[Federal Register Volume 77, Number 226 (Friday, November 23, 2012)]
[Proposed Rules]
[Pages 70213-70354]
[FR Doc No: 2012-26164]

Vol. 77

Friday,

No. 226

November 23, 2012

Part II

Securities and Exchange Commission

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17 CFR Part 240

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

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

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-68071; File No. S7-08-12]
RIN 3235-AL12

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

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (``Dodd-Frank Act''), the Securities
and Exchange Commission (``Commission''), pursuant to the Securities
Exchange Act of 1934 (``Exchange Act''), is proposing capital and
margin requirements for security-based swap dealers (``SBSDs'') and
major security-based swap participants (``MSBSPs''), segregation
requirements for SBSDs, and notification requirements with respect to
segregation for SBSDs and MSBSPs. The Commission also is proposing to
increase the minimum net capital requirements for broker-dealers
permitted to use the alternative internal model-based method for
computing net capital (``ANC broker-dealers'').

DATES: Comments should be received on or before January 22, 2013.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number S7-08-12 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-08-12. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments also are available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. All comments received will be posted without change;
the Commission does not edit personal identifying information from
submissions. You should submit only information that you wish to make
publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at<PHONE_NUMBER>; Thomas K. McGowan, Deputy Associate
Director, at<PHONE_NUMBER>; Randall W. Roy, Assistant Director, at
(202) 551-5522; Mark M. Attar, Branch Chief, at<PHONE_NUMBER>; Sheila
Dombal Swartz, Special Counsel, at<PHONE_NUMBER>; Valentina M. Deng,
Attorney, at<PHONE_NUMBER>; or Teen I. Sheng, Attorney, at 202-551-
5511, Division of Trading and Markets, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Proposed Rules and Rule Amendments
    A. Capital
    1. Introduction
    2. Proposed Capital Rules for Nonbank SBSDs
    a. Computing Required Minimum Net Capital
    i. Stand-alone SBSDs Not Using Internal Models
    ii. Broker-Dealer SBSDs Not Using Internal Models
    iii. Stand-alone SBSDs Using Internal Models
    iv. Broker-Dealer SBSDs Using Internal Models and ANC Broker-
Dealers
    b. Computing Net Capital
    i. The Net Liquid Assets Test
    ii. Standardized Haircuts for Security-Based Swaps
    iii. VaR Models
    iv. Credit Risk Charges
    v. Capital Charge In Lieu of Margin Collateral
    vi. Treatment of Swaps
    c. Risk Management
    d. Funding Liquidity Stress Test Requirement
    e. Other Rule 15c3-1 Provisions Incorporated into Rule 18a-1
    i. Debt-Equity Ratio Requirements
    ii. Capital Withdrawal Requirements
    iii. Appendix C
    iv. Appendix D
    3. Proposed Capital Rules for Nonbank MSBSPs
    B. Margin
    1. Introduction
    2. Proposed Margin Requirements for Nonbank SBSDs and Nonbank
MSBSPs
    a. Scope of Rule 18a-3
    b. Daily Calculations
    i. Nonbank SBSDs
    ii. Nonbank MSBSPs
    c. Account Equity Requirements
    i. Nonbank SBSDs
    ii. Nonbank MSBSPs
    d. $100,000 Minimum Transfer Amount
    e. Risk Monitoring and Procedures
    3. Specific Request for Comment to Limit the Use of Collateral
    C. Segregation
    1. Background
    2. Proposed Rule 18a-4
    a. Possession and Control of Excess Securities Collateral
    b. Security-Based Swap Customer Reserve Account
    c. Special Provisions for Non-cleared Security-Based Swap
Counterparties
III. General Request for Comment
IV. Paperwork Reduction Act
    A. Summary of Collections of Information Under the Proposed
Rules and Rule Amendments
    1. Proposed Rule 18a-1 and Amendments to Rule 15c3-1
    2. Proposed Rule 18a-2
    3. Proposed Rule 18a-3
    4. Proposed Rule 18a-4
    B. Proposed Use of Information
    C. Respondents
    D. Total Initial and Annual Recordkeeping and Reporting Burden
    1. Proposed Rule 18a-1 and Amendments to Rule 15c3-1
    2. Proposed Rule 18a-2
    3. Proposed Rule 18a-3
    4. Proposed Rule 18a-4
    E. Collection Of Information Is Mandatory
    F. Confidentiality
    G. Retention Period For Recordkeeping Requirements
    H. Request For Comment
V. Economic Analysis
    A. Baseline Of Economic Analysis
    1. Overview of the OTC Derivatives Markets--Baseline for
Proposed Rules 18a-1 through 18a-4
    2. Baseline for Amendments to Rule 15c3-1
    B. Analysis of the Proposals and Alternatives
    1. Overview--The Proposed Financial Responsibility Program
    a. Nonbank SBSDs
    b. Nonbank MSBSPs
    2. The Proposed Capital Rules
    a. Nonbank SBSDs and ANC Broker-dealers
    i. Minimum Capital Requirements
    ii. Standardized Haircuts
    iii. Capital Charge in Lieu of Margin Collateral
    iv. Credit Risk Charge
    v. Funding Liquidity Stress Test Requirement
    vi. Risk Management Procedures
    b. Capital Requirements for MSBSPs
    c. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
    3. The Proposed Margin Rule--Rule 18a-3

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

I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act into
law.\1\ Title VII of the Dodd-Frank Act (``Title VII'') established a
new regulatory framework for OTC derivatives.\2\ In this regard, Title
VII was enacted, among other reasons, to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (i) Providing for the registration and
regulation of SBSDs and MSBSPs; (ii) imposing clearing and trade
execution requirements on standardized derivative products; (iii)
creating recordkeeping and real-time reporting regimes; and (iv)
enhancing the Commission's rulemaking and enforcement authorities with
respect to all registered entities and intermediaries subject to the
Commission's oversight.\3\
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    \1\ See Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.'' See Public Law 111-203 Sec.  701. The Dodd-Frank Act assigns
responsibility for the oversight of the U.S. OTC derivatives markets
to the Commission, the Commodity Futures Trading Commission
(``CFTC''), and certain ``prudential regulators,'' discussed below.
The Commission has oversight authority with respect to a security-
based swap as defined in section 3(a)(68) of the Exchange Act (15
U.S.C. 78c(a)(68)), including to implement a registration and
oversight program for a security-based swap dealer as defined in
section 3(a)(71) of the Exchange Act (15 U.S.C. 78c(a)(71)) and a
major security-based swap participant as defined in section 3(a)(67)
of the Exchange Act (15 U.S.C. 78c(a)(67)). The CFTC has oversight
authority with respect to a swap as defined in section 1(a)(47) of
the Commodity Exchange Act (``CEA'') (7 U.S.C. 1(a)(47)), including
to implement a registration and oversight program for a swap dealer
as defined in section 1(a)(49) of the CEA (7 U.S.C. 1(a)(49)) and a
major swap participant as defined in section 1(a)(33) of the CEA (7
U.S.C. 1(a)(33)). The Commission and the CFTC jointly have adopted
rules to further define, among other things, those terms and the
terms swap, security-based swap, swap dealer, major swap
participant, security-based swap dealer, and major security-based
swap participant. See Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, Exchange Act Release
No. 64372 (Apr. 29, 2011), 76 FR 29818 (May 23, 2011) (``Product
Definitions Proposing Release''); Further Definition of ``Swap,''
``Security-Based Swap,'' and ``Security-Based Swap Agreement'';
Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Exchange
Act Release No. 67453 (July 18, 2012), 77 FR 48208 (Aug. 13, 2012)
(Joint final rule with the CFTC) (``Product Definitions Adopting
Release''); Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant'', Exchange
Act Release No. 63452 (Dec. 7, 2010), 75 FR 80174 (Dec. 21, 2010)
(Joint proposal with the CFTC) (``Entity Definitions Proposing
Release''); and Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-
Based Swap Participant'' and ``Eligible Contract Participant'',
Exchange Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596 (May 23,
2012) (Joint final rule with the CFTC) (``Entity Definitions
Adopting Release'').
    \3\ See Public Law 111-203 Sec. Sec.  701-774.
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    Section 764 of the Dodd-Frank Act added section 15F to the Exchange
Act.\4\ Section 15F(e)(1)(B) of the Exchange Act provides that the
Commission shall prescribe capital and margin requirements for SBSDs
and nonbank MSBSPs that do not have a prudential regulator
(respectively, ``nonbank SBSDs'' and ``nonbank MSBSPs'').\5\ Section
763 of the Dodd-Frank Act added section 3E to the Exchange Act.\6\
Section 3E provides the Commission with authority to establish
segregation requirements for SBSDs and MSBSPs.\7\
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    \4\ See id. Sec.  764; 15 U.S.C. 78o-10.
    \5\ See 15 U.S.C. 78o-10(e)(1)(B). Specifically, section
15F(e)(1)(B) of the Exchange Act provides that each registered SBSD
and MSBSP for which there is not a prudential regulator shall meet
such minimum capital requirements and minimum initial and variation
margin requirements as the Commission shall by rule or regulation
prescribe. The term ``prudential regulator'' is defined in section
1(a)(39) of the CEA (7 U.S.C. 1(a)(39)) and that definition is
incorporated by reference in section 3(a)(74) of the Exchange Act
(15 U.S.C. 78c(a)(74)). Pursuant to the definition, the Board of
Governors of the Federal Reserve System (``Federal Reserve''), the
Office of the Comptroller of the Currency (``OCC''), the Federal
Deposit Insurance Corporation (``FDIC''), the Farm Credit
Administration, or the Federal Housing Finance Agency (collectively,
the ``prudential regulators'') is the ``prudential regulator'' of an
SBSD, MSBSP, swap participant, or major swap participant if the
entity is directly supervised by that agency.
    \6\ See Public Law 111-203 Sec.  763; 15 U.S.C. 78c-5.
    \7\ See 15 U.S.C. 78c-5(a)-(g). Section 3E of the Exchange Act
does not distinguish between bank and nonbank SBSDs and bank and
nonbank MSBSPs, and, consequently, provides the Commission with the
authority to establish segregation requirements for SBSDs and
MSBSPs, whether or not they have a prudential regulator. Id.
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    Section 4s(e)(1)(B) of the CEA provides that the CFTC shall
prescribe capital and margin requirements for swap dealers and major
swap participants for which there is not a prudential regulator
(``nonbank swap dealers'' and ``nonbank swap participants'').\8\
Section 15F(e)(1)(A) of the Exchange Act provides that the prudential
regulators shall prescribe capital and margin requirements for bank
SBSDs and bank MSBSPs, and section 4s(e)(1)(A) of the CEA provides that
the prudential regulators shall prescribe capital and margin
requirements for swap dealers and major swap participants for which
there is a prudential regulator (``bank swap dealers'' and ``bank swap
participants'').\9\ The prudential regulators have proposed capital and
margin requirements for bank swap dealers, bank SBSDs, bank swap
participants, and bank MSBSPs.\10\ The CFTC has proposed capital and
margin requirements for nonbank swap dealers and nonbank major swap
participants.\11\ The CFTC also has adopted segregation requirements
for cleared swaps and proposed segregation requirements for non-cleared
swaps.\12\
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    \8\ See 7 U.S.C. 6s(e)(1)(B).
    \9\ See 15 U.S.C. 78o-10(e)(1)(A); 7 U.S.C. 6s(e)(1)(A).
    \10\ See Margin and Capital Requirements for Covered Swap
Entities, 76 FR 27564 (May 11, 2011) (``Prudential Regulator Margin
and Capital Proposing Release''). The prudential regulators, as part
of their proposed margin requirements for non-cleared security-based
swaps, proposed a segregation requirement for collateral received as
margin. Id.
    \11\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011) (``CFTC Capital Proposing
Release''); Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 76 FR 23732 (Apr. 28, 2011) (``CFTC
Margin Proposing Release''). The CFTC reopened the comment period
for the CFTC Margin Proposing Release to allow interested parties to
comment on the CFTC proposed rules in light of the proposals
discussed in the international consultative paper. See Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 77 FR 41109 (July 12, 2012).
    \12\ See Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions, 77 FR 6336 (Feb. 7, 2012) and Protection of Collateral
of Counterparties to Non-cleared Swaps; Treatment of Securities in a
Portfolio Margining Account in a Commodity Broker Bankruptcy, 75 FR
75432 (Dec. 3, 2010).
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    Pursuant to sections 763 and 764 of the Dodd-Frank Act, the
Commission is proposing to amend Rule 15c3-1 and Rule 15c3-3 and
propose new Rules 18a-1 (including appendices to Rule 18a-1), 18a-2,
18a-3, and 18a-4 (including an exhibit to Rule 18a-4).\13\ The proposed
amendments and new rules would establish capital and margin
requirements for nonbank SBSDs, including broker-dealers that are
registered as SBSDs (``broker-dealer SBSDs''), and nonbank MSBSPs. They
also would establish segregation requirements for SBSDs and
notification requirements with respect to segregation for SBSDs and
MSBSPs.
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    \13\ See 17 CFR 240.15c3-1; 17 CFR 240.15c3-3.
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    Further, the proposals also would increase the minimum net capital

