the original
margin has been depleted by 50 percent

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or more. Provided, To the extent a
deficit is deducted from net worth in
accordance with paragraph (a)(2)(ii) of
this Appendix B, such amount shall not
also be deducted under this paragraph
(a)(2)(x). In the event that an owner of
a customer account has deposited an
asset other than cash to margin,
guarantee or secure his account, the
value attributable to such asset for
purposes of this paragraph shall be the
lesser of (A) the value attributable to
such asset pursuant to the margin rules
of the applicable board of trade, or (B)
the market value of such asset after
application of the percentage
deductions specified in paragraph
(a)(2)(ix) of this Appendix B or, where
appropriate, specified in paragraph
(c)(1)(iv), (vi), or (vii) of § 240.18a–1 of
this chapter;
(xi) Deduct for undermargined noncustomer and omnibus commodity
futures accounts the amount of funds
required in each such account to meet
maintenance margin requirements of the
applicable board of trade or, if there are
no such maintenance margin
requirements, clearing organization
margin requirements applicable to such
positions, after application of calls for
margin, or other required deposits
which are outstanding two business
days or less. If there are no such
maintenance margin requirements or
clearing organization margin
requirements, then deduct the amount
of funds required to provide margin
equal to the amount necessary after
application of calls for margin, or other
required deposits outstanding two days
or less to restore original margin when
the original margin has been depleted
by 50 percent or more. Provided, To the
extent a deficit is deducted from net
worth in accordance with paragraph
(a)(2)(ii) of this Appendix B such
amount shall not also be deducted
under this paragraph (a)(2)(xi). In the
event that an owner of a non-customer
or omnibus account has deposited an
asset other than cash to margin,
guarantee or secure his account, the
value attributable to such asset for
purposes of this paragraph shall be the
lesser of (A) the value attributable to
such asset pursuant to the margin rules
of the applicable board of trade, or (B)
the market value of such asset after
application of the percentage
deductions specified in paragraph
(a)(2)(ix) of this Appendix B or, where
appropriate, specified in paragraph
(c)(1)(iv), (vi), or (vii) of § 240.18a–1 of
this chapter;
(xii) In the case of open futures
contracts and granted (sold) commodity
options held in proprietary accounts
carried by the security-based swap

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dealer which are not covered by a
position held by the security-based
swap dealer or which are not the result
of a ‘‘changer trade’’ made in
accordance with the rules of a contract
market, deduct:
(A) For a security-based swap dealer
which is a clearing member of a contract
market for the positions on such
contract market cleared by such
member, the applicable margin
requirement of the applicable clearing
organization; (B) For a security-based
swap dealer which is a member of a selfregulatory organization, 150% of the
applicable maintenance margin
requirement of the applicable board of
trade or clearing organization,
whichever is greater; or
(C) For all other security-based swap
dealers, 200% of the applicable
maintenance margin requirement of the
applicable board of trade or clearing
organization, whichever is greater; or
(D) For open contracts or granted
(sold) commodity options for which
there are no applicable maintenance
margin requirements, 200% of the
applicable initial margin requirement;
Provided, the equity in any such
proprietary account shall reduce the
deduction required by this paragraph
(a)(2)(xii) if such equity is not otherwise
includable in net capital.
(xiii) In the case of a security-based
swap dealer which is a purchaser of a
commodity option which is traded on a
contract market, the deduction shall be
the same safety factor as if the securitybased swap dealer were the grantor of
such option in accordance with
paragraph (a)(2)(xii), but in no event
shall the safety factor be greater than the
market value attributed to such option.
(xiv) In the case of a security-based
swap dealer which is a purchaser of a
commodity option not traded on a
contract market which has value and
such value is used to increase net
capital, the deduction is ten percent of
the market value of the physical or
futures contract which is the subject of
such option but in no event more than
the value attributed to such option.
(xv) A loan or advance or any other
form of receivable shall not be
considered ‘‘secured’’ for the purposes
of paragraph (a)(2) of this Appendix B
unless the following conditions exist:
(A) The receivable is secured by
readily marketable collateral which is
otherwise unencumbered and which
can be readily converted into cash:
Provided, however, That the receivable
will be considered secured only to the
extent of the market value of such
collateral after application of the
percentage deductions specified in

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(xvii) The term customer for purposes
of this Appendix B shall mean customer
as defined in 17 CFR 1.17(b)(2). The
term non-customer for purposes of this
Appendix B shall mean non-customer as
defined in 17 CFR 1.17(b)(4).
(b) Every registered security-based
swap dealer in computing net capital
pursuant to § 240.18a–1 shall comply
with the following:
(1) Swaps. Where a swap-related asset
or liability is specifically treated or
defined in 17 CFR 1.17 and is not
generally or specifically treated or
defined in § 240.15c3–1 or this

paragraph (a)(2)(ix) of this Appendix B;
and
(B)(1) The readily marketable
collateral is in the possession or control
of the security-based swap dealer; or
(2) The security-based swap dealer
has a legally enforceable, written
security agreement, signed by the
debtor, and has a perfected security
interest in the readily marketable
collateral within the meaning of the
laws of the State in which the readily
marketable collateral is located.
(xvi) The term cover for purposes of
this Appendix B shall mean cover as
defined in 17 CFR 1.17(j).

70345

Appendix B, the inclusion or exclusion
of all or part of such asset or liability for
net capital shall be in accordance with
17 CFR 1.17.
(i) Credit default swaps referencing
broad-based securities indices. (A) Short
positions (selling protection). In the case
of a swap that is a short credit default
swap referencing a broad-based
securities index, deducting the
percentage of the notional amount based
upon the current basis point spread of
the credit default swap and the maturity
of the credit default swap in accordance
with the following table:

Basis point spread
Length of time to maturity of
CDS contract

100 or less
(%)

emcdonald on DSK7TPTVN1PROD with PROPOSALS2

12 months or less ....................................
13 months to 24 months ..........................
25 months to 36 months ..........................
37 months to 48 months ..........................
49 months to 60 months ..........................
61 months to 72 months ..........................
73 months to 84 months ..........................
85 months to 120 months ........................
121 months and longer ............................

0.67
1.00
1.33
2.00
2.67
3.67
4.67
5.67
6.67

(B) Long positions (purchasing
protection). In the case of a swap that is
a long credit default swap referencing a
broad-based securities index, deducting
50% of the deduction that would be
required by paragraph (b)(1)(i)(A) of this
Appendix B if the swap was a short
credit default swap.
(C) Long and short positions. (1) Long
and short credit default swaps. In the
case of swaps that are long and short
credit default swaps referencing the
same obligor or obligation, that are in
the same spread category, and that are
in the same maturity category or are in
the next maturity category and have a
maturity date within three months of
the other maturity category, deducting
the percentage of the notional amount
specified in the higher maturity category
under paragraph (b)(1)(i)(A) of this
Appendix B on the excess of the long or
short position.
(2) Long basket of obligors and long
credit default swap. In the case of a
swap that is a long credit default swap
referencing a broad-based securities
index and the security-based swap
dealer is long a basket on the same
underlying obligors, deducting 50% of
the amount specified in § 240.15c3–
1(c)(2)(vi) for the components of the
basket, provided the security-based
swap dealer can deliver the components
of the basket to satisfy the obligation of
the security-based swap dealer on the
credit default swap.

