require, the temporary use of a provisional model by an ANC broker-
dealer, including an ANC broker-dealer SBSD, or a stand-alone SBSD for
the purposes of computing net capital if the model had been approved by
certain other supervisors.\244\ Further, as discussed below in section
II.B.2.a.i. of this release, the Commission also may approve, subject
to any condition or limitations that the Commission may require, the
temporary use of a provisional model by a nonbank SBSD for the purposes
of calculating initial margin pursuant to the requirements of Rule 18a-
3, as adopted.
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    \244\ See paragraph (a)(7)(ii) of Rule 15c3-1e, as amended;
paragraph (d)(5)(ii) of Rule 18a-1, as adopted. As a result of this
modification, paragraph (a)(7) of Rule 15c3-1e has been re-
designated paragraph (a)(7)(i) of Rule 15c3-1e, as amended, and
paragraph (d)(5) of Rule 18a-1, as proposed, has been re-designated
paragraph (d)(5)(i) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    To qualify, the firm must have a complete application pending for
approval to use a model.\245\ The requirement that a complete
application be pending is designed to limit the amount of time that the
firm uses the provisional model and incentivize firms to promptly file
applications for model approval.
---------------------------------------------------------------------------

    \245\ See paragraph (a)(7)(ii)(A) of Rule 15c3-1e, as amended;
paragraph (d)(5)(ii)(A) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    In addition, to be approved by the Commission, the use of the
provisional model must have been approved by a prudential regulator,
the CFTC, a CFTC-registered futures association, a foreign financial
regulatory authority that administers capital and/or margin
requirements that the Commission has found are eligible for substituted
compliance, or any other foreign supervisory authority that the
Commission finds has approved and monitored the use of the provisional
model through a process comparable to the process set forth in the
final rules.\246\ This condition is designed to ensure that the
provisional model has been approved by a financial regulator that is
administering a program for approving and monitoring the use of models
that is consistent with the Commission's program, including with
respect to the qualitative and quantitative requirements for models in
the final rules being adopted today.
---------------------------------------------------------------------------

    \246\ See paragraph (a)(7)(ii)(B) of Rule 15c3-1e, as amended;
paragraph (d)(5)(ii)(B) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

v. Credit Risk Models
    The pre-existing provisions of paragraph (a)(7) of Rule 15c3-1 and
paragraph (c) of Rule 15c3-1e permit an ANC broker-dealer to treat
uncollateralized current exposure to a counterparty arising from
derivatives transactions as part of its tentative net capital instead
of deducting 100% of the value of the unsecured receivable (as is
required with respect to most unsecured receivables under Rule 15c3-
1).\247\ These provisions further require the ANC broker-dealer to take
a credit risk charge to tentative net capital (along with the market
risk charges--the model-based haircuts--discussed above in section
II.A.2.b.iv. of this release) to compute its net capital. The credit
risk charge typically will be significantly less than the 100%
deduction to net worth that would have otherwise applied to the
unsecured receivable since the credit risk charge is a percentage of
the amount of the receivable. The pre-existing provisions of paragraph
(c) of Rule 15c3-1e prescribe the method for calculating credit risk
charges (``ANC credit risk model''). In particular, the credit risk
charge is the sum of 3 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 the aggregate current exposure to all
counterparties exceeds 50% of the firm's tentative net capital.
---------------------------------------------------------------------------

    \247\ See paragraph (c)(15) of Rule 15c3-1 (defining the term
``tentative net capital'').
---------------------------------------------------------------------------

    The capital rules governing OTC derivatives dealers similarly
permit them to include uncollateralized current exposures to a
counterparty arising from derivatives transactions in their tentative
net capital, and require them to take a credit risk charge to tentative
net capital with respect to these exposures to compute net
capital.\248\

Paragraph (d) of Rule 15c3-1f prescribes the method for computing the
credit risk charges for OTC derivatives dealers (``OTCDD credit risk
model''). The OTCDD credit risk model is similar to the ANC credit risk
model except that the former does not include a portfolio concentration
charge.\249\
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    \248\ See paragraphs (a)(5) and (c)(15) of Rule 15c3-1; 17 CFR
240.15c3-1f (``Rule 15c3-1f'').
    \249\ See paragraph (d) of Rule 15c3-1f.
---------------------------------------------------------------------------

    Commission staff reviews an ANC broker-dealer's use of the ANC
credit risk model as part of the overall review of the firm's ANC
application and monitors the firm's use of the model thereafter.
Moreover, the process is subject to the pre-existing provisions of
paragraphs (a)(8), (a)(10), and (a)(11) of Rule 15c3-1e, which provide,
respectively, that: (1) An ANC broker-dealer must amend and submit to
the Commission for approval its ANC application before materially
changing its ANC credit risk model; (2) an ANC broker-dealer must
notify the Commission 45 days before it ceases using its ANC credit
risk model; and (3) the Commission, by order, can revoke an ANC broker-
dealer's ability to use the ANC credit risk model. Commission staff
also reviews and monitors an OTC derivatives dealer's use of its OTCDD
credit risk model.\250\
---------------------------------------------------------------------------

    \250\ See paragraph (a) of Rule 15c3-1f.
---------------------------------------------------------------------------

    Under the pre-existing provisions of Rule 15c3-1e, an ANC broker-
dealer approved to use an ANC credit risk model can apply the model to
unsecured receivables arising from OTC derivatives instruments from all
types of counterparties. The Commission proposed to narrow this
treatment so that ANC broker-dealers could apply the ANC credit risk
model to unsecured receivables arising exclusively from security-based
swap transactions with commercial end users (i.e., unsecured
receivables arising from other types of derivative transactions were
subject to the 100% deduction from net worth).\251\
---------------------------------------------------------------------------

    \251\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70240-44.
---------------------------------------------------------------------------

    The Commission proposed that stand-alone SBSDs authorized to use
models also could apply a credit risk model to unsecured receivables
arising from security-based swap transactions with commercial end
users.\252\ The proposed credit risk model for stand-alone SBSDs was
modeled on the ANC credit risk model (as opposed to the OTCDD credit
risk model). Consequently, the credit risk model for stand-alone SBSDs
included a portfolio concentration charge if aggregate current
exposures to all counterparties exceeded 50% of the firm's tentative
net capital.
---------------------------------------------------------------------------

    \252\ See 77 FR at 70240-44.
---------------------------------------------------------------------------

    In the 2018 comment reopening, the Commission asked whether the
final rules should cap the ability of ANC broker-dealers and stand-
alone SBSDs authorized to use models to apply the credit risk models to
uncollateralized current exposures arising from security-based swap and
swap transactions with commercial end users. The Commission asked
whether this cap should equal 10% of the firm's tentative net
capital.\253\ In addition, the Commission asked whether the use of the
credit risk models by ANC broker-dealers and stand-alone SBSDs should
be expanded to apply to uncollateralized potential exposures to
counterparties arising from electing not to collect initial margin for
non-cleared security-based swap and swap transactions pursuant to
exceptions in the margin rules of the Commission and the CFTC. This
treatment would be an alternative to taking the 100% deduction to net
worth in lieu of collecting initial margin.
---------------------------------------------------------------------------

    \253\ See Capital, Margin, and Segregation Comment Reopening, 83
FR at 53010-11.
---------------------------------------------------------------------------

Comments and Final Requirements for Using Credit Risk Models
    A commenter urged the Commission not to limit the circumstances in
which the credit risk models could be used.\254\ The commenter stated
that uncollateralized receivables arising from a counterparty failing
to post margin typically result from operational issues that are
temporary in nature (i.e., that are addressed in a matter of days) and
are liquidated if they last for longer periods of time. The commenter
stated that a credit risk charge adequately addresses the risks of
under-collateralized positions during the interim period before margin
is posted and that ``a punitive 100% deduction is unnecessary.'' The
commenter also stated that requiring a nonbank SBSD to hold additional
capital for each dollar of margin it did not collect from a non-
financial entity for a swap would effectively undermine an exception
proposed by the CFTC, which the commenter indicated would deter the
dual registration of nonbank SBSDs as swap dealers. The commenter also
requested that the Commission permit ANC broker-dealers and stand-alone
SBSDs authorized to use models to apply a counterparty credit risk
charge in lieu of a 100% deduction for security-based swaps and swaps
with sovereigns, central banks, supranational institutions, and
affiliates to the extent that an exception to applicable margin
requirements applies. Similarly, another commenter recommended that the
Commission calibrate the capital charges so that they do not make
compliance with other regulators' margin rules punitive.\255\
---------------------------------------------------------------------------

    \254\ See SIFMA 2/22/2013 Letter.
    \255\ See Memorandum from Richard Gabbert, Counsel to
Commissioner Hester M. Peirce, regarding an April 24, 2018 meeting
with representatives of Citigroup (April 26, 2018) (``Citigroup 4/
24/2018 Meeting'').
---------------------------------------------------------------------------

    A commenter stated that ANC broker-dealers and stand-alone SBSDs
should be permitted to apply the credit risk models to uncollateralized
exposures to multilateral development banks in which the U.S. is a
member.\256\ This commenter stated that the Commission's proposal to
limit use of the models to commercial end users is unwarranted, on
either risk-based or policy grounds. A commenter stated that requiring
a 100% deduction for unsecured receivables from commercial end users
with respect to swap transactions (as compared to security-based swap
transactions for which the credit risk models would apply) will make it
difficult, if not impossible, to maintain a dually-registered nonbank
SBSD and swap dealer.\257\ Another commenter urged the Commission to
modify its proposal to avoid the pass-through of costs to commercial
end users that the commenter argued would result if SBSDs are required
to hold capital to cover unsecured credit exposures to them.\258\ This
commenter also recommended that the Commission allow nonbank SBSDs and
nonbank MSBSPs that are not approved to use internal models to take the
credit risk charge (i.e., not limit its use to ANC broker-dealers and
stand-alone SBSDs authorized to use models). One commenter suggested
that the Commission substitute a credit risk charge or a credit
concentration charge in place of the 100% charge for legacy accounts,
with an exception permitting SBSDs to exclude any currently non-cleared
positions for which a clearing agency has made an application to the
Commission to accept for clearing.\259\
---------------------------------------------------------------------------

    \256\ See Letter from Anne-Marie Leroy, Senior Vice President
and Group General Counsel, and David Harris, Acting Vice President
and General Counsel, The World Bank (Feb. 21, 2013) (``World Bank
Letter'').
    \257\ See Financial Services Roundtable Letter.
    \258\ See Sutherland Letter.
    \259\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to the 2018 comment reopening, a commenter expressed
support for expanding the use of credit risk models to uncollected
initial margin from legacy accounts.\260\ This commenter argued that
this would be comparable to capital rules for bank SBSDs. Similarly, a
commenter supported expanding the use of credit

risk models, noting that it would be consistent with the Basel capital
standards as well as the manner in which the current net capital rule
applies to ANC broker-dealers.\261\ Conversely, a commenter opposed
expanding the use of credit risk models.\262\
---------------------------------------------------------------------------

    \260\ See Morgan Stanley 11/19/2018 Letter.
    \261\ See SIFMA 11/19/2018 Letter.
    \262\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    Finally, a commenter raised concerns about the potential rule
language in the 2018 comment reopening because it narrowed the ability
to use credit risk models for transactions in security-based swaps and
swaps.\263\ The commenter noted that the current capital rules permit
ANC broker-dealers to use the ANC credit risk models with respect to
derivatives instruments, which encompass--among other things--OTC
options that are not security-based swaps or swaps.
---------------------------------------------------------------------------

    \263\ See Morgan Stanley 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission is persuaded that the
ability to apply the credit risk models should not be narrowed as
proposed in 2012 (i.e., to exposures arising from uncollected variation
and initial margin from commercial end users). The Commission believes
the better approach is to maintain the existing provision in Rule 15c3-
1 that permits an ANC broker-dealer to apply the ANC credit risk model
to credit exposures arising from all derivatives transactions. The
Commission further believes that Rule 18a-1 should permit stand-alone
SBSDs authorized to use models to similarly apply the credit risk
model. Consequently, under the final rules, the credit risk models can
be applied to uncollateralized current exposures to counterparties
arising from all derivatives instruments, including such exposures
arising from not collecting variation margin from counterparties
pursuant to exceptions in the margin rules of the Commission and the
CFTC.\264\
---------------------------------------------------------------------------