requirements and establish liquidity requirements for ANC broker-
dealers.\14\ An ANC broker-dealer is a broker-dealer that has been
approved by the Commission to use internal value-at-risk (``VaR'')
models to determine market risk charges for proprietary securities and
derivatives positions and to take a credit risk charge in lieu of a
100% charge for unsecured receivables related to OTC derivatives
transactions (hereinafter, collectively ``internal models''). The
proposed amendments applicable to ANC broker-dealers are designed to
account for their large size, the scale of their custodial activities,
and the potential substantial leverage they may take on if they become
more active in the security-based swap markets under the Dodd-Frank Act
reforms, which, among other things, require dealers in security-based
swaps to register with the Commission.\15\ Finally, some of the
proposed amendments to Rule 15c3-1 would apply to broker-dealers that
are not registered as SBSDs. These proposed amendments are designed to
maintain a consistent capital treatment for security-based swaps and
swaps under Rule 15c3-1 and proposed new Rule 18a-1.
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    \14\ See 17 CFR 240.15c3-1(a)(7); 17 CFR 240.15c3-1e.
    \15\ See, e.g., 15 U.S.C. 78o-10(a)(1) (``It shall be unlawful
for any person to act as a security-based swap dealer unless the
person is registered as a security-based swap dealer with the
Commission.'').
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    As discussed in detail below, the proposals for capital, margin,
and segregation requirements for SBSDs and MSBSPs are based in large
part on existing capital, margin, and segregation requirements for
broker-dealers (``broker-dealer financial responsibility
requirements'').\16\ The broker-dealer financial responsibility
requirements served as the model for the proposals because the
financial markets in which SBSDs and MSBSPs are expected to operate are
similar to the financial markets in which broker-dealers operate. In
addition, as discussed below, the objectives of the broker-dealer
financial responsibility requirements are similar to the objectives
underlying the proposals. Moreover, the broker-dealer financial
responsibility requirements have existed for many years and have
facilitated the prudent operation of broker-dealers.\17\ Consequently,
they provide a reasonable template for building a financial
responsibility program for SBSDs and MSBSPs. Furthermore, it is
expected that some nonbank SBSDs also will register as broker-dealers
in order to be able to offer customers a broader range of services than
a nonbank SBSD not registered as a broker-dealer (``stand-alone SBSD'')
would be permitted to engage in. Therefore, establishing consistent
financial responsibility requirements would avoid potential competitive
disparities between stand-alone SBSDs and broker-dealer SBSDs.
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    \16\ See infra section II.A.1. of this release (describing
generally the broker-dealer capital standards); section II.B.1. of
this release (describing generally the broker-dealer margin
standards); section II.C.1. of this release (describing generally
the broker-dealer segregation requirements).
    \17\ For example, one of the objectives of the broker-dealer
financial responsibility requirements is to protect customers from
the consequences of the financial failure of a broker-dealer in
terms of safeguarding customer securities and funds held by the
broker-dealer. It should be noted that the Securities Investor
Protection Corporation (``SIPC''), since its inception in 1971, has
initiated customer protection proceedings for only 324 broker-
dealers, which is less than 1% of the approximately 39,200 broker-
dealers that have been members of SIPC during that timeframe. From
1971 through December 31, 2011, approximately 1% of the $117.5
billion of cash and securities distributed for accounts of customers
came from the SIPC fund rather than debtors' estates. See SIPC,
Annual Report 2011, available at http://www.sipc.org/Portals/0/PDF/2011_Annual_Report.pdf (``SIPC 2011 Annual Report'').
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    However, the Commission recognizes that there may be other
approaches to establishing financial responsibility requirements that
may be appropriate--including, for example, applying a standard based
on the international capital standard for banks (``Basel Standard'')
\18\ in the case of entities that are part of a bank holding company,
as has been proposed by the CFTC.\19\ In general, the bank capital
model requires the holding of specified levels of capital as a
percentage of ``risk weighted assets.'' \20\ It does not require
generally a full capital deduction for unsecured receivables, given
that banks, as lending entities, are in the business of extending
credit to a range of counterparties.
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    \18\ The Basel Standard was developed by the Basel Committee on
Banking Supervision of the Bank for International Settlements
(``BCBS''). More information about the Basel Standard is available
at the Web site of the Bank for International Settlements (``BIS'')
at http://www.bis.org/bcbs/index.htm.
    \19\ CFTC Capital Proposing Release, 76 FR 27802.
    \20\ The prudential regulators also have proposed capital rules
that would require a covered swap entity to comply with the
regulatory capital rules already made applicable to that covered
swap entity as part of its prudential regulatory regime. Prudential
Regulator Margin and Capital Proposing Release, 76 FR at 27568. The
prudential regulators note that they have ``had risk-based capital
rules in place for banks to address over-the-counter derivatives
since 1989 when the banking agencies implemented their risk-based
capital adequacy standards * * * based on the first Basel Accord.''
Id.
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    This approach could promote a consistent view and management of
capital within a bank holding company structure. The Commission is not
proposing this approach, however, both because of the distinctions
between bank and nonbank dealer business models and access to backstop
liquidity, as well as uncertainties as to how a bank capital standard
would in practice affect valuations and the conduct of business in a
nonbank entity; but the Commission is specifically seeking comment on
this approach. In addition, detailed comment is requested below on
alternative financial responsibility frameworks that could serve as a
model for establishing financial responsibility requirements for SBSDs
and MSBSPs.
    The minimum financial and customer protection requirements proposed
today--like other financial tests that market participants use in the
ordinary course of business to manage risk or to comply with applicable
regulations--incorporate many specific numerical thresholds, limits,
deductions, and ratios.\21\ The Commission recognizes that each such
quantitative requirement could be read by some to imply a definitive
conclusion based on quantitative analysis of that requirement and its
alternatives.
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    \21\ For example, the proposed capital requirements would
include in the formula that determines minimum net capital an amount
generally equal to 8% of the amount of margin that nonbank SBSDs
would be required to collect from counterparties. Similarly, the
capital and margin proposals, in setting ``haircut'' requirements to
reflect market risk for certain types of security-based swaps,
propose to use a numerical grid that establishes specific deductions
depending on spread and tenor, among other factors.
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    The Commission notes in this regard that the specific quantitative
requirements included in this proposal have not been derived directly
from econometric or mathematical models, nor has the Commission
performed a detailed quantitative analysis of the likely economic
consequences of the specific quantitative requirements being included
in this proposal. As discussed in the economic analysis below, there
are a number of challenges presented in conducting such a quantitative
analysis in a robust fashion. Accordingly, the selection of a
particular quantitative requirement proposed below reflects a
qualitative assessment by the Commission regarding the appropriate
financial standard for an identified issue. In making such assessments
and in turn selecting proposed quantitative requirements, the
Commission has drawn from its experiences in regulating broker-dealers
and has frequently looked to comparable quantitative elements in the
existing broker-dealer financial responsibility regime (e.g., the
current capital charges in the existing broker-dealer net capital rule)
or, where appropriate, the existing or proposed regulations of the
prudential regulators,

FINRA, or the CFTC with respect to similar activities. For example, the
Commission may propose using a specified haircut percentage (e.g., 15%,
as opposed to a percentage that is higher or lower) because it
believes, based on its experience regulating markets, that such
percentage should be sufficient to cover a severe market movement. The
Commission has used these comparable quantitative requirements as a
reasonable starting point for purposes of the various proposals
because, as noted above, there are substantial similarities between the
proposed rules and those other regimes in terms of the relevant
markets, entities, and regulatory objectives, and because many nonbank
SBSDs may also be subject to the existing broker-dealer financial
responsibility requirements.
    The Commission invites comment, including relevant data and
analysis, regarding all aspects of the various quantitative
requirements reflected in the proposed rules. In particular, data and
comment from market participants and other interested parties regarding
the likely effect of each proposed quantitative requirement, the effect
of such requirements in the aggregate, and potential alternative
requirements will be particularly useful to the Commission in
evaluating modifications to the proposals. Commenters are also
requested to describe in detail any econometric or mathematical models
or economic analyses of data, to the extent they exist, that they
believe would be relevant for evaluating or modifying any quantitative
provisions contained in the proposals.
    The Commission staff consulted with the prudential regulators and
the CFTC in drafting the proposals discussed in this release.\22\ In
addition, the proposals of the prudential regulators and the CFTC were
considered in developing the Commission's proposed capital, margin, and
segregation requirements for SBSDs and MSBSPs. The Commission's
proposals differ in some respects from proposals of the prudential
regulators and the CFTC, and such differences are described below in
connection with the relevant proposals. While some differences are
based on differences in the activities of securities firms, banks, and
commodities firms, or differences in the products at issue, other
differences may reflect an alternative approach to balancing the
relevant policy choices and considerations. Where these differences
exist, comment is sought on the advantages and disadvantages of each
proposal and whether a given proposal is appropriate based on
differences in the business models of the types of entities that would
be subject to the respective proposal, the risks of these entities, and
any other factors commenters believe relevant.\23\
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    \22\ See 15 U.S.C. 78o-10(e)(3)(D)(i) (``The prudential
regulators, the [CFTC], and the [Commission] shall periodically (but
not less frequently than annually) consult on the minimum capital
requirements and minimum initial and variation margin
requirements.'').
    \23\ See 15 U.S.C. 78o-10(e)(3)(D)(ii) (providing that the
prudential regulators, the CFTC, and the Commission ``shall, to the
maximum extent practicable establish and maintain comparable minimum
capital requirements and minimum initial and variation margin
requirements, including the use of noncash collateral,'' for SBSDs
and swap dealers).
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    The capital, margin, and segregation requirements ultimately
adopted, like other requirements established under the Dodd-Frank Act,
could have a substantial impact on international commerce and the
relative competitive position of intermediaries operating in various,
or multiple, jurisdictions. In particular, intermediaries operating in
the U.S. and in other jurisdictions could be advantaged or
disadvantaged if corresponding requirements are not established in
other jurisdictions or if the Commission's rules are substantially more
or less stringent than corresponding requirements in other
jurisdictions. This could, among other potential impacts, affect the
ability of intermediaries and other market participants based in the
U.S. to participate in non-U.S. markets, the ability of non-U.S.-based
intermediaries and other market participants to participate in U.S.
markets, and whether and how international firms make use of global
``booking entities'' to centralize risks related to security-based
swaps. These issues have been the focus of numerous comments to the
Commission and other regulators, Congressional inquiries, and other
public dialogue.\24\
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    \24\ See, e.g., letter from Senator Tim Johnson, Chairman of the
U.S. Senate Committee on Banking, Housing, and Urban Affairs, and
Congressman Barney Frank, Ranking Member of the U.S. House Committee
on Financial Services, to the CFTC, Commission, Federal Reserve, and
FDIC (Oct. 4, 2011), available at http://www.sec.gov/comments/s7-25-11/s72511-34.pdf (``Given the global nature of this market, U.S.
regulators should avoid creating opportunities for international
regulatory arbitrage that could increase systemic risk and reduce
the competitiveness of U.S. firms abroad''); letter from Barclays
Bank PLC, BNP Paribas S.A., Credit Suisse AG, Deutsche Bank AG,
HSBC, Nomura Securities International, Inc., Rabobank Nederland,
Royal Bank of Canada, The Royal Bank of Scotland Group PLC, Societe
Generale, The Toronto-Dominion Bank, and UBS AG, to the CFTC,
Commission, and Federal Reserve (Feb. 17, 2011), available at http://www.sec.gov/comments/s7-39-10/s73910-25.pdf (``[T]he home country
regulator has the greatest interest in and is in the best position
to protect a foreign bank swap dealer under its primary supervision
by setting appropriate margin requirements or functionally
equivalent capital charges for non-cleared swaps''); letter from
Carlos Tavares, Vice-Chairman of European Securities and Markets
Authority, to the Commission (Jan. 17, 2011), available at http://www.sec.gov/comments/s7-35-10/s73510-19.pdf (``if the foreign
supervision were not taken into account * * * a foreign [entity
would] be subject to multiple regimes * * * [which would be] very
challenging for regulated entities and would significantly raise the
costs for both the industry and supervisors''); BCBS, Board of the
International Organization of Securities Commissions (``IOCSO''),
Consultative Document, Margin Requirements for Non-centrally-cleared
Derivatives (July 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD387.pdf (consultative document seeking comment on
margin requirements for non-centrally-cleared derivatives).
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    The potential international implications of the proposed capital,
margin, and segregation requirements warrant further consideration.
However, consistent with the Commission's general approach with respect
to its other proposals under Title VII, these implications are
recognized here but not fully addressed. Instead, the Commission
intends to publish a comprehensive release seeking public comment on
the full spectrum of issues relating to the application of Title VII to
cross-border security-based swap transactions and non-U.S. persons that
act in capacities regulated under the Dodd-Frank Act. This approach
will provide market participants, foreign regulators, and other
interested parties with an opportunity to consider, as an integrated
whole, the proposed approach to the cross-border application of Title
VII, including capital, margin, and segregation requirements.