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101–300
(%)

301–400
(%)

1.33
2.33
3.33
4.00
4.67
5.67
6.67
10.00
13.33

3.33
5.00
6.67
8.33
10.00
11.67
13.33
15.00
16.67

(3) Short basket of obligors and short
credit default swap. In the case of a
swap that is a short credit default swap
referencing a broad-based securities
index and the security-based swap
dealer is short a basket on the same
underlying obligors, deducting the
amount specified in § 240.15c3–
1(c)(2)(vi) for the components of the
basket.
(2) All other swaps. (i) In the case of
any swap that is not a credit default
swap, deducting the amount calculated
by multiplying the notional value of the
swap by the percentage specified in:
(A) § 240.15c3–1 applicable to the
reference asset if § 240.15c3–1 specifies
a percentage deduction for the type of
asset;
(B) 17 CFR 1.17 applicable to the
reference asset if 17 CFR 1.17 specifies
a percentage deduction for the type of
asset and § 240.15c3–1 does not specify
a percentage deduction for the type of
asset; or
(C) In the case of an interest rate
swap, § 240.15c3–1(c)(2)(vi)(A) based on
the maturity of the swap, provided that
the percentage deduction must be no
less than 1%.
(ii) A security-based swap dealer may
reduce the deduction under this
paragraph (b)(2)(ii) by an amount equal
to any reduction recognized for a
comparable long or short position in the
reference asset or interest rate under 17
CFR 1.17 or § 240.15c3–1.

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401–500
(%)
5.00
6.67
8.33
10.00
11.67
13.33
15.00
16.67
18.33

501–699
(%)
6.67
8.33
10.00
11.67
13.33
15.00
16.67
18.33
20.00

700 or more
(%)
10.00
11.67
13.33
15.00
16.67
18.33
20.00
26.67
33.33

11. Section 240.18a–1c is added to
read as follows:
§ 240.18a–1c Consolidated Computations
of Net Capital for Certain Subsidiaries and
Affiliates of Security-Based Swap Dealers
(Appendix C to 17 CFR 240.18a–1).

Every security-based swap dealer in
computing its net capital pursuant to
§ 240.18a–1 shall include in its
computation all liabilities or obligations
of a subsidiary or affiliate that the
security-based swap dealer guarantees,
endorses, or assumes either directly or
indirectly.
12. Section 240.18a–1d is added to
read as follows:
§ 240.18a–1d Satisfactory Subordinated
Loan Agreements (Appendix D to 17 CFR
240.18a–1).

(a) Introduction. (1) This Appendix
sets forth minimum and non-exclusive
requirements for satisfactory
subordinated loan agreements. The
Commission may require or the
security-based swap dealer may include
such other provisions as deemed
necessary or appropriate to the extent
such provisions do not cause the
subordinated loan agreement to fail to
meet the minimum requirements of this
Appendix D.
(2) Certain definitions. For purposes
of § 240.18a–1 and this Appendix D:
(i) The term ‘‘subordinated loan
agreement’’ shall mean the agreement or

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agreements evidencing or governing a
subordinated borrowing of cash.
(ii) The term ‘‘Payment Obligation’’
shall mean the obligation of a securitybased swap dealer to repay cash loaned
to the security-based swap dealer
pursuant to a subordinated loan
agreement and ‘‘Payment’’ shall mean
the performance by a security-based
swap dealer of a Payment Obligation.
(iii) The term ‘‘lender’’ shall mean the
person who lends cash to a securitybased swap dealer pursuant to a
subordinated loan agreement.
(b) Minimum requirements for
subordinated loan agreements. (1)
Subject to paragraph (a) of this section,
a subordinated loan agreement shall
mean a written agreement between the
security-based swap dealer and the
lender, which has a minimum term of
one year, and is a valid and binding
obligation enforceable in accordance
with its terms (subject as to enforcement
to applicable bankruptcy, insolvency,
reorganization, moratorium and other
similar laws) against the security-based
swap dealer and the lender and their
respective heirs, executors,
administrators, successors and assigns.
(2) Specific amount. All subordinated
loan agreements shall be for a specific
dollar amount which shall not be
reduced for the duration of the
agreement except by installments as
specifically provided for therein and
except as otherwise provided in this
Appendix D.
(3) Effective subordination. The
subordinated loan agreement shall
effectively subordinate any right of the
lender to receive any Payment with
respect thereto, together with accrued
interest or compensation, to the prior
payment or provision for payment in
full of all claims of all present and
future creditors of the security-based
swap dealer arising out of any matter
occurring prior to the date on which the
related Payment Obligation matures
consistent with the provisions of
§ 240.18a–1 and § 240.18a–1d, except
for claims which are the subject of
subordinated loan agreements that rank
on the same priority as or junior to the
claim of the lender under such
subordinated loan agreements.
(4) Proceeds of subordinated loan
agreements. The subordinated loan
agreement shall provide that the cash
proceeds thereof shall be used and dealt
with by the security-based swap dealer
as part of its capital and shall be subject
to the risks of the business.
(5) Certain rights of the security-based
swap dealer. The subordinated loan
agreement shall provide that the
security-based swap dealer shall have
the right to deposit any cash proceeds

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of a subordinated loan agreement in an
account or accounts in its own name in
any bank or trust company;
(6) Permissive prepayments. A
security-based swap dealer at its option
but not at the option of the lender may,
if the subordinated loan agreement so
provides, make a Payment of all or any
portion of the Payment Obligation
thereunder prior to the scheduled
maturity date of such Payment
Obligation (hereinafter referred to as a
‘‘Prepayment’’), but in no event may any
Prepayment be made before the
expiration of one year from the date
such subordinated loan agreement
became effective. No Prepayment shall
be made, if, after giving effect thereto
(and to all Payments of Payment
Obligations under any other
subordinated loan agreements then
outstanding the maturity or accelerated
maturities of which are scheduled to fall
due within six months after the date
such Prepayment is to occur pursuant to
this provision or on or prior to the date
on which the Payment Obligation in
respect of such Prepayment is
scheduled to mature disregarding this
provision, whichever date is earlier)
without reference to any projected profit
or loss of the security-based swap
dealer, either its net capital would fall
below $24 million, its net capital would
fall below 10% of the risk margin
amount under § 240.18a–1, or, if the
security-based swap dealer is approved
to calculate net capital under § 240.18a–
1(d), its tentative net capital would fall
to an amount below $120 million.
Notwithstanding the above, no
Prepayment shall occur without the
prior written approval of the
Commission.
(7) Suspended repayment. The
Payment Obligation of the securitybased swap dealer in respect of any
subordinated loan agreement shall be
suspended and shall not mature if, after
giving effect to Payment of such
Payment Obligation (and to all
Payments of Payment Obligations of
such security-based swap dealer under
any other subordinated loan
agreement(s) then outstanding that are
scheduled to mature on or before such
Payment Obligation) either its net
capital would fall below $24 million, its
net capital would fall below 10% of the
risk margin amount under § 240.18a–1,
or, if the security-based swap dealer is
approved to calculate net capital under
§ 240.18a–1(d), its tentative net capital
would fall to an amount below $120
million. The subordinated loan
agreement may provide that if the
Payment Obligation of the securitybased swap dealer thereunder does not
mature and is suspended as a result of

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the requirement of this paragraph (b)(7)
for a period of not less than six months,
the security-based swap dealer shall
thereupon commence the rapid and
orderly liquidation of its business, but
the right of the lender to receive
Payment, together with accrued interest
or compensation, shall remain
subordinate as required by the
provisions of § 240.18a–1 and
§ 240.18a–1d.
(8) Accelerated maturity—obligation
to repay to remain subordinate. (i)
Subject to the provisions of paragraph
(b)(7) of this appendix, a subordinated
loan agreement may provide that the
lender may, upon prior written notice to
the security-based swap dealer and the
Commission given not earlier than six
months after the effective date of such
subordinated loan agreement, accelerate
the date on which the Payment
Obligation of the security-based swap
dealer, together with accrued interest or
compensation, is scheduled to mature to
a date not earlier than six months after
the giving of such notice, but the right
of the lender to receive Payment,
together with accrued interest or
compensation, shall remain subordinate
as required by the provisions of
§§ 240.18a–1 and 240.18a–1d.
(ii) Notwithstanding the provisions of
paragraph (b)(7) of this appendix, the
Payment Obligation of the securitybased swap dealer with respect to a
subordinated loan agreement, together
with accrued interest and
compensation, shall mature in the event
of any receivership, insolvency,
liquidation, bankruptcy, assignment for
the benefit of creditors, reorganization
whether or not pursuant to the
bankruptcy laws, or any other
marshalling of the assets and liabilities
of the security-based swap dealer but
the right of the lender to receive
Payment, together with accrued interest
or compensation, shall remain
subordinate as required by the
provisions of § 240.18a–1 and
§ 240.18a–1d.
(9) Accelerated maturity of
subordinated loan agreements on event
of default and event of acceleration—
obligation to repay to remain
subordinate. (i) A subordinated loan
agreement may provide that the lender
may, upon prior written notice to the
security-based swap dealer and the
Commission of the occurrence of any
Event of Acceleration (as hereinafter
defined) given no sooner than six
months after the effective date of such
subordinated loan agreement, accelerate
the date on which the Payment
Obligation of the security-based swap
dealer, together with accrued interest or
compensation, is scheduled to mature,

