23. Should there be an exception from the account equity
requirements for small banks, savings associations, farm credit system
institutions, and credit unions from the account equity requirements
(e.g., for entities with assets of $10 billion or less)? \594\ Explain
why or why not.
---------------------------------------------------------------------------

    \594\ See, e.g., 15 U.S.C. 78c-3(g)(3)(B) (requiring the
Commission to consider whether to exempt small banks, savings
associations, farm credit system institutions and credit unions from
the definition of ``financial entity'' contained in Exchange Act
section 3C(g)(3)(A) for the purposes of mandatory clearing of
security-based swaps). See also End-User Exception to Mandatory
Clearing of Security-Based Swaps, Exchange Act Release No. 63556
(Dec. 15, 2010), 75 FR 79992, 80000-80002 (Dec. 21, 2010).
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    24. Should there be an exception from the account equity
requirements for affiliates of the nonbank SBSD? For example, do
affiliates present less credit risk than non-affiliates? If there
should be an exception for affiliates, should it be limited to certain
affiliates? For example, should the exception only apply to affiliates
that are subject to capital and other regulatory requirements? Please
explain.
    25. Should there be an exception for foreign governmental entities?
Explain why or why not. Should types of foreign governmental entities
be distinguished for purposes of an exception? For example, are there
objective benchmarks based on creditworthiness that could be used to
distinguish between foreign governmental entities for which the
exception to the account equity requirements would and would not be
appropriate? If so, identify the benchmarks and explain how they could
be incorporated into the rule.
    26. Do dealers in OTC derivatives currently collect collateral from
foreign governmental entities for their OTC derivatives transactions?
If so, from which types of foreign governmental entities?
    27. Do national foreign governments typically guarantee the
obligations of political subdivisions and agencies? If so, identify the
types of political subdivisions and agencies that are guaranteed and
are not guaranteed.
ii. Nonbank MSBSPs
    A nonbank MSBSP would be required to calculate as of the close of
each business day the amount of equity in the account of each
counterparty to a non-cleared security-based swap.\595\ On the next
business day following the calculation, the nonbank MSBSP would be
required to either collect or deliver cash, securities, and/or money
market instruments to the counterparty depending on whether there was
negative or positive equity in the account of the counterparty.\596\
Specifically, if the account has negative equity as calculated on the
previous business day, the nonbank MSBSP would be required to collect
cash, securities, and/or money market instruments in an amount equal to
the negative equity.\597\ Conversely, if the account has positive
equity as calculated on the previous business day, the nonbank MSBSP
would be required to deliver cash, securities, and/or money market
instruments to the counterparty in an amount equal to the positive
equity.\598\
---------------------------------------------------------------------------

    \595\ See paragraph (c)(2)(i) of proposed new Rule 18a-3.
    \596\ See paragraph (c)(2)(ii) of proposed new Rule 18a-3. As
indicated, the nonbank MSBSP would need to deliver cash, securities,
and/or money market instruments and, consequently, other types of
assets would not be eligible as collateral.
    \597\ See paragraph (c)(2)(ii)(A) of proposed new Rule 18a-3. In
this case, the nonbank MSBSP would have current exposure to the
counterparty in an amount equal to the negative equity.
    \598\ See paragraph (c)(2)(ii)(B) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    Nonbank MSBSPs may not maintain two-sided markets or otherwise
engage in activities that would require them to register as an
SBSD.\599\ They will, however, by definition, maintain substantial
positions in particular categories of security-based swaps.\600\ These
positions could create significant risk to counterparties to the extent
the counterparties have uncollateralized current exposure to the
nonbank MSBSP. In addition, they could pose significant risk to the
nonbank MSBSP to the extent it has uncollateralized current exposure to
its counterparties. The proposed account equity requirements for
nonbank MSBSPs are designed to address these risks by imposing a
requirement that nonbank MSBSPs on a daily basis must ``neutralize''
the credit risk between the nonbank MSBSP and the counterparty either
by collecting or delivering cash, securities, and/or money market
instruments in an amount equal to the positive or negative equity in
the account.
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    \599\ See Entity Definitions Adopting Release, 77 FR 30596.
    \600\ See 15 U.S.C. 78c(a)(67); Entity Definitions Adopting
Release, 77 FR 30596.
---------------------------------------------------------------------------

    Unlike nonbank SBSDs, nonbank MSBSPs would not be required to
reduce the fair market value of securities and money market instruments
held in the account of a counterparty (or delivered to a counterparty)
for purposes of determining whether the level of equity in the account
meets the minimum

requirement. As discussed above in section II.B.2.c.i. of this release,
the reductions taken by a nonbank SBSD would be based on the deductions
that would apply to the positions pursuant to Rule 15c3-1, as proposed
to be amended, and proposed new Rule 18a-1, as applicable.\601\ Nonbank
MSBSPs would not be subject to these rules and, consequently, would not
be required to comply with them for purposes of proposed new Rule 18a-
3.
---------------------------------------------------------------------------

    \601\ See paragraph (c)(3) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    Like nonbank SBSDs, nonbank MSBSPs would be subject to the
requirements in paragraph (c)(4) of proposed new Rule 18a-3, which are
modeled on the existing collateral requirements in Appendix E to Rule
15c3-1.\602\ As discussed above in section II.A.2.b.iv of this release,
these requirements are designed to ensure that the collateral is an
asset of stable and predictable value, an asset that is not linked to
the value of the transaction in any way, and an asset that can be sold
quickly and easily if the need arises.
---------------------------------------------------------------------------

    \602\ See paragraph (c)(4) of proposed new Rule 18a-3; 17 CFR
240.15c3-1e(c)(4)(v).
---------------------------------------------------------------------------

    Nonbank MSBSPs would be required to take prompt steps to liquidate
securities and money market instruments in the account to the extent
necessary to eliminate an account equity deficiency.\603\ These steps
could include liquidating non-cleared security-based swap positions in
the account to reduce debits arising from those transactions. The rule
would not require that the liquidations must be completed within a
specific timeframe in order to provide the nonbank MSBSP flexibility to
conduct an orderly liquidation, taking into account market conditions
and the risk profile of the account.
---------------------------------------------------------------------------

    \603\ See paragraph (c)(8) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    There would be three exceptions to the account equity requirements
for nonbank MSBSPs.\604\ The first exception would apply to
counterparties that are commercial end users.\605\ Under this
exception, the nonbank MSBSP would not be required to collect
collateral from a commercial end user when the account of the end user
has negative equity.\606\ This exception would be consistent with the
proposed exception from the account equity requirements for accounts of
commercial end users at nonbank SBSDs. However, nonbank MSBSPs would
not be required to take a credit risk charge or capital charge relating
to the amount of the uncollected margin.\607\ The reason for this
proposed exception is the concern that requiring commercial end users
to deliver collateral could impair their ability to manage commercial
risks through hedging transactions. A nonbank MSBSP would be required
to deliver cash, securities, and/or money market instruments to a
commercial end user as necessary to collateralize the end user's
current exposure to the nonbank MSBSP.
---------------------------------------------------------------------------

    \604\ See paragraph (c)(2)(iii) of proposed new Rule 18a-3.
MSBSPs could choose to collect collateral in these cases.
    \605\ See paragraph (c)(2)(iii)(A) of proposed new Rule 18a-3.
    \606\ Id.
    \607\ Compare paragraph (c)(1)(iii)(A) of proposed new Rule 18a-
3, with paragraph (c)(2)(iii)(A) of proposed Rule new 18a-3.
---------------------------------------------------------------------------

    Under the second exception, a nonbank MSBSP would not be required
to collect cash, securities, and/or money market instruments from an
SBSD to collateralize the amount of the negative equity in the account
of the SBSD. Under the account equity requirements in proposed new Rule
18a-3, a nonbank SBSD would be required to collect collateral from a
nonbank MSBSP to cover the negative equity and margin amount in the
account of the nonbank MSBSP carried by the nonbank SBSD.\608\ Once a
nonbank SBSD collected these amounts, a nonbank MSBSP would have
current exposure to the nonbank SBSD, at a minimum, equal to the amount
of the positive equity required to be maintained in the nonbank MSBSP's
account at the nonbank SBSD. A regulatory requirement that the nonbank
MSBSP must collect collateral from the nonbank SBSD to collateralize
the amount of the positive equity in the account at the nonbank SBSD
could defeat the purpose of proposed new Rule 18a-3; namely, that
nonbank SBSDs collect cash, securities, and/or money market instruments
to collateralize their potential future exposure to the counterparties,
including nonbank MSBSPs.\609\ In essence, the proposed requirements
reflect a general preference in favor of requiring counterparties to
nonbank SBSDs to fully collateralize their obligations to the nonbank
SBSDs.
---------------------------------------------------------------------------

    \608\ See paragraph (c)(1)(ii) of proposed Rule 18a-3. As
discussed above, MSBSPs would not be included in the definition of
commercial end user. Consequently, an MSBSP would be required to
deliver cash, securities, and/or money market instruments to
collateralize the negative equity and the margin amount in its
security-based swap account at a nonbank SBSD.
    \609\ For example, assume a nonbank SBSD calculates that the
account of a nonbank MSBSP has a negative equity of $20 (current
exposure) and a margin amount of $50 (potential future exposure)
pursuant to paragraph (c)(1)(i) of proposed new Rule 18a-3. On the
next business day, the nonbank SBSD would need to collect cash,
securities, and/or money market instruments to collateralize these
amounts pursuant to paragraph (c)(1)(ii) of proposed new Rule 18a-3.
Assume the nonbank MSBSP delivers cash as collateral. It would need
to deliver $70 in cash, of which $50 (as collateral for the margin
amount) would be a receivable from the nonbank SBSD to the nonbank
MSBSP. In other words, the $50 (as a receivable from the nonbank
SBSD) would be the nonbank MSBSP's current exposure to the nonbank
SBSD. If the nonbank MSBSP was required to collect collateral from
the nonbank SBSD to cover this amount, the account of the nonbank
MSBSP at the nonbank SBSD would not meet the minimum equity
requirement of $50.
---------------------------------------------------------------------------

    The third exception would apply to a security-based swap legacy
account.\610\ Under this exception, consistent with the proposed
corresponding exception applying to accounts with nonbank SBSDs, a
nonbank MSBSP would not be required to collect cash, securities, and/or
money market instruments to collateralize the negative equity in a
security-based swap legacy account. In addition, the MSBSP would not be
required to deliver collateral to cover the positive equity in the
account. This exception would be designed to address the impracticality
of renegotiating contracts governing security-based swap transactions
that predate the effectiveness of proposed new Rule 18a-3 in order to
come into compliance with the account equity requirements in the rule.
---------------------------------------------------------------------------

    \610\ See paragraph (c)(2)(iii)(C) of proposed new Rule 18a-3.
The term security-based swap legacy account would be defined to mean
an account that holds no security-based swaps entered into after the
effective date of the rule and that is used only to hold security-
based swaps entered into prior to the effective date of the rule and
collateral for those security-based swaps. See paragraph (b)(9) of
proposed new Rule 18a-3.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposed account
equity requirements for counterparties of nonbank MSBSPs in proposed
Rule 18a-3. Commenters are referred to the questions about the account
equity requirements for nonbank SBSDs above in section II.B.2.c.i. of
this release to the extent those questions address provisions in
proposed new Rule 18a-3 that also apply to nonbank MSBSPs. In addition,
the Commission requests comment, including empirical data in support of
comments, in response to the following questions:
    1. Are the proposed account equity requirements for nonbank MSBSPs
appropriate? If not, explain why not.
    2. Should nonbank MSBSPs be required to reduce the fair market
value of securities and money market instruments for purposes of
determining whether the level of equity in the account meets the
minimum requirement? What would be the impact of not requiring nonbank
MSBSPs to reduce the fair market value of

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

    \611\ See paragraph (c)(6) of proposed Rule 18a-3.
---------------------------------------------------------------------------

    The proposed minimum transfer provision is designed to establish a
threshold so that the degree of risk reduction achieved by requiring
account equity requirements to be collateralized is sufficiently small
that the costs of delivering collateral may not be justified. The
proposed $100,000 threshold is based on the proposals of the prudential
regulators and the CFTC.\612\
---------------------------------------------------------------------------

