Alert October 23, 2012

SEC Proposes Capital, Margin, and Segregation Rules for Security-Based Swap Dealers and Major Security-Based Swap Participants

The SEC voted unanimously to issue a rule proposal that would impose capital and margin requirements for security-based swap dealers (“SBSDs”) and major security-based swap participants (“MSBSPs”) and segregation rules for SBSDs.  The proposed rules are generally based on existing requirements applicable to broker-dealers and would impose different, but structurally similar, capital, margin and segregation requirements on broker-dealer SBSDs and on SBSDs not registered as broker-dealers (“stand-alone SBSDs”).  Some of the changes to the net capital rule, Rule 15c3-1 under the Securities Exchange Act of 1934 (“Exchange Act”), would also apply to broker-dealers that are not registered as SBSDs, in order to maintain a consistent capital treatment for security-based swaps and swaps.  The SEC proposed a tangible net worth capital standard for MSBSPs, recognizing that MSBSPs may be entities engaged in a diverse range of business activities different from, and broader than, the securities activities of broker-dealers and SBSDs, and that a significant percentage of their assets may consist of unsecured receivables generated in the ordinary course of their businesses, but which have a value of zero under the haircuts applied to the tentative net capital of broker-dealers under Rule 15c3-1.

The SEC acknowledged that the specific quantitative requirements included in the proposal were not derived from econometric or mathematical models, and that it had not performed a detailed quantitative analysis of the likely economic consequences of the specific quantitative requirements being included in the proposal.  Rather, the SEC stated that it had drawn from its experiences in regulating broker-dealers and had looked to comparable quantitative elements in the existing broker-dealer financial responsibility regime or, where appropriate, existing or proposed regulations of FINRA or the CFTC with respect to similar activities.  The SEC invites comment, including relevant data and analysis, regarding all aspects of the quantitative requirements reflected in the proposed rules.


The proposal would establish a fixed dollar minimum capital requirement -- $20 million for most entities, and $1 billion for broker-dealers that use the alternative net capital computation under Rule 15c3-1(a)(7) (“ANC broker-dealers”).  ANC broker-dealers have been approved by the SEC 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 related to OTC derivatives transactions in lieu of the 100% haircut charged to other broker-dealers for unsecured receivables.  The proposal would also establish a ratio requirement equal to 8% of the margin required of the SBSD’s customers for cleared and non-cleared security-based swaps; thus the minimum capital requirement would be the greater of the fixed dollar minimum and 8% of the firm’s risk margin amount.  The SEC believes that the 8% margin factor would adjust the firm’s minimum capital to take into account the firm’s level of risk, since the margin required varies with the size and riskiness of the business conducted by the regulated entity.  Non-bank SBSDs and SBSDs that are broker-dealers would also be subject to ratio requirements currently applicable to OTC derivatives dealers pursuant to existing Exchange Act Rule 15c3-4, while stand-alone SBSDs would be required to comply with several similar ratio requirements through new Rule 18a-1 under the Exchange Act.

The proposal would also require SBSDs that are not approved to use internal VaR models to apply standardized “haircuts” when computing net capital for certain derivatives, including security-based swaps, with the haircuts varying based upon the class of security at issue.  

ANC broker-dealers and non-bank SBSDs would be subject to liquidity risk management requirements. 

Non-bank MSBSPs would be required to maintain a positive tangible net worth.  The term “tangible net worth” would be defined to mean the MSBSP’s net worth as determined in accordance with generally accepted accounting principles in the U.S., excluding goodwill and other intangible assets.  In determining net worth, all long and short positions in security-based swaps, swaps and related positions would need to be marked to their market value.  Further, a non-bank MSBSP would be required to include in its computation of tangible net worth all liabilities and obligations of a subsidiary or affiliate that the MSBSP guarantees, endorses or assumes, either directly or indirectly.  MSBSPs would also be required to comply with Rule 15c3-4.


Margin requirements for SBSDs would be modeled on those set for broker-dealers.  Unless an exception applies, SBSDs would need to collect both initial and variation margin from counterparties to non‑cleared security-based swap transactions.  The proposal details how these margins will be calculated and what constitutes acceptable collateral.  Certain exceptions would apply.  For example, non-bank SBSDs would not need to collect margin collateral for transactions with commercial end users.  The SEC is seeking comment regarding whether SBSDs should be required to collect initial margin in transactions with each other (variation margin would be required).  MSBSPs would be required to calculate and collect or deliver collateral covering variation margin, but not initial margin.  Margin requirements for both SBSDs and MSBSPs will be subject to a $100,000 minimum transfer amount.  Under this provision, an SBSD or 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 $100,000 or less.  If the minimum transfer amount is exceeded, the entire account equity requirement would need to be collateralized, not just the amount over $100,000.


The proposal would establish additional collateral segregation requirements for cleared and non-cleared security-based swaps.  It would allow an SBSD to commingle counterparty collateral in a segregated account under certain conditions.  SBSDs would be required to maintain possession and control of all “excess securities collateral,” which refers to securities and money market instruments of security-based swap customers held by the SBSD that exceed the SBSD’s current exposure to the customer, excluding certain securities and instruments held by a clearing agency and certain securities and instruments held by another SBSD.  This is similar to provisions of Exchange Act Rule 15c3-3 that require broker-dealers to maintain possession and control of fully-paid securities and excess margin securities.  Non-bank SBSDs would also be required to maintain a separate reserve of funds or qualified securities for the benefit of their security-based swap customers.

Public Comment

Comments on the proposal are due 60 days after its forthcoming publication in the Federal Register.