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
to the last business day of a calendar
month which is not less than six months
after notice of acceleration is received
by the security-based swap dealer and
the Commission. Any subordinated loan
agreement containing such Events of
Acceleration may also provide, that if
upon such accelerated maturity date the
Payment Obligation of the securitybased swap dealer is suspended as
required by paragraph (b)(7) of this
Appendix D and liquidation of the
security-based swap dealer has not
commenced on or prior to such
accelerated maturity date, then
notwithstanding paragraph (b)(7) of this
appendix the Payment Obligation of the
security-based swap dealer with respect
to such subordinated loan agreement
shall mature on the day immediately
following such accelerated maturity
date and in any such event the Payment
Obligations of the security-based swap
dealer with respect to all other
subordinated loan agreements then
outstanding shall also mature at the
same time but the rights of the
respective lenders to receive Payment,
together with accrued interest or
compensation, shall remain subordinate
as required by the provisions of this
Appendix D. Events of Acceleration
which may be included in a
subordinated loan agreement complying
with this paragraph (b)(9) shall be
limited to:
(A) Failure to pay interest or any
installment of principal on a
subordinated loan agreement as
scheduled;
(B) Failure to pay when due other
money obligations of a specified
material amount;
(C) Discovery that any material,
specified representation or warranty of
the security-based swap dealer which is
included in the subordinated loan
agreement and on which the
subordinated loan agreement was based
or continued was inaccurate in a
material respect at the time made;
(D) Any specified and clearly
measurable event which is included in
the subordinated loan agreement and
which the lender and the security-based
swap dealer agree:
(1) Is a significant indication that the
financial position of the security-based
swap dealer has changed materially and
adversely from agreed upon specified
norms; or
(2) Could materially and adversely
affect the ability of the security-based
swap dealer to conduct its business as
conducted on the date the subordinated
loan agreement was made; or
(3) Is a significant change in the
senior management of the securitybased swap dealer or in the general

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business conducted by the securitybased swap dealer from that which
obtained on the date the subordinated
loan agreement became effective;
(E) Any continued failure to perform
agreed covenants included in the
subordinated loan agreement relating to
the conduct of the business of the
security-based swap dealer or relating to
the maintenance and reporting of its
financial position; and
(ii) Notwithstanding the provisions of
paragraph (b)(7) of this appendix, a
subordinated loan agreement may
provide that, if liquidation of the
business of the security-based swap
dealer has not already commenced, the
Payment Obligation of the securitybased swap dealer shall mature, together
with accrued interest or compensation,
upon the occurrence of an Event of
Default (as hereinafter defined). Such
agreement may also provide that, if
liquidation of the business of the
security-based swap dealer has not
already commenced, the rapid and
orderly liquidation of the business of
the security-based swap dealer shall
then commence upon the happening of
an Event of Default. Any subordinated
loan agreement which so provides for
maturity of the Payment Obligation
upon the occurrence of an Event of
Default shall also provide that the date
on which such Event of Default occurs
shall, if liquidation of the security-based
swap dealer has not already
commenced, be the date on which the
Payment Obligations of the securitybased swap dealer with respect to all
other subordinated loan agreements
then outstanding shall mature but the
rights of the respective lenders to
receive Payment, together with accrued
interest or compensation, shall remain
subordinate as required by the
provisions of this Appendix (D). Events
of Default which may be included in a
subordinated loan agreement shall be
limited to:
(A) The net capital of the securitybased swap dealer falling to an amount
below either of $20 million or 8% of the
risk margin amount under § 240.18a–1,
or, if the security-based swap dealer is
approved to calculate net capital under
§ 240.18a–1(d), its tentative net capital
falling below $100 million, throughout
a period of 15 consecutive business
days, commencing on the day the
security-based swap dealer first
determines and notifies the
Commission, or the Commission first
determines and notifies the securitybased swap dealer of such fact;
(B) The Commission revoking the
registration of the security-based swap
dealer;

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70347

(C) The Commission suspending (and
not reinstating within 10 days) the
registration of the security-based swap
dealer;
(D) Any receivership, insolvency,
liquidation, bankruptcy, assignment for
the benefit of creditors, reorganization
whether or not pursuant to bankruptcy
laws, or any other marshalling of the
assets and liabilities of the securitybased swap dealer. A subordinated loan
agreement that contains any of the
provisions permitted by this paragraph
(b)(9) shall not contain the provision
otherwise permitted by paragraph
(b)(8)(i) of this section.
(c) Miscellaneous provisions. (1)
Prohibited cancellation. The
subordinated loan agreement shall not
be subject to cancellation by either
party; no Payment shall be made with
respect thereto and the agreement shall
not be terminated, rescinded or
modified by mutual consent or
otherwise if the effect thereof would be
inconsistent with the requirements of
§§ 240.18a–1 and 240.18a–1d.
(2) Every security-based swap dealer
shall immediately notify the
Commission if, after giving effect to all
Payments of Payment Obligations under
subordinated loan agreements then
outstanding that are then due or mature
within the following six months without
reference to any projected profit or loss
of the security-based swap dealer, either
its net capital would fall below $24
million, its net capital would fall below
10% of the risk margin amount under
§ 240.18a–1, or, if the security-based
swap dealer is approved to calculate net
capital under § 240.18a–1(d), its
tentative net capital would fall to an
amount below $120 million.
(3) Certain legends. If all the
provisions of a satisfactory subordinated
loan agreement do not appear in a single
instrument, then the debenture or other
evidence of indebtedness shall bear on
its face an appropriate legend stating
that it is issued subject to the provisions
of a satisfactory subordinated loan
agreement which shall be adequately
referred to and incorporated by
reference.
(4) Revolving subordinated loan
agreements. A security-based swap
dealer shall be permitted to enter into a
revolving subordinated loan agreement
that provides for prepayment within
less than one year of all or any portion
of the Payment Obligation thereunder at
the option of the security-based swap
dealer upon the prior written approval
of the Commission. The Commission,
however, shall not approve any
prepayment if:
(i) After giving effect thereto (and to
all Payments of Payment Obligations

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under any other subordinated loan
agreements then outstanding, the
maturity or accelerated maturities of
which are scheduled to fall due within
six months after the date such
prepayment is to occur pursuant to this
provision or on or prior to the date on
which the Payment Obligation in
respect of such prepayment is
scheduled to mature disregarding this
provision, whichever date is earlier)
without reference to any projected profit
or loss of the security-based swap
dealer, either its net capital would fall
below $24 million, its net capital would
fall below 10% of the risk margin
amount under § 240.18a–1, or, if the
security-based swap dealer is approved
to calculate net capital under § 240.18a–
1(d), its tentative net capital would fall
to an amount below $120 million; or
(ii) Pre-tax losses during the latest
three-month period equaled more than
15% of current excess net capital.
Any subordinated loan agreement
entered into pursuant to this paragraph
(c)(4) shall be subject to all the other
provisions of this Appendix D. Any
such subordinated loan agreement shall
not be considered equity for purposes of
paragraph (h) of § 240.18a–1, despite the
length of the initial term of the loan.
(5) Filing. Two copies of any proposed
subordinated loan agreement (including
nonconforming subordinated loan
agreements) shall be filed at least 30
days prior to the proposed execution
date of the agreement with the
Commission. The security-based swap
dealer shall also file with the
Commission a statement setting forth
the name and address of the lender, the
business relationship of the lender to
the security-based swap dealer, and
whether the security-based swap dealer
carried an account for the lender for
effecting transactions in security-based
swaps at or about the time the proposed
agreement was so filed. All agreements
shall be examined by the Commission
prior to their becoming effective. No
proposed agreement shall be a
satisfactory subordinated loan
agreement for the purposes of this
section unless and until the
Commission has found the agreement
acceptable and such agreement has
become effective in the form found
acceptable.
13. Section 240.18a–2 is added to read
as follows:
§ 240.18a–2 Capital requirements for major
security-based swap participants for which
there is not a prudential regulator.