    \612\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27575; CFTC Margin Proposing Release, 76 FR at
23735 (``In order to reduce transaction costs, proposed Sec.  23.150
would establish a `minimum transfer amount' of $100,000. Initial and
variation margin payments would not be required to be made if below
that amount. This amount was selected in consultation with the
prudential regulators. It represents an amount sufficiently small
that the level of risk reduction might not be worth the transaction
costs of moving the money. It only affects the timing of collection;
it does not change the amount of margin that must be collected once
the $100,000 level is exceeded.''). Some commenters to the CFTC and
Prudential Regulators proposed margin rules, while generally
supporting the use of minimum transfer amounts, stated that they
should have the flexibility to set higher minimum transfer amounts
and that minimum transfer amounts up to $250,000 were more
consistent with prevailing industry practice. See letter from the
Coalition for Derivatives End-Users, to David A. Stawick, Secretary,
CFTC (July 11, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47804; letter from Carl B.
Wilkerson, Vice President & Chief Counsel, Securities & Litigation,
American Council of Life Insurers, to the Prudential Regulators and
David A. Stawick, Secretary, CFTC (July 11, 2011), available at
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47742;
letter from Lisa M. Ledbetter, Vice President and Deputy General
Counsel, Legislative and Regulatory Affairs, Freddie Mac, to David
A. Stawick, Secretary, CFTC (July 11, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47771.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the minimum transfer
amount in proposed new Rule 18a-3. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
    1. Is it appropriate to have a minimum transfer amount? If not,
explain why not. For example, should an account equity requirement be
collateralized regardless of the amount of cash, securities, and/or
money market instruments that would need to be transferred to meet the
requirement?
    2. Is $100,000 an appropriate minimum transfer amount? Should the
amount be greater than $100,000 (e.g., $150,000, $200,000, $500,000, or
some other amount)? If so, identify the amount and explain why it would
be a better threshold. Should the amount be less than $100,000 (e.g.,
$75,000, $50,000, $25,000, or some other amount)? If so, identify the
amount and explain why it would be a better threshold.
e. Risk Monitoring and Procedures
    A nonbank SBSD would be required to monitor the risk of each
account of a counterparty to a non-cleared security-based swap and
establish, maintain, and document procedures and guidelines for
monitoring the risk of such accounts.\613\ The nonbank SBSD also would
be required to review, in accordance with written procedures, and at
reasonable periodic intervals, its non-cleared security-based swap
activities for consistency with the risk monitoring procedures and
guidelines.\614\ The risk monitoring procedures and guidelines would
need to include, at a minimum, procedures and guidelines for:
---------------------------------------------------------------------------

    \613\ See paragraph (e) of proposed new Rule 18a-3. Paragraph
(e) of proposed new Rule 18a-3 would not apply to nonbank MSBSPs. As
discussed below, the proposed risk monitoring procedures are
designed to address the risk that results from dealing in non-
cleared security-based swaps (i.e., the type of activity that would
require a nonbank MSBSP to register as an SBSD). See 15 U.S.C. 78o-
10(a)(1); Entity Definitions Proposing Release, 75 FR at 80174. As
discussed above in section II.A.3 of this release, a nonbank MSBSP
would be required to comply with Rule 15c3-4, which requires an
entity subject to its provisions to establish a risk management
control system.
    \614\ See paragraph (e) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

     Obtaining and reviewing the account documentation and
financial information necessary for assessing the amount of current and
potential future exposure to a given counterparty permitted by the
nonbank SBSD;
     Determining, approving, and periodically reviewing credit
limits for each counterparty, and across all counterparties;
     Monitoring credit risk exposure to the security-based swap
dealer from non-cleared security-based swaps, including the type,
scope, and frequency of reporting to senior management;
     Using stress tests to monitor potential future exposure to
a single counterparty and across all counterparties over a specified
range of possible market movements over a specified time period;
     Managing the impact of credit exposure related to non-
cleared security-based swaps on the nonbank SBSD's overall risk
exposure;
     Determining the need to collect collateral from a
particular counterparty, including whether that determination was based
upon the creditworthiness of the counterparty and/or the risk of the
specific non-cleared security-based swap contracts with the
counterparty;
     Monitoring the credit exposure resulting from concentrated
positions with a single counterparty and across all counterparties, and
during periods of extreme volatility; and
     Maintaining sufficient equity in the account of each
counterparty to protect against the largest individual potential future
exposure of a non-cleared security-based swap carried in the account of
the counterparty as measured by computing the largest maximum possible
loss that could result from the exposure.

    These proposed requirements are modeled on similar requirements in
FINRA Rule 4240, which establishes an interim pilot program imposing
margin requirements for transactions in credit default swaps executed
by a FINRA member.\615\ As discussed above in section II.A.2.c. of this
release, nonbank SBSDs would be required to comply with Rule 15c3-
4.\616\ Rule 15c3-4 requires an OTC derivatives dealer to establish,
document, and maintain a system of internal risk management controls to
assist in managing the risks associated with its business activities,
including market, credit, leverage, liquidity, legal, and operational
risks.\617\ Risk management systems are designed to help ensure an
awareness of, and accountability for, the risks taken throughout a firm
and to develop tools to address those risks.\618\ A key objective of a
risk management system is to ensure that a firm does not ignore any
material source of risk.\619\
---------------------------------------------------------------------------

    \615\ See FINRA Rule 4240. The risk monitoring requirements in
FINRA Rule 4240 were, in turn, modeled on risk monitoring
requirement in SRO portfolio margining rules. See FINRA Rule
4210(g); Rules 12.4 and 15.8A of the CBOE.
    \616\ 17 CFR 240.15c3-4.
    \617\ Id.
    \618\ See Joint Forum, Bank of International Settlements, Trends
in Risk Integration and Aggregation, (Aug. 2003), available at
http://www.bis.org/publ/joint07.pdf.
    \619\ Id.
---------------------------------------------------------------------------

    The procedures and guidelines that a nonbank SBSD would establish
pursuant to proposed new Rule 18a-3 would be a part of the broader
system of risk management controls the nonbank SBSD would establish
pursuant to Rule 15c3-4.\620\ The requirement in proposed new Rule 18a-
3 is designed to require specific risk management procedures and
guidelines with respect to the risks of acting as a dealer in non-
cleared security-based swaps, which could result in a nonbank SBSD
carrying accounts for significant numbers of counterparties and
effecting numerous transactions for counterparties on a daily basis.
For example, the nonbank SBSD would be required to have procedures and
guidelines for determining, approving, and periodically reviewing
credit limits for each counterparty, and across all
counterparties.\621\ In addition, the nonbank SBSD would be required to
have procedures and guidelines for determining the need to collect
collateral from a particular counterparty, including whether that
determination was based upon the creditworthiness of the counterparty
and/or the risk of the specific non-cleared security-based swap
contracts with the counterparty.\622\ As discussed above in section
II.B.2.c.i. of this release, nonbank SBSDs would not be required to
collect collateral from a commercial end user to meet the account
equity requirements in proposed new Rule 18a-3.\623\ However, the firm
would be required to determine credit limits for the end user and
analyze the need for collecting collateral from the end user. These
risk monitoring procedures and guidelines are designed to prevent the
nonbank SBSD from allowing its credit exposure to the end user to reach
a level that creates a substantial risk that the default of the end
user could have a material adverse impact on the nonbank SBSD.
---------------------------------------------------------------------------

    \620\ 17 CFR 240.15c3-4.
    \621\ See paragraph (e)(2) of proposed new Rule 18a-3.
    \622\ See paragraph (e)(6) of proposed new Rule 18a-3.
    \623\ See paragraph (c)(1)(iii)(A) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the requirements in
proposed new Rule 18a-3 to monitor risk and to have risk monitoring
procedures and guidelines. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
    1. Are the required elements of the risk monitoring procedures and
guidelines appropriate? If not, explain why not. Should there be
additional or alternative required elements to the risk monitoring
procedures and guidelines? If so, identify them and explain why they
should be included.
    2. Are the descriptions of the required elements of the risk
monitoring procedures and guidelines in paragraphs (e)(1) through (8)
of proposed new Rule 18a-3 sufficiently clear in terms of what is
proposed to be required of nonbank SBSDs? If not, explain why not and
suggest changes to make the elements more clear.
    3. Is it appropriate to require that the risk monitoring procedures
and guidelines be a part of the system of risk management control
prescribed in Rule 15c3-4? If not, explain why not.
    4. What are the current practices of dealers in OTC derivatives in
terms of monitoring the risk of counterparties? Are the requirements in
proposed new Rule 18a-3 consistent with current practices? Are they
more limited or are they broader than current practices?
    5. Should nonbank MSBSPs be subject to the requirements of
paragraph (e) of proposed new Rule 18a-3? If so, explain why. If not,
explain why not.
3. Specific Request for Comment To Limit the Use of Collateral
    Proposed new Rule 18a-3 does not specifically identify classes of
assets that could be used to meet the account equity requirements in
the rule. The Commission, however, is considering whether it would be
appropriate to adopt limits on eligible collateral similar to those the
prudential regulators and the CFTC proposed.\624\ Specifically, comment
is sought on whether proposed new Rule 18a-3 should define the term
eligible collateral in order to narrowly prescribe the classes of
assets that would qualify as collateral to meet the account equity
requirements. For example, one approach would be to limit eligible
collateral to cash and U.S. government securities.
---------------------------------------------------------------------------

    \624\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27578; CFTC Margin Proposing Release, 76 FR at
23738-23739.
---------------------------------------------------------------------------

    Limiting eligible collateral to cash and U.S. government securities
could be a way to ensure that a nonbank SBSD will be able to liquidate
the collateral promptly and at current market prices if necessary to
cover the obligations of a defaulting counterparty. During a period of
market stress, the value of collateral other than cash pledged as
margin also may come under stress through rapid market declines and
systemic liquidations and deleveraging by financial institutions.
Generally, U.S. government securities are substantially less
susceptible to this risk than other types of securities and, in fact,
may become the investment of choice during a period of market stress as
investors seek the relative safety of these securities.\625\
---------------------------------------------------------------------------

    \625\ See IMF, Global Financial Stability Report, The Quest for
Lasting Stability (Apr. 2012), available at http://www.imf.org/external/pubs/ft/gfsr/2012/01/pdf/text.pdf.
---------------------------------------------------------------------------

    Another approach would be to adopt the definition of eligible
collateral proposed by the prudential regulators or to adopt the
``forms of margin'' proposed by the CFTC.\626\ Both of these proposed
approaches would extend eligible collateral beyond cash and U.S.
government securities but would not permit the use of certain
securities (e.g., listed equities that would be permitted by proposed
Rule 18a-3).
---------------------------------------------------------------------------

    \626\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27578; CFTC Margin Proposing Release, 76 FR at
23738-23739 (proposing that only certain types of financial
instruments be eligible collateral).
---------------------------------------------------------------------------

    The Commission also seeks comment in response to the following
questions, including empirical data in support of comments:
    1. Should the types of assets that could be used to meet the
nonbank

SBSD account equity requirements in proposed new Rule 18a-3 be more
limited? Explain why or why not. For example, are the proposed
provisions that would require a nonbank SBSD to mark-to-market the
value of the collateral, apply haircuts to the collateral, and adhere
to the collateral requirements incorporated from Appendix E to Rule
15c3-1 sufficient to ensure that collateral is able to serve the
purpose of protecting the nonbank SBSD from the credit exposure of a
counterparty to a non-cleared security-based swap? If so, explain why.
If not, explain why not.
    2. Explain the risk to nonbank SBSDs if they are permitted to
accept a broader range of securities and money market instruments (as
proposed in new Rule 18a-3) to meet the account equity requirements.
    3. Should the types of assets that could be used to meet the
nonbank MSBSP account equity requirements in proposed new Rule 18a-3 be
more limited? Explain why or why not. Since nonbank MSBSPs would not be
required to apply haircuts to the collateral or adhere to the
collateral requirements incorporated from Appendix E to Rule 15c3-1,
should the types of collateral they are allowed to accept be more
limited? Explain why or why not.
    4. Explain the risk to nonbank MSBSPs if they are permitted to
accept a broader range of securities and money market instruments (as
proposed in new Rule 18a-3) to meet the account equity requirements.
    5. If the term eligible collateral is defined for purposes of
proposed new Rule 18a-3, should the definition include securities of
government-sponsored entities? If so, identify the government-sponsored
entities and explain why the securities of the identified entity would
be appropriate collateral. Alternatively, explain why securities of
government-sponsored entities generally or individually should not be
included in a potential definition of eligible collateral.
    6. If the term eligible collateral is defined for purposes of
proposed new Rule 18a-3, should the definition include immediately-
available cash funds denominated in a foreign currency when the
currency is the same currency in which payment obligations under the
security-based swap are required to be settled? If so, should eligible
collateral be limited to specific foreign currencies? If so, identify
the currencies and explain why the identified currencies would be
appropriate collateral. Alternatively, explain why foreign currencies
generally or individually should not be included in a potential
definition of eligible collateral.
    7. If the term eligible collateral is defined for purposes of
proposed new Rule 18a-3, should the definition include immediately-
available cash funds denominated in foreign currency even in cases
where the currency is not the same currency in which payment
obligations under the security-based swap are required to be settled?
If so, should eligible collateral be limited to specific foreign
currencies? If so, identify the currencies and explain why the
identified currencies would be appropriate collateral in this
circumstance. Alternatively, explain why foreign currencies in this
circumstance should not be included in a potential definition of
eligible collateral.
    8. If the term eligible collateral is defined for purposes of
proposed new Rule 18a-3, should the definition include securities of
foreign sovereign governments? If so, identify the foreign sovereign
governments and explain why the securities of the identified foreign
sovereign governments would be appropriate collateral. Alternatively,
explain why securities of foreign sovereign governments should not be
included in the definition of eligible collateral.
    9. If the term eligible collateral is defined for purposes of
proposed new Rule 18a-3, should the definition include a fully paid
margin equity security, as that term is defined in 12 CFR 220.2,\627\
in the case where a non-cleared equity security-based swap references
the margin equity security? If so, explain why margin equity securities
would be appropriate collateral in this circumstance. Alternatively,
explain why margin equity securities in this circumstance should not be
included in the definition of eligible collateral.
---------------------------------------------------------------------------