II. Proposed Rules and Rule Amendments

A. Capital

1. Introduction
    Section 15F(e)(1)(B) of the Exchange Act requires that the
Commission prescribe capital requirements for nonbank SBSDs and nonbank
MSBSPs.\25\ The Commission also has concurrent authority under section
15(c)(3) of the Exchange Act to prescribe capital requirements for
broker-dealers.\26\ The existing broker-dealer capital requirements are
contained in

Rule 15c3-1,\27\ including seven appendices to Rule 15c3-1.\28\ The
minimum capital requirements for stand-alone SBSDs would be contained
in proposed new Rule 18a-1,\29\ and the minimum capital requirements
for broker-dealer SBSDs would be contained in Rule 15c3-1, as proposed
to be amended. Proposed Rule 18a-1 would be structured similarly to
Rule 15c3-1 and would contain many provisions that correspond to those
in Rule 15c3-1.\30\
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    \25\ 15 U.S.C. 78o-10(e)(1)(B).
    \26\ 15 U.S.C. 78o(c)(3). Section 771 of the Dodd-Frank Act
states that unless otherwise provided by its terms, its provisions
relating to the regulation of the security-based swap markets do not
divest any appropriate Federal banking agency, the Commission, the
CFTC, or any other Federal or State agency, of any authority derived
from any other provision of applicable law. See Public Law 111-203
Sec.  771. In addition, section 15F(e)(3)(B) of the Exchange Act
provides that nothing in section 15F ``shall limit, or be construed
to limit, the authority'' of the Commission ``to set financial
responsibility rules for a broker or dealer * * * in accordance with
Section 15(c)(3).'' 15 U.S.C. 78o-8(e)(3)(B).
    \27\ 17 CFR 240.15c3-1.
    \28\ 17 CFR 240.15c3-1a (Options); 17 CFR 240.15c3-1b
(Adjustments to net worth and aggregate indebtedness for certain
commodities transactions); 17 CFR 240.15c3-1c (Consolidated
computations of net capital and aggregate indebtedness for certain
subsidiaries and affiliates); 17 CFR 240.15c3-1d (Satisfactory
subordination agreements); 17 CFR 240.15c3-1e (Deductions for market
and credit risk for certain brokers or dealers); 17 CFR 240.15c3-1f
(Optional market and credit risk requirements for OTC derivatives
dealers); 17 CFR 240.15c3-1g (Conditions for ultimate holding
companies of certain brokers or dealers).
    \29\ See proposed new Rule 18a-1.
    \30\ For example, proposed new Rule 18a-1 would include four
appendices: Appendix A (proposed new Rule 18a-1a); Appendix B
(proposed new Rule18a-1b); Appendix C (proposed new Rule 18a-1c);
and Appendix D (proposed new Rule 18a-1d). The appendices would
correspond to the following appendices to Rule 15c3-1: Appendix A
(Options) (17 CFR 240.15c3-1a); Appendix B (Adjustments to net worth
and aggregate indebtedness for certain commodities transactions) (17
CFR 240.15c3-1b); Appendix C (Consolidated computations of net
capital and aggregate indebtedness for certain subsidiaries and
affiliates) (17 CFR 240.15c3-1c); and Appendix D (Satisfactory
subordination agreements) (17 CFR 240.15c3-1d).
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    As described above, the capital and other financial responsibility
requirements for broker-dealers generally provide a reasonable template
for crafting the corresponding requirements for nonbank SBSDs. For
example, among other considerations, the objectives of capital
standards for both types of entities are similar. Rule 15c3-1,
described in detail below, is a net liquid assets test that is designed
to require a broker-dealer to maintain sufficient liquid assets to meet
all obligations to customers and counterparties and have adequate
additional resources to wind-down its business in an orderly manner
without the need for a formal proceeding if it fails financially.\31\
In turn, the objective of the proposed capital standards for nonbank
SBSDs is to protect customer assets and mitigate the consequences of a
firm failure, while allowing these firms the flexibility in how they
conduct a security-based swaps business.
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    \31\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb.
6, 1997), 62 FR 6474 (Feb. 12, 1997) (``Rule 15c3-1 requires
registered broker-dealers to maintain sufficient liquid assets to
enable those firms that fall below the minimum net capital
requirements to liquidate in an orderly fashion without the need for
a formal proceeding.''). As indicated, the goal of the rule is to
require a broker-dealer to hold sufficient liquid net capital to
meet all obligations to creditors, except for creditors who agree to
subordinate their claims to all other creditors. As discussed in
more detail below, Rule 15c3-1d (Appendix D to Rule 15c3-1) sets
forth minimum requirements for a subordinated loan agreement. See 17
CFR 240.15c3-1d. Typically, affiliates of the broker-dealer (e.g.,
the firm's holding company) or individual owners of the broker-
dealer make subordinated loans to the broker-dealer. If the broker-
dealer fails financially and is liquidated, the obligations of the
broker-dealer to all other creditors would need to be paid in full
before the obligations of the broker-dealer to a subordinated lender
are paid.
---------------------------------------------------------------------------

    In addition, the Dodd-Frank Act divided responsibility for SBSDs by
providing the prudential regulators with authority to prescribe the
capital and margin requirements for bank SBSDs and the Commission with
authority to prescribe capital and margin requirements for nonbank
SBSDs.\32\ This division also suggests it may be appropriate to model
the capital requirements for nonbank SBSDs on the capital standards for
broker-dealers, while the capital requirements for bank SBSDs are
modeled on capital standards for banks (as reflected in the proposal by
the prudential regulators).\33\ Certain operational, policy, and legal
differences appear to support this distinction between nonbank SBSDs
and bank SBSDs. First, based on the Commission staff's understanding of
the activities of nonbank dealers in over-the counter (``OTC'')
derivatives, nonbank SBSDs are expected to engage in a securities
business with respect to security-based swaps that is more similar to
the dealer activities of broker-dealers than to the activities of
banks; indeed, some broker-dealers likely will be registered as nonbank
SBSDs.\34\ Second, existing capital standards for banks and broker-
dealers reflect, in part, differences in their funding models and
access to certain types of financial support, and those same
differences also will exist between bank SBSDs and nonbank SBSDs. For
example, banks obtain funding through customer deposits and can obtain
liquidity through the Federal Reserve's discount window, whereas
broker-dealers do not--and nonbank SBSDs will not--have access to these
sources of funding and liquidity. Third, Rule 15c3-1 currently contains
provisions designed to address dealing in OTC derivatives by broker-
dealers and, therefore, to some extent already can accommodate this
type of activity (although, as discussed below, proposed amendments to
Rule 15c3-1 would be designed to more specifically address the risks of
security-based swaps and the potential for increased involvement of
broker-dealers in the security-based swaps markets).\35\
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    \32\ See 15 U.S.C. 78o-10, in general; 15 U.S.C. 78o-
10(e)(2)(A)-(B), in particular.
    \33\ The prudential regulators have proposed capital
requirements for bank SBSDs and bank swap dealers that are based on
the capital requirements for banks. See Prudential Regulator Margin
and Capital Proposing Release, 76 FR at 27582.
    \34\ Id.
    \35\ See 17 CFR 240.15c3-1f and 17 CFR 240.15c3-1e. See also
Alternative Net Capital Requirements for Broker-Dealers That Are
Part of Consolidated Supervised Entities, Exchange Act Release No.
49830 (June 8, 2004), 69 FR 34428 (June 21, 2004) (``Alternative Net
Capital Requirements Adopting Release''); OTC Derivatives Dealers,
Exchange Act Release No. 40594 (Oct. 23, 1998), 63 FR 59362 (Nov. 3,
1998).
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    For these reasons, the proposed capital standard for nonbank SBSDs
is a net liquid assets test modeled on the broker-dealer capital
standard in Rule 15c3-1.\36\ However, the Commission

recognizes that there may be alternative approaches to financial
responsibility requirements that may be appropriate.\37\ Accordingly,
in the requests for comment below on the various capital standards,
commenters are encouraged: (1) To consider alternative approaches to
capital for nonbank SBSDs generally; (2) for nonbank SBSDs that are
broker-dealers, to identify what, if any, specific amendments to Rule
15c3-1 and its appendices they believe would not be appropriate for
broker-dealers; and (3) for stand-alone SBSDs, to identify what, if
any, specific provisions in proposed new Rule 18a-1 and its appendices
(including those modeled on provisions in Rule 15c3-1 and its
appendices) they believe would not be appropriate for stand-alone
SBSDs.
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    \36\ As noted above, the prudential regulators similarly
proposed capital standards for bank SBSDs based on the capital
standards for banks. See Prudential Regulator Margin and Capital
Proposing Release 76 FR 27564. The CFTC has proposed three different
capital standards for nonbank swap dealers. First, a futures
commission merchant (``FCM'') that is registered as a swap dealer
would be subject to the CFTC's net capital rule for FCMs, which is
similar to the Commission's net capital rule for broker-dealers in
that it imposes a net liquid assets test. See CFTC Capital Proposing
Release, 76 FR 27802. Second, a swap dealer that is not an FCM and
not affiliated with a U.S. bank holding company would be subject to
a ``tangible net equity'' capital standard (the CFTC proposal
defines tangible net equity as equity determined under U.S.
generally accepted accounting principles (``GAAP''), and excludes
goodwill and other intangible assets). Third, a swap dealer that is
not an FCM and is affiliated with a U.S. bank holding company would
be subject to the capital standard that applies to U.S. banking
institutions. Id. The proposed capital standard for nonbank SBSDs
would not make such distinctions and, therefore, all nonbank SBSDs
would be subject to the net liquid assets test embodied in Rule
15c3-1 (i.e., regardless of whether they are registered as broker-
dealers or affiliates of U.S. bank holding companies). The CFTC
proposed a tangible net equity requirement for certain swap dealers
to address the probability that commercial entities (e.g., entities
engaged in agricultural or energy businesses) may need to register
as swap dealers and that imposing a net liquid assets test could
require them to engage in significant corporate restructuring and
potentially cause undue costs because their equity is comprised of
physical and other non-current assets. Differences between the swaps
markets and the security-based swaps markets may make a single
capital standard more workable for nonbank SBSDs. The swaps market
is significantly larger than the security-based swaps market and has
many more active participants that are commercial entities. See BIS,
OTC Derivatives Market Activity in the Second Half of 2010, Monetary
and Economic Department, (May 2011), available at http://www.bis.org/publ/otc_hy1105.pdf. It is expected that financial
institutions will comprise a large segment of the security-based
swaps market as is currently the case and that these entities are
more likely to have affiliates dedicated to OTC derivatives trading
and affiliates that are broker-dealers registered with the
Commission. See infra section V.A. of this release (providing an
overview of the security-based swaps markets). Consequently, these
affiliates--because their capital structures are geared towards
securities trading or because they already are broker-dealers--would
be able to more readily adhere to a net liquid assets test. In
addition, many broker-dealers currently are affiliates within bank
holding companies. Consequently, these broker-dealers are subject to
Rule 15c3-1, while their bank affiliates are subject to bank capital
standards.
    \37\ CFTC Capital Proposing Release, 76 FR 27802.
---------------------------------------------------------------------------

    The capital standard in Rule 15c3-1--that serves as a model for the
proposed capital standard for nonbank SBSDs--is a net liquid assets
test. This standard is designed to promote liquidity; the rule allows a
broker-dealer to engage in activities that are part of conducting a
securities business (e.g., taking securities into inventory) but in a
manner that places the firm in the position of holding at all times
more than one dollar of highly liquid assets for each dollar of
unsubordinated liabilities (e.g., money owed to customers,
counterparties, and creditors).\38\ For example, Rule 15c3-1 allows
securities positions to count as allowable net capital, subject to
standardized or internal model-based haircuts.\39\ The rule, however,
does not permit most unsecured receivables to count as allowable net
capital.\40\ This aspect of the rule severely limits the ability of
broker-dealers to engage in activities, such as unsecured lending, that
generate unsecured receivables. The rule also does not permit fixed
assets or other illiquid assets to count as allowable net capital,
which creates disincentives for broker-dealers to own real estate and
other fixed assets that cannot be readily converted into cash. For
these reasons, Rule 15c3-1 incentivizes broker-dealers to confine their
business activities and devote capital to activities such as
underwriting, market making, and advising on and facilitating customer
securities transactions.
---------------------------------------------------------------------------