    \264\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph
(a)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    The final rules also permit use of the credit risk models instead
of taking the 100% deductions to net worth for electing not to collect
initial margin for non-cleared security-based swaps and swaps pursuant
to exceptions in the margin rules of the Commission and the CFTC,
respectively. This broader application of the credit risk models with
respect to security-based swap and swap transactions--which will reduce
the amount of the capital charges--should mitigate concerns raised by
commenters about the impact that the 100% deductions to net worth would
have on nonbank SBSDs and their counterparties. It also responds to
commenters who requested that the ability to use the credit risk models
be expanded to a broader range of transactions. In addition, the
broader application of credit risk models should mitigate the concerns
raised by commenters that applying the 100% deduction to net worth with
respect to swap transactions would make it difficult, if not
impossible, to maintain an entity dually-registered as a nonbank SBSD
and swap dealer.
    As noted above, the 2018 comment reopening described a potential
cap equal to 10% of the firm's tentative net capital that would limit
the firm's ability to apply the credit risk models to uncollateralized
current exposures arising from electing not to collect variation
margin.\265\ Under this potential threshold, a firm would need to take
a capital charge equal to the aggregate amount of uncollateralized
current exposures that exceeded 10% of the firm's tentative net
capital.
---------------------------------------------------------------------------

    \265\ See Capital, Margin, and Segregation Comment Reopening, 83
FR at 53010.
---------------------------------------------------------------------------

    Commenters addressed this potential cap. One commenter recommended
that rather than an aggregate cap, the Commission adopt a counterparty-
by-counterparty threshold equal to 1% of the firm's tentative net
capital.\266\ In the alternative, this commenter suggested using a 20%
cap, if the Commission deemed it necessary to impose an aggregate
limit. Another commenter suggested that the Commission not adopt the
10% cap and instead rely on the existing portfolio concentration charge
in Rule 15c3-1e that is part of the credit risk model used to calculate
the credit risk charges.\267\
---------------------------------------------------------------------------

    \266\ See Morgan Stanley 11/19/2018 Letter.
    \267\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to the comments, the 10% cap was designed to limit the
amount of a firm's capital base that is comprised of unsecured
receivables. These assets generally are illiquid and cannot be readily
converted to cash, particularly in a time of market stress. Permitting
additional unsecured receivables to be allowable assets for capital
purposes (in the form of either a higher aggregate cap or alternative
thresholds) could substantially impair the firm's liquidity and ability
to withstand a financial shock. Moreover, as discussed above, the
Commission is broadening the application of the credit risk models to
all types of counterparties and transactions that are subject to
exceptions in the margin rules for non-cleared security-based swaps and
swaps.
    For these reasons, the Commission believes it is an appropriate and
prudent measure to adopt the 10% cap for ANC broker-dealers, including
ANC broker-dealer SBSDs. These firms engage in a wide range of
securities activities beyond dealing in security-based swaps, including
maintaining custody of securities and cash for retail customers. They
are significant participants in the securities markets and,
accordingly, the Commission believes it is appropriate to adopt rules
that promote their safety and soundness by limiting the amount of
unsecured receivables that can be part of their regulatory capital.
Thus, the Commission does not believe increasing the 10% cap to a 20%
cap would be appropriate.
    Consequently, under the final rule, these firms are subject to a
portfolio concentration charge equal to 100% of the amount of the
firm's aggregate current exposure to all counterparties in excess of
10% of the firm's tentative net capital.\268\ Thus, unsecured
receivables arising from electing not to collect variation margin are
included in the portfolio concentration charge. The charge does not
include potential future exposure arising from electing not to collect
initial margin.
---------------------------------------------------------------------------

    \268\ See paragraph (c)(3) of Rule 15c3-1e, as amended.
---------------------------------------------------------------------------

    In response to comments, the Commission has reconsidered the
proposed portfolio concentration charge for stand-alone SBSDs
(including stand-alone SBSDs registered as OTC derivatives
dealers).\269\ These firms will engage in a much more limited
securities business as compared to ANC broker-dealers, including ANC
broker-dealer SBSDs. Consequently, they will be a less significant
participant in the broader securities market. Moreover, under existing
requirements, OTC derivatives dealers are not subject to a portfolio
concentration charge.\270\ Therefore, not including a portfolio
concentration charge for stand-alone SBSDs will more closely align the
credit risk model for these firms with the OTCDD credit risk model. The
Commission believes this is appropriate as both types of entities are
limited in the activities they can engage in as compared to ANC broker-
dealers. Further, as discussed above in section II.A.4. of this
release, a stand-alone SBSD that also is registered as an OTC
derivatives dealer will be subject to

Rules 18a-1, 18a-1a, 18a-1b, 18a-1c and 18a-1d rather than Rule 15c3-1
and its appendices (and, in particular, Rule 15c3-1f). Consequently,
not including a portfolio concentration charge in Rule 18a-1 will avoid
having two different standards: one for OTC derivatives dealers that
also are SBSDs and the other for OTC derivatives dealers that are not
SBSDs. For these reasons, the credit risk model for stand-alone SBSDs
in Rule 18a-1 has been modified from the proposal to eliminate the
portfolio concentration charge.\271\
---------------------------------------------------------------------------

    \269\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70244 (proposing a portfolio concentration charge in Rule 18a-
1 for stand-alone SBSDs).
    \270\ See paragraph (c) of Rule 15c3-1f.
    \271\ See paragraph (e)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    In addition to the foregoing modifications to the credit risk
models for ANC broker-dealers and stand-alone SBSDs, the Commission is
making an additional modification to the term ``collateral'' as defined
in the rules for purposes of the models.\272\ In particular, the
existing definition in Rule 15c3-1e and the proposed definition in Rule
18a-1 provided that in applying the credit risk model the fair market
value of collateral pledged by the counterparty could be taken into
account if, among other conditions, the firm maintains possession or
control of the collateral.\273\ Consequently, under the existing and
proposed rules, collateral held at a third-party custodian could not be
taken into account because it was not in the possession or control of
the firm.
---------------------------------------------------------------------------

    \272\ See paragraph (c)(4)(v) of Rule 15c3-1e, as amended;
paragraph (e)(2)(iii)(E) of Rule 18a-1, as adopted.
    \273\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70243.
---------------------------------------------------------------------------

    As discussed above in section II.A.2.b.ii. of this release, the
Commission believes it would be appropriate to recognize a broader
range of custodians for purposes of the exception to taking the
deduction to net worth when initial margin is held at a third-party
custodian. Consequently, the Commission modified that provision so
that, for purposes of the exception, a stand-alone broker-dealer or
nonbank SBSD could recognize collateral held at a bank as defined in
Section 3(a)(6) of the Exchange Act or a registered U.S. clearing
organization or depository that is not affiliated with the counterparty
or, if the collateral consists of foreign securities or currencies, a
supervised foreign bank, clearing organization, or depository that is
not affiliated with the counterparty and that customarily maintains
custody of such foreign securities or currencies.\274\ The Commission
believes the same types of custodians should be recognized for purposes
of the credit risk models and accordingly is modifying the definitions
of ``collateral'' in Rules 15c3-1e, as amended, and 18a-1, as adopted,
to permit an ANC broker-dealer or nonbank SBSD to take into account
collateral held at a third-party custodian that is one of these
entities, subject to the same conditions with respect to foreign
securities and currencies.\275\
---------------------------------------------------------------------------

    \274\ See paragraph (c)(2)(xv)(C)(1) of Rule 15c3-1, as amended;
paragraph (c)(1)(ix)(C)(1) of Rule 18a-1, as adopted.
    \275\ See paragraph (c)(4)(v)(B)(2) of Rule 15c3-1e, as amended;
paragraph (e)(2)(iii)(E)(2) of Rule 18a-1, as adopted. As part of
this modification, paragraph (c)(4)(v)(B) was re-designated
paragraph (c)(4)(v)(B)(1) and the phrase ``and may be liquidated
promptly by the firm without intervention by any other party'' was
added before the semicolon. This rule text was moved from paragraph
(c)(4)(v)(D) of Rule 15c3-1e, because this provision is not
applicable to the third-party custodial provisions in paragraph
(c)(4)(v)(B)(2). As a result, paragraph (c)(4)(v)(D) of Rule 15c3-1e
was deleted and the remaining subparagraphs re-numbered. Conforming
changes also were made to paragraph (e)(2)(iii) of Rule 18a-1, as
amended.
---------------------------------------------------------------------------

    A commenter urged the Commission to modify the proposed application
of the credit risk models to avoid the pass-through of costs to
commercial end users that the commenter argued would result if nonbank
SBSDs are required to hold capital to cover unsecured credit exposures
to these counterparties.\276\ The commenter recommended that the
Commission allow nonbank SBSDs not authorized to compute model-based
haircuts to use the credit risk models (i.e., not limit the use of
credit risk models to ANC broker-dealers and stand-alone SBSDs
authorized to use models). Another commenter suggested that nonbank
SBSDs that have not been approved to use models for capital purposes
also be allowed to compute credit risk charges for uncollected initial
margin by multiplying the exposure by 8% and a credit-risk-weight
factor.\277\
---------------------------------------------------------------------------

    \276\ See Sutherland Letter.
    \277\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response, the Commission does not believe it would be
appropriate to permit stand-alone SBSDs that are not authorized to use
models to apply model-derived credit risk charges. First, the credit
risk models used by ANC broker-dealers and nonbank SBSDs require a
calculation of maximum potential exposure to the counterparty
multiplied by a back-testing-determined factor.\278\ The maximum
potential exposure amount is a charge to address potential future
exposure and is calculated using the firm's market risk model (i.e.,
the model to calculate model-based haircuts) 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. Second, ANC broker-dealers and stand-
alone SBSDs authorized to use models are subject to higher minimum
tentative net capital and net capital requirements. These enhanced
minimum capital requirements are designed to account for the lower
deductions that result from using models. Nonbank SBSDs that have not
been authorized to use models will not be subject to these additional
requirements. Moreover, as a practical matter, the Commission expects
that most nonbank SBSDs will apply to use models.
---------------------------------------------------------------------------

    \278\ See paragraph (c)(4)(i) and Rule 15c3-1e, as amended;
paragraph (e)(2)(iii)(A) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    A commenter argued that adopting an exception from collecting
initial margin from another SBSD for a non-cleared security-based swap
transaction without imposing a deduction from net worth would be
inappropriate.\279\ The commenter argued that these counterparties
could default, which, in turn, could increase systemic risk. In
response, as discussed above in section II.A.2.b.ii. of this release,
the final rules require a nonbank SBSD to take a deduction in lieu of
margin when it does not collect initial margin from a counterparty,
including an SBSD. The capital charge is designed to achieve the same
objective as collecting margin (i.e., protect the nonbank SBSD from the
consequences of the counterparty's default). Moreover, a nonbank SBSD
will be required to collect variation margin from other financial
market intermediaries such as SBSDs.
---------------------------------------------------------------------------

    \279\ See OneChicago 2/19/2013 Letter.
---------------------------------------------------------------------------

    A commenter stated that uncollateralized receivables arising from a
counterparty failing to post margin typically result from operational
issues that are temporary in nature (i.e., that are addressed in a
matter of days) and are liquidated if they last for longer periods of
time.\280\ Consequently, the commenter requested that the Commission
expand the use of credit risk models to instances when the nonbank SBSD
does not collect required margin (i.e., as distinct from when the SBSD
elects not collect margin pursuant to an exception in the margin
rules). As discussed above in section II.A.2.b.ii. of this release with
respect to under-margined accounts, when margin is required it should
be collected promptly, as it is designed to protect the nonbank SBSD
from the consequences of the counterparty defaulting on its
obligations. The 100% deduction from net worth for failing to collect
required margin will serve as an incentive for nonbank SBSDs to have a
well-

functioning margin collection system and the capital needed to take the
deduction will protect the nonbank SBSD from the consequences of the
counterparty's default. However, the final margin rule being adopted
today provides a nonbank SBSD or MSBSP an additional day to collect
required margin from a counterparty (including variation margin due
from an affiliate) if the counterparty is located in a different
country and is more than 4 time zones away.\281\ This should mitigate
the commenter's concern about having to take a deduction when required
margin is not collected in a timely manner.
---------------------------------------------------------------------------

    \280\ See SIFMA 2/22/2013 Letter.
    \281\ See paragraphs (c)(1)(iii) and (c)(2)(ii) of Rule 18a-3,
as adopted. These and other provisions related to the margin rule
are discussed in more detail in section II.B.2. of this release.
---------------------------------------------------------------------------

