to section 3E(f) of the Exchange Act prior to the execution of the
first non-cleared security-based swap transaction with the counterparty
occurring after the effective date of the proposed rule.\910\ All 50
SBSDs and 5 MSBSPs would be required to provide these notices to their
counterparties. The Commission staff estimates that these 55 entities
would engage outside counsel to draft and review the notice at a cost
of $400 per hour for an average of 10 hours per respondent, resulting
in a one-time cost burden of $220,000 for all of these 55
entities.\911\
---------------------------------------------------------------------------

    \910\ See paragraph (d)(1) of proposed new Rule 18a-4.
    \911\ [50 SBSDs + 5 MSBSPs] x $400 per hour x 10 hours =
$220,000. The Commission expects that these functions would likely
be performed by outside counsel with an expertise in financial
services law to help ensure that counterparties are receiving the
proper notice under the statutory requirement.
---------------------------------------------------------------------------

    The number of notices sent in the first year the rule is effective
would depend on the number of counterparties with which each SBSD and
MSBSP engages in security-based swap transactions. The number of
counterparties an SBSD and MSBSP would have would vary depending on the
size and complexity of the firm and its operations. The Commission
staff estimates that each of the 50 SBSDs and 5 MSBSPs would have
approximately 1,000 counterparties at any given time.\912\ Therefore,
the Commission staff estimates that approximately 55,000 notices would
be sent in the first year the rule is effective.\913\ The Commission
staff estimates that the each of the 50 SBSDs and 5 MSBSPs would spend
approximately 10 minutes sending out the notice, resulting in an
industry-wide one-time hour burden of approximately 9,167 hours.\914\
The Commission staff further estimates that the 50 SBSDs and 5 MSBSPs
would establish account relationships with 200 new counterparties per
year. Therefore, the Commission staff estimates that approximately
11,000 notices would be sent annually,\915\ resulting in an industry-
wide annual hour burden of approximately 1,833 hours.\916\
---------------------------------------------------------------------------

    \912\ The Commission previously estimated that there are
approximately 8,500 market participants in security-based swap
transactions. See Business Conduct Release, 76 FR at 42443. Based on
the 8,500 market participants and Commission staff experience
relative to the securities and OTC derivatives industry, the
Commission staff estimates that each SBSD and MSBSP would have 1,000
counterparties at any given time. The number of counterparties may
widely vary depending on the size of the SBSD or MSBSP. A large firm
may have thousands or counterparties at one time, while a smaller
firm may have substantially less than 1,000. The Commission staff
also estimates, based on staff experience, that these entities would
establish account relationships with approximately 200 new
counterparties a year, or approximately 20% of a firm's existing
counterparties.
    \913\ [50 SBSDs + 5 MSBSPs] x 1,000 counterparties = 55,000
notices.
    \914\ (55,000 notices x 10 minutes)/60 minutes = 9,167 hours. A
compliance clerk would likely send these notices. Therefore, the
estimated internal cost for this hour burden would be calculated as
follows: Compliance clerk for 9,167 hours at $60 per hour =
$550,020. The hourly rates use for internal office employees used
throughout this section are taken from SIFMA's Office Salaries in
the Securities Industry 2011, modified by the Commission staff to
account for an 1800-hour work-year and multiplied by 2.93 to account
for bonuses, firm size, employee benefits and overhead.
    \915\ [50 SBSDs + 5 MSBSPs] x 200 counterparties = 11,000
notices.
    \916\ (11,000 notices x 10 minutes)/60 minutes = 1,833 hours. A
compliance clerk would likely send these notices. Therefore, the
estimated internal cost for this hour burden would be calculated as
follows: compliance clerk for 1,833 hours at $60 per hour =
$109,980.
---------------------------------------------------------------------------

    Under proposed new Rule 18a-4(d)(2), an SBSD would be required to
obtain agreements from counterparties that do not choose to require
segregation of funds or other property pursuant to Section 3E(f) of the
Exchange Act or paragraph (c)(3) of Rule 18a-4 in which the
counterparty agrees to subordinate all of its claims against the SBSD
to the claims of security-based swap customers of the SBSD.\917\ The
Commission staff estimates that an SBSD would spend, on average,
approximately 200 hours to draft and prepare standard subordination
agreements, resulting in an industry-wide one-time hour burden of
10,000 hours.\918\ Because the SBSD would enter into these agreements
with

security-based swap customers, after the SBSD prepares a standard
subordination agreement in-house, the Commission staff also estimates
that an SBSD would have outside counsel a review the standard
subordination agreements and that the review would take approximately
20 hours at a cost of approximately $400 per hour. As a result, the
Commission staff estimates that each SBSD would incur one-time costs of
approximately $8,000,\919\ resulting in an industry-wide one-time cost
of approximately $400,000.\920\
---------------------------------------------------------------------------

    \917\ See paragraph (d)(2) of proposed new Rule 18a-4.
    \918\ 200 hours x 50 SBSDs = 10,000 hours. An in-house attorney
would likely draft these agreements because the Commission staff
expects that drafting contracts would be one of the typical job
functions of an in-house attorney. Therefore, the estimated internal
cost for this hour burden would be calculated as follows: In-house
attorney for 10,000 hours at $378 per hour = $3,780,000.
    \919\ $400 x 20 hours = $8,000.
    \920\ $8,000 x 50 = $400,000.
---------------------------------------------------------------------------

    As discussed above, the Commission staff estimates that each of the
50 SBSDs would have approximately 1,000 counterparties at any given
time. The Commission staff further estimates that approximately 50% of
these counterparties would either elect individual segregation or waive
segregation altogether.\921\ The Commission staff estimates that an
SBSD would spend 20 hours per counterparty to enter into a written
subordination agreement, resulting in an industry-wide one-time hour
burden of approximately 500,000 hours.\922\ Further, as discussed the
Commission staff estimates that each of the 50 SBSDs would establish
account relationships with 200 new counterparties per year. The
Commission staff further estimates that 50% or 100 of these
counterparties would either elect individual segregation or waive
segregation altogether. Therefore, the Commission staff estimates an
industry-wide annual hour burden of approximately 100,000 hours.\923\
---------------------------------------------------------------------------

    \921\ Based on discussions with market participants, the
Commission staff understands that many large buy-side financial end
users currently ask for individual segregation and the Commission
staff assumes that many of these end users will continue to do so.
However, Commission staff believes that some smaller end users may
not choose to incur additional cost that may come with individual
segregation. Therefore, the Commission staff estimates that
approximately 50% of counterparties will either elect individual
segregation or waiver segregation altogether.
    \922\ 50 SBSDs x 500 counterparties x 20 hours = 500,000 hours.
These functions would likely be performed by a compliance attorney
(250,000 hours) and a compliance clerk (250,000 hours). Therefore,
the estimated internal cost for this hour burden would be calculated
as follows: ((compliance attorney for 250,000 hours at $322 per
hour) + (compliance clerk for 250,000 hours at $60 per hour)) =
$95,500,000.
    \923\ 50 SBSDs x 100 counterparties x 20 hours = 100,000 hours.
These functions would likely be performed by a compliance attorney
(50,000 hours) and a compliance clerk 50,000 hours). Therefore, the
estimated internal cost for this hour burden would be calculated as
follows: ((compliance attorney for 50,000 hours at $322 per hour) +
(compliance clerk for 50,000 hours at $60 per hour)) = $19,100,000.
---------------------------------------------------------------------------

E. Collection of Information Is Mandatory

    The collections of information pursuant to the proposed amendments
and new rules are mandatory, as applicable, for ANC broker-dealers,
SBSDs, and MSBSPs.

F. Confidentiality

    The Commission expects to receive confidential information in
connection with the proposed collections of information. To the extent
that the Commission receives confidential information pursuant to these
collections of information, the Commission is committed to protecting
the confidentiality of such information to the extent permitted by
law.\924\
---------------------------------------------------------------------------

    \924\ See, e.g., 15 U.S.C. 78 x (governing the public
availability of information obtained by the Commission); 5 U.S.C.
552 et seq. (Freedom of Information Act--``FOIA''). See also
paragraph (d)(1) of proposed new Rule 18a-1(d). FOIA provides at
least two pertinent exemptions under which the Commission has
authority to withhold certain information. FOIA Exemption 4 provides
an exemption for ``trade secrets and commercial or financial
information obtained from a person and privileged or confidential.''
5 U.S.C. 552(b)(4). FOIA Exemption 8 provides an exemption for
matters that are ``contained in or related to examination,
operating, or condition reports prepared by, on behalf of, or for
the use of an agency responsible for the regulation or supervision
of financial institutions.'' 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------

G. Retention Period for Recordkeeping Requirements

    ANC broker-dealers are required to preserve for a period of not
less than three years, the first two years in an easily accessible
place, certain records required under Rule 15c3-4 and certain records
under Appendix E to Rule 15c3-1.\925\ Rule 17a-4 specifies the required
retention periods for a broker-dealer.\926\ Many of a broker-dealer's
records must be retained for three years; certain other records must be
retained for longer periods.\927\
---------------------------------------------------------------------------

    \925\ See 17 CFR 17a-4(b)(9), (10), and (12).
    \926\ 17 CFR 240.17a-4.
    \927\ Id.
---------------------------------------------------------------------------

    As noted above, the recordkeeping burdens with respect to some
requirements in proposed new Rules 18a-1 through 18a-4 will be
addressed in the SBSD and MSBSP recordkeeping requirements, which will
the subject of a separate release.

H. Request for Comment

    Pursuant to 44 U.S.C. 3306(c)(2)(B), the Commission requests
comment on the proposed collections of information in order to:
     Evaluate whether the proposed collections of information
are necessary for the proper performance of the functions of the
Commission, including whether the information would have practical
utility;
     Evaluate the accuracy of the Commission's estimates of the
burden of the proposed collections of information;
     Determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected; and
     Evaluate whether there are ways to minimize the burden of
the collection of information on those who respond, including through
the use of automated collection techniques or other forms of
information technology.

Persons submitting comments on the collection of information
requirements should direct their comments to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
DC 20503, and should also send a copy of their comments to Elizabeth M.
Murphy, Secretary, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-1090, and refer to File No. S7-08-12. OMB is
required to make a decision concerning the collections of information
between 30 and 60 days after publication of this document in the
Federal Register; therefore, comments to OMB are best assured of having
full effect if OMB receives them within 30 days of this publication.
Requests for the materials submitted to OMB by the Commission with
regard to these collections of information should be in writing, refer
to File No. S7-08-12, and be submitted to the Securities and Exchange
Commission, Records Management, Office of Filings and Information
Services, 100 F Street NE., Washington, DC 20549.

V. Economic Analysis

    The Commission is sensitive to the costs and benefits of its rules.
Some of these costs and benefits stem from statutory mandates, while
others are affected by the discretion exercised in implementing the
mandates. The following economic analysis seeks to identify and
consider the benefits and costs--including the effects on efficiency,
competition, and capital formation--that would result from the proposed
capital, margin, and segregation rules for SBSDs and MSBSPs and from
the proposed amendments to Rule 15c3-1. The costs and benefits
considered in proposing these new rules and amendments are discussed
below and have informed the policy choices described throughout this
release.

