authority upon the occurrence of certain events under Appendix D to
Rule 15c3-1.\463\ Because the term ``designated examining authority''
applies only to registered broker-dealers (i.e., stand-alone SBSDs
would not have a designated examining authority), the provisions of
Appendix D to Rule 18a-1 refer to the ``Commission'' instead of the
``designated examining authority.'' Specifically, under paragraph
(c)(5) of Appendix D to proposed Rule 18a-1, a stand-alone SBSD would
be required to file two copies of any proposed subordinated loan
agreement (including nonconforming subordinated loan agreements) at
least 30 days prior to the proposed execution date of the agreement
with the Commission.\464\ The rule would also require an SBSD to file
with the Commission a statement setting forth the name and address of
the lender, the business relationship of the lender to the SBSD, and
whether the SBSD carried an account for the lender effecting
transactions in security-based swaps at or about the time the proposed
agreement was filed.\465\
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    \462\ See 17 CFR 240.15c3-1d(c)(6)(i). See also FINRA Rule
4110(e)(1), which provides that subordinated loans and secured
demand notes must be approved by FINRA in order to receive
beneficial regulatory capital treatment.
    \463\ See, e.g., 17 CFR 240.15c3-1d(b)(6).
    \464\ See paragraph (c)(5) of proposed new Rule 18a-1d.
    \465\ Id.
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Request for Comment
    The Commission generally requests comment on Appendix D to both
Rule 15c3-1 and proposed new Rule 18a-1. In addition, the Commission
requests comment, including empirical data in support of comments, in
response to the following questions:
    1. Should the secured demand note provisions of Appendix D to Rule
15c3-1 be eliminated? Alternatively, should the secured demand note
provisions be incorporated into Appendix D to proposed new Rule 18a-1?
If so, explain why.
    2. Would stand-alone SBSDs be disadvantaged vis-[agrave]-vis
broker-dealer SBSDs as a result of the differences between proposed
Appendix D to proposed new Rule 18a-1 and Appendix D to Rule 15c3-1?
Would these differences provide an incentive for an entity to register
a nonbank SBSD as a broker-dealer SBSD? Please explain.
3. Proposed Capital Rules for Nonbank MSBSPs
    Proposed new Rule 18a-2 would establish capital requirements for
nonbank MSBSPs. In particular, a nonbank MSBSP would be required at all
times to have and maintain positive tangible net worth.\466\ A tangible
net worth standard is being proposed for nonbank MSBSPs, rather than
the net liquid assets test in Rule 15c3-1, because the entities that
may need to register as nonbank MSBSPs may engage in a diverse range of
business activities different from, and broader than, the securities
activities conducted by broker-dealers or SBSDs (otherwise they would
be required to register as an SBSD and/or broker-dealer). For example,
these entities may engage in commercial activities that require them to
have substantial fixed assets to support manufacturing and/or result in
them having significant assets comprised of unsecured receivables.
Requiring them to adhere to a net liquid assets test could result in
their having to obtain significant additional capital or engage in
costly restructurings.
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    \466\ See paragraph (a) of proposed new Rule 18a-2. If a broker-
dealer is required to register as a nonbank MSBSP, it would need to
continue to comply with Rule 15c3-1 in addition to proposed new Rule
18a-2.
---------------------------------------------------------------------------

    The term tangible net worth would be defined to mean the nonbank
MSBSP's net worth as determined in accordance with generally accepted
accounting principles in the United States, excluding goodwill and
other intangible assets.\467\ In determining net worth, all long and
short positions in security-based swaps, swaps, and related positions
would need to be marked to

their market value.\468\ Further, a nonbank MSBSP would be required to
include in its computation of tangible net worth all liabilities or
obligations of a subsidiary or affiliate that the participant
guarantees, endorses, or assumes, either directly or indirectly.\469\
The proposed definition of tangible net worth would allow nonbank
MSBSPs to include as regulatory capital assets that would be deducted
from net worth under Rule 15c3-1, such as property, plant, equipment,
and unsecured receivables. At the same time, it would require the
deduction of goodwill and other intangible assets.\470\
---------------------------------------------------------------------------

    \467\ See paragraph (b) of proposed new Rule 18a-2.
    \468\ Id. This provision is modeled on paragraph
(c)(2)(vi)(B)(1) of Rule 15c3-1. See 17 CFR 240.15c3-
1(c)(2)(vi)(B)(1). See also paragraph (c)(1)(i)(B)(1) of proposed
new Rule 18a-1.
    \469\ See paragraph (b) of proposed new Rule 18a-2.
    \470\ The proposed definition of tangible net worth is
consistent with the CFTC's proposed definition of tangible net
equity. See CFTC Capital Proposing Release, 76 FR at 27828 (defining
tangible net equity as ``equity as determined under U.S. generally
accepted accounting principles, and excludes goodwill and other
intangible assets.'').
---------------------------------------------------------------------------

    Because nonbank MSBSPs, by definition, will be entities that engage
in a substantial security-based swap business, they would be required
to comply with Rule 15c3-4 with respect to their security-based swap
and swap activities.\471\ As discussed above in section II.A.2.c. of
this release, Rule 15c3-4 requires OTC derivatives dealers and ANC
broker-dealers to establish, document, and maintain a system of
internal risk management controls to assist in managing the risks
associated with their business activities, including market, credit,
leverage, liquidity, legal, and operational risks.\472\ The proposal
that nonbank MSBSPs be subject to Rule 15c3-4 is designed to promote
sound risk management practices with respect to the risks associated
with OTC derivatives.
---------------------------------------------------------------------------

    \471\ See paragraph (c) of proposed new Rule 18a-2.
    \472\ See 17 CFR 240.15c3-4.
---------------------------------------------------------------------------

    Finally, the risk that the failure of a nonbank MSBSP could have a
destabilizing market impact is being addressed in part by the account
equity requirements in proposed new Rule 18a-3--as discussed below in
section II.B.2.c.ii. of this release--that would require a nonbank
MSBSP to deliver collateral to counterparties to cover the
counterparty's current exposure to the nonbank MSBSP. The proposed
requirement that nonbank MSBSPs deliver collateral to counterparties is
designed to address a risk that arose during the 2008 credit crisis
(i.e., the existence of large uncollateralized exposures of market
participants to a single entity). The proposed requirements in proposed
new Rule 18a-2 that a nonbank MSBSP maintain positive tangible net
worth and establish risk management controls are designed to serve as
an extra measure of protection but be flexible enough to account for
the potential range of business activities of these entities.
Request for Comment
    The Commission generally requests comment on the proposed capital
requirements for nonbank MSBSPs. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
    1. Is a tangible net worth test an appropriate standard for a
nonbank MSBSP? Would a net liquid assets test capital standard be more
appropriate? If so, describe the rationale for such an approach.
    2. Should nonbank MSBSPs be permitted to calculate their tangible
net worth using generally accepted accounting principles in
jurisdictions other than U.S., such as where the nonbank MSBSP is
incorporated, organized, or has its principal office? If so, explain
why.
    3. Can the risks to market stability presented by nonbank MSBSPs be
largely addressed through margin requirements?
    4. Should proposed new Rule 18a-2 require that a nonbank MSBSP
maintain a minimum fixed-dollar amount of tangible net equity, for
example, equal to $20,000,000 or some greater or lesser amount? If so,
explain the merits of imposing a fixed-dollar amount and identify the
recommended fixed-dollar amount.
    5. Should proposed new Rule 18a-2 require that a nonbank MSBSP
compute capital charges for market risk and credit risk? For example,
should such a requirement be modeled on the CFTC's proposed market and
credit risk charges for nonbank swap dealers and nonbank major swap
participants that are not using internal models and are not FCMs? \473\
If nonbank SBSDs should be required to take market and credit risk
charges, explain why. If not, explain why not.
---------------------------------------------------------------------------

    \473\ See CFTC Capital Proposing Release, 76 FR at 27809-27812.
---------------------------------------------------------------------------

    6. Should nonbank MSBSPs be subject to a leverage test and if so,
how should it be designed? Explain the rationale for such a test.
    7. Should a nonbank MSBSP be subject to a minimum tangible net
worth requirement that is proportional to the amount of risk incurred
by the MSBSP through its outstanding security-based swap transactions?
More specifically, should an MSBSP calculate an ``adjusted tangible net
worth'' by subtracting market risk deductions for their security-based
swaps (either based on the standardized haircuts or on approved models)
from their tangible net worth and be required to maintain sufficient
capital such that this adjusted tangible net worth figure is positive?

B. Margin

1. Introduction
    As discussed above in section II.A.2.b.iv. of this release, dealers
in OTC derivatives manage credit risk to their OTC derivatives
counterparties through collateral and netting agreements.\474\ The two
types of credit exposure arising from OTC derivatives are current
exposure and potential future exposure. The current exposure is the
amount that the counterparty would be obligated to pay the dealer if
all the OTC derivatives contracts with the counterparty were terminated
(i.e., it is the amount of the current receivable from the
counterparty). This form of credit risk arises from the potential that
the counterparty may default on the obligation to pay the current
receivable. The potential future exposure is the amount that the
current exposure may increase in favor of the dealer in the future.
This form of credit risk arises from the potential that the
counterparty may default before providing the dealer with additional
collateral to cover the incremental increase in the current exposure or
that the current exposure will increase after a default when the
counterparty has ceased to provide additional collateral to cover such
increases and before the dealer can liquidate the position.
---------------------------------------------------------------------------

    \474\ See Market Review of OTC Derivative Bilateral
Collateralization Practices; OTC Derivatives: Settlement Procedures
and Counterparty Risk Management.
---------------------------------------------------------------------------

    Dealers may require counterparties to provide collateral to cover
their current and potential future exposures to the counterparty.\475\
On the other hand, they may not require collateral for these purposes
because, for example, the counterparty is deemed to be of low

credit risk.\476\ Alternatively, agreements between a dealer and its
counterparties could require the counterparties to begin delivering
collateral during the pendency of the transaction if certain ``trigger
events,'' e.g., a downgrade of the counterparty's credit rating, occur.
Prior to the financial crisis, the ability to enter into OTC
derivatives transactions without having to deliver collateral allowed
counterparties to enter into OTC derivatives transactions without the
necessity of using capital to support the transactions.\477\ So, when
``trigger events'' occurred during the financial crisis, counterparties
faced significant liquidity strains in seeking to meet the requirements
to deliver collateral.\478\ As a result, some dealers experienced large
uncollateralized exposures to counterparties experiencing financial
difficulty, which, in turn, risked exacerbating the already severe
market dislocation.\479\
---------------------------------------------------------------------------

    \475\ In the Dodd-Frank Act, collateral collected to cover
current exposure is referred to as variation margin and collateral
collected to cover potential future exposure is referred to as
initial margin. See, e.g., section 15F(e)(2)(B)(i)-(ii) of the
Exchange Act (15 U.S.C. 78o-10(e)(2)(B)(i)-(ii)) and section
4s(e)(1)(A)-(B) of the CEA (7 U.S.C. 6s(e)(1)(A)-(B)), added by the
Dodd-Frank Act. In this release, collateral collected to cover
potential future exposure is referred to as margin collateral.
    \476\ See, e.g., Orice M. Williams, Director, Financial Markets
and Community Investment, General Accountability Office (``GAO''),
Systemic Risk: Regulatory Oversight and Recent Initiatives to
Address Risk Posed by Credit Default Swaps, GAO-09-397T (Mar. 2009),
available at http://www.gao.gov/new.items/d09397t.pdf (testimony
before the U.S. House Financial Services Subcommittee on Capital
Markets, Insurance, and Government Sponsored Enterprises).
    \477\ Id. at 13.
    \478\ Id. See also GAO, Financial Crisis: Review of Federal
Reserve System Financial Assistance to American International Group,
Inc., GAO-11-616 (Sept. 2011), available at http://www.gao.gov/assets/590/585560.pdf (``Financial Crisis: Review of Federal Reserve
System Financial Assistance to American International Group,
Inc.'').
    \479\ See Financial Crisis: Review of Federal Reserve System
Financial Assistance to American International Group, Inc. at 5-6.
---------------------------------------------------------------------------