(a) Every major security-based swap
participant for which there is not a
prudential regulator must at all times

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have and maintain positive tangible net
worth.
(b) The term tangible net worth means
the net worth of the major securitybased swap participant as determined in
accordance with generally accepted
accounting principles in the United
States, excluding goodwill and other
intangible assets. In determining net
worth, all long and short positions in
security-based swaps, swaps, and
related positions must be marked to
their market value. A major securitybased swap participant must include in
its computation of tangible net worth all
liabilities or obligations of a subsidiary
or affiliate that the participant
guarantees, endorses, or assumes either
directly or indirectly.
(c) Every major security-based swap
participant must comply with
§ 240.15c3–4 as though it were an OTC
derivatives dealer with respect to its
security-based swap and swap activities,
except that paragraphs (c)(5)(xiii) and
(xiv) and (d)(8) and (9) of § 240.15c3–4
shall not apply.
14. Section 240.18a–3 is added to read
as follows:
§ 240.18a–3 Non-cleared security-based
swap margin requirements for securitybased swap dealers and major securitybased swap participants for which there is
not a prudential regulator.

(a) Every security-based swap dealer
and major security-based swap
participant for which there is not a
prudential regulator must comply with
this section.
(b) Definitions. For the purposes of
this section:
(1) The term account means an
account carried by a security-based
swap dealer or major security-based
swap participant for a counterparty that
holds non-cleared security-based swaps.
(2) The term commercial end user
means any person (other than a natural
person) that:
(i) Engages primarily in commercial
activities that are not financial in nature
and that is not a financial entity as that
term is defined in 3C(g)(3) of the Act (15
U.S.C. 78o–3(g)(3)); and
(ii) Is using non-cleared securitybased swaps to hedge or mitigate risk
relating to the commercial activities.
(3) The term counterparty means a
person with whom the security-based
swap dealer or major security-based
swap participant has entered into a noncleared security-based swap transaction.
(4) The term equity means the total
current fair market value of securities
positions in an account of a
counterparty (excluding the time value
of an over-the-counter option), plus any
credit balance and less any debit

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balance in the account after applying a
qualifying netting agreement with
respect to gross derivatives payables and
receivables.
(5) The term margin means the
amount of positive equity in an account
of a counterparty.
(6) The term negative equity means
equity of less than $0.
(7) The term positive equity means
equity of greater than $0.
(8) The term non-cleared securitybased swap means a security-based
swap that is not, directly or indirectly,
cleared by a clearing agency registered
pursuant to section 17A of the Act.
(9) The term security-based swap
legacy account means an account that
holds no security-based swaps entered
into after the effective date of this
section and that only is used to hold
security-based swaps entered into prior
to the effective date of this section and
collateral for those security-based
swaps.
(c) Margin requirements. (1) Securitybased swap dealers. (i) Calculation
required. A security-based swap dealer
must calculate with respect to each
account of a counterparty as of the close
of each business day:
(A) The amount of equity in the
account of the counterparty; and
(B) The margin amount for the
account of the counterparty calculated
pursuant to paragraph (d) of this
section.
(ii) Account equity requirements.
Except as provided in paragraph
(c)(1)(iii) of this section, a securitybased swap dealer must collect from a
counterparty by noon of each business
day cash, securities, and/or money
market instruments in an amount at
least equal to, as applicable:
(A) The negative equity in the account
calculated as of the previous business
day; and
(B) The margin amount calculated
under paragraph (c)(1)(i)(B) of this
section as of the previous business day
to the extent that amount is greater than
the amount of positive equity in the
account on the previous business day.
(iii) Exceptions. (A) Commercial end
users. The requirements of paragraph
(c)(1)(ii) of this section do not apply to
an account of a counterparty that is a
commercial end user.
Alternative A to § 240.18a–3(c)(1)(iii)(B)
(B) Security-based swap dealers. The
requirements of paragraph (c)(1)(ii)(B) of
this section do not apply to an account
of a counterparty that is a security-based
swap dealer.
Alternative B to § 240.18a–3(c)(1)(iii)(B)
(B) Security-based swap dealers. Cash,
securities and money market

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instruments posted by a counterparty
that is a security-based swap dealer to
meet the requirements of paragraph
(c)(1)(ii)(B) of this section must be
carried by an independent third-party
custodian pursuant to the requirements
of section 3E(f) of the Act.
(C) Counterparties that require thirdparty custodians. The requirements of
paragraph (c)(1)(ii)(B) of this section do
not apply to an account of a
counterparty that is not a commercial
end user and that requires the cash,
securities, and money market
instruments delivered to meet the
margin amount to be carried by an
independent third-party custodian
pursuant to the requirements of section
3E(f) of the Act, provided cash,
securities, and money market
instruments necessary to meet the
requirements of paragraph (c)(1)(ii)(B) of
this section are delivered to the
independent third-party custodian.
(D) Security-based swap legacy
accounts. The requirements of
paragraph (c)(1)(ii)(B) of this section do
not apply to a legacy security-based
swap account of a counterparty that is
not a commercial end user.
(2) Major security-based swap
participants. (i) Calculation required. A
major security-based swap participant
must calculate as of the close of each
business day the amount of equity in the
account of each counterparty.
(ii) Account equity requirements.
Except as provided in paragraph
(c)(2)(iii) of this section, a major
security-based swap participant must by
noon of each business day:
(A) Collect from a counterparty cash,
securities and/or money market
instruments in an amount equal to the
negative equity in the account
calculated on the previous business day
pursuant to paragraph (c)(2)(i) of this
section; and
(B) Deliver to a counterparty cash,
securities and/or money market
instruments in an amount equal to the
positive equity in the account calculated
on the previous business day pursuant
to paragraph (c)(2)(i) of this section.
(iii) Exceptions. (A) Transactions with
commercial end users. The
requirements of paragraph (c)(2)(ii)(A)
of this section do not apply to a
counterparty that is a commercial end
user.
(B) Transactions with security-based
swap dealers. The requirements of
paragraph (c)(2)(ii)(A) of this section do
not apply to a counterparty that is a
security-based swap dealer.
Note to paragraph (c)(2)(iii)(B): A securitybased swap dealer must collect from a
counterparty that is a major security-based
swap participant cash, securities, and/or

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money market instruments as required by
paragraph (c)(1)(ii) of this section.

