Title 17—Commodity and Securities Exchanges--Volume 1
PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
§ 240.17Ad-16   Notice of assumption or termination of transfer agent services.
(a) A registered transfer agent that ceases to perform transfer agent services on behalf of an issuer of securities, including a registered transfer agent that ceases to perform transfer agent services on behalf of an issuer of securities because of a merger or acquisition by another transfer agent, shall send written notice of such termination to the appropriate qualified registered securities depository on or before the later of ten calendar days prior to the effective date of such termination or the day the transfer agent is notified of the effective date of such termination. Such notice shall include the full name, address, telephone number, and Financial Industry Number Standard (“FINS”) number of the transfer agent ceasing to perform the transfer agent services for the issuer; the issuer's name; the issue or issues handled and their CUSIP number(s); and if known, the name, address, and telephone number of the transfer agent that thereafter will provide transfer services for the issuer. If no successor transfer agent is known, the notice shall include the name and address of a contact person at the issuer.
(b) A registered transfer agent that changes its name or address or that assumes transfer agent services on behalf of an issuer of securities, including a transfer agent that assumes transfer agent services on behalf of an issuer of securities because of a merger or acquisition of another transfer agent, shall send written notice of such to the appropriate qualified registered securities depository on or before the later of ten calendar days prior to the effective date of such change in status or the day the transfer agent is notified of the effective date of such change in status. A notice regarding a change of name or address shall include the full name, address, telephone number, and FINS number of the transfer agent and the location where certificates are received for transfer. A notice regarding the assumption of transfer agent services on behalf of an issuer of securities, including assumption of transfer agent services resulting from the merger or acquisition of another transfer agent, shall include the full name, address, telephone number, and FINS number of the transfer agent assuming the transfer agent services for the issuer; the issuer's name; and the issue or issues handled and their CUSIP number(s).
(c) The notice described in paragraphs (a) and (b) of this section shall be delivered by means of secure communication. For purposes of this section, secure communication shall include telegraph, overnight mail, facsimile, or any other form of secure communication.
(d)(1) The appropriate qualified registered securities depository that receives notices pursuant to paragraphs (a) and (b) of this section shall deliver within 24 hours a copy of such notices to each qualified registered securities depository. A qualified registered securities depository that receives notice pursuant to this section shall deliver a copy of such notices to its own participants within 24 hours.
(2) A qualified registered securities depository may comply with its notice requirements under paragraph (d)(1) of this section by making available the notice of all material information from the notice within 24 hours in a manner set forth in the rules of the qualified registered securities depository.
(3) A qualified registered securities depository shall maintain such notices for a period of not less than two years, the first six months in an easily accessible place. Such notice shall be made available to the Commission or other persons as the Commission may designate by order.
(4) A registered transfer agent that provides notice pursuant to paragraphs (a) and (b) of this section shall maintain such notice for a period of not less than two years, the first six months in an easily accessible place.
(e) For purposes of this section, a qualified registered securities depository shall mean a clearing agency registered under section 17A of the Act (15 U.S.C. 78q-1) that performs clearing agency functions as described in section 3(a)(23)(A)(i) of the Act (15 U.S.C. 78c(a)(23)(A)(i)) and that has rules and procedures concerning its responsibility for maintaining, updating, and providing appropriate access to the information it receives pursuant to this section.
(f) For purposes of this section, an appropriate qualified registered securities depository shall mean the qualified registered securities depository that the Commission so designates by order or, in the absence of such designation, the qualified registered securities depository that is the largest holder of record of all qualified registered securities depositories as of the most recent record date.
§ 240.17Ad-17   Lost securityholders and unresponsive payees.