    \627\ Regulation T defines margin equity security as a margin
security that is an equity security (as defined in section 3(a)(11)
of the Exchange Act). See 12 CFR 220.2.
---------------------------------------------------------------------------

    10. Should there be separate eligible collateral requirements for
collateralizing negative equity and the margin amount? For example,
should the assets permitted to collateralize negative equity be limited
to cash and U.S. government securities, while the assets permitted to
collateralize the margin amount encompass a broader range of
securities?

C. Segregation

1. Background
    The U.S. Bankruptcy Code provides special protections for customers
of stockbrokers (the ``stockbroker liquidation provisions'').\628\
Among other protections, customers share ratably with other customers
ahead of all other creditors in the customer property held by the
failed stockbroker.\629\ Segregation requirements are designed to
identify customer property as distinct from the proprietary assets of
the firm and to protect customer property by, for example, preventing
the firm from using it to make proprietary investments. The goal of
segregation is to facilitate the prompt return of customer property to
customers either before or during a liquidation proceeding if the firm
fails.\630\
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    \628\ See 11 U.S.C. 741-753. SIPA provides similar protections
for ``customers'' of registered broker-dealers. See 15 U.S.C. 78aaa
et seq. However, SIPA also provides additional protections such as
the right for each customer to receive an advance of up to $500,000
to facilitate the prompt satisfaction of a claim for securities and
cash ($250,000 of the $500,000 may be used to satisfy the cash
portion of a claim).
    \629\ See 11 U.S.C. 752.
    \630\ See Michael P. Jamroz, The Customer Protection Rule, 57
Bus. Law. 1069 (May 2002).
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    The Dodd-Frank Act contains provisions designed to ensure that cash
and securities held by an SBSD relating to security-based swaps will be
deemed customer property under the stockbroker liquidation
provisions.\631\ In particular, section 3E(g) of the Exchange Act
provides, among other things, that a security-based swap shall be
considered to be a security as such term is ``used in section
101(53A)(B) and subchapter III of title 11, United States Code'' \632\
and in the stockbroker liquidation provisions.\633\ Section 3E(g) also
provides that an account that holds a security-based swap shall be
considered to be a securities account as that term is ``defined'' in
the stockbroker liquidation provisions.\634\ In addition, section 3E(g)
provides that the terms purchase and sale as defined in sections
3(a)(13) and (14) of the Exchange Act, respectively, shall be applied
to the terms purchase and sale as used in the

stockbroker liquidation provisions.\635\ Finally, section 3E(g)
provides that the term customer as defined in the stockbroker
liquidation provisions excludes any person to the extent the person has
a claim based on a non-cleared security-based swap transaction except
to the extent of any margin delivered to or by the customer with
respect to which there is a customer protection requirement under
section 15(c)(3) of the Exchange Act or a segregation requirement.\636\
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    \631\ See Public Law 111-203 Sec.  763(d) adding section 3E(g)
to the Exchange Act (15 U.S.C. 78c-5(g)).
    \632\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 101(53A)(B). Section
101(53A)(B) defines a stockbroker to mean a person--(1) with respect
to which there is a customer, as defined in section 741, subchapter
III, title 11, United States Code (the definition section of the
stockbroker liquidation provisions); and (2) that is engaged in the
business of effecting transactions in securities--(i) for the
account of others; or (ii) with members of the general public, from
or for such person's own account. 11 U.S.C. 101(53A)(B).
    \633\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 741-753.
    \634\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 741. There is no
definition of securities account in 11 U.S.C. 741. The term
securities account is used in 11 U.S.C. 741(2) and (4) in defining
the terms customer and customer property.
    \635\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 741-753. Section
3(a)(13) of the Exchange Act, as amended by the Dodd-Frank Act (Pub.
L. 111-203 Sec.  761(a)), defines the term purchase to mean, in the
case of security-based swaps, the execution, termination (prior to
its scheduled maturity date), assignment, exchange, or similar
transfer or conveyance of, or extinguishing of rights or obligations
under, a security-based swap, as the context may require. 15 U.S.C.
78c(a)(13). Section 3(a)(14) of the Exchange Act, as amended by the
Dodd-Frank Act (Pub. L. 111-203 Sec.  761(a)), defines the term sale
to mean, in the case of security-based swaps, the execution,
termination (prior to its scheduled maturity date), assignment,
exchange, or similar transfer or conveyance of, or extinguishing of
rights or obligations under, a security-based swap, as the context
may require. See 15 U.S.C. 78c(a)(14).
    \636\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 741(2).
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    The provisions of section 3E(g) of the Exchange Act apply the
customer protection elements of the stockbroker liquidation provisions
to cleared security-based swaps, including related collateral, and, if
subject to segregation requirements, to collateral delivered as margin
for non-cleared security-based swaps.\637\ The Dodd-Frank Act
established segregation requirements for cleared and non-cleared
security-based swaps and provided the Commission with the authority to
adopt rules with respect to segregation. In particular, section 763 of
the Dodd-Frank Act amended the Exchange Act to add new section 3E.\638\
Section 3E sets forth requirements applicable to SBSDs and MSBSPs with
respect to the segregation of cleared and non-cleared security-based
swap collateral and provides the Commission with rulemaking authority
in this area.\639\ The Commission also has concurrent authority under
section 15(c)(3) of the Exchange Act to prescribe segregation
requirements for broker-dealers.\640\
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    \637\ See 15 U.S.C. 78c-5(g); 11 U.S.C. 741-753.
    \638\ See Public Law 111-203 Sec.  763; 15 U.S.C. 78c-5.
    \639\ See 15 U.S.C. 78c-5. Unlike the grants of capital and
margin rulemaking authority in the Dodd-Frank Act, section 3E does
not divide rulemaking authority for segregation requirements for
SBSDs and MSBSPs between the Commission and the prudential
regulators. Compare 15 U.S.C. 78o-10(e)(1), with 15 U.S.C. 78c-5.
Consequently, the Commission's rulemaking authority in this area
extends to bank SBSDs and bank MSBSPs. 15 U.S.C. 78c-5.
    \640\ See 15 U.S.C. 78o(c)(3). See also Public Law 111-203 Sec.
771 (codified at 15 U.S.C. 78o-10(e)(3)(B)). Section 771 of the
Dodd-Frank Act states that unless otherwise provided by its terms,
its provisions relating to the regulation of the security-based swap
markets do not divest any appropriate Federal banking agency, the
Commission, the CFTC, or any other Federal or State agency, of any
authority derived from any other provision of applicable law. See
Public Law 111-203 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).
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    Section 3E(b)(1) of the Exchange Act provides that a broker,
dealer, or SBSD shall treat and deal with all money, securities, and
property of any security-based swap customer received to margin,
guarantee, or secure a cleared security-based swap transaction as
belonging to the customer.\641\ Section 3E(b)(2) provides that the
money, securities, and property shall be separately accounted for and
shall not be commingled with the funds of the broker, dealer, or SBSD
or used to margin, secure, or guarantee any trades or contracts of any
security-based swap customer or person other than the person for whom
the money, securities, or property are held.\642\
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    \641\ See section 3E(b)(1) of the Exchange Act (15 U.S.C. 78c-
5(b)(1)). As indicated, the provisions of section 3E(b) do not apply
to MSBSPs.
    \642\ See section 3E(b)(2) of the Exchange Act (15 U.S.C. 78c-
5(b)(2)).
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    Section 3E(c)(1) of the Exchange Act provides that, notwithstanding
section 3E(b), money, securities, and property of cleared security-
based swap customers of a broker, dealer, or SBSD may, for convenience,
be commingled and deposited in the same one or more accounts with any
bank, trust company, or clearing agency.\643\ Section 3E(c)(2) further
provides that the Commission may by rule, regulation, or order
prescribe terms and conditions under which money, securities, and
property of a customer with respect to cleared security-based swaps may
be commingled and deposited with any other money, securities, and
property received by the broker, dealer, or SBSD and required by the
Commission to be separately accounted for and treated and dealt with as
belonging to the security-based swap customer of the broker, dealer, or
SBSD.\644\
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    \643\ See section 3E(c)(1) of the Exchange Act (15 U.S.C. 78c-
5(c)(1)).
    \644\ See section 3E(c)(2) of the Exchange Act (15 U.S.C. 78c-
5(c)(2)).
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    With respect to non-cleared security-based swaps, section
3E(f)(1)(A) of the Exchange Act provides that an SBSD and an MSBSP
shall be required to notify a counterparty of the SBSD or MSBSP at the
beginning of a non-cleared security-based swap transaction that the
counterparty has the right to require the segregation of the funds or
other property supplied to margin, guarantee, or secure the obligations
of the counterparty.\645\ Section 3E(f)(1)(B) provides that, if
requested by the counterparty, the SBSD or MSBSP shall segregate the
funds or other property for the benefit of the counterparty and, in
accordance with such rules and regulations as the Commission may
promulgate, maintain the funds or other property in a segregated
account separate from the assets and other interests of the SBSD or
MSBSP.\646\ Section 3E(f)(3) provides that the segregated account shall
be carried by an independent third-party custodian and be designated as
a segregated account for and on behalf of the counterparty
(``individual segregation'').\647\ In the case of non-cleared security-
based swaps, therefore, each counterparty has the right to require its
collateral to be isolated in an account at an independent custodian
that identifies the counterparty by name, rather than commingled with
collateral of other counterparties.
---------------------------------------------------------------------------