(C) Security-based swap legacy
accounts. The requirements of
paragraph (c)(2)(ii) of this section do not
apply to a legacy security-based swap
account of a counterparty that is not a
commercial end user.
(3) Deductions for securities held as
collateral. The fair market value of
securities and money market
instruments held in the account of a
counterparty must be reduced by the
amount of the deductions the securitybased swap dealer would apply to the
securities and money market
instruments pursuant to § 240.15c3–1 or
§ 240.18a–1, as applicable, for the
purpose of determining whether the
level of equity in the account meets the
requirement of paragraph (c)(1)(ii) of
this section.
(4) Collateral requirements. A
security-based swap dealer and a major
security-based swap participant when
calculating the amount of equity in the
account of a counterparty may take into
account cash and the fair market value
of securities and money market
instruments pledged and held as
collateral in the account provided:
(i) The collateral is subject to the
physical possession or control of the
security-based swap dealer or the major
security-based swap participant;
(ii) The collateral is liquid and
transferable;
(iii) The collateral may be liquidated
promptly by the security-based swap
dealer or the major security-based swap
participant without intervention by any
other party;
(iv) The collateral agreement between
the security-based swap dealer or the
major security-based swap participant
and the counterparty is legally
enforceable by the security-based swap
dealer or the major security-based swap
participant against the counterparty and
any other parties to the agreement;
(v) The collateral does not consist of
securities issued by the counterparty or
a party related to the security-based
swap dealer, the major security-based
swap participant, or to the counterparty;
and
(vi) If the Commission has approved
the security-based swap dealer’s use of
a VaR model to compute net capital, the
approval allows the security-based swap
dealer to calculate deductions for
market risk for the type of collateral.
(5) Qualified netting agreements. A
security-based swap dealer or major
security-based swap participant may
include the effect of a netting agreement
that allows the security-based swap
dealer or major security-based swap

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70349

participant to net gross receivables from
and gross payables to a counterparty
upon the default of the counterparty, for
the purposes of the calculations
required pursuant to paragraphs
(c)(1)(i)(A) and (c)(2)(i) of this section,
if:
(i) The netting agreement is legally
enforceable in each relevant
jurisdiction, including in insolvency
proceedings;
(ii) The gross receivables and gross
payables that are subject to the netting
agreement with a counterparty can be
determined at any time; and
(iii) For internal risk management
purposes, the security-based swap
dealer or major security-based swap
participant monitors and controls its
exposure to the counterparty on a net
basis.
(6) Minimum transfer amount.
Notwithstanding any other provision of
this rule, a security-based swap dealer
or major security-based swap
participant is not required to collect or
deliver cash, securities or money market
instruments pursuant to this section
with respect to a particular counterparty
unless and until the total amount of
cash, securities or money market
instruments that is required to be
collected or delivered, and has not yet
been collected or delivered, with respect
to the counterparty is greater than
$100,000.
(7) Frequency of calculations
increased. The calculations required
pursuant to paragraphs (c)(1)(i) and
(c)(2)(i) of this section must be made
more frequently than the close of each
business day during periods of extreme
volatility and for accounts with
concentrated positions.
(8) Liquidation. A security-based
swap dealer and major security-based
swap participant must take prompt
steps to liquidate securities and money
market instruments in an account that
does not meet the account equity
requirements of this section to the
extent necessary to eliminate the
account equity deficiency.
(d) Calculating margin amount. A
security-based swap dealer must
calculate the margin amount required by
paragraph (c)(1)(i)(B) of this section for
non-cleared security-based swaps as
follows:
(1) Standardized approach. (i) Credit
default swaps. For credit default swaps,
the security-based swap dealer must use
the method specified in § 240.18a–
1(c)(1)(vi)(A) or, if the security-based
swap dealer is registered with the
Commission as a broker or dealer, the
method specified in § 240.15c3–
1(c)(2)(vi)(O)(1).

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(ii) All other security-based swaps.
For security-based swaps other than
credit default swaps, the security-based
swap dealer must use the method
specified in § 240.18a–1(c)(1)(vi)(B) or,
if the security-based swap dealer is
registered with the Commission as a
broker or dealer, the method specified
in § 240.15c3–1(c)(2)(vi)(O)(2).
(2) Model approach. For securitybased swaps other than equity securitybased swaps, a security-based swap
dealer authorized by the Commission to
compute net capital pursuant to
§ 240.18a–1(d) or § 240.15c3–1e may use
its internal market risk model subject to
the requirements in § 240.18a–1(d) or
§ 240.15c3–1e in lieu of using the
methods required in paragraphs (d)(1)(i)
and (ii) of this section.
(e) Risk monitoring and procedures. A
security-based swap dealer must
monitor the risk of each account and
establish, maintain, and document
procedures and guidelines for
monitoring the risk of accounts as part
of the risk management control system
required by § 240.15c3–4. The securitybased swap dealer must review, in
accordance with written procedures, at
reasonable periodic intervals, its noncleared security-based swap activities
for consistency with the risk monitoring
procedures and guidelines required by
this section. The security-based swap
dealer also must determine whether
information and data necessary to apply
the risk monitoring procedures and
guidelines required by this section are
accessible on a timely basis and whether
information systems are available to
adequately capture, monitor, analyze,
and report relevant data and
information. The risk monitoring
procedures and guidelines must
include, at a minimum, procedures and
guidelines for:
(1) Obtaining and reviewing account
documentation and financial
information necessary for assessing the
amount of current and potential future
exposure to a given counterparty
permitted by the security-based swap
dealer;
(2) Determining, approving, and
periodically reviewing credit limits for
each counterparty, and across all
counterparties;
(3) Monitoring credit risk exposure to
the security-based swap dealer from
non-cleared security-based swaps,
including the type, scope, and
frequency of reporting to senior
management;
(4) Using stress tests to monitor
potential future exposure to a single
counterparty and across all
counterparties over a specified range of

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possible market movements over a
specified time period;
(5) Managing the impact of credit
exposure related to non-cleared
security-based swaps on the securitybased swap dealer’s overall risk
exposure;
(6) Determining the need to collect
collateral from a particular
counterparty, including whether that
determination was based upon the
creditworthiness of the counterparty
and/or the risk of the specific noncleared security-based swap contracts
with the counterparty;
(7) Monitoring the credit exposure
resulting from concentrated positions
with a single counterparty and across all
counterparties, and during periods of
extreme volatility; and
(8) Maintaining sufficient equity in
the account of each counterparty to
protect against the largest individual
potential future exposure of a noncleared security-based swap carried in
the account of the counterparty as
measured by computing the largest
maximum possible loss that could result
from the exposure.
15. Section 240.18a–4 is added to read
as follows:
§ 240.18a–4 Segregation requirements for
security-based swap dealers and major
security-based swap participants.

(a) Definitions. For the purposes of
this section:
(1) The term cleared security-based
swap means any security-based swap
that is, directly or indirectly, submitted
to and cleared by a clearing agency
registered with the Commission
pursuant to section 17A of the Act (15
U.S.C. 78q–1);
(2) The term excess securities
collateral means securities and money
market instruments carried for the
account of a security-based swap
customer that have a market value in
excess of the current exposure of the
security-based swap dealer to the
customer, excluding:
(i) Securities and money market
instruments held in a qualified clearing
agency account but only to the extent
the securities and money market
instruments are being used to meet a
margin requirement of the clearing
agency resulting from a security-based
swap transaction of the customer; and
(ii) Securities and money market
instruments held in a qualified
registered security-based swap dealer
account but only to the extent the
securities and money market
instruments are being used to meet a
margin requirement of the other
security-based swap dealer resulting
from the security-based swap dealer

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entering into a non-cleared securitybased swap transaction with the other
security-based swap dealer to offset the
risk of a non-cleared security-based
swap transaction between the securitybased swap dealer and the customer.
(3) The term qualified clearing agency
account means an account of a securitybased swap dealer at a clearing agency
established to hold funds and other
property in order to purchase, margin,
guarantee, secure, adjust, or settle
cleared security-based swap
transactions for the security-based swap
customers of the security-based swap
dealer that meets the following
conditions:
(i) The account is designated ‘‘Special
Clearing Account for the Exclusive
Benefit of the Cleared Security-Based
Swap Customers of [name of securitybased swap dealer]’’;
(ii) The clearing agency has
acknowledged in a written notice
provided to and retained by the
security-based swap dealer that the
funds and other property in the account
are being held by the clearing agency for
the exclusive benefit of the securitybased swap customers of the securitybased swap dealer in accordance with
the regulations of the Commission and
are being kept separate from any other
accounts maintained by the securitybased swap dealer with the clearing
agency; and
(iii) The account is subject to a
written contract between the securitybased swap dealer and the clearing
agency which provides that the funds
and other property in the account shall
be subject to no right, charge, security
interest, lien, or claim of any kind in
favor of the clearing agency or any
person claiming through the clearing
agency, except a right, charge, security
interest, lien, or claim resulting from a
cleared security-based swap transaction
effected in the account.
(4) The term qualified registered
security-based swap dealer account
means an account at another securitybased swap dealer registered with the
Commission pursuant to section 15F of
the Act that is not an affiliate of the
security-based swap dealer and that
meets the following conditions:
(i) The account is designated ‘‘Special
Account for the Exclusive Benefit of the
Security-Based Swap Customers of
[name of security-based swap dealer]’’;
(ii) The account is subject to a written
acknowledgement by the other securitybased dealer provided to and retained
by the security-based swap dealer that
the funds and other property held in the
account are being held by the other
security-based swap dealer for the
exclusive benefit of the security-based