    Finally, a commenter requested that the Commission permit a nonbank
SBSD to substitute the credit risk charge that would apply to a
transaction with a counterparty with the credit risk charge that would
apply to a transaction with a different counterparty that hedges the
transaction with the first counterparty, as permitted under bank
capital rules under certain conditions.\282\ The commenter cited a bank
regulation that permits this shifting of credit risk charges.\283\ The
bank regulation cited in support of this comment is integrated into the
broader set of bank capital regulations. The commenter did not describe
why such a provision would be appropriate for a nonbank or which bank
regulations would need to be codified into the ANC broker-dealer and
nonbank SBSD capital rules to prudently and effectively implement it.
Consequently, the Commission is not incorporating such a provision into
the ANC broker-dealer and nonbank SBSD capital rules.\284\
---------------------------------------------------------------------------

    \282\ See SIFMA 11/19/2018 Letter.
    \283\ 12 CFR 217.36.
    \284\ See also section II.A.1. of this release (discussing why
the Commission does not believe it would be appropriate to apply a
bank capital standard to a nonbank SBSD).
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting final rules
that permit ANC broker-dealers and stand-alone SBSDs authorized to use
credit risk models to apply the credit risk charges with the
modifications discussed above.\285\ The Commission also is adopting
final rules regarding the operation of the credit risk models with the
modifications discussed above.\286\
---------------------------------------------------------------------------

    \285\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph
(a)(2) of Rule 18a-1, as adopted.
    \286\ See paragraph (c) of Rule 15c3-1e, as amended; paragraph
(e)(2) to Rule 18a-1, as adopted. The following non-substantive
changes are being made. First, ``%'' is replaced with ``percent'' in
paragraph (e)(2) of Rule 18a-1, as adopted, to improve internal
consistency in the rule. Second, ``paragraphs (c)(1)(iv), (vi), and
(vii) of this section'' are replaced with ``paragraphs (c)(1)(iv),
(vi), and (vii) of this section, and Sec.  240.18a-1b,'' in
paragraph (d)(1) of Rule 18a-1, as adopted. Third, ``ten business
day'' is replaced with ``ten-business day'' in paragraph
(d)(9)(i)(C)(5)(i) of Rule 18a-1, as adopted. Fourth, ``paragraphs
(c)(1)(iii), (iv), (vii), or (viii)'' is replaced with ``paragraphs
(c)(1)(iii), (iv), (vi), (vii),'' in paragraph (d)(9)(iii) of Rule
18a-1, as adopted.
---------------------------------------------------------------------------

c. Risk Management
    ANC broker-dealers and OTC derivatives dealers are subject to a
risk management rule.\287\ Rule 15c3-4 requires these firms to, among
other things, 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. The Commission proposed that
nonbank SBSDs be required to comply with Rule 15c3-4 to promote the
establishment of effective risk management control systems by these
firms.\288\
---------------------------------------------------------------------------

    \287\ See 17 CFR 240.15c3-4 (``Rule 15c3-4''); paragraph
(a)(7)(iii) of Rule 15c3-1.
    \288\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70250-70251.
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    Commenters expressed support for the Commission's proposal.\289\ A
commenter stated that requiring nonbank SBSDs to comply with Rule 15c3-
4 ``will better enable nonbank SBSDs to identify and mitigate and
manage the risks they are facing.'' \290\ A second commenter stated
that Rule 15c3-4 should already contemplate the unique needs of a
dealer in derivatives.\291\ The Commission is adopting, as proposed,
the requirement that nonbank SBSDs comply with Rule 15c3-4.\292\
---------------------------------------------------------------------------

    \289\ See Letter from Chris Barnard (Dec. 4, 2012) (``Barnard
Letter''); Financial Services Roundtable Letter.
    \290\ See Barnard Letter.
    \291\ See Financial Services Roundtable Letter.
    \292\ See paragraph (a)(10)(ii) of Rule 15c3-1, as amended
(which applies Rule 15c3-4 to broker-dealer SBSDs not authorized to
use model-based haircuts); paragraph (f) of Rule 18a-1, as adopted
(which applies Rule 15c3-4 to stand-alone SBSDs). In the final rule,
paragraph (g) of Rule 18a-1, as proposed to be adopted, was re-
designated paragraph (f). See paragraph (f) of Rule 18a-1, as
adopted. See also paragraph (a)(7)(iii) of Rule 15c3-1 (which
applies Rule 15c3-4 to ANC broker-dealers, including ANC broker-
dealer SBSDs).
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d. Other Rule 15c3-1 Provisions Incorporated Into Rule 18a-1
i. Debt-Equity Ratio Requirements
    Paragraph (d) of Rule 15c3-1 sets limits on the amount of a stand-
alone broker-dealer's outstanding subordinated loans. The debt-to-
equity limits are designed to ensure that a stand-alone 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. Paragraph (h) of proposed Rule 18a-1
contained parallel debt-to-equity limits.\293\ The Commission did not
receive comments concerning the debt-to-equity limits in proposed Rule
18a-1 and for the reasons discussed in the proposing release is
adopting them as proposed.\294\
---------------------------------------------------------------------------

    \293\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70254-55.
    \294\ See paragraph (g) of Rule 18a-1, as adopted. The debt-
equity ratio requirements were set forth in re-designated paragraph
(g) of Rule 18a-1, as adopted, and conforming changes were made to
applicable cross-references in the rule.
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ii. Capital Withdrawal Requirements
    Paragraph (e)(1) of Rule 15c3-1 requires that a stand-alone broker-
dealer provide notice when it seeks to withdraw capital in an amount
that exceeds certain thresholds. Paragraph (e)(2) of Rule 15c3-1
permits the Commission to issue an order temporarily restricting a
stand-alone broker-dealer from withdrawing capital or making loans or
advances to stockholders, insiders, and affiliates under certain
circumstances. The Commission proposed parallel requirements for stand-
alone SBSDs.\295\ The Commission did not receive comments concerning
the proposed capital withdrawal requirements for stand-alone SBSDs and
for the reasons discussed in the proposing release is adopting them as
proposed.\296\
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    \295\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70254-55.
    \296\ See paragraph (h) of Rule 18a-1, as adopted. The capital
withdrawal requirements were set forth in re-designated paragraph
(h) of Rule 18a-1, as adopted, and conforming changes were made to
applicable cross-references in the rule.
---------------------------------------------------------------------------

iii. Appendix C
    Appendix C to Rule 15c3-1 requires a stand-alone 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.\297\ 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
stand-alone broker-dealer may also be consolidated. Subject to certain
conditions in Appendix C to Rule 15c3-1, a stand-alone broker-dealer
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. However, based on
Commission staff experience and information from an SRO, very few
stand-alone broker-dealers consolidate subsidiaries or affiliates to
obtain the flow-through capital benefits permitted under Appendix C to
Rule 15c3-1.
---------------------------------------------------------------------------

    \297\ See Rule 15c3-1c.
---------------------------------------------------------------------------

    Consequently, the Commission proposed a parallel requirement for a
stand-alone SBSD to 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, but the Commission did not propose parallel
provisions permitting flow-through capital benefits.\298\ The
Commission did not receive comments on this proposed consolidation
requirement and for the reasons discussed in the proposing release is
adopting it as proposed.\299\
---------------------------------------------------------------------------

    \298\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70255.
    \299\ See Rule 18a-1c, as adopted.
---------------------------------------------------------------------------

iv. Appendix D
    Paragraph (c)(2)(ii) of Rule 15c3-1 permits a stand-alone broker-
dealer when computing net capital to exclude liabilities that are
subordinated to the claims of creditors pursuant to a satisfactory
subordination agreement. Excluding these liabilities has the effect of
increasing the firm's net capital. Appendix D to Rule 15c3-1 (Rule
15c3-1d) sets forth minimum and non-exclusive requirements for
satisfactory subordination agreements.\300\ There are two types of
subordination agreements under Rule 15c3-1d: (1) A subordinated loan
agreement, which is used when a third party lends cash to a stand-alone
broker-dealer;\301\ and (2) a secured demand note agreement, which is a
promissory note in which a third party agrees to give cash to a stand-
alone broker-dealer on demand during the term of the note and provides
cash or securities to the broker-dealer as collateral.\302\ Based on
Commission staff experience, stand-alone broker-dealers infrequently
utilize secured demand notes as a source of capital, and the amounts of
these notes are relatively small in size.
---------------------------------------------------------------------------

    \300\ See 17 CFR 240.15c3-1d (``Rule 15c3-1d'').
    \301\ See paragraph (a)(2)(ii) of Rule 15c3-1d.
    \302\ See paragraph (a)(2)(v)(A) of Rule 15c3-1d.
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    Certain of the provisions in Rule 15c3-1d are tied to the minimum
net capital requirements of stand-alone broker-dealers. Consequently,
the Commission proposed amendments to the rule to reflect the proposed
minimum net capital requirements of broker-dealer SBSDs so that they
could realize the net capital benefits of qualified subordination
agreements.\303\ The Commission also included parallel provisions in
proposed Rules 18a-1 and 18a-1d so that stand-alone SBSDs could realize
the net capital benefits of qualified subordination agreements.\304\
However, because stand-alone broker-dealers rarely use secured demand
notes, the proposed provisions for stand-alone SBSDs did not include
this option for entering into a qualified subordinated agreement. The
Commission did not receive comments on the proposed amendments to Rule
15c3-1d or the proposed parallel provisions for stand-alone SBSDs and
for the reasons discussed in the proposing release is adopting them
with certain non-substantive modifications.\305\
---------------------------------------------------------------------------

    \303\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70256, n. 460.
    \304\ See 77 FR at 70255-70256.
    \305\ See Rule 15c3-1d, as amended; paragraph (c)(1)(ii) of Rule
18a-1, as adopted; Rule 18a-1d, as adopted. The final rules are
modified in the following non-substantive ways. The proposed rule
text in Rule 15c3-1d is modified to refer generically to minimum
capital requirements, rather than specific numbers and percentages,
to account for the additional financial ratios that broker-dealer
SBSDs are subject to under Rule 15c3-1. The term ``%'' is replaced
with ``percent'' to improve internal consistency in paragraphs
(b)(7), (b)(8)(i), (b)(10)(ii)(B), and (c)(5)(B) of Rule 15c3-1d, as
amended, and in paragraphs (b)(6), (b)(7), (b)(9)(ii)(A), (c)(2),
and (c)(4) of Rule 18a-1, as adopted. The headers ``(i)'' and
``(ii)'' are removed in paragraph (b)(1) of Rule 18a-1d, as adopted.
The semicolon at the end of paragraph is replaced with a period in
paragraph (c)(2) of Rule 15c3-1d, as amended, and paragraph (b)(5)
of Rule 18a-1d, as adopted. The phrase ``Sec.  240.18a-1 and Sec.
240.18a-1d'' is replaced with ``Sec. Sec.  18a-1 and 18a-1d'' in
paragraphs (b)(8)(i) and (c)(1) of Rule 18a-1d, as adopted.
Semicolons are added at the end of paragraphs (b)(9)(D) and (D)(1)
of Rule 18a-1d, as adopted. The phrase ``[C]lause (i) of paragraph
(b)(8)'' is replaced with ``paragraph (b)(8)(i) of this section'' in
paragraph (b)(9)(ii)(D) of Rule 18a-1d, as adopted.
---------------------------------------------------------------------------

v. Capital Charge for Unresolved Securities Differences
    Paragraph (c)(2)(v) of Rule 15c3-1 requires a stand-alone broker-
dealer to take a capital charge for short securities differences that
are unresolved for seven days or longer and for long securities
differences where the securities have been sold before they are
adequately resolved. These capital charges were inadvertently omitted
from the text of Rule 18a-1 when it was proposed and, consequently, the
Commission proposed to include them in the rule when proposing the
recordkeeping and reporting rules for SBSDs and MSBSPs.\306\ The
Commission received one comment, which addressed concerns regarding
short sale buy-in requirements that are beyond the scope of this
rulemaking.\307\ For the reasons discussed in the proposing release,
the Commission is adopting the capital charges as proposed with minor
non-substantive changes.\308\
---------------------------------------------------------------------------

    \306\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers; Capital Rule for Certain Security-Based Swap
Dealers, 79 FR at 25254.
    \307\ See Shatto Letter.
    \308\ See paragraph (c)(1)(x)(A) through (C) of Rule 18a-1, as
adopted. In the final rule, the Commission replaced the phrase
``broker or dealer'' with ``security-based swap dealer'' in
paragraph (c)(1)(x)(B) and the term ``designated examining authority
for a broker or dealer'' with ``Commission'' in paragraph
(c)(1)(x)(C).
---------------------------------------------------------------------------