    \645\ See 15 U.S.C. 78c-5(f)(1)(A). See also section 3E(f)(2)(A)
of the Exchange Act, which provides that the provisions of section
3E(f)(1) apply only to a security-based swap between a counterparty
and SBSD or MSBSP that is not submitted for clearing to a clearing
agency. See 15 U.S.C. 78c-5(f)(2)(A).
    \646\ See 15 U.S.C. 78c-5(f)(1)(B).
    \647\ See 15 U.S.C. 78c-5(f)(3).
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    The objective of individual segregation is for the funds and other
property of the counterparty to be carried in a manner that will keep
these assets separate from the bankruptcy estate of the SBSD or MSBSP
if it fails financially and becomes subject to a liquidation
proceeding. Having these assets carried in a bankruptcy-remote manner
protects the counterparty from the costs of retrieving assets through a
bankruptcy proceeding caused, for example, because another counterparty
of the SBSD or MSBSP defaults on its obligations to the SBSD or MSBSP.
    Section 3E(f)(2)(B)(i) of the Exchange Act provides that the
segregation requirements for non-cleared security-based swaps do not
apply to variation margin payments, so that the right of a counterparty
to require individual account segregation applies only to initial and
not variation margin.\648\ It also provides that the segregation
requirements shall not preclude any commercial arrangement regarding
the investment of segregated funds or other property that may only be
invested in such investments as the Commission may permit by rule or
regulation, and the related allocation of gains and losses

resulting from any investment of the segregated funds or other
property.\649\ Finally, section 3E(f)(4) provides that if the
counterparty does not choose to require segregation of funds or other
property, the SBSD or MSBSP shall send a quarterly report to the
counterparty that the firm's back office procedures relating to margin
and collateral requirements are in compliance with the agreement of the
counterparties.\650\
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    \648\ See 15 U.S.C. 78c-5(f)(2)(B)(i).
    \649\ See 15 U.S.C. 78c-5(f)(2)(B)(ii). No requirements are
being proposed at this time pursuant to the authority in section
3E(f)(1)(B)(ii) of the Exchange Act.
    \650\ See section 3E(f)(4) of the Exchange Act (15 U.S.C. 78c-
5(f)(4)).
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    Pursuant, in part, to the grants of rulemaking authority in
sections 3E and 15(c)(3) of the Exchange Act, the Commission is
proposing new Rule 18a-4 to establish segregation requirements for
SBSDs with respect to cleared and non-cleared security-based swaps that
would supplement the requirements in section 3E.\651\ Proposed new Rule
18a-4 would apply to all types of SBSDs (i.e., it would apply to bank
SBSDs, stand-alone SBSDs, and broker-dealer SBSDs).\652\ As discussed
in more detail below, proposed new Rule 18a-4 would prescribe detailed
requirements for how cash, securities, and money market instruments of
a customer with cleared security-based swaps must be segregated when an
SBSD commingles those assets with the cash and securities of other
customers (``omnibus segregation'') pursuant to section 3E(c)(1) of the
Exchange Act.\653\ In addition, the proposed rule would require that
cash, securities, and money market instruments of a customer with
respect to non-cleared security-based swaps must be treated in the same
manner as cash, securities, and money market instruments of a customer
with respect to cleared security-based swaps in cases where the
counterparty does not elect individual segregation \654\ and does not
affirmatively waive segregation altogether.\655\ In other words,
proposed new Rule 18a-4 would establish an alternative omnibus, or
``commingled'', segregation approach for non-cleared security-based
swaps. This approach would be the default requirement under which an
SBSD would be required to segregate securities and funds relating to
non-cleared security-based swaps and, therefore, apply in the absence
of a counterparty electing individual segregation or affirmatively
waiving segregation.\656\
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    \651\ See 15 U.S.C. 78c-5; 15 U.S.C. 78o(c)(3).
    \652\ Unlike section 15F of the Exchange Act that divides
responsibility for capital and margin rules between the Commission
and the prudential regulators, section 3E of the Exchange Act
provides authority solely to the Commission. Compare 15 U.S.C. 78o-
10, with 15 U.S.C. 78c-5.
    \653\ See 15 U.S.C. 78c-5(c)(1).
    \654\ See 15 U.S.C. 78c-5(f)(1)-(3).
    \655\ See 15 U.S.C. 78c-5(f)(4).
    \656\ As discussed below in section II.C.2.c. of this release,
an SBSD would be required to obtain a subordination agreement from a
counterparty that waives segregation. By entering into the
subordination agreement, the counterparty would affirmatively waive
segregation. The absence of a subordination agreement would mean
that the counterparty is presumed not to have waived segregation and
the SBSD would need to treat the counterparty's cash, securities,
and/or money market instruments pursuant to the omnibus segregation
requirements of proposed new Rule 18a-4.
---------------------------------------------------------------------------

    The omnibus segregation requirements in Rule 18a-4 would not apply
to MSBSPs.\657\ Consequently, if an MSBSP holds collateral from a
counterparty with respect to non-cleared security-based swaps, it would
be subject only to the segregation requirements in section 3E of the
Exchange Act with respect to the collateral, and would not be required
to segregate the collateral unless the counterparty required individual
segregation under section 3E.\658\ The omnibus segregation requirements
in Rule 18a-4 may not be practical for MSBSPs for the same reasons
discussed in sections II.A.3. and II.B.2. of this release with respect
to the proposed capital and margin requirements for MSBSPs (i.e., the
potentially wide range of business models under which nonbank MSBSPs
may operate under the proposed rule, and the uncertain impact that
requirements designed for broker-dealers could have on these entities).
MSBSPs will instead be subject to the provisions in section 3E(f) of
the Exchange Act, which provide certain baseline segregation
requirements for non-cleared security-based swaps.\659\ In addition,
counterparties would be able to negotiate customized segregation
agreements with MSBSPs, subject to these provisions.\660\
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    \657\ As discussed in more detail below, MSBSPs would be subject
to a notification requirement. See paragraph (d)(1) of proposed new
Rule 18a-4.
    \658\ The provisions of section 3E of the Exchange Act governing
cleared security-based swaps do not apply to nonbank MSBSPs. See 15
U.S.C. 78c-5(b) (referring specifically to a ``broker, dealer, or
security-based swap dealer'' and not to an MSBSP.).
    \659\ See 15 U.S.C. 78c-5(f).
    \660\ Id.
---------------------------------------------------------------------------

    As discussed in more detail below, the omnibus segregation
requirements of Rule 18a-4 are modeled on the provisions of the broker-
dealer segregation rule--Rule 15c3-3.\661\ Rule 15c3-3 is designed ``to
give more specific protection to customer funds and securities, in
effect forbidding brokers and dealers from using customer assets to
finance any part of their businesses unrelated to servicing securities
customers; e.g., a firm is virtually precluded from using customer
funds to buy securities for its own account.'' \662\ To meet this
objective, Rule 15c3-3 requires a broker-dealer that maintains custody
of customer securities and cash (a ``carrying broker-dealer'') to take
two primary steps to safeguard these assets. The steps are designed to
protect customers by segregating their securities and cash from the
broker-dealer's proprietary business activities. If the broker-dealer
fails financially, the securities and cash should be readily available
to be returned to the customers. In addition, if the failed broker-
dealer is liquidated in a formal proceeding under SIPA, the securities
and cash should be isolated and readily identifiable as ``customer
property'' and, consequently, available to be distributed to customers
ahead of other creditors.\663\
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    \661\ See 17 CFR 240.15c3-3.
    \662\ See Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 21651 (Jan. 11, 1985), 50 FR 2690, 2690
(Jan. 18, 1985). See also Broker-Dealers; Maintenance of Certain
Basic Reserves, Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR
25224, 25224 (Nov. 29, 1972).
    \663\ See 15 U.S.C. 78aaa et seq.
---------------------------------------------------------------------------

    The first step required by Rule 15c3-3 is that a carrying broker-
dealer must maintain physical possession or control over customers'
fully paid and excess margin securities.\664\ Physical possession or
control means the broker-dealer must hold these securities in one of
several locations specified in Rule 15c3-3 and free of liens or any
other

interest that could be exercised by a third-party to secure an
obligation of the broker-dealer.\665\ Permissible locations include a
bank, as defined in section 3(a)(6) of the Exchange Act, and a clearing
agency.\666\
---------------------------------------------------------------------------

    \664\ See 17 CFR 240.15c3-3(d). The term fully paid securities
includes all securities carried for the account of a customer in a
special cash account as defined in Regulation T promulgated by the
Board of Governors of the Federal Reserve System, as well as margin
equity securities within the meaning of Regulation T which are
carried for the account of a customer in a general account or any
special account under Regulation T during any period when section 8
of Regulation T (12 CFR 220.8) specifies that margin equity
securities shall have no loan value in a general account or special
convertible debt security account, and all such margin equity
securities in such account if they are fully paid: provided,
however, that the term ``fully paid securities'' shall not apply to
any securities which are purchased in transactions for which the
customer has not made full payment. 17 CFR 240.15c3-3(a)(3). The
term margin securities means those securities carried for the
account of a customer in a general account as defined in Regulation
T, as well as securities carried in any special account other than
the securities referred to in paragraph (a)(3) of Rule 15c3-3. 17
CFR 240.15c3-3(a)(4). The term excess margin securities means those
securities referred to in paragraph (a)(4) of Rule 15c3-3 carried
for the account of a customer having a market value in excess of 140
percent of the total of the debit balances in the customer's account
or accounts encompassed by paragraph (a)(4) of Rule 15c3-3 which the
broker-dealer identifies as not constituting margin securities. 17
CFR 240.15c3-3(a)(5).
    \665\ See 17 CFR 240.15c3-3(c). Customer securities held by the
carrying broker-dealer are not assets of the firm. Rather, the
carrying broker-dealer holds them in a custodial capacity and the
possession and control requirement is designed to ensure that the
carrying broker-dealer treats them in a manner that allows for their
prompt return.
    \666\ Id.
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    The second step is that a carrying broker-dealer must maintain a
reserve of funds or qualified securities in an account at a bank that
is at least equal in value to the net cash owed to customers.\667\ The
account must be titled ``Special Account for the Exclusive Benefit of
Customers of the Broker-Dealer'' (``customer reserve account'').\668\
The amount of net cash owed to customers is computed pursuant to a
formula set forth in Exhibit A to Rule 15c3-3 (``Exhibit A
formula'').\669\ Under the Exhibit A formula, the broker-dealer adds up
customer credit items (e.g., cash in customer securities accounts) and
then subtracts from that amount customer debit items (e.g., margin
loans).\670\ If credit items exceed debit items, the net amount must be
on deposit in the customer reserve account in the form of cash and/or
qualified securities.\671\ A broker-dealer cannot make a withdrawal
from the customer reserve account until the next computation and even
then only if the computation shows that the reserve requirement has
decreased.\672\ The broker-dealer must make a deposit into the customer
reserve account if the computation shows an increase in the reserve
requirement.
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    \667\ 17 CFR 240.15c3-3(e). The term ``qualified security'' is
defined in Rule 15c3-3 to mean a security issued by the United
States or a security in respect of which the principal and interest
are guaranteed by the United States (``U.S. government security'').
See 17 CFR 240.15c3-3(a)(6).
    \668\ See 17 CFR 240.15c3-3(e)(1). The purpose of giving the
account this title is to alert the bank and creditors of the broker-
dealer that this reserve fund is to be used to meet the broker-
dealer's obligations to customers (and not the claims of general
creditors) in the event the broker-dealer must be liquidated in a
formal proceeding.
    \669\ 17 CFR 240.15c3-3a.
    \670\ See id.
    \671\ 17 CFR 240.15c3-3(e). Customer cash is a balance sheet
item of the carrying broker-dealer (i.e., the amount of cash
received from a customer increases the amount of the carrying
broker-dealer's assets and creates a corresponding liability to the
customer). The reserve formula is designed to isolate these broker-
dealer assets so that an amount equal to the net liabilities to
customers is held as a reserve in the form of cash or U.S.
government securities. The requirement to establish this reserve is
designed to effectively prevent the carrying broker-dealer from
using customer funds for proprietary business activities such as
investing in securities. The goal is to put the carrying broker-
dealer in a position to be able to readily meet its cash obligations
to customers by requiring the firm to make deposits of cash and/or
U.S. government securities into the customer reserve account in the
amount of the net cash owed to customers.
    \672\ See 17 CFR 240.15c3-3(e).
---------------------------------------------------------------------------

    In addition, the Exhibit A formula permits the broker-dealer to
offset customer credit items only with customer debit items.\673\ This
means the broker-dealer can use customer cash to facilitate customer
transactions such as financing customer margin loans and borrowing
securities to make deliveries of securities customers have sold
short.\674\ As discussed above in section II.B. of this release, the
broker-dealer margin rules require securities customers to maintain a
minimum level of equity in their securities accounts. In addition to
protecting the broker-dealer from the consequences of a customer
default, this equity serves to over-collateralize the customers'
obligations to the broker-dealer. This buffer protects the customers
whose cash was used to facilitate the broker-dealer's financing of
securities purchases and short-sales by customers. For example, if the
broker-dealer fails, the customer debits, because they generally are
over-collateralized, should be attractive assets for another broker-
dealer to purchase or, if not purchased by another broker-dealer, they
should be able to be liquidated to a net positive equity.\675\ The
proceeds of the debits sale or liquidation can be used to repay the
customer cash used to finance the customer obligations. This cash plus
the funds and/or U.S. government securities held in the customer
reserve account should equal or exceed the total amount of customer
credit items (i.e., the total amount owed by the broker-dealer to its
customers).\676\
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    \673\ See 17 CFR 240.15c3-3a.
    \674\ For example, if a broker-dealer holds $100 for customer A,
the broker-dealer can use that $100 to finance a security purchase
of customer B. The $100 the broker-dealer owes customer A is a
credit in the formula and the $100 customer B owes the broker-dealer
is a debit in the formula. Therefore, under the Exhibit A formula
there would be no requirement to maintain cash and/or U.S.
government securities in the customer reserve account. However, if
the broker-dealer did not use the $100 held in customer A's account
for this purpose, there would be no offsetting debit and,
consequently, the broker-dealer would need to have on deposit in the
customer reserve account cash and/or U.S. government securities in
an amount at least equal to $100.
    \675\ The attractiveness of the over-collateralized debits
facilitates the bulk transfer of customer accounts from a failing or
failed broker-dealer to another broker-dealer.
    \676\ See Net Capital Requirements for Broker-Dealers; Amended
Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512,
3513 (Jan. 25, 1982) (``The alternative approach is founded on the
concept that, if the debit items in the Reserve Formula can be
liquidated at or near their contract value, these assets along with
any cash required to be on deposit under the [customer protection]
rule, will be sufficient to satisfy all liabilities to customers
(which are represented as credit items in the Reserve Formula).'').
---------------------------------------------------------------------------