(a)(1) Every recordkeeping transfer agent whose master securityholder file includes accounts of lost securityholders and every broker or dealer that has customer security accounts that include accounts of lost securityholders shall exercise reasonable care to ascertain the correct addresses of such securityholders. In exercising reasonable care to ascertain such lost securityholders' correct addresses, each such recordkeeping transfer agent and each such broker or dealer shall conduct two database searches using at least one information database service. The transfer agent, broker, or dealer shall search by taxpayer identification number or by name if a search based on taxpayer identification number is not reasonably likely to locate the securityholder. Such database searches must be conducted without charge to a lost securityholder and with the following frequency:
(i) Between three and twelve months of such securityholder becoming a lost securityholder; and
(ii) Between six and twelve months after the first search for such lost securityholder by the transfer agent, broker, or dealer.
(2) A transfer agent, broker, or dealer may not use a search method or service to establish contact with lost securityholders that results in a charge to a lost securityholder prior to completing the searches set forth in paragraph (a)(1) of this section.
(3) A transfer agent, broker, or dealer need not conduct the searches set forth in paragraph (a)(1) of this section for a lost securityholder if:
(i) It has received documentation that such securityholder is deceased; or
(ii) The aggregate value of assets listed in the lost securityholder's account, including all dividend, interest, and other payments due to the lost securityholder and all securities owned by the lost securityholder as recorded in the master securityholder files of the transfer agent or in the customer security account records of the broker or dealer, is less than $25; or
(iii) The securityholder is not a natural person.
(b) For purposes of this section:
(1) Information data base service means either:
(i) Any automated data base service that contains addresses from the entire United States geographic area, contains the names of at least 50% of the United States adult population, is indexed by taxpayer identification number or name, and is updated at least four times a year; or
(ii) Any service or combination of services which produces results comparable to those of the service described in paragraph (b)(1)(i) of this section in locating lost securityholders.
(2) Lost securityholder means a securityholder:
(i) To whom an item of correspondence that was sent to the securityholder at the address contained in the transfer agent's master securityholder file or customer security account records of the broker or dealer has been returned as undeliverable; provided, however, that if such item is re-sent within one month to the lost securityholder, the transfer agent, broker, or dealer may deem the securityholder to be a lost securityholder as of the day the resent item is returned as undeliverable; and
(ii) For whom the transfer agent, broker, or dealer has not received information regarding the securityholder's new address.
(c)(1) The paying agent, as defined in paragraph (c)(2) of this section, shall provide not less than one written notification to each unresponsive payee, as defined in paragraph (c)(3) of this section, stating that such unresponsive payee has been sent a check that has not yet been negotiated. Such notification may be sent with a check or other mailing subsequently sent to the unresponsive payee but must be provided no later than seven (7) months (or 210 days) after the sending of the not yet negotiated check. The paying agent shall not be required to send a written notice to an unresponsive payee if such unresponsive payee would be considered a lost securityholder by a transfer agent, broker, or dealer.
(2) The term paying agent shall include any issuer, transfer agent, broker, dealer, investment adviser, indenture trustee, custodian, or any other person that accepts payments from the issuer of a security and distributes the payments to the holders of the security.
(3) A securityholder shall be considered an unresponsive payee if a check is sent to the securityholder by the paying agent and the check is not negotiated before the earlier of the paying agent's sending the next regularly scheduled check or the elapsing of six (6) months (or 180 days) after the sending of the not yet negotiated check. A securityholder shall no longer be considered an unresponsive payee when the securityholder negotiates the check or checks that caused the securityholder to be considered an unresponsive payee.
(4) A paying agent shall be excluded from the requirements of paragraph (c)(1) of this section where the value of the not yet negotiated check is less than $25.
(5) The requirements of paragraph (c)(1) of this section shall have no effect on state escheatment laws.
(d) Every recordkeeping transfer agent, every broker or dealer that has customer security accounts, and every paying agent shall maintain records to demonstrate compliance with the requirements set forth in this section, which records shall include written procedures that describe the transfer agent's, broker's, dealer's, or paying agent's methodology for complying with this section, and shall retain such records in accordance with Rule 17Ad-7(i) (§ 240.17Ad-7(i)).