3. Capital Rules for Nonbank MSBSPs
    The Commission proposed Rule 18a-2 to establish capital
requirements for nonbank MSBSPs.\309\ Under the proposal, nonbank
MSBSPs were required at all times to have and maintain positive
tangible net worth. The Commission proposed a tangible net worth
standard, 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 stand-alone
broker-dealers or SBSDs. As proposed, the term ``tangible net worth''
was defined to mean the nonbank MSBSP's net worth as determined in
accordance with GAAP, excluding goodwill and other intangible assets.
Consequently, the definition of ``tangible net worth'' allowed 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.
---------------------------------------------------------------------------

    \309\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70256-57.
---------------------------------------------------------------------------

    The Commission also proposed that nonbank MSBSPs must comply with
Rule 15c3-4 with respect to their security-based swap and swap
activities. Requiring nonbank MSBSPs to be subject to Rule 15c3-4 was
intended to promote sound risk management practices with respect to the
risks associated with OTC derivatives.
    Commenters expressed support for the Commission's proposed
requirements for nonbank MSBSPs.\310\ A commenter stated that the
positive tangible net worth test is more appropriate than the net
liquid assets test particularly for entities that have never been
prudentially regulated before.\311\ Another commenter supported ``the
proposed requirement

that MSBSPs maintain a positive tangible net worth.'' \312\ However,
the commenter also stated that the proposed rule ``should recognize and
respect state insurance regulators' role in ensuring the capital
adequacy of financial guaranty insurers, and should accordingly
recognize that, in the case of a financial guaranty insurer, any
positive tangible net worth requirement should be satisfied if an
insurer maintains the minimum statutory capital and complies with the
investment requirements under applicable insurance law.'' \313\ This
commenter also stated that, to the extent that financial guaranty
insurers use affiliates to write CDS that they in turn insure, and
insofar as such affiliates are designated as MSBSPs, the positive
tangible net worth test should refer back to the financial guaranty
insurer itself, as that is the entity that the CDS counterparties look
to for paying the affiliates' obligations under the insured CDS.
---------------------------------------------------------------------------

    \310\ See Barnard Letter; Sutherland Letter.
    \311\ See Sutherland Letter.
    \312\ See Letter from Bruce E. Stern, Chairman, Association of
Financial Guaranty Insurers (Feb. 15, 2013) (``AFGI 2/15/2013
Letter''). See also Letter from Bruce E. Stern, Chairman,
Association of Financial Guaranty Insurers (July 22, 2013) (``AFGI
7/22/2013 Letter'').
    \313\ See AFGI 2/15/2013 Letter.
---------------------------------------------------------------------------

    With respect to the Commission's proposal that nonbank MSBSPs
comply with Rule 15c3-4, the commenter stated that it recognized the
need for nonbank MSBSPs to maintain strong internal risk controls, but
cautioned the Commission against imposing unnecessarily burdensome,
duplicative, and costly risk management controls on financial guaranty
insurers. This commenter also stated that financial guaranty insurers
that are determined to be MSBSPs should be able to establish compliance
with Rule 15c3-4 by virtue of compliance with the New York Department
of Financial Services Circular Letter No. 14, which calls for the
establishment of comprehensive internal risk management controls.
    The Commission has considered the comments on its proposed
requirements for nonbank MSBSPs and is adopting the requirements
substantially as proposed.\314\ The requirement that nonbank MSBSPs at
all times have and maintain positive tangible net worth is intended to
be a less rigorous requirement than the net liquid assets test
applicable to stand-alone broker-dealers and nonbank SBSDs. It will
provide a workable standard for entities that engage in a diverse range
of business activities that differ from, and are broader than, the
securities activities conducted by stand-alone broker-dealers or SBSDs.
---------------------------------------------------------------------------

    \314\ See Rule 18a-2, as adopted. The Commission modified
paragraph (a) of the rule to provide that the tangible net worth
requirement does not apply to a broker-dealer MSBSP. However, a
broker-dealer MSBSP will be required to comply with Rule 15c3-4. See
paragraph (c) of Rule 18a-2, as adopted.
---------------------------------------------------------------------------

    In response to the comment that the rule should recognize and
respect existing state insurance law capital adequacy standards, the
commenter supported the proposed tangible net worth requirement for
nonbank MSBSPs.\315\ The final rule imposes a relatively simple capital
standard--the requirement to maintain positive tangible net worth
(i.e., positive net worth after deducting intangible assets). This
should not impose a significant burden on nonbank MSBSPs, including
firms that also are subject to capital requirements under state
insurance laws. If it is possible that a nonbank MSBSP's capital
position could drop below a positive tangible net worth but at the same
time still comply with a state insurance law capital requirement, the
Commission believes the rule's positive tangible net worth standard
should be the binding constraint with respect to the nonbank MSBSP's
activities as an MSBSP. The Commission does not believe it would be
appropriate to permit a nonbank MSBSP to continue to operate as an
MSBSP if it cannot meet the capital requirement of the positive
tangible net worth test. In such a case, the firm's precarious capital
position would pose a significant risk to its security-based swap
counterparties.
---------------------------------------------------------------------------

    \315\ See AFGI 2/15/2013 Letter (``We support the proposed
requirement that MSBSPs maintain a positive tangible net worth.'').
---------------------------------------------------------------------------

    In response to the comment about nonbank MSBSPs with CDS insured by
an affiliate, the commenter did not identify an alternative capital
standard that should apply to such nonbank MSBSPs. If the commenter was
suggesting that these nonbank MSBSPs should be subject to a lesser
requirement than the positive tangible net worth standard, the
Commission disagrees. As discussed above, the Commission believes this
standard will not impose a substantial burden on nonbank MSBSPs.
Further, to the extent the affiliate insuring the CDS fails, the
nonbank MSBSP will need to rely on its own financial resources.
    The Commission also is adopting, as proposed, the requirement that
MSBSPs comply with Rule 15c3-4.\316\ Although a commenter cautioned the
Commission against imposing unnecessarily burdensome, duplicative, and
costly risk management controls on financial guaranty insurers, the
Commission believes that establishing and maintaining a strong risk
management control system that complies with Rule 15c3-4 is necessary
for entities engaged in a security-based swaps business. Participants
in the securities markets are exposed to various risks, including
market, credit, leverage, liquidity, legal, and operational risk. Risk
management controls 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. Moreover, to the extent an entity, such as a financial guaranty
insurer, complies with existing risk management requirements applicable
to its business, the entity will likely have in place some, if not
many, of the required risk management controls. Thus, the incremental
burdens and costs associated with complying with Rule 15c3-4 should not
be great.
---------------------------------------------------------------------------

    \316\ See paragraph (c) of Rule 18a-2, as adopted.
---------------------------------------------------------------------------

4. OTC Derivatives Dealers
    OTC derivatives dealers are limited purpose broker-dealers that are
authorized to trade in OTC derivatives (including a broader range of
derivatives than security-based swaps) and to use models to calculate
net capital. They are required to maintain minimum tentative net
capital of $100 million and minimum net capital of $20 million.\317\
OTC derivatives dealers also are subject to Rule 15c3-4.
---------------------------------------------------------------------------

    \317\ See paragraph (a)(5) of Rule 15c3-1, as amended.
---------------------------------------------------------------------------

    A commenter stated that OTC derivatives dealers will register as
nonbank SBSDs in order to conduct an integrated equity derivatives
business (i.e., trade in equity security-based swaps and equity OTC
options).\318\ The commenter requested that the Commission modify its
framework for OTC derivatives dealers to allow them to register as
nonbank SBSDs. The commenter further stated that the Commission should
permit an OTC derivatives dealer that is dually registered as a nonbank
SBSD to deal in OTC options and qualifying forward contracts, subject
to the rules applicable to the nonbank SBSD.
---------------------------------------------------------------------------

    \318\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    The Commission agrees with the commenter that entities may seek to
deal in a broader range of OTC derivatives that are securities other
than dealing in just security-based swaps. In order to engage in this
broader securities activity, the entity would need to register as a
broker-dealer. The capital

rules the Commission is adopting today address entities that will
register as broker-dealer SBSDs. In response to the comments, the
Commission believes it would be appropriate to also adopt final rules
to address OTC derivatives dealers that will register as nonbank SBSDs.
Accordingly, the final rules provide that an OTC derivatives dealer
that is registered as a nonbank SBSD must comply with Rule 18a-1, as
adopted, and Rules 18a-1a, 18a-1b, 18a-1c and 18a-1d instead of Rule
15c3-1 and its appendices.\319\ This will simplify the capital rules
for such an entity by requiring the firm to comply with a single set of
requirements.
---------------------------------------------------------------------------

    \319\ See paragraph (a)(5)(ii) of Rule 15c3-1, as amended;
undesignated introductory paragraph to Rule 18a-1, as adopted
(stating that the rule applies to stand-alone SBSDs registered as
OTC derivatives dealers).
---------------------------------------------------------------------------

    Moreover, the provisions of Rule 18a-1 and related rules are
similar to the provisions of Rule 15c3-1 and its appendices. For
example, the minimum fixed-dollar capital requirements in both sets of
rules are $100 million in tentative net capital and $20 million in net
capital. Both sets of rules permit the firms to compute net capital
using models. In addition, as discussed above in section II.A.2.b.v. of
this release, the methodology for computing the credit risk charges in
Rule 18a-1 does not include the proposed portfolio concentration
charge. As a result of this modification, both sets of rules are
consistent in that they do not require this charge. Stand-alone SBSDs
and OTC derivatives dealers also are both subject to Rule 15c3-4. For
these reasons, the Commission believes a stand-alone SBSD should be
able to efficiently incorporate its activities as an OTC derivatives
dealer into its capital and risk management requirements under Rule
18a-1, as adopted.

B. Margin

1. Introduction
    The Commission is adopting Rule 18a-3 pursuant to Section 15F of
the Exchange Act to establish margin requirements for nonbank SBSDs and
MSBSPs with respect to non-cleared security-based swaps. The Commission
modeled Rule 18a-3 on the margin rules applicable to stand-alone
broker-dealers (the ``broker-dealer margin rules'').\320\ A commenter
supported the Commission's decision to base its proposal on the
existing margin rules for stand-alone broker-dealers, noting that it is
critically important that the Commission maintain a level playing field
for similar financial instruments.\321\
---------------------------------------------------------------------------

    \320\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70259.
    \321\ See OneChicago 2/19/2013 Letter.
---------------------------------------------------------------------------

    A number of commenters raised concerns about the Commission's
decision to model proposed Rule 18a-3 on the broker-dealer margin rules
to the extent that doing so resulted in inconsistencies with the margin
rules of the CFTC and the prudential regulators as well as with the
recommendations in the BCBS/IOSCO Paper.\322\ A commenter argued that
the broker-dealer margin rules are not consistent with the restrictions
on re-hypothecation recommended by the BCBS/IOSCO Paper.\323\ This
commenter stated that the Commission needed to tailor its margin
requirements to the realities of the security-based swap and swap
markets.
---------------------------------------------------------------------------

    \322\ The CFTC and the prudential regulators incorporated the
recommendations in the BCBS/IOSCO Paper into their final margin
rules for non-cleared security-based swaps and/or swaps. See CFTC
Margin Adopting Release, 81 FR 636; Prudential Regulator Margin and
Capital Adopting Release, 80 FR 74840.
    \323\ See Letter from Paul Schott Stevens, President and CEO,
Investment Company Institute (May 11, 2015) (``ICI 5/11/2015
Letter'').
---------------------------------------------------------------------------

    Another commenter appreciated that the Commission largely modeled
its proposed margin rules on the broker-dealer margin rules in an
effort to promote consistency with existing rules, but suggested that
the Commission more closely conform its final rules to the
recommendations in the final BCBS/IOSCO Paper to promote the
comparability of margin requirements among jurisdictions.\324\ A second
commenter noted that material differences and inconsistencies between
the proposal and domestic and international standards could cause a
need for separate documentation and tri-party arrangements for
security-based swaps and swaps, which could lead to separate margin
calls and different netting sets.\325\
---------------------------------------------------------------------------

    \324\ See MFA 2/22/2013 Letter.
    \325\ See SIFMA AMG 11/19/2018 Letter.
---------------------------------------------------------------------------