    Proposed new Rule 18a-4 would contain certain provisions that are
modeled on corresponding provisions of Rule 15c3-3.\677\ Paragraph (a)
of the proposed rule would define key terms used in the rule.\678\
Paragraph (b) would require an SBSD to promptly obtain and thereafter
maintain physical possession or control of all excess securities
collateral (a term defined in paragraph (a)) and specify certain
locations where excess securities collateral could be held and would be
deemed to be in the SBSD's control.\679\ Paragraph (c) would require an
SBSD to maintain a special account for the exclusive benefit of
security-based swap customers and have on deposit in that account at
all times an amount of cash and/or qualified securities (a term defined
in paragraph (a)) determined through a computation using the formula in
Exhibit A to proposed new Rule 18a-4.\680\ A broker-dealer SBSD would
need to treat security-based swap accounts separately from other
securities accounts and, consequently, would need to perform separate
possession and control and reserve account computations for security-
based swap accounts and other securities accounts. The former would be
subject to the possession and control and reserve account requirements
in proposed new Rule 18a-4 and the latter would continue to be subject
to the analogous requirements in Rule 15c3-3. This would keep separate
the segregated customer property related to security-based swaps from
customer property related to other securities, including property of
retail securities customers.
---------------------------------------------------------------------------

    \677\ Compare 17 CFR 240.15c3-3, with proposed new Rule 18a-4.
    \678\ Compare 17 CFR 240.15c3-3(a), with paragraph (a) of
proposed new Rule 18a-4.
    \679\ Compare 17 CFR 240.15c3-3(b)-(d), with paragraph (b) of
proposed new Rule 18a-4.
    \680\ Compare 17 CFR 240.15c3-3(e), with paragraph (c) of
proposed new Rule 18a-4.
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    Paragraph (d) of Rule 18a-4 would contain certain additional
provisions that do not have analogues in Rule 15c3-3. First, it would
require an SBSD and an MSBSP to provide the notice required by section
3E(f)(1)(A) of the Exchange Act prior to the execution of the first
non-cleared security-based swap transaction with the counterparty.\681\
Second, it would require the SBSD to obtain subordination agreements
from counterparties that opt out of the segregation requirements in
proposed

new Rule 18a-4 because they either elect individual segregation
pursuant to the provisions of section 3E(f) of the Exchange Act \682\
or agree that the SBSD need not segregate their assets at all.\683\
---------------------------------------------------------------------------

    \681\ See 15 U.S.C. 78c-5(f)(1)(A); paragraph (d)(1) of proposed
new Rule 18a-4.
    \682\ See 15 U.S.C. 78c-5(f)(1)-(3).
    \683\ See 15 U.S.C. 78c-5(f)(4).
---------------------------------------------------------------------------

    As discussed in more detail below, the omnibus segregation
requirements in proposed new Rule 18a-4 are designed to accommodate the
operational aspects of an SBSD collecting cash, securities, and/or
money market instruments from security-based swap customers to margin
cleared security-based swaps and delivering cash, securities, and/or
money market instruments to registered clearing agencies to meet margin
requirements of the clearing agencies with respect to the customers'
transactions. Similarly, the omnibus segregation requirements are
designed to accommodate the current practice of dealers in OTC
derivatives to collect cash, securities, and/or money market
instruments from a counterparty to cover current and potential future
exposure arising from an OTC derivatives transaction with the
counterparty and concurrently deliver cash, securities, and/or money
market instruments to another dealer as collateral for an OTC
derivatives transaction that hedges (takes the opposite side of) the
OTC derivatives transaction with the counterparty. At the same time,
the omnibus segregation requirements are designed to isolate, identify,
and protect cash, securities, and/or money market instruments received
by the SBSD as collateral for cleared and non-cleared security-based
swaps, whether the collateral is held by the SBSD, a registered
clearing agency, or another SBSD.
    Finally, the Commission is proposing a conforming amendment to add
new paragraph (p) to Rule 15c3-3 to state that a broker-dealer that is
registered as an SBSD pursuant to section 15F of the Exchange Act must
also comply with the provisions of Rule 18a-4.\684\ This proposed
amendment would clarify that a broker-dealer SBSD must comply with both
Rule 15c3-3 and Rule 18a-4.
---------------------------------------------------------------------------

    \684\ See proposed paragraph (p) of Rule 15c3-3.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the approach of
proposed new Rule 18a-4. In addition, the Commission requests comment,
including empirical data in support of comments, in response to the
following questions:
    1. Should there be rules under section 3E(f)(1)(B)(i) of the
Exchange Act with respect to how an SBSD and an MSBSP must segregate
funds and other property relating to non-cleared security-based swaps
to supplement the individual segregation provisions in section 3E(f)?
If so, describe the types of requirements the rules should impose.
    2. Should there be rules under section 3E(f)(2)(B)(ii)(I) of the
Exchange Act with respect to how an SBSD and an MSBSP may invest funds
or other property relating to non-cleared security-based swaps to
supplement the individual segregation provisions in section 3E(f)? If
so, describe the types of requirements the rules should impose. For
example, should the rules require that the funds may be invested only
in U.S. government securities or in qualified securities as that term
is defined in paragraph (a)(5) of proposed new Rule 18a-4? Explain why
or why not.
    3. Is it appropriate to model the segregation provisions for
security-based swap customers on the provisions of Rule 15c3-3? If not,
explain why and identify another segregation model.
    4. Should MSBSPs be required to comply with all the omnibus
segregation requirements of proposed new Rule 18a-4? If so, explain
why. If not, explain why not.
    5. Should the omnibus segregation requirements accommodate the
ability to hold swaps in security-based swap customer accounts to
facilitate a portfolio margin treatment for related or offsetting
positions in the account? What practical or legal impediments may exist
to doing so? If swaps could be held in the account along with security-
based swaps, how would the existence of differing bankruptcy regimes
for securities and commodities instruments impact the ability to unwind
positions or distribute assets to customers in the event of insolvency
of the SBSD?
2. Proposed Rule 18a-4
a. Possession and Control of Excess Securities Collateral
    Paragraph (b)(1) of Rule 18a-4 would require an SBSD to promptly
obtain and thereafter maintain physical possession or control of all
excess securities collateral carried for the accounts of security-based
swap customers.\685\ Physical possession or control as used in Rule
15c3-3 means a broker-dealer cannot lend or hypothecate securities
subject to the requirement and must hold them itself or, as is more
common, in a satisfactory control location.\686\ As discussed below,
physical possession or control is intended to have the same meaning in
proposed new Rule 18a-4.
---------------------------------------------------------------------------

    \685\ This paragraph is modeled on paragraph (b)(1) of Rule
15c3-1. Compare 17 CFR 240.15c3-1(b)(1), with paragraph (b)(1) of
proposed new Rule 18a-4.
    \686\ See Amendments to Financial Responsibility Rules for
Broker-Dealers, 72 FR 12862.
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    The term security-based swap customer would be defined to mean any
person from whom or on whose behalf the SBSD has received or acquired
or holds funds or other property for the account of the person with
respect to a cleared or non-cleared security-based swap
transaction.\687\ The definition would exclude a person to the extent
that person has a claim for funds or other property which by contract,
agreement or understanding, or by operation of law, is part of the
capital of the SBSD or is subordinated to all claims of security-based
swap customers of the SBSD.\688\ This proposed definition of security-
based swap customer is modeled on the current definition of customer in
Rule 15c3-3.\689\ As discussed above, an SBSD would be required to
obtain subordination agreements from counterparties that elect
individual segregation pursuant to the self-executing provisions of
section 3E(f) of the Exchange Act \690\ or that waive segregation.\691\
Because these counterparties would enter into subordination agreements,
they would not meet the definition of security-based swap customer and,
consequently, the omnibus segregation requirements of proposed new Rule
18a-4 would not apply to their funds and other property.\692\
---------------------------------------------------------------------------

    \687\ See paragraph (a)(6) of proposed new Rule 18a-4. Paragraph
(a)(1) of proposed Rule 18a-4 would define the term cleared
security-based swap to mean a security-based swap that is, directly
or indirectly, submitted to and cleared by a clearing agency
registered with the Commission pursuant to section 17A of the
Exchange Act (15 U.S.C. 78q-1). Any other security-based swap would
be a non-cleared security-based swap.
    \688\ See paragraph (a)(6) of proposed new Rule 18a-4.
    \689\ Compare 17 CFR 240.15c3-3(a)(1), with paragraph (a)(6) of
proposed new Rule 18a-4. The proposed definition also is based on
the definitions of ``customer'' in 11 U.S.C. 741(2) and 15 U.S.C.
78lll(2), which, respectively, apply to liquidations of stockbrokers
under the stockbroker liquidation provisions and broker-dealers
under the SIPA. As discussed above in section II.C.1 of this
release, under these liquidation provisions, customers receive
special protections such as priority claims to customer property
over general creditors. See 11 U.S.C. 101 et seq.; 15 U.S.C. 78aaa
et seq.
    \690\ See 15 U.S.C. 78c-5(f)(1)-(3).
    \691\ See 15 U.S.C. 78c-5(f)(4).
    \692\ Counterparties that elect individual segregation would not
need the protections of the omnibus segregation requirements because
their funds and other property would be held by an independent
third-party custodian and, therefore, the third-party custodian--
rather than the SBSD--would owe the securities and funds to the
counterparty. Counterparties that waive segregation, in effect, have
agreed that their funds and other property can be used by the SBSD
for its proprietary business purposes. Therefore, they have agreed
to forego the benefits of segregation.

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

    Proposed new Rule 18a-4 would define the term excess securities
collateral to mean securities and money market instruments carried for
the account of a security-based swap customer that have a market value
in excess of the current exposure of the SBSD to the customer,
excluding: (1) Securities and money market instruments held in a
qualified clearing agency account but only to the extent the securities
and money market instruments are being used to meet a margin
requirement of the clearing agency resulting from a security-based swap
transaction of the customer; and (2) securities and money market
instruments held in a qualified registered security-based swap dealer
account but only to the extent the securities and money market
instruments are being used to meet a margin requirement of the other
SBSD resulting from the SBSD entering into a non-cleared security-based
swap transaction with the other SBSD to offset the risk of a non-
cleared security-based swap transaction between the SBSD and the
customer. The proposed definition of excess securities collateral is
based on the provisions of Rule 15c3-3 requiring a broker-dealer to
maintain physical possession or control of fully paid and excess margin
securities (i.e., securities that are not being used to secure the
obligations of the customer to the broker-dealer).\693\ Under the
proposed definition of excess securities collateral, securities and
money market instruments of a security-based swap customer of the SBSD
that are not being used to collateralize the SBSD's current exposure to
the customer would need to be in the physical possession or control of
the SBSD unless one of the two exceptions in the definition applies to
the securities and money market instruments.
---------------------------------------------------------------------------

    \693\ See 17 CFR 240.15c3-3(d); 17 CFR 240.15c3-3(a)(3)
(defining the term fully paid securities); 17 CFR 240.15c3-3(a)(4)
(defining the term margin securities); 17 CFR 240.15c3-3(a)(5)
(defining the term excess margin securities).
---------------------------------------------------------------------------