    The Commission discusses below a baseline against which the rules
may be evaluated. For the purposes of this economic analysis, the
baseline is the OTC derivatives markets as they exist today prior to
the effectiveness of the statutory and regulatory provisions that will
govern these markets in the future pursuant to the Dodd-Frank Act. With
respect to the proposed amendments to Rule 15c3-1, the baseline for
purposes of this economic analysis is the current capital regime for
broker-dealers under Rule 15c3-1.\928\
---------------------------------------------------------------------------

    \928\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

    While the Commission does not have comprehensive information on the
U.S. OTC derivatives markets, the Commission is using the limited data
currently available in considering in this economic analysis the
effects of the proposals, including their intended benefits and
anticipated possible costs.\929\ Additionally, the Commission requests
that commenters identify sources of data and information as well as
provide data and information to assist the Commission in analyzing the
economic consequences of the proposed rules. More generally, the
Commission requests comment on all aspects of this initial economic
analysis, including on whether the analysis has: (1) Identified all
benefits and costs, including all effects on efficiency, competition,
and capital formation; (2) given due consideration to each benefit and
cost, including each effect on efficiency, competition, and capital
formation; and (3) identified and considered reasonable alternatives to
the proposed new rules and rule amendments.
---------------------------------------------------------------------------

    \929\ Information that is available for the purposes of this
economic analysis includes an analysis of the market for single-name
credit default swaps performed by the Commission's Division of Risk,
Strategy, and Financial Innovation. See CDS Data Analysis.
---------------------------------------------------------------------------

    If these proposed rules and rule amendments are adopted, their
benefits and costs would affect competition, efficiency, and capital
formation in the security-based swap market broadly, with the impact
not being limited to SBSDs and MSBSPs. Section 3(f) of the Exchange Act
provides that whenever the Commission engages in rulemaking under the
Exchange Act and is required to consider or determine whether an action
is necessary or appropriate in the public interest, the Commission
shall also consider, in addition to the protection of investors,
whether the action will promote efficiency, competition, and capital
formation.\930\ In addition, section 23(a)(2) of the Exchange Act
requires the Commission, when adopting rules under the Exchange Act, to
consider the effect such rules would have on competition.\931\ Section
23(a)(2) of the Exchange Act also prohibits the Commission from
adopting any rule that would impose a burden on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.\932\
---------------------------------------------------------------------------

    \930\ 15 U.S.C. 78c(f).
    \931\ 15 U.S.C. 78w(a)(2).
    \932\ Id.
---------------------------------------------------------------------------

    As discussed more fully in section II. above, the Commission is
proposing: (1) Rules 18a-1 and 18a-2, and amendments to Rule 15c3-1, to
establish capital requirements for nonbank SBSDs and nonbank MSBSPs;
(2) Rule 18a-3 to establish customer margin requirements applicable to
nonbank SBSDs and nonbank MSBSPs for non-cleared security-based swaps;
and (3) Rule 18a-4 to establish segregation requirements for SBSDs and
notification requirements with respect to segregation for SBSDs and
MSBSPs.\933\ Some of the proposed amendments to Rule 15c3-1 would apply
to broker-dealers that are not registered as SBSDs or MSBSPs to the
extent that they hold positions in security-based swaps and swaps. The
Commission also is proposing to amend Rule 15c3-1 to increase the
minimum capital requirements for ANC broker-dealers. Finally, the
Commission is proposing a liquidity requirement for ANC broker-dealers
and for nonbank stand-alone SBSDs that use internal models to compute
net capital.
---------------------------------------------------------------------------

    \933\ The Commission is also proposing a conforming amendment to
Rule 15c3-3 to clarify that broker-dealer SBSDs must comply with
Rule 15c3-3 and Rule 18a-4, as applicable.
---------------------------------------------------------------------------

    The sections below present an overview of the OTC derivatives
markets, a discussion of the general costs and benefits of the proposed
financial responsibility requirements, and a discussion of the costs
and benefits of each proposed amendment and new rule. The sections that
follow also incorporate a consideration of the potential effects of the
proposed amendments and new rules on competition, efficiency, and
capital formation.

A. Baseline of Economic Analysis

1. Overview of the OTC Derivatives Markets--Baseline for Proposed Rules
18a-1 Through 18a-4
    As stated above, to assess the costs and benefits of these rules, a
baseline must be established against which the rules may be evaluated.
For the purposes of this economic analysis, the baseline is the OTC
derivatives markets \934\ as they exist today prior to the
effectiveness of the statutory and regulatory provisions that will
govern these markets in the future pursuant to the Dodd-Frank Act.\935\
The markets as they exist today are dominated, both globally and
domestically, by a small number of firms, generally entities affiliated
with or within large commercial banks.\936\
---------------------------------------------------------------------------

    \934\ OTC derivatives may include forwards, swaps and options on
foreign exchange, and interest rate, equity and commodity
derivatives.
    \935\ The baseline, however, for amendments to Rule 15c3-1 is
the current financial responsibility regime for broker-dealers under
this rule.
    \936\ See, e.g., ISDA Margin Survey 2012.
---------------------------------------------------------------------------

    The OTC derivatives markets have been described as opaque because,
for example, transaction-level data about OTC derivatives trading
generally is not publicly available.\937\ This economic analysis is
supported, where possible, by data currently available to the
Commission from The Depository Trust & Clearing Corporation Trade
Information Warehouse (``DTCC-TIW''). This evaluation takes into
account data regarding the security-based swap market and especially
data regarding the activity--including activity that may be suggestive
of dealing behavior--of participants in the single-name credit default
swap market.\938\ While a large segment of the security-based swap
market is comprised of single-name credit default swaps, these
derivatives do not comprise the entire security-based swap market.\939\
Moreover, credit

default swaps are a small percentage of the overall OTC derivatives
market, which, in addition to security-based swaps, includes foreign
currency swaps and interest rate swaps.
---------------------------------------------------------------------------

    \937\ See Orice M. Williams, GAO, Systemic Risk: Regulatory
Oversight and Recent Initiatives to Address Risk Posed by Credit
Default Swaps at 2, 5, 27. See also Robert E. Litan, The Brookings
Institution, The Derivatives Dealers' Club and Derivatives Market
Reform: A Guide for Policy Makers, Citizens and Other Interested
Parties 15-20 (Apr. 7, 2010), available at http://www.brookings.edu/
~/media/research/files/papers/2010/4/07%20derivatives%20litan/0407--
derivatives--litan.pdf; Security-Based Swap Data Repository
Registration, Duties, and Core Principles, Exchange Act Release No.
63347 (Nov. 19, 2010), 75 FR 77306, 77354 (Dec. 10, 2010); IOSCO,
The Credit Default Swap Market, Report FR05/12, (June 2012),
available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD385.pdf
(stating although the amount of public information on CDS has
increased over recent years, the CDS market is still quite opaque).
    \938\ The CDS Data Analysis provides reasonably comprehensive
information regarding the credit default swap activities and
positions of U.S. market participants, but the Commission notes that
the data does not encompass those credit default swaps that both:
(i) Do not involve U.S. counterparties; and (ii) are based on non-
U.S. reference entities. Reliance on this data should not be
interpreted to indicate our views as to the nature or extent of the
application of Title VII to non-U.S. persons; instead, it is
anticipated that issues regarding the extraterritorial application
of Title VII will be addressed in a separate release.
    \939\ In addition, it is reasonable to believe that the
implementation of Title VII itself will change the security-based
swap market, and, with the full implementation of Title VII--which
in part is conditioned on the implementation of the proposed
financial responsibility program--more information will be available
for this analysis.
---------------------------------------------------------------------------

    Available information about the global OTC derivatives markets
suggests that swap transactions, in contrast to security-based swap
transactions, dominate trading activities, notional amounts, and market
values.\940\ For example, the BIS estimates that the total notional
amounts outstanding and gross market value of global OTC derivatives
were over $648 trillion and $27.2 trillion, respectively, as of the end
of 2011.\941\ Of these totals, the BIS estimates that foreign exchange
contracts, interest rate contracts, and commodity contracts comprised
approximately 88% of the total notional amount and 84% of the gross
market value.\942\ Credit default swaps, including index credit default
swaps, comprised approximately 4.4% of the total notional amount and
5.8% of the gross market value. Equity-linked contracts, including
forwards, swaps and options, comprised approximately an additional 1.0%
of the total notional amount and 2.5% of the gross market value.\943\
---------------------------------------------------------------------------

    \940\ See BIS, Statistical Release: OTC derivatives statistics
at end-December 2011, 5 (May 2012), available at http://www.bis.org/publ/otc_hy1205.pdf (reflecting data reported by central banks in
14 countries: Belgium, Canada, France, Germany, England, Italy,
Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, the
United States, Australia, and Spain).
    \941\ Id. at 12 (``Nominal or notional amounts outstanding are
defined as the gross nominal or notional value of all deals
concluded and not yet settled on the reporting date * * * Gross
market values are defined as the sums of the absolute values of all
open contracts with either positive or negative replacement values
evaluated at market prices prevailing on the reporting date * * *
gross market values supply information about the potential scale of
market risk in derivatives transactions. Furthermore, gross market
value at current market prices provides a measure of economic
significance that is readily comparable across markets and
products.'').
    \942\ Id.
    \943\ Id. Similarly, the OCC has found that interest rate
products comprised 81% of the total notional amount of OTC
derivatives held by bank dealers whereas credit derivative contracts
comprised 6.4% and equity contracts comprised 1% of that notional
amount. See OCC, Quarterly Report on Bank Trading and Derivatives
Activities, Fourth Quarter 2011, available at http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf.
---------------------------------------------------------------------------

    Because the financial responsibility program for SBSDs and MSBSPs
would apply to dealers and participants in the security-based swap
markets, they are expected to affect a substantially smaller portion of
the U.S. OTC derivatives markets than the proposed financial
responsibility rules for swap dealers and major swap participants
proposed by the CFTC and prudential regulators.\944\ In addition,
though the proposed capital, segregation and margin rules apply to all
security-based swaps, not just single-name credit default swaps, the
data on single-name credit default swaps are currently sufficiently
representative of the market to help inform this economic analysis
because currently an estimated 95% of all security-based swap
transactions appear likely to be single-name credit default swaps.\945\
The majority of these single-name credit default swaps, both in terms
of aggregate total notional amount and total volume by product type,
are based on corporate and sovereign reference entities.\946\
---------------------------------------------------------------------------

    \944\ See CFTC Margin Proposing Release, 76 FR 27802; Prudential
Regulator Margin and Capital Proposing Release, 76 FR 27564.
    \945\ See Entity Definitions Adopting Release, 77 FR at 30636.
See also Product Definitions Adopting Release, 77 FR 48205 (defining
the term security-based swap).
    \946\ Data compiled by the Commission's Division of Risk,
Strategy, and Financial Innovation on credit default transactions
from the DTCC-TIW between January 1, 2011 and December 31, 2011.
---------------------------------------------------------------------------

    While the number of transactions is larger in single-name credit
default swaps than in index credit default swaps, the aggregate total
notional amount of the latter exceeds that of single-name credit
default swaps.\947\ For example, the total aggregate notional amount
for single-name credit default swaps was $6.2 trillion, while the
aggregate total notional amount for index credit default swaps was
$16.8 trillion over the sample period of January 1, 2011 to December
31, 2011. For the same sample period, however, single-name credit
default swaps totaled 69% of transactional volume, while index credit
default swaps comprised 31% of the total transactional volume.\948\ The
majority of trades in both notional amount and volume for both single-
name and index credit default swaps over the 2011 sample period were
new trades in contrast to assignments, increases, terminations or
exits.\949\ The analysis of the 2011 data further shows that by total
notional amount and total volume the majority of single-name and index
credit default contracts have a tenor of 5 years.\950\ In addition, the
data from the sample period indicates that the geographical
distribution of counterparties' parent country domiciles in single name
contracts are concentrated in the United States, United Kingdom, and
Switzerland.\951\
---------------------------------------------------------------------------

    \947\ Id. This data also shows the average mean and median
single-name and index credit default swap notional transaction size
in millions is 6.47 and 4.12, and 39.22 and 14.25, respectively.
    \948\ Id.
    \949\ Id.
    \950\ Id.
    \951\ Id.
---------------------------------------------------------------------------

    As described more fully in the CDS Data Analysis,\952\ based on
2011 transaction data, Commission staff identified entities currently
transacting in the credit default swap market that may register as
SBSDs by analyzing various criteria of their dealing activity. The
results suggest that there is currently a high degree of concentration
of potential dealing activity in the single-name credit default swap
market. For example, using the criterion that dealers are likely to
transact with many counterparties who themselves are not dealers, the
analysis of the 2011 data show that only 28 out of 1,084 market
participants have three or more counterparties that themselves are not
recognized as dealers by ISDA.\953\ In addition, the analysis suggests
that dealers appear, based on the percentage of trades between buyer
and seller principals, in the majority of all trades on either one or
both sides in single-name and index credit default swaps.\954\
---------------------------------------------------------------------------

    \952\ See CDS Data Analysis.
    \953\ Id. at Table 3c. The analysis of this transaction data is
imperfect as a tool for identifying dealing activity, given that the
presence or absence of dealing activity ultimately turns upon the
relevant facts and circumstances of an entity's security-based swap
transactions, as informed by the dealer-trader distinction. Criteria
based on the number of an entity's counterparties that are not
recognized as dealers nonetheless appear to be useful for
identifying apparent dealing activity in the absence of full
analysis of the relevant facts and circumstances, given that
engaging in security-based swap transactions with non-dealers would
be consistent with the conduct of seeking to profit by providing
liquidity to others, as anticipated by the dealer-trader
distinction.
    \954\ Data compiled by the Commission's Division of Risk,
Strategy, and Financial Innovation on credit default transactions
from the DTCC-TIW between January 1, 2011 and December 31, 2011.
Additionally, according to the OCC, at the end of the first quarter
of 2012, derivatives activity in the U.S. banking system continues
to be dominated by a small group of large financial institutions.
Four large commercial banks represent 93% of the total banking
industry notional amounts and 81% of industry net current credit
exposure. See OCC, Quarterly Report on Bank Trading and Derivatives
Activities, First Quarter 2012, available at http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq112.pdf.
---------------------------------------------------------------------------