    The Dodd-Frank Act seeks to address the risk of uncollateralized
credit risk exposure arising from OTC derivatives by, among other
things, mandating margin requirements for non-cleared security-based
swaps and swaps. In particular, section 764 of the Dodd-Frank Act added
new section 15F to the Exchange Act.\480\ Section 15F(e)(2)(B) of the
Exchange Act provides that the Commission shall adopt rules for nonbank
SBSDs and nonbank MSBSPs imposing ``both initial and variation margin
requirements on all security-based swaps that are not cleared by a
registered clearing agency.'' \481\ Section 15F(e)(2)(A) of the
Exchange Act provides that the prudential regulators shall prescribe
initial and variation margin requirements for non-cleared security-
based swap transactions applicable to bank SBSDs and bank MSBSPs.\482\
Section 15F(e)(3)(A) also provides that ``[t]o offset the greater risk
to the security-based swap dealer or major security-based swap
participant and the financial system arising from the use of security-
based swaps that are not cleared,'' the margin requirements proposed by
the Commission and prudential regulators shall ``help ensure the safety
and soundness'' of the SBSDs and the MSBSPs, and ``be appropriate for
the risk associated with non-cleared security-based swaps held'' by an
SBSD or MSBSP.\483\
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    \480\ See Public Law 111-203 Sec.  764.
    \481\ 15 U.S.C. 78o-10(e)(2)(B).
    \482\ See 15 U.S.C. 78o-10(e)(2)(A). The prudential regulators
have proposed margin rules with respect to non-cleared swaps and
security-based swaps that would apply to bank swap dealers, bank
major swap participants, bank SBSDs, and bank MSBSPs. See Prudential
Regulator Margin and Capital Proposing Release, 76 FR 27564. The
prudential regulators refer to collateral to cover current exposure
as variation margin and collateral to cover potential future
exposure as initial margin. Id.
    \483\ 15 U.S.C. 78o-10(e)(3)(A).
---------------------------------------------------------------------------

    Similarly, sections 4s(e)(1)(A) and (B) of the CEA provide that the
prudential regulators and the CFTC shall prescribe margin requirements
for, respectively, bank swap dealers and bank major swap participants,
and nonbank swap dealers and nonbank major swap participants.\484\
Further, section 4s(e)(3)(A) of the CEA provides, among other things,
that ``[t]o offset the greater risk to the swap dealer or major swap
participant and the financial system arising from the use of swaps that
are not cleared,'' the margin requirements adopted by the prudential
regulators and the CFTC shall ``help ensure the safety and soundness''
of swap dealers and major swap participants, and ``be appropriate for
the risk associated with non-cleared swaps held'' by these
entities.\485\
---------------------------------------------------------------------------

    \484\ See 7 U.S.C. 6s(e)(1)(A) and (B). The CFTC has proposed
margin requirements with respect to non-cleared swaps that would
apply to nonbank swap dealers and nonbank major swap participants.
See CFTC Margin Proposing Release, 76 FR 23732. The CFTC refers to
collateral to cover current exposure as variation margin and
collateral to cover potential future exposure as initial margin. Id.
    \485\ 7 U.S.C. 6s(e)(3)(A).
---------------------------------------------------------------------------

    The margin requirements that must be established with respect to
non-cleared security-based swaps and non-cleared swaps will operate in
tandem with provisions in the Dodd-Frank Act requiring that security-
based swaps and swaps must be cleared through a registered clearing
agency or registered DCO, respectively, unless an exception to
mandatory clearing exists.\486\ More specifically, section 3C of the
Exchange Act,\487\ as added by section 763(a) of the Dodd-Frank Act,
creates, among other things, a clearing requirement with respect to
certain security-based swaps. Specifically, this section provides that
``[i]t shall be unlawful for any person to engage in a security-based
swap unless that person submits such security-based swap for clearing
to a clearing agency that is registered under this Act or a clearing
agency that is exempt from registration under this Act if the security-
based swap is required to be cleared.'' \488\
---------------------------------------------------------------------------

    \486\ See Public Law 111-203 Sec.  763 (adding section 3C(a)(1)
of the Exchange Act (15 U.S.C. 78c-3(a)(1) (mandatory clearing of
security-based swaps)) and Public Law 111-203 Sec.  723 (adding
section 2(h) of the CEA (7 U.S.C. 2(h) (mandatory clearing of
swaps)). The mandatory clearing provisions in the Exchange Act and
CEA contain exceptions from the mandatory clearing requirement for
certain types of entities, security-based swaps, and swaps. See
Process for Submissions for Review of Security-Based Swaps for
Mandatory Clearing and Notice Filing Requirements for Clearing
Agencies; Technical Amendments to Rule 19b-4 and Form 19b-4
Applicable to All Self-Regulatory Organizations, Exchange Act
Release No. 67286 (June 28, 2012), 77 FR 41602 (July 13, 2012)
(explaining exceptions to mandatory clearing for security-based
swaps) (``Process for Submissions of Security-Based Swaps'');
Process for a Designated Contract Market or Swap Execution Facility
To Make a Swap Available To Trade, 76 FR 77728 (Dec. 30, 2010)
(explaining exceptions to mandatory clearing for swaps). Security-
based swaps and swaps that are not required to be cleared would be
non-cleared security-based swaps and swaps.
    \487\ 15 U.S.C. 78c-3 et seq.
    \488\ 15 U.S.C. 78c-3(a)(1) (as added by section 763(a) of the
Dodd-Frank Act). The requirement that a security-based swap must be
cleared will stem from the determination to be made by the
Commission. Such determination may be made in connection with the
review of a clearing agency's submission regarding a security-based
swap, or any group, category, type or class of security-based swap,
the clearing agency plans to accept for clearing. See 15 U.S.C. 78c-
3(b)(2)(C)(ii) (as added by section 763(a) of the Dodd-Frank Act)
(``[t]he Commission shall * * * review each submission made under
subparagraphs (A) and (B), and determine whether the security-based
swap, or group, category, type, or class of security-based swaps,
described in the submission is required to be cleared''.). In
addition, section 3C(b)(1) of the Exchange Act provides that ``[t]he
Commission on an ongoing basis shall review each security-based
swap, or any group, category, type, or class of security-based swaps
to make a determination that such security-based swap, or group,
category, type, or class of security-based swaps should be required
to be cleared.''
---------------------------------------------------------------------------

    Clearing agencies and DCOs that operate as central counterparties
(``CCPs'') manage credit and other risks through a range of controls
and methods, including prescribed margin rules for their members.\489\
Thus, the

mandatory clearing requirements established by the Dodd-Frank Act for
security-based swaps and swaps, in effect, will establish margin
requirements for cleared security-based swaps and cleared swaps and,
thereby, complement the margin requirements for non-cleared security-
based swaps and non-cleared swaps established by the Commission, the
prudential regulators, and the CFTC.\490\
---------------------------------------------------------------------------

    \489\ See Clearing Agency Standards for Operation and
Governance, Exchange Act Release No. 64017 (Mar. 3, 2011), 76 FR
14472 (Mar. 16, 2011) (``Clearing Agency Standards for Operation and
Governance''). A CCP interposes itself between two counterparties to
a transaction. See Process for Submissions of Security-Based Swaps,
77 FR at 41603. For example, when an OTC derivatives contract
between two counterparties that are members of a CCP is executed and
submitted for clearing, it is typically replaced by two new
contracts--separate contracts between the CCP and each of the two
original counterparties. At that point, the original counterparties
are no longer counterparties to each other. Instead, each acquires
the CCP as its counterparty, and the CCP assumes the counterparty
credit risk of each of the original counterparties that are members
of the CCP. To address the credit risk of acting as a CCP, clearing
agencies and DCOs require their clearing members to post collateral
for proprietary and customer positions of the member cleared by the
clearing agency or DCO. They also may require their clearing members
to collect collateral from their customers. In addition, as
discussed below, the Federal Reserve and the broker-dealer SROs
prescribe margin rules requiring broker-dealers to collect margin
collateral from their customers for financed securities transactions
and facilitated short sales of securities. Id.
    \490\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27567 (``In the derivatives clearing process,
central counterparties (CCPs) manage the credit risk through a range
of controls and methods, including a margining regime that imposes
both initial margin and variation margin requirements on parties to
cleared transactions. Thus, the mandatory clearing requirement
established by the Dodd-Frank Act for swaps and security-based swaps
will effectively require any party to any transaction subject to the
clearing mandate to post initial and variation margin to the CCP in
connection with that transaction.'') (footnote omitted). See also
Clearing Agency Standards for Operation and Governance, 76 FR at
14482 (proposing a requirement that clearing agencies acting as CCPs
must establish, implement, maintain, and enforce written policies
and procedures reasonably designed to use margin requirements to
limit credit exposures to members in normal market conditions, use
risk-based models and parameters to set margin requirements, and
review the models and parameters at least monthly).
---------------------------------------------------------------------------

    Pursuant to section 15F(e) of the Exchange Act, the Commission is
proposing new Rule 18a-3 to establish margin requirements for nonbank
SBSDs and nonbank MSBSPs with respect to non-cleared security-based
swaps. The provisions of proposed Rule 18a-3 are based on the margin
rules applicable to broker-dealers (the ``broker-dealer margin
rules'').\491\ The goal of modeling proposed new Rule 18a-3 on the
broker-dealer margin rules is to promote consistency with existing
rules and to facilitate the portfolio margining of security-based swaps
with other types of securities. In the securities markets, margin rules
have been set by relevant regulatory authorities (the Federal Reserve
and the SROs) since the 1930s.\492\ The requirement that an SRO file
proposed margin rules with the Commission has promoted the
establishment of consistent margin levels across the SROs, which
mitigates the risk that SROs (as well as their member firms) will
compete by implementing lower margin levels and also helps ensure that
margin levels are set at sufficiently prudent levels to reduce systemic
risk.\493\ Basing proposed Rule 18a-3 on the broker-dealer margin rules
is intended to achieve these same objectives in the market for
security-based swaps.
---------------------------------------------------------------------------

    \491\ Broker-dealers are subject to margin requirements in rules
promulgated by the Federal Reserve (12 CFR 220.1, et seq.), SROs
(see, e.g., FINRA Rules 4210-4240), and, with respect to security
futures, jointly by the Commission and the CFTC (17 CFR 242.400-
406).
    \492\ The Federal Reserve originally adopted Regulation T
pursuant to section 7 of the Exchange Act shortly after the
enactment of the Exchange Act. See 1934 Fed. Res. Bull. 675. The
purposes of the Federal Reserve's margin rules include: (1)
Regulation of the amount of credit directed into securities
speculation and away from other uses; (2) protection of the
securities markets from price fluctuations and disruptions caused by
excessive margin credit; (3) protection of investors against losses
arising from undue leverage in securities transactions; and (4)
protection of broker-dealers from the financial exposure involved in
excessive margin lending to customers. See Charles F. Rechlin,
Securities Credit Regulation Sec.  1:3 (2d ed. 2008).
    \493\ Pursuant to section 19(b)(1) of the Exchange Act, each SRO
must file with the Commission any proposed change in, addition to,
or deletion from the rules of the exchange electronically on a Form
19b-4 through the Electronic Form 19b-4 Filing System, which is a
secure Web site operated by the Commission. 15 U.S.C. 78s(b)(1); 17
CFR 240.19b-4.
---------------------------------------------------------------------------

    Under the broker-dealer margin rules, an accountholder is required
to maintain a specified level of equity in a securities account at a
broker-dealer (i.e., the market value of the assets in the account must
exceed the amount of the accountholder's obligations to the broker-
dealer by a prescribed amount).\494\ This equity serves as a buffer in
the event the accountholder fails to meet an obligation to the broker-
dealer and the broker-dealer must liquidate the assets in the account
to satisfy the obligation.\495\ The equity also provides liquidity to
the broker-dealer with which to fund the credit extended to the
accountholder. The amount of the equity required to be maintained in
the account depends on the securities transactions being facilitated
through the resources of the broker-dealer because the equity
requirement increases as the risk of the securities purchased with
borrowed funds or sold short with borrowed securities increases.
---------------------------------------------------------------------------

    \494\ See, e.g., 12 CFR 220.2; FINRA Rule 4210(a)(5); 17 CFR
242.401(a)(8). Accountholder obligations to the broker-dealer
generally arise from the accountholder borrowing funds from the
broker-dealer to finance securities purchases and the accountholder
relying on the broker-dealer to borrow securities or use its own
securities to make delivery on short sales of securities by the
accountholder.
    \495\ The account equity requirement, in effect, mandates that
the account contain sufficient collateral to cover the broker-
dealer's current exposure to the accountholder plus a buffer to
address potential future exposure.
---------------------------------------------------------------------------

    Proposed new Rule 18a-3 is based on these same principles and is
intended to form part of an integrated program of financial
responsibility requirements, along with the proposed capital and
segregation standards. For example, proposed new Rule 18a-1 would
impose a capital charge in certain cases for uncollateralized exposures
arising from security-based swaps. The segregation requirements are
intended to ensure that initial margin collected by SBSDs is protected
from their proprietary business risks.\496\
---------------------------------------------------------------------------

