All Things FinReg


On October 11, 2018, the Securities and Exchange Commission (SEC) will have an open meeting to consider whether to reopen the comment period and request additional comments (including potential modifications to proposed rule language) regarding the following:

(1) Capital, margin, and segregation requirements for security-based swap (SBS) dealers and major SBS participants, and amendments to Rule 15c3-1 for broker-dealers that were proposed in October 2012 (Financial Responsibility Proposal)

(2) Amendments proposed in May 2013 that would establish the cross-border treatment of SBS capital, margin, and segregation requirements (Cross-Border Proposal)

(3) An amendment proposed in April 2014 that would establish an additional capital requirement for SBS dealers that do not have a prudential regulator (Prudential Regulator Proposal)

Given the amount of time that has elapsed since these proposals were first published, it is not surprising that the SEC would reopen the comment period for the various proposals. In brief, the original proposals would have done the following:

Financial Responsibility Proposal

As proposed, the Financial Responsibility Proposal would

  • set minimum capital requirements for SBS dealers and major SBS participants (Capital Rules Proposal);
  • establish margin requirements for SBS dealers and major SBS participants (Margin Proposal); and
  • establish segregation requirements for SBS dealers and notification requirements with respect to these requirements for SBS dealers and major SBS participants (Segregation Proposal).

Capital Proposal: The Capital Proposal was modeled heavily after the existing SEC net capital rule, Rule 15c3-1 under the Securities Exchange Act of 1934 (Exchange Act), which in general requires the maintenance of a minimum level of liquid net capital at all times. The Capital Proposal would impose different net capital requirements that depend on (a) whether the entity in question (i) is registered only as an SBS dealer, (ii) is registered as both a broker-dealer and an SBS dealer, or (iii) is a major SBS participant that is not a bank; and (b) whether the entity is using a value-at-risk model to compute net capital. Under the original Capital Proposal, these variables could result in net capital requirements ranging from $20 million to more than $1 billion dollars.

Margin Proposal: The Margin Proposal outlined the processes by which initial and variation margins would be collected for SBS transactions, as well as the minimum amounts of equity required in accounts. The Margin Proposal would also require certain entities to monitor the risk posed by certain SBS counterparties.

Segregation Proposal: The Segregation Proposal would impose requirements regarding (a) the possession or control of excess collateral carried for an account of SBS customers; (b) the establishment and maintenance of special reserve accounts for the exclusive benefit of SBS customers similar to the requirements outlined in the SEC customer protection rule, Rule 15c3-3 under the Exchange Act; and (c) special provisions applicable to non-cleared SBS .

Cross-Border Proposal

Among other things, the Cross-Border Proposal outlined a framework for entity-level requirements for capital, margin, and segregation that would permit certain non-US entities to satisfy the financial responsibility rules by complying with their home jurisdiction’s equivalent requirements, subject to certain conditions.

Prudential Regulator Proposal

Among other things, this proposal would have added a capital charge requirement applicable to standalone SBS dealers that was inadvertently omitted from the Financial Responsibility Proposal. These capital charge provisions are based on those found in Rule 15c3-1 under the Exchange Act.

Preliminary Thoughts

While we will not know what, if any, changes the SEC will make to the proposals outlined above, the reopening of the comment period could mean that the SEC is moving to finalize the regulatory framework applicable to SBS. While this may provide a certain measure of certainty to some market participants, it could also be the beginning of the end to certain exemptions the SEC has issued over the years because of the lack of a completed regulatory framework. That said, market participants that may have been operating SBS entities in reliance on an existing exemption may want to start considering what changes in their operations, if any, will be required now that the SEC appears to be moving forward on its SBS regulatory agenda.