    This concentration to a large extent appears to reflect the fact
that those larger entities are well-capitalized and therefore possess
competitive advantages in engaging in OTC security-based swap dealing
activities by providing potential counterparties with adequate
assurances of financial performance.\955\ As such, it is

reasonable to conclude that currently there likely are high barriers to
entry in terms of capitalization in connection with security-based swap
dealing activity.\956\
---------------------------------------------------------------------------

    \955\ See, e.g., Craig Pirrong, Rocket Science, Default Risk and
The Organization of Derivatives Markets, Working Paper 17-18 (2006),
available at http://www.cba.uh.edu/spirrong/Derivorg1.pdf (noting
that counterparties seek to reduce risk of default by engaging in
credit derivative transactions with well-capitalized firms). See
also Entity Definitions Adopting Release, 77 FR at 30739-30742.
    \956\ See id. at 18-19 (noting lack of success among new
entrants into derivatives dealing market due to perception that AAA
rating for subsidiary is less desirable than a slightly lower rating
for a larger entity, and suggesting that there are ``economies of
scale in bearing default risk'' that may induce ``substantial
concentration in dealer activities''). See also Entity Definitions
Adopting Release, 77 FR at 30739-30742.
---------------------------------------------------------------------------

    Other than OTC derivatives dealers, which are subject to
significant limitations on their activities, broker-dealers
historically have not participated in a significant way in security-
based swap trading for at least two reasons. First, because the
Exchange Act has not previously defined security-based swaps as
``securities,'' they have not been required to be traded through
registered broker-dealers.\957\ And second, a broker-dealer engaging in
security-based swap activities is currently subject to existing
regulatory requirements with respect to those activities, including
capital, margin, segregation, and recordkeeping requirements.
Specifically, the existing broker-dealer capital requirements make it
relatively costly to conduct these activities in broker-dealers, as
discussed in section II.A.2. of this release. As a result, security-
based swap activities are currently mostly concentrated in entities
that are affiliated with the parent companies of broker-dealers, but
not in broker-dealers themselves.\958\
---------------------------------------------------------------------------

    \957\ See definition of ``security'' in section 3(a)(10) of the
Exchange Act and ``security-based swap'' in section 3(a)(68) of the
Exchange Act.
    \958\ See ISDA Margin Survey 2012.
---------------------------------------------------------------------------

    End users enter into OTC derivatives transactions to take
investment positions or to hedge commercial and financial risk. These
non-dealer end users of OTC derivatives are, for example, commercial
companies, governmental entities, financial institutions, investment
vehicles, and individuals. Available data suggests that the largest end
users of credit default swaps are, in descending order, hedge funds,
asset managers, and banks, which may have a commercial need to hedge
their credit exposures to a wide variety of entities or may take an
active view on credit risk.\959\ Based on the available data, the
Commission further estimates that commercial end users currently
participate in the security-based swap markets on a very limited
basis.\960\
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    \959\ This information is based on available market data from
DTCC-TIW compiled by the Commission's Division of Risk, Strategy,
and Financial Innovation. For example, data compiled by the
Commission's Division of Risk, Strategy, and Financial Innovation on
credit default transactions from the DTCC-TIW between January 1,
2011 and December 31, 2011 suggests that for single-name credit
default swap transactions, dealer to dealer transactions composed
68.26% of trades between buyer and seller principals over the sample
period.
    \960\ For example, data compiled by the Commission's Division of
Risk, Strategy, and Financial Innovation on credit default
transactions from the DTCC-TIW between January 1, 2011 and December
31, 2011 suggest that the total percentage of trades between buyer
and seller principals over the sample period for single-name credit
default swaps was only 0.03% of the total trade counterparty
distribution for non-financial end users, which are composed of non-
financial companies and family trusts.
---------------------------------------------------------------------------

    Finally, this baseline for proposed new Rules 18a-1 through 18a-4
will be further discussed in the applicable sections of the release
below.
Request for Comment
    The Commission generally requests comment about its preliminary
estimates of the scale and composition of the OTC derivatives market,
including the relative size of the security-based swap segment of that
market. In addition, the Commission requests that commenters provide
data and sources of data to quantify:
    1. The average daily and annual volume of OTC derivatives
transactions;
    2. The volume of transactions in each class of OTC derivatives
(e.g., interest rate swaps, index credit default swaps, single-name
credit default swaps, currency swaps, commodity swaps, and equity-based
swaps);
    3. The total notional amount of all pending swap transactions;
    4. The total current exposure of all pending swap transactions;
    5. The total notional amount of all pending security-based swap
transactions;
    6. The total current exposure of all pending security-based swap
transactions;
    7. The types and numbers of dealers in OTC derivatives (e.g.,
banks, broker-dealers, unregulated entities);
    8. The capital levels of dealers, particularly those not subject to
regulatory capital requirements;
    9. The types and numbers of dealers in OTC derivatives dealers that
engage in both a swap and security-based swap business;
    10. The types and numbers of dealers in OTC derivatives that engage
only in a swap business;
    11. The types and numbers of dealers in OTC derivatives that engage
only in a security-based swaps business;
    12. The classes of end users (e.g., commercial end users, financial
end users, and others) and the number of end users in each class;
    13. The types of OTC derivatives transactions that each class of
end user commonly engages in;
    14. The amount of assets posted for OTC derivatives to
collateralize current exposure;
    15. The amount of assets posted for OTC derivatives to
collateralize potential future exposure;
    16. The type of assets used as collateral; and
    17. The amount of assets that are held under the different types of
collateral arrangements (e.g., held by the dealer but not segregated,
held by the dealer in omnibus segregation, held by a third-party
custodian).
2. Baseline for Amendments to Rule 15c3-1
    As discussed in more detail above, the Commission is proposing
amendments to Rule 15c3-1.\961\ These amendments would establish
minimum net capital requirements for broker-dealers that register as
SBSDs, increase the minimum net capital requirements for ANC broker-
dealers, narrow the current treatment of credit risk charges for ANC
broker-dealers to apply only to uncollateralized receivables from
commercial end users arising from security-based swaps, and establish
liquidity requirements for ANC broker-dealers and nonbank SBSDs using
internal models. Some of those proposed amendments to Rule 15c3-1 would
also apply to broker-dealers not registering as SBSDs or MSBSPs to the
extent they hold security-based swap positions or non-security-based
swap positions.
---------------------------------------------------------------------------

    \961\ See section II.B. of this release.
---------------------------------------------------------------------------

    As discussed in section II.A.1. of this release, the existing
broker-dealer capital requirements are contained in Rule 15c3-1 \962\
and seven appendices to Rule 15c3-1.\963\ The baseline for this
economic analysis with respect to the proposed amendments to Rule 15c3-
1 is

the broker-dealer capital regime as it exists today.
---------------------------------------------------------------------------

    \962\ 17 CFR 240.15c3-1.
    \963\ 17 CFR 240.15c3-1a (Options); 17 CFR 240.15c3-1b
(Adjustments to net worth and aggregate indebtedness for certain
commodities transactions); 17 CFR 240.15c3-1c (Consolidated
computations of net capital and aggregate indebtedness for certain
subsidiaries and affiliates; 17 CFR 240.15c3-1d (Satisfactory
subordination agreements); 17 CFR 240.15c3-1e (Deductions for market
and credit risk for certain brokers or dealers); 17 CFR 240.15c3-1f
(Optional market and credit risk requirements for OTC derivatives
dealers); 17 CFR 240.15c3-1g (Conditions for ultimate holding
companies of certain brokers or dealers).
---------------------------------------------------------------------------

    Specifically, current Rule 15c3-1 requires broker-dealers to
maintain a minimum level of net capital (meaning highly liquid capital)
at all times.\964\ The rule requires that a broker-dealer perform two
calculations: (1) A computation of the minimum amount of net capital
the broker-dealer must maintain; \965\ and (2) a computation of the
amount of net capital the broker-dealer is maintaining.\966\ The
minimum net capital requirement is the greater of a fixed-dollar amount
specified in the rule and an amount determined by applying one of two
financial ratios: the 15-to-1 aggregate indebtedness to net capital
ratio or the 2% of aggregate debit items ratio.\967\
---------------------------------------------------------------------------

    \964\ See 17 CFR 240.15c3-1.
    \965\ See 17 CFR 240.15c3-1(a).
    \966\ See 17 CFR 240.15c3-1(c)(2). The computation of net
capital is based on the definition of ``net capital'' in paragraph
(c)(2) of Rule 15c3-1. Id.
    \967\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    In computing net capital, the broker-dealer must, among other
things, make certain adjustments to net worth such as deducting
illiquid assets and taking other capital charges and adding qualifying
subordinated loans.\968\ ``Tentative net capital'' is defined as the
amount remaining after these deductions.\969\ The final step in
computing net capital is to deduct from the mark-to-market values of
the proprietary positions (e.g. in securities, money market
instruments, and commodities) that are included in its tentative net
capital prescribed percentages (``standardized haircuts'').\970\ The
standardized haircuts are designed to account for the market risk
inherent in these proprietary positions and to create a buffer of
liquidity to protect against other risks associated with the securities
business.\971\ With Commission approval, ANC broker-dealers and OTC
derivative dealers are permitted to calculate deductions for market
risk and credit risk from tentative net capital using internal models
in lieu of the standardized haircuts.\972\ Because the use of internal
models to compute net capital generally can substantially reduce the
deductions for proprietary positions compared to standardized haircuts
and only certain risks are addressed by these internal models, current
Rule 15c3-1 imposes substantially higher minimum capital requirements
for ANC broker-dealers and OTC derivatives dealers as compared to other
types of broker-dealers.\973\ For example, under current Rule 15c3-1,
ANC broker-dealers are required to at all times maintain tentative net
capital of not less than $1 billion and net capital of not less than
$500,000,\974\ and they are required to provide notice to the
Commission if their tentative net capital falls below $5 billion.\975\
The current rule requires that a broker-dealer must ensure that its net
capital exceeds its minimum net capital requirement at all times.\976\
---------------------------------------------------------------------------

    \968\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
    \969\ See 17 CFR 240.15c3-1(c)(15).
    \970\ See 17 CFR 240.15c3-1(c)(2)(vi).
    \971\ See, e.g., Uniform Net Capital Rule, 42 FR 31778
(``[Haircuts] are intended to enable net capital computations to
reflect the market risk inherent in the positioning of the
particular types of securities enumerated in [the rule]'').
    \972\ See 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR 240.15c3-
1e; 17 CFR 240.15c3-1f. As part of the application to use internal
models, an entity seeking to become an ANC broker-dealer or an OTC
derivatives dealer must identify the types of positions it intends
to include in its model calculation. See 17 CFR 240.15c3-
3e(a)(1)(iii); 17 CFR 240.15c3-1f(a)(1)(ii). After approval, the ANC
broker-dealer or OTC derivatives dealer must obtain Commission
approval to make a material change to the model, including a change
to the types of positions included in the model. See 17 CFR
240.15c3-1e(a)(8); 17 CFR 240.15c3-f(a)(3).
    \973\ See 17 CFR 240.15c3-1(a)(5) and (a)(7).
    \974\ 17 CFR 240.15c3-1(a)(7)(i).
    \975\ 17 CFR 240.15c3-1(a)(7)(ii).
    \976\ 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    Finally, the baseline of the current capital regime will be further
discussed in the applicable sections of the release below.