    \38\ See, e.g., Interpretation Guide to Net Capital Computation
for Brokers and Dealers, Exchange Act Release No. 8024 (Jan. 18,
1967), 32 FR 856 (Jan. 25, 1967) (``Rule 15c3-1 (17 CFR 240.15c3-1)
was adopted to provide safeguards for public investors by setting
standards of financial responsibility to be met by brokers and
dealers. The basic concept of the rule is liquidity; its object
being to require a broker-dealer to have at all times sufficient
liquid assets to cover his current indebtedness.'') (footnotes
omitted); Net Capital Treatment of Securities Positions, Obligations
and Transactions in Suspended Securities, Exchange Act Release No.
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973) (Commission
release of a letter from the Division of Market Regulation) (``The
purpose of the net capital rule is to require a broker or dealer to
have at all times sufficient liquid assets to cover its current
indebtedness. The need for liquidity has long been recognized as
vital to the public interest and for the protection of investors and
is predicated on the belief that accounts are not opened and
maintained with broker-dealers in anticipation of relying upon suit,
judgment and execution to collect claims but rather on a reasonable
demand one can liquidate his cash or securities positions.''); Net
Capital Requirements for Brokers and Dealers, Exchange Act Release
No. 15426 (Dec. 21, 1978), 44 FR 1754 (Jan. 8, 1979) (``The rule
requires brokers or dealers to have sufficient cash or liquid assets
to protect the cash or securities positions carried in their
customers' accounts. The thrust of the rule is to insure that a
broker or dealer has sufficient liquid assets to cover current
indebtedness.''); Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 26402 (Dec. 28, 1989), 54 FR 315 (Jan. 5,
1989) (``The rule's design is that broker-dealers maintain liquid
assets in sufficient amounts to enable them to satisfy promptly
their liabilities. The rule accomplishes this by requiring broker-
dealers to maintain liquid assets in excess of their liabilities to
protect against potential market and credit risks.'') (footnote
omitted).
    \39\ See 17 CFR 240.15c3-1(c)(2)(vi); 17 CFR 240.15c3-1e; 17 CFR
240.15c3-1f.
    \40\ See 17 CFR 240.15c3-1(c)(2)(iv).
---------------------------------------------------------------------------

    Rule 15c3-1 requires broker-dealers to maintain a minimum level of
net capital (meaning highly liquid capital) at all times.\41\ The rule
requires that a broker-dealer perform two calculations: (1) A
computation of the minimum amount of net capital the broker-dealer must
maintain; \42\ and (2) a computation of the amount of net capital the
broker-dealer is maintaining.\43\ The minimum net capital requirement
is the greater of a fixed-dollar amount specified in the rule and an
amount determined by applying one of two financial ratios: the 15-to-1
aggregate indebtedness to net capital ratio or the 2% of aggregate
debit items ratio.\44\
---------------------------------------------------------------------------

    \41\ See 17 CFR 240.15c3-1.
    \42\ See 17 CFR 240.15c3-1(a).
    \43\ See 17 CFR 240.15c3-1(c)(2). The computation of net capital
is based on the definition of net capital in paragraph (c)(2) of
Rule 15c3-1. Id.
    \44\ See 17 CFR 240.15c3-1(a).
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    In computing net capital, the broker-dealer must, among other
things, make certain adjustments to net worth such as deducting
illiquid assets and taking other capital charges and adding qualifying
subordinated loans.\45\ The amount remaining after these deductions is
defined as ``tentative net capital.'' \46\ The final step in computing
net capital is to take prescribed percentage deductions (``standardized
haircuts'') from the mark-to-market value of the proprietary positions
(e.g., securities, money market instruments, and commodities) that are
included in its tentative net capital.\47\ The standardized haircuts
are designed to account for the market risk inherent in these positions
and to create a buffer of liquidity to protect against other risks
associated with the securities business.\48\ ANC broker-dealers and a
type of limited purpose broker-dealer that deals solely in OTC
derivatives (``OTC derivative dealers'') are permitted, with Commission
approval, to calculate net capital using internal models as the basis
for taking market risk and credit risk charges in lieu of the
standardized haircuts for classes of positions for which they have been
approved to use models.\49\ Rule 15c3-1 imposes substantially higher
minimum capital requirements for ANC broker-dealers and OTC derivatives
dealers, as compared to other types of broker-dealers, because, among
other reasons, the use of internal models to compute net capital can
substantially reduce the deductions for securities and money market
positions as compared with the standardized haircuts.\50\ Consequently,
the higher minimum capital requirements are designed to account for
risks that may not be addressed by the internal models. A broker-dealer
must ensure that its net capital exceeds

its minimum net capital requirement at all times.\51\
---------------------------------------------------------------------------

    \45\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
    \46\ See 17 CFR 240.15c3-1(c)(15).
    \47\ See 17 CFR 240.15c3-1(c)(2)(vi).
    \48\ See, e.g., Uniform Net Capital Rule, Exchange Act Release
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts]
are intended to enable net capital computations to reflect the
market risk inherent in the positioning of the particular types of
securities enumerated in [the rule]''); Net Capital Rule, Exchange
Act Release No. 22532 (Oct. 15, 1985), 50 FR 42961 (Oct. 23, 1985)
(``These percentage deductions, or `haircuts', take into account
elements of market and credit risk that the broker-dealer is exposed
to when holding a particular position.''); Net Capital Rule,
Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec.
30, 1997) (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against
adverse market movements and other risks faced by the firms,
including liquidity and operational risks.'') (footnote omitted).
    \49\ See 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR 240.15c3-1e;
17 CFR 240.15c3-1f. As part of the application to use internal
models, an entity seeking to become an ANC broker-dealer or an OTC
derivatives dealer must identify the types of positions it intends
to include in its model calculation. See 17 CFR 240.15c3-
3e(a)(1)(iii); 17 CFR 240.15c3-1f(a)(1)(ii). After approval, an ANC
broker-dealer and OTC derivatives dealer must obtain Commission
approval to make a material change to the model, including a change
to the types of positions included in the model. See 17 CFR
240.15c3-1e(a)(8); 17 CFR 240.15c3-f(a)(3).
    \50\ See 17 CFR 240.15c3-1(a)(5) and (a)(7).
    \51\ 17 CFR 240.15c3-1(a).
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    A different capital standard than the net liquid assets test is
proposed for nonbank MSBSPs. As discussed in more detail below,
proposed Rule 18a-2 would require nonbank MSBSPs to maintain positive
tangible net worth.\52\ The Commission preliminarily believes that a
tangible net worth standard--as opposed to the net liquid assets test--
is more workable for nonbank MSBSPs because these entities may engage
in a diverse range of business activities different from, and broader
than, the securities activities conducted by broker-dealers or SBSDs
(and, to the extent they did not, they likely would be required to
register as an SBSD and/or broker-dealer).\53\ Consequently, requiring
nonbank MSBSPs to adhere to a capital standard based on a net liquid
assets test could restrict these entities from engaging in commercial
activities that are part of their core business models. For example,
some of these entities may engage in manufacturing and supply
activities that generate large amounts of unsecured receivables and
require substantial fixed assets.\54\ Accordingly, as discussed below,
proposed Rule 18a-2 is not modeled on Rule 15c3-1 because of the
expected differences between nonbank SBSDs and broker-dealers, on the
one hand, and the entities that may register as nonbank MSBSPs, on the
other hand.
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    \52\ See proposed new Rule 18a-2.
    \53\ An entity will need to register with the Commission as an
MSBSP and, consequently, be subject to proposed new Rule 18a-2 if it
falls within the definition of major security-based swap participant
in section 3(a)(67) of the Exchange Act (15 U.S.C. 78c(a)(67)) as
further defined by the Commission by rule. See Entity Definitions
Adopting Release, 77 FR 30596.
    \54\ See CFTC Capital Proposing Release, 76 FR at 27807
(proposing a tangible net equity test for major swap participants
that are not part of bank holding companies noting that although
these firms ``may have significant amounts of balance sheet equity,
it may also be the case that significant portions of their equity is
comprised of physical and other noncurrent assets, which would
preclude the firms from meeting FCM capital requirements without
engaging in significant corporate restructuring and incurring
potentially undue costs.'').
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposals to
impose a net liquid assets test capital standard for nonbank SBSDs and
a tangible net worth standard for nonbank MSBSPs. In addition, the
Commission requests comment, including empirical data in support of
comments, in response to the following questions:
    1. Will the entities that register as nonbank SBSDs engage in a
securities business with respect to security-based swaps that is
similar to the securities business conducted by broker-dealers? If not,
describe how the securities activities of nonbank SBSDs will differ
from the securities activities of broker-dealers.
    2. Will some broker-dealers register as nonbank SBSDs? If so, which
types of broker-dealers and which types of activities do these broker-
dealers currently engage in?
    3. Should there be different capital standards for nonbank SBSDs
depending on whether they are registered as broker-dealers or
affiliated with bank holding companies, or not registered as broker-
dealers and not affiliated with bank holding companies? If so, explain
why. If not, explain why not. For example, should stand-alone SBSDs be
subject to a tangible net worth standard or, if affiliated with a bank
holding company, the bank capital standard? Would different standards
create competitive advantages? If so, explain why. If different capital
standards would be appropriate, explain the appropriate capital
standard that should apply to each of these classes of nonbank SBSDs.
    4. Generally, is there a level of capital under which
counterparties will not transact with a dealer in OTC derivatives
because the counterparty credit risk is too great? If so, identify that
level of capital.
    5. Will stand-alone SBSDs seek to effect transactions in securities
OTC derivatives products other than security-based swaps, such as OTC
options, that would necessitate registration as a broker-dealer? If so,
would registering as a limited purpose broker-dealer under the
provisions applicable to OTC derivatives dealers provide a workable
alternative to registering as a full-service broker-dealer? For
example, would there be conflicts between the proposed capital, margin,
and segregation requirements for SBSDs and the existing requirements
for OTC derivatives dealers? If so, identify the conflicts.
    6. Should the requirements for OTC derivatives dealers be amended
(by exemptive relief or otherwise) to accommodate firms that want to
deal in security-based swaps? If so, explain how the requirements
should be amended and why.
    7. Should the Commission exempt nonbank SBSDs engaged in activities
with respect to securities OTC derivatives products other than
security-based swaps from any requirements applicable to OTC
derivatives dealers? Please identify which requirements and explain
why.
    8. As discussed below, the proposed minimum net capital
requirements would differ substantially for stand-alone SBSDs that are
approved to use models in computing net capital (i.e., a $20 million
fixed-dollar minimum net capital requirement and $100 million tentative
net capital requirement) compared to broker-dealer SBSDs approved to
use models (i.e., a $1 billion fixed-dollar minimum net capital
requirement and $5 billion tentative net capital requirement). In
general, because the definition of ``security-based swap dealer'' in
the Dodd-Frank Act does not include acting as a broker or agent in
security-based swaps, entities engaging in brokerage activities with
respect to security-based swaps could be required to register as
broker-dealers. To the extent these broker-dealer SBSDs wanted to use
models to compute net capital, they would be subject to the higher
minimum net capital requirements. Accordingly, in order to avoid being
subject to higher minimum net capital requirements applicable to
broker-dealer SBSDs approved to use models to compute net capital, a
stand-alone SBSD may need to limit the activity it could conduct on
behalf of customers so that it does not fall within the definition of a
``broker'' under the Exchange Act and, thereby, need to register as a
broker-dealer. Commenters are requested to address this issue,
including any potential changes to the proposed capital requirements
for stand-alone SBSDs and broker-dealer SBSDs discussed below. For
example, should broker-dealer SBSDs approved to use internal models to
compute net capital and that register as broker-dealers only in order
to conduct brokerage activities with respect to security-based swaps,
and that do not conduct a general business in securities with
customers, be subject to the minimum net capital requirements
applicable to stand-alone SBSDs approved to use internal models? If so,
explain why. If not, explain why not. If different capital standards
would be appropriate, explain the appropriate capital standard that
should apply to this class of broker-dealer SBSDs and whether any
limitations should apply, including with respect to the types of broker
activities in which the nonbank SBSD may engage in order to qualify for
a particular capital treatment. Alternatively, or in addition, should
the Commission allow OTC derivatives dealers (which are subject to a
$20 million fixed-dollar minimum net capital requirement and $100
million tentative net capital requirement) to be dually registered as
nonbank SBSDs and/or amend the rules for OTC derivatives dealers to
conduct a broader range of activities than are currently