    \496\ See proposed new Rules 18a-1, 18a-3, and 18a-4.
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposal to model
the nonbank SBSD margin rule for non-cleared security-based swaps on
the broker-dealer margin rules. In addition, the Commission requests
comment, including empirical data in support of comments, in response
to the following questions:
    1. Are there other margin standards that would more appropriately
address the risks of non-cleared security-based swaps and/or be more
practical margining programs for non-cleared security-based swaps? If
so, identify them and explain how they would be more appropriate and/or
practical.
    2. What are the current margining practices of dealers in OTC
derivatives with respect to contracts that likely would be security-
based swaps subject to proposed new Rule 18a-3? How do those margining
practices differ from the proposed requirements in proposed new Rule
18a-3?
    3. As a practical matter, would the structure of proposed new Rule
18a-3 accommodate portfolio margining of security-based swaps and
swaps? If so, explain why. If not, explain why not.
2. Proposed Margin Requirements for Nonbank SBSDs and Nonbank MSBSPs
a. Scope of Rule 18a-3
    Proposed new Rule 18a-3 would apply to nonbank SBSDs and nonbank
MSBSPs.\497\ As discussed in more detail below, the proposed rule would
require nonbank SBSDs to collect collateral from their counterparties
to non-cleared security-based swaps to cover both current exposure and
potential future exposure to the counterparty (i.e., the rule would
require the account to have prescribed minimum levels of equity);
however, there would be exceptions to

these requirements for certain types of counterparties and for certain
types of transactions. The collateral collected to address the
potential future exposure (the margin collateral) would need to be
sufficient to meet the level of account equity required by the proposed
rule. The required level of account equity would be based on the risk
of the positions in the account.
---------------------------------------------------------------------------

    \497\ See paragraph (a) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    Proposed new Rule 18a-3 would require a nonbank MSBSP to collect
collateral from counterparties to which the nonbank MSBSP has current
exposure and deliver collateral to counterparties that have current
exposure to the nonbank MSBSP; however, there would be exceptions to
these requirements for certain types of counterparties. These
requirements would apply only to current exposure (i.e., nonbank MSBSPs
and their counterparties would not be required to exchange collateral
to cover potential future exposure to each other).
    The proposed rule would not identify the types of instruments that
must be delivered as collateral (e.g., U.S. government securities).
However, it would place limitations on the collateral that could be
collected by nonbank SBSDs. First, the rule would require the nonbank
SBSD to take haircuts on the collateral equal to the amounts of the
deductions required under Rule 15c3-1, as proposed to be amended, and
proposed new Rule 18a-1, as applicable to the nonbank SBSD. Second, the
rule would prescribe conditions with respect to the collateral modeled
on the conditions in Appendix E to Rule 15c3-1, discussed above in
section II.A.2.b.iv. of this release, that determine when collateral
can be taken into account for purposes of determining a potential
credit risk charge for exposure to certain counterparties.\498\
---------------------------------------------------------------------------

    \498\ See 17 CFR 240.15c3-1e(c)(4)(v)(A)-(H).
---------------------------------------------------------------------------

    Finally, the provisions in proposed new Rule 18a-3 are intended to
establish minimum margin requirements for non-cleared security-based
swaps. A nonbank SBSD and a nonbank MSBSP could establish ``house''
margin requirements that are more conservative than those specified in
the proposed new rule.\499\ For example, a nonbank SBSD could require
that a minimum level of equity must be maintained in the accounts of
counterparties that exceed the level of equity required to be
maintained pursuant to the proposed new rule. In addition, a nonbank
SBSD and a nonbank MSBSP could specifically identify and thereby limit
the types of instruments they will accept as collateral.
---------------------------------------------------------------------------

    \499\ Under broker-dealer margin rules, broker-dealers also can
establish ``house'' margin requirements as long as they are at least
as restrictive as the Federal Reserve and SRO margin rules. See,
e.g., FINRA Rule 4210(d).
---------------------------------------------------------------------------

b. Daily Calculations
i. Nonbank SBSDs
    Proposed new Rule 18a-3 would require nonbank SBSDs to collect
collateral from their counterparties to non-cleared security-based
swaps to cover both current exposure and potential future exposure,
subject to certain exceptions discussed below.\500\ Consequently,
proposed new Rule 18a-3 would require a nonbank SBSD to perform two
calculations as of the close of each business day with respect to each
account carried by the firm for a counterparty to a non-cleared
security-based swap transaction.\501\ A nonbank SBSD would be required
to increase the frequency of the calculations (i.e., perform intra-day
calculations) during periods of extreme volatility and for accounts
with concentrated positions.\502\ These more frequent calculations
would be designed to monitor the nonbank SBSD's counterparty risk
exposure in situations where a default by a counterparty or multiple
counterparties would have a more significant adverse impact on the
financial condition of the nonbank SBSD than under more normal
circumstances.\503\ One consequence of the more frequent calculations
could be that the nonbank SBSD requests that a counterparty deliver
collateral during the day pursuant to a ``house'' margin requirement to
account for changes in the value of the securities and money market
instruments held in the account.
---------------------------------------------------------------------------

    \500\ See paragraphs (c)(1)(ii) and (iii) of proposed new Rule
18a-3.
    \501\ See paragraphs (c)(1)(i)(A) and (B) of proposed new Rule
18a-3. For purposes of proposed new Rule 18a-3, the term account
would mean an account carried by a nonbank SBSD or nonbank MSBSP for
a counterparty that holds non-cleared security-based swaps. See
paragraph (b)(1) of proposed new Rule 18a-3. In addition, the term
counterparty would mean a person with whom the nonbank SBSD or
nonbank MSBSP has entered into a non-cleared security-based swap
transaction. See paragraph (b)(3) of proposed new Rule 18a-3.
    \502\ See paragraph (c)(7) of proposed new Rule 18a-3.
    \503\ Compare FINRA Rule 4210(d) which states that procedures
shall be established by members to: ``(1) review limits and types of
credit extended to all customers; (2) formulate their own margin
requirements; and (3) review the need for instituting higher margin
requirements, mark-to-markets and collateral deposits than are
required by this [margin rule] for individual securities or customer
accounts.''
---------------------------------------------------------------------------

    As discussed below in section II.B.2.c.i. of this release, the
daily calculations would form the basis for the nonbank SBSD to
determine the amount of collateral the counterparty would need to
deliver to cover any current exposure and potential future exposure the
nonbank SBSD has to the counterparty. The proposed rule would except
certain counterparties from this requirement. Even if the counterparty
is not required to deliver collateral, the calculations--by measuring
the current and potential future exposure to the counterparty--would
assist the nonbank SBSD in managing its credit risk and understanding
the extent of its uncollateralized credit exposure to the counterparty
and across all counterparties. In addition, as discussed above in
section II.A.2.a. of this release, the calculations would be used for
determining the risk margin amount for purposes of calculating the 8%
margin factor to determine the nonbank SBSD's minimum net capital
requirement.\504\
---------------------------------------------------------------------------

    \504\ See proposed new paragraph (c)(16) of Rule 15c3-1;
paragraph (c)(6) of proposed new Rule 18a-1.
---------------------------------------------------------------------------

    The first calculation would be to determine the amount of equity in
the account.\505\ For purposes of the rule, the term equity would mean
the total current fair market value of securities positions in an
account of a counterparty (excluding the time value of an over-the-
counter option), plus any credit balance and less any debit balance in
the account after applying a qualifying netting agreement with respect
to gross derivatives payables and receivables.\506\ Consequently, the
first step in calculating the equity would be to mark-to-market all of
the securities positions in the account, including non-cleared
security-based swap positions. The second step would be to add to that
amount any credit balance in the account or subtract from that amount
any debit balance in the account. Credit balances would include
payables the nonbank SBSD owed to the counterparty. Payables could
relate to cash deposited into the account, the proceeds of the sales of
securities held in the account, and/or interest and dividends earned
from securities held in the account. In addition, payables could relate
to derivatives in the account, including non-cleared security-based
swaps with a net replacement value in the favor of the counterparty.
Debit balances would be receivables to the nonbank SBSD owed by the

counterparty, including any net replacement values in favor of the
nonbank SBSD arising from derivatives positions and any other amounts
owed to the nonbank SBSD by the counterparty.
---------------------------------------------------------------------------

    \505\ See paragraph (c)(1)(i)(A) of proposed new Rule 18a-3.
    \506\ See paragraph (b)(4) of proposed new Rule 18a-3. The time
value of an OTC option is the amount that the current market value
of the option exceeds the in-the-money amount of the option. See
also, generally, FINRA Rule 4210(a)(5) (defining equity to mean the
customer's ownership interest in the account, computed by adding the
current market value of all securities ``long'' and the amount of
any credit balance and subtracting the current market value of all
securities ``short'' and the amount of any debit balance).
---------------------------------------------------------------------------

    As indicated by the proposed definition of equity, the nonbank SBSD
could offset payables and receivables relating to derivatives in the
account by applying a qualifying netting agreement with the
counterparty. To qualify for this treatment, a netting agreement would
need to meet the minimum requirements prescribed in Appendix E to Rule
15c3-1 to qualify for purposes of the credit risk charge discussed
above in section II.A.2.b.iv. of this release.\507\ These requirements
are designed to ensure that the netting agreement between the nonbank
SBSD and the counterparty permits the nonbank SBSD to reduce the
receivables and payables relating to derivatives between the two
entities to a single net payment obligation.
---------------------------------------------------------------------------

    \507\ See paragraph (c)(5) of proposed new Rule 18a-3; 17 CFR
240.15c3-1e(c)(4)(iv).
---------------------------------------------------------------------------

    The equity is the amount that results after marking-to-market the
securities positions and adding the credit balance or subtracting the
debit balance (including giving effect to qualifying netting
agreements). If the value of the securities positions in the account
exceeds the amount of any debit balance, the account would have a
positive equity.\508\ On the other hand, if the amount of the debit
balance is greater, the account would have a negative equity.\509\ The
negative equity in an account would be equal to the nonbank SBSD's
current exposure to the counterparty.
---------------------------------------------------------------------------

    \508\ The proposed rule would define the term positive equity to
mean equity of greater than $0. See paragraph (b)(7) of proposed new
Rule 18a-3.
    \509\ The proposed rule would define the term negative equity to
mean equity of less than $0. See paragraph (b)(6) of proposed new
Rule 18a-3.
---------------------------------------------------------------------------

    The second calculation would be to determine a margin amount for
the account to address potential future exposure.\510\ The proposed
rule would prescribe a standardized method and a model-based method for
calculating the margin amount.\511\ The method for determining the
margin amount would be similar to the approach a nonbank SBSD would
need to use to determine haircuts on proprietary security-based swap
positions when computing net capital.\512\ This approach would maintain
consistency between the proposed margin and capital rules.
Specifically, paragraph (d) of proposed new Rule 18a-3 would divide
security-based swaps into two classes: CDS security-based swaps and all
other security-based swaps. Paragraph (d) would define the standardized
methodology for determining the margin amount for each class of
security-based swap by reference to the standardized haircuts that
would apply to the class in proposed new Rule 18a-1 (if a stand-alone
SBSD) or Rule 15c3-1, as proposed to be amended (if a broker-dealer
SBSD).\513\ Paragraph (d) would provide further that, if the nonbank
SBSD was approved to use internal models to compute net capital, the
firm could use its internal VaR model to determine the margin amount
for security-based swaps for which the firm had been approved to use
the model, except that the margin amount for equity security-based
swaps would need to be determined exclusively using the standardized
haircuts.\514\ Consequently, for debt security-based swaps, a nonbank
SBSD approved to use internal models could calculate the margin amount
using the firm's VaR model to the extent the firm is approved to
include these types of positions in the model for the purposes of
computing net capital. For all other positions, a nonbank SBSD would
need to use the standardized haircut approach. Nonbank SBSDs that are
not approved to use internal models to compute net capital would need
to use the standardized haircuts for all positions to calculate the
margin amount.
---------------------------------------------------------------------------