    The first exception in the definition refers to securities and
money market instruments held in a qualified clearing agency account
but only to the extent the securities and money market instruments are
being used to meet a margin requirement of the clearing agency
resulting from a security-based swap transaction of the customer. This
exception is designed to accommodate the margin requirements of
clearing agencies, which will require SBSDs to deliver margin
collateral to the clearing agency to cover exposures arising from
cleared security-based swaps of the SBSD's security-based swap
customers.\694\ Customer securities and money market instruments
provided to the clearing agency for this purpose would not meet the
definition of excess securities collateral and, therefore, would not be
subject to the physical possession or control requirement.\695\ This
exception would allow the clearing agency to hold the securities as
collateral against obligations of the SBSD's customers arising from
their cleared security-based swaps.
---------------------------------------------------------------------------

    \694\ As discussed above, security-based swap clearing agencies
will require SBSDs to deliver margin collateral for the security-
based swap transactions of the SBSD's customers that are cleared by
the clearing agency.
    \695\ While the Commission is proposing this exemption, these
customer securities and money market instruments would still be
required to be included in the SBSD's reserve formula calculation
under proposed new Rule 18a-4a.
---------------------------------------------------------------------------

    The term qualified clearing agency account would be defined to mean
an account of an SBSD at a clearing agency established to hold funds
and other property in order to purchase, margin, guarantee, secure,
adjust, or settle cleared security-based swaps of the SBSD's security-
based swap customers that meets the following conditions:
     The account is designated ``Special Clearing Account for
the Exclusive Benefit of the Cleared Security-Based Swap Customers of
[name of the SBSD]''; \696\
---------------------------------------------------------------------------

    \696\ See paragraph (a)(3)(i) of proposed new Rule 18a-4. This
provision is modeled on paragraph (e)(1) of Rule 15c3-3, which
requires a broker-dealer to maintain a ``Special Reserve Bank
Account for the Exclusive Benefit of Customers.'' Compare 17 CFR
240.15c3-3(e), with paragraph (a)(3)(i) of proposed new Rule 18a-4.
---------------------------------------------------------------------------

     The clearing agency has acknowledged in a written notice
provided to and retained by the SBSD that the funds and other property
in the account are being held by the clearing agency for the exclusive
benefit of the security-based swap customers of the SBSD in accordance
with the regulations of the Commission and are being kept separate from
any other accounts maintained by the SBSD with the clearing agency;
\697\ and
---------------------------------------------------------------------------

    \697\ See paragraph (a)(3)(ii) of proposed new Rule 18a-4. This
provision is modeled on paragraph (f) of Rule 15c3-3, which requires
a broker-dealer to obtain a written notification from a bank where
it maintains a customer reserve account. Compare 17 CFR 240.15c3-
3(f), with paragraph (a)(3)(iii) of proposed new Rule 18a-4.
---------------------------------------------------------------------------

     The account is subject to a written contract between the
SBSD and the clearing agency which provides that the funds and other
property in the account shall be subject to no right, charge, security
interest, lien, or claim of any kind in favor of the clearing agency or
any person claiming through the clearing agency, except a right,
charge, security interest, lien, or claim resulting from a cleared
security-based swap transaction effected in the account.\698\
---------------------------------------------------------------------------

    \698\ See paragraph (a)(3)(iii) of proposed new Rule 18a-4. This
provision is modeled on paragraph (f) of Rule 15c3-3, which requires
a broker-dealer to obtain a contract from a bank where it maintains
a ``Special Reserve Bank Account for the Exclusive Benefit of
Customers.'' Compare 17 CFR 240.15c3-3(f), with paragraph (a)(3)(ii)
of proposed new Rule 18a-4.
---------------------------------------------------------------------------

    These provisions are designed to ensure that securities and money
market instruments of security-based swap customers related to cleared
security-based swaps provided to a clearing agency are isolated from
the proprietary assets of the SBSD and identified as property of the
security-based swap customers.
    The second exception in the definition of excess securities
collateral is for securities and money market instruments held in a
qualified registered security-based swap dealer account but only to the
extent the securities and money market instruments are being used to
meet a margin requirement of the other SBSD resulting from the SBSD
entering into a non-cleared security-based swap transaction with the
other SBSD to offset the risk of a non-cleared security-based swap
transaction between the SBSD and the customer. This exception is
designed to accommodate the practice of dealers in OTC derivatives
transactions maintaining ``matched books'' of transactions in which an
OTC derivatives transaction with a counterparty is hedged with an
offsetting transaction with another dealer. SBSDs, as dealers in
security-based swaps, are expected to actively manage the risk of their
non-cleared security-based swap positions by entering into offsetting
transactions with other SBSDs.\699\ These other SBSDs may require
margin collateral from the SBSD.\700\ Customer securities and

money market instruments provided to another SBSD for this purpose
would be excepted from the definition of excess securities collateral
and, therefore, would not be subject to the physical possession or
control requirement. Thus, this provision would allow an SBSD to
finance customer transactions in non-cleared security-based swaps by
using customer collateral to secure offsetting transactions with
another SBSD, provided that the collateral is held in an account with
the other SBSD that meets certain requirements.
---------------------------------------------------------------------------

    \699\ For example, assume an SBSD and a counterparty enter into
a CDS security-based swap on XYZ Company with a notional amount of
$10 million and term of five years and in which the SBSD is the
seller of protection and counterparty is the buyer of protection.
The SBSD could enter into a matching transaction (a CDS security-
based swap on XYZ Company with a notional amount of $10 million and
term of five years) with another SBSD in which the SBSD is the buyer
of protection and the other SBSD is the seller of protection. This
would match the transaction with the counterparty with the
transaction with the other SBSD and hedge the SBSD's risk resulting
from the transaction with the customer.
    \700\ As discussed above in section II.B.2.c.i. of this release,
an SBSD would not be required to collect collateral equal to the
margin amount if the counterparty was another SBSD under the
Alternative A account equity requirement in proposed new Rule 18a-3.
See paragraph (c)(1)(iii)(B)--Alternative A of proposed new Rule
18a-3. Consequently, an SBSD would not be required to maintain a
minimum level of positive equity in its account at another SBSD with
respect to non-cleared security-based swaps. This would mean that
the SBSD may not need to provide collateral to the other SBSD other
than an amount necessary to cover the current exposure of the other
SBSD, which, in turn could reduce the need to use securities and
money market instruments of security-based swap customers to
collateralize hedging transactions. However, under the Alternative B
account equity requirement, an SBSD would be required to provide
collateral equal to the margin amount to the other SBSD. See
paragraph (c)(1)(iii)(B)--Alternative B of proposed new Rule 18a-3.
This could increase the need to use securities and money market
instruments of security-based swap customers to collateralize
hedging transactions.
---------------------------------------------------------------------------

    The term qualified registered security-based swap dealer account
(``qualified SBSD account'') would be defined to mean an account at
another SBSD registered with the Commission pursuant to section 15F of
the Exchange Act that is not an affiliate of the SBSD and that meets
the following conditions:
     The account is designated ``Special Account for the
Exclusive Benefit of the Security-Based Swap Customers of [name of the
SBSD]''; \701\
---------------------------------------------------------------------------

    \701\ See paragraph (a)(4)(i) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account, this provision is modeled on paragraph (e)(1) of Rule 15c3-
3, which requires a broker-dealer to maintain a ``Special Reserve
Bank Account for the Exclusive Benefit of Customers.'' Compare 17
CFR 240.15c3-3(e), with paragraph (a)(4)(i) of proposed new Rule
18a-4.
---------------------------------------------------------------------------

     The account is subject to a written acknowledgement by the
other SBSD provided to and retained by the SBSD that the funds and
other property held in the account are being held by the other SBSD for
the exclusive benefit of the security-based swap customers of the SBSD
in accordance with the regulations of the Commission and are being kept
separate from any other accounts maintained by the SBSD with the other
SBSD; \702\
---------------------------------------------------------------------------

    \702\ See paragraph (a)(4)(ii) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account, this provision is modeled on paragraph (f) of Rule 15c3-3,
which requires a broker-dealer to obtain a written notification from
a bank where it maintains a ``Special Reserve Bank Account for the
Exclusive Benefit of Customers.'' Compare 17 CFR 240.15c3-3(f), with
paragraph (a)(4)(ii) of proposed new Rule 18a-4.
---------------------------------------------------------------------------

     The account is subject to a written contract between the
SBSD and the other SBSD which provides that the funds and other
property in the account shall be subject to no right, charge, security
interest, lien, or claim of any kind in favor of the other SBSD or any
person claiming through the SBSD, except a right, charge, security
interest, lien, or claim resulting from a non-cleared security-based
swap transaction effected in the account; \703\ and
---------------------------------------------------------------------------

    \703\ See paragraph (a)(4)(iii) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account, this provision is modeled on paragraph (f) of Rule 15c3-3,
which requires a broker-dealer to obtain a contract from a bank
where it maintains a ``Special Reserve Bank Account for the
Exclusive Benefit of Customers.'' Compare 17 CFR 240.15c3-3(f), with
paragraph (a)(4)(iii) of proposed new Rule 18a-4.
---------------------------------------------------------------------------

     The account and the assets in the account are not subject
to any type of subordination agreement.\704\
---------------------------------------------------------------------------

    \704\ See paragraph (a)(4)(iv) of proposed new Rule 18a-4.

These conditions are largely identical to the conditions for a
qualified clearing agency account and are similarly designed to ensure
that securities and money market instruments of security-based swap
customers relating to non-cleared security-based swaps provided to
another SBSD are isolated from the proprietary assets of the SBSD and
are identified as property of the security-based swap customers.
Further, the account and the assets in the account could not be subject
to any type of subordination agreement. This condition is designed to
ensure that if the other SBSD holding the qualified SBSD account fails,
the SBSD accountholder will be treated as a security-based swap
customer in a liquidation proceeding and, therefore, could make a pro
rata claim for customer property with other customers ahead of all
other creditors.\705\
---------------------------------------------------------------------------

    \705\ See paragraph (a)(6) of proposed new Rule 18a-4 (excluding
persons who subordinate their claims against the SBSD to all other
creditors from the definition of security-based swap customer).
---------------------------------------------------------------------------

    Paragraph (b)(2) of proposed new Rule 18a-4 would identify five
satisfactory control locations for excess securities collateral.\706\
Rule 15c3-3 identifies the same locations as satisfactory control
locations.\707\ Proposed new Rule 18a-4 would provide that an SBSD has
control of excess securities collateral only if the securities and
money market instruments:
---------------------------------------------------------------------------

    \706\ See paragraph (b)(2) of proposed new Rule 18a-4.
    \707\ Compare 17 CFR 240.15c3-3(c), with paragraph (b)(2) of
proposed new Rule 18a-4. Rule 15c3-3 identifies two control
locations that the Commission is not proposing be identified in
proposed new Rule 18a-4. First, paragraph (c)(2) of Rule 15c3-3
identifies as a control location ``a special omnibus account in the
name of such broker or dealer with another broker or dealer in
compliance with the requirements of section 4(b) of Regulation T
under the Act (12 CFR 220.4(b)), such securities being deemed to be
under the control of such broker or dealer to the extent that he has
instructed such carrying broker or dealer to maintain physical
possession or control of them free of any charge, lien, or claim of
any kind in favor of such carrying broker or dealer or any persons
claiming through such carrying broker or dealer.'' See 17 CFR
240.15c3-3(c)(2). Stand-alone SBSDs are not expected to maintain
such accounts. Second, Rule 15c3-3 identifies as a control location
``a foreign depository, foreign clearing agency or foreign custodian
bank which the Commission upon application from a broker or dealer,
a registered national securities exchange or a registered national
securities association, or upon its own motion shall designate as a
satisfactory control location for securities.'' See 17 CFR 240.15c3-
3(c)(4). See also Interpretative Release: Guidelines for Control
Locations for Foreign Securities, Exchange Act Release No. 10429
(Oct. 12, 1973), 38 FR 29217, 29217 (Oct. 23, 1973). As discussed
below, the last control location identified in Rule 15c3-3 and
proposed to be identified in new Rule 18a-4 is such other location
``as the Commission shall upon application from a broker or dealer
find and designate to be adequate for the protection of customer
securities.'' See 17 CFR 240.15c3-3(c)(7) and paragraph (b)(2)(v) of
proposed new Rule 18a-4. Under the Commission's proposal, SBSDs
seeking to have a foreign depository, foreign clearing agency, or
foreign custodian bank identified as a satisfactory control location
would need to apply to the Commission under paragraph (b)(2)(v) of
proposed new Rule 18a-4.
---------------------------------------------------------------------------