permitted? If the Commission took this action, should it also remove
the exemption for OTC derivatives dealers from membership in a self-
regulatory organization (``SRO'')?
    9. Describe the types of entities that may need to register as
MSBSPs and how the activities that these entities engage in would
impact the entity's capital position.
    10. Should nonbank MSBSPs be subject to a net liquid assets test
capital standard (in contrast to a tangible net worth test)? If so,
explain why. If not, explain why not.
2. Proposed Capital Rules for Nonbank SBSDs
    As discussed in detail below, proposed new Rule 18a-1 would
prescribe capital requirements for stand-alone SBSDs and amendments to
Rule 15c3-1 would prescribe capital requirements for broker-dealer
SBSDs. Proposed new Rule 18a-1 would require a stand-alone SBSD to
compute net capital using standardized haircuts prescribed in the rule
(including standardized haircuts specifically for security-based swaps
and swaps) or, alternatively, with Commission approval, to use internal
models for positions for which the stand-alone SBSD has been approved
to use internal models. Under the proposed amendments to Rule 15c3-1, a
broker-dealer SBSD would be required to use the existing standardized
haircuts in the rule plus proposed new additional standardized haircuts
specifically for security-based swaps and swaps. A broker-dealer SBSD
that seeks to compute net capital using internal models would need to
apply to the Commission for approval to operate as an ANC broker-
dealer. A nonbank SBSD permitted to use internal models to compute net
capital (whether a stand-alone SBSD subject to proposed new Rule 18a-1
or an ANC broker-dealer subject to Rule 15c3-1, as amended) would need
to comply with additional requirements as compared to a nonbank SBSD
that is not approved to use internal models. This would be consistent
with the existing requirements in Rule 15c3-1, which impose additional
requirements on ANC broker-dealers and OTC derivatives dealers as
compared with other broker-dealers.\55\ Finally, the amendments to Rule
15c3-1 would apply to broker-dealers that are not registered as SBSDs
to the extent they hold positions in security-based swaps and swaps.
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    \55\ See, e.g., 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR
240.15c3-1e; 17 CFR 240.15c3-1f; 17 CFR 240.15c3-4.
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a. Computing Required Minimum Net Capital
    Rule 15c3-1 prescribes the minimum net capital requirement for a
broker-dealer as the greater of a fixed-dollar amount specified in the
rule and an amount determined by applying one of two financial ratios:
the 15-to-1 aggregate indebtedness to net capital ratio or the 2% of
aggregate debit items ratio.\56\ The proposed capital requirements for
nonbank SBSDs would use a similar framework. Under the proposals, there
would be different minimum net capital requirements for stand-alone
SBSDs that are not approved to use internal models, broker-dealer SBSDs
that are not approved to use internal models, stand-alone SBSDs that
are approved to use internal models, and broker-dealer SBSDs that are
approved to use internal models (i.e., ANC broker-dealers). The
following table provides a summary of the proposed minimum net capital
requirements, which are discussed in the following sections.
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    \56\ See 17 CFR 240.15c3-1(a).
    [GRAPHIC] [TIFF OMITTED] TP23NO12.000

i. Stand-alone SBSDs Not Using Internal Models

    A stand-alone SBSD would be subject to the capital requirements set
forth in proposed new Rule 18a-1. Under this proposed new rule, a
stand-alone SBSD that is not approved to use internal models to compute
haircuts would be required to maintain minimum net capital of not less
than the greater of $20 million or 8% of the firm's risk margin amount
(``8% margin factor'').\57\ The term risk margin amount would be
defined as the sum of: (1) The greater of the total margin required to
be delivered by the nonbank SBSD with respect to security-based swap
transactions cleared for security-based swap customers at a clearing
agency or the amount of the deductions that would apply to the cleared
security-based swap positions of the security-based swap customers
pursuant to paragraph (c)(1)(vi) of Rule 18a-1; and (2) the total
margin amount calculated by the stand-alone SBSD with respect to non-
cleared security-based swaps pursuant to proposed new Rule 18a-3.\58\
Accordingly, to determine its minimum net capital requirement, a stand-
alone SBSD would need to calculate the amount equal to the 8% margin
factor.\59\ The firm's minimum net capital requirement would be the
greater of $20 million or the amount equal to the 8% margin factor.\60\
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    \57\ See paragraph (a)(1) of proposed new Rule 18a-1. The
rationales for these minimum requirements are discussed below.
    \58\ See paragraph (c)(6) of proposed new Rule 18a-1. The
components of the risk margin amount are discussed in detail below.
    \59\ See paragraphs (a)(1) and (c)(6) of proposed new Rule 18a-
1.
    \60\ See paragraph (a)(1) of proposed new Rule 18a-1.
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    The proposed $20 million fixed-dollar minimum requirement would be
the same as the fixed-dollar minimum

requirement applicable to OTC derivatives dealers and already familiar
to existing market participants.\61\ OTC derivatives dealers are
limited purpose broker-dealers that are authorized to trade in certain
derivatives, including security-based swaps, and to use internal models
to calculate net capital. They are required to maintain minimum
tentative net capital of $100 million and minimum net capital of $20
million.\62\ These current fixed-dollar minimums have been the minimum
capital standards for OTC derivative dealers for over a decade, and are
substantially lower than the fixed-dollar minimums in Rule 15c3-1
currently applicable to ANC broker-dealers, which use internal models
to calculate net capital.\63\ In addition, available data regarding the
current population of broker-dealers suggests that these minimums would
not prevent new entrants in the security-based swap market.\64\ To
date, there have been no indications that these minimums are not
adequately meeting the objective of requiring OTC derivatives dealers
to maintain sufficient levels of regulatory capital to account for the
risks inherent in their activities.
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    \61\ See 17 CFR 240.15c3-1(a)(5). The CFTC proposed a $20
million fixed-dollar minimum net capital requirement for FCMs that
are registered as swap dealers, regardless of whether the firm is
approved to use internal models to compute regulatory capital. See
CFTC Capital Proposing Release, 76 FR 27802.
    Further, the CFTC proposed a $20 million fixed-dollar ``tangible
net equity'' minimum requirement for swap dealers and major swap
participants that are not FCMs and are not affiliated with a U.S.
bank holding company. Finally, the CFTC proposed a $20 million
fixed-dollar Tier 1 capital minimum requirement for swap dealers and
major swap participants that are not FCMs and are affiliated with a
U.S. bank holding company (the term ``Tier 1 capital'' refers to the
regulatory capital requirement for U.S. banking institutions). Id.
    \62\ See 17 CFR 240.15c3-1(a)(5). When adopting the capital
requirements for OTC derivatives dealers, the Commission stated
``[t]he minimum tentative net capital and net capital requirements
are necessary to ensure against excessive leverage and risks other
than credit or market risk, all of which are now factored into the
current haircuts. Further, while the mathematical assumptions
underlying VaR may be useful in projecting possible daily trading
losses under `normal' market conditions, VaR may not help firms
measure losses that fall outside of normal conditions, such as
during steep market declines. Accordingly, the minimum capital
requirements provide additional safeguards to account for possible
extraordinary losses or decreases in liquidity during times of
stress which are not incorporated into VaR calculations.'' See OTC
Derivatives Dealers, 63 FR 59362.
    \63\ Paragraph (a)(7) of Rule 15c3-1 currently requires that ANC
broker-dealers at all times maintain tentative net capital of not
less than $1 billion and net capital of not less than $500 million.
17 CFR 240.15c3-1(a)(7).
    \64\ See infra section V.B.2.a.i. of this release (economic
analysis discussion based on year-end 2011 data showing that
approximately 270 broker-dealers maintain net capital of $20 million
or more).
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    At the same time, the proposed $20 million fixed-dollar minimum
requirement for stand-alone SBSDs that do not use internal models to
calculate net capital would be substantially higher than the fixed-
dollar minimums in Rule 15c3-1 currently applicable to broker-dealers
that do not use internal models (i.e., that are not ANC broker-dealers
or OTC derivatives dealers).\65\ Under the proposals, stand-alone SBSDs
that do not use models would not be able to avail themselves of such
minimums and would be subject to the same $20 million minimum net
capital requirement as OTC derivatives dealers, even though they would
not be using models like such derivatives dealers. In other words, the
same minimum net capital requirement will apply to stand-alone SBSDs
regardless of whether or not they use models.
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    \65\ For example, a broker-dealer that carries customer accounts
has a fixed-dollar minimum requirement of $250,000; a broker-dealer
that does not carry customer accounts but engages in proprietary
securities trading (defined as more than ten trades a year) has a
fixed-dollar minimum requirement of $100,000; and a broker-dealer
that does not carry accounts for customers or otherwise does not
receive or hold securities and cash for customers, and does not
engage in proprietary trading activities, has a fixed-dollar minimum
requirement of $5,000. See 17 CFR 240.15c3-1(a)(2).
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    This level of minimum capital may be appropriate because of the
nature of the business of a stand-alone SBSD and the differences from
the business of a broker-dealer or OTC derivatives dealer. Generally,
OTC derivatives, such as security-based swaps, are contracts between a
dealer and its counterparty. Consequently, the counterparty's ability
to collect amounts owed to it under the contract depends on the
financial wherewithal of the dealer. In contrast, the returns on
financial instruments held by a broker-dealer for an investor (other
than a derivative issued by the broker-dealer) are not linked to the
financial wherewithal of the broker-dealer holding the instrument for
the customer. Accordingly, if a stand-alone SBSD fails, the
counterparty may not be able to liquidate the contract or replace the
contract with a new counterparty without incurring a loss on the
position. The entities that will register and operate as nonbank SBSDs
should be sufficiently capitalized to minimize the risk that they
cannot meet their obligations to counterparties, particularly given
that the counterparties will not be limited to other dealers but will
include customers and other counterparties as well.
    In addition, stand-alone SBSDs will not be subject to the same
limitations that apply to OTC derivative dealers in effecting
transactions with customers and engaging in dealing activities.\66\
Therefore, the failure of a stand-alone SBSD could have a broader
adverse impact on a larger number of market participants, including
customers and counterparties.\67\ The proposed capital requirements for
this group of firms, in part, are meant to account for this potential
broader impact on market participants.\68\
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    \66\ See 17 CFR 240.3b-12; 17 CFR 240.15a-1. Rule 3b-12,
defining the term OTC derivatives dealer, provides, among other
things, that an OTC derivatives dealer's securities activities must
be limited to: (1) Engaging in dealer activities in eligible OTC
derivative instruments (as defined in the rule) that are securities;
(2) issuing and reacquiring securities that are issued by the
dealer, including warrants on securities, hybrid securities, and
structured notes; (3) engaging in cash management securities
activities (as defined in Rule 3b-14 (17 CFR 240.3b-14)); (4)
engaging in ancillary portfolio management securities activities (as
defined in the rule); and (5) engaging in such other securities
activities that the Commission designates by order. See 17 CFR
240.3b-12. Rule 15a-1, governing the securities activities of OTC
derivatives dealers, provides that an OTC derivatives dealer must
effect transactions in OTC derivatives with most types of
counterparties through an affiliated Commission-registered broker-
dealer that is not an OTC derivatives dealer. See 17 CFR 240.15a-1.
    \67\ The proposal is consistent with the CFTC's proposed capital
requirements for nonbank swap dealers, which impose $20 million
fixed-dollar minimum requirements regardless of whether the firm is
approved to use internal models to compute regulatory capital. See
CFTC Capital Proposing Release, 76 FR 27802.
    \68\ As discussed above, stand-alone SBSDs would be subject to a
minimum ratio amount based on the 8% margin factor. OTC derivatives
dealers are not subject to a minimum ratio amount.
---------------------------------------------------------------------------

    Consequently, stand-alone SBSDs that do not use internal models
would be subject to the same $20 million fixed-dollar minimum net
capital requirement that applies to OTC derivatives dealers. The same
firms would not, however, be subject to a minimum tentative net capital
requirement, which is applied to firms that use internal models to
account for risks that may not be fully captured by the models.\69\
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    \69\ OTC derivatives dealers are subject to a $100 million
minimum tentative net capital requirement. ANC broker-dealers are
currently subject to a $1 billion minimum tentative net capital
requirement. The minimum tentative net capital requirements are
designed to address risks that may not be captured when using
internal models rather than standardized haircuts to compute net
capital. See OTC Derivatives Dealers, 63 FR at 59384; Alternative
Net Capital Requirements for Broker-Dealers That Are Part of
Consolidated Supervised Entities; Proposed Rule, Exchange Act
Release No. 48690 (Oct. 24, 2003), 68 FR 62872, 62875 (Nov. 6, 2003)
(``We expect that net capital charges will be reduced for broker-
dealers that use the proposed alternative net capital computation.
The present haircut structure is designed so that firms will have a
sufficient capital base to account for, in addition to market and
credit risk, other types of risk, such as operational risk, leverage
risk, and liquidity risk. Raising the minimum tentative net capital
requirement to $1 billion and net capital requirement to $500
million is one way to ensure that firms that use the alternative
capital computation maintain sufficient capital reserves to account
for these other risks. In addition, based on our experience, firms
must have this scale of operations in order to have developed
internal risk management control systems necessary to support
reliable VaR computations.'').