    \510\ See paragraph (c)(1)(i)(B) of proposed new Rule 18a-3.
    \511\ See paragraph (d) of proposed new Rule 18a-3. Similarly,
the prudential regulators have proposed that bank SBSDs and bank
swap dealers have the option of using internal models to calculate
initial margin requirements for non-cleared security-based swaps.
See Prudential Regulator Margin and Capital Proposing Release, 76 FR
at 27567-27568 (``With respect to initial margin, the proposed rule
permits a covered swap entity to select from two alternatives to
calculate its initial margin requirements. A covered swap entity may
calculate its initial margin requirements using a standardized
`lookup' table that specifies the minimum initial margin that must
be collected, expressed as a percentage of the notional amount of
the swap or security-based swap. These percentages depend on the
broad asset class of the swap or security-based swap. Alternatively,
a covered swap entity may calculate its minimum initial margin
requirements using an internal margin model that meets certain
criteria and that has been approved by the relevant prudential
regulator.'') (footnotes omitted). On the other hand, the CFTC,
because of concerns about the resources necessary to approve the use
of internal models for margining purposes and the fact that nonbank
swap dealers may not have internal models, proposed that nonbank
swap dealers must use either external models or a standardized
approach to determine initial margin (though the CFTC did propose a
provision under which the CFTC could approve the use of an internal
model should the CFTC obtain sufficient resources). See CFTC Margin
Proposing Release, 76 FR at 23737. The external models proposed by
the CFTC are: (1) a model currently in use for margining cleared
swaps at a DCO; (2) a model currently in use for modeling non-
cleared swaps by an entity subject to regular assessment by a
prudential regulator; or (3) a model available for licensing to any
market participant by a vendor. Id. The use of external models is
not being proposed for nonbank SBSDs because the basis for
permitting firms to use VaR models to compute net capital is to
align their internally developed (i.e., not vender-developed) risk
management processes with the process for computing net capital. See
Alternative Net Capital Requirements Adopting Release, 69 FR at
34428 (the option to use VaR models is ``intended to reduce
regulatory costs for broker-dealers by allowing very highly
capitalized firms that have developed robust internal risk
management practices to use those risk management practices, such as
mathematical risk measurement models, for regulatory purposes'').
    \512\ See paragraph (d) of proposed new Rule 18a-3; proposed new
paragraph (c)(2)(vi)(O) of Rule 15c3-1; paragraph (c)(1)(vi) of
proposed new Rule 18a-1.
    \513\ See paragraphs (d)(1)(i) and (ii) of proposed new Rule
18a-3. As discussed in section II.A.2.b.ii. of this release,
proposed new Rule 18a-1 and Rule 15c3-1, as proposed to be amended,
would prescribe standardized haircuts for security-based swaps. See
proposed new paragraph (c)(2)(vi)(O) of Rule 15c3-1; paragraph
(c)(1)(vi) of proposed new Rule 18a-1. Consequently, for CDS
security-based swaps, the nonbank SBSD would use the proposed
maturity/spread grid in proposed new paragraph (c)(2)(vi)(O)(1) of
Rule 15c3-1 and paragraph (c)(1)(vi)(A) of proposed new Rule 18a-1
to determine the margin amount. See paragraph (d)(1)(i) of proposed
new Rule 18a-3. While the required standardized haircuts would be
the same in Rule 15c3-1, as proposed to be amended, and proposed new
Rule 18a-1, the nonbank SBSD would refer to Rule 15c3-1 if it is a
broker-dealer SBSD and proposed new Rule 18a-1 if it is a stand-
alone SBSD. For all equity security-based swaps and debt security-
based swaps (other than CDS security-based swaps), the nonbank SBSD
would use the method of multiplying the notional amount of the
position by the standardized haircut that would apply to the
underlying security as specified in proposed new paragraph
(c)(2)(vi)(O)(2) of Rule 15c3-1 and paragraph (c)(1)(vi)(B) of
proposed new Rule 18a-1. See paragraph (d)(ii) of proposed new Rule
18a-3. For equity security-based swaps, this would include being
able to use the methodology in Appendix A to Rule 15c3-1, as
proposed to be amended, and in Appendix A to proposed new Rule 18a-
1, as applicable to the nonbank SBSD. For debt security-based swaps,
this would include being able to use the offsets that are permitted
in the debt maturity grids in paragraph (c)(2)(vi) of Rule 15c3-1.
See 17 CFR 240.15c3-1(c)(2)(vi).
    \514\ See paragraph (d)(2) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    As noted above, a nonbank SBSD (regardless of whether it is
approved to use internal models to compute net capital) would be
required to calculate the margin amount for equity security-based swaps
using the standardized haircuts, which includes the ability to use the
methodology in Appendix A to Rule 15c3-1. This proposal is designed to
establish a margin requirement for equity security-based swaps that is
consistent with SRO portfolio margin rules for equity securities, which
are based on the Appendix A methodology.\515\ This provision would

allow broker-dealer SBSDs to include equity security-based swaps in the
portfolios of equity securities positions for which they calculate
margin requirements using the SRO portfolio margin rules.\516\ The
proposal also would ensure a consistent portfolio margin approach for
equity security products across nonbank SBSDs and broker-dealers that
are not SBSDs, and thereby reduce opportunity for regulatory arbitrage.
---------------------------------------------------------------------------

    \515\ See FINRA Rule 4210(g); CBOE Rule 12.4. See also FINRA,
Portfolio Margin Frequently Asked Questions, available at
www.finra.org. As discussed in section II.A.2.b.ii. of this release,
Appendix A to Rule 15c3-1 permits a broker-dealer to group options,
futures, long securities positions, and short securities positions
involving the same underlying security and stress the current market
price for each position at ten equidistant points along a range of
positive and negative potential future market movements, using an
approved theoretical options pricing model that satisfies certain
conditions specified in the rule. See 17 CFR 240.15c3-1a. The gains
and losses of each position in the portfolio offset each other to
yield a net gain or loss at each stress point. The stress point that
yields the largest potential net loss for the portfolio would be
used to calculate the aggregate haircut for all the positions in the
portfolio. Id.
    \516\ See, e.g., FINRA Rule 4210(g)(2)(G) (defining the term
``unlisted derivative'' for purposes of inclusion in the Appendix A
methodology as used in the rule to calculate a portfolio margin
requirement to mean ``any equity-based or equity index-based
unlisted option, forward contract, or security-based swap that can
be valued by a theoretical pricing model approved by the
[Commission].'') (emphasis added).
---------------------------------------------------------------------------

Request for Comment
    The Commission generally requests comment on the proposed daily
calculation requirements for nonbank SBSDs in proposed new Rule 18a-3.
In addition, the Commission requests comment, including empirical data
in support of comments, in response to the following questions:
    1. Is the proposed definition of equity appropriate? For example,
would the proposed definition be practical in terms of determining the
net equity in an account holding non-cleared security-based swaps? If
the proposed definition is not appropriate, explain why and provide
suggested alternative definitions.
    2. Should the definition of equity include the time value of an
over-the-counter option? If so, explain why.
    3. Should the terms current market value, credit balance, and debit
balance be defined for the purpose of proposed new Rule 18a-3? For
example, would defining these terms provide greater clarity to the
definition of equity in the proposed rule? If these terms should be
defined, explain why and provide suggested definitions.
    4. Are the proposed requirements for netting agreements to qualify
for purposes of determining the amount of equity in an account
appropriate? If not, explain why not. Are there additional or
alternative provisions that should be contained in the netting
agreement requirements? If so, identify and explain them.
    5. Is the proposed method for calculating the margin amount
appropriate? If not, explain why not. For example, is it appropriate to
use the techniques in Rule 15c3-1, as proposed to be amended, and
proposed new Rule 18a-1 to determine the margin amount? If not, explain
why not. Are there alternative methods for calculating the margin
amount that would be preferable? If so, identify them and explain why
they would be preferable.
    6. Should proposed new Rule 18a-3 allow an alternative method of
calculating the margin amount that would permit a nonbank SBSD to
determine the margin amount for a non-cleared security-based swap based
on the margin required by a registered clearing agency for a cleared
security-based swap whose terms and conditions closely resemble the
terms and conditions of the non-cleared security-based swap (similar to
the CFTC's proposal)? Would there be sufficient similarity between
certain cleared and non-cleared security-based swaps to make this
approach workable? In addition, if this alternative approach was
permitted, how could the potential differences in margin requirements
across clearing agencies be addressed?
    7. In addition to internal models, should external models be
permitted such as: (1) a model currently in use for margining cleared
security-based swaps at a clearing agency; (2) a model currently in use
for modeling non-cleared swaps by an entity subject to regular
assessment by a prudential regulator; or (3) a model available for
licensing to any market participant by a vendor? What would be the
advantages and disadvantages of permitting external models?
    8. How would the proposed standardized approaches to determining
the margin amount differ from the standardized approaches the
prudential regulators proposed for determining the initial margin
amount?
    9. The provisions for using VaR models to compute net capital
require that the model use a 99%, one-tailed confidence level with
price changes equivalent to a ten-business-day movement in rates and
prices. This means the VaR model used for the purpose of determining a
counterparty's margin amount also would need to use a 99%, one-tailed
confidence level with price changes equivalent to a ten-business-day
movement in rates and prices. The ten-business-day requirement is
designed to account for market movements that occur over a period of
time as opposed to a single day. This is designed to ensure that the
VaR model uses potential market moves that are large enough to capture
multi-day moves in rates and prices. Given this purpose, should the VaR
model be required to use a longer period of time (e.g., 15, 20, 25, or
30 business days) to establish a potentially greater margin collateral
requirement for customers given that they may not be subject to capital
and other prudential requirements? Would the 3-times multiplication
factor proposed to be required for VaR models used by nonbank SBSDs
(which, under the proposal, would need to be increased in response to
back-testing exceptions) be necessary if the time period were longer
than 10 business days? If not, explain why not.
ii. Nonbank MSBSPs
    Proposed new Rule 18a-3 would require nonbank MSBSPs to collect
collateral from counterparties to which the nonbank MSBSP has current
exposure and provide collateral to counterparties that have current
exposure to the nonbank MSBSP.\517\ Consequently, a nonbank MSBSP would
be required to calculate as of the close of business each day the
amount of equity in each account of a counterparty.\518\ Consistent
with the proposal for nonbank SBSDs, a nonbank MSBSP would be required
to increase the frequency of its calculations (i.e., perform intra-day
calculations) during periods of extreme volatility and for accounts
with concentrated positions.\519\
---------------------------------------------------------------------------

    \517\ See paragraph (c)(2)(ii) of proposed new Rule 18a-3.
    \518\ See paragraph (c)(2)(i) of proposed new Rule 18a-3. A
nonbank MSBSP would apply the definitions in paragraph (b) of
proposed new Rule 18a-3 for the purposes of complying with the
requirements in the rule. See paragraph (b) of proposed new Rule
18a-3. The term equity would be defined to mean the total current
fair market value of securities positions in an account of a
counterparty (excluding the time value of an over-the-counter
option), plus any credit balance and less any debit balance in the
account after applying a qualifying netting agreement with respect
to gross derivatives payables and receivables. See paragraph (b)(4)
of proposed new Rule 18a-3. The time value of an OTC option is the
amount that the current market value of the option exceeds the in-
the-money amount of the option. In addition, the term account is
proposed to be defined to mean an account carried by a nonbank SBSD
or nonbank MSBSP for a counterparty that holds non-cleared security-
based swaps. See paragraph (b)(1) of proposed new Rule 18a-3.
Furthermore, the term counterparty is proposed to mean a person with
whom the nonbank SBSD or nonbank MSBSP has entered into a non-
cleared security-based swap transaction. See paragraph (b)(3) of
proposed new Rule 18a-3.
    \519\ See paragraph (c)(7) of proposed new Rule 18a-3. These
more frequent calculations would be designed to monitor the nonbank
MSBSP's counterparty risk exposure in situations where a default by
a counterparty or multiple counterparties would have a more
significant adverse impact on the financial condition of the nonbank
MSBSP than under more normal circumstances. One consequence of the
more frequent calculations could be that the nonbank MSBSP requests
that a counterparty deliver collateral during the day pursuant to a
``house'' margin requirement to account for changes in the value of
the securities and money market instruments held in the account.

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

    As would be the case for a nonbank SBSD, the first step for a
nonbank MSBSP in calculating the equity in an account would be to mark-
to-market all of the securities positions in the account, including
non-cleared security-based swap positions. The second step would be to
add to that amount any credit balance in the account or subtract from
that amount any debit balance.\520\ The nonbank MSBSP could offset
payables and receivables relating to derivatives in the account by
applying a qualifying netting agreement with the counterparty. To
qualify for this treatment, a netting agreement would need to meet the
minimum requirements prescribed in Appendix E to Rule 15c3-1 to qualify
for purposes of the credit risk charge discussed above in section
II.A.2.b.iv. of this release.\521\ These requirements, set forth in
paragraph (c)(5) of Rule 18a-3, are designed to ensure that the netting
agreement between the nonbank MSBSP and the counterparty permits the
nonbank MSBSP to reduce the receivables and payables between the two
entities to a single net payment obligation.\522\
---------------------------------------------------------------------------

    \520\ Credit balances would include payables the nonbank MSBSP
owed to the counterparty. Payables could relate to cash deposited
into the account, the proceeds of the sales of securities held in
the account, and interest and dividends earned from securities held
in the account. In addition, payables could relate to derivatives in
the account such as non-cleared security-based swaps with a net
replacement value in the favor of the counterparty. Debit balances
would be receivables to the nonbank MSBSP owed by the counterparty.
Receivables could relate to derivatives in the account such as non-
cleared security-based swaps with a net replacement value in the
favor of the nonbank MSBSP.
    \521\ See paragraph (c)(5) of proposed new Rule 18a-3; 17 CFR
240.15c3-1e(c)(4)(iv).
    \522\ See paragraph (c)(5) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    If the value of the securities positions plus the amount of any
cash in the account exceeds the amount of the debit balance, the
account would have positive equity.\523\ This would mean the
counterparty has current exposure to the nonbank MSBSP. On the other
hand, if the amount of the debit balance is greater, the account would
have negative equity.\524\ This would mean the nonbank MSBSP has
current exposure to the counterparty.
---------------------------------------------------------------------------

    \523\ The proposed rule would define the term positive equity to
mean equity of greater than $0. See paragraph (b)(7) of proposed new
Rule 18a-3.
    \524\ The proposed rule would define the term negative equity to
mean equity of less than $0. See paragraph (b)(6) of proposed new
Rule 18a-3.
---------------------------------------------------------------------------