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swap customers of the security-based
swap dealer in accordance with the
regulations of the Commission and are
being kept separate from any other
accounts maintained by the securitybased swap dealer with the other
security-based swap dealer;
(iii) The account is subject to a
written contract between the securitybased swap dealer and the other
security-based swap dealer which
provides that the funds and other
property in the account shall be subject
to no right, charge, security interest,
lien, or claim of any kind in favor of the
other security-based swap dealer or any
person claiming through the other
security-based swap dealer, except a
right, charge, security interest, lien, or
claim resulting from a non-cleared
security-based swap transaction effected
in the account; and
(iv) The account and the assets in the
account are not subject to any type of
subordination agreement between the
security-based swap dealer and the
other security-based swap dealer.
(5) The term qualified security means:
(i) Obligations of the United States;
(ii) Obligations fully guaranteed as to
principal and interest by the United
States; and
(iii) General obligations of any State
or subdivision of a State that:
(A) Are not traded flat and are not in
default;
(B) Were part of an initial offering of
$500 million or greater; and
(C) Were issued by an issuer that has
published audited financial statements
within 120 days of its most recent fiscal
year-end.
(6) The term security-based swap
customer means any person from whom
or on whose behalf the security-based
swap dealer has received or acquired or
holds funds or other property for the
account of the person with respect to a
cleared or non-cleared security-based
swap transaction. The term does not
include a person to the extent that
person has a claim for funds or other
property which by contract, agreement
or understanding, or by operation of
law, is part of the capital of the securitybased swap dealer or is subordinated to
all claims of security-based swap
customers of the security-based swap
dealer.
(7) The term special account for the
exclusive benefit of security-based swap
customers means an account at a bank
that is not the security-based swap
dealer or an affiliate of the securitybased swap dealer and that meets the
following conditions:
(i) The account is designated ‘‘Special
Account for the Exclusive Benefit of the

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Security-Based Swap Customers of
[name of security-based swap dealer]’’;
(ii) The account is subject to a written
acknowledgement by the bank provided
to and retained by the security-based
swap dealer that the funds and other
property held in the account are being
held by the bank for the exclusive
benefit of the security-based swap
customers of the security-based swap
dealer in accordance with the
regulations of the Commission and are
being kept separate from any other
accounts maintained by the securitybased swap dealer with the bank; and
(iii) The account is subject to a
written contract between the securitybased swap dealer and the bank which
provides that the funds and other
property in the account shall at no time
be used directly or indirectly as security
for a loan or other extension of credit to
the security-based swap dealer by the
bank and, shall be subject to no right,
charge, security interest, lien, or claim
of any kind in favor of the bank or any
person claiming through the bank.
(b) Physical possession or control of
excess securities collateral. (1) A
security-based swap dealer must
promptly obtain and thereafter maintain
physical possession or control of all
excess securities collateral carried for
the accounts of security-based swap
customers.
(2) A security-based swap dealer has
control of excess securities collateral
only if the securities and money market
instruments:
(i) Are represented by one or more
certificates in the custody or control of
a clearing corporation or other
subsidiary organization of either
national securities exchanges, or of a
custodian bank in accordance with a
system for the central handling of
securities complying with the
provisions of §§ 240.8c–1(g) and
240.15c2–1(g) the delivery of which
certificates to the security-based swap
dealer does not require the payment of
money or value, and if the books or
records of the security-based swap
dealer identify the security-based swap
customers entitled to receive specified
quantities or units of the securities so
held for such security-based swap
customers collectively;
(ii) Are the subject of bona fide items
of transfer; provided that securities and
money market instruments shall be
deemed not to be the subject of bona
fide items of transfer if, within 40
calendar days after they have been
transmitted for transfer by the securitybased swap dealer to the issuer or its
transfer agent, new certificates
conforming to the instructions of the
security-based swap dealer have not

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been received by the security-based
swap dealer, the security-based swap
dealer has not received a written
statement by the issuer or its transfer
agent acknowledging the transfer
instructions and the possession of the
securities or money market instruments,
or the security-based swap dealer has
not obtained a revalidation of a window
ticket from a transfer agent with respect
to the certificate delivered for transfer;
(iii) Are in the custody or control of
a bank as defined in section 3(a)(6) of
the Act, the delivery of which securities
or money market instruments to the
security-based swap dealer does not
require the payment of money or value
and the bank having acknowledged in
writing that the securities and money
market instruments in its custody or
control are not subject to any right,
charge, security interest, lien or claim of
any kind in favor of a bank or any
person claiming through the bank;
(iv)(A) Are held in or are in transit
between offices of the security-based
swap dealer; or
(B) Are held by a corporate subsidiary
if the security-based swap dealer owns
and exercises a majority of the voting
rights of all of the voting securities of
such subsidiary, assumes or guarantees
all of the subsidiary’s obligations and
liabilities, operates the subsidiary as a
branch office of the security-based swap
dealer, and assumes full responsibility
for compliance by the subsidiary and all
of its associated persons with the
provisions of the Federal securities laws
as well as for all of the other acts of the
subsidiary and such associated persons;
or
(v) Are held in such other locations as
the Commission shall upon application
from a security-based swap dealer find
and designate to be adequate for the
protection of customer securities.
(3) Each business day the securitybased swap dealer must determine from
its books and records the quantity of
excess securities collateral in its
possession and control as of the close of
the previous business day and the
quantity of excess securities collateral
not in its possession and control as of
the previous business day. If the
security-based swap dealer did not
obtain possession or control of all
excess securities collateral on the
previous business day as required by
this section and there are securities or
money market instruments of the same
issue and class in any of the following
non-control locations:
(i) Securities or money market
instruments subject to a lien securing an
obligation of the security-based swap
dealer, then the security-based swap
dealer, not later than the next business

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day on which the determination is
made, must issue instructions for the
release of the securities or money
market instruments from the lien and
must obtain physical possession or
control of the securities or money
market instruments within two business
days following the date of the
instructions;
(ii) Securities or money market
instruments held in a qualified clearing
agency account, then the security-based
swap dealer, not later than the next
business day on which the
determination is made, must issue
instructions for the release of the
securities or money market instruments
by the clearing agency and must obtain
physical possession or control of the
securities or money market instruments
within two business days following the
date of the instructions;
(iii) Securities or money market
instruments held in a qualified
registered security-based swap dealer
account maintained by another securitybased swap dealer, then the securitybased swap dealer, not later than the
next business day on which the
determination is made, must issue
instructions for the release of the
securities or money market instruments
by the other security-based swap dealer
and must obtain physical possession or
control of the securities or money
market instruments within two business
days following the date of the
instructions;
(iv) Securities or money market
instruments loaned by the securitybased swap dealer, then the securitybased swap dealer, not later than the
next business day on which the
determination is made, must issue
instructions for the return of the loaned
securities or money market instruments
and must obtain physical possession or
control of the securities or money
market instruments within five business
days following the date of the
instructions;
(v) Securities or money market
instruments failed to receive more than
30 calendar days, then the securitybased swap dealer, not later than the
next business day on which the
determination is made, must take
prompt steps to obtain physical
possession or control of the securities or
money market instruments through a
buy-in procedure or otherwise;
(vi) Securities or money market
instruments receivable by the securitybased swap dealer as a security
dividend, stock split or similar
distribution for more than 45 calendar
days, then the security-based swap
dealer, not later than the next business
day on which the determination is