B. Analysis of the Proposals and Alternatives

1. Overview--The Proposed Financial Responsibility Program
    Generally, the financial responsibility requirements the Commission
is proposing today are intended to enhance the financial integrity of
SBSDs and MSBSPs. As discussed more fully below, in proposing these
requirements, the Commission is seeking to appropriately consider both
the potential benefits of minimizing the risk that the failure of one
firm will cause financial distress to other firms and disrupt financial
markets and the U.S. financial system and the potential costs to that
firm, the financial markets, and the U.S. financial system if SBSDs and
MSBPs are required to comply with overly restrictive capital, margin
and segregation requirements. This introductory section reviews at a
general level certain considerations regarding the economic analysis of
the proposed rules that is set forth in greater detail below.
    As discussed in section I. of the release, the current broker-
dealer financial responsibility requirements serve as the template for
the proposals for several reasons. First, the financial markets in
which SBSDs and MSBSPs are expected to operate are similar to the
financial markets in which broker-dealers operate in the sense that
they are driven in significant part by dealers that buy and sell on a
regular basis and that take principal risk. Second, like nonbank
dealers in securities but unlike bank SBSDs, nonbank SBSDs will not be
able to rely on a backstop provider of liquidity but rather need to be
able to liquidate assets quickly in the event of a counterparty
default. Third, the broker-dealer financial responsibility requirements
have existed for many years and have facilitated the prudent operation
of broker-dealers.\977\ Fourth, some broker-dealers likely will be
registered as nonbank SBSDs so as to be able to offer customers a
broader range of services than would be permitted as a stand-alone
SBSD. Therefore, establishing consistent financial responsibility
requirements would avoid potential competitive disparities between
stand-alone SBSDs and broker-dealer SBSDs. And fifth, by placing an
emphasis on maintaining liquid assets and requiring the segregation of
customer funds, the current broker-dealer financial responsibility
requirements have generally been successful in limiting losses to
customers due to broker-dealer defaults.\978\ Consequently, the current
broker-dealer financial responsibility requirements provide a
reasonable template for building a financial responsibility program for
SBSDs and MSBSPs.
---------------------------------------------------------------------------

    \977\ For example, one of the objectives of the broker-dealer
financial responsibility requirements is to protect customers from
the consequences of the financial failure of a broker-dealer in
terms of safeguarding customer securities and funds held by the
broker-dealer. In this regard, SIPC, since its inception in 1971,
has initiated customer protection proceedings for only 324 broker-
dealers, which is less than 1% of the approximately 39,200 broker-
dealers that have been members of SIPC during that timeframe. During
the same period, only $1.1 billion of the $117.5 billion of cash and
securities distributed for accounts of customers came from the SIPC
fund rather than debtors' estates. See SIPC 2011 Annual Report.
    \978\ For example, of the more than 625,200 claims satisfied in
completed or substantially completed cases since SIPC's inception in
1971, as of December 31, 2011, a total of 351 were for cash and
securities whose value was greater than the limits of protection
afforded by SIPA. The 351 claims, unchanged during 2011, represent
less than one-tenth of one percent of all claims satisfied. The
unsatisfied portion of claims, $47.2 million, is unchanged in 2011.
These remaining claims approximate three-tenths of one percent of
the total value of securities and cash distributed for accounts of
customers in those cases. See SIPC 2011 Annual Report. These figures
do not include the SIPA liquidations of Bernard L. Madoff Investment
Securities LLC and Lehman Brothers Inc., which are not complete.
---------------------------------------------------------------------------

    However, the Commission recognizes that there may be other
appropriate

approaches to establishing financial responsibility requirements--
including, for example, requirements based on the Basel Standard in the
case of entities that are part of a bank holding company, as has been
proposed by the CFTC.\979\ Generally, the bank capital model requires
the holding of specified levels of capital as a percentage of ``risk
weighted assets.'' \980\ In general, it does not require a full capital
deduction for unsecured receivables, given that banks, as lending
entities, are in the business of extending credit to a range of
counterparties.
---------------------------------------------------------------------------

    \979\ CFTC Capital Proposing Release, 76 FR 27802.
    \980\ The prudential regulators also have proposed capital rules
that would require a covered swap entity to comply with the
regulatory capital rules already made applicable to that covered
swap entity as part of its prudential regulatory regime. Prudential
Regulator Margin and Capital Proposing Release, 76 FR at 27568. The
prudential regulators note that they have ``had risk-based capital
rules in place for banks to address over-the-counter derivatives
since 1989 when the banking agencies implemented their risk-based
capital adequacy standards * * * based on the first Basel Accord.''
Id.
---------------------------------------------------------------------------

    This approach could promote a consistent view and management of
capital within a bank holding company structure. However, it would not
be a net liquid assets standard. In addition, applying capital rules
designed for banks to a non-bank entity would raise various practical
and policy issues that are not directly implicated by the proposed
approach. First, it would need to be clear whether a regulator with
primary responsibility for the non-bank entity would defer to bank
regulators with respect to the interpretation of Basel standards as
applied to the entity, or instead develop its own interpretation of
those standards. Further, it would need to be clear how trading and
other risks of the non-bank entity and its bank affiliate or affiliates
would be expected to be managed, whether such risks would be managed
holistically at the holding company level or separately at the entity
level, and what limitations, if any, would apply to transfers of risks
from a bank to its non-bank entity affiliate, or vice versa. In
addition, to the extent that bank capital standards would permit the
non-bank entity to hold more illiquid assets as regulatory capital, an
additional liquidity standard might be required at the entity level in
order to assure that the entity maintained sufficient liquidity to
support its trading activity. Similarly, if the non-bank entity were an
SBSD that held assets for customers, the impact of any reduced
liquidity associated with the application of bank capital standards on
the ability of the entity to quickly wind down operations and
distribute assets to customers would need to be considered. The
Commission specifically seeks comment as to whether to adapt Basel
capital standards to non-bank affiliates of banks, and how such a
regime would work in practice--including how it would address the
issues described above and similar challenges.
    The Commission also recognizes that in determining appropriate
financial responsibility requirements--whether based on current broker-
dealer rules or other alternative approaches described above--it must
assess and consider a number of different costs and benefits, and the
determinations it ultimately makes can have a variety of economic
consequences for the relevant firms, markets, and the financial system
as a whole. On the one hand, the capital and margin requirements in
particular are broadly intended to work in tandem to strengthen the
financial system by reducing the potential for default to an acceptable
level and limiting the amount of leverage that can be employed by SBSDs
and other market participants. Requiring particular firms to hold more
capital or exchange more margin may reduce the risk of default by one
or more market participants and reduce the amount of leverage employed
in the system generally, which in turn may have a number of important
benefits. The failure of an SBSD could result in immediate financial
loss to its counterparties or customers, particularly those that are
not able to avoid losses by liquidating collateral or those that have
delivered assets for custody by the SBSD. Since the primary benefit of
the capital and margin requirements is to reduce the probability of a
SBSD failure, potential counterparties may be more willing to transact
when they have greater assurance that they will be paid following a
credit event. Depending on the size of the SBSD and its
interconnectedness with other market participants, such a default also
could have adverse spillover or contagion effects that could create
instability for the financial markets more generally, such as limiting
the willingness of healthy market participants to extend credit to each
other, and thus substantially reduce liquidity and valuations for
particular types of financial instruments.\981\ Further, to the extent
that market participants generally perceive that the prudential
requirements are sufficient to protect them from losses due to a
counterparty's default, the security-based swap market may experience
increased trading activity, reduced transaction costs, improved
liquidity, enhanced capital formation, and an improved ability to
manage risk.
---------------------------------------------------------------------------

    \981\ See, e.g., Markus K. Brunnermeier and Lasse Heje Pedersen,
Market Liquidity and Funding Liquidity, Review of Financial Studies,
22 Review of Financial Studies 2201 (2009); Denis Gromb and Dimitri
Vayanos, A Model of Financial Market Liquidity Based on Intermediary
Capital, 8 Journal of the European Economic Association 456 (2010).
---------------------------------------------------------------------------

    On the other hand, as described below, higher financial
responsibility requirements for individual firms also give rise to
direct costs for the firms involved and potentially significant
collective costs for the markets and the financial system as a whole.
For example, overly restrictive requirements that increase the cost of
trading by individual firms could reduce their willingness to engage in
such trading, adversely affecting liquidity in the security-based swaps
markets and increasing transaction costs for market participants.
Similarly, capital requirements that are set high enough to limit or
restrict the willingness or ability of new firms to enter the market
may impair or reduce competition in the markets, which in turn could
also adversely affect liquidity and price discovery and increase
transaction costs. Any such reduction in liquidity or price discovery,
or increase in transaction costs, could adversely affect efficiency and
impose direct costs on those market participants who rely on security-
based swaps to manage or hedge the risks arising from their business
activities that may support or promote capital formation. Even if the
cost of overly restrictive financial responsibility requirements were
shouldered only by those market participants that are subject to them,
the excess amount of capital or margin tied up as a result of those
requirements would not be available for potentially more efficient
uses, which thereby could impair effective capital allocation and
formation.
    Although, in establishing appropriate financial responsibility
requirements that are neither insufficient nor excessive, the
Commission must seek to consider these and other potential benefits and
costs, the Commission notes that it is difficult to quantify such
benefits and costs. For example, although the adverse spillover effects
of defaults on liquidity and valuations were evident during the
financial crisis,\982\ it is difficult to quantify the

effects of measures intended to reduce the default probability of the
individual intermediary, the ensuing prevention of contagion, and the
adverse effects on liquidity and valuation. More broadly, it is
difficult to quantify the costs and benefits that may be associated
with steps to mitigate or avoid a future financial crisis. Similarly,
although capital, margin, or segregation requirements may, among other
things, affect liquidity and transaction costs in the security-based
swap markets, and result in a different allocation of capital than may
otherwise occur, it is difficult to quantify the extent of these
effects, or the resulting effect on the financial system more
generally.
---------------------------------------------------------------------------

    \982\ See aggregate derivatives claims on Lehman Brothers
Special Finance initially filed by the top 30 financial institution
counterparties was estimated to be approximately $22 billion,
available at http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1386611 and http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1430484.
---------------------------------------------------------------------------

    These difficulties are further aggravated by the fact that only
limited public data related to the security-based swap market, in
general, and to security-based swap market participants in particular,
exist, all of which could assist in quantifying certain benefits and
costs. It also is difficult to demonstrate empirically that the
customer protections associated with the proposed financial
responsibility requirements would alter the likelihood that any
specific market participant would suffer injury, or the degree to which
the participant would suffer injury, from participating in an under- or
over-regulated security-based swap market.
    In light of these challenges, much of the discussion of the
proposed rules in this economic analysis will remain qualitative in
nature, although where possible the economic analysis attempts to
quantify these benefits and costs. The inability to quantify these
benefits and costs, however, does not mean that the benefits and costs
of the proposals are any less significant. In addition, as noted above,
the proposed rules include a number of specific quantitative
requirements--such as numerical thresholds, limits, deductions and
ratios. The Commission recognizes that the specificity of each such
quantitative requirement could be read by some to imply a definitive
conclusion based on quantitative analysis of that requirement and its
alternatives. These quantitative requirements have not been derived
directly from econometric or mathematical models. Instead, they reflect
a preliminary assessment by the Commission, based on qualitative
analysis, regarding the appropriate financial standard for an
identified issue, drawing (as noted above) from the Commission's long-
term experience in administering its existing broker-dealer financial
responsibility regime as well as its general experience in regulating
broker-dealers and markets and from comparable quantitative
requirements in its own rules and those of other regulators.
Accordingly, the discussion generally describes in a qualitative way
the primary costs, benefits and other economic effects that the
Commission has identified and taken into account in developing these
specific quantitative requirements. The Commission emphasizes that it
invites comment, including relevant data and analysis, regarding all
aspects of the various quantitative requirements reflected in the
proposed rules.
    Finally, the Commission notes that the proposals ultimately
adopted, like other requirements under the Dodd-Frank Act, could have a
substantial impact on international commerce and the relative
competitive position of intermediaries operating in various, or
multiple, jurisdictions. U.S. or foreign firms could be advantaged or
disadvantaged depending on how the rules ultimately adopted by the
Commission compare with corresponding requirements in other
jurisdictions. Such differences could in turn affect cross-border
capital flows and the ability of global firms to most efficiently
allocate capital among legal entities to meet the demands of their
counterparties. The Commission intends to address the potential
international implications of the proposed capital, margin and
segregation requirements, together with the full spectrum of other
issues relating to the application of Title VII to cross-border
security-based swap transactions, in a separate proposal.
a. Nonbank SBSDs
    In addition to fulfilling a statutory requirement, it is expected
that the proposed capital, margin and segregation rules should be
beneficial to market participants by advancing market transparency,
risk reduction and counterparty protection as Title VII of the Dodd-
Frank Act intended.\983\ It can be further expected that these benefits
manifest themselves over the long-term and benefit the market as a
whole. To the extent that the proposed rules increase the safety and
soundness of entities that register as nonbank SBSDs and not just
codify current practice, the proposals should specifically reduce the
likelihood of default by an intermediary with substantial positions in
security-based swaps and possible negative spillover effects. This
would further imply that without the proposed rules in place, such an
event could result in significant losses to counterparties whose
exposures to the defaulting dealer are not sufficiently secured, which,
depending on the size of individual counterparty exposures, could lead
to defaults of those counterparties. Such events could then deter
intermediaries from entering into financing transactions,\984\ even
with creditworthy counterparties, which could ultimately adversely
affect valuation and liquidity in the broader financial markets.\985\
---------------------------------------------------------------------------