    Nonbank MSBSPs would not be required to deliver or collect margin
collateral to collateralize potential future exposure.\525\ For that
reason, Rule 18a-3 would not require nonbank MSBSPs to calculate a
margin amount, and the rule would not require counterparties to provide
margin collateral to nonbank MSBSPs to maintain equity levels above the
nonbank MSBSP's current exposure. When a counterparty provides margin
collateral to collateralize potential future exposure, the counterparty
is exposed to credit risk in the amount that the collateral provided to
the dealer exceeds the dealer's current exposure to the counterparty.
With respect to nonbank SBSDs, collateralizing potential future
exposure is intended to promote the financial responsibility of the
nonbank SBSD, as the margin collateral received from the counterparty
protects the nonbank SBSD from the risks arising from fluctuations in
the value of the underlying positions before the collateral can be
sold. The counterparty, in turn, would be protected by the net liquid
assets test standard applicable to the nonbank SBSD,\526\ which is
significantly more conservative than the tangible net worth capital
standard proposed for nonbank MSBSPs.\527\ The counterparties also
would be protected by the proposed segregation requirements with
respect to the margin collateral delivered by counterparties.\528\
---------------------------------------------------------------------------

    \525\ See paragraph (c)(2)(i) of proposed new Rule 18a-3 (only
requiring calculation of the equity in the account of each
counterparty).
    \526\ See 17 CFR 240.15c3-1; proposed new Rule 18a-1.
    \527\ See proposed new Rule 18a-2.
    \528\ See proposed new Rule 18a-4.
---------------------------------------------------------------------------

    The proposed margin requirements for nonbank MSBSPs are designed to
``neutralize'' the credit risk between a nonbank MSBSP and a
counterparty. The collection of collateral from counterparties would
strengthen the liquidity of the nonbank MSBSP by collateralizing its
current exposure to counterparties. Nonbank MSBSPs, in contrast to
nonbank SBSDs, would be required to deliver collateral to
counterparties to collateralize their current exposure to the nonbank
MSBSP, which would lessen the impact on the counterparties if the
nonbank MSBSP failed, and is intended to account for the fact that
nonbank MSBSPs would be subject to less stringent capital requirements
than nonbank SBSDs.
    In addition, as discussed in section II.A.3. of the release, the
entities that may need to register as nonbank MSBSPs could include
companies that engage in commercial activities that are not necessarily
financial in nature (e.g., manufacturing, agriculture, and energy) and
for which a net liquid assets test could be impractical. Finally,
because of these differences in business models, nonbank MSBSPs may not
have the systems and personnel necessary to operate daily margin
collateral programs to address potential future exposure.
Request for Comment
    The Commission generally requests comment on the proposed daily
calculation requirements for nonbank MSBSPs. Commenters are referred to
the questions about the daily calculation requirements for nonbank
SBSDs above in section II.B.2.b.i. of this release to the extent those
questions address provisions in proposed new Rule 18a-3 that also apply
to nonbank MSBSPs. In addition, the Commission requests comment,
including empirical data in support of comments, in response to the
following questions:
    1. Which types of counterparties would be expected to transact with
nonbank MSBSPs? Which types of security-based swap transactions would
these counterparties enter into with nonbank MSBSPs?
    2. Should nonbank MSBSPs be required to calculate a daily margin
amount for each counterparty? For example, even if they were not
required to collect collateral to cover potential future exposure,
would the calculation of the margin amount better enable them to
measure and understand their counterparty risk?
    3. If nonbank MSBSPs should calculate a daily margin amount, how
should such amount be calculated? Should a nonbank MSBSP be required to
calculate a margin amount using the methods prescribed in paragraph (d)
of proposed new Rule 18a-3 or some other method? For example, should
nonbank MSBSPs be permitted to use external models to determine a
margin amount?
    4. Would nonbank MSBSPs have the systems and personnel necessary to
operate daily margin collateral programs to calculate a daily margin
amount?
c. Account Equity Requirements
i. Nonbank SBSDs
    A nonbank SBSD would be required to calculate as of the close of
each business day: (1) the amount of equity

in the account of each counterparty; and (2) a margin amount for the
account of each counterparty.\529\ On the next business day following
the calculations, the nonbank SBSD would be required to collect cash,
securities, and/or money market instruments from the counterparty in an
amount at least equal to the negative equity (current exposure) in the
account plus the margin amount (potential future exposure).\530\ The
collateral collected would be designed to ensure that the counterparty
maintains a minimum level of positive net equity in the account. The
proposed rule would require the nonbank SBSD to collect collateral for
this purpose from each counterparty, except as discussed below.
---------------------------------------------------------------------------

    \529\ See paragraph (c)(1)(i) of proposed new Rule 18a-3. See
also paragraph (b)(4) of proposed new Rule 18a-3 (defining the term
equity).
    \530\ See paragraph (c)(1)(ii) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    A nonbank SBSD would need to collect cash, securities, and/or money
market instruments to meet the account equity requirements in proposed
new Rule 18a-3. Other types of assets would not be eligible as
collateral. In addition, under proposed new Rule 18a-3, the fair market
value of securities and money market instruments held in the account of
a counterparty would need to be reduced by the amount of the deductions
the nonbank SBSD would apply to the positions pursuant to Rule 15c3-1,
as proposed to be amended, or proposed new Rule 18a-1, as applicable,
for the purpose of determining whether the level of equity in the
account meets the minimum requirement.\531\ Accordingly, securities and
money market instruments with no ``ready market'' or which cannot be
publicly offered or sold because of statutory, regulatory, or
contractual arrangements or other restrictions would be subject to a
100% deduction and, therefore, these types of securities and money
market instruments would have no value in terms of meeting the account
equity requirement.\532\ All other securities and money market
instruments in the account would be reduced in value by the amount of
the deductions required in Rule 15c3-1, as proposed to be amended, and
proposed new Rule 18a-1, as applicable to the nonbank SBSD.\533\ The
amount of the deductions would increase for securities and money market
instruments with greater market risk and, thereby, account for the risk
that the nonbank SBSD may not be able to liquidate the securities and
money market instruments at current market values to satisfy the
obligation of a defaulted counterparty.\534\ These deductions would
limit the types of securities and money market instruments a
counterparty could provide as collateral and require a counterparty to
increase the amount of collateral delivered to account for the
deductions taken on securities collateral in the account.\535\
---------------------------------------------------------------------------

    \531\ See paragraph (c)(3) of proposed new Rule 18a-3.
    \532\ See 17 CFR 240.15c3-1(c)(2)(vii); paragraph (c)(1)(iv) of
proposed new Rule 18a-1.
    \533\ See 17 CFR 240.15c3-1(c)(2)(vi); paragraphs (c)(1)(vi)-
(vii) of proposed new Rule 18a-1.
    \534\ See 17 CFR 240.15c3-1(c)(2)(vi); paragraphs (c)(1)(vi)-
(vii) of proposed new Rule 18a-1.
    \535\ For example, assume an account holds securities and money
market instruments valued at $50, a credit balance of $10, and a
debit balance of $58. The equity in the account would be $2 ($50 of
securities and money market instruments' value + $10 in credits-$58
in debits = $2). Assume that the margin amount calculated for the
account is $10. This would mean that the account needs to have
positive equity of at least $10 (it currently has positive equity of
only $2). Assume that the deduction under Rule 15c3-1 for the $50 of
securities and money market positions held in the account is $7.
This would mean that the counterparty would need to deliver $15 in
cash (i.e., not $8) to meet the minimum $10 account equity
requirement ($50 of securities and money market instruments' value-
$7 deduction + $10 in credits-$58 in debits + $15 cash collateral
deposit = $10). Moreover, if the counterparty delivered securities
and/or money market instruments to meet the account equity
requirement, the fair market value of the securities and money
market instruments would need to be greater than $15 because their
value would be reduced by the amount of the deduction in Rule 15c3-1
or proposed new Rule 18a-1, as applicable.
---------------------------------------------------------------------------

    The prudential regulators and the CFTC are proposing to
specifically identify the asset classes that would be eligible
collateral for purposes of their margin rules.\536\ Proposed new Rule
18a-3 would not limit collateral in this way. However, comment is
sought below in section II.B.3. of this release on the question of
whether to define the term eligible collateral in a manner that is
similar to the proposals of the prudential regulators and the CFTC.
---------------------------------------------------------------------------

    \536\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR 27564; CFTC Margin Proposing Release, 76 FR 23732.
The proposal of the prudential regulators would limit eligible
collateral to cash, foreign currency to the extent the payment
obligation under the security-based swap or swap is denominated in
the currency, obligations guaranteed by the United States as to
principal and interest, and, with respect to initial margin only, a
senior debt obligation of the Federal National Mortgage Association,
the Federal Home Loan Mortgage Corporation, the Federal Home Loan
Banks, and the Federal Agricultural Mortgage Corporation, or any
obligation that is an ``insured obligation,'' as the term is defined
in 12 U.S.C. 2277a(3), of a Farm Credit System bank. See Prudential
Regulator Margin and Capital Proposing Release, 76 FR at 27589. The
proposal of the CFTC would limit eligible collateral for initial
margin to cash, foreign currency to the extent the payment
obligation under the security-based swap or swap is denominated in
the currency, obligations guaranteed by the United States as to
principal and interest, and a senior debt obligation of the Federal
National Mortgage Association, the Federal Home Loan Mortgage
Corporation, the Federal Home Loan Banks, and the Federal
Agricultural Mortgage Corporation, or any obligation that is an
``insured obligation,'' as the term is defined in 12 U.S.C.
2277a(3), of a Farm Credit System bank. CFTC Margin Proposing
Release, 76 FR at 23747. The CFTC's proposal would limit eligible
collateral for variation margin to cash and obligations guaranteed
by the United States as to principal and interest. Id.
---------------------------------------------------------------------------

    The reason for not proposing a definition of eligible collateral is
that counterparties are expected to engage in a wide range of trading
strategies that include security-based swaps. Consequently, the account
of a counterparty may hold, for example, the security underlying a
security-based swap, as well as a short position, option, and single
stock future on the underlying security.\537\ Because of the
relationship between security-based swaps and these other security
positions, permitting various types of securities to count as
collateral may be more practical for margin arrangements involving
security-based swaps than for other types of derivatives. A more
limited definition of eligible collateral could require a counterparty
that has positive equity in an account equal to or in excess of the
margin amount to deliver additional collateral to the extent the
positions in the account did not meet the definition. The
counterparty's credit exposure to the nonbank SBSD therefore would be
increased in a way that may not be necessary to account for the nonbank
SBSD's potential future exposure to the counterparty.\538\
---------------------------------------------------------------------------

    \537\ See, e.g., FINRA Rule 4210(g) (permitting customer
portfolio margining); 17 CFR 240.15c3-1a; Appendix A to proposed new
Rule 18a-1.
    \538\ A counterparty will have credit exposure to a nonbank SBSD
to the extent that collateral held in the account of the
counterparty has a mark-to-market value in excess of the nonbank
SBSD's current exposure to the counterparty.
---------------------------------------------------------------------------

    The Commission is proposing certain additional requirements for
eligible collateral, which are modeled on the existing collateral
requirements in Appendix E to Rule 15c3-1.\539\ As discussed above in
section II.A.2.b.iv. of this release, collateral ``ideally'' is ``an
asset of stable and predictable value, an asset that is not linked to
the value of the transaction in any way, and an asset that can be sold
quickly and easily if the need arises.'' \540\ The requirements in
Appendix E to Rule 15c3-1 are designed to achieve these
objectives.\541\ The proposed additional requirements include:
---------------------------------------------------------------------------

    \539\ See paragraph (c)(4) of proposed new Rule 18a-3.
    \540\ Market Review of OTC Derivative Bilateral
Collateralization Practices at 5.
    \541\ See 17 CFR 240.15c3-1e(c)(4)(v).
---------------------------------------------------------------------------

     The collateral must be subject to the physical possession
or control of the nonbank SBSD;

     The collateral must be liquid and transferable;
     The collateral must be capable of being liquidated
promptly by the nonbank SBSD without intervention by any other party;
     The collateral agreement between the nonbank SBSD and the
counterparty must be legally enforceable by the nonbank SBSD against
the counterparty and any other parties to the agreement;
     The collateral must not consist of securities issued by
the counterparty or a party related to the nonbank SBSD, or to the
counterparty; and
     If the Commission has approved the nonbank SBSD's use of a
VaR model to compute net capital, the approval allows the nonbank SBSD
to calculate deductions for market risk for the type of
collateral.\542\
---------------------------------------------------------------------------

    \542\ See paragraphs (c)(4)(i)-(c)(4)(vi) of proposed new Rule
18a-3.
---------------------------------------------------------------------------