---------------------------------------------------------------------------

    The proposed 8% margin factor would be part of determining the
stand-alone SBSD's minimum net capital requirement. As noted above, the
stand-alone SBSD would determine this amount by adding:
     The greater of the total margin required to be delivered
by the stand-alone SBSD with respect to security-based swap
transactions cleared for security-based swap customers at a clearing
agency or the amount of the deductions that would apply to the cleared
security-based swap positions of the security-based swap customers
pursuant to paragraph (c)(1)(vi) of Rule 18a-1; \70\ and
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    \70\ See paragraph (c)(6) of proposed new Rule 18a-1. As
discussed below in section II.B. of this release, nonbank SBSDs will
be subject to margin requirements imposed by clearing agencies
pursuant to which nonbank SBSDs will be required to collect
collateral from customers relating to the customers' cleared
security-based swap transactions. The amount of collateral required
to be collected as a result of customers' cleared security-based
swap transactions would be used to determine the first component of
the risk margin amount. This amount would be added to the second
component of the risk margin amount relating to non-cleared
security-based swaps and that amount would be multiplied by 8% to
determine the 8% margin factor. However, if the margin requirements
of the clearing agencies require the stand-alone SBSD to collect
total collateral in an amount that is less than the deductions the
firm would apply to the customers' cleared security-based swap
positions under proposed new Rule 18a-1, the stand-alone SBSD would
need to add the amount of the deductions to the second component of
the risk margin amount relating to non-cleared security-based swaps
and multiply that amount by 8% to determine the 8% margin factor.
---------------------------------------------------------------------------

     The total margin amount calculated by the stand-alone SBSD
with respect to non-cleared security-based swaps pursuant to paragraph
(c)(1)(i)(B) of proposed new Rule 18a-3.\71\
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    \71\ See paragraph (c)(6) of proposed new Rule 18a-1. As
discussed below in section II.B. of this release, proposed new Rule
18a-3 would establish margin requirements for nonbank SBSDs with
respect to non-cleared security-based swaps. See proposed new Rule
18a-3. The proposed rule would define the term margin to mean the
amount of positive equity in an account of a counterparty. See
paragraph (b)(5) of proposed new Rule 18a-3. Under the proposed
rule, a nonbank SBSD would be required to calculate daily a margin
amount for the account of each counterparty to a non-cleared
security-based swap. See paragraph (c)(1)(i)(B) of proposed new Rule
18a-3. These calculations of counterparty margin amounts for the
purposes of proposed new Rule 18a-3 would be used to determine the
component of the risk margin amount relating to non-cleared
security-based swaps. This amount would be added to the first
component relating to cleared security-based swaps, and the total
amount would be multiplied by 8% to determine the 8% margin factor.
---------------------------------------------------------------------------

    The total of these two amounts--i.e., the risk margin amount--would
be multiplied by 8% to determine the amount of the 8% margin factor,
which, if greater than the $20 million fixed-dollar amount, would be
the stand-alone SBSD's minimum net capital requirement.\72\ This
proposed 8% margin factor ratio requirement is similar to an existing
requirement in the CFTC's net capital rule for FCMs.\73\ Further, the
CFTC has proposed a similar requirement for swap dealers and major swap
participants registered as FCMs.\74\ Under the CFTC's proposal, an FCM
would be required to maintain adjusted net capital that is equal to or
greater than 8% of the risk margin required for customer and non-
customer exchange-traded futures and swaps positions that are cleared
by a derivatives clearing organization (``DCO'').\75\ The CFTC's
proposed 8% of margin, or risk-based capital rule, ``is intended to
require FCMs to maintain a minimum level of capital that is associated
with the level of risk associated with the customer positions that the
FCM carries.'' \76\ Based on Commission staff experience with dually-
registered broker-dealer/FCMs, the Commission preliminarily believes
that the 8% margin factor would serve as a reasonable measure to ensure
that a firm's minimum capital requirement increases or decreases in
tandem with the level of risk arising from customer futures
transactions. Consequently, the 8% margin factor is being proposed to
provide a similar adjustable minimum net capital requirement for
nonbank SBSDs with respect to their security-based swap activity.\77\
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    \72\ See paragraphs (a)(1) and (c)(6) of proposed new Rule 18a-
1.
    \73\ See 17 CFR 1.17(a)(1)(i)(B). See also Minimum Financial and
Related Reporting Requirements for Futures Commission Merchants and
Introducing Brokers, 69 FR 49784 (Aug. 12, 2004). The CFTC proposed
the 8% risk margin requirement to establish a margin-based capital
computation identical to the margin-based minimum net capital
computation that several futures self-regulatory organizations,
including one derivatives clearing organization, adopted for their
respective member-FCMs. Id. at note 16.
    \74\ See CFTC Capital Proposing Release, 76 FR 27802. The 8%
risk margin calculation under the CFTC's proposal relates to cleared
swaps or futures transactions, whereas the 8% margin factor proposed
in new Rule 18a-1 would be based on cleared and non-cleared
security-based swaps. As discussed below, the proposed minimum net
capital requirement is based on a nonbank SBSD's cleared and non-
cleared security-based swap activity in order to account for the
risks of both types of positions.
    \75\ See CFTC Capital Proposing Release, 76 FR 27802.
    \76\ Id. at 27807.
    \77\ As discussed below in section II.A.2.b.iv. of this release,
an 8% multiplier is used for purposes of calculating credit risk
charges under Appendix E to Rule 15c3-1. While this is a different
calculation than the proposed 8% margin factor, using an 8%
multiplier for purposes of computing regulatory capital requirements
is an international standard. See Alternative Net Capital
Requirements Adopting Release, 69 FR 34428, note 42 (describing the
8% multiplier in Appendix E to Rule 15c3-1 as being ``consistent
with the calculation of credit risk in the OTC derivatives dealers
rules and with the Basel Standard'' and as being ``designed to
dampen leverage to help ensure that the firm maintains a safe level
of capital.'').
---------------------------------------------------------------------------

    Under the proposed rule, nonbank SBSDs--including stand-alone SBSDs
that are not approved to use internal models to calculate net capital--
would be subject to a minimum net capital requirement that increases in
tandem with an increase in the risks associated with nonbank SBSD's
security-based swap activities.\78\ Without the 8% margin factor, the
minimum net capital requirement for a nonbank SBSD would be the same
(i.e., $20 million) regardless of the volume, size, and risk of its
outstanding security-based swap transactions.
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    \78\ As discussed below in sections II.A.2.a.ii., II.A.2.a.iii.,
and II.A.2.a.iv. of this release, the 8% margin factor would be used
to compute the minimum net capital requirement for all nonbank
SBSDs.
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    The amount computed under the 8% margin factor generally would
increase as the stand-alone SBSD increased the volume, size, and risk
of its security-based swap transactions. Specifically, the proposed
definition of the term risk margin amount is designed to link the
stand-alone SBSD's minimum net capital requirement to its cleared and
non-cleared security-based swap activity. For example, the definition
in proposed new Rule 18a-1 provides that, for cleared security-based
swaps, the amount is the greater of the margin required to be collected
or the amount of the deductions that would apply pursuant to proposed
new Rule 18a-1 (i.e., the amount of the deductions using standardized
haircuts).\79\ The margin requirement for cleared security-based swap
positions generally should increase with the volume, size, and risk of
the positions as would the amount of the standardized haircuts
applicable to the positions. Further, the ``greater of'' provision is
designed to ensure that the 8% margin factor requirement is based on,
at a minimum, the standardized haircuts as these provide a uniform
approach for all cleared security-based

swaps, whereas margin requirements for cleared security-based swaps
will vary over time and across different clearing agencies.
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    \79\ For a stand-alone SBSD approved to use internal models and
an ANC broker-dealer, it would be the amount of the deductions
determined using a VaR model, except for types of positions for
which the firm has not been approved to use a VaR model.
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    As proposed, the 8% margin factor is determined using the greater
of required margin or standardized haircuts with respect to cleared
security-based swaps plus the margin amount for non-cleared security-
based swaps calculated under proposed new Rule 18a-3.\80\ Thus, the 8%
margin factor would be based on a stand-alone SBSD's activity in both
cleared and non-cleared security-based swaps. As noted above, the goal
of the provision is to require the stand-alone SBSD to increase its net
capital in tandem with an increase in the risk of its security-based
swap transactions. The proposal does not limit the computation to only
cleared security-based swaps, as proposed by the CFTC, because such a
limitation would allow the stand-alone SBSD to increase the amount of
its non-cleared security-based swaps positions without a corresponding
increase in net capital. This could create greater risk to the stand-
alone SBSD's customers because--as discussed above--their ability to
collect amounts owing on security-based swaps depends on the ability of
the stand-alone SBSD to meets its obligations.
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    \80\ Proposed new Rule 18a-3 would require a nonbank SBSD to
calculate daily a margin amount for the account of each counterparty
to a non-cleared security-based swap. See paragraph (c)(1)(i)(B) of
proposed new Rule 18a-3. As discussed below in section II.B. of this
release, a nonbank SBSD would be required to perform this
calculation even though proposed new Rule 18a-3 would not require
the nonbank SBSD to collect collateral from all counterparties to
collateralize the margin amount. For example, the Commission is
proposing that collateral need not be collected from commercial end
users. Nonetheless, the calculation of the margin amount for
purposes of proposed new Rule 18a-3 would determine the non-cleared
security-based swap component of the risk margin amount regardless
of whether the nonbank SBSD would be required to collect collateral
from the counterparty to collateralize the margin amount. In other
words, the amount of the risk margin amount would be based on the
calculation required by proposed new Rule 18a-3 for all
counterparties to non-cleared security-based swaps and not on
whether the stand-alone SBSD would be required to collect collateral
from a counterparty to collateralize the margin amount. As discussed
in section II.B. of this release, this is designed to ensure that
the risk margin amount is based on all non-cleared security-based
swap activity of the stand-alone SBSD and not just on security-based
swap activity that would require the firm to collect collateral.
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Request for Comment
    The Commission generally requests comment on the proposed minimum
net capital requirements in proposed new Rule 18a-1 for stand-alone
SBSDs that are not approved to use internal models to compute net
capital. In addition, the Commission requests comment, including
empirical data in support of comments, in response to the following
questions:
    1. Is the proposed $20 million minimum net capital requirement for
stand-alone SBSDs not using internal models appropriate? If not,
explain why not. What minimum amount would be more appropriate? For
example, should the minimum fixed-dollar amount be greater than $20
million to account for the broader range of activities that stand-alone
SBSDs will be able to engage in as compared with OTC derivatives
dealers? If so, explain why. If it should be a greater amount, how much
greater should it be (e.g., $30 million, $50 million, $100 million, or
some other amount)? Alternatively, should the minimum fixed-dollar
amount be less than $20 million because these firms will not be using
internal models to compute net capital? If so, explain why. If it
should be a lower amount, how much lower (e.g., $15 million, $10
million, $5 million, or some other amount)? If a greater or lesser
alternative amount is recommended, explain why it would be more
appropriate for broker-dealer SBSDs that are not approved to use
internal models.
    2. Is the proposed definition of risk margin amount appropriate? If
not, explain why and suggest modifications to the definition. For
example, are there modifications that could make the definition more
accurately reflect the nonbank SBSD's risk exposure from dealing in
security-based swaps? If so, describe the modifications and explain why
they would achieve this result.
    3. Is the component of the risk margin amount definition addressing
margin delivered for cleared swaps appropriate? If not, explain why
not. Would the definition be more appropriate if this component was
dropped so that the first prong of the definition only incorporated the
haircuts for cleared security-based swaps?
    4. Should the proposed definition of risk margin amount only
address cleared security-based swaps, consistent with the CFTC's
proposal? If so, explain why, including how the risk of non-cleared
security-based swap activities could be addressed through other
measures.
    5. Is the component of the risk margin amount definition addressing
margin collected for non-cleared security-based swaps appropriate? If
not, explain why not.
    6. Is the 8% margin factor an appropriate metric for determining a
nonbank SBSD's minimum net capital requirement in terms of increasing a
nonbank SBSD's minimum net capital requirement as the risk of its
security-based swap activities increases? If not, explain why not. For
example, should the percentage be greater than 8% (e.g., 10%, 12%, or
some other percentage)? If so, identify the percentage and explain why
it would be preferable. Should the percentage be less than 8% (e.g.,
6%, 4%, or some other percentage)? If so, identify the percentage and
explain why it would be preferable.
    7. Should the 8% multiplier be tiered as the amount of the risk
margin amount increases? If so, explain why. For example, should the
multiplier decrease from 8% to 6% for the amount of the risk margin
amount that exceeds a certain threshold, such as $1 billion or $5
billion? If so, explain why. Should the amount of the multiplier
increase from 8% to 10% for the amount of the risk margin amount that
exceeds a certain threshold such as $1 billion or $5 billion? If so,
explain why.
    8. Should the 8% margin factor be an adjustable ratio (e.g.,
increase to 10% or decrease to 6%)? For example, should the multiplier
adjust periodically if certain conditions occur? If so, explain the
conditions under which the 8% multiplier would adjust upward or
downward and why having an adjustable ratio would be appropriate.
    9. Would the 8% margin factor be a sufficient minimum net capital
requirement without the $20 million fixed-dollar minimum? If so,
explain why.
    10. Are there metrics other than a fixed-dollar minimum and the 8%
margin factor for calculating required minimum capital that would more
appropriately reflect the risk of nonbank SBSDs? If so, identify them
and explain why they would be preferable. For example, instead of an
absolute fixed-dollar minimum, should the minimum net capital
requirement be linked to a scalable metric such as the size of the
nonbank SBSD or the amount of the deductions taken by the nonbank SBSD
when computing net capital? For any scalable minimum net capital
requirements identified, explain how the computation would work in
practice and how the minimum requirement would address the same
objectives of a fixed-dollar minimum.
    11. Would the 8% margin factor address the risk of extremely large
nonbank SBSDs? If not, explain why not. For example, if the customer
margin requirements for cleared and non-cleared security-based swaps
carried by the nonbank SBSD were low because the positions were hedged
or otherwise not high risk, the 8% margin