    \983\ See section I. of this release.
    \984\ See, e.g., Markus K. Brunnermeier and Lasse Heje Pedersen,
Market Liquidity and Funding Liquidity, Review of Financial Studies
at 22; Denis Gromb and Dimitri Vayanos, A Model of Financial Market
Liquidity Based on Intermediary Capital at 8.
    \985\ See aggregate derivatives claims on Lehman Brothers
Special Finance initially filed by the top 30 financial institution
counterparties was estimated to be approximately $22 billion,
available at http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1386611 and http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1430484.
---------------------------------------------------------------------------

    Apart from the positive impact on the safety and soundness of the
security-based swap market, the proposed new rules and rule amendments
could create the potential for regulatory arbitrage to the extent that
they differ from corresponding rules other regulators adopt. As noted
above in section I. of this release, the Commission is proposing
capital and margin requirements for nonbank SBSDs that differ in some
respects from the prudential regulators' proposed capital and margin
requirements for bank SBSDs.\986\ Depending on the final rules the
Commission adopts, the financial responsibility requirements could make
it more or less costly to conduct security-based swaps trading in banks
as compared to nonbank SBSDs. For example, if the application of the
proposed 8% margin risk factor substantially increases capital
requirements for nonbank SBSDs compared to the risk-based capital
requirements imposed by the prudential regulators on the same activity,
bank holding companies could be incentivized to conduct these
activities in their bank affiliates.\987\ On the other hand, if the
Commission does not require nonbank SBSDs to collect initial margin in
their transactions with each other, as is generally current market
practice,\988\ while the prudential regulators require the collection
of initial margin for the same trades as their proposed rules suggest,
intermediaries could have an incentive

to conduct business through nonbank entities.\989\ These differences
could create competitive inequalities and affect the allocation of
trading activities within a holding company structure.
    The proposed financial responsibility requirements for SBSDs would
also result in costs to individual market participants and may affect
the amount of capital available to support security-based swap
transactions generally.\990\ As described in section V.B.1 immediately
above, if SBSDs are required to maintain an excessive amount of
capital, that amount may result in certain costs for the markets and
the financial system, including the potential for the reduced
availability of security-based swaps for market participants who would
otherwise use such transactions to hedge the risks of their business,
or engage in other activities that would promote capital formation. In
addition, in some cases, these costs may include costs to financial
conglomerates to restructure their security-based swap activities or
move them into affiliates that register as SBSDs.\991\ Nonbank SBSDs as
well as other market participants would also incur costs to hire
compliance personnel and to establish internal systems, procedures and
controls designed to ensure compliance with the new requirements. Some
of these costs were discussed in the PRA analysis in section IV of this
release. Finally, the full cost impact of the proposed financial
responsibility requirements will depend to some extent on other rules
related to SBSDs (e.g., registration) that the Commission has not yet
adopted.\992\
---------------------------------------------------------------------------

    \986\ See section I. of this release.
    \987\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR 27564.
    \988\ See generally ISDA Margin Survey 2011.
    \989\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR 27564.
    \990\ See section II. of this release.
    \991\ See SBSD Registration Proposing Release, 76 FR 65784.
    \992\ Id.
---------------------------------------------------------------------------

    Costs related to specific sections of the proposed new rules and
rule amendments are discussed below. Some of these costs may be largely
fixed in nature; other costs (such as minimum capital requirements and
margin costs) may be variable as they reflect the level of the nonbank
SBSD's security-based swap activity. End users also may incur increased
transaction costs in connection with the proposals as SBSDs are likely
to pass on the financial burden of any increased capital, margin or
segregation requirements to customers.\993\
---------------------------------------------------------------------------

    \993\ If the rules succeed in improving competition among
dealers in the security-based swap market rules this pass-through
behavior should be less of a concern.
---------------------------------------------------------------------------

    This economic analysis considers the overall benefits and costs of
the proposed new rules and amendments, keeping in mind that the
benefits may be distributed across market participants, accrue over the
long-term, and are difficult to quantify or to measure as easily as
certain costs.
Request for Comment
    The Commission generally requests comment about its analysis of the
general costs and benefits of the proposed rules. The Commission
requests data to quantify and estimates of the costs and the value of
the benefits of the proposals described above. The Commission also
requests data to quantify the impact of the proposals against the
baseline. In addition, the Commission requests comment in response to
the following questions:
    1. In general terms, how effectively would the proposed rules limit
systemic risk arising from security-based swap transactions? Please
explain.
    2. In general, how would the proposed rules and rule amendments
impact the capital of entities that would need to register as nonbank
SBSDs? For example, would they require these entities to hold more
capital? If so, what would be the impact of the availability of sources
of funding to these entities?
    3. How important is parity of treatment between nonbank SBSDs and
bank SBSDs in terms of regulatory requirements, and how should parity
be understood? For example, should nonbank SBSDs and bank SBSDs be
required to hold the same amounts of capital to support a certain level
of security-based swaps business?
    4. To what extent would the proposed regulatory requirements impact
the amount of liquidity provided for or required by security-based swap
market participants, and to what extent will that affect the funding
cost for the financial sector in particular and the economy in general?
Please quantify.
b. Nonbank MSBSPs
    As with their application to nonbank SBSDs, in addition to
fulfilling a statutory requirement, it is expected that the proposed
capital, margin and notification requirements under the segregation
rules for MSBSPs will advance market transparency, risk reduction and
counterparty protection as Title VII of the Dodd-Frank Act
intended.\994\ However, in contrast to capital and margin requirements
for nonbank SBSDs, the proposed rules for nonbank MSBSPs are intended
to limit the impact on counterparties of a potential default by a
nonbank MSBSP, rather than to create prudential standards that would
render the possibility of its failure more remote. Capital standards of
the type that would apply to SBSDs \995\ may not be practical for
nonbank MSBSPs, depending on their individual business models and
whether they are subject to any other prudential requirements.
Accordingly, the proposals are intended to ensure that nonbank MSBSPs
meet a minimum capital standard by maintaining a positive tangible net
worth,\996\ collateralize their current exposures to end users, and
post collateral to counterparties that covers at least the amount of
the current exposure of those counterparties to them.\997\
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    \994\ See section I. of this release.
    \995\ See proposed new Rule 18a-1.
    \996\ See proposed new Rule 18a-2.
    \997\ See proposed new Rule 18a-3.
---------------------------------------------------------------------------

    These proposed requirements are expected to have a relatively
smaller aggregate effect than the proposed financial responsibility
requirements for nonbank SBSDs because they are likely to affect
relatively fewer entities. The Commission expects that only 5 or fewer
entities will register as nonbank MSBSPs with the Commission.\998\
Another approach, discussed further below, would subject MSBSPs to a
capital regime similar to that proposed for nonbank SBSDs.
---------------------------------------------------------------------------

    \998\ See section IV.C. of this release.
---------------------------------------------------------------------------

    The proposed financial responsibility requirements for MSBSPs would
also result in costs to individual market participants and may affect
the amount of capital available to support security-based swap
transactions overall and the financial markets generally. To the extent
that the proposed capital and margin requirements are too restrictive,
it could limit capital formation and the use of security-based swaps to
hedge risks associated with the MSBSP's business activities.\999\
---------------------------------------------------------------------------

    \999\ See section II. of this release.
---------------------------------------------------------------------------

    The proposed requirements may also impose more limited compliance
burdens on MSBSPs. For example, nonbank MSBSPs as well as other market
participants would also incur costs to hire compliance personnel and to
establish internal systems, procedures and controls designed to ensure
compliance with the new requirements.\1000\ Some of these costs are
discussed in the PRA analysis in section IV. of this release. Finally,
the full cost impact of the proposed financial responsibility
requirements will depend to some extent on other rules related to
MSBSPs (e.g., registration) that the Commission has not yet
adopted.\1001\
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    \1000\ See section V.C. of this release.
    \1001\ See SBSD Registration Proposing Release, 76 FR 65784.

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    Costs related to specific sections of the proposed new rules and
rule amendments are discussed below. Some of these costs may be largely
fixed in nature; other costs (such as minimum capital requirements and
margin costs) may be variable as they reflect the level of the nonbank
MSBSP's security-based swap activity.
Request for Comment
    The Commission generally requests comment about its analysis of the
general costs and benefits of the proposed rules on MSBSPs. The
Commission requests data to quantify and estimates of the costs and the
value of the benefits of the proposals for MSBSPs described above.
2. The Proposed Capital Rules
a. Nonbank SBSDs and ANC Broker-Dealers
    As discussed above in section II.A. of this release, proposed new
Rule 18a-1 would prescribe capital requirements for stand-alone SBSDs,
and proposed amendments to Rule 15c3-1 would prescribe capital
requirements for broker-dealer SBSDs and increase existing capital
requirements for ANC broker-dealers.\1002\ The proposed amendments to
Rule 15c3-1 would apply to broker-dealers that are not registered as
SBSDs to the extent they hold positions in security-based swaps and
swaps. In addition, the Commission is proposing liquidity requirements
for ANC broker-dealers and stand-alone SBSDs that use internal models
to compute net capital.\1003\ Finally, the Commission is proposing to
require that all nonbank SBSDs comply with Rule 15c3-4, which requires
the establishment of a risk management control system.\1004\
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    \1002\ See proposed new Rule 18a-1.
    \1003\ See proposed paragraph (f) to Rule 15c3-1; paragraph (f)
of proposed new Rule 18a-1.
    \1004\ See proposed new paragraph (a)(10)(ii) of Rule 15c3-1;
paragraph (g) of proposed new Rule 18a-1. See also 17 CFR 240.15c3-
4.
---------------------------------------------------------------------------

    As described above, the capital and other financial responsibility
requirements for broker-dealers generally provide a reasonable template
for crafting the corresponding requirements for nonbank SBSDs. For
example, among other considerations, the objectives of capital
standards for both types of entities are similar. Rule 15c3-1 is a net
liquid assets test that is designed to require a broker-dealer to
maintain sufficient liquid assets to meet all obligations to customers
and counterparties and have adequate additional resources to wind-down
its business in an orderly manner without the need for a formal
proceeding if it fails financially. The objective of the proposed
capital standards for nonbank SBSDs is the same.
    In addition, as discussed in section II.A.1. above, the Dodd-Frank
Act divided responsibility for SBSDs and MSBSPs by providing the
prudential regulators with authority to prescribe the capital and
margin requirements for bank SBSDs and the Commission with authority to
prescribe capital and margin requirements for nonbank SBSDs.\1005\ This
division also suggests it may be appropriate to model the capital
requirements for nonbank SBSDs on the capital standards for broker-
dealers, while the capital requirements for bank SBSDs are modeled on
capital standards for banks (as reflected in the proposal by the
prudential regulators).\1006\
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    \1005\ See 15 U.S.C. 78o-10, in general; 15 U.S.C. 78o-
10(e)(2)(A)-(B), in particular.
    \1006\ The prudential regulators have proposed capital
requirements for bank SBSDs and bank swap dealers that are based on
the capital requirements for banks. See Prudential Regulator Margin
and Capital Proposing Release, 76 FR at 27582.
---------------------------------------------------------------------------

    As discussed in section II.A.1. above, certain differences in the
activities of securities firms, banks, and commodities firms,
differences in the products at issue, or the balancing of relevant
policy choices and considerations, appear to support this distinction
between nonbank SBSDs and bank SBSDs. First, based on the Commission
staff's understanding of the activities of nonbank dealers in OTC
derivatives, nonbank SBSDs are expected to engage in a securities
business with respect to security-based swaps that is more similar to
the dealer activities of broker-dealers than to the activities of
banks; indeed, some broker-dealers likely will be registered as nonbank
SBSDs.\1007\ Second, existing capital standards for banks and broker-
dealers reflect, in part, differences in their funding models and
access to certain types of financial support, and those same
differences also will exist between bank SBSDs and nonbank SBSDs. For
example, banks obtain funding through customer deposits and can obtain
liquidity through the Federal Reserve's discount window; whereas
broker-dealers do not--and nonbank SBSDs will not--have access to these
sources of funding and liquidity. Third, Rule 15c3-1 currently contains
provisions designed to address dealing in OTC derivatives by broker-
dealers and, therefore, to some extent already can accommodate this
type of activity (although, as discussed below, proposed amendments to
Rule 15c3-1 would be designed to more specifically address the risks of
security-based swaps and the potential for increased involvement of
broker-dealers in the security-based swaps markets).\1008\ For these
reasons, the proposed capital standard for nonbank SBSDs is a net
liquid assets test modeled on the broker-dealer capital standard in
Rule 15c3-1.
---------------------------------------------------------------------------