    These proposed collateral requirements are designed to ensure that
the treatment of collateral requirements remains consistent between the
proposed capital and margin requirements. As discussed above in section
II.A.2.b.v. of this release, a nonbank SBSD would be required to take a
capital charge if a counterparty does not deliver cash, securities,
and/or money market instruments to the nonbank SBSD to meet an account
equity requirement within one business day of the requirement being
triggered. In addition, proposed new Rule 18a-3 would require the
nonbank SBSD to take prompt steps to liquidate securities and money
market instruments in the account to the extent necessary to eliminate
the account equity deficiency.\543\ Under this provision, which is
modeled on a similar requirement in the broker-dealer margin
rules,\544\ a nonbank SBSD could need to liquidate positions in the
account to reduce debits arising from those transactions. The rule
would not require that the liquidations must be completed within a
specific timeframe.\545\ Instead, the rule is designed to give the
nonbank SBSD the flexibility to conduct an orderly liquidation, taking
into account market conditions and the risk profile of the account.
---------------------------------------------------------------------------

    \543\ See paragraph (c)(8) of proposed new Rule 18a-3.
    \544\ See 12 CFR 220.4(d) (providing that if a margin call is
not met within the required time, the broker-dealer must liquidate
securities sufficient to meet the margin call or to eliminate any
margin deficiency existing on the day such liquidation is required,
whichever is less).
    \545\ See paragraph (c)(8) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    There would be four exceptions to the account equity
requirements.\546\ The first would apply to counterparties that are
commercial end users.\547\ The second would apply to counterparties
that are SBSDs.\548\ The third would apply to counterparties that are
not commercial end users and that require their margin collateral to be
segregated pursuant to section 3E(f) of the Exchange Act.\549\ The
fourth would apply to accounts of counterparties that are not
commercial end users and that hold legacy non-cleared security-based
swaps.\550\ Under these exceptions, applicable accounts would not need
to meet certain account equity requirements in proposed new Rule 18a-3
and, therefore, the nonbank SBSD would be exempted from the
requirements to take prompt steps to liquidate securities in the
account to the extent necessary to eliminate the account equity
deficiency. However, as discussed above in section II.A.2.b.v. of this
release, in these cases the nonbank SBSD would need to take capital
charges in lieu of meeting the account equity requirements in certain
circumstances.\551\
---------------------------------------------------------------------------

    \546\ See paragraphs (c)(1)(iii)(A)-(D) of proposed new Rule
18a-3.
    \547\ See paragraph (c)(1)(iii)(A) of proposed new Rule 18a-3.
    \548\ See paragraph (c)(1)(iii)(B)--Alternative A of proposed
new Rule 18a-3. An alternative approach is being proposed that would
not be an exception to the account equity requirement under which a
nonbank SBSD would need to collect collateral from another SBSD to
cover the negative equity in the account and the margin amount for
the account. In addition, the collateral collected to cover the
margin amount would need to be held by an independent third-party
custodian. See paragraph (c)(1)(iii)(B)--Alternative B of proposed
new Rule 18a-3.
    \549\ See paragraph (c)(1)(iii)(C) of proposed new Rule 18a-3.
    \550\ See paragraph (c)(1)(iii)(D) of proposed new Rule 18a-3.
    \551\ See proposed new paragraph (c)(2)(xiv) of Rule 15c3-1;
paragraph (c)(1)(viii) of proposed Rule 18a-1.
---------------------------------------------------------------------------

Exception for Commercial End Users
    Under the first exception to the account equity requirements, a
nonbank SBSD would not be required to collect cash, securities, and/or
money market instruments to cover the negative equity (current
exposure) or margin amount (potential future exposure) in the account
of a counterparty that is a commercial end user.\552\ As discussed
above in section II.A.2.b.v. of this release, this proposed exception
to the requirement to collect collateral is intended to address
concerns that have been expressed by commercial end users and others
that the imposition of margin requirements on commercial companies that
use derivatives to mitigate the risk of business activities that are
not financial in nature could unduly disrupt their ability to enter
into hedging transactions. The proposed exception is intended to permit
nonbank SBSDs and commercial end users to negotiate individual
agreements that would reflect the credit risk of the commercial end
user and the nature and extent of the non-cleared security-based swap
transactions with the end user, without creating an undue impediment to
the ability of the commercial end user to hedge its commercial
risks.\553\
---------------------------------------------------------------------------

    \552\ See paragraph (c)(1)(iii)(A) of proposed Rule 18a-3. The
exception would apply to negative equity in the account and the
margin amount calculated for the account. However, a nonbank SBSD
would be required to take a 100% deduction from net worth for the
amount of the uncollateralized negative equity and take the proposed
capital charge in lieu of margin collateral discussed above in
section II.A.2.b.v. of this release. See 17 CFR 240.15c3-
1(c)(2)(iv)(B) (deductions for unsecured receivables); paragraph
(c)(1)(iii)(B) of proposed new Rule 18a-1 (deductions for unsecured
receivables); proposed new paragraph (c)(2)(xiv) of Rule 15c3-1
(proposed capital charge in lieu of margin); paragraph (c)(1)(viii)
of proposed Rule 18a-1 (proposed capital charge in lieu of margin).
As an alternative to these capital charges, ANC broker-dealers and
stand-alone SBSDs using internal models could take the credit risk
charge discussed in section II.A.2.b.iv. of this release. See
amendments to paragraph (a)(7) of Rule 15c3-1; paragraph (a)(2) of
proposed new Rule 18a-1.
    \553\ The margin rule proposed by the prudential regulators
would require the entities subject to the rule to establish credit
exposure limits for each nonfinancial end user ``under appropriate
credit processes and standards,'' and to collect collateral to the
extent that individual exposures exceed those limits. See Prudential
Regulator Margin and Capital Proposing Release, 76 FR at 27587. The
margin rule proposed by the CFTC would permit entities subject to
the rule and nonfinancial end users ``to set initial margin and
variation margin requirements in their discretion'' but each entity
subject to the proposed rule would be required to calculate daily
exposure amounts for nonfinancial end users for risk management
purposes. See CFTC Margin Proposing Release, 76 FR at 27736.
---------------------------------------------------------------------------

    The proposed exception for commercial end users also is intended to
account for the different risk profiles of commercial end users as
compared with financial end users.\554\ When credit markets are under
strain, as in 2008, financial end users, such as hedge funds, can face
liquidity stress, which increases their risk of default. Further,

financial end users as a group, due to the nature of their business,
may engage in security-based swap transactions in greater volume than
commercial end users, increasing the risk of substantial concentration
of counterparty exposure to nonbank SBSDs, and potentially creating
greater systemic risk from the failure of a single entity.\555\
---------------------------------------------------------------------------

    \554\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27571 (``Among end users, financial end users are
considered more risky than nonfinancial end users because the
profitability and viability of financial end users is more tightly
linked to the health of the financial system than nonfinancial end
users. Because financial counterparties are more likely to default
during a period of financial stress, they pose greater systemic risk
and risk to the safety and soundness of the covered swap entity.'').
See also CFTC Margin Proposing Release, 76 FR at 27735 (``The
Commission believes that financial entities, which are generally not
using swaps to hedge or mitigate commercial risk, potentially pose
greater risk to CSEs than non-financial entities.'').
    \555\ The margin rules proposed by the prudential regulators and
the CFTC would differentiate collateral requirements based on
whether a financial end user is ``high risk'' or ``low risk.'' See
Prudential Regulator Margin and Capital Proposing Release, 76 FR at
27571-27572; CFTC Margin Proposing Release, 76 FR at 23736-23737. A
``low risk'' financial end user is defined in their proposals as an
entity that: (1) is subject to capital requirements established by a
prudential regulator or a state insurance regulator; (2)
predominantly uses OTC derivatives for hedging purposes; and (3)
does not have significant OTC derivatives exposure. See Prudential
Regulator Margin and Capital Proposing Release, 76 FR at 27572; CFTC
Margin Proposing Release, 76 FR at 23735-23736. A low risk financial
end user would not be required to deliver initial or variation
margin if the amounts required are less than certain prescribed
thresholds. See id. While not all financial end users present the
same degree of counterparty risk, an exception from the account
equity requirements based on the risk profile of the financial end
user is not being proposed. This is because margin collateral is an
important means of managing credit risk and the concerns expressed
with respect to commercial end users being required to deliver
margin collateral generally do not apply to financial end users as
they customarily deliver margin collateral. As discussed in sections
II.A.1. and II.A.2.b.i. of this release, the proposed capital
standard for nonbank SBSDs is based on the net liquid assets test
embodied in Rule 15c3-1. Under this test, most unsecured receivables
are deducted in full when computing net capital because of their
illiquidity. Proposed new Rule 18a-3 is designed to complement this
treatment of unsecured receivables by limiting the exceptions to the
requirement to collect collateral from counterparties to
circumstances that provide a compelling reason for the trade-off
between the risk-mitigating benefits of collateral and practical
impediments to delivering collateral. With respect to nonbank SBSDs,
there does not appear to be a compelling reason to establish a two-
tiered approach for financial end users. First, financial end users
generally pose more risk than commercial end users. Second, the
different credit risk profiles of financial end users may not always
be clear, which may make it difficult to differentiate between high
and low risk financial end users. Third, market participants have
told the Commission staff that financial end users entering into
security-based swap transactions generally already deliver
collateral to dealers to cover current and potential future
exposure.
---------------------------------------------------------------------------

    For purposes of the rule, the term commercial end user means any
person (other than a natural person) that: (1) Engages primarily in
commercial activities that are not financial in nature and that is not
a financial entity as that term is defined in section 3C(g)(3) of the
Exchange Act; \556\ and (2) is using non-cleared security-based swaps
to hedge or mitigate risk relating to the commercial activities.\557\
The proposed definition of commercial end user is modeled on the
exception to the mandatory clearing provisions for security-based swaps
in section 3C of the Exchange Act.\558\ Among other things, to qualify
for the mandatory clearing exception, one of the counterparties to the
security-based swap transaction must not be a financial entity and must
be using security-based swaps to hedge or mitigate commercial
risk.\559\
---------------------------------------------------------------------------

    \556\ See 15 U.S.C. 78o-3(g)(3). Section 3C(g) of the Exchange
Act defines the term financial entity to mean: (1) a swap dealer;
(2) an SBSD; (3) a major swap participant; (4) an MSBSP; (5) a
commodity pool as defined in section 1a(10) of the CEA; (6) a
private fund as defined in section 202(a) of the Investment Advisors
Act of 1940; (7) an employee benefit plan as defined in paragraphs
(3) and (32) of section 3 of the Employee Retirement Income and
Security Act of 1974 (29 U.S.C. 1002); or (8) a person predominantly
engaged in activities that are in the business of banking, or in
activities that are financial in nature as defined in section 4(k)
of the Bank Holding Company Act of 1956.
    \557\ See paragraph (b)(2) of proposed new Rule 18a-3.
    \558\ Compare 15 U.S.C. 78c-3(g)(1), with paragraph (b)(2) of
proposed new Rule 18a-3.
    \559\ See 15 U.S.C. 78c-3(g)(1).
---------------------------------------------------------------------------

    Under the proposed definition, an individual could not qualify as a
commercial end user. In addition, because the proposed definition
provides that a commercial end user must engage primarily in commercial
activities that are not financial in nature and must not be a financial
entity as defined in section 3C(g)(3) of the Exchange Act, entities
such as banks, broker-dealers, FCMs, SBSDs, swap dealers, MSBSPs, swap
participants, mutual funds, private funds, commodity pools, and
employee benefit plans would not qualify as a commercial end user.\560\
Furthermore, the proposed definition provides that the commercial end
user must be using non-cleared security-based swaps to hedge or
mitigate commercial risk.
---------------------------------------------------------------------------

    \560\ See, e.g., 15 U.S.C. 78c-3(g)(3). The prudential
regulators and the CFTC have proposed definitions of financial end
user and financial entity, respectively, in their non-cleared
security-based swap margin rules in addition to their proposed
definitions of nonfinancial end user. See Prudential Regulator
Margin and Capital Proposing Release, 76 FR at 27571 (defining
financial end user), and CFTC Capital Proposing Release, 76 FR at
23736 (defining financial entity). As discussed above, the CFTC and
prudential regulators are proposing margin requirements that would
differentiate collateral requirements based on whether a financial
end user or financial entity is ``high risk'' or ``low risk.'' Id.
In other words, their proposals would provide for potentially
different treatment for three classes of entities: (1) Nonfinancial
end users; (2) financial end users (low risk and high risk); and (3)
entities that are neither a nonfinancial end user nor a financial
end user. Therefore, they need to define the terms financial end
user and financial entity, respectively. Because proposed new Rule
18a-3 would treat financial end users no differently than entities
that are neither a commercial end user nor a financial end user, the
Commission's proposed margin rule does not contain a definition of
financial end user. However, as discussed below, the proposed rule
would provide different treatment for counterparties that are SBSDs.
---------------------------------------------------------------------------

    The rationale for exempting commercial end users from the
requirement to deliver collateral to meet the account equity
requirements is that these end users often do not deliver collateral by
current practice, and requiring them to do so could adversely impact
their ability to mitigate the risk of their commercial activities by
entering into hedging transactions. If an end user is using non-cleared
security-based swaps for purposes other than hedging (e.g., to take
directional investment positions), the rationale for exempting the end
user from the account equity requirements would not apply. An end user
that is using non-cleared security-based swaps for investment purposes
is not acting like a commercial end user, and, as such, no exemption
would be available under the rule.
    As discussed below in section II.B.2.e. of this release, a nonbank
SBSD would be required to establish, maintain, and document procedures
and guidelines for monitoring the risk of accounts holding non-cleared
security-based swaps.\561\ Among other things, a nonbank SBSD would be
required to have procedures and guidelines for determining, approving,
and periodically reviewing credit limits for each counterparty to a
non-cleared security-based swap.\562\ Consequently, if a nonbank SBSD
does not collect collateral from a commercial end user, it would need
to establish a credit limit for the end user and periodically review
the credit limit in accordance with its risk monitoring
guidelines.\563\ The rule would not prohibit a nonbank SBSD from
requiring margin collateral from a commercial end user.
---------------------------------------------------------------------------

    \561\ See paragraph (e) of proposed new Rule 18a-3.
    \562\ See paragraph (e)(2) of proposed new Rule 18a-3. This is
also consistent with the broker-dealer margin rules. See FINRA Rule
4210(d), which requires that FINRA member firms establish procedures
to: (1) Review limits and types of credit extended to all customers;
(2) formulate their own margin requirements; and (3) review the need
for instituting higher margin requirements, mark-to-markets and
collateral deposits than are required by the Rule for individual
securities or customer accounts. See also FINRA Interpretation
4210(d)/01, available at http://www.finra.org/web/groups/industry/@ip/<EMAIL_ADDRESS>(noting that FINRA
Rule 4210(d) ``requires that members determine the total dollar
amount of credit to be extended to any one customer or on any one
security to limit the potential loss or exposure to the member. It
is important that specific limits be established to prevent any one
customer or group of customers from endangering the member's
capital.'').
    \563\ See id.