    A commenter suggested that the Commission coordinate its margin
rules with the CFTC and the prudential regulators and raised a concern
that the cumulative effects of multiple regulations potentially could
tie up significant amounts of financial resources.\326\ Other
commenters recommended re-proposing the margin rule after publication
of the final recommendations of the BCBS/IOSCO Paper, as well as
coordinating and harmonizing with the margin rules of the CFTC and
other foreign and domestic regulators.\327\ A commenter argued that
inconsistent rules potentially could be incompatible in practice and
that international adoption of the recommended standards in the BCBS/
IOSCO Paper will prevent regulatory arbitrage and lead to a more level
playing field between competitors in different jurisdictions.\328\
Other commenters argued that the Commission should more closely align
its margin requirements to the recommended standards in the BCBS/IOSCO
Paper to promote more comparable margin requirements across
jurisdictions.\329\ One commenter argued that several components of the
proposed margin rules differ from the recommended framework in the
BCBS/IOSCO Paper and would generally make nonbank SBSDs uncompetitive
with bank SBSDs and foreign SBSDs.\330\ The commenter argued that the
Commission could best address these differences by permitting OTC
derivatives dealers and stand-alone SBSDs to collect and maintain
margin in a manner consistent with the recommendations in the BCBS/
IOSCO Paper.
---------------------------------------------------------------------------

    \326\ See Financial Services Roundtable Letter.
    \327\ See, e.g., Letter from William J. Harrington (Nov. 19,
2018) (``Harrington 11/19/2018 Letter''); ICI 1/23/2013 Letter; ICI
11/19/2018 Letter; ISDA 1/23/13 Letter; Morgan Stanley 10/29/2014
Letter; PIMCO Letter; SIFMA AMG 11/19/2018 Letter. The CFTC and the
prudential regulators re-proposed their margin rules after
publication of the BCBS/IOSCO Paper. See Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 FR
59898 (Oct. 3, 2014); Margin and Capital Requirements for Covered
Swap Entities, 79 FR 57348 (Sept. 24, 2014). As noted above, these
agencies incorporated the recommendations of the BCBS/IOSCO Paper
into their final margin rules. The Commission reopened the comment
period for the proposed capital, margin, and segregation
requirements in October 2018--well after the final recommendations
of the BCBS/IOSCO Paper. In reopening the comment period, the
Commission asked specific questions about potential rule language
that would modify rule text in the proposed margin rule. See
Capital, Margin, and Segregation Comment Reopening.
    \328\ See ISDA 2/5/2014 Letter.
    \329\ See American Council of Life Insurers 2/22/2013 Letter;
American Council of Life Insurers 11/19/2018 Letter; Letter from Dan
Waters, Managing Director, ICI Global (Nov. 24, 2014) (``ICI Global
11/24/2014 Letter''); MFA 2/22/2013 Letter; Letter from Christopher
A. Klem, Leigh R. Fraser, and Molly Moore, Ropes & Gray LLP (Jan.
22, 2013) (``Ropes & Gray Letter''); SIFMA 11/19/2018 Letter.
    \330\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Section 15F(e)(3)(D) of the Exchange Act requires that, to the
maximum extent practicable, the Commission, the CFTC, and the
prudential regulators shall establish and maintain comparable minimum
initial and variation margin requirements for SBSDs and MSBSPs. In
response to the comments above, the Commission has modified the
proposal to more closely align the final rule with the margin rules of
the CFTC and the prudential regulators and, in doing so,

the recommendations in the IOSCO/BCBS Paper. As discussed in more
detail below, these modifications to harmonize the final rule include:
     An extra day to collect margin in the event a counterparty
is located in a different country and more than 4 time zones away;
     A requirement that SBSDs post variation margin to most
counterparties;
     An exception pursuant to which a nonbank SBSD need not
collect initial margin to the extent that the initial margin amount
when aggregated with other security-based swap and swap exposures of
the nonbank SBSD and its affiliates to the counterparty and its
affiliates does not exceed a fixed-dollar $50 million threshold;
     An exception pursuant to which a nonbank SBSD need not
collect initial margin from a counterparty that is an affiliate of the
nonbank SBSD;
     An exception pursuant to which a nonbank SBSD need not
collect variation or initial margin from a counterparty that is the
BIS, the European Stability Mechanism, or certain multilateral
development banks;
     An exception pursuant to which a nonbank SBSD need not
collect initial margin from a counterparty that is a sovereign entity
with minimal credit risk;
     An option for nonbank SBSDs to use models to calculate
initial margin that are different from the models they use to calculate
capital charges;
     An option for nonbank SBSDs to use models developed by
third parties (which will permit the use of an industry standard model
such as ISDA's SIMMTM model); \331\
---------------------------------------------------------------------------

    \331\ Information about ISDA's SIMMTM model is
available at https://www.isda.org/category/margin/isda-simm/.
---------------------------------------------------------------------------

     An option for stand-alone SBSDs to use a model to
calculate initial margin for equity security-based swaps subject to
certain conditions;
     An option for nonbank SBSDs to collect and deliver
collateral that is eligible under the CFTC's margin rules; and
     An option for nonbank SBSDs to use the standardized
haircuts prescribed in the CFTC's margin rule to determine deductions
for collateral received or delivered as margin.
    While differences remain, the Commission believes the final nonbank
SBSD margin rule for non-cleared security-based swaps is largely
comparable to the margin rules of the CFTC and the prudential
regulators. The main differences are that the Commission's rule:
     Does not require (but permits) nonbank SBSDs to collect
initial margin from counterparties that are financial market
intermediaries such as SBSDs, swap dealers, FCMs, and domestic and
foreign broker-dealers and banks;
     Does not require (but permits) nonbank SBSDs to post
initial margin to a counterparty;
     Does not contain the exceptions from the requirement to
collect margin for counterparties such as financial end users that do
not have material exposures to security-based swaps and swaps; and
     Does not require (but permits) initial margin to be held
at a third-party custodian.
    These differences between the Commission's final rule and the
margin rules of the CFTC and the prudential regulators reflect the
Commission's judgment of how ``to help ensure the safety and
soundness'' of nonbank SBSDs and MSBSPs as required by Section
15F(e)(3)(i) of the Exchange Act. The Commission has sought to strike
an appropriate balance between addressing the concerns of commenters
and promulgating a final margin rule that promotes the safety and
soundness of nonbank SBSDs.\332\ For these reasons, the Commission is
adopting a final rule--Rule 18a-3--that is modeled on the broker-dealer
margin rule but with the significant modifications noted above. These
modifications further harmonize the rule with the final margin rules of
the CFTC and the prudential regulators. In particular, and as discussed
in more detail below, these changes are intended, in part, to permit
firms that are registered as SBSDs and swap dealers to collect initial
margin and collect and deliver variation margin in a manner consistent
with current practices under the CFTC's margin rules, which should in
turn reduce operational burdens that would arise due to differences in
these requirements.\333\ Moreover, while paragraphs (c)(4) and (5) of
Rule 18a-3, as adopted, respectively require netting and collateral
agreements to be in place,\334\ the rule does not impose a specific
margin documentation requirement as do the margin rules of the CFTC and
the prudential regulators.\335\ Consequently, an existing netting or
collateral agreement with a counterparty that was entered into by the
nonbank SBSD in order to comply with the margin documentation
requirements of the CFTC or the prudential regulators will suffice for
the purposes of Rule 18a-3, as adopted, if the agreement meets the
requirements of paragraph (c)(4) or (5), as applicable.
---------------------------------------------------------------------------

    \332\ See Section VI of this release (discussing benefits and
costs of the final margin requirements).
    \333\ Furthermore, although Rule 18a-3 does not mandate that
SBSDs deliver initial margin to their counterparties (or to deliver
or collect initial margin from financial market intermediaries) as
the CFTC's margin rules do, nothing in Rule 18a-3 prohibits nonbank
SBSDs from delivering initial margin to these counterparties or
collecting initial margin from or posting initial margin to
financial market intermediaries. In addition, as above in section
II.A.2.b.i. of this release, the Commission is providing guidance
that would permit nonbank SBSDs to post initial margin to
counterparties without taking a capital charge pursuant to certain
conditions.
    \334\ See paragraph (c)(4) of Rule 18a-3, as adopted (providing
that a nonbank SBSD or MSBSP may take into account the fair market
value of collateral delivered by a counterparty, provided the
collateral is subject to an agreement between the SBSD or the MSBSP
and the counterparty that is legally enforceable by the SBSD or
MSBSP against the counterparty and any other parties to the
agreement); paragraph (c)(5) of Rule 18a-3, as adopted (prescribing
requirements for qualified netting agreements).
    \335\ See 17 CFR 23.159 (CFTC rule requiring that margin
documentation: (1) Specify the methods, procedures, rules, inputs,
and data sources to be used for determining the value of non-cleared
swaps for purposes of calculating variation margin; (2) describe the
methods, procedures, rules, inputs, and data sources to be used to
calculate initial margin for non-cleared swaps entered into between
the covered swap entity and the counterparty; and (3) specify the
procedures by which any disputes concerning the valuation of non-
cleared swaps, or the valuation of assets collected or posted as
initial margin or variation margin may be resolved); see also CFTC
Margin Adopting Release, 81 FR at 672-73, 702-3; Prudential
Regulator Margin and Capital Adopting Release, 80 FR at 74886-87,
74908-909.
---------------------------------------------------------------------------

2. Margin Requirements for Nonbank SBSDs and Nonbank MSBSPs
a. Daily Calculations
i. Nonbank SBSDs
    Proposed Rule 18a-3 required a nonbank SBSD to perform two
calculations for the account of each counterparty: (1) The amount of
equity in the account (variation margin); and (2) the initial margin
amount for the account.\336\ The term ``equity'' was 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 meeting the requirements
of the rule. As indicated by the definition, the Commission proposed
that the nonbank SBSD could offset payables and receivables relating to
derivatives in the account by applying a qualifying netting agreement
with the counterparty. Proposed Rule 18a-3 set forth the requirements
for a netting agreement to qualify for this treatment. The equity in
the account was the amount that resulted after

marking-to-market the securities positions and adding the credit
balance or subtracting the debit balance (including giving effect to
qualifying netting agreements). An account with negative equity was
subject to a variation margin requirement unless an exception from
collecting collateral to cover the negative equity (i.e., the nonbank
SBSD's current exposure) applied.
---------------------------------------------------------------------------

    \336\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70260-62.
---------------------------------------------------------------------------

    The proposed rule set forth a standardized and a model-based
approach for calculating initial margin.\337\ The rule divided
security-based swaps into two classes for purposes of the standardized
approach: (1) CDS; and (2) all other security-based swaps. In both
cases, the initial margin amount was to be calculated using the
standardized haircuts in the proposed capital rules for nonbank SBSDs.
---------------------------------------------------------------------------

    \337\ See 77 FR at 70261.
---------------------------------------------------------------------------

    Proposed Rule 18a-3 provided that, if the nonbank SBSD was
authorized to use model-based haircuts, the firm could use them to
calculate initial margin for security-based swaps for which the firm
had been approved to apply such haircuts.\338\ However, model-based
haircuts could not be used to calculate initial margin for equity
security-based swaps. Initial margin for equity security-based swaps
needed to be calculated using standardized haircuts in order to be
consistent with SRO margin rules for cash equity positions.
Consequently, a nonbank SBSD authorized to use model-based haircuts for
certain types of debt security-based swaps could use these haircuts to
calculate initial margin for the same types of positions. For all other
positions, a nonbank SBSD needed to use the standardized haircuts.
Nonbank SBSDs not authorized to use model-based haircuts needed to use
the standardized haircuts to calculate initial margin for all types of
positions.
---------------------------------------------------------------------------

    \338\ In the 2018 comment reopening, the Commission also sought
comment on whether the margin rule should permit nonbank SBSDs to
apply to use models other than proprietary capital models to compute
initial margin, including applying to use an industry standard
model. Capital, Margin, and Segregation Comment Reopening, 83 FR at
53013.
---------------------------------------------------------------------------

    Finally, proposed Rule 18a-3 required a nonbank SBSD to increase
the frequency of the variation and initial margin calculations (i.e.,
perform intra-day calculations) during periods of extreme volatility
and for accounts with concentrated positions.\339\
---------------------------------------------------------------------------

    \339\ See Capital, Margin, and Segregation Proposing Release, 77
FR at 70260.
---------------------------------------------------------------------------

Comments and Final Requirements To Calculate Variation Margin
    A commenter sought clarification as to whether the mark-to-market
value of security-based swap positions would only be counted in the
definition of ``equity'' as part of the credit balance or the debit
balance, as appropriate.\340\ This commenter believed the absence of
credit and debit balance definitions created a potential issue that the
mark-to-market value of non-cleared security-based swap positions would
be double counted in the calculation of the equity in a counterparty's
account. In response, a nonbank SBSD should only include the mark-to-
market value of a security-based swap once when calculating equity in
determining the variation margin requirement.
---------------------------------------------------------------------------

    \340\ See SIFMA 2/22/13 Letter.
---------------------------------------------------------------------------