     Are represented by one or more certificates in the custody
or control of a clearing corporation or other subsidiary organization
of either national securities exchanges, or of a custodian bank in
accordance with a system for the central handling of securities
complying with the provisions of Exchange Act Rule 8c-1(g) and Exchange
Act Rule 15c2-1(g) the delivery of which certificates to the SBSD does
not require the payment of money or value, and if the books or records
of the SBSD identify the security-based swap customers entitled to
receive specified quantities or units of the securities so held for
such security-based swap customers collectively; \708\
---------------------------------------------------------------------------

    \708\ See paragraph (b)(2)(i) of proposed new Rule 18a-4. This
provision is modeled on paragraph (c)(1) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(c)(1), with paragraph (b)(2)(i) of proposed new Rule
18a-4.
---------------------------------------------------------------------------

     Are the subject of bona fide items of transfer; provided
that securities and money market instruments shall be deemed not to be
the subject of bona fide items of transfer if, within 40 calendar days
after they have been transmitted for transfer by the SBSD to the issuer
or its transfer agent, new certificates conforming to the instructions
of the SBSD have not been received by the SBSD, the SBSD has not

received a written statement by the issuer or its transfer agent
acknowledging the transfer instructions and the possession of the
securities and money market instruments, or the security-based swap
dealer has not obtained a revalidation of a window ticket from a
transfer agent with respect to the certificate delivered for transfer;
\709\
---------------------------------------------------------------------------

    \709\ See paragraph (b)(2)(ii) of proposed new Rule 18a-4. This
provision is modeled on paragraph (c)(3) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(c)(3), with paragraph (b)(2)(ii) of proposed new Rule
18a-4.
---------------------------------------------------------------------------

     Are in the custody or control of a bank as defined in
section 3(a)(6) of the Act, the delivery of which securities and money
market instruments to the SBSD does not require the payment of money or
value and the bank having acknowledged in writing that the securities
and money market instruments in its custody or control are not subject
to any right, charge, security interest, lien or claim of any kind in
favor of a bank or any person claiming through the bank; \710\
---------------------------------------------------------------------------

    \710\ See paragraph (b)(2)(iii) of proposed new Rule 18a-4. This
provision is modeled on paragraph (c)(5) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(c)(5), with paragraph (b)(2)(iii) of proposed new
Rule 18a-4.
---------------------------------------------------------------------------

     Are held in or are in transit between offices of the SBSD;
or are held by a corporate subsidiary if the SBSD owns and exercises a
majority of the voting rights of all of the voting securities of such
subsidiary, assumes or guarantees all of the subsidiary's obligations
and liabilities, operates the subsidiary as a branch office of the
SBSD, and assumes full responsibility for compliance by the subsidiary
and all of its associated persons with the provisions of the Federal
securities laws as well as for all of the other acts of the subsidiary
and such associated persons; \711\ or
---------------------------------------------------------------------------

    \711\ See paragraph (b)(2)(iv) of proposed new Rule 18a-4. This
provision is modeled on paragraph (c)(6) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(c)(6), with paragraph (b)(2)(iv) of proposed new Rule
18a-4.
---------------------------------------------------------------------------

     Are held in such other locations as the Commission shall
upon application from an SBSD find and designate to be adequate for the
protection of customer securities.\712\
---------------------------------------------------------------------------

    \712\ See paragraph (b)(2)(v) of proposed new Rule 18a-4. This
provision is modeled on paragraph (c)(7) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(c)(7), with paragraph (b)(2)(v) of proposed new Rule
18a-4. See Guidelines for Control Locations for Foreign Securities,
Exchange Act Release No. 10429 (Oct. 12, 1973, 38 FR 29217 (Oct. 23,
1973) (prescribing the process under Rule 15c3-3 for a broker-dealer
to apply to the Commission to utilize a foreign control location).
Among other things, certain conditions must be met for the foreign
control location to be deemed satisfactory. A broker-dealer must
represent in an application to the Commission that the conditions
are satisfied. An application submitted shall be considered accepted
unless the Commission rejects the application within 90 days of
receipt by the Commission. Id.

The identification of these locations as satisfactory control locations
is designed to limit where the SBSD can hold excess securities
collateral. The identified locations are places from which the
securities and money market instruments can promptly be retrieved and
returned to the security-based swap customers.
    Paragraph (b)(3) of Rule 18a-4 would require that each business day
the SBSD must determine from its books and records the quantity of
excess securities collateral that the firm had in possession and
control as of the close of the previous business day and the quantity
of excess securities collateral the firm did not have in possession or
control on that day.\713\ The paragraph would provide further that the
SBSD must take steps to retrieve excess securities collateral from
certain specifically identified non-control locations if securities and
money market instruments of the same issue and class are at these
locations.\714\ Specifically, paragraph (b)(3) would provide that if
securities or money market instruments of the same issue and class are:
---------------------------------------------------------------------------

    \713\ See paragraph (b)(3) of proposed new Rule 18a-4. The
provisions in this paragraph are modeled on the provisions in
paragraph (d) of Rule 15c3-3. Compare 17 CFR 240.15c3-3(d), with
paragraph (b)(3) of proposed new Rule 18a-4.
    \714\ See paragraph (b)(3) of proposed new Rule 18a-4.
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     Subject to a lien securing an obligation of the SBSD, then
the SBSD, not later than the next business day on which the
determination is made, must issue instructions for the release of the
securities or money market instruments from the lien and must obtain
physical possession or control of the securities and money market
instruments within two business days following the date of the
instructions; \715\
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    \715\ See paragraph (b)(3)(i) of proposed new Rule 18a-4. This
provision is modeled on paragraph (d)(1) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(d)(1), with paragraph (b)(3)(i) of proposed new Rule
18a-4.
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     Held in a qualified clearing agency account, then the
SBSD, not later than the next business day on which the determination
is made, must issue instructions for the release of the securities or
money market instruments by the clearing agency and must obtain
physical possession or control of the securities or money market
instruments within two business days following the date of the
instructions; \716\
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    \716\ See paragraph (b)(3)(ii) of proposed new Rule 18a-4. As
discussed above, securities held in a qualified clearing agency
account are not excess securities collateral, but only to the extent
the securities are being used to meet a margin requirement of the
clearing agency resulting from a security-based swap transaction of
the customer. See paragraph (a)(2)(i) of proposed new Rule 18a-4.
Consequently, if securities held in a qualified clearing agency
account are not necessary to meet a margin requirement of the
clearing agency, they would be excess securities collateral and the
SBSD would need to move them to a satisfactory control location.
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     Held in a qualified SBSD account maintained by another
SBSD, then the SBSD, not later than the next business day on which the
determination is made, must issue instructions for the release of the
securities and money market instruments by the other SBSD and must
obtain physical possession or control of the securities or money market
instruments within two business days following the date of the
instructions; \717\
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    \717\ See paragraph (b)(3)(iii) of proposed new Rule 18a-4. As
discussed above, securities held in a qualified SBSD account are not
excess securities collateral but only to the extent the securities
are being used to meet a margin requirement of the other SBSD
resulting from the SBSD entering into a non-cleared security-based
swap transaction with the other SBSD to offset the risk of a non-
cleared security-based swap transaction between the SBSD and the
customer. See paragraph (a)(2)(ii) of proposed new Rule 18a-4.
Consequently, if securities held in a qualified clearing agency
account are not necessary to meet a margin requirement of the other
SBSD and/or are not collateralizing a transaction that offsets the
risk of n non-cleared security-based swap with the customer, they
would be excess securities collateral and the SBSD would need to
move them to a satisfactory control location.
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     Loaned by the SBSD, then the SBSD, not later than the next
business day on which the determination is made, must issue
instructions for the return of the loaned securities and money market
instruments and must obtain physical possession or control of the
securities or money market instruments within five business days
following the date of the instructions; \718\
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    \718\ See paragraph (b)(3)(iv) of proposed new Rule 18a-4. This
provision is modeled on paragraph (d)(1) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(d)(1), with paragraph (b)(3)(iv) of proposed new Rule
18a-4.
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     Failed to receive more than 30 calendar days, then the
SBSD, not later than the next business day on which the determination
is made, must take prompt steps to obtain physical possession or
control of the securities or money market instruments through a buy-in
procedure or otherwise; \719\
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    \719\ See paragraph (b)(3)(v) of proposed new Rule 18a-4. This
provision is modeled on paragraph (d)(2) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(d)(2), with paragraph (b)(3)(v) of proposed new Rule
18a-4.
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     Receivable by the SBSD as a security dividend, stock split
or similar distribution for more than 45 calendar days, then the SBSD,
not later than the next business day on which the determination is
made, must take

prompt steps to obtain physical possession or control of the securities
or money market instruments through a buy-in procedure or otherwise;
\720\ or
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    \720\ See paragraph (b)(3)(vi) of proposed new Rule 18a-4. This
provision is modeled on paragraph (d)(3) of Rule 15c3-3. Compare 17
CFR 240.15c3-3(d)(3), with paragraph (b)(3)(vi) of proposed new Rule
18a-4.
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     Included on the books or records of the SBSD as a
proprietary short position or as a short position for another person
more than 10 business days (or more than 30 calendar days if the SBSD
is a market maker in the securities), then the SBSD must, not later
than the business day following the day on which the determination is
made, take prompt steps to obtain physical possession or control of
such securities or money market instruments.\721\
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    \721\ See paragraph (b)(3)(vii) of proposed new Rule 18a-4. This
provision is modeled on a proposed amendment to Rule 15c3-3 that is
still pending. See Amendments to Financial Responsibility Rules for
Broker-Dealers, 72 FR at 12895. The provisions of paragraph
(b)(3)(vii) of proposed new Rule 18a-4 are intended to achieve the
same objectives of the proposed amendments to Rule 15c3-3. See id.
at 12865-66 (explaining the basis for the proposed amendment to Rule
15c3-3).
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Request for Comment
    The Commission generally requests comment on the proposed physical
possession and control requirements in proposed new Rule 18a-4. In
addition, the Commission requests comment, including empirical data in
support of comments, in response to the following questions:
    1. Are possession and control requirements modeled on Rule 15c3-3
appropriate for security-based swaps? If not, explain why not.
    2. Is the proposed definition of security-based swap customer
appropriate? If not, explain why not and suggest modifications to the
definition.
    3. Is the proposed definition of excess securities collateral
appropriate? If not, explain why not and suggest modifications to the
definition.
    4. Is the proposed exception in the definition of excess securities
collateral for securities and money market instruments held in a
qualified clearing agency account appropriate? If not, explain why not.
Would this proposed exception raise practical or legal issues? If so,
explain why.
    5. Is the proposed definition of qualified clearing agency account
appropriate? If not, explain why not and suggest modifications to the
definition.
    6. Is the proposed exception in the definition of excess securities
collateral for securities and money market instruments held in a
qualified registered security-based swap dealer account appropriate? If
not, explain why not. Would this proposed exception raise practical or
legal issues? If so, explain why.
    7. Is the proposed definition of qualified registered security-
based swap dealer account appropriate? For example, is the condition
that the qualified registered security-based swap dealer account not be
held by an affiliate of the SBSD appropriate? If the definition is not
appropriate, explain why not and suggest modifications to the
definition.
    8. How do dealers in OTC derivatives that will be security-based
swaps use offsetting transactions to hedge the risk of these positions?
Would the proposed possession and control requirements for non-cleared
security-based swaps adversely affect the ability of SBSDs to enter
into hedging transactions? If so, explain why and suggest modifications
to the requirements that could address this issue.
    9. Are the control locations identified in proposed new Rule 18a-4
appropriate for security-based swaps? If not, explain why not. Should
the two additional control locations in paragraphs (c)(2) and (c)(4) of
Rule 15c3-3 that are not being incorporated into proposed new Rule 18a-
4 be included in the rule? If so, explain why.
    10. Should the process for applying to the Commission to have a
location designated to be adequate for the protection of customer
securities and money market instruments under paragraph (b)(2)(v) of
proposed new Rule 18a-4 be similar to the current process for a broker-
dealer to utilize a foreign control location under Rule 15c3-3 (i.e., a
process in which the SBSD must submit an application representing that
certain conditions are met and in which an application is deemed
accepted if not specifically rejected by the Commission within 90
days)? Alternatively, should the Commission be required to formally act
on each application through the issuance of an order?
    11. Are the steps in paragraph (b)(3) of proposed new Rule 18a-4
that an SBSD would be required to take to move securities and money
market instruments from non-control locations to control locations
appropriate for security-based swaps? If not, explain why not.
    12. Are there any possession and control provisions in Rule 15c3-3
that are not being incorporated in proposed new Rule 18a-4 that should
be included in the rule? If so, identify them and explain why they
should be incorporated into proposed new Rule 18a-4.
b. Security-Based Swap Customer Reserve Account
    Paragraph (c)(1) of Rule 18a-4 would require an SBSD, among other
things, to maintain a special account for the exclusive benefit of
security-based swap customers separate from any other bank account of
the SBSD.\722\ The term special account for the exclusive benefit of
security-based swap customers (``Rule 18a-4 Customer Reserve Account'')
would be defined to mean an account at a bank that is not the SBSD or
an affiliate of the SBSD and that meets the following conditions:
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    \722\ See paragraph (c) of proposed new Rule 18a-4. The
provisions of paragraph (c) of proposed new Rule 18a-4 are modeled
on paragraph (e) of Rule 15c3-3. Compare 17 CFR 240.15c3-3(e), with
paragraph (c) of proposed new Rule 18a-4.
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     The account is designated ``Special Account for the
Exclusive Benefit of the Security-Based Swap Customers of [name of the
SBSD]''; \723\
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    \723\ See paragraph (a)(7)(i) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account and a qualified SBSD account, this provision is modeled on
paragraph (e)(1) of Rule 15c3-3, which requires a broker-dealer to
maintain a ``Special Reserve Bank Account for the Exclusive Benefit
of Customers'' (the ``Rule 15c3-3 Customer Reserve Account'').
Compare 17 CFR 240.15c3-3(e), with paragraph (a)(7)(i) of proposed
new Rule 18a-4.
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     The account is subject to a written acknowledgement by the
bank provided to and retained by the SBSD that the funds and other
property held in the account are being held by the bank for the
exclusive benefit of the security-based swap customers of the SBSD in
accordance with the regulations of the Commission and are being kept
separate from any other accounts maintained by the SBSD with the bank;
\724\ and
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    \724\ See paragraph (a)(7)(ii) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account and a qualified SBSD account, this provision is modeled on
paragraph (f) of Rule 15c3-3, which requires a broker-dealer to
obtain a written notification from a bank where it maintains a Rule
15c3-3 Customer Reserve Account. Compare 17 CFR 240.15c3-3(f), with
paragraph (a)(7)(ii) of proposed new Rule 18a-4.
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     The account is subject to a written contract between the
SBSD and the bank which provides that the funds and other property in
the account shall at no time be used directly or indirectly as security
for a loan or other extension of credit to the SBSD by the bank and,
shall be subject to no right, charge, security interest, lien, or claim
of any kind in favor of the bank or any person claiming through the
bank.\725\
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    \725\ See paragraph (a)(7)(iii) of proposed new Rule 18a-4.
Similar to the proposed conditions for a qualified clearing agency
account and a qualified SBSD account, this provision is modeled on
paragraph (f) of Rule 15c3-3, which requires a broker-dealer to
obtain a written contract from a bank where it maintains a ``Special
Reserve Bank Account for the Exclusive Benefit of Customers.''
Compare 17 CFR 240.15c3-3(f), with paragraph (a)(7)(iii) of proposed
new Rule 18a-4.

