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

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 Security￾Based Swap Participants and Capital Requirements for Broker-Dealers AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: In accordance with the Dodd￾Frank 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 security￾based 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:
Electronic Comments

• Use the Commission’s Internet
  comment form (http://www.sec.gov/ rules/proposed.shtml); or
• Send an email to rule￾comments@sec.gov. 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. 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 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 Security￾Based 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
4. Introduction
5. 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
6. Specific Request for Comment to Limit
   the Use of Collateral
   C. Segregation
7. Background
8. 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
9. Proposed Rule 18a–1 and Amendments
   to Rule 15c3–1
10. Proposed Rule 18a–2
11. Proposed Rule 18a–3
12. Proposed Rule 18a–4
    B. Proposed Use of Information
    C. Respondents
    D. Total Initial and Annual Recordkeeping and Reporting Burden
13. Proposed Rule 18a–1 and Amendments
    to Rule 15c3–1
14. Proposed Rule 18a–2
15. Proposed Rule 18a–3
16. 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
17. Overview of the OTC Derivatives
    Markets—Baseline for Proposed Rules 18a–1 through 18a–4
18. Baseline for Amendments to Rule 15c3–
    1
    B. Analysis of the Proposals and Alternatives
19. Overview—The Proposed Financial
    Responsibility Program a. Nonbank SBSDs b. Nonbank MSBSPs
20. 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
21. The Proposed Margin Rule—Rule 18a–
    3

1See Public Law 111–203, 124 Stat. 1376 (2010). 2Pursuant 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 security￾based 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,’’ ‘‘Security￾Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘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’’). 3See Public Law 111–203 §§ 701–774. 4See id. § 764; 15 U.S.C. 78o–10. 5See 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. 6See Public Law 111–203 § 763; 15 U.S.C. 78c– 5. 7See 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. 8See 7 U.S.C. 6s(e)(1)(B). 9See 15 U.S.C. 78o–10(e)(1)(A); 7 U.S.C. 6s(e)(1)(A). 10See 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 non￾cleared security-based swaps, proposed a
segregation requirement for collateral received as margin. Id. 11See 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). 12See 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). 13See 17 CFR 240.15c3–1; 17 CFR 240.15c3–3. a. Calculation of Margin Amount b. Account Equity Requirements
i. Commercial end users
ii. SBSDs—Alternatives A and B
c. Margin Requirements for Nonbank￾MSBSPs
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 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 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

14See 17 CFR 240.15c3–1(a)(7); 17 CFR 240.15c3– 1e. 15See, 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.’’). 16See 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). 17For 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. 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’’). 18The 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. 19CFTC Capital Proposing Release, 76 FR 27802. 20The 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. 21For 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 security￾based swaps, propose to use a numerical grid that establishes specific deductions depending on spread and tenor, among other factors. 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 security￾based 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 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 (‘‘stand￾alone SBSD’’) would be permitted to engage in. Therefore, establishing consistent financial responsibility requirements would avoid potential competitive disparities between stand￾alone 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 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,

22See 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.’’). 23See 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). 24See, 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 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 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). 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 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 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 broker￾dealers.26 The existing broker-dealer capital requirements are contained in

27 17 CFR 240.15c3–1.
28 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). 29See proposed new Rule 18a–1. 30For 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). 31See 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 broker￾dealer 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 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 broker￾dealer to all other creditors would need to be paid in full before the obligations of the broker-dealer to a subordinated lender are paid. 32See 15 U.S.C. 78o–10, in general; 15 U.S.C. 78o–10(e)(2)(A)–(B), in particular. 33The 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. 35See 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). 36As 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 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 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 broker￾dealers 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 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).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

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. 37CFTC Capital Proposing Release, 76 FR 27802. 38See, 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 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 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). 39See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f. 40See 17 CFR 240.15c3–1(c)(2)(iv). 41See 17 CFR 240.15c3–1. 42See 17 CFR 240.15c3–1(a). 43See 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. 44See 17 CFR 240.15c3–1(a). 45See 17 CFR 240.15c3–1(c)(2)(i)–(xiii). 46See 17 CFR 240.15c3–1(c)(15). 47See 17 CFR 240.15c3–1(c)(2)(vi). 48See, 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). 49See 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). 50See 17 CFR 240.15c3–1(a)(5) and (a)(7). 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 broker￾dealers, 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 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 broker￾dealer 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 broker￾dealer 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 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 broker￾dealers and OTC derivatives dealers, as compared to other types of broker￾dealers, 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

51 17 CFR 240.15c3–1(a). 52See proposed new Rule 18a–2. 53An 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. 54See 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.’’). 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 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 broker￾dealers.
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 security￾based 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 security￾based 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 would differ substantially for stand￾alone 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 stand￾alone 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 stand￾alone 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

55See, 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. 56See 17 CFR 240.15c3–1(a). 57See paragraph (a)(1) of proposed new Rule 18a–

1. The rationales for these minimum requirements
   are discussed below.
   58See paragraph (c)(6) of proposed new Rule 18a–
2. The components of the risk margin amount are
   discussed in detail below.
   59See paragraphs (a)(1) and (c)(6) of proposed new Rule 18a–1. 60See paragraph (a)(1) of proposed new Rule 18a– 1. 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’’)?
3. 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.
4. 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.
5. Proposed Capital Rules for Nonbank
   SBSDs
   As discussed in detail below, proposed new Rule 18a–1 would prescribe capital requirements for stand￾alone 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 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 broker￾dealer 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 stand￾alone 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 broker￾dealers.55 Finally, the 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. a. Computing Required Minimum Net Capital Rule 15c3–1 prescribes the minimum net capital requirement for a broker￾dealer 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, broker￾dealer 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.
   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 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 stand￾alone 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 EP23NO12.000</GPH>

61See 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 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. 62See 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. 63Paragraph (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). 64See infra section V.B.2.a.i. of this release (economic analysis discussion based on year-end 2011 data showing that approximately 270 broker￾dealers maintain net capital of $20 million or more). 65For 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). 66See 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 broker￾dealer that is not an OTC derivatives dealer. See 17 CFR 240.15a–1. 67The 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. 68As 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. 69OTC 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 Broker￾Dealers 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 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 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 broker￾dealers 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 stand￾alone 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 broker￾dealer 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. 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 fixed￾dollar 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

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.’’). 70See 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 security￾based swaps and multiply that amount by 8% to determine the 8% margin factor. 71See paragraph (c)(6) of proposed new Rule 18a–
2. 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, and the total amount would be multiplied by 8% to determine the 8% margin factor. 72See paragraphs (a)(1) and (c)(6) of proposed new Rule 18a–1. 73See 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 member￾FCMs. Id. at note 16. 74See CFTC Capital Proposing Release, 76 FR
3. 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. 75See CFTC Capital Proposing Release, 76 FR 27802. 76 Id. at 27807. 77As 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.’’). 78As 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. 79For 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. The proposed 8% margin factor would be part of determining the stand￾alone SBSD’s minimum net capital requirement. As noted above, the stand￾alone SBSD would determine this amount by adding:

• The greater of the total margin
  required to be delivered by the stand￾alone 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; 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 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 fixed￾dollar 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 SBSDs with respect to their security￾based 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 security￾based 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

80Proposed new Rule 18a–3 would require a nonbank SBSD 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. 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. 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 security￾based 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. 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 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 non￾cleared 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 nonbank SBSD’s minimum net capital requirement as the risk of its security￾based 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 fixed￾dollar 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

81See proposed new paragraph (a)(10) of Rule 15c3–1. 82 Id. 83See 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. 84See 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 broker￾dealers that do not hold customer securities and cash. 85See 17 CFR 240.15c3–1(a)(1)(i)–(ii). 86See 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 broker￾dealer 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. 87See proposed new paragraph (a)(10)(i) of Rule 15c3–1. 88 Id. 89See Net Capital Requirements for Brokers and Dealers, Exchange Act Release No. 17208 (Oct. 9, 1980), 45 FR 69915 (Oct. 22, 1980). 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 security￾based 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?
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 broker￾dealer 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 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 broker￾dealer 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 broker￾dealer 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 broker￾dealer’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

90See 17 CFR 240.15c3–1(a)(1)(ii); 17 CFR 240.15c3–3a. 91See proposed new Rule 18a–1. 92See paragraphs (a)(2) and (d) of proposed new Rule 18a–1; the discussion below in section II.A.2.b.iii. of this release. 93See 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. 94See paragraph (a)(2) of proposed new Rule 18a– 1. 95Both 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). 96OTC Derivatives Dealers, 63 FR at 59384 (‘‘The final rule contains the minimum requirements of $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). 97See 17 CFR 240.15c3–1(c)(10). 98See 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 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 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 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

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.’’). 99See 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. 100OTC Derivatives Dealers, 63 FR 59362. 101See 17 CFR 240.15c3–1e. 102 Id. 103See proposed amendments to 17 CFR 240.15c3–1; 17 CFR 240.15c3–1e. 104See 17 CFR 240.15c3–1(a)(7)(i). 105See 17 CFR 240.15c3–1(a)(7)(ii). 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 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 fixed￾dollar 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 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 fixed￾dollar 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.
   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 broker￾dealer 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 broker￾dealers. Broker-dealer SBSDs using internal models would be subject to the existing provisions and proposed amendments to those provisions currently applicable to ANC broker￾dealers. 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

106For 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. 107See Alternative Net Capital Requirements Adopting Release, 69 FR 34428. 108See, 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. 109See Alternative Net Capital Requirements Adopting Release, 69 FR 34428. 110The 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 the Commission with information about the current practices of the ANC broker-dealers. 111This expectation is based on information gathered as part of the ANC broker-dealer supervision program. 112See proposed amendments to paragraph (a)(7)(i) of Rule 15c3–1. 113See 17 CFR 240.15c3–1(a)(7)(i). 114The 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. 115See 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 security￾based swap activity. 116See proposed amendments to paragraph (a)(7)(i) of Rule 15c3–1. 117See 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. 118See 17 CFR 240.17a–11(c)(3). 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 broker￾dealers. 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 broker￾dealer 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 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 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 broker￾dealer 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

119See 17 CFR 240.15c3–1e(e)(1).
120 Id.
121 Id. See also Alternative Net Capital Requirements Adopting Release, 69 FR 34428. 122See 17 CFR 240.15c3–1e(e). 123Risk Based Capital Guidelines: Market Risk, Federal Reserve, FDIC, OCC, 77 FR 53059 (Aug. 30, 2012). requirement for OTC derivatives dealers. The rules applicable to ANC broker￾dealers 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, category￾specific, 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 broker￾dealers. 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 broker￾dealers 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 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 broker￾dealer SBSDs to become ANC broker￾dealers 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.
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 VaR￾based capital requirements for ANC broker-dealers, OTC derivatives dealers, and, as proposed, for nonbank SBSDs approved to use internal models. The Banking Agencies’ stressed VaR￾based 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

124See 17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f. 125See 17 CFR 240.15c3–1(c)(2). 126See 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. 127See 17 CFR 240.15c3–1(c)(2). 128See, 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). 129See 17 CFR 240.15c3–1(c)(2)(i)–(xiii). 130See 17 CFR 240.15c3–1(c)(2)(ii); 17 CFR 240.15c3–1d. 131See 17 CFR 240.15c3–1d(b). 132See 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 broker￾dealer’s business. 17 CFR 240.15c3–1d(b)(1), (3), and (4). 133See 17 CFR 240.15c3–1(c)(2)(i). 134See 17 CFR 240.15c3–1(c)(2)(iv). 135 Id. 136See 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 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 one￾year 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
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 broker￾dealers and because some broker-dealers 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 broker￾dealer 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 broker￾dealer 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 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 re￾pay 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-to￾market 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

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 broker￾dealer 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. 138See 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. 139See, 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). 140See 17 CFR 240.15c3–1e; 17 CFR 240.15c3–1f. 141See 17 CFR 240.15c3–1(c)(2)(vi). 142See proposed new Rule 18a–1. 143Compare 17 CFR 240.15c3–1(c)(2), with paragraph (c)(1) of proposed new Rule 18a–1. 144See 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. 145See section II.A.1. of this release. 146See 17 CFR 240.15c3–1(c)(2)(vi); paragraph (c)(1)(vi) of proposed new Rule 18a–1. As proposed, 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. 147See 17 CFR 240.15c3–1(c)(2)(vi)(A). 148See 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). 149See 17 CFR 240.15c3–1(c)(2)(vi)(C). 150See 17 CFR 240.15c3–1(c)(2)(vi)(D). 151See 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’’). 152See 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. 153See 17 CFR 240.15c3–1(c)(2)(vi)(G). 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 broker￾dealer 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 broker￾dealers 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 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 broker￾dealer 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 Security￾Based 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 broker￾dealers 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 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

154See 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. 155See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR 240.15c3–1a. 156See 17 CFR 240.15c3–1(c)(2)(vi)(J)–(K). 157Compare 17 CFR 240.15c3–1(c)(2)(vi)(A)–(H), with 17 CFR 240.15c3–1(c)(2)(vi)(J)–(K). 158See 17 CFR 240.15c3–1(c)(2)(vii). 159See 17 CFR 240.15c3–1(c)(2)(vi). 160See proposed new paragraph (c)(2)(vi)(O) of Rule 15c3–1; paragraph (c)(1)(vi) of proposed new Rule 18a–1. 161See 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’’). 162See Net Capital Rule, Exchange Act Release No. 32256 (May 6, 1993), 58 FR 27486, 27490 (May 10, 1993). 163See proposed new paragraph (c)(2)(vi)(O) of Rule 15c3–1; paragraph (c)(1)(vi) of proposed new Rule 18a–1. 164See 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). 165See 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. 166See Product Definitions Adopting Release, 77 FR at 48267. 167 Id. at 48267, note 682. 168While 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. 169Most 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. 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 broker￾dealers 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 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 non￾payment 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 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 asset￾backed 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