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

Exception for Counterparties That Are SBSDs
    The second exception to the account equity requirements in proposed
new Rule 18a-3 would apply to counterparties that are SBSDs.\564\ Two
alternatives with respect to SBSD counterparties are being proposed.
Under the first alternative, a nonbank SBSD would not need to collect
cash, securities, and/or money instruments to collateralize the margin
amount (potential future exposure) in the account of a counterparty
that is another SBSD (``Alternative A''). This approach is consistent
with the broker-dealer margin rules, which generally do not require a
broker-dealer to collect margin collateral from another broker-dealer.
Under the second alternative, a nonbank SBSD would be required to
collect cash, securities and/or money market instruments to
collateralize both the negative equity (current exposure) and the
margin amount (potential future exposure) in the account of a
counterparty that is another SBSD (``Alternative B'').\565\ Moreover,
the cash, securities, and/or money market instruments would be required
to be segregated in an account at an independent third-party custodian
pursuant to the requirements of section 3E(f) of the Exchange Act.\566\
Alternative B is consistent with the proposals of the prudential
regulators and the CFTC.\567\
---------------------------------------------------------------------------

    \564\ See paragraph (c)(1)(iii)(B) of proposed new Rule 18a-3.
    \565\ Alternative B is not an exception to the account equity
requirements in proposed new Rule 18a-3 because it would require
collateral to cover the negative equity and margin amount in an
account of another SBSD. However, its requirement for how the
collateral must be held--at an independent third-party custodian on
behalf of the counterparty--is different from how the proposed rule
requires that collateral from other types of counterparties be held
(other than counterparties that elect segregation under section
3E(f) of the Exchange Act (15 U.S.C. 78c-5(f)).
    \566\ See 15 U.S.C. 78c-5(f).
    \567\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR 27564; CFTC Margin Proposing Release, 76 FR 23732.
---------------------------------------------------------------------------

    The two alternatives are being proposed in order to elicit detailed
comment on each approach in terms of comparing how they would meet the
goals of the Dodd-Frank Act,\568\ address systemic issues relating to
non-cleared security-based swaps, raise practical issues, alter current
market practices and conventions, result in benefits and costs, and
impact the security-based swap markets and the participants in those
markets.
---------------------------------------------------------------------------

    \568\ See 15 U.S.C. 78o-10(e)(3)(A) (``[t]o offset the greater
risk to the security-based swap dealer or major security-based swap
participant and the financial system arising from the use of
security-based swaps that are not cleared,'' the margin requirements
proposed by the Commission and prudential regulators shall ``help
ensure the safety and soundness'' of the SBSD and the MSBSP and ``be
appropriate for the risk associated with non-cleared security-based
swaps held'' by an SBSD and MSBSP).
---------------------------------------------------------------------------

    Under Alternative A, a nonbank SBSD would be required to collect
cash, securities, and/or money market instruments from another SBSD
only to cover the amount of negative equity (the current exposure) in
the account of the counterparty.\569\ Accordingly, under this approach,
the nonbank SBSD would not be required to collect cash, securities,
and/or money market instruments from another SBSD to collateralize the
margin amount (the potential future exposure).\570\ In other words, a
counterparty that is another SBSD would not be required to maintain a
minimum level of positive equity in the counterparty's account.
---------------------------------------------------------------------------

    \569\ See paragraph (c)(1)(iii)(B) of proposed new Rule 18a-3-
Alternative A. To the extent the margin amount was not
collateralized, the nonbank SBSD would be required to take the
proposed capital charge in lieu of margin collateral discussed above
in section II.A.2.b.v. of this release.
    \570\ Id. Like all counterparties to non-cleared security-based
swaps, counterparties that are SBSDs would be subject to the risk
monitoring requirements in paragraph (e) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

    Requiring a nonbank SBSD to deliver collateral to cover potential
future exposure could impact its liquidity. As discussed above in
sections II.A.1. and II.A.2.b.i. of this release, the proposed capital
requirements for nonbank SBSDs are based on a net liquid assets test.
The objective of the test is to require the firm to maintain in excess
of a dollar of highly liquid assets for each dollar of liabilities in
order to facilitate the liquidation of the firm if necessary and
without the need for a formal proceeding. When assets are delivered to
another party as margin collateral, they become unsecured receivables
from the party holding the margin collateral. Consequently, they no
longer are readily available to be liquidated by the delivering party.
In times of market stress, a nonbank SBSD may need to liquidate assets
to raise funds and reduce its leverage. However, if assets are in the
control of another nonbank SBSD, they would not be available for this
purpose. For this reason, the assets would need to be deducted from net
worth when the nonbank SBSD computes net capital under the proposed
capital requirements.\571\ As a result, the nonbank SBSD would need to
maintain the required minimum amount of net capital after taking into
account these deductions.
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    \571\ See 17 CFR 240.15c3-1(c)(2)(iv)(B); paragraph
(c)(1)(iii)(B) of proposed Rule 18a-1. Collateral provided to
another party as margin would be subject to this 100% deduction.
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    Promoting the liquidity of nonbank SBSDs is the policy
consideration underlying Alternative A. In addition, the prudential
regulators and the CFTC have received comments on this issue in
response to their proposals raising concerns about requiring bank SBSDs
and swap dealers to exchange collateral to cover potential future
exposure and to have the collateral held by an independent third-party
custodian. For example, some commenters assert that imposing segregated
initial margin requirements on trades between swap entities would
result in a tremendous cost to the financial system in the form of a
massive liquidity drain, and that swap dealers will lose the ability to
reinvest this collateral to finance other lending or derivatives
transactions, thereby reducing capital formation and increasing
costs.\572\ One commenter stated that, in general, with respect to non-
cleared swaps, charging more initial margin (as compared to cleared
swaps) could have unintended consequences, including the inefficient
use of capital by sophisticated market participants in highly regulated
industries, which could create a drag on the financial system, slow
economic

growth, and diminish customer choice.\573\
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    \572\ See, e.g., letter from Robert Pickel, Executive Vice
Chairman, ISDA, and Kenneth E. Bentsen, Jr., Executive Vice
President, Public Policy and Advocacy, Securities Industry and
Financial Markets Association (``SIFMA''), to David Stawick,
Secretary, CFTC (July 11, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47802&SearchText=SIFMA (``SIFMA/ISDA Comment
Letter to the CFTC''); letter from Robert Pickel, Executive Vice
Chairman, ISDA, and Kenneth E. Bentsen, Jr., Executive Vice
President, Public Policy and Advocacy, SIFMA, to Jennifer J.
Johnson, Secretary, Federal Reserve, et al. (July 6, 2011),
available at http://www.fdic.gov/regulations/laws/federal/2011/11c22ad79.PDF (``SIFMA/ISDA Comment Letter to the Prudential
Regulators''); letter from the Honorable Darrell Issa, Chairman,
Committee on Oversight and Government Reform, U.S. House of
Representatives, to Ben Bernanke, Chairman, Federal Reserve et al.
(July 22, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47943&SearchText=issa, and letter
from Mark Scanlan, Vice President, Agriculture and Rural Policy,
Independent Community Bankers of America, to the CFTC et al. (July
11, 2011), available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47762&SearchText=scanlan. One commenter noted
that there is no statutory requirement for covered swap entities to
hold initial margin of other covered swap entities at an independent
third party custodian. See letter from Christine Cochran, President,
Commodity Markets Council, to the OCC et al. (July 11, 2011),
available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47777&SearchText=cochran. Here and below, this
release refers to public comments on the margin proposals by the
CFTC and the prudential regulators to more fully reflect the
available views without endorsing those comments or expressing a
view as to the validity of the comments.
    \573\ See letter from Mark R. Thresher, Executive Vice
President, Chief Financial Officer, Nationwide, to the OCC (June 24,
2011), available at http://www.federalreserve.gov/SECRS/2011/June/20110628/R-1415/R-1415_062311_81363_349039663039_1.pdf.
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    Another commenter stated that a combination of daily variation
margin, robust operational procedures, legally enforceable netting and
collateral agreements, and regulatory capital requirements provide
comprehensive risk mitigation for collateralized derivatives, and that
any additional initial margin requirements for swaps between swap
entities would be unnecessary and unwarranted.\574\ A commenter argued
that the proposed initial margin requirements are inconsistent with
proven market practice, ignore significant differences in credit
quality among swap dealers and financial entities which justify
different margining treatment, and will lead to excessive amounts of
collateral being required in comparison to the actual risks of the
underlying swap transactions and portfolios.\575\ Finally, a commenter
argued that initial margin requirements should differentiate based on
credit quality, and that the prudential regulators' margin rulemaking
identifies no risk-based justification for layering zero threshold,
bilateral initial margin requirements for all swap dealers above and
beyond their existing variation margin requirements.\576\
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    \574\ See SIFMA/ISDA Comment Letter to the CFTC; SIFMA/ISDA
Comment Letter to the Prudential Regulators. This commenter also
stated that precedent exists in the broker-dealer margin rules for
not imposing any initial margin requirements on trades between swap
entities. Id.
    \575\ See letter from Don Thompson, Managing Director and
Associate General Counsel, J.P. Morgan Chase & Co., to the OCC et
al. (June 24, 2011), available at http://www.federalreserve.gov/SECRS/2011/June/20110627/R-1415/R-1415_062311_81366_349039350535_1.pdf (``J.P. Morgan Letter''). Another commenter
pointed out that life insurers also typically do not post initial
margin and recommended that initial margin requirements be
appropriately sized to reflect the potential exposure during the
close out of a defaulting party. See letter from Carl B. Wilkerson,
Vice President and Chief Counsel, Securities and Litigation,
American Council of Life Insurers, to the OCC et al. (July 11,
2011), available at http://www.federalreserve.gov/SECRS/2011/July/20110728/R-1415/R-1415_071111_81817_507164831320_1.pdf.
    \576\ See J.P. Morgan Letter. This commenter stated that initial
margin is appropriate in some circumstances, but it must take into
account the credit quality of counterparties.
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    On the other hand, a number of comments submitted in response to
the proposals of the prudential regulators and the CFTC supported
bilateral margining and argued that it should be extended to require
SBSDs and swap dealers to exchange margin collateral with all
counterparties.\577\ For example, one commenter stated that the
financial crisis demonstrated that the premise of one-way margin is
flawed.\578\ This commenter stated that two-way margin requirements
would aid safety and soundness by helping a swap dealer and its
counterparty offset their exposures and prevent them from building up
exposures they cannot fulfill.\579\
---------------------------------------------------------------------------