    Another commenter stated that counterparties should be permitted to
reference third parties for dispute resolution, valuations, and inputs
in relation to their account equity variation margin calculations.\341\
In response, the Commission agrees that price and valuation information
from third parties can be useful in validating the nonbank SBSD's
variation margin calculations and in the dispute resolution process.
---------------------------------------------------------------------------

    \341\ See Letter from Kevin Gould, President, Markit (Feb. 22,
2013) (``Markit Letter'').
---------------------------------------------------------------------------

    The Commission is adopting the requirement to calculate variation
margin for the account of a counterparty on a daily basis, with certain
non-substantive modifications to the rule, in response to comments and
to use terms that are more commonly used in the security-based swap
market.\342\ In the final rule, the Commission has deleted the term
``equity'' and the definitions of ``positive equity'' and ``negative
equity'' and has included the phrase ``current exposure'' without
defining it.\343\ The phrase ``current exposure'' is used more commonly
in the non-cleared security-based swap market when describing
uncollateralized mark-to-market gains or losses.
---------------------------------------------------------------------------

    \342\ See paragraph (c)(1)(i)(A) of Rule 18a-3, as adopted.
    \343\ See paragraph (c)(1)(i)(A) of Rule 18a-3, as adopted. The
Commission also proposed to define the term ``positive equity'' to
mean equity of greater than $0 and ``negative equity'' to mean
equity of less than $0. The Commission received no comments on these
proposed definitions. However, the Commission is deleting them in
the final rule because the term equity is no longer being defined.
In addition, paragraph (b)(1) of proposed Rule 18a-3 defined the
term ``account'' for purposes of the daily calculations of variation
and initial margin to mean an account carried by a nonbank SBSD or
MSBSP for a counterparty that holds non-cleared security-based
swaps. The Commission did not receive any comments on this
definition. However, the Commission is modifying the definition to
move the clause ``for a counterparty'' to the end of the definition
to clarify that the nonbank SBSD holds non-cleared security-based
swaps for a counterparty, and to add the term ``one or more'' before
the phrase ``non-cleared security-based swaps.'' Furthermore,
paragraph (b)(3) of proposed Rule 18a-3 defined the term
``counterparty'' to mean a person with whom the nonbank SBSD or
MSBSP has entered into a non-cleared security-based swap
transaction. The Commission received no comments on this definition
and is adopting it as proposed.
---------------------------------------------------------------------------

Comments and Final Requirements To Calculate Initial Margin Using the
Standardized Approach
    Commenters argued that the standardized approach to calculating
initial margin was too conservative and not sufficiently risk
sensitive.\344\ A commenter stated that the standardized approach would
result in excessive margin requirements because the standardized
haircuts in the capital rules were applied to gross notional amounts
and only permitted limited netting.\345\ This commenter also argued
that it was unclear how the proposed grids applied to more complex
products.
---------------------------------------------------------------------------

    \344\ See ISDA 1/23/2013 Letter; Markit Letter.
    \345\ See ISDA 1/23/2013 Letter.
---------------------------------------------------------------------------

    In response to these concerns, nonbank SBSDs may seek authorization
to calculate initial margin using the model-based approach. Based on
staff experience and the ongoing implementation of margin rules for
non-cleared security-based swaps and swaps by other regulators and
market participants, the Commission believes that most nonbank SBSDs
will seek authorization to use a model. The availability of an initial
margin model and the widespread use of initial margin models by
industry participants should alleviate commenters' concerns that using
standardized haircuts to calculate initial margin will lead to
excessive initial margin requirements. While the Commission agrees that
standardized haircuts likely will lead to more conservative
requirements in contrast to the model-based initial margin
calculations, the Commission does not believe these requirements will
be excessive. The standardized haircuts have been used by stand-alone
broker-dealers for many years. Moreover, as discussed below, the
Commission is modifying the proposal to add a threshold under which
initial margin need not be collected. This should mitigate the concern
raised by the commenter with regard to using the standardized haircuts
to calculate initial margin. Finally, the ability to use the simpler
standardized haircuts for initial margin calculations may be preferable
for nonbank SBSDs that occasionally trade in non-cleared security-based
swaps but not in a substantial enough

volume to justify the initial and ongoing systems and personnel costs
that may be associated with the implementation and operation of an
initial margin model.
    Commenters argued that nonbank SBSDs should be permitted to use
approaches other than the standardized approach to calculate initial
margin for equity security-based swaps.\346\ One commenter stated that
the standardized haircuts in the capital rules that would be used to
calculate initial margin for equity security-based swaps--including the
more risk sensitive standardized haircut approach in Rule 15c3-1a and
proposed Rule 18a-1a (``Appendix A methodology'')--are inadequate and
inefficient for a proper initial margin calculation and do not
sufficiently recognize portfolio margining. This commenter argued that
the Appendix A methodology does not incorporate critical factors such
as volatility, and, as a result, initial margin on equity security-
based swaps would likely be insufficient in times of market stress (in
contrast to a model-based approach). Finally, this commenter stated
that requiring the Appendix A methodology for non-cleared equity
security-based swaps would place U.S.-based nonbank SBSDs at a
competitive disadvantage in the market because no other jurisdiction
(or other U.S. regulator) has proposed to prohibit the use of models
for specific asset classes.\347\ Another commenter similarly raised
concerns that applying the Appendix A methodology (as compared to a
model) would result in initial margin requirements that are
substantially less sensitive to the economic risks of a security-based
swap portfolio, and suggested that the Commission permit a nonbank SBSD
to use a model to calculate initial margin for equity security-based
swaps.\348\ Several other commenters endorsed the use of models to
compute initial margin for equity security-based swaps.\349\
---------------------------------------------------------------------------

    \346\ See ISDA 1/23/2013 Letter; SIFMA 2/22/2013 Letter; SIFMA
11/19/2018 Letter.
    \347\ See ISDA 1/23/2013 Letter.
    \348\ See SIFMA 2/22/2013 Letter.
    \349\ See Center for Capital Markets Competitiveness, Chamber of
Commerce 11/19/2018 Letter; Letter from Scott O'Malia, Chief
Executive Officer, International Swaps and Derivatives Association
(Nov. 19, 2018) (``ISDA 11/19/2018''); OneChicago 11/19/2018 Letter;
SIFMA AMG 2/22/2013 Letter; SIFMA 11/19/2018 Letter. One commenter
suggested that the Commission permit stand-alone SBSDs and SBSDs
dually-registered as OTC derivatives dealers to calculate initial
margin for equity security-based swaps using an industry standard
model such as SIMMTM. See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission continues to believe it is important to maintain
parity between the margin requirements in the cash equity markets and
the margin requirements for equity security-based swaps. The only
method currently available to portfolio margin positions in the cash
equity markets is the Appendix A methodology.\350\ Consequently, the
Commission is adopting the requirement to use the standardized approach
to calculate initial margin for non-cleared equity security-based
swaps, but with a modification to address commenters' concerns.\351\ In
particular, the Commission is modifying the margin rule to permit a
stand-alone SBSD to use a model to calculate initial margin for non-
cleared equity security-based swaps, provided the account does not hold
equity security positions other than equity security-based swaps and
equity swaps (e.g., the account cannot hold long and short positions,
options, or single stock futures).\352\ The Commission believes
permitting the model-based approach under these limited circumstances
strikes an appropriate balance in terms of addressing commenters'
concerns and maintaining regulatory parity between the cash equity
market and the equity security-based swap market. Moreover, a nonbank
stand-alone SBSD could seek authorization to use a model to portfolio
margin equity security-based swaps with equity swaps. Similarly, as
discussed above in relation to the standardized haircuts, the
Commission modified the Appendix A methodology from the proposal to
permit equity swaps to be included in a portfolio of equity products.
The ability to use the model-based approach for equity security-based
swaps (and potentially equity swaps) and the modification to the
Appendix A methodology will facilitate portfolio margining of equity
security-based swaps and equity swaps, though the Commission and the
CFTC will need to coordinate further to implement this type of
portfolio margining.\353\
---------------------------------------------------------------------------

    \350\ See FINRA Rule 4210(g).
    \351\ See paragraph (d)(1) of Rule 18a-3, as adopted. In the
final rule, the Commission replaced the term ``margin'' with the
term ``initial margin amount'' and replaced the phrase ``of positive
equity in an account of a counterparty'' with the phrase
``calculated pursuant to paragraph (d) of this section.'' See
paragraph (b)(4) of Rule 18a-3, as adopted. These are non-
substantive changes to conform the rule text to changes made to
other paragraphs of the final rule. In addition, in the final rule
the Commission deleted the phrase ``calculated pursuant to paragraph
(d)(2) of this section'' from paragraph (c)(1)(i)(B) of the rule,
because the phrase, as modified, was moved to paragraph (b)(4) of
the rule to define the term ``initial margin amount.''
    \352\ See paragraph (d)(2)(ii) of Rule 18a-3, as adopted. See
also Capital, Margin, and Segregation Comment Reopening, 83 FR at
53015-16. In the reopening, the potential modifications to the rule
contained the phrase ``provided, however, the account of the
counterparty subject to the requirements of this paragraph may not
hold equity securities or listed options.'' 83 FR at 53016. The
final rule contains the phrase ``provided, however, the account of
the counterparty subject to the requirements of this paragraph may
not hold equity security positions other than equity security-based
swaps and equity swaps.'' The final rule clarifies that the account
of a counterparty utilizing this paragraph may not hold equity
security positions other than equity security-based swaps and equity
swaps.
    \353\ See, e.g., Order Granting Conditional Exemption Under the
Securities Exchange Act of 1934 in Connection with Portfolio
Margining of Swaps and Security-Based Swaps, 77 FR 75211.
---------------------------------------------------------------------------

Comments and Final Requirements To Calculate Initial Margin Using the
Model-Based Approach
    Comments addressing the model-based approach to calculating initial
margin generally fell into one of two broad categories: (1) Comments
raising concerns about the risks of using models; and (2) comments
supporting the use of models but suggesting modifications to the
proposal or seeking clarifications as to how the proposal would work in
practice.
    In terms of concerns about the risks of models, one commenter
argued that using models for capital and margin calculations likely
will make capital and margin more pro-cyclical because market data used
in the models will show less risk during strong periods of the economic
cycle and more risk during downturns.\354\ This commenter recommended,
among other things, that if internal models continue to be used, they
should be ``floored'' at the level set by standardized approaches
(e.g., those used in bank capital regimes), and that the Commission
should continue with a review of the implications of the use of
internal models. Another commenter stated that netting derivatives
exposures (a component of model-based initial margin calculations) when
calculating potential losses is an unsound risk management
practice.\355\ According to the commenter, even if two positions appear
to offset one another, liquidity conditions, replacement costs, and
counterparty credit risk may vary considerably.
---------------------------------------------------------------------------

    \354\ See Americans for Financial Reform Letter.
    \355\ See Better Markets 1/22/2013 Letter; Better Markets 7/22/
2013 Letter.
---------------------------------------------------------------------------

    The Commission acknowledges the concerns expressed by commenters
about the efficacy of models, particularly in times of market stress.
The Commission nonetheless believes it is appropriate to permit firms
to employ a model to calculate initial margin. The Commission's
supervision of the firms' use of models as well as the conditions that
will be imposed governing their use will provide checks that are
designed to address the risks identified by the

commenters, such as the potential for firms to manipulate their
collateral needs. In addition, the CFTC, the prudential regulators, and
foreign financial regulators permit the use of internal models to
calculate initial margin. Permitting nonbank SBSDs to use models for
this purpose will further harmonize the Commission's margin rule with
the rules of domestic and foreign regulators and, therefore, minimize
potential competitive impacts of imposing different requirements.
    Commenters supporting the use of models commented on the proposed
requirement that the initial margin model needed to be the same model
used by the nonbank SBSD to calculate haircuts for purposes of the
proposed capital rules. These commenters supported the Commission's
potential modification to permit nonbank SBSDs to use models other than
proprietary capital models to compute initial margin, including an
industry standard model.\356\ A commenter stated that the rule should
provide a nonbank SBSD with the option to choose between internal and
third-party models to avoid an uneven playing field among
counterparties, noting that not all entities have sufficient resources
to develop internal models.\357\ This commenter argued that permitting
a nonbank SBSD to use a third-party model would reduce the time and
resources needed for the Commission to authorize the use of the model.
A second commenter requested that nonbank SBSDs be permitted to use an
industry standard model to compute initial margin and argued that such
a model would result in efficiency, transparency, and consistency in
the marketplace.\358\ Other commenters generally supported the use of
an industry standard model to compute initial margin.\359\
---------------------------------------------------------------------------