170See proposed new paragraph (c)(2)(vi)(O)(1) of Rule 15c3–1; paragraph (c)(1)(vi)(A) of proposed new Rule 18a–1. 171See 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 security￾based 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% 173See 17 CFR 240.15c3–1(c)(2)(vi)(A), (B), (C), (E), and (G). 174Netting 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. 175See 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 security￾based swap offered by the market at the time of the net capital computation and not the spread specified under the terms of the contract. 176See 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. 178See 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). 179Broker-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 broker￾dealers. 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 broker￾dealers, but not in broker-dealers themselves. 180See 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. 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 broker￾dealer to reduce its required deductions.174 The proposed grid for CDS security￾based 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 security￾based 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 security￾based swap market is conducted by entities that are not members of 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 un￾hedged short position in a CDS security￾based 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 un￾hedged long position in a CDS security￾based 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

181See 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 4.25- year (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. 184See 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, 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-DIR￾3-02.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/. 185See 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. 186See 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. 187See Product Definitions Adopting Release, 77 FR at 48207. 188See 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. 191See proposed new paragraph (c)(2)(vi)(O)(2) of Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed new Rule 18a–1. 192See 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. 194See 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). obligation (in the case of CDS securities￾based 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 security￾based 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 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 asset￾backed 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 asset￾backed 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 return swaps are an example of a non￾CDS 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 security￾based 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 security￾based swap multiplied by 15%.193 The same approach would apply to a non￾CDS 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 non￾CDS security-based swap referencing such a bond would require a deduction equal to the contract’s notional amount multiplied by 7%.195 Linking the

196See Net Capital Rule, 58 FR at 27490. 197See 17 CFR 240.15c3–1(c)(2)(vi)(J). 198See 17 CFR 240.15c3–1(c)(2)(vi)(F)(1). 199See, 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.’’). 200See proposed new paragraph (c)(2)(vi)(O)(2) of Rule 15c3–1; paragraph (c)(1)(vi)(B) of proposed new Rule 18a–1. 201See 17 CFR 240.15c3–1a; Appendix A to proposed new Rule 18a–1. 202See 17 CFR 240.15c3–1(c)(2)(vi). 203See 17 CFR 240.15c3–1a; Appendix A to proposed new Rule 18a–1. 204Specifically, 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 security￾based 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 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). 205See proposed new Rule 18a–1a. 206See 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. 207This 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). 208For 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. standardized deduction for the non-CDS security-based swap to the standardized deduction that would apply to the instrument referenced by the security￾based swap is based on the rationale that changes in the market value of the instrument underlying the security￾based 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 security￾based 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 non￾CDS 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 security￾based 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 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 security￾based 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 security￾based swaps to be included in portfolios of equity positions for which the
Appendix A methodology is used to
compute a portfolio haircut.204 Under these proposed amendments, broker￾dealer 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 stand￾alone 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

209Because 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. 210See 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). 211See 17 CFR 240.15c3–1(c)(2)(vi)(F)(1). 212 Id. 213See 17 CFR 240.15c3–1(c)(2)(vi)(F)(2). 214See 17 CFR 240.15c3–1(c)(2)(vi)(F)(3). 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 broker￾dealer 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 broker￾dealer 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 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 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

215See 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 broker￾dealers.’’). 216See, 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. 217See 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. 218See Prudential Regulator Margin and Capital Proposing Release, 76 FR 27564; CFTC Capital Proposing Release, 76 FR 27802. 219See 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. 220See Alternative Net Capital Requirements Adopting Release, 69 FR at 34433. 221See paragraph (d)(1) of proposed new Rule 18a–1. Appendix E to Rule 15c3–1 requires a broker-dealer applying to become an ANC broker￾dealer to provide information about the broker￾dealer’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 Continued 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 security￾based swap on the same underlying bond appropriate? If not, explain why not.
17. Should the Commission propose
separate grids for CDS security-based 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 security￾based 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 security￾based 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 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. Stand￾alone 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

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 stand￾alone 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. 222See 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. 223See 17 CFR 240.15c3–1e(a)(1)(ii). A stand￾alone 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. 224See 17 CFR 240.15c3–1e(a)(1)(iii). A stand￾alone 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. 225See 17 CFR 240.15c3–1e(a)(1)(iv). A stand￾alone 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. 226See 17 CFR 240.15c3–1e(a)(1)(v). A stand￾alone 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 broker￾dealers can use scenario analysis in certain cases to determine deductions for some positions. 227See 17 CFR 240.15c3–1e(a)(1)(vi). A stand￾alone 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. 228See 17 CFR 240.15c3–1e(a)(1)(vii). A stand￾alone 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. 229See
17 CFR 240.15c3–1e(a)(2)(xi). A stand￾alone 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. 230See 17 CFR 240.15c3–1e(a)(2)(xiii). A stand￾alone 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 stand￾alone 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.’’ 231See 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. 232See 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. 233See 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. 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 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 broker￾dealer 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 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

234See 17 CFR 240.15c3–1e(a)(7). A similar provision would apply to applications of stand￾alone SBSDs applying to use internal models. See paragraph (d)(5) of proposed new Rule 18a–1. 235The Commission also reviews the broker￾dealer’s credit risk model. 236See 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. 237See 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. 238See 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 would apply to stand-alone SBSDs approved to use internal models. See paragraph (d)(8) of proposed new Rule 18a–1. 239See 17 CFR 15c3–1e(d). 240Compare 17 CFR 15c3–1e(d), with paragraph (d)(9) of proposed new Rule 18a–1. 241See 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. 242See 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. 243See 17 CFR 240.15c3–1e(d)(1)(iii). A back￾testing exception occurs when the ANC broker￾dealer’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.’’). 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. 244See 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. 245See 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. 246See 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. 247See 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. 248See 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. 249See 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. 250See 17 CFR 240.15c3–1e(b)(2). Specific risk is the risk that a security price will change for reasons Continued 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 broker￾dealer’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 broker￾dealer 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 broker￾dealer’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 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 The quantitative requirements specify that the VaR model of the ANC broker￾dealer must, among other things: (1) Use a 99%, one-tailed confidence level with price changes equivalent to a ten￾business-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

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. 251See 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. 252See 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. 253More 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. 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. 255See 17 CFR 240.15c3–1e(a)(8). 256See, 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 Euro￾currency 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’’). charge is for positions not included in the VaR model where the ANC broker￾dealer 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, 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?
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

257See, 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. 262See proposed new Rule 18a–3. 263See 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
discussed in this section of the release would not apply to these other exceptions. 264See, 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). 265See 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). 266See proposed new paragraph (c)(2)(xiv) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed Rule 18a–1. 267See proposed amendments to paragraph (a)(7) of Rule 15c3–1; paragraph (a)(2) of proposed new Rule 18a–1. 268See 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. 269See 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. 272See proposed amendments to paragraphs (a) and (c) of Rule 15c3–1e. 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 non￾cleared 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 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 stand￾alone SBSD using internal models could take a credit risk charge using a 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 broker￾dealers 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