    \577\ See, e.g., letter from Scott C. Goebel, Senior Vice
President, General Counsel, FMR Co., to John Walsh, Acting
Comptroller of the Currency, OCC (July 11, 2011); letter from Kevin
M. Budd, Associate General Counsel, and Todd F. Lurie, Assistant
General Counsel, MetLife, to OCC et al. (July 11, 2011); letter from
John R. Gidman, on behalf of the Association of Institutional
Investors, to Ms. Jennifer Johnson, Secretary, Federal Reserve, et
al. (July 11, 2011); letter from R. Glenn Hubbard, Co-Chair, John L.
Thornton, Co-Chair, and Hal S. Scott, Director, Committee on Capital
Markets Regulation, to John Walsh, Acting Comptroller, OCC (July 11,
2011), available at http://www.federalreserve.gov/SECRS/2011/July/20110719/R-1415/R-1415_071111_81821_322996697020_1.pdf; letter
from Dennis M. Kelleher, President and Chief Executive Officer, and
Wallace C. Turbeville, Derivatives Specialist, Better Markets, Inc.,
to Jennifer J. Johnson, Secretary, Federal Reserve (July 11, 2011),
available at http://www.federalreserve.gov/SECRS/2011/July/20110728/R-1415/R-1415_071111_81861_504963784471_1.pdf; letter from
Americans for Financial Reform, to John Walsh, Acting Comptroller,
OCC (July 11, 2011), available at http://www.federalreserve.gov/SECRS/2011/July/20110728/R-1415/R-1415_071111_81864_448738394756_1.pdf.
    \578\ Letter from Karrie McMillan, General Counsel, Investment
Company Institute, to David Stawick, Secretary, CFTC (July 11,
2011), available at is http://www.ici.org/pdf/25344.pdf (``ICI
Letter'').
    \579\ See the ICI Letter.
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    The prudential regulators explained the reasoning behind their
proposal as follows:

    Non-cleared swaps transactions with counterparties that are
themselves swap entities pose risk to the financial system because
swap entities are large players in swap and security-based swap
markets and therefore have the potential to generate systemic risk
through their swap activities. Because of their interconnectedness
and large presence in the market, the failure of a single swap
entity could cause severe stress throughout the financial system.
Accordingly, it is the preliminary view of the Agencies that all
non-cleared swap transactions with swap entities should require
margin.\580\
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    \580\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27570-27571 (footnote omitted). See also CFTC
Margin Proposing Release, 76 FR at 23735 (``It is the nature of the
dealer business that dealers are at the center of the markets in
which they participate. Similarly, a major swap participant, by its
terms, is a significant trader. Collectively, [swap dealers and
major swap participants] pose greater risk to the markets and the
financial system than other swap market participants. Accordingly,
under the mandate of Section 4s(e), the Commission believes that
they should be required to collect margin from one another.'').

    Alternative B is being proposed in light of the policy
considerations underlying the proposals of the prudential regulators
and the CFTC.\581\ Under Alternative B, a nonbank SBSD would be
required to obtain cash, securities, and/or money market instruments
from another SBSD to cover the negative equity (current exposure) and
margin amount (potential future exposure) in the other SBSD's
account.\582\ In addition, the cash, securities, and/or money market
instruments delivered to cover the margin amount would need to be
carried by an independent third party custodian pursuant to the
requirements of section 3E(f) of the Exchange Act.\583\ Therefore, not
only would there be no exception to the account equity requirement for
counterparties that are SBSDs, but the treatment of the collateral
would be different than for other types of counterparties in that it
would be required to be held by an independent third-party
custodian.\584\
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    \581\ See Prudential Regulator Margin and Capital Proposing
Release, 76 FR 27564; CFTC Margin Proposing Release, 76 FR 23744.
    \582\ See paragraph (c)(1)(iii)(B) of proposed Rule 18a-3--
Alternative B.
    \583\ Id.
    \584\ Id.
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Exception for Counterparties That Elect Segregation Under Section 3E(f)
    Under the third exception to the account equity requirements in
proposed new Rule 18a-3, a nonbank SBSD would not be required to hold
the cash, securities, and/or money market instruments delivered by a
counterparty that is not a commercial end user to cover the margin
amount (potential future exposure), if the counterparty elects to have
the cash, securities, and/or money market instruments segregated
pursuant to section 3E(f) of the Exchange Act.\585\ Section 3E(f) sets
forth provisions under which a counterparty to a non-cleared security-
based swap with an SBSD can require that collateral to cover potential
future exposure must be segregated.\586\ Among other things, section
3E(f) provides that the collateral must be segregated in an account
carried by an independent third-party custodian and designated as a
segregated account for and on behalf of the counterparty.\587\
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    \585\ See paragraph (c)(1)(iii)(C) of proposed new Rule 18a-3.
This exception would not apply to negative equity in the
counterparty's account, which would need to be collateralized by
cash, securities, and/or money market instruments held by the
nonbank SBSD. See 15 U.S.C. 78c-5(f)(2)(B)(i) (providing that the
segregation provisions in section 3E(f) of the Exchange Act do not
apply to variation margin payments).
    \586\ See 15 U.S.C. 78c-5(f)(1)-(3).
    \587\ See 15 U.S.C. 78c-5(f)(3).
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    As discussed below in section II.C. of this release, proposed new
Rule 18a-3 would establish certain conditions that

collateral would need to meet before its value could be included in the
determination of the amount of equity in an account.\588\ Among other
conditions, the collateral would need to be subject to the physical
possession or control of the nonbank SBSD and capable of being
liquidated promptly by the nonbank SBSD without intervention by any
other party.\589\ Margin collateral segregated pursuant to section
3E(f) of the Exchange Act would not meet either of these conditions.
First, the collateral would be in the physical possession or control of
an independent third-party custodian rather than the nonbank SBSD.
Second, the collateral could not be liquidated by the nonbank SBSD
without the intervention of the independent third-party custodian. For
these reasons, the value of the margin collateral held by the
independent third-party custodian could not be included when
determining the amount of equity in the account of the counterparty at
the nonbank SBSD.
---------------------------------------------------------------------------

    \588\ See paragraph (c)(4) of proposed new Rule 18a-3.
    \589\ See paragraphs (c)(4)(i)-(iii) of proposed new Rule 18a-3.
---------------------------------------------------------------------------

Exception for Accounts Holding Legacy Security-Based Swaps
    Under the fourth exception to the account equity requirements in
proposed new Rule 18a-3, a nonbank SBSD would not be required to
collect cash, securities, and/or money market instruments to cover the
negative equity (current exposure) or margin amount (potential future
exposure) in a security-based swap legacy account.\590\ Proposed new
Rule 18a-3 would define security-based swap legacy account to mean an
account that holds no security-based swaps entered into after the
effective date of the rule and that is used to hold only security-based
swaps entered into prior to the effective date of the rule, as well as
collateral for those security-based swaps.\591\ As discussed above in
section II.A.2.b.v. of this release, this exception would be designed
to address the impracticality of renegotiating contracts governing
security-based swap transactions that predate the effectiveness of
proposed new Rule 18a-3 in order to come into compliance with the
account equity requirements in the rule.\592\
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    \590\ See paragraph (c)(1)(iii)(D) of proposed new Rule 18a-3.
While this exception would apply to negative equity in the account
and the margin amount calculated for the account, a nonbank SBSD
would be required to take a 100% deduction from net worth for the
amount of the uncollateralized current exposure and take the
proposed capital charge in lieu of margin collateral discussed above
in section II.A.2.b.v. of this release. See proposed new paragraph
(c)(2)(xiv) of Rule 15c3-1; paragraph (c)(1)(viii) of proposed new
Rule 18a-1. In addition, like all counterparties to non-cleared
security-based swaps, these counterparties would be subject to the
risk monitoring requirements in paragraph (e) of proposed new Rule
18a-3.
    \591\ See paragraph (b)(9) of proposed new Rule 18a-3.
    \592\ As noted above in section II.A.2.b.v. of this release, the
CFTC has proposed a similar exception for legacy swaps. See CFTC
Margin Proposing Release, 76 FR at 23734. The prudential regulators
proposed to permit a covered swap entity to exclude pre-effective
swaps from initial margin calculations, while requiring these
entities to collect variation margin, consistent with industry
practice. See Prudential Regulator Margin and Capital Proposing
Release, 76 FR at 27569.
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Request for Comment
    The Commission generally requests comment on the proposed account
equity requirements for counterparties of nonbank SBSDs in proposed new
Rule 18a-3.\593\ In addition, the Commission requests comment,
including empirical data in support of comments, in response to the
following questions:
---------------------------------------------------------------------------

    \593\ As discussed earlier, the Commission is soliciting comment
below in section II.B.3. of this release on whether to define the
term eligible collateral in a manner similar to the prudential
regulators and the CFTC.
---------------------------------------------------------------------------

    1. Would it be appropriate to limit the assets that could be used
to collateralize the negative equity and margin amounts in an account
to cash, securities, and money market instruments? Are there other
types of assets that should be permitted to meet the account equity
requirements in proposed new Rule 18a-3? If so, identify the other
asset types and compare their liquidity to cash, securities, and money
market instruments.
    2. Is the proposed requirement to take deductions on securities and
money market instruments in calculating the amount of equity in an
account appropriate? If not, explain why not. Are there other measures
that a nonbank SBSD could be required to take to address the risk that
securities and money market instruments may not be able to be
liquidated at current market values to cover the obligations of a
defaulted counterparty? If so, explain how the other measures would be
an adequate substitute to deductions.
    3. Are the proposed conditions (modeled on the Appendix E
conditions) for taking into account collateral in determining the
amount of equity in an account appropriate for proposed new Rule 18a-3?
If not, explain why not. Should any individual condition be eliminated?
If so, explain why. Are there additional conditions that should be
added? If so, identify them and explain how they would promote the goal
of ensuring that collateral can be promptly liquidated to cover the
obligation of a defaulted counterparty.
    4. Is the proposed requirement that a nonbank SBSD take prompt
steps to liquidate securities in an account to the extent necessary to
eliminate an account equity deficiency appropriate? For example, should
there be a specific time-frame (e.g., 1, 2, 3, 4, 5, or some other
number of business days) in which the nonbank SBSD is required to
liquidate securities in the account? If so, explain why a specific
time-frame would be preferable to requiring the nonbank SBSD to act
promptly.
    5. Is the proposed exception to the account equity requirements for
commercial end users appropriate? If not, explain why not. Should
commercial end users be required to collateralize negative equity and
the margin amount in their accounts? Explain why or why not. Should the
exception apply only to the margin amount (i.e., should commercial end
users be required to collateralize the negative equity in their
accounts)? Explain why or why not.
    6. Is the proposed definition of commercial end user appropriate?
If not, explain why not. For example, would the proposed definition of
commercial end user be too broad, or too narrow, in terms of capturing
types of counterparties for which the exception would not be
appropriate? If so, explain why and suggest how the definition could be
modified to address this issue.
    7. Should the rule contain a proposed definition of financial end
user? If so, explain why. For example, would a definition of financial
end user similar to the definitions of the prudential regulators and
CFTC provide needed clarity to the definition of commercial end user
(i.e., by specifying certain entities that are not commercial end
users)?
    8. Do commercial end users use security-based swaps to hedge
commercial risk? If so, identify the type of commercial risk they hedge
with security-based swaps and explain how security-based swaps are used
to hedge this risk.
    9. Should proposed new Rule 18a-3 define the term commercial risk
for the purpose of providing greater clarity as to the meaning of the
term commercial end user? If so, how should the term commercial risk be
defined?
    10. Should there be a two-tiered approach with respect to the
account equity requirements for financial end users based on whether
they are low risk or high risk, similar to the proposed approach of the
prudential regulators and the CFTC? If so, explain why.

    11. How do non-commercial end users presently use security-based
swaps? For example, do they use them to hedge commercial risk? If so,
identify the type of commercial risk they hedge with security-based
swaps.
    12. With respect to counterparties that are SBSDs, how would
Alternatives A and B compare in terms of promoting the goals of the
Dodd-Frank Act, including limiting the risks posed by non-cleared
security-based swaps? How would each address or fail to address
systemic issues relating to non-cleared security-based swaps?
    13. What would be the impact of Alternatives A and B on the
efficient use of capital?
    14. What would be the practical effects of Alternatives A and B on
the capital and liquidity positions, or the financial health generally,
of nonbank SBSDs? How would each alter current market practices and
conventions with respect to collateralizing credit exposures arising
from non-cleared security-based swaps? Are there practical issues with
respect to Alternatives A and B? If so, identify and explain them.
    15. How would the benefits of Alternatives A and B compare? How
would the costs compare?
    16. How would Alternatives A and B impact the market for security-
based swaps? How would they impact participants in those markets?
    17. How would Alternatives A and B promote the clearing of
security-based swaps? For example, would Alternative B--because of the
requirement to fund margin collateral requirements--incentivize nonbank
SBSDs to transact in cleared security-based swaps? If so, explain why.
    18. What would be the potential impact if the Commission adopted
Alternative A and the prudential regulators and the CFTC adopted rules
similar to Alternative B? Consider and explain the impact competitively
and practically.
    19. Would the proposed exception to the account equity requirements
for counterparties that elect segregation under section 3E(f) of the
Exchange Act be appropriate? If not, explain why not.
    20. Would the proposed exception to the account equity requirements
for accounts that elect to hold legacy security-based swaps be
appropriate? If not, explain why not.
    21. Would it be appropriate to permit legacy security-based swaps
to be held in an entity that is not an SBSD? If so, why, and what
conditions should be imposed on such an entity?
    22. Should counterparties be required to post variation margin with
respect to legacy swaps? Is this consistent with current market
practice?