    \1007\ Id.
    \1008\ See 17 CFR 240.15c3-1f and 17 CFR 240.15c3-1e. See also
Alternative Net Capital Requirements Adopting Release, 69 FR 34428;
OTC Derivatives Dealers, 63 FR 59362.
---------------------------------------------------------------------------

    The net liquid assets test is designed to allow a broker-dealer to
engage in activities that are part of conducting a securities business
(e.g., taking securities into inventory) but in a manner that places
the firm in the position of holding at all times more than one dollar
of highly liquid assets for each dollar of unsubordinated liabilities
(e.g., money owed to customers, counterparties, and creditors). For
example, Rule 15c3-1 allows securities positions to count as allowable
net capital, subject to standardized or internal model-based
haircuts.\1009\ The rule, however, does not permit most unsecured
receivables to count as allowable net capital.\1010\
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    \1009\ See 17 CFR 240.15c3-1(c)(2)(vi); 17 CFR 240.15c3-1e; 17
CFR 240.15c3-1f.
    \1010\ See 17 CFR 240.15c3-1(c)(2)(iv).
---------------------------------------------------------------------------

    This aspect of the rule severely limits the ability of broker-
dealers to engage in activities, such as unsecured lending, that
generate unsecured receivables. The rule also does not permit fixed
assets or other illiquid assets to count as allowable net capital,
which creates disincentives for broker-dealers to own real estate and
other fixed assets that cannot be readily converted into cash. For
these reasons, Rule 15c3-1 incentivizes broker-dealers to confine their
business activities and devote capital to activities such as
underwriting, market making, and advising on and facilitating customer
securities transactions.
    Proposed new Rule 18a-1 and the proposed amendments to Rule 15c3-1
would provide a number of benefits, as well as impose certain costs on
nonbank SBSDs, broker-dealer SBSDs, and broker-dealers, which are
described below. In considering costs, in cases where the Commission is
proposing amendments to Rule 15c3-1, the baseline is the current
broker-dealer capital regime under Rule 15c3-1.\1011\ The proposed rule
also will have possible effects on competition, efficiency, and capital
formation, which will be discussed further below.
---------------------------------------------------------------------------

    \1011\ 17 CFR 240.15c3-1.

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

i. Minimum Capital Requirements
    The following table provides a summary of the proposed minimum
capital requirements under the proposed new Rule 18a-1 and proposed
amendments to Rule 15c3-1:
[GRAPHIC] [TIFF OMITTED] TP23NO12.001

    Stand-alone SBSDs and broker-dealer SBSDs that are not approved to
use internal models, that is, are neither ANC broker-dealers nor OTC
derivatives dealers, would be required to maintain net capital of the
larger of $20 million or 8% of the firm's margin factor. The proposed
$20 million fixed-dollar minimum requirement would be consistent with
the fixed-dollar minimum requirement applicable to OTC derivatives
dealers and already familiar to existing market participants.\1012\ OTC
derivatives dealers are limited purpose broker-dealers that are
authorized to trade in certain derivatives, including security-based
swaps, use internal models to calculate net capital, and they are
required to maintain minimum tentative net capital of $100 million and
minimum net capital of $20 million.\1013\ These current fixed-dollar
minimums have been the minimum capital standards for OTC derivative
dealers for over a decade and to date, there have been no indications
that these minimums are not adequately meeting the objective of
requiring OTC derivatives dealers to maintain sufficient levels of
regulatory capital to account for the risks inherent in their
activities.
---------------------------------------------------------------------------

    \1012\ See 17 CFR 240.15c3-1(a)(5). The CFTC proposed a $20
million fixed-dollar minimum net capital requirement for FCMs that
are registered as swap dealers, regardless of whether the firm is
approved to use internal models to compute regulatory capital. See
CFTC Capital Proposing Release, 76 FR 27802. Further, the CFTC
proposed a $20 million fixed-dollar ``tangible net equity'' minimum
requirement for swap dealers and major swap participants that are
not FCMs and are not affiliated with a U.S. bank holding company.
Finally, the CFTC proposed a $20 million fixed-dollar Tier 1 capital
minimum requirement for swap dealers and major swap participants
that are not FCMs and are affiliated with a U.S. bank holding
company (the term ``Tier 1 capital'' refers to the regulatory
capital requirement for U.S. banking institutions). Id.
    \1013\ See 17 CFR 240.15c3-1(a)(5).
---------------------------------------------------------------------------

    However, the proposed $20 million fixed-dollar minimum requirement
for stand-alone SBSDs not using internal models to calculate net
capital would be substantially higher than the fixed-dollar minimums in
Rule 15c3-1 currently applicable to broker-dealers that do not use
internal models.\1014\ The proposed more stringent minimum capital
requirement of $20 million for stand-alone SBSDs not approved to use
models reflects the facts that these firms: (1) Unlike broker-dealers,
will be able to deal in security-based swaps, which, in general, pose
risks that are different from, and in some respects greater than, those
arising from dealing in securities; but (2) unlike OTC derivative
dealers have direct customer relationships and have custody of customer
funds.\1015\ Therefore, without the increased requirements, a failure
of a stand-alone SBSD would, ceteris paribus, be more likely than a
failure of an OTC derivatives dealer and, as a consequence of the
relationships with customers, would have a broader adverse impact on a
larger number of market participants, including customers and
counterparties.\1016\ Consequently, these heightened requirements
should enhance the safety and soundness of the nonbank SBSDs, and
thereby reduce systemic risk, as well as increase market participants'
confidence in the security-based swap markets. Stand-alone SBSDs not
approved to use internal models would not, however, be subject to a
minimum tentative net capital requirement, which is applied to only
firms that use internal models to account for risks not fully captured
by the models.\1017\
---------------------------------------------------------------------------

    \1014\ For example, a broker-dealer that carries customer
accounts has a fixed-dollar minimum requirement of $250,000; a
broker-dealer that does not carry customer accounts but engages in
proprietary securities trading (defined as more than ten trades a
year) has a fixed-dollar minimum requirement of $100,000; and a
broker-dealer that does not carry accounts for customers or
otherwise receive or hold securities and cash for customers, and
does not engage in proprietary trading activities, has a fixed-
dollar minimum requirement of $5,000. See 17 CFR 240.15c3-1(a)(2).
    \1015\ See 17 CFR 240.3b-12; 17 CFR 240.15a-1.
    \1016\ The proposal is consistent with the CFTC's proposed
capital requirements for nonbank swap dealers, which impose $20
million fixed-dollar minimum requirements regardless of whether the
firm is approved to use internal models to compute regulatory
capital. See CFTC Capital Proposing Release, 76 FR 27802.
    \1017\ OTC derivatives dealers are subject to a $100 million
minimum tentative net capital requirement. ANC broker-dealers are
currently subject to a $1 billion minimum tentative net capital
requirement. The minimum tentative net capital requirements are
designed to address risks that may not be captured when using
internal models rather than standardized haircuts to compute net
capital. See OTC Derivatives Dealers, 63 FR at 59384; Alternative
Net Capital Requirements for Broker-Dealers That Are Part of
Consolidated Supervised Entities; Proposed Rule, Exchange Act
Release No. 48690 (Oct. 24, 2003), 68 FR 62872, 62875 (Nov. 6,
2003).
---------------------------------------------------------------------------

    Stand-alone SBSDs using models would be required to maintain
minimum net capital of the higher of $20 million or the 8% margin
factor, as well as a minimum tentative net capital of $100 million, a
requirement that also applies to OTC derivatives dealers. Models to
calculate deductions from tentative net capital for proprietary
positions take only market and credit risk into account and therefore
generally lead to lower deductions and higher levels of net
capital.\1018\ The minimum

tentative net capital requirement for firms using models is intended to
provide an additional assurance of adequate capital to reflect this
concern.
---------------------------------------------------------------------------

    \1018\ See, e.g., Alternative Net Capital Requirements Adopting
Release, 69 FR at 34455 (describing benefits of alternative net
capital requirements for broker-dealers using models stating a
``major benefit for the broker-dealer will be lower deductions from
net capital for market and credit risk that we expect will result
from the use of the alternative method.''). Therefore, it is likely
that for new entrants to capture substantial volume in security-
based swaps they will need to use VaR models. See also OTC
Derivatives Dealer Release, 63 FR 59362 (discussing benefits of
minimum capital requirements as an additional measure of
protection).
---------------------------------------------------------------------------

    However, because the tentative net capital calculation does not
take account of market risk deductions, the minimum $100 million
tentative net capital requirement might be a less effective standard in
cases where a dealer maintains a substantial amount of less liquid
positions that require relatively large deductions for market risk. As
an alternative, the Commission could impose a minimum requirement that
increases according to the nature and size of the positions held, for
example, 25% of the market risk deductions that are required to be
taken in determining actual net capital. This approach could better
scale the tentative net capital requirement according to the risk of
the proprietary positions held by an SBSD. On the other hand, a
variable tentative net capital test would not serve as an accurate
measure of risk if the model did not appropriately capture all material
risks of the positions or the assumptions underlying the use of the
model were no longer appropriate. The variable tentative net capital
test also could increase the tentative net capital requirement in some
cases to a level that could limit or discourage the entry of firms that
do not presently compete in the security-based swap markets. Further,
as noted above, the minimum net capital requirement in each case would
increase in accordance with an increase in the amount of business
conducted as a result of the 8% margin factor. The Commission is
specifically seeking comment on this alternative in section II.A.1. of
this release.
    Under the proposed amendments to Rule 15c3-1, ANC broker-dealers
would be required to maintain: (1) Tentative net capital of not less
than $5 billion; and (2) net capital of not less than the greater of $1
billion or the financial ratio amount required pursuant to paragraph
(a)(1) of Rule 15c3-1 plus the 8% margin factor.\1019\ These relatively
high minimum capital requirements for ANC dealers (as compared with the
requirements for other types of broker-dealers) reflect the substantial
and diverse range of business activities engaged in by ANC broker-
dealers and their importance as intermediaries in the securities
markets.\1020\ Further, the heightened capital requirements reflect the
fact that, as noted above, VaR models are more risk sensitive but also
generally permit substantially reduced deductions to tentative net
capital as compared to the standardized haircuts as well as the fact
that VaR models may not capture all risks.\1021\
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    \1019\ See proposed amendments to paragraph (a)(7)(i) of Rule
15c3-1.
    \1020\ As noted above, the six ANC broker-dealers collectively
hold in excess of one trillion dollars' worth of customer
securities.
    \1021\ See Alternative Net Capital Requirements Adopting
Release, 69 FR 34428.
---------------------------------------------------------------------------

    Based on financial information reported by the ANC broker-dealers
in their monthly FOCUS Reports filed with the Commission, the six
current ANC broker-dealers maintain capital levels in excess of these
proposed increased minimum requirements. For example, at the end of
2011, the interquartile range of net capital and tentative net capital
levels among the six ANC broker-dealers were from $1.11 billion to
$7.77 billion and from $1.32 billion to $9.69 billion, respectively.
Further, ANC broker-dealers are currently required to notify the
Commission if their tentative net capital falls below $5 billion.\1022\
This notification provision is used by the Commission to trigger
increased supervision of the firm's operations and to take any
necessary corrective action and is similar to corollary ``early
warning'' requirements for OTC derivatives dealers.\1023\ Consequently,
this $5 billion ``early warning'' level currently acts as the de facto
minimum tentative net capital requirement since the ANC broker-dealers
seek to avoid providing this regulatory notice that their tentative net
capital has fallen below the early warning level.\1024\
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    \1022\ 17 CFR 240.15c3-1(a)(ii).
    \1023\ OTC derivatives dealers are required to provide
notification promptly (but within 24 hours) if their tentative net
capital falls below 120% of the firm's required minimum tentative
net capital amount. See 17 CFR 240.17a-11(c)(3). Rule 17a-11 also
requires ANC broker-dealers and OTC derivatives dealers to provide
same day notification if their tentative net capital falls below
required minimums. See 17 CFR 240.17a-11(b)(2).
    \1024\ See 17 CFR 240.15c3-1(a)(7)(i).
---------------------------------------------------------------------------