273See 17 CFR 240.15c3–1(c)(2)(iv).
274See Interpretation Guide to Net Capital Computation for Brokers and Dealers, 32 FR at 858. 275See proposed amendments to paragraphs (a) and (c) of Rule 15c3–1e. 276See paragraph (e)(2) of proposed new Rule 18a–1. 277See proposed new paragraph (c)(2)(xiv) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed Rule 18a–1. 278 Id. 279See paragraph (c)(1)(iii)(A) of proposed new Rule 18a–3. 280See 17 CFR 240.15c3–1e(c); paragraph (e)(2) of proposed new Rule 18a–1. 281See 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. 284See 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. 285See 17 CFR 240.15c3–1e(c)(1)(ii). 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)(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. 286See 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 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 risk￾based 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 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 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

would determine the credit equivalent amount in the same manner. See paragraph (e)(2)(iv)(A) of proposed new Rule 18a–1. 287See 17 CFR 240.15c3–1e(c)(4)(ii). A stand￾alone 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. 288See 17 CFR 240.15c3–1e(c)(4)(iii). A stand￾alone 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. 289See Market Review of OTC Derivative Bilateral Collateralization Practices at 5. 290 Id. 291See 17 CFR 240.15c3–1e(c)(4)(v). A stand￾alone 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. 292This refers to an internal maintenance margin requirement (i.e., not one imposed by regulation). 293See 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. 294Netting 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 non￾defaulting 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. 295See 17 CFR 240.15c3–1e(c)(4)(iv). A stand￾alone 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. 296See 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. 297See 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. 298See 17 CFR 240.15c3–1e(c)(4)(vi). A stand￾alone 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). 299See 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 broker￾dealers are approved to use internally derived credit ratings. See Reference Removal Release, 76 FR at 26555. Pursuant to section 939A of the Dodd￾Frank 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 Continued The MPE amount is a charge to address potential future exposure and is calculated using the ANC broker￾dealer’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 broker￾dealer’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 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 broker￾dealer to reduce the receivables and 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 broker￾dealer 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 broker￾dealer 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

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). 300See 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. 301Concentration charges are intended to provide a liquidity cushion if a lack of diversification of positions exposes the firm to additional risk. 302See 17 CFR 240.15c3–1e(c)(2)(i)–(iii). A stand￾alone 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. 303See 17 CFR 240.15c3–1e(c)(1)(i)–(iii). A stand￾alone 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. 304See 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). 306See 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. 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 broker￾dealer.302 In this case, the ANC broker￾dealer 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 broker￾dealer 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 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 broker￾dealers 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, 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

307See Market Review of OTC Derivative Bilateral Collateralization Practices. 308See Independent Amounts. 309 Id. at 4. 310See discussion below in section II.B. of this release. 311See proposed new Rule 18a–3. 312See FINRA Rule 4240. 313See 17 CFR 240.15c3–1(c)(2)(xii). 314 Id. 315See proposed new paragraph (c)(2)(xii)(B) of Rule 15c3–1. 316See paragraph (c)(1)(ix) of proposed new Rule 18a–1. 317See section II.B.1. of this release for a discussion of the purpose of margin collateral. 318See paragraph (c)(1)(ii) of proposed new Rule 18a–3. 319See 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. 320As 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. (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 broker￾dealer is required to deduct from net 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 broker￾dealer is required to take on proprietary securities positions in that they account for risk of the positions in the customer’s account, which the broker￾dealer 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, self￾regulatory 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 security￾based 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 under￾margined capital charge for security￾based swap accounts would be triggered within one day of the margin 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

322See proposed paragraph (c)(2)(xiv)(A) of Rule 15c3–1; paragraph (c)(1)(viii)(A) of proposed Rule 18a–1. 323As discussed in section II.B.2. of this release, the margin requirements for non-cleared security￾based 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. 324See 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 (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 third￾party 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.
325See 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. 326See 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. 327See 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 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. 328See proposed paragraph (c)(2)(xiv)(B)(1) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(1) of proposed new Rule 18a–1. 329See paragraph (c)(1)(iii)(A) of proposed new Rule 18a–3. 330See 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. 331See proposed new paragraph (c)(2)(xiv)(B)(2) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(2) of proposed new Rule 18a–1. 332See 15 U.S.C. 78c–5(f)(3). 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 security￾based swaps, the rules would impose capital charges to address three exceptions in proposed new Rule 18a– 3 (the nonbank SBSD margin rule).324 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 security￾based 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 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 non￾cleared 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

333See paragraphs (c)(4)(i) and (iii) of proposed new Rule 18a–3. 334See proposed new paragraph (c)(2)(xiv)(B)(2) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(2) of proposed new Rule 18a–1. 335See proposed new paragraph (c)(2)(xiv)(B)(3) of Rule 15c3–1; paragraph (c)(1)(viii)(B)(3) of proposed new Rule 18a–1. 336See 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. 337The 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 pre￾effective 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. 338The 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 broker￾dealers 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. 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 non￾cleared security-based swap because the transaction was entered into prior to the effective date of proposed new Rule 18a–3 (a ‘‘legacy non-cleared security￾based 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 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 under￾margined 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.
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 security￾based 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

339See 17 CFR 1.17.
340 Id.
341See 17 CFR 240.15c3–1; 17 CFR 1.17. 342See 17 CFR 1.17(a)(1)(i)(D). 343See 17 CFR 1.17(c)(5)(v)–(vii). 344See 17 CFR 240.15c3–1b(a)(1). 345 17 CFR 240.15c3.–1b. 346Compare 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 broker￾dealer’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. 347See 17 CFR 240.15c3–1b; Appendix B to proposed new Rule 18a–1. 348See proposed new paragraph (b) of Rule 15c3– 1b; paragraph (b) of proposed new Rule 18a–1b. 349A 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 broker￾dealer registered as an FCM must comply with Rule 15c3–1 and CFTC Rule 1.17). 350See proposed new paragraph (b)(1)(i) of Rule 15c3–1b; paragraph (b)(1)(i) of proposed new Rule 18a–1b. 351See proposed new paragraph (b)(1)(i)(A) of Rule 15c3–1b; paragraph (b)(1)(i)(A) of proposed new Rule 18a–1b. 352 Id. 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 security￾based 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 security￾based 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 security￾based 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 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 broker￾dealers) 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 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