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These conditions are largely identical to the conditions for a
qualified clearing agency account and qualified SBSD account and are
similarly designed to ensure that cash and qualified securities
deposited into the special bank account (as discussed below) are
isolated from the proprietary assets of the SBSD and identified as
property of the security-based swap customers.
    Paragraph (c)(1) of proposed new Rule 18a-4 would provide that the
SBSD must at all times maintain in a Rule 18a-4 Customer Reserve
Account, through deposits into the account, cash and/or qualified
securities in amounts computed in accordance with the formula set forth
in Exhibit A to Rule 18a-4.\726\ The formula in Exhibit A to proposed
new Rule 18a-4 is modeled on the formula in Exhibit A to Rule 15c3-1,
which requires a broker-dealer to add up various credit items and debit
items.\727\ The credit items include credit balances in customer
accounts and funds obtained through the use of customer
securities.\728\ The debit items include money owed by customers (e.g.,
from margin lending), securities borrowed by the broker-dealer to
effectuate customer short sales, and required margin posted to certain
clearing agencies as a consequence of customer securities
transactions.\729\ If, under the formula, customer credit items exceed
customer debit items, the broker-dealer must maintain cash and/or
qualified securities in that net amount in a Rule 15c3-3 Customer
Reserve Account.
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    \726\ See paragraph (c)(1) of proposed new Rule 18a-4; Exhibit A
to proposed new Rule 18a-4.
    \727\ Compare 17 CFR 240.15c3-3a, with Exhibit A to proposed new
Rule 18a-4.
    \728\ See 17 CFR 240.15c3-3a, Items 1-9. Broker-dealers are
permitted to use customer margin securities to, for example, obtain
bank loans to finance the funds used to lend to customers to
purchase the securities. The amount of the bank loan is a credit in
the formula because this is the amount that the broker-dealer would
need to pay the bank to retrieve the securities. Similarly, broker-
dealers may use customer margin securities to make stock loans to
other broker-dealers in which the lending broker-dealer typically
receives cash in return. The amount payable to the other broker-
dealer on the stock loan is a credit in the formula because this is
the amount the broker-dealer would need to pay the other broker-
dealer to retrieve the securities.
    \729\ See 17 CFR 240.15c3-3a, Items 10-14. Item 13 identifies as
a debit item margin required and on deposit with the Options
Clearing Corporation for all option contracts written or purchased
in accounts of securities customers. See 17 CFR 240.15c3-3a, Item
13. Similarly, Item 14 identifies as a debit item margin related to
security futures products written, purchased, or sold in accounts
carried for security-based swap customers required and on deposit
with a clearing agency registered with the Commission under section
17A of the Exchange Act (15 U.S.C. 78q-1) or a DCO registered with
the CFTC under section 5b of the CEA (7 U.S.C. 78q-1). These debits
reflect the fact that customer options and security futures
transactions that are cleared generate margin requirements in which
the broker-dealer must deliver collateral to the Options Clearing
Corporation in the case of options or a clearing agency or DCO in
the case of security futures products. Identifying the collateral
delivered to the Options Clearing Corporation, a clearing agency, or
a DCO as a debit item permits the broker-dealer to use customer cash
or securities to meet margin requirements generated by customer
transactions.
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    The formula in Exhibit A for determining the amount to be
maintained in a Rule 18a-4 Customer Reserve Account similarly would
require an SBSD to add up credit items and debit items.\730\ If, under
the formula, the credit items exceed the debit items, the SBSD would be
required to maintain cash and/or qualified securities in that net
amount in a Rule 18a-4 Customer Reserve Account.\731\ The credit and
debit items identified in Exhibit A to proposed new Rule 18a-4 are the
same as the credit and debit items in Exhibit A to Rule 15c3-1, though
Exhibit A to proposed new Rule 18a-4 would identify two additional
debit items.\732\ As discussed above, SBSDs will be required to deliver
collateral to meet margin requirements of clearing agencies arising
from cleared security-based swap transactions of their customers. In
addition, SBSDs may deliver collateral to other SBSDs to meet margin
requirements under proposed new Rule 18a-3 and, possibly, to meet
``house'' margin requirements of the other SBSD with respect to non-
cleared security-based swaps the SBSD is using to hedge the risk of
customer non-cleared security-based swaps. Consequently, Exhibit A to
proposed new Rule 18a-4 would identify the following debit items that
are not identified in Exhibit A to Rule 15c3-3:
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    \730\ See proposed new Rule 18a-4a. Exhibit A to Rule 15c3-3 has
a number of ``Notes'' that provide further explanation of the credit
and debit items. See 17 CFR 240.15c3-3a, Notes A-G. Exhibit A to
proposed new Rule 18a-4 would have substantially similar notes. See
Notes A-G to Exhibit A to proposed new Rule 18a-4.
    \731\ As discussed above, the account would need to be at a bank
that is not the SBSD or an affiliate of the SBSD and that meets
certain additional conditions. See paragraph (a)(7) of proposed new
Rule 18a-4.
    \732\ Compare 17 CFR 240.15c3-3a, with Exhibit A to proposed new
Rule 18a-4.
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     Margin related to cleared security-based swap transactions
in accounts carried for security-based swap customers required and on
deposit at a clearing agency registered with the Commission pursuant to
section 17A of the Exchange Act (15 U.S.C. 78q-1); and
     Margin related to non-cleared security-based swap
transactions in accounts carried for security-based swap customers held
in a qualified registered SBSD account at another SBSD.

These debit items would serve the same purpose as the debit items in
Exhibit A to Rule 15c3-3 that identify margin required and on deposit
at the Options Clearing Corporation, a registered clearing agency, and
a DCO.\733\
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    \733\ See 17 CFR 240.15c3-3a, Items 13-14.
---------------------------------------------------------------------------

    If the total credits exceed the total debits, an SBSD would need to
maintain that amount on deposit in a Rule 18a-4 Customer Reserve
Account in the form of funds and/or qualified securities.\734\ An SBSD
would be permitted under the proposed rule to use qualified securities
to meet this account deposit requirement to implement section 3E(d) of
the Exchange Act.\735\ Section 3E(d) provides that money of security-
based swap customers received by an SBSD to margin, guarantee, or
secure a cleared security-based swap may be invested in obligations of
the United States, obligations fully guaranteed as to principal and
interest by the United States, general obligations of a State or any
subdivision of a State (``municipal securities''), and in any other
investment that the Commission may by rule or regulation
prescribe.\736\ Section 3E(d) further provides that such investments
shall be made in accordance with such rules and regulations and subject
to such conditions as the Commission may prescribe.\737\
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    \734\ See paragraph (c)(1) of proposed new Rule 18a-4.
    \735\ 15 U.S.C. 78c-5(d).
    \736\ Id.
    \737\ Id.
---------------------------------------------------------------------------

    The term qualified security as used in proposed new Rule 18a-4
would be defined to mean: (1) Obligations of the United States; (2)
obligations fully guaranteed as to principal and interest by the United
States; and (3) general obligations of any State or subdivision of a
State that are not traded flat or are not in default, were part of an
initial offering of $500 million or greater, and were issued by an
issuer that has published audited financial statements within 120 days
of its most recent fiscal year-end.\738\ Rule 15c3-3 contains a similar
definition of qualified security, except the definition does not
include municipal securities.\739\
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    \738\ See paragraph (a)(5) of proposed new Rule 18a-4.
    \739\ See 17 CFR 240.15c3-3(a)(6) (defining the term qualified
security to mean a security issued by the United States or a
security in respect of which the principal and interest are
guaranteed by the United States).
---------------------------------------------------------------------------

    While section 3E(d) of the Exchange Act permits the use of
municipal

securities, the rule imposes conditions on their use designed to ensure
that only municipal securities with the most reliable valuations--and
therefore greater safety and liquidity--are permitted to meet the Rule
18a-4 Customer Reserve Account funding requirement in paragraph (c)(1)
of proposed new Rule 18a-4 (consistent with the objective of the
current definition of ``qualified security'' in Rule 15c3-3).\740\
Because of the diversity and breadth of the municipal market, the
availability of issuer information and the related ability to value and
trade a particular municipal security can vary considerably.\741\ The
objective of segregation requirements is to isolate customer assets
from a firm's proprietary business and, therefore, enable the firm to
quickly return the assets to the customers if the firm fails. Rule
15c3-3 limits the definition of qualified securities to U.S. government
securities to ensure that securities deposited in a customer reserve
account can be liquidated quickly at current market values even in
stressed market conditions. The proposed conditions for depositing
municipal securities into the SBSD's Rule 18a-4 Customer Reserve
Account are designed to help ensure that only securities that are
likely to have significant issuer information available and that can be
valued and liquidated quickly at current market values are permitted to
meet the minimum account deposit requirement.\742\
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    \740\ See paragraphs (a)(5)(iii)(A)-(C) of proposed new Rule
18a-4.
    \741\ Despite its size and importance, the municipal securities
market has not been subject to the same level of regulation as other
sectors of the U.S. capital markets. See Commission, Report on the
Municipal Securities Market (July 31, 2012) (``Municipal Securities
Report''), available at http://www.sec.gov/news/studies/2012/munireport073112.pdf. The Municipal Securities Report notes concerns
about access to issuer information; the presentation and
comparability of information; and the existence/adequacy of
disclosure controls and procedures. Id. at iv, 108-09. For example,