factor may not increase in tandem with the level of the nonbank SBSD's
security-based swap activity. In this case, would the 8% margin factor
adequately address the risk of the nonbank SBSD, particularly if it
carried substantial security-based swap positions? If not, explain why
not. Would the 8% margin factor be necessary for small nonbank SBSDs?
If not, explain why not.
    12. Would the 8% margin factor provide an appropriate and workable
restraint on the amount of leverage incurred by stand-alone SBSDs not
using internal models because the amount of minimum net capital would
increase as the risk margin amount increases? If not, explain why not.
Is there another measure that would more accurately and effectively
address the leverage risk of these firms? If so, identify the measure
and explain why it would be more accurate and effective.
    13. Should the 8% margin factor be applied to margin related to
cleared and non-cleared swap transactions in addition to security-based
swap transactions? For example, the provision could require that 8% of
the margin required for cleared and non-cleared swaps be added to the
8% of margin required for cleared and non-cleared security-based swaps
in determining the minimum net capital requirement. Would this be a
workable approach to address the fact that the CFTC's proposed 8%
margin requirement would not apply to swap dealers that are not
registered as FCMs and, with respect to dually-registered FCM swap
dealers, it would apply only to cleared swaps? Including swaps in the
8% margin factor calculation would provide for equal treatment of
security-based swaps and swaps in determining a minimum net capital
requirement. Would this be a workable approach? If so, explain why. If
not, explain why not.
    14. Would the 8% margin factor be practical as applied to a
portfolio margin account that contains security-based swaps and swaps?
If so, explain why. If not, explain why not.
    15. What will be the practical impacts of the 8% margin factor? For
example, what will be the effect on transaction costs, liquidity in
security-based swaps, availability of capital to support security-based
swap transactions generally and/or for non-security-based swap-related
uses, use of security-based swaps for hedging purposes, risk management
at SBSDs, the costs for potential new SBSDs to participate in the
security-based swap markets, etc.? How would these impacts increase or
decrease if the 8% margin factor were set at a higher or lower
percentage?
ii. Broker-Dealer SBSDs Not Using Internal Models
    A broker-dealer that registers as an SBSD would continue to be
subject to the capital requirements in Rule 15c3-1, as proposed to be
amended to account for security-based swap activities. Proposed
amendments to paragraph (a) of Rule 15c3-1 would establish minimum net
capital requirements for a broker-dealer SBSD that is not approved to
use internal models to compute net capital.\81\ Under these proposed
amendments, the broker-dealer SBSD would be subject to the same $20
million fixed-dollar minimum net capital requirement as a stand-alone
SBSD that does not use internal models.\82\ As discussed above in
section II.A.2.a.i. of this release, the proposed $20 million fixed-
dollar minimum would be consistent with the current fixed-dollar
minimum that applies to OTC derivatives dealers, which has been used as
a minimum capital standard for OTC derivative dealers for over a
decade.
---------------------------------------------------------------------------

    \81\ See proposed new paragraph (a)(10) of Rule 15c3-1.
    \82\ Id.
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    In addition, a broker-dealer SBSD that does not use internal models
would be required to use the 8% margin factor to compute its minimum
net capital amount. As discussed above in section II.A.2.a.i. of this
release, the 8% margin factor is designed to adjust the broker-dealer
SBSD's minimum net capital requirement in tandem with the risk
associated with the broker-dealer SBSD's security-based swap activity.
Without the 8% margin factor, the minimum net capital requirement for a
broker-dealer SBSD would be the same (i.e., $20 million) regardless of
the number, size, and risk of its outstanding security-based swap
transactions. Consequently, the proposed rule would include the 8%
margin factor in order to increase the broker-dealer SBSD's net capital
requirement as the risk of its security-based swap activities
increases.
    Moreover, the broker-dealer SBSD--as a broker-dealer--would be
subject to the existing financial ratio requirements in Rule 15c3-1
and, therefore, would need to include the applicable financial ratio
amount when determining the firm's minimum net capital requirement.\83\
A broker-dealer's minimum net capital requirement is the greater of the
applicable fixed-dollar amount and one of two alternative financial
ratios. The first financial ratio requirement provides that a broker-
dealer must not permit its aggregate indebtedness to all other persons
to exceed 1500% of its net capital (i.e., a 15-to-1 aggregate
indebtedness to net capital requirement).\84\ This is the default
financial ratio requirement that all broker-dealers must apply unless
they affirmatively elect to be subject to the second financial ratio
requirement by notifying their designated examining authority of the
election.\85\ The second financial ratio requirement provides that a
broker-dealer must not permit its net capital to be less than 2% of
aggregate debit items (i.e., customer-related obligations to the
broker-dealer).\86\
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    \83\ See 17 CFR 240.15c3-1(a)(1); proposed new paragraph
(a)(10)(i) of Rule 15c3-1. Currently, all broker-dealers, including
the ANC broker-dealers, are subject either to the aggregate
indebtedness standard or the aggregate debit items (alternative
standard) financial ratio requirements.
    \84\ See 17 CFR 240.15c3-1(a)(1)(i). Stated another way, the
broker-dealer must maintain, at a minimum, an amount of net capital
equal to 1/15th (or 6.67%) of its aggregate indebtedness. This
financial ratio generally is used by smaller broker-dealers that do
not hold customer securities and cash.
    \85\ See 17 CFR 240.15c3-1(a)(1)(i)-(ii).
    \86\ See 17 CFR 240.15c3-1(a)(1)(ii). Customer debit items--
computed pursuant to Rule 15c3-3--consist of, among other things,
margin loans to customers and securities borrowed by the broker-
dealer to effectuate deliveries of securities sold short by
customers. See 17 CFR 240.15c3-3; 17 CFR 240.15c3-3a. This ratio
generally is used by larger broker-dealers that hold customer
securities and cash.
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    The proposed amendments to Rule 15c3-1 would provide that a broker-
dealer SBSD that is not approved to use internal models would be
required to maintain a minimum net capital level of not less than the
greater of: (1) $20 million or (2) the financial ratio amount required
pursuant to paragraph (a)(1) of Rule 15c3-1 plus the 8% margin
factor.\87\ Thus, the proposed minimum net capital requirement for a
broker-dealer SBSD would incorporate the requirement in Rule 15c3-1
that a broker-dealer maintain the greater of a fixed-dollar amount or
one of the two financial ratio amounts, as applicable.\88\ The
financial ratio requirements in Rule 15c3-1 are designed to link the
broker-dealer's minimum net capital requirement to the level of its
securities activities. For example, the aggregate debit ratio
requirement is designed for broker-dealers that carry customer
securities and cash.\89\ This provision increases the minimum net
capital requirement for these broker-dealers as they increase their
debit items by engaging in margin lending and facilitating of customer
short-sale

transactions.\90\ The proposal to combine the Rule 15c3-1 financial
ratios with the 8% margin factor in a broker-dealer SBSD's computation
of its minimum net capital requirement is designed to require the
broker-dealer SBSD to maintain a capital cushion to support its
traditional securities activities (e.g., margin lending) and its
security-based swap activities.
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    \87\ See proposed new paragraph (a)(10)(i) of Rule 15c3-1.
    \88\ Id.
    \89\ See Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 17208 (Oct. 9, 1980), 45 FR 69915 (Oct. 22,
1980).
    \90\ See 17 CFR 240.15c3-1(a)(1)(ii); 17 CFR 240.15c3-3a.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposed minimum
net capital requirements for broker-dealer SBSDs that are not approved
to use internal models. Commenters are referred to the general
questions above in section II.A.2.a.i. of this release about the 8%
margin factor as applied broadly to nonbank SBSDs. In addition, the
Commission requests comment, including empirical data in support of
comments, in response to the following questions:
    1. Is the proposed $20 million minimum net capital requirement
appropriate for broker-dealer SBSDs that are not approved to use
internal models? If not, explain why not. What minimum amount would be
more appropriate? For example, should the minimum fixed-dollar amount
be greater than $20 million to account for the broader range of
activities that broker-dealer SBSDs will be able to engage in (e.g.,
traditional securities activities such as margin lending), as compared
with stand-alone SBSDs and OTC derivatives dealers? If it should be a
greater amount, how much greater should it be (e.g., $30 million, $50
million, $100 million, or some other amount)? Alternatively, should the
minimum fixed-dollar amount be less than $20 million because these
firms will not be using internal models to compute net capital? If it
should be a lower amount, how much lower (e.g., $15 million, $10
million, $5 million or some other amount)? If a greater or lesser
alternative amount is recommended, explain why it would be preferable
for broker-dealer SBSDs that are not approved to use internal models.
    2. Is combining the 8% margin factor requirement with the
applicable Rule 15c3-1 financial ratio requirement an appropriate way
to determine a minimum net capital requirement for broker-dealer SBSDs
that are not approved to use internal models? If not, explain why not.
    3. Would the 8% margin factor combined with the Rule 15c3-1
financial ratio provide an appropriate and workable restraint on the
amount of leverage incurred by broker-dealer SBSDs not using internal
models? If not, explain why not. Is there another measure that would
more accurately and effectively address the leverage risk of these
firms? If so, identify the measure and explain why it would be more
accurate and effective.
iii. Stand-Alone SBSDs Using Internal Models
    As discussed above, a stand-alone SBSD would be subject to the
capital requirements in proposed new Rule 18a-1.\91\ Rule 18a-1 would
permit stand-alone SBSDs to apply to use internal models to compute net
capital.\92\ In terms of minimum capital requirements, a stand-alone
SBSD that has been approved to use internal models would be required to
maintain: (1) a minimum tentative net capital level of not less than
$100 million; and (2) a minimum net capital level of not less than the
greater of $20 million or the 8% margin factor.\93\ The proposed
minimum net capital requirement for stand-alone SBSDs using internal
models (i.e., the greater of $20 million or the 8% margin factor) is
the same as the proposed minimum net capital requirement for stand-
alone SBSDs and broker-dealer SBSDs not using internal models (though
the latter would need to incorporate the Rule 15c3-1 financial ratio
requirement into their minimum net capital computations).
---------------------------------------------------------------------------

    \91\ See proposed new Rule 18a-1.
    \92\ See paragraphs (a)(2) and (d) of proposed new Rule 18a-1;
the discussion below in section II.A.2.b.iii. of this release.
    \93\ See paragraph (a)(2) of proposed Rule 18a-1. As discussed
above in section II.A.2.a.i. of this release, the 8% margin factor
is designed to adjust the stand-alone SBSD's minimum net capital
requirement in tandem with the risk associated with the broker-
dealer firm's security-based swap activity.
---------------------------------------------------------------------------

    A stand-alone SBSD approved to use internal models also would be
subject to a minimum tentative net capital requirement of $100
million.\94\ This proposed minimum tentative net capital requirement
would be consistent with the current minimum tentative net capital
requirement applicable to OTC derivatives dealers.\95\ A minimum
tentative net capital requirement is designed to operate as a
prudential control on the use of internal models for regulatory capital
purposes.\96\ Tentative net capital is the amount of net capital
maintained by a broker-dealer before applying the standardized haircuts
or using internal models to determine deductions on the mark-to-market
value of proprietary positions to arrive at the broker-dealer's amount
of net capital.\97\ OTC derivatives dealers, therefore, compute
tentative net capital before using internal VaR models to take the
market risk deductions. The minimum tentative net capital requirement
is designed to account for the fact that VaR models, while more risk
sensitive than standardized haircuts, tend to substantially reduce the
amount of the deductions to tentative net capital in comparison to the
standardized haircuts because the models recognize more offsets between
related positions (i.e., positions that show historical correlations)
than the standardized haircuts.\98\ In addition, VaR models may

not capture all risks and, therefore, having a minimum tentative net
capital requirement (i.e., one that is not derived using the VaR model)
is designed to require that capital be sufficient to withstand events
that the model may not take into account (e.g., extraordinary losses or
decreases in liquidity during times of stress that are not incorporated
into VaR calculations).\99\ Consequently, the proposed $100 million
minimum tentative net capital requirement is designed to provide a
sufficient liquid capital cushion for stand-alone SBSDs that use
models, just as it has done in practice for entities registered as OTC
derivatives dealers.\100\
---------------------------------------------------------------------------