353 Id.
354 Id.
355See proposed new paragraph (b)(1)(i)(B) of Rule 15c3–1b; paragraph (b)(1)(i)(B) of proposed new Rule 18a–1b. 356See 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. 358See 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. 361See proposed new paragraph (b)(1)(i)(C)(3) of Rule 15c3–1b; paragraph (b)(1)(i)(C)(3) of proposed new Rule 18a–1b. 362See 17 CFR 240.15c3–1(c)(2)(vi)(A). 363See Net Capital Rule, Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec. 30, 1997). 364Under 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). 365See proposed new paragraph (b)(2) of Rule 15c3–1b; paragraph (b)(2) of proposed new Rule 18a–1b. 366See 17 CFR 240.15c3–1b(a)(3)(ix)(C); paragraph (a)(2)(ix)(C) of proposed new Rule 18a– 1b. 367See 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). 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 two￾thirds 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 un￾hedged 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 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 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

368See 17 CFR 240.15c3–1b(a)(3)(ix)(B); paragraph (a)(2)(ix)(B) of proposed new Rule 18a– 1b. 369See 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. 374See 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. 375See 17 CFR 240.15c3–4; OTC Derivatives Dealers, 63 FR 59362. 376See 17 CFR 240.15c3–4. 377See 17 CFR 240.15c3–4; 17 CFR 240.15a-1. 378See 17 CFR 240.15c3–4(c). 379See 17 CFR 240.15c3–4(c)(1). 380See 17 CFR 240.15c3–4(c)(2). 381See 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. 382See 17 CFR 240.15c3–4(c)(4). 383See 17 CFR 240.15c3–4(c)(5)(iii). 384See 17 CFR 240.15c3–4(c)(5)(iv). 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.
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 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 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

385See 17 CFR 240.15c3–4(c)(5)(v).
386See 17 CFR 240.15c3–4(c)(5)(vi).
387See 17 CFR 240.15c3–4(c)(5)(vii). 388See 17 CFR 240.15c3–4(c)(5)(viii). 389See 17 CFR 240.15c3–4(c)(5)(ix). 390See 17 CFR 240.15c3–4(c)(5)(x). 391See 17 CFR 240.15c3–4(c)(5)(xi). 392See 17 CFR 240.15c3–4(c)(5)(xii). 393See 17 CFR 240.15c3–4(d). 394See 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.
   395Alternative Net Capital Requirements Adopting Release, 69 FR at 34449. 396Like 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. 397See OTC Derivatives: Settlement Procedures And Counterparty Risk Management at 11–15. 398See OTC Derivatives Dealers, Exchange Act Release No. 39454 (Dec. 17, 1997), 62 FR 67940 (Dec. 30, 1997). 399See 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 broker￾dealer SBSDs); 17 CFR 240.15c3–1(a)(7)(iii) (which applies Rule 15c3–4 to ANC broker-dealers); 17 CFR 240.15c3–4. 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 broker￾dealers 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 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 exchange￾traded 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, 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 security￾based 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.

400See 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). 401See The management of liquidity risk in financial groups at 10. 402See id. at 6–8. 403See 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’’). 404The management of liquidity risk in financial groups at 8–12. 405 Id. at 10–11. 406 Id. 407 Id. 408See 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’ twelve￾month 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). 411See 17 CFR 240.15c3–4. 412 17 CFR 240.15c3–4. 413A 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. 416See 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). 418Based on the Commission staff’s experience, ANC broker-dealers currently perform regular liquidity stress tests. 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., 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 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 broker￾dealers 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 broker￾dealer 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

419See proposed new paragraph (f)(1) to Rule 15c3–1; paragraph (f)(1) of proposed new Rule 18a– 1. 420See proposed new paragraph (f)(3) of Rule 15c3–1; paragraph (f)(3) of proposed new Rule 18a– 1. 421See proposed new paragraph (f)(3) of Rule 15c3–1; paragraph (f)(3) of proposed new Rule 18a– 1. 422See, 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. 424Based 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 stand￾alone 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. 425See proposed new paragraph (f)(4) of Rule 15c3–1; paragraph (f)(4) of proposed new Rule 18a– 1. 426See 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. Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies, 77 FR at 611. 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 broker￾dealers 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 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 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.

427See 17 CFR 240.15c3–1(d).
428See 17 CFR 240.15c3–1(e).
429See 17 CFR 240.15c3–1c.
430See 17 CFR 240.15c3–1d.
431See 17 CFR 240.15c3–1(d).
432 Id.
433See 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.’’). 434See paragraph (h) of proposed new Rule 18a– 1. 435See 17 CFR 240.15c3–1(e)(1). 436See 17 CFR 240.15c3–1(e)(1). 437See 17 CFR 240.15c3–1(e)(2). 438See 17 CFR 240.15c3–1(e)(3). 439See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5, 1991). 440 Id. at 9125. 441See paragraph (i) of proposed new Rule 18a– 1. 442Amendments to Financial Responsibility Rules for Broker-Dealers, 72 FR 12862. 443See 17 CFR 240.15c3–1(e)(3)(i). To issue an order, the Commission must, based on the facts and information available, conclude that the withdrawal, advance or loan may be detrimental to the financial integrity of the broker-dealer, or may unduly jeopardize the broker-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 broker￾dealer to loss without taking into account the application of the Securities Investor Protection Act of 1970 (‘‘SIPA’’). See 17 CFR 240.15c3– 1(e)(3)(i)(B). Furthermore, the rule provides that 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 and that the hearing will be held within two business days from the date of the request in writing by the broker￾dealer. See 17 CFR 240.15c3–1(e)(3)(ii). 444See Amendments to Financial Responsibility Rules for Broker-Dealers, 72 FR at 12873. 445 Id. 446See paragraph (i) of proposed new Rule 18a– 1; Amendments to Financial Responsibility Rules for Broker-Dealers, 72 FR at 12873. .
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) Debt￾equity 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 broker￾dealer 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 provision in Rule 18a–1 is to require nonbank SBSDs to maintain a base of permanent capital. Request for Comment The Commission generally requests comment on the proposal to incorporate the debt-equity ratio 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 question:

1. Are the debt-equity ratio
   requirements in Rule 15c3–1 appropriate standards for stand-alone SBSDs? If not, explain why not and suggest an alternative standard.
   ii. Capital Withdrawal Requirements
   Rule 15c3–1 requires that a broker￾dealer provide notice when it seeks to withdraw capital in an amount that exceeds certain thresholds.435 For example, a broker-dealer must give the Commission a two-day notice before a withdrawal that would exceed 30% of the firm’s excess net capital and a notice within two days after a withdrawal that exceeded 20% of that measure.436 The notice provisions are designed to alert the Commission and the firm’s designated examining authority that capital is being withdrawn to assist in the monitoring of the financial condition of the broker-dealer. Rule 15c3–1 also restricts capital withdrawals that could have certain financial impacts on the firm, including withdrawals that reduce net capital below certain numerical levels.437 These restrictions are designed to ensure that the broker-dealer maintains a buffer of net capital above its minimum required amount. Finally, under the rule, the Commission may issue an order temporarily restricting a broker-dealer from withdrawing capital or making loans or advances to stockholders, insiders, and affiliates under certain circumstances.438 This provision and several of the notice and restriction provisions were put in place after the failure of the investment bank Drexel Burnham Lambert, Inc. (‘‘Drexel’’).439 Drexel, prior to its bankruptcy, transferred significant funds from its broker-dealer subsidiary to the holding company without notice to the Commission or Drexel’s designated examining authority.440 Stand-alone SBSDs would be subject to the same provisions, with one difference.441 In 2007, the Commission proposed amendments to Rule 15c3–1 to eliminate certain of the conditions required in an order restricting the withdrawals or the making of loans or advances to stockholders, insiders, and affiliates.442 More specifically, under Rule 15c3–1, the Commission can, by order, restrict a broker-dealer for a period up to 20 business days from making capital withdrawals, loans, and advances only to the extent the withdrawal, loan, or advance would exceed 30% of the broker-dealer’s excess net capital when aggregated with other such transactions over a 30-day period.443 The current requirement raises a concern, based on Commission staff experience, that to the extent the books and records of a broker-dealer that is in financial distress are incomplete or inaccurate it can be difficult for regulators to determine the firm’s actual net capital and excess net capital amounts.444 An order that limits withdrawals to a percentage of excess net capital may be difficult to enforce as it may not always be clear when that threshold had been reached.445 Given these concerns and consistent with the proposed amendment to Rule 15c3–1, the Commission is proposing that its ability to restrict withdrawals of capital, loans or advances by stand-alone SBSDs not be limited based on the amount of the withdrawal, loan or advance in relation to the amount of the firms’ excess net capital.446

447See 17 CFR 240.15c3–1c.
448 Id.
449See 17 CFR 240.15c3–1c.
450See 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. 451See 17 CFR 240.15c3–1c(c)(2). 452See 17 CFR 240.15c3–1c(d). 453 17 CFR 240.15c3–1d. 454See 17 CFR 240.15c3–1(c)(2)(ii). 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 stand￾alone 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.
   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 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 broker￾dealer.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 broker￾dealer (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 broker￾dealer unless the obligations also are subordinated to the claims of present and future creditors of the broker￾dealer.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 broker￾dealer 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 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 flow￾through 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 vis￾a`-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:
5. 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.
6. 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

455 Id.
456See 17 CFR 240.15c3–1d(b)(1).
457See Net Capital Requirements for Broker￾Dealers; Amended Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512, 3516 (Jan. 25, 1982). 458See 17 CFR 240.15c3–1d(a)(2)(ii). 459See 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). 460Appendix 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 broker￾dealer 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. 461The term ‘‘subordination agreements’’ as used in Appendix D to Rule 15c3–1 references both subordinated loan agreements and secured demand note agreements. 462See 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. 463See, e.g., 17 CFR 240.15c3–1d(b)(6). 464See paragraph (c)(5) of proposed new Rule 18a–1d. 465 Id. 466See 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. 467See paragraph (b) of proposed new Rule 18a– 2. 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, stand￾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. 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 security￾based swaps, swaps, and related positions would need to be marked to

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. 469See paragraph (b) of proposed new Rule 18a– 2. 470The 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.’’). 471See paragraph (c) of proposed new Rule 18a– 2. 472See 17 CFR 240.15c3–4. 473See CFTC Capital Proposing Release, 76 FR at 27809–27812. 474See 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. 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 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 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
8. 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

476See, 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.’’). 479See Financial Crisis: Review of Federal Reserve System Financial Assistance to American International Group, Inc. at 5–6. 480See Public Law 111–203 § 764. 481 15 U.S.C. 78o–10(e)(2)(B). 482See 15 U.S.C. 78o–10(e)(2)(A). The prudential regulators have proposed margin rules with respect 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). 484See 7 U.S.C. 6s(e)(1)(A) and (B). The CFTC has proposed margin requirements with respect to non￾cleared 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). 486See 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 Security￾Based Swaps for Mandatory Clearing and Notice 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.’’ 489See 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 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 Dodd￾Frank 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 security￾based 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 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 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

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. 490See 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). 491Broker-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). 492The 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 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). 493Pursuant 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. 494See, 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 broker￾dealer 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. 495The 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. 496See proposed new Rules 18a–1, 18a–3, and 18a–4. 497See paragraph (a) of proposed new Rule 18a– 3. 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 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 security￾based 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 broker￾dealer 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 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 non￾cleared 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.
4. 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

498See 17 CFR 240.15c3–1e(c)(4)(v)(A)–(H). 499Under broker-dealer margin rules, broker￾dealers 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). 500See paragraphs (c)(1)(ii) and (iii) of proposed new Rule 18a–3. 501See 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. 502See paragraph (c)(7) of proposed new Rule 18a–3. 503Compare 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-to￾markets and collateral deposits than are required by this [margin rule] for individual securities or customer accounts.’’ 504See proposed new paragraph (c)(16) of Rule 15c3–1; paragraph (c)(6) of proposed new Rule 18a–

1. 505See paragraph (c)(1)(i)(A) of proposed new
   Rule 18a–3. 506See 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). 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 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 security￾based 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 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 non￾cleared 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

507See paragraph (c)(5) of proposed new Rule 18a–3; 17 CFR 240.15c3–1e(c)(4)(iv). 508The 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. 509The 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. 510See paragraph (c)(1)(i)(B) of proposed new Rule 18a–3. 511See 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 non￾cleared 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 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 vender￾developed) 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’’). 512See 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. 513See 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 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 stand￾alone 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).
   514See paragraph (d)(2) of proposed new Rule 18a–3. 515See 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 Continued 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 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 security￾based 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) 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 security￾based 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

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. 516See, 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). 517See paragraph (c)(2)(ii) of proposed new Rule 18a-3. 518See 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 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 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. 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. 519See paragraph (c)(7) of proposed new Rule 18a–3. These more frequent calculations would be designed to monitor the nonbank MSBSP’s 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. 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-the￾counter 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 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 non￾cleared security-based swap based on the margin required by a registered clearing agency for a cleared security￾based swap whose terms and conditions closely resemble the terms and conditions of the non-cleared security￾based 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 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? 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 ten￾business-day movement in rates and prices. The ten-business-day requirement is designed to account for market movements that occur over a 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 multi￾day 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

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. 520Credit 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. 521See paragraph (c)(5) of proposed new Rule 18a–3; 17 CFR 240.15c3–1e(c)(4)(iv). 522See paragraph (c)(5) of proposed new Rule 18a–3. 523The 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. 524The 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. 525See paragraph (c)(2)(i) of proposed new Rule 18a-3 (only requiring calculation of the equity in the account of each counterparty). 526See 17 CFR 240.15c3–1; proposed new Rule 18a–1. 527See proposed new Rule 18a–2. 528See proposed new Rule 18a–4. 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 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.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 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 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