    \356\ See Center for Capital Markets Competitiveness, Chamber of
Commerce 11/19/2018 Letter; ISDA 11/19/2018 Letter; MFA/AIMA 11/19/
2018 Letter; SIFMA 11/19/2018 Letter.
    \357\ See Markit Letter.
    \358\ See SIFMA 3/12/2014 Letter; SIFMA 11/19/2018 Letter.
    \359\ See Center for Capital Markets Competitiveness, Chamber of
Commerce 11/19/2018 Letter; MFA/AIMA 11/19/2018 Letter; SIFMA 11/19/
2018 Letter.
---------------------------------------------------------------------------

    Making a similar point about the benefits of model transparency, a
commenter suggested that internal models should be available to
counterparties upon request.\360\ Similarly, commenters suggested that
the ability of a counterparty to replicate a firm's initial margin
model should be a condition of the Commission's approval of the model,
or that the calculation of initial margin should be independently
verifiable.\361\ A commenter argued that external models, in some
cases, are preferable to internal models because there is less
potential for firms to manipulate their collateral needs.\362\ The
commenter also supported the use of pre-approved clearing agency and
DCO models as one input in the calculation of initial margin for non-
cleared positions, but cautioned that additional inputs should be
required. The commenter opposed the use of vendor-supplied models for
the calculation of margin due to concerns that vendors may develop
models that would help firms minimize required margin.
---------------------------------------------------------------------------

    \360\ See Sutherland Letter.
    \361\ See MFA 2/22/2013 Letter; MFA/AIMA 11/19/2018 Letter;
Letter from Timothy W. Cameron, Managing Director, and Matthew J.
Nevins, Managing Director and Associate General Counsel, Securities
Industry and Financial Markets Association Asset Management Group
(Feb. 22, 2013) (``SIFMA AMG 2/22/2013 Letter'').
    \362\ See CFA Institute Letter.
---------------------------------------------------------------------------

    Commenters also addressed the potential offsets that could be
permitted with respect to the model-based initial margin calculations.
A commenter argued that netting should be limited to exactly offsetting
positions and that positions that are potentially correlated due to,
for example, long and short positions in the same broad industry should
not be permitted to be offset.\363\ On the other hand, another
commenter requested that counterparties be permitted to use a broader
product set to calculate initial margin than the set required by each
counterparty's applicable regulation.\364\ The commenter stated that
this broader product set potentially could include a wide set of
bilaterally traded products, even if such products are not swaps or
derivatives. Other commenters asked the Commission to clarify whether
cleared and non-cleared security-based swaps could be offset.\365\ A
commenter stated that if U.S. registrants must structure their
activities so as to margin non-centrally cleared security-based swaps
and swaps separately from other non-centrally cleared derivatives, they
would be at a significant competitive disadvantage to foreign
competitors.\366\ Another commenter encouraged the Commission to
consider allowing participants to calculate the risk of positions
within broad asset classes and then sum the risk calculations for each
asset class.\367\ A commenter also stated that it is essential that
national supervisors provide consistent and more comprehensive guidance
regarding model inputs (including baseline stress scenarios) and the
adjustment of model inputs.\368\ Commenters supported the cross-
margining of security-based swaps with other products under a single
cross-product netting agreement, as well as the portfolio margining of
cleared security-based swaps and swaps.\369\
---------------------------------------------------------------------------

    \363\ See Americans for Financial Reform Letter.
    \364\ See Letter from Mary P. Johannes, Senior Director and Head
of ISDA WGMR Initiative, International Swaps and Derivatives
Association (May 15, 2015) (``ISDA 5/15/2015 Letter'').
    \365\ See, e.g., AIMA 2/22/2013 Letter; Letter from American
Benefits Council, Committee on Investment of Employee Benefit
Assets, European Federation for Retirement Provision, the European
Association of Paritarian Institutions, the National Coordinating
Committee for Multiemployer Plans, and the Pension Investment
Association of Canada (Jan. 29, 2013) (``American Benefits Council,
et al. 1/29/2013 Letter''); ISDA 2/5/2014 Letter; MFA 2/22/2013
Letter; Ropes & Gray Letter; SIFMA 2/22/2013 Letter.
    \366\ See Letter from Kenneth E. Bentsen, Jr., President and
Chief Executive Officer, Securities Industry and Financial Markets
Association (Mar. 12, 2014) (``SIFMA 3/12/2014 Letter'').
    \367\ See ISDA 2/5/2014 Letter.
    \368\ See SIFMA 3/12/14 Letter.
    \369\ See FIA 11/19/2018 Letter; MFA/AIMA 11/19/20178 Letter;
OneChicago 11/19/2018 Letter; SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Commenters also requested that the Commission facilitate portfolio
margining.\370\ A commenter supported the Commission's proposal to
allow portfolio margining between cash market securities and security-
based swaps, and encouraged the Commission to work with other
regulators to make such an approach as expansive as possible.\371\
Other commenters encouraged the Commission to permit a nonbank SBSD
(including a broker-dealer SBSD) to portfolio margin non-cleared
security-based swaps with non-cleared swaps in accordance with the
CFTC's margin and segregation rules, subject to appropriate conditions
(including appropriately calibrated capital charges and waiver of
customer protection rules).\372\ Another commenter argued that the
CFTC, in turn, should expand its existing relief allowing a swap dealer
to collect and post margin on a portfolio basis for swaps and security-
based swaps under the CFTC's margin rules by reciprocally allowing a
dually registered swap dealer and nonbank SBSD to portfolio margin
security-based swaps and swaps under the Commission's margin
rules.\373\ One commenter suggested that the Commission clarify that
the portfolio margining of cleared and non-cleared

security-based swaps and swaps should be permitted and encouraged the
Commission to coordinate with the CFTC to determine appropriate
conditions for enhanced portfolio margining.\374\
---------------------------------------------------------------------------

    \370\ See Capital, Margin, and Segregation Comment Reopening, 83
FR at 53014-16. See also Center for Capital Markets Competitiveness,
Chamber of Commerce 11/19/2018 Letter; ICI 11/19/2018 Letter; ISDA
11/19/2018 Letter; SIFMA 11/19/2018 Letter.
    \371\ See Financial Services Roundtable Letter.
    \372\ See Citigroup 4/24/2018 Meeting; IIB/SIFMA Letter.
    \373\ See IIB/SIFMA Letter; see also CFTC Letter 16-71 (Aug. 23,
2016).
    \374\ See MFA/AIMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    To expedite the approval process, some commenters suggested that
the Commission permit the use of initial margin models approved by
other domestic and foreign regulators, or a model already approved for
a firm's parent company.\375\ One commenter suggested that the
Commission provisionally approve proprietary models used by nonbank
SBSDs when the margin rules first become effective subject to further
Commission review.\376\ The commenter argued that such a process would
prevent those firms whose models were reviewed earlier from having an
unfair market advantage over those firms that are positioned later in
the Commission's review schedule.
---------------------------------------------------------------------------

    \375\ See IIB11/19/2018 Letter; ISDA 1/23/2013 Letter; SIFMA 3/
12/2014 Letter.
    \376\ See ISDA 1/23/2013 Letter.
---------------------------------------------------------------------------

    Other commenters argued that the Commission should restrict the use
of portfolio margining to ensure greater security for market
participants, or stated that the Commission did not provide an
explanation as to how the Commission would oversee portfolio margin
models.\377\
---------------------------------------------------------------------------

    \377\ See Americans for Financial Reform Education Fund Letter;
Better Markets 11/19/2018 Letter; Rutkowski 11/20/2018 Letter.
Another commenter opposed the portfolio margining of swaps with flip
clauses, walkaway clauses, or similar provisions. See Harrington 11/
19/2018 Letter.
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    In response to comments, the Commission made the following
modifications to the proposed model-based approach to calculating
initial margin: (1) Nonbank SBSDs may use a model other than their
capital model; (2) the final rule provides more clarity as to the
offsets permitted of an initial margin model; (3) the final rule
permits stand-alone SBSDs to use a model to portfolio margin equity
security-based swaps and will permit these entities to include equity
swaps in the portfolio, subject to further coordination with the CFTC;
and (4) as discussed above in section II.A.2.b.iv. of this release, the
final capital rule provides that the Commission may approve the
temporary use of a provisional model by a nonbank SBSD for the purposes
of calculating initial margin if the model had been approved by certain
other supervisors.
    As indicated, the final rule does not limit a nonbank SBSD to using
its capital model to calculate initial margin.\378\ For example, after
the Commission proposed Rule 18a-3, the CFTC and the prudential
regulators adopted final margin rules permitting the use of a model to
calculate initial margin subject to the approval of the CFTC or a
firm's prudential regulator.\379\ The first compliance date for these
rules for both variation and initial margin was September 1, 2016 for
the largest firms.\380\ The Commission understands that the firms
subject to these final rules have widely adopted the use of an industry
standard model to compute initial margin.\381\ Based on these
developments, the Commission believes that most nonbank SBSDs likely
will apply to the Commission to use the industry standard model to
compute initial margin. The final rule permits the use of such a model,
subject to approval by the Commission.
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    \378\ See paragraph (d)(2) of Rule 18a-3, as adopted. See
Capital, Margin, and Segregation Comment Reopening, 83 FR at 53012-
13 (soliciting comment on potential rule language that would modify
the proposal in this manner).
    \379\ See Prudential Regulator Margin and Capital Adopting
Release, 80 FR at 74876; CFTC Margin Adopting Release, 81 FR at 654.
    \380\ See, e.g., Prudential Regulator Margin and Capital
Adopting Release, 80 FR at 74849-74851; CFTC Margin Adopting
Release, 81 FR at 674-677. Variation margin requirements have been
implemented pursuant to these rules, while initial margin
requirements are being phased in through September 1, 2020.
    \381\ See, e.g., ISDA, ISDA SIMM\TM\ Deployed Today; New
Industry Standard for Calculating Initial Margin Widely Adopted by
Market Participants (Sept. 1, 2016), available at https://www.isda.org/2016/09/01/isda-simm-deployed-today-new-industry-standard-for-calculating-initial-margin-widely-adopted-by-market-participants/.
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    The Commission believes that the ability to use an initial margin
model (other than the firm's capital model)--including the industry
standard model that has been widely adopted by market participants--
will mitigate many of the concerns raised by commenters. Counterparties
will be better able to replicate the initial margin calculations of the
nonbank SBSDs with whom they transact. Giving counterparties the
ability to meaningfully estimate potential future initial margin calls
will allow them to prepare for contingencies and minimize the risk of
their failure to meet a margin call. This increased transparency will
benefit the nonbank SBSD and the counterparty. Consequently, widespread
use of an industry standard model to calculate initial margin may
increase transparency and decrease margin disputes. This should
mitigate commenters' concerns regarding the transparency of a nonbank
SBSD's proprietary model used to calculate initial margin, as the
Commission believes that most nonbank SBSDs likely will apply to the
Commission to use the industry standard model to compute initial
margin.
    The Commission acknowledges that some nonbank SBSDs may choose to
use models other than the industry standard model. However, the
anticipated widespread use of the industry standard model will provide
counterparties with the option of taking their business to nonbank
SBSDs that use this model to the extent they are concerned about a lack
of transparency with respect to other models used by nonbank SBSDs.
Moreover, this could incentivize firms that use other models to make
them more transparent to market participants.
    The final rule also provides that the initial margin model must use
a 99%, one-tailed confidence level with price changes equivalent to a
10 business-day movement in rates and prices, and must use risk factors
sufficient to cover all the material price risks inherent in the
positions for which the initial margin amount is being calculated,
including foreign exchange or interest rate risk, credit risk, equity
risk, and commodity risk, as appropriate.\382\ Several commenters
opposed a 10 business-day movement in rates and prices as part of the
quantitative requirements for using a model and recommended that the
Commission reduce the close-out period to 3 or 5 days.\383\ One of
these commenters argued that a 10-day period substantially overstates
the risk of many non-cleared security-based swaps and will create
unnecessarily high initial margin requirements.\384\ Other commenters
recommended that the Commission establish a more flexible, risk-
specific approach to determine and adjust the appropriate liquidation
time horizon by product type or asset class.\385\
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    \382\ See paragraph (d)(2) of Rule 18a-3, as adopted. This
approach is consistent with the final margin rules of the CFTC and
the prudential regulators. See Prudential Regulator Margin and
Capital Adopting Release, 80 FR at 74906; CFTC Margin Adopting
Release, 81 FR at 699.
    \383\ See American Benefits Council, et al. 1/29/2013 Letter;
MFA 2/22/2013 Letter; PIMCO Letter; SIFMA AMG 2/22/2013 Letter.
    \384\ See American Benefits Council, et al. 1/29/2013 Letter.
    \385\ See MFA 2/22/2013 Letter; MFA/AIMA 11/19/2018 Letter.
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    The Commission believes the prudent approach is to retain the
proposed 10 business-day period in the final requirements governing the
use of models to calculate initial margin.\386\ The 10-day standard has
been part of the quantitative requirements for broker-dealers in
calculating model-based haircuts under the net capital rule since