    Although increases to minimum tentative and minimum net capital
requirements are being proposed, the proposals may not present a
material cost to the current ANC broker-dealers, because they already
hold more than the proposed minimum requirements in the amendments to
Rule 15c3-1. The more relevant number is the proposed increase in the
early warning notification threshold from $5 billion to $6 billion. The
existing early warning requirement for OTC derivatives dealers triggers
a notice when the firm's tentative net capital falls below an amount
that is 120% of the firm's required minimum tentative net capital
amount of $100 million ($120 million = 1.2 x $100 million).\1025\ The
proposed new ``early warning'' threshold for ANC broker-dealers of $6
billion (= 1.2 x $5 billion) in tentative net capital is modeled on
this requirement. In general, because the amount of actual net capital
is subject to volatility commensurate with market volatility in
proprietary instruments, the Commission expects ANC broker-dealers to
maintain a reasonable cushion in excess of the minimum. Since, based on
the Commission staff's supervision of the ANC broker-dealers, the
current ANC broker-dealers report tentative net capital levels
generally well in excess of $6 billion, the costs to the ANC broker-
dealers to comply with this new requirement are not expected to be
material.\1026\ However, these costs may be prohibitive to new entrants
that wish to register as broker-dealer SBSDs using internal models if
they currently do not, or cannot, maintain these proposed capital
levels. As noted below, such barriers to entry may prevent or reduce
competition among SBSDs, which in turn can lead to higher transaction
costs and less liquidity than would otherwise exist.
---------------------------------------------------------------------------

    \1025\ See 17 CFR 240.17a-11(c)(3).
    \1026\ Id.
---------------------------------------------------------------------------

    In addition to the proposed minimum fixed tentative and minimum net
capital requirements, the proposed 8% margin factor would be part of
determining a nonbank SBSD's minimum net capital requirement.\1027\ The
8% margin factor is intended to establish a minimum capital requirement
that scales with the level of a nonbank SBSD's security-based swap
activity and to limit the amount of leverage a nonbank SBSD can employ
by requiring an increase in capital commensurate with the amount of
leverage extended.
---------------------------------------------------------------------------

    \1027\ Since the 8% margin factor would be additive to the
minimum capital requirements for ANC broker-dealers conducting a
security-based swap business, the cost impact to an ANC broker-
dealer using its current minimum capital requirements under Rule
15c3-1 and 15c3-1e as a baseline, would at minimum, increase by the
8% margin factor.
---------------------------------------------------------------------------

    The 8% margin factor ratio requirement also is similar to an
existing requirement in the CFTC's net capital rule for FCMs,\1028\ and
the CFTC has proposed a similar requirement for swap dealers and major
swap participants registered as FCMs.\1029\

Under the CFTC's proposal, an FCM would be required to maintain
adjusted net capital \1030\ that is equal to or greater than 8% of the
risk margin required for customer and non-customer exchange-traded
futures and swaps positions that are cleared by a DCO.\1031\ Because
exchange-traded futures, however, are generally more liquid and give
rise to lower margins than non-cleared security-based swaps with the
same notional amount, the proposed 8% margin factor (which includes
margin for both cleared and non-cleared swaps) would require allocating
substantially more capital to support a non-cleared security-based swap
contract compared to a futures contract. Requiring such additional
capital could impose the types of costs on these firms and the markets
more generally that are described above in section V.B.1. of this
release. On the other hand, applying the 8% margin factor to non-
cleared security-based swaps (rather than just cleared security-based
swaps) would permit the nonbank SBSD's minimum capital requirement to
vary based on this aspect of its business, which can entail similar
leverage and present greater credit risk than cleared security-based
swaps. This would have the benefit of further promoting the goals of
the financial responsibility rules described above in section V.B.1. of
this release.
---------------------------------------------------------------------------

    \1028\ See 17 CFR 1.17(a)(1)(i)(B).
    \1029\ See CFTC Capital Proposing Release, 76 FR 27802. The 8%
calculation under the CFTC's proposal relates to cleared swaps or
futures transactions, whereas the 8% margin factor proposed in new
Rule 18a-1 would be based on cleared and non-cleared security-based
swaps.
    \1030\ The CFTC has proposed that swap dealers and major swap
participants that are also FCMs would be required to meet the
existing FCM requirement to hold minimum levels of adjusted net
capital, and also would be required to calculate the required
minimum level as the greatest of the following: (1) A fixed dollar
amount which under the CFTC's proposed rules would be $20 million;
(2) the amount required for FCMs that also act as retail foreign
exchange dealers; (3) 8% of the proposed risk margin; (4) the amount
required by a registered futures association of which the FCM is a
member; or (4) for an FCM, that is also a broker-dealer, the amount
required by Commission rules. See CFTC Capital Proposing Release, 76
FR 27802.
    \1031\ See CFTC Capital Proposing Release, 76 FR 27802. The
CFTC's proposed 8% margin requirement is intended to establish a
minimum capital requirement that corresponds to the level of risk
arising from the FCM's swap activity. Id. at 27807. One commenter
objected to the inclusion of the 8% test in the CFTC's capital
proposal, noting that margin and capital are complementary concepts
in that both incorporate counterparty risk, and accordingly, the
higher the initial margin requirement for a particular swap, the
less regulatory capital a swap dealer should need to carry the
client's position. The commenter believed that the CFTC's 8% charge
would lead to allocations of dealer and client funding and capital
to client portfolios in amounts disproportionately large in
comparison to the risks of the relevant transactions. This commenter
recommended to the CFTC that the CFTC defer incorporating swaps into
the 8% margin multiplier for capital until after margin and capital
requirements are finalized and the CFTC and market participants have
had an opportunity to evaluate margin levels and the
interrelationship between swap margin and capital. Letter from John
M. Damgard, President, Futures Industry Association, Robert G.
Pickel, Chief Executive Officer, ISDA and Kenneth E. Bentsen, Jr.,
Executive Vice President, Public Policy and Advocacy, SIFMA, to the
CFTC (July 7, 2011) (``FIA/ISDA/SIFMA Comment Letter to the CFTC'').
---------------------------------------------------------------------------

    Based on FOCUS Report information as of year-end 2011,
approximately ten broker-dealers, including the current ANC broker-
dealers, maintain tentative net capital in excess of $5 billion,\1032\
approximately 31 broker-dealers maintain net capital in excess of $1
billion, approximately 145 broker-dealers maintain tentative net
capital in excess of $100 million, and approximately 270 broker-dealers
maintain net capital in excess of $20 million.
---------------------------------------------------------------------------

    \1032\ These 10 broker-dealers also maintain tentative net
capital in excess of $6.0 billion based on FOCUS Report information
as of year-end 2011.
---------------------------------------------------------------------------

    Although the proposed increase in minimum capital and early warning
requirements for ANC broker-dealers will not affect firms that already
have this classification, it would reduce the number of additional
firms (from 31 to 4, according to FOCUS Report data) that would
currently qualify for this designation and hence represents a
significant potential cost for additional registrants. As noted above,
these costs may be prohibitive to new entrants that wish to register as
ANC broker-dealer SBSDs using internal models. If these additional
costs were not imposed or were lower, there might be greater
opportunities for more competition in the security-based swap markets,
which in turn could lower transaction costs and increase liquidity in
these markets. However, setting capital levels that allow new entrants
that do not have sufficient capital to engage in the diverse business
of ANC broker dealers could be disruptive to the market. In addition,
to the extent that potential new entrants are able to operate
effectively in these markets as stand-alone SBSDs (i.e., swap dealers
that are not registered as broker-dealers), they would be eligible for
lower minimum capital requirements and competition could further
increase without compromising the heightened requirements for ANC
broker-dealers.
    With respect to the derivatives markets in particular, it is
difficult to quantify the impact of the proposed capital requirements
against the baseline of the OTC derivatives markets as they exist today
because prior to the adoption of Title VII, swaps and security-based
swaps were by and large unregulated.\1033\ As discussed above in
section V.A. of this release, however, most trading in security-based
swaps and other derivatives is currently conducted by large banks and
their affiliates. Among these entities are the current ANC broker-
dealers. Other broker-dealers affiliated with firms presently
conducting business in security-based swaps may be among the 270
broker-dealers that maintain net capital in excess of $20 million.
Consequently, broker-dealers presently trading in security-based swaps
may not need to raise significant new amounts of capital in order to
register as nonbank SBSDs. At the same time, the proposed minimum
capital requirements could discourage entry by entities other than the
approximately 270 broker-dealers that already have capital in excess of
the required minimums.
---------------------------------------------------------------------------

    \1033\ See Product Definitions Adopting Release, 77 FR 48207.
---------------------------------------------------------------------------

    As discussed above in section II.A.1. of this release, the
Commission is seeking comment on possible modifications to the capital
requirements in ways that may lessen potential compliance costs. First,
to the extent that a nonbank SBSD that is approved to use models may be
required to register as a broker-dealer solely to conduct certain
brokerage activity, e.g., sending customer orders for execution to a
security-based swap execution facility, the Commission could modify the
capital requirements by setting lower minimum capital requirements for
such firms than apply to ANC broker-dealers. Further, the requirements
for OTC derivatives dealers could be amended to allow these firms to
conduct a broader range of activities. This modification could increase
the ability of firms that are not capitalized at minimum capital
requirements proposed for the ANC firms to use models and compete for
business in security-based swaps.
    The Commission also could consider modifications that would
increase the flexibility for a broader group of firms to conduct a
derivatives business that extends beyond security-based swaps. For
example, the Commission could determine to allow a firm to register
jointly as an OTC derivatives dealer and SBSD. This modification could
allow the registrant to conduct a broader range of derivatives
activities than dealing only in security-based swaps, and to be able to
use internal models for capital purposes without being subject to much
higher capital requirements that apply to ANC broker-dealers. On the
other hand, there could be practical difficulties in merging the
registration regimes. For example, because OTC derivatives dealers are
prohibited from having custody of customers' assets, while nonbank
SBSDs would be