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made, must take prompt steps to obtain
physical possession or control of the
securities or money market instruments
through a buy-in procedure or
otherwise; or
(vii) Securities or money market
instruments included on the books or
records of the security-based swap
dealer as a proprietary short position or
as a short position for another person
more than 10 business days (or more
than 30 calendar days if the securitybased swap dealer is a market maker in
the securities), then the security-based
swap dealer must, not later than the
business day following the day on
which the determination is made, take
prompt steps to obtain physical
possession or control of such securities
or money market instruments.
(c) Deposit requirement for special
account for the exclusive benefit of
security-based swap customers. (1) A
security-based swap dealer must
maintain a special account for the
exclusive benefit of security-based swap
customers that is separate from any
other bank account of the security-based
swap dealer. The security-based swap
dealer must at all times maintain in the
special account for the exclusive benefit
of security-based swap customers,
through deposits into the account, cash
and/or qualified securities in amounts
computed in accordance with the
formula set forth in § 240.18a–4a. In
determining the amount maintained in
a special account for the exclusive
benefit of security-based swap
customers, the security-based swap
dealer must deduct:
(i) The percentage of the value of a
general obligation of a State or
subdivision of a State specified in
§ 240.15c3–1(c)(2)(vi);
(ii) The aggregate value of general
obligations of a State or subdivision of
a State to the extent the amount of the
obligations of a single issuer exceeds
2% of the amount required to be
maintained in the special account for
the exclusive benefit of security-based
swap customers;
(iii) The aggregate value of all general
obligations of a State or subdivision of
a State to the extent the amount of the
obligations exceeds 10% of the amount
required to be maintained in the special
account for the exclusive benefit of
security-based swap customers; and
(iv) The amount of funds held at a
single bank to the extent the amount
exceeds 10% of the equity capital of the
bank as reported by the bank in its most
recent Consolidated Reports of
Condition and Income.
(2) It is unlawful for a security-based
swap dealer to accept or use credits
identified in the items of the formula set

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forth in § 240.18a–4a except to establish
debits for the specified purposes in the
items of the formula.
(3) The computations necessary to
determine the amount required to be
maintained in the special account for
the exclusive benefit of security-based
swap customers must be made daily as
of the close of the previous business day
and any deposit required to be made
into the account must be made on the
next business day following the
computation no later than 1 hour after
the opening of the bank that maintains
the account. The security-based swap
dealer may make a withdrawal from the
special account for the exclusive benefit
of security-based swap customers only if
the amount remaining in the account
after the withdrawal is equal to or
exceeds the amount required to be
maintained in the account pursuant to
paragraph (c)(1) of this section.
(4) A security-based swap dealer must
promptly deposit into a special account
for the exclusive benefit of securitybased swap customers funds or
qualified securities of the security-based
swap dealer if the amount of funds and/
or qualified securities in one or more
special accounts for the exclusive
benefit of security-based swap
customers falls below the amount
required to be maintained pursuant to
this section.
(d) Requirements for non-cleared
security-based swaps. (1) Notice. A
security-based dealer and a major
security-based swap participant must
provide the notice required pursuant to
section 3E(f)(1)(A) of the Act (15 U.S.C.
78c–5(f)) to a counterparty in writing
prior to the execution of the first noncleared security-based swap transaction
with the counterparty occurring after
the effective date of this section.
(2) Subordination. (i) Counterparty
that elects to have individual
segregation at an independent thirdparty custodian. A security-based swap
dealer must obtain an agreement from a
counterparty that chooses to require
segregation of funds or other property
pursuant to section 3E(f) of the Act (15
U.S.C. 78c–5(f)) in which the
counterparty agrees to subordinate all of
its claims against the security-based
swap dealer to the claims of securitybased swap customers of the securitybased swap dealer but only to the extent
that funds or other property provided by
the counterparty to the independent
third-party custodian are not treated as
customer property as that term is
defined in 11 U.S.C. 741 in a liquidation
of the security-based swap dealer.
(ii) Counterparty that elects to have
no segregation. A security-based swap
dealer must obtain an agreement from a

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Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Proposed Rules
counterparty that does not choose to
require segregation of funds or other
property pursuant to section 3E(f) of the
Act (15 U.S.C. 78c–5(f)) or paragraph

(c)(3) of this section in which the
counterparty agrees to subordinate all of
its claims against the security-based
swap dealer to the claims of security-

70353

based swap customers of the securitybased swap dealer.
16. Section 240.18a–4a is added to
read as follows:

RULE 18A–4A—FORMULA FOR DETERMINING THE AMOUNT TO BE MAINTAINED IN THE SPECIAL ACCOUNT FOR THE
EXCLUSIVE BENEFIT OF SECURITY-BASED SWAP CUSTOMERS
Credits
Free credit balances and other credit balances in the accounts carried for security-based swap customers ..............
Monies borrowed collateralized by securities in accounts carried for security-based swap customers ........................
Monies payable against security-based swap customers’ securities loaned .................................................................
Security-based swap customers’ securities failed to receive .........................................................................................
Credit balances in firm accounts which are attributable to principal sales to security-based swap customers ............
Market value of stock dividends, stock splits and similar distributions receivable outstanding over 30 calendar days
Market value of short security count differences over 30 calendar days old .................................................................
Market value of short securities and credits (not to be offset by longs or by debits) in all suspense accounts over
30 calendar days.
9. Market value of securities which are in transfer in excess of 40 calendar days and have not been confirmed to be
in transfer by the transfer agent or the issuer during the 40 days.
10. Debit balances in accounts carried for security-based swap customers, excluding unsecured accounts and accounts doubtful of collection.
11. Securities borrowed to effectuate short sales by security-based swap customers and securities borrowed to make
delivery on security-based swap customers’ securities failed to deliver.
12. Failed to deliver of security-based swap customers’ securities not older than 30 calendar days ...............................
13. Margin required and on deposit with the Options Clearing Corporation for all option contracts written or purchased
in accounts carried for security-based swap customers.
14. Margin related to security future products written, purchased or sold in accounts carried for security-based swap
customers required and on deposit in a qualified clearing agency account at a clearing agency registered with the
Commission under section 17A of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with
the Commodity Futures Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1).
15. Margin related to cleared security-based swap transactions in accounts carried for security-based swap customers
required and on deposit in a qualified clearing agency account at a clearing agency registered with the Commission
pursuant to section 17A of the Act (15 U.S.C. 78q–1).
16. Margin related to non-cleared security-based swap transactions in accounts carried for security-based swap customers required and held in a qualified registered security-based swap dealer account at another security-based
swap dealer.
Total Credits .................................................................................................................................................................
Total Debits ..................................................................................................................................................................
Excess of Credits over Debits ......................................................................................................................................

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1.
2.
3.
4.
5.
6.
7.
8.