529See 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). 530See paragraph (c)(1)(ii) of proposed new Rule 18a-3. 531See paragraph (c)(3) of proposed new Rule 18a-3. 532See 17 CFR 240.15c3–1(c)(2)(vii); paragraph (c)(1)(iv) of proposed new Rule 18a–1. 533See 17 CFR 240.15c3–1(c)(2)(vi); paragraphs (c)(1)(vi)–(vii) of proposed new Rule 18a–1. 534See 17 CFR 240.15c3–1(c)(2)(vi); paragraphs (c)(1)(vi)–(vii) of proposed new Rule 18a–1. 535For 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. 536See 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. 537See, e.g., FINRA Rule 4210(g) (permitting customer portfolio margining); 17 CFR 240.15c3–1a;
  Appendix A to proposed new Rule 18a–1.
  538A counterparty will have credit exposure to a nonbank SBSD to the extent that collateral held in the account of the counterparty has a mark-to￾market value in excess of the nonbank SBSD’s current exposure to the counterparty. 539See paragraph (c)(4) of proposed new Rule 18a-3. 540 Market Review of OTC Derivative Bilateral Collateralization Practices at 5. 541See 17 CFR 240.15c3–1e(c)(4)(v). 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, 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 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;

542See paragraphs (c)(4)(i)–(c)(4)(vi) of proposed new Rule 18a–3. 543See paragraph (c)(8) of proposed new Rule 18a–3. 544See 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). 545See paragraph (c)(8) of proposed new Rule 18a–3. 546See paragraphs (c)(1)(iii)(A)–(D) of proposed new Rule 18a–3. 547See paragraph (c)(1)(iii)(A) of proposed new Rule 18a–3. 548See 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. 549See paragraph (c)(1)(iii)(C) of proposed new Rule 18a–3. 550See paragraph (c)(1)(iii)(D) of proposed new Rule 18a–3. 551See proposed new paragraph (c)(2)(xiv) of Rule 15c3–1; paragraph (c)(1)(viii) of proposed Rule 18a–1. 552See 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. 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. 553The 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. 554See 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.’’).

• 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. 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 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,

555The 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. 556See 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) 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. 557See paragraph (b)(2) of proposed new Rule 18a–3. 558Compare 15 U.S.C. 78c–3(g)(1), with paragraph (b)(2) of proposed new Rule 18a–3. 559See 15 U.S.C. 78c–3(g)(1). 560See, 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. 561See paragraph (e) of proposed new Rule 18a– 3. 562See 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-to￾markets 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.’’). 563See id. 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 non￾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 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 security￾based 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 non￾cleared 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.

564See paragraph (c)(1)(iii)(B) of proposed new Rule 18a–3. 565Alternative 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)). 566See 15 U.S.C. 78c–5(f). 567See Prudential Regulator Margin and Capital Proposing Release, 76 FR 27564; CFTC Margin Proposing Release, 76 FR 23732. 568See 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 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 SBSD and the MSBSP and ‘‘be appropriate for the risk associated with non￾cleared security-based swaps held’’ by an SBSD and MSBSP). 569See 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. 571See 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. 572See, 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. 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 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 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

573See 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. 574See 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. 575See 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. 576See 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. 577See, 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. 578Letter 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’’). 579See the ICI Letter. 580See 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.’’). 581See Prudential Regulator Margin and Capital Proposing Release, 76 FR 27564; CFTC Margin Proposing Release, 76 FR 23744. 582See paragraph (c)(1)(iii)(B) of proposed Rule 18a–3—Alternative B. 583 Id. 584 Id. 585See 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). 586See 15 U.S.C. 78c–5(f)(1)–(3). 587See 15 U.S.C. 78c–5(f)(3). 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 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 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

588See paragraph (c)(4) of proposed new Rule 18a–3. 589See paragraphs (c)(4)(i)–(iii) of proposed new Rule 18a–3. 590See 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. 591See paragraph (b)(9) of proposed new Rule 18a–3. 592As 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. 593As 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. 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. 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 security￾based swap legacy account.590 Proposed new Rule 18a–3 would define security￾based 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 security￾based 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 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 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.

594See, 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). 595See paragraph (c)(2)(i) of proposed new Rule 18a–3. 596See 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. 597See 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. 598See paragraph (c)(2)(ii)(B) of proposed new Rule 18a–3. 599See Entity Definitions Adopting Release, 77 FR 30596. 600See 15 U.S.C. 78c(a)(67); Entity Definitions Adopting Release, 77 FR 30596.
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 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 non￾cleared security-based swap.595 On the next business day following the calculation, the nonbank MSBSP would be required to either collect or deliver 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

601See paragraph (c)(3) of proposed new Rule 18a–3. 602See paragraph (c)(4) of proposed new Rule 18a–3; 17 CFR 240.15c3–1e(c)(4)(v). 603See paragraph (c)(8) of proposed new Rule 18a–3. 604See paragraph (c)(2)(iii) of proposed new Rule 18a–3. MSBSPs could choose to collect collateral in these cases. 605See paragraph (c)(2)(iii)(A) of proposed new Rule 18a–3. 606 Id. 607Compare paragraph (c)(1)(iii)(A) of proposed new Rule 18a–3, with paragraph (c)(2)(iii)(A) of proposed Rule new 18a–3. 608See 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. 609For 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 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. 610See 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. 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 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 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

611See paragraph (c)(6) of proposed Rule 18a–3. 612See Prudential Regulator Margin and Capital Proposing Release, 76 FR at 27575; CFTC Margin 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 End￾Users, 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. 613See 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 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. 614See paragraph (e) of proposed new Rule 18a– 3. 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 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 security￾based swap and establish, maintain, and document procedures and guidelines for monitoring the risk of such accounts.613 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 non￾cleared 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.

615See 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. 618See 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. 621See paragraph (e)(2) of proposed new Rule 18a–3. 622See paragraph (e)(6) of proposed new Rule 18a–3. 623See paragraph (c)(1)(iii)(A) of proposed new Rule 18a–3. 624See Prudential Regulator Margin and Capital Proposing Release, 76 FR at 27578; CFTC Margin Proposing Release, 76 FR at 23738–23739. 625See 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. 626See 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). 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 and/or the risk of the specific non￾cleared 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.
6. 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:
7. Should the types of assets that
   could be used to meet the nonbank

627Regulation 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. 628See 11 U.S.C. 741–753. SIPA provides similar protections for ‘‘customers’’ of registered broker￾dealers. 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). 629See 11 U.S.C. 752. 630See Michael P. Jamroz, The Customer Protection Rule, 57 Bus. Law. 1069 (May 2002). 631See Public Law 111–203 § 763(d) adding
section 3E(g) to the Exchange Act (15 U.S.C. 78c–
5(g)).
632See 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). 633See 15 U.S.C. 78c–5(g); 11 U.S.C. 741–753. 634See 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. 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 security￾based 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 government￾sponsored 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 generally or individually should not be 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 non￾cleared 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 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