permitted to do so, subject to compliance with new Rule 18a-4, dual
registrants could be required to maintain separate sets of compliance
processes and procedures, based on product type.
    Alternatively, the Commission could provide conditional relief on a
case-by-case basis to allow a firm that is registered as an SBSD to
conduct dealing activity in derivatives other than security-based
swaps. This also could provide a means for an entity to do business in
a broad set of derivative instruments, subject to the basic capital
standards that would apply to SBSDs. This approach also could allow the
Commission to fashion exemptive relief on a case-by-case basis, pending
further consideration of how and whether to reconcile the SBSD and OTC
derivatives dealer regimes. On the other hand, allowing SBSDs to deal
in products that OTC derivatives dealers can deal in, without the
restrictions that apply to their activities, could undermine the
purpose for the restrictions. The Commission is specifically soliciting
comment on these potential approaches above in section II.A.1.
ii. Standardized Haircuts
    As discussed in section II.A.2.b.ii. of this release, under
proposed new Rule 18a-1 and the amendments to Rule 15c3-1, a nonbank
SBSD would be required to apply standardized haircuts to its
proprietary positions, unless the Commission approved it to use
internal models for specific positions. In general, all haircut regimes
are intended to be conservative estimates of risk as they tend to
overcompensate for the actual risks and hence generally impose higher
costs in terms of capital compared to VaR models.\1034\
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    \1034\ Commenters to the proposed CFTC capital rule for swap
dealers stated that they believe that model-based approaches are
generally superior to grid-based approaches. One commenter argued
that grid-based approaches are generally insufficiently risk
sensitive, are not part of integrated risk management systems, and
are hard to keep up-to-date to include innovative product and
trading strategies. FIA/ISDA/SIFMA Comment Letter to the CFTC. Grid-
based approaches, however, provide alternatives to firms that are
unable to or chose not to use models.
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    As discussed in section II.A.2.b.ii. of this release, for positions
that are not security-based swaps, broker-dealer SBSDs and stand-alone
SBSDs also would be required to apply the standardized haircuts
currently set forth in Rule 15c3-1.\1035\ Standardized ``haircuts'' for
credit default swaps would be based on a maturity grid approach.
Modeled after similar ``haircut'' approaches currently employed under
Rule 15c3-1, the proposed approach for credit default swaps is designed
to be more risk-sensitive than a haircut approach that determines
market deductions based on the type of each position without
recognizing offsets among securities with similar risk characteristics
(the proposed rules also permit firms to reduce the required haircut
for certain netted positions). The number of maturity and spread
categories in the proposed grid for credit default swaps is based on
staff experience with the maturity grids for other securities in Rule
15c3-1 and, in part, on FINRA Rule 4240.\1036\ While the haircut grid
design takes into account that positions in credit defaults swaps with
larger spreads or longer tenors are riskier and hence should be
supported by larger haircuts, the Commission is specifically seeking
comment on the design of the grid and particularly whether the haircuts
appropriately reflect the risk inherent in long and short positions of
credit defaults swaps across the spread and tenor spectrum.
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    \1035\ See 17 CFR 240.15c3-1(c)(2)(vi); paragraph (c)(1)(vii) of
proposed new Rule 18a-1. See also section II.A.2.b.vi. of this
release (discussing the treatment of swaps).
    \1036\ See Notice of Filing and Order Granting Accelerated
Approval of Proposed Rule Change to Amend FINRA Rule 4240 (Margin
Requirements for Credit Default Swaps), Exchange Act Release No.
66527 (Mar. 7, 2012) (File No. SR-FINRA-2012-015) (in which FINRA
amended the maturity grid in Rule 4240 in the interest of regulatory
clarity and efficiency, and based upon FINRA's experience in the
administration of the rule). While FINRA Rule 4240 is one reference
point, the maturity grid it specifies does not appear to have been
widely used by market participants, in part because a significant
amount of business in the current credit default swap market is
conducted by entities that are not members of FINRA.
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    Security-based swaps that are not credit default swaps can be
divided into two broad categories: Those that reference equity
securities and those that reference debt instruments. Since each type
of security-based swap can be viewed as being equivalent to a highly-
levered synthetic position in the referenced instrument and therefore
has the same price volatility as the referenced instrument, the
standardized haircut for these categories of security-based swaps would
be the deduction currently prescribed in Rule 15c3-1 applicable to the
instrument referenced by the security-based swap multiplied by the
contract's notional amount.\1037\ It is likely that a nonbank SBSD that
maintains substantial positions in such instruments would maintain
portfolios of multiple instruments in such categories with offsetting
long and short positions to hedge its risk.
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    \1037\ See proposed new paragraph (c)(2)(vi)(O)(2) of Rule 15c3-
1; paragraph (c)(1)(vi)(B) of proposed new Rule 18a-1. For example,
if a dealer maintained a position in a security-based swap with a
notional amount of $1 million that provided the dealer with long
exposure to a nonconvertible debt security maturing in 2\1/2\ years
(assuming no offsetting short positions), the dealer would look to
Rule 15c3-1(c)(2)(vi)(F) to find the applicable haircut percentage
(5%) and the firm would be required to take a capital deduction of
$50,000.
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    Under the Commission's proposed standardized haircuts for these
categories of security-based swaps, nonbank SBSDs would also be able to
recognize the offsets currently permitted under Rule 15c3-1.\1038\ In
particular, as discussed below, nonbank SBSDs would be permitted to
treat equity security-based swaps under the provisions of Appendix A to
Rule 15c3-1, which produces a single haircut for portfolios of equity
options and related positions.\1039\ This method would permit a nonbank
SBSD to compute deductions for a portfolio of equity security-based
swaps using a comprehensive risk perspective by accounting for the risk
of the entire portfolio, rather than the risk of each position within
the portfolio.\1040\ Appendix A provides a relatively less costly
mechanism for a nonbank SBSD to calculate haircuts (in contrast to the
standardized haircuts) since it is used for other equity derivatives
and generally may reduce haircuts for a nonbank SBSD by allowing a swap
referencing an equity security to be considered as part of a related
portfolio. This, in turn, may permit a nonbank SBSD to more efficiently
deploy this capital savings in other areas of its operations, as well
as enhance operational efficiencies.
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    \1038\ See proposed new paragraph (c)(2)(vi)(O)(2) of Rule 15c3-
1; paragraph (c)(1)(vi)(B) of proposed new Rule 18a-1.
    \1039\ See 17 CFR 240.15c3-1a; Appendix A to proposed new Rule
18a-1.
    \1040\ See section II.A.2.b.ii. of this release.
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    Similarly, nonbank SBSDs would be permitted to treat a debt
security-based swap in the same manner as debt instruments are treated
in the Rule 15c3-1 grids in terms of allowing offsets between long and
short positions where the instruments are in the same maturity
categories, subcategories, and in some cases, adjacent
categories.\1041\ Consequently, nonbank SBSDs could recognize the
offsets and hedges that those provisions permit to reduce the
deductions on portfolios of debt security-based swaps, and thereby
reduce their capital costs. This, in turn, may permit a nonbank SBSD to
more efficiently deploy this capital savings in other areas of its
operations.
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    \1041\ See 17 CFR 240.15c3-1(c)(2)(vi).
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    The proposed approaches, like other types of standardized haircuts,
likely will require a higher amount of capital to conduct security-
based swaps

business, in contrast to a VaR model. While the standardized haircuts
and proposed CDS grid recognize certain offsets, standardized haircuts
generally result in higher costs of capital because the standardized
approaches do not recognize other ways in which a nonbank SBSD may
mitigate its exposures, including unwinding unprofitable trades,
entering into certain hedges that would not be recognized under the
proposed capital rules, and portfolio diversification. The higher
amounts that may result from using the standardized haircut and a grid-
based approach \1042\ may be acceptable for nonbank SBSDs that
occasionally trade in security-based swaps but not in a substantial
enough volume to justify the initial and ongoing systems and personnel
costs to develop, implement, and monitor the performance of internal
models. On the other hand, firms that conduct a substantial business in
securities-based swaps in general will need to use the more cost-
efficient models to measure and manage the risks of their positions
over time.
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    \1042\ See section II.A.2.b.2. of this release.
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    The benefit of the standardized haircut approach of measuring
market risk, besides its inherent simplicity, is that it may reduce the
likelihood of default or failure by nonbank SBSDs that have not
demonstrated that they have the risk management capabilities, of which
VaR models are an integral part, or capital levels to support the use
of VaR models. Therefore, the standardized haircut approach, in turn,
may improve customer protections and reduce systemic risk. In addition,
a standardized haircut approach may reduce costs for the nonbank SBSD
related to the risk of failing to observe or correct a problem with the
use of VaR models that could adversely impact the firm's financial
condition, because the use of VaR models would require the allocation
by the nonbank SBSD of additional firm resources and personnel.
    Conversely, if the proposed standardized haircuts are too
conservative, they could make the conduct of security-based swaps
business too costly, preventing or impairing the ability of firms to
engage in security-based swaps, increasing transaction costs, reducing
liquidity, and reducing the availability of security-based swaps for
risk mitigation by end users.
iii. Capital Charge in Lieu of Margin Collateral
    As discussed in section II.A.2.b.v. of this release, the Commission
is proposing certain capital charges in lieu of margin. Generally,
margin collateral is designed to serve as a buffer to account for a
decrease in the market value of the counterparty's positions between
the time of default and liquidation. If the amount of the margin
collateral is insufficient to make up the difference, the nonbank SBSD
will incur losses. The proposal requires the nonbank SBSD to hold
sufficient net capital to enable it to, first, withstand such losses
and to cover counterparty exposures that are not sufficiently secured
with liquid collateral, and, second, to create a strong incentive for
dealers to collateralize these exposures. Consequently, this proposed
capital charge may serve as an alternative to margin collateral,
enhance the financial soundness of the nonbank SBSD and, in turn,
ultimately reduce systemic risk.
    With respect to cleared security-based swaps, the rules would
impose a capital charge if a nonbank SBSD collects margin collateral
from a counterparty in an amount that is less than the deduction that
would apply to the security-based swap if it were a proprietary
position of the nonbank SBSD (i.e., less than an amount determined by
using the standardized haircuts in Rule 15c3-1, as proposed to be
amended, and in proposed new Rule 18a-1 or a VaR model, as
applicable).\1043\ As discussed in section II.A.2.b.v. of this release,
the proposed capital charge, therefore, is designed to protect the
nonbank SBSDs against this risk, and thereby, serves to increase the
safety and soundness of the nonbank SBSD.
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    \1043\ See proposed paragraph (c)(2)(xiv)(A) of Rule 15c3-1;
paragraph (c)(1)(viii)(A) of proposed Rule 18a-1.
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    This proposed charge, however, could impose additional capital
costs on cleared transactions where the amount of the additional costs
would depend on the differences between amounts required under Rule
18a-1 and margin amounts the clearing agency sets. It is difficult to
estimate the cost impact of this proposal because there is currently a
lack of trading for customers in cleared security-based swaps that
could be used for comparative purposes.\1044\ In addition, requiring
nonbank SBSDs to take a capital charge equal to the difference between
the haircut amount and the clearing agency margin could reduce
incentives to use cleared security-based swap contracts, which would be
inconsistent with the goal of reducing systemic risk. However,
incentives to clear security-based swaps will be substantially affected
by a variety of other factors, including the amount of margin required
for non-cleared contracts, and clearing volume will also be affected by
mandatory clearing determinations by the Commission under Section
763(a) of the Dodd-Frank Act. In general, it is unclear whether the
additional costs to conduct business on a cleared basis would
materially affect the volume of business that SBSDs conduct on an
uncleared basis when they have the choice to do so.
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    \1044\ See Process for Submissions of Security-Based Swaps, 77
FR 41602 (although the volume of interdealer CDS cleared to date is
quite large, many security-based swap transactions are still
ineligible for central clearing, and many transactions in security-
based swaps eligible for clearing at a CCP continue to settle
bilaterally. Voluntary clearing of security-based swaps in the U.S.
is currently limited to CDS products. Central clearing of security-
based swaps began in March 2009 for index CDS products, in December
2009 for single-name corporate CDS products, and in November 2011
for single-name sovereign CDS products. At present, there is no
central clearing in the U.S. for security-based swaps that are not
CDS products, such as those based on equity securities.). Id.
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    As discussed in section II.A.2.b.v. of the release, with respect to
non-cleared security-based swaps, the Commission is proposing capital
charges to address three exceptions in proposed new Rule 18a-3 (nonbank
SBSD margin rule), including margin not collected from commercial end
users, margin collateral collected but segregated pursuant to section
3E(f) of the Exchange Act, and margin that has not been collected for a
legacy swap.\1045\ The rule is designed to reduce systemic risk by
requiring capital to cover counterparty exposures, because the capital
levels will serve in lieu of margin as a buffer in case of counterparty
defaults. If the nonbank SBSD did not hold capital in lieu of margin, a
counterparty default could lead to the default of the nonbank SBSD
itself. This capital charge should have the benefit of reducing the
likelihood of default of the nonbank SBSD due to under-margined
counterparty exposure. Conversely it will increase the cost of capital
for nonbank SBSDs that engage in non-cleared security-based swaps
because they must use their own capital to support the counterparty's
transaction, which in turn could reduce the liquidity of such security-
based swaps. However, the proposed rule imposes a charge only if a firm
fails to collect margin under Rule 18a-3, and thus no additional costs
would be imposed on a nonbank SBSDs that

collects margin. Therefore, the proposed rule is designed to create a
strong incentive for nonbank SBSDs to collect margin and collateralize
counterparty exposures.
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    \1045\ This proposed rule also provides the nonbank SBSDs
certain flexibility in determining whether to collect margin from
certain counterparties exempt from certain requirements of proposed
Rule 18a-3 and thus attempts to appropriately consider both the
concerns of commercial end users and other entities/transactions
exempt from proposed new Rule 18a-3 and the need to enhance the
financial soundness of the nonbank SBSD.
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    The charge for collateral segregated in individual accounts under
Section 3E(f) of the Exchange Act reflects the potential that
collateral collected by an SBSD but held in a third-party custodian
account may not be readily liquidated immediately following a
counterparty's default. Accordingly, this aspect of the rule would
create an additional capital cost to SBSDs that hold collateral in
independent third-party accounts.\1046\ If these costs are passed on to
counterparties electing an independent segregation option, they could
deter counterparties from electing the option and reduce their
flexibility in determining the optimal way to hold their collateral.
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    \1046\ See discussion above in section II.A.2.b.v. of this
release. See also discussion above in section V.B.1. of this release
(discussing quantification of costs).
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    The third proposed capital charge would apply to margin not
collected in the case of legacy non-cleared security-based swaps. This
proposal should benefit nonbank SBSDs and their counterparties in that
it is designed to avoid the difficulties of requiring a nonbank SBSD to
renegotiate security-based swap contracts to come into compliance with