Note A. Item 1 shall include all
outstanding drafts payable to security-based
swap customers which have been applied
against free credit balances or other credit
balances and shall also include checks drawn
in excess of bank balances per the records of
the security-based swap dealer.
Note B. Item 2 shall include the amount of
options-related or security futures productrelated Letters of Credit obtained by a
member of a registered clearing agency or a
derivatives clearing organization which are
collateralized by security-based swap
customers’ securities, to the extent of the
member’s margin requirement at the
registered clearing agency or derivatives
clearing organization.
Note C. Item 3 shall include in addition to
monies payable against security-based swap
customer’s securities loaned the amount by
which the market value of securities loaned
exceeds the collateral value received from the
lending of such securities.
Note D. Item 4 shall include in addition to
security-based swap customers’ securities
failed to receive the amount by which the
market value of securities failed to receive
and outstanding more than thirty (30)
calendar days exceeds their contract value.
Note E. (1) Debit balances in accounts shall
be reduced by the amount by which a
specific security (other than an exempted

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security) which is collateral for margin
requirements exceeds in aggregate value 15
percent of the aggregate value of all securities
which collateralize all accounts receivable;
provided, however, the required reduction
shall not be in excess of the amount of the
debit balance required to be excluded
because of this concentration rule. A
specified security is deemed to be collateral
for an account only to the extent it is not an
excess margin security.
(2) Debit balances in special omnibus
accounts, maintained in compliance with the
requirements of section 4(b) of Regulation T
under the Act (12 CFR 220.4(b)) or similar
accounts carried on behalf of another
security-based swap dealer, shall be reduced
by any deficits in such accounts (or if a
credit, such credit shall be increased) less
any calls for margin, marks to the market, or
other required deposits which are
outstanding 5 business days or less.
(3) Debit balances in security-based swap
customers’ accounts included in the formula
under item 10 shall be reduced by an amount
equal to 1 percent of their aggregate value.
(4) Debit balances in accounts of household
members and other persons related to
principals of a security-based swap dealer
and debit balances in cash and margin
accounts of affiliated persons of a securitybased swap dealer shall be excluded from the

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Debits

$llll
$llll
$llll
$llll
$llll
$llll
$llll
$llll
$llll
..................

$llll

..................

$llll

..................
..................

$llll
$llll

..................

$llll

..................

$llll

..................

$llll

$llll
..................
$llll

$llll

Reserve Formula, unless the security-based
swap dealer can demonstrate that such debit
balances are directly related to credit items
in the formula.
(5) Debit balances in accounts (other than
omnibus accounts) shall be reduced by the
amount by which any single security-based
swap customer’s debit balance exceeds 25%
(to the extent such amount is greater than
$50,000) of the broker-dealer’s tentative net
capital (i.e., net capital prior to securities
haircuts) unless the security-based swap
dealer can demonstrate that the debit balance
is directly related to credit items in the
Reserve Formula. Related accounts (e.g., the
separate accounts of an individual, accounts
under common control or subject to cross
guarantees) shall be deemed to be a single
security-based swap customer’s accounts for
purposes of this provision.
If the Commission is satisfied, after taking
into account the circumstances of the
concentrated account including the quality,
diversity, and marketability of the collateral
securing the debit balances in accounts
subject to this provision, that the
concentration of debit balances is
appropriate, then the Commission may, by
order, grant a partial or plenary exception
from this provision.
The debit balance may be included in the
reserve formula computation for five

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emcdonald on DSK7TPTVN1PROD with PROPOSALS2

business days from the day the request is
made.
(6) Debit balances of joint accounts,
custodian accounts, participations in hedge
funds or limited partnerships or similar type
accounts or arrangements of a person who
would be excluded from the definition of
security-based swap customer (‘‘nonsecurity-based swap customer’’) which
persons includible in the definition of
security-based swap customer shall be
included in the Reserve Formula in the
following manner: if the percentage
ownership of the non-security-based swap
customer is less than 5 percent then the
entire debit balance shall be included in the
formula; if such percentage ownership is
between 5 percent and 50 percent then the
portion of the debit balance attributable to
the non-security-based swap customer shall
be excluded from the formula unless the
security-based swap dealer can demonstrate
that the debit balance is directly related to
credit items in the formula; if such
percentage ownership is greater than 50
percent, then the entire debit balance shall be
excluded from the formula unless the
security-based swap dealer can demonstrate
that the debit balance is directly related to
credit items in the formula.
Note F. Item 13 shall include the amount
of margin required and on deposit with
Options Clearing Corporation to the extent
such margin is represented by cash,
proprietary qualified securities, and letters of
credit collateralized by security-based swap
customers’ securities.
Note G. (a) Item 14 shall include the
amount of margin required and on deposit
with a clearing agency registered with the
Commission under section 17A of the Act (15
U.S.C. 78q–1) or a derivatives clearing
organization registered with the Commodity
Futures Trading Commission under section
5b of the Commodity Exchange Act (7 U.S.C.
7a–1) for security-based swap customer
accounts to the extent that the margin is
represented by cash, proprietary qualified
securities, and letters of credit collateralized
by security-based swap customers’ securities.
(b) Item 14 shall apply only if the securitybased swap dealer has the margin related to
security futures products on deposit with:
(1) A registered clearing agency or
derivatives clearing organization that:
(i) Maintains security deposits from
clearing members in connection with
regulated options or futures transactions and

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assessment power over member firms that
equal a combined total of at least $2 billion,
at least $500 million of which must be in the
form of security deposits. For purposes of
this Note G, the term ‘‘security deposits’’
refers to a general fund, other than margin
deposits or their equivalent, that consists of
cash or securities held by a registered
clearing agency or derivative clearing
organization;
(ii) Maintains at least $3 billion in margin
deposits; or
(iii) Does not meet the requirements of
paragraphs (b)(1)(i) through (b)(1)(ii) of this
Note G, if the Commission has determined,
upon a written request for exemption by or
for the benefit of the security-based swap
dealer, that the security-based swap dealer
may utilize such a registered clearing agency
or derivatives clearing organization. The
Commission may, in its sole discretion, grant
such an exemption subject to such conditions
as are appropriate under the circumstances,
if the Commission determines that such
conditional or unconditional exemption is
necessary or appropriate in the public
interest, and is consistent with the protection
of investors; and
(2) A registered clearing agency or
derivatives clearing organization that, if it
holds funds or securities deposited as margin
for security futures products in a bank, as
defined in section 3(a)(6) of the Act (15
U.S.C. 78c(a)(6)), obtains and preserves
written notification from the bank at which
it holds such funds and securities or at which
such funds and securities are held on its
behalf. The written notification shall state
that all funds and/or securities deposited
with the bank as margin (including securitybased swap customer security futures
products margin), or held by the bank and
pledged to such registered clearing agency or
derivatives clearing agency as margin, are
being held by the bank for the exclusive
benefit of clearing members of the registered
clearing agency or derivatives clearing
organization (subject to the interest of such
registered clearing agency or derivatives
clearing organization therein), and are being
kept separate from any other accounts
maintained by the registered clearing agency
or derivatives clearing organization with the
bank. The written notification also shall
provide that such funds and/or securities
shall at no time be used directly or indirectly
as security for a loan to the registered
clearing agency or derivatives clearing

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organization by the bank, and shall be subject
to no right, charge, security interest, lien, or
claim of any kind in favor of the bank or any
person claiming through the bank. This
provision, however, shall not prohibit a
registered clearing agency or derivatives
clearing organization from pledging securitybased swap customer funds or securities as
collateral to a bank for any purpose that the
rules of the Commission or the registered
clearing agency or derivatives clearing
organization otherwise permit; and
(3) A registered clearing agency or
derivatives clearing organization that
establishes, documents, and maintains:
(i) Safeguards in the handling, transfer, and
delivery of cash and securities;
(ii) Fidelity bond coverage for its
employees and agents who handle securitybased swap customer funds or securities. In
the case of agents of a registered clearing
agency or derivatives clearing organization,
the agent may provide the fidelity bond
coverage; and
(iii) Provisions for periodic examination by
independent public accountants; and
(4) A derivatives clearing organization that,
if it is not otherwise registered with the
Commission, has provided the Commission
with a written undertaking, in a form
acceptable to the Commission, executed by a
duly authorized person at the derivatives
clearing organization, to the effect that, with
respect to the clearance and settlement of the
security-based swap customer security
futures products of the broker-dealer, the
derivatives clearing organization will permit
the Commission to examine the books and
records of the derivatives clearing
organization for compliance with the
requirements set forth in § 240.15c3–3a, Note
G. (b)(1) through (3).
(c) Item 14 shall apply only if a securitybased swap dealer determines, at least
annually, that the registered clearing agency
or derivatives clearing organization with
which the security-based swap dealer has on
deposit margin related to security futures
products meets the conditions of this Note G.
By the Commission.
Dated: October 18, 2012.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012–26164 Filed 11–21–12; 8:45 am]
BILLING CODE 8011–01–P

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