    \94\ See paragraph (a)(2) of proposed new Rule 18a-1.
    \95\ Both ANC broker-dealers and OTC derivatives dealers--
entities that use internal models--are subject to a minimum
tentative net capital requirement. See 17 CFR 240.15c3-1(a)(5) and
(a)(7).
    \96\ OTC Derivatives Dealers, 63 FR at 59384 (``The final rule
contains the minimum requirements of $100 million in tentative net
capital and $20 million in net capital. The minimum tentative net
capital and net capital requirements are necessary to ensure against
excessive leverage and risks other than credit or market risk, all
of which are now factored into the current haircuts. Further, while
the mathematical assumptions underlying VaR may be useful in
projecting possible daily trading losses under `normal' market
conditions, VaR may not help firms measure losses that fall outside
of normal conditions, such as during steep market declines.
Accordingly, the minimum capital requirements provide additional
safeguards to account for possible extraordinary losses or decreases
in liquidity during times of stress which are not incorporated into
VaR calculations.''). See also Alternative Net Capital Requirements
Adopting Release, 69 FR at 34431 (``The current haircut structure
[use of the standardized haircuts] seeks to ensure that broker-
dealers maintain a sufficient capital base to account for
operational, leverage, and liquidity risk, in addition to market and
credit risk. We expect that use of the alternative net capital
computation [internal models] will reduce deductions for market and
credit risk substantially for broker-dealers that use that method.
Moreover, inclusion in net capital of unsecured receivables and
securities that do not have a ready market under the current net
capital rule will reduce the liquidity standards of Rule 15c3-1.
Thus, the alternative method of computing net capital and, in
particular, its requirements that broker-dealers using the
alternative method of computing [sic] maintain minimum tentative net
capital of at least $1 billion, maintain net capital of at least
$500 million, notify the Commission that same day if their tentative
net capital falls below $5 billion, and comply with Rule 15c3-4 are
intended to provide broker-dealers with sufficient capital reserves
to account for market, credit, operational, and other risks.'')
(Text in brackets added).
    \97\ See 17 CFR 240.15c3-1(c)(10).
    \98\ See OTC Derivatives Dealers, 63 FR 53962. See Net Capital
Rule, Exchange Act Release No. 39456 (Dec. 17, 1997), 62 FR 68011
(Dec. 30, 1997) (concept release considering the extent to which
statistical models should be used in setting the capital
requirements for a broker-dealer's proprietary positions) (``For
example, the current method of calculating net capital by deducting
fixed percentages from the market value of securities can allow only
limited types of hedges without becoming unreasonably complicated.
Accordingly, the net capital rule recognizes only certain specified
hedging activities, and the Rule does not account for historical
correlations between foreign securities and U.S. securities or
between equity securities and debt securities. By failing to
recognize offsets from these correlations between and within asset
classes, the fixed percentage haircut method may cause firms with
large, diverse portfolios to reserve capital that actually
overcompensates for market risk.'' Id. ``The primary advantage of
incorporating models into the net capital rule is that a firm would
be able to recognize, to a greater extent, the correlations and
hedges in its securities portfolio and have a comparatively smaller
capital charge for market risk.'').
    \99\ See OTC Derivatives Dealers, 63 FR 59362; Alternative Net
Capital Requirements Adopting Release, 69 FR 34428. Further, the
deductions to tentative net capital taken by nonbank SBSDs and
broker-dealers are intended to create a pool of new liquid assets
that can be used for any risk assumed by the firm and not only
market risk. A tentative net capital requirement also serves as a
capital buffer for these other risks to offset the narrower type of
risk intended to be covered by calculating net capital using
internal models.
    \100\ OTC Derivatives Dealers, 63 FR 59362.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposed capital
requirements for stand-alone SBSDs using internal models. Commenters
are referred to the general questions above in section II.A.2.a.i. of
this release about the 8% margin factor as applied broadly to nonbank
SBSDs. In addition, the Commission requests comment, including
empirical data in support of comments, in response to the following
questions:
    1. Is the proposed minimum net capital requirement of $20 million
appropriate for stand-alone SBSDs that are approved to use internal
models, in comparison to OTC derivatives dealers which are more limited
by the activities they are permitted to conduct (such as being
prohibited from effecting transactions with customers)? If not, explain
why not. What minimum amount would be more appropriate? For example,
should the minimum fixed-dollar amount be greater than $20 million to
account for the use of internal models? If it should be a greater
amount, how much greater should it be (e.g., $30 million, $50 million,
$100 million, or some other amount)? Alternatively, should the minimum
fixed-dollar amount be less than $20 million? If it should be a lower
amount, how much lower (e.g., $15 million, $10 million, $5 million or
some other amount)? If a greater or lesser alternative amount is
recommended, explain why it would be more appropriate for stand-alone
SBSDs that are approved to use internal models.
    2. Is it necessary to impose a minimum tentative net capital
requirement for stand-alone SBSDs using internal models to capture
additional risks not incorporated into VaR models (consistent with
those tentative minimum met capital requirements imposed on OTC
derivatives dealers)? If not, why not?
    3. Is the proposed amount of the minimum tentative net capital
level of $100 million for stand-alone SBSDs using internal models
appropriate? If not, explain why not. For example, should the minimum
tentative net capital amount be greater than $100 million to account
for the use of internal models? If it should be a greater amount, how
much greater should it be (e.g., $150 million, $200 million, $250
million, or some other amount)? Should it be a lesser amount (e.g., $75
million, $50 million, or some other amount)? If a greater or lesser
alternative amount is recommended, explain why it would be more
appropriate for stand-alone SBSDs that are approved to use internal
models.
    4. Are there metrics other than a fixed-dollar minimum tentative
net capital requirement that would more appropriately reflect the risk
of nonbank SBSDs? If so, identify them and explain why they would be
preferable. For example, instead of an absolute fixed-dollar minimum
tentative net capital requirement, should the minimum tentative net
capital requirement be linked to a scalable metric such as the size of
a nonbank SBSD? For any scalable minimum tentative net capital
requirements identified, explain how the computation would work in
practice and how the minimum requirement would address the same
objectives of a fixed-dollar minimum. Would the 8% margin factor
provide an appropriate and workable restraint on the amount of leverage
incurred by stand-alone SBSDs that are approved to use internal models?
Is there another measure that would more accurately and effectively
address the leverage risk of these firms? If so, identify the measure
and explain why it would be more accurate and effective.
iv. Broker-Dealer SBSDs Using Internal Models and ANC Broker-Dealers
    Under the current requirements of Rule 15c3-1, a broker-dealer that
seeks to use internal models to compute net capital must apply to the
Commission to become an ANC broker-dealer.\101\ If the application is
granted, the ANC broker-dealer is able to take less than 100%
deductions for unsecured receivables from OTC derivatives
counterparties (non-ANC broker-dealers must deduct these receivables in
full) and can use VaR models in lieu of the standardized haircuts to
take deductions on their proprietary positions in securities and money
market instruments to the extent the firm has been approved to use an
internal model for the type of position.\102\ It is expected that some
broker-dealer SBSDs would seek to use internal models to compute net
capital--as have some broker-dealers--by applying to become ANC broker-
dealers. Broker-dealer SBSDs using internal models would be subject to
the existing provisions and proposed amendments to those provisions
currently applicable to ANC broker-dealers.
---------------------------------------------------------------------------

    \101\ See 17 CFR 240.15c3-1e.
    \102\ Id.
---------------------------------------------------------------------------

    Under the proposed amendments, the current net capital requirements
for ANC broker-dealers in Rule 15c3-1 would be enhanced to account for
the firms' large size, the scale of their custodial activities, and the
potential that they may become substantially more active in the
security-based swap markets under the Dodd-Frank Act's OTC derivatives
reforms. As discussed in more detail below, the proposed enhancements
would include increasing the minimum tentative net capital and minimum
net capital requirements; increasing the ``early warning'' notice
threshold; narrowing the types of unsecured receivables for which ANC
broker-dealers may take a credit risk charge in lieu of a 100%
deduction; and requiring ANC broker-dealers to comply with a new
liquidity requirement.\103\
---------------------------------------------------------------------------

    \103\ See proposed amendments to 17 CFR 240.15c3-1; 17 CFR
240.15c3-1e.
---------------------------------------------------------------------------

    Currently, an ANC broker-dealer must maintain minimum tentative net
capital of at least $1 billion and minimum net capital of at least $500
million.\104\ In addition, an ANC broker-dealer must provide the
Commission with an ``early warning'' notice when its tentative net
capital falls below $5 billion.\105\ These relatively high minimum
capital requirements (as compared with the requirements for other types
of broker-

dealers) reflect the substantial and diverse range of business
activities engaged in by ANC broker-dealers and their importance as
intermediaries in the securities markets.\106\ Further, the heightened
capital requirements reflect the fact that, as noted above, VaR models
are more risk sensitive but also may not capture all risks and
generally permit substantially reduced deductions to tentative net
capital as compared to the standardized haircuts.\107\
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    \104\ See 17 CFR 240.15c3-1(a)(7)(i).
    \105\ See 17 CFR 240.15c3-1(a)(7)(ii).
    \106\ For example, based on data from broker-dealer FOCUS
Reports, the six ANC broker-dealers collectively hold in excess of
one trillion dollars' worth of customer securities. Under Rule 17a-5
(17 CFR 240.17a-5), broker-dealers must file periodic reports on
Form X-17A-5 (Financial and Operational Combined Uniform Single
Reports, ``FOCUS Reports''). Unless an exception applies, the
Commission's rules deem all reports filed under Rule 17a-5
confidential. 17 CFR 240.17a-5(a)(3). The FOCUS Report requires,
among other financial information, a balance sheet, income
statement, and net capital and customer reserve computations. The
FOCUS Report data used in this release is year-end 2011 FOCUS Report
data.
    \107\ See Alternative Net Capital Requirements Adopting Release,
69 FR 34428.
---------------------------------------------------------------------------

    The proposals to strengthen the requirements for ANC broker-dealers
are made in response to issues that arose during the 2008 financial
crisis, recognizing the large size of these firms, and the scale of
their custodial responsibilities. The proposals also are based on the
Commission staff's experience supervising the ANC broker-dealers. The
financial crisis demonstrated the risks to financial firms when market
conditions are stressed and how the failure of a large firm can
accelerate the further deterioration of market conditions.\108\ The
proposals are designed to bolster the ANC broker-dealer net capital
rules to ensure that these firms continue to maintain sufficient
capital reserves to account for market, credit, operational, and other
risks.\109\ While the rationale for these enhancements exists
irrespective of whether the ANC broker-dealers ultimately register as
SBSDs, the proposed increased capital requirements also are designed to
account for increased security-based swap activities by these firms.
FOCUS Report data and the Commission staff's supervision of the ANC
broker-dealers indicate that these firms currently do not engage in a
substantial business in security-based swaps.\110\ It is expected,
however, that they may increase their security-based swap activities
after the Dodd-Frank Act's OTC derivatives reforms are implemented and
become effective because security-based swap activities will need to be
conducted in regulated entities.\111\ Consequently, financial
institutions that currently deal in security-based swaps will need to
register as an SBSD or register one or more affiliates as an SBSD. To
the extent they want to offer securities products and services beyond
those related to security-based swaps, they also will need to be
registered as broker-dealers. Using an existing broker-dealer--
particularly an ANC broker-dealer that already is capitalized and has
risk management systems and personnel in place--could provide
efficiencies that create incentives to register the same entity as a
nonbank SBSD.
---------------------------------------------------------------------------

    \108\ See, e.g., World Economic Outlook: Crisis and Recovery,
International Monetary Fund (``IMF'') (Apr. 2009), available at
http://www.imf.org/external/pubs/ft/weo/2009/01/pdf/text.pdf.
    \109\ See Alternative Net Capital Requirements Adopting Release,
69 FR 34428.
    \110\ The ANC broker-dealers are subject to ongoing Commission
staff supervision, which includes monthly meetings with senior staff
of the ANC broker-dealers. This supervision program provides the
Commission with information about the current practices of the ANC
broker-dealers.
    \111\ This expectation is based on information gathered as part
of the ANC broker-dealer supervision program.