635See 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). 636See 15 U.S.C. 78c–5(g); 11 U.S.C. 741(2). 637See 15 U.S.C. 78c–5(g); 11 U.S.C. 741–753. 638See Public Law 111–203 § 763; 15 U.S.C. 78c– 5. 639See 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. 640See 15 U.S.C. 78o(c)(3). See also Public Law 111–203 § 771 (codified at 15 U.S.C. 78o– 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). 641See 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.
642See section 3E(b)(2) of the Exchange Act (15 U.S.C. 78c–5(b)(2)). 643See section 3E(c)(1) of the Exchange Act (15 U.S.C. 78c–5(c)(1)). 644See section 3E(c)(2) of the Exchange Act (15 U.S.C. 78c–5(c)(2)). 645See 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). 646See 15 U.S.C. 78c–5(f)(1)(B). 647See 15 U.S.C. 78c–5(f)(3). 648See 15 U.S.C. 78c–5(f)(2)(B)(i). 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 non￾cleared 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 security￾based 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 broker￾dealers.640
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 security￾based 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 security￾based swap customer of the broker, dealer, or SBSD.644 With respect to non-cleared security￾based 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 non￾cleared security-based swap transaction 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 non￾cleared 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 security￾based 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

649See 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. 650See section 3E(f)(4) of the Exchange Act (15 U.S.C. 78c–5(f)(4)). 651See 15 U.S.C. 78c–5; 15 U.S.C. 78o(c)(3). 652Unlike 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. 653See 15 U.S.C. 78c–5(c)(1). 654See 15 U.S.C. 78c–5(f)(1)–(3). 655See 15 U.S.C. 78c–5(f)(4). 656As 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. 657As discussed in more detail below, MSBSPs would be subject to a notification requirement. See paragraph (d)(1) of proposed new Rule 18a–4. 658The 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.). 659See 15 U.S.C. 78c–5(f). 660 Id. 661See 17 CFR 240.15c3–3. 662See 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). 663See 15 U.S.C. 78aaa et seq. 664See 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 broker￾dealer identifies as not constituting margin securities. 17 CFR 240.15c3–3(a)(5). 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 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 non￾cleared 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 security￾based 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 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 broker￾dealer’’) 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 broker￾dealer must hold these securities in one of several locations specified in Rule 15c3–3 and free of liens or any other

665See 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). 668See 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. 670See 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 broker￾dealer 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. 672See 17 CFR 240.15c3–3(e). 673See 17 CFR 240.15c3–3a. 674For 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 broker￾dealer 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. 675The attractiveness of the over-collateralized debits facilitates the bulk transfer of customer accounts from a failing or failed broker-dealer to another broker-dealer. 676See Net Capital Requirements for Broker￾Dealers; 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 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).’’). 677Compare 17 CFR 240.15c3–3, with proposed new Rule 18a–4. 678Compare 17 CFR 240.15c3–3(a), with paragraph (a) of proposed new Rule 18a–4. 679Compare 17 CFR 240.15c3–3(b)–(d), with paragraph (b) of proposed new Rule 18a–4. 680Compare 17 CFR 240.15c3–3(e), with paragraph (c) of proposed new Rule 18a–4. 681See 15 U.S.C. 78c–5(f)(1)(A); paragraph (d)(1) of proposed new Rule 18a–4. 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 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 over￾collateralize 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 broker￾dealer fails, the
customer debits, because they generally are over￾collateralized, 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 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 broker￾dealer 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 security￾based 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

682See 15 U.S.C. 78c–5(f)(1)–(3).
683See 15 U.S.C. 78c–5(f)(4).
684See proposed paragraph (p) of Rule 15c3–3. 685This 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. 686See Amendments to Financial Responsibility Rules for Broker-Dealers, 72 FR 12862. 687See 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 non￾cleared security-based swap. 688See paragraph (a)(6) of proposed new Rule 18a–4. 689Compare 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. 690See 15 U.S.C. 78c–5(f)(1)–(3). 691See 15 U.S.C. 78c–5(f)(4). 692Counterparties 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, 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 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 security￾based 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 security￾based 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?
6. 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, 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 self￾executing 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

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. 693See 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). 694As 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. 695While 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. 696See 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 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)(3)(i) of proposed new Rule 18a–4. 697See 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. 698See 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. 699For 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. 700As 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 Continued 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 security￾based 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 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 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 security￾based 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 security￾based 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 security￾based 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

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. 701See 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. 702See 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 Benefit of Customers.’’ Compare 17 CFR 240.15c3– 3(f), with paragraph (a)(4)(ii) of proposed new Rule 18a–4. 703See 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. 704See paragraph (a)(4)(iv) of proposed new Rule 18a–4. 705See 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). 706See paragraph (b)(2) of proposed new Rule 18a–4. 707Compare 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 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. 708See 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. 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 security￾based 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
• 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 non￾cleared 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 security￾based swap customers relating to non￾cleared security-based swaps provided to another SBSD are isolated from the proprietary assets of the SBSD and are identified as property of the security￾based 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 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

709See 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. 710See 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. 711See 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. 712See 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 accepted unless the Commission rejects the application within 90 days of receipt by the Commission. Id. 713See 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. 714See paragraph (b)(3) of proposed new Rule 18a–4. 715See 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. 716See 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 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. 717See 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. 718See 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. 719See 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. 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 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
• 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

720See 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. 721See 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). 722See 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. 723See 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. 724See 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. 725See 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 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 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 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. 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 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 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

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. 726See paragraph (c)(1) of proposed new Rule 18a–4; Exhibit A to proposed new Rule 18a–4. 727Compare 17 CFR 240.15c3–3a, with Exhibit A to proposed new Rule 18a–4. 728See 17 CFR 240.15c3–3a, Items 1–9. Broker￾dealers 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, broker￾dealers 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 broker￾dealer 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. 729See 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 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. 730See 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. 731As 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. 732Compare 17 CFR 240.15c3–3a, with Exhibit A to proposed new Rule 18a–4. 733See 17 CFR 240.15c3–3a, Items 13–14. 734See paragraph (c)(1) of proposed new Rule 18a–4. 735 15 U.S.C. 78c–5(d). 736 Id. 737 Id. 738See paragraph
(a)(5) of proposed new Rule 18a–4. 739See 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). 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 security￾based 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, 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 non￾cleared 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 security￾based 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 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

740See 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. 742See 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). 743See Municipal Securities Report at 7. 744 Id. 745See, 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). 746See 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/ 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. 747While 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)). 748See, 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. 749See MSRB Notice 2010–15 (June 2, 2010), available at http://www.msrb.org/Rules-and￾Interpretations/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 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 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 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

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)). 750See paragraph (c)(1) of proposed new Rule 18a–4. 751See 17 CFR 240.15c3–1(c)(2)(vi)(B). 752Compare to Rule 15c3–1(c)(2)(vi)(M)(1) (imposing undue concentration charges on certain securities in the proprietary account of a broker￾dealer whose market value exceeds more than 10% of the ‘‘net capital’’ of a broker-dealer before application of haircuts). 753With 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 Dodd￾Frank 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). 754Amendments to Financial Responsibility Rules for Broker-Dealers, 72 FR at 12864. 755 Id. 756See 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. 757See paragraph (c)(3) of proposed new Rule 18a–4. 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 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 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 broker￾dealer 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