the rule permitted the use of models. The Commission does not believe
it would be appropriate to have a less conservative standard for
calculating initial margin (which is designed to account for the risk
of the counterparty's positions) than for calculating model-based
haircuts under Rule 15c3-1e, as amended, and Rule 18a-1, as adopted
(which is designed to account for the risk of the nonbank SBSD's own
positions). Further, the Commission does not believe that a period of
less than 10 business days--such as the 3 to 5 business-day period
typically used by clearing agencies and DCOs--would be appropriate
given that non-cleared security-based swaps may be, in some cases, less
liquid than cleared security-based swaps in terms of how long it would
take to close them out. Moreover, the initial margin model requirements
of the CFTC and the prudential regulators mandate a 10-day standard
and, therefore, the Commission's rule is harmonized with their
rules.\387\
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    \386\ See paragraph (d)(2) of Rule 18a-3, as adopted.
    \387\ See Prudential Regulator Margin and Capital Adopting
Release, 80 FR at 74875; CFTC Margin Adopting Release, 81 FR at 653.
See also BCBS/IOSCO Paper at 12.
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    The final rule provides more clarity as to the offsets permitted in
calculating initial margin using a model. In particular, it provides
that an initial margin model must use risk factors sufficient to cover
all the material price risks inherent in the positions for which the
initial margin is being calculated, including foreign exchange or
interest rate risk, credit risk, equity risk, and commodity risk, as
appropriate.\388\ The final rule also provides that empirical
correlations may be recognized by the model within each broad risk
category, but not across broad risk categories. This means that each
non-cleared security-based swap and related position must be assigned
to a single risk category for purposes of calculating initial margin.
Thus, the initial margin calculation can offset cleared and non-cleared
security-based swaps (in answer to the question raised by some
commenters) to the extent they are within the same asset class.\389\
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    \388\ See paragraph (d)(2) of Rule 18a-3, as adopted. Although
the final rule uses the term ``risk factors,'' the approach of
assigning each non-cleared security-based swap to a specific risk
factor category is sometimes referred to by market participants as
the ``asset class approach.''
    \389\ However, the clearing agency's margin requirement for the
cleared security-based swaps in a portfolio likely will permit
offsets only for positions it clears.
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    The presence of any common risks or risk factors across asset
classes (e.g., credit, commodity, and interest rate risks) cannot be
recognized for initial margin purposes. This approach is designed to
help ensure a conservative and robust margin regime that potentially
reduces counterparty exposures to offset the greater risk to the
nonbank SBSD and the financial system arising from the use of non-
cleared security-based swaps.\390\ Margin calculations that limit
correlations to asset classes generally will result in more
conservative initial margin amounts than calculations that permit
offsets across different asset classes. Finally, this approach is
consistent with the final margin rules adopted by the CFTC and the
prudential regulators, and with the industry standard model being used
today to comply with the margin rules of the CFTC and the prudential
regulators.\391\
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    \390\ See Section 15F(e)(3)(A) of the Exchange Act.
    \391\ See Prudential Regulator Margin and Capital Adopting
Release, 80 FR at 74876 (``Each derivative contract must be assigned
to a single asset class in accordance with the classifications in
the final rule (i.e., foreign exchange or interest rate, commodity,
credit, and equity)''); CFTC Margin Adopting Release, 81 FR at 657-
58 (``The final rule does not permit an initial margin model to
reflect offsetting exposures, diversification, or other hedging
benefits across broad risk categories. Hence, the margin
calculations for derivatives in distinct product-based asset
classes, such as equity and credit, must be performed separately
without regard to derivatives contracts in other asset classes. Each
derivatives contract must be assigned to a single asset class. .
.''). See also BCBS/IOSCO Paper at 12-13.
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    The final rule permits stand-alone SBSDs to use a model to
calculate initial margin for equity security-based swaps and will
permit these entities to include equity swaps in the portfolio, subject
to further coordination with the CFTC.\392\ Under the final rule, these
entities are not required to use the standardized approach to calculate
initial margin for equity security-based swaps. However, the account of
a counterparty for which the stand-alone SBSD provides model-based
portfolio margining may not hold equity security positions other than
equity security-based swaps and equity swaps. Therefore, cash market
positions such as long and short equity positions, listed options
positions, and single stock futures positions cannot be held in the
accounts or otherwise included in the portfolio margin calculations.
This is designed to ensure that a stand-alone SBSD cannot provide more
favorable treatment for these types of equity positions than a stand-
alone or ANC broker-dealer that is subject to the margin requirements
of the Federal Reserve's Regulation T and the margin rules of the SROs.
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    \392\ See paragraph (d)(2) of Rule 18a-3, as adopted.
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    A commenter requested that qualified netting agreements be
permitted in calculating initial margin.\393\ Other commenters argued
that effective netting agreements lower systemic risk by reducing both
the aggregate requirement to deliver margin and trading costs for
market participants.\394\ A commenter stated that netting, among other
things, is an important tool for the reduction of counterparty credit
risk.\395\ Another commenter supported the Commission's proposal to
permit certain netting under a qualified netting agreement to determine
margin requirements, stating that netting obligations under derivatives
and other trading positions reduces counterparty credit risk and allows
market participants to make the most efficient use of their
capital.\396\ Finally, a commenter stated that differences in the
security-based swap and swap margin rules may fragment the market by
causing firms to engage only in a security-based swaps business through
a Commission-regulated nonbank SBSD.\397\ The commenter stated that,
upon the insolvency of a nonbank SBSD and an affiliated swap dealer, a
counterparty would likely be unable to close out and net security-based
swaps entered into with the nonbank SBSD with swaps entered into with
the swap dealer because the entities are not the same. This commenter
also believed that the Commission's proposals may undermine the
mutuality of obligations for close-out netting, stating that the
Commission appeared to treat a nonbank SBSD as an agent of the
counterparty rather than a direct counterparty, which may cause a
bankruptcy court to reject attempts by a counterparty to close out
derivatives positions with the debtor.
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    \393\ See MFA 2/22/2013 Letter.
    \394\ See AIMA 2/22/2013 Letter; MFA 2/22/2013 Letter.
    \395\ See MFA 2/22/2013 Letter.
    \396\ See Sutherland Letter.
    \397\ See ICI 11/19/2018 Letter.
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    In response, the Commission has modified the rule to clarify that
qualified netting agreements may be used in the calculation of initial
margin (in addition to variation margin).\398\ Generally, industry
practice is to use netting in variation and initial margin
calculations. Further, the Commission believes that in most cases a
counterparty entering into a non-cleared security-based swap
transaction with a nonbank SBSD will be a direct counterparty of the
nonbank SBSD. In response to the comment regarding potential
fragmentation of the market

and the proposed rule's effects on close-out netting, as discussed
above, the Commission believes the final margin rule for non-cleared
security-based swaps is largely comparable to the final margin rules of
the CFTC and the prudential regulators.\399\ In addition, as discussed
above, the Commission has modified the final rules to facilitate the
portfolio margining of security-based swaps and swaps, subject to
further coordination with the CFTC.\400\ For example, the Commission
modified Rules 15c3-1a and 18a-1a to permit swaps to be included in the
Appendix A methodology, which can be used by broker-dealer SBSDs to
calculate initial margin.\401\ Moreover, the Commission modified
paragraph (d)(2) of Rule 18a-3 to permit stand-alone SBSDs to use a
model to portfolio margin equity security-based swaps with equity
swaps, subject to certain conditions. The Commission believes that
these modifications will provide a means for market participants to
conduct security-based swap and swap activity in the same legal entity
without incurring significant additional operational or compliance
costs.
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    \398\ Specifically, the Commission has modified paragraph (c)(5)
in the final rule to delete the ``(A)'' from the reference to
paragraph (c)(1)(i)(A) (as a result, paragraph (c)(5), governing the
use of netting agreements, now refers to the variation and
initiation margin calculations as opposed to just the variation
margin calculation).
    \399\ See section II.B.1. of this release (summarizing
similarities and differences between the Commission's final margin
rules for non-cleared security-based swaps and the final margin
rules of the CFTC and the prudential regulators).
    \400\ See also Order Granting Conditional Exemption Under the
Securities Exchange Act of 1934 in Connection with Portfolio
Margining of Swaps and Security-Based Swaps, 77 FR 75211.
    \401\ See also section II.A.2.b.iii. of this release (discussing
adding swaps to the Appendix A methodology for purposes of the
standardized haircuts).
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    A commenter stated that the Commission's potential modification of
the proposed rules to permit the use of an industry standard model
provides too little information concerning the parameters that would be
required for such models and the process for nonbank SBSDs to approve,
establish, maintain, review, and validate margin models.\402\ In
response, the final rule provides that a nonbank SBSD seeking approval
to use a model (including an industry standard model) to calculate
initial margin will be subject to the application process in Rule 15c3-
1e, as amended, or paragraph (d) of Rule 18a-1, as adopted, as
applicable, governing the use of model-based haircuts.\403\ As part of
the application process, the Commission staff will review whether the
model meets the qualitative and quantitative requirements of Rule 18a-
3. Therefore, a nonbank SBSD will need to submit sufficient information
to allow the Commission to make a determination regarding the
performance of the nonbank SBSD's initial margin model. The use of
internal models, industry standard models, or other models to calculate
initial margin by nonbank SBSDs will be subject to the same application
and approval process under the final rule. The application process and
any condition imposed in connection with Commission approval of the use
of the model should mitigate the risk that nonbank SBSDs will compete
by implementing lower initial margin levels and should also help ensure
that initial margin levels are set at sufficiently prudent levels to
reduce risk to the firm and, more generally, systemic risk.
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    \402\ See Better Markets 11/19/2018 Letter.
    \403\ If a nonbank SBSD's model is approved for use to compute
initial margin under paragraph (d) of Rule 18a-3, the performance of
the model would be subject to ongoing regulatory supervision, and
the nonbank SBSD will need to submit an amendment to the Commission
for approval before materially changing its model. See, e.g., Rule
15c3-1e, as amended; paragraph (d) of Rule 18a-1, as adopted.
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    If an industry standard model is widely used by nonbank SBSDs,
concerns about competing through lower margin requirements should be
further mitigated. However, the Commission reiterates that each nonbank
SBSD individually must receive approval from the Commission to use an
initial margin model, including an industry standard model, because,
among other things, each firm must submit a comprehensive description
of its internal risk management control system and how that system
satisfies the requirements set forth in Rule 15c3-4. Thus, any approval
by the Commission for a particular nonbank SBSD to use a specific model
to calculate initial margin will not be deemed approval for another
nonbank SBSD to use the same model.
    As noted above, some commenters made suggestions about how to
expedite the model approval process.\404\ In response to these
comments, the Commission recognizes that the timing of such approvals
could raise competitive issues if one nonbank SBSD is authorized to use
a model before one or more other firms. Timing issues may also arise
with respect to the review and approval process if multiple firms
simultaneously apply to the Commission for approval to use a model. The
Commission is sensitive to these issues and, similar to the capital
model approval process, encourages all firms that intend to register as
nonbank SBSDs and seek model approval to begin working with the staff
as far in advance of their targeted registration date as is feasible.
However, as discussed above with respect to capital models, the
Commission acknowledges the possibility that it may not be able to make
a determination regarding a firm's margin model before it is required
to register as an SBSD. Consequently, the Commission is modifying Rule
15c3-1e and Rule 18a-1 to provide that the Commission may approve the
temporary use of a provisional model by a nonbank SBSD for the purposes
of calculating initial margin if the model had been approved by certain
other supervisors.
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    \404\ See IIB11/19/2018 Letter; ISDA 1/23/2013 Letter; SIFMA 3/
12/2014 Letter.
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    Two commenters suggested the Commission allow market participants
to delegate the duty to run a model to a counterparty or third party
noting that it is an accepted market practice for a counterparty to
agree that a dealer will make determinations for a security-based swap
in the dealer's capacity as calculation agent.\405\ In response to this
comment, a nonbank SBSD could enter into a commercial arrangement to
serve as a third-party calculation agent for entities that are not
required to calculate initial margin pursuant to Rule 18a-3, as
adopted. In addition, a nonbank SBSD's model can use third-party inputs
(e.g., price calculations). However, a nonbank SBSD retains
responsibility for the model-based initial margin calculations required