§ 240.17Ad-18   Year 2000 Reports to be made by certain transfer agents.
(a) Each registered non-bank transfer agent must file Part I of Form TA-Y2K (§ 249.619 of this chapter) with the Commission describing the transfer agent's preparation for Year 2000 Problems. Part I of Form TA-Y2K shall be filed no later than August 31, 1998, and April 30, 1999. Part I of Form TA-Y2K shall reflect the transfer agent's preparation for the Year 2000 as of July 15, 1998, and March 15, 1999, respectively.
(b) Each registered non-bank transfer agent, except for those transfer agents that qualify for the exemption in paragraph (d) of § 240.17Ad-13, must file with the Commission Part II of Form TA-Y2K (§ 249.619 of this chapter) in addition to Part I of Form TA-Y2K. Part II of Form TA-Y2K report shall address the following topics:
(1) Whether the board of directors (or similar body) of the transfer agent has approved and funded plans for preparing and testing its computer systems for Year 2000 Problems;
(2) Whether the plans of the transfer agent exist in writing and address all mission critical computer systems of the transfer agent wherever located throughout the world;
(3) Whether the transfer agent has assigned existing employees, has hired new employees, or has engaged third parties to provide assistance in addressing Year 2000 Problems; and if so, a description of the work that these groups of individuals have performed as of the date of each report;
(4) The current progress on each stage of preparation for potential problems caused by Year 2000 Problems. These stages are:
(i) Awareness of potential Year 2000 Problems;
(ii) Assessment of what steps the transfer agent must take to address Year 2000 Problems;
(iii) Implementation of the steps needed to address Year 2000 Problems;
(iv) Internal testing of software designed to address Year 2000 Problems, including the number and description of the material exceptions resulting from such testing that are unresolved as of the reporting date;
(v) Point-to point or industry-wide testing of software designed to address Year 2000 Problems (including testing with other transfer agents, other financial institutions, and customers), including the number and description of the material exceptions resulting from such testing that are unresolved as of the reporting date; and
(vi) Implementation of tested software that will address Year 2000 Problems;
(5) Whether the transfer agent has written contingency plans in the event that, after December 31, 1999, it has computer problems caused by Year 2000 Problems; and
(6) What levels of the transfer agent's management are responsible for addressing potential problems caused by Year 2000 Problems, including a description of the responsibilities for each level of management regarding the Year 2000 Problems;
(7) Any additional material information in both reports concerning its management of Year 2000 Problems that could help the Commission assess the transfer agent's readiness for the Year 2000.
(8) Part II of Form TA-Y2K (§ 249.619 of this chapter) shall be filed no later than August 31, 1998, and April 30, 1999. Part II of Form TA-Y2K shall reflect the transfer agent's preparation for the Year 2000 as of July 15, 1998, and March 15, 1999, respectively.
(c) Any non-bank transfer agent that registers between the adoption of the final rule and December 31, 1999, must file with the Commission Part I of Form TA-Y2K (§ 249.619 of this chapter) no later than 30 days after their registration becomes effective. New transfer agents whose registration with the Commission becomes effective between January 1, 1999, and April 30, 1999, would be required to file the second report due on April 30, 1999.
(d) For purposes of this section, the term Year 2000 Problem shall include problems arising from:
(1) Computer software incorrectly reading the date “01/01/00” as being the year 1900 or another incorrect year;
(2) Computer software incorrectly identifying a date in the Year 1999 or any year thereafter;
(3) Computer software failing to detect that the Year 2000 is a leap year; or
(4) Any other computer software error that is directly or indirectly caused by paragraph (d)(1), (2), or (3) of this section.
(e) For purposes of this section, the term non-bank transfer agent means a transfer agent whose:
(1) Appropriate regulatory agency, as that term is defined by 15 U.S.C. 78(c)(34)(B), is the Securities and Exchange Commission; and
(2) Is not a savings association, as defined by Section 3 of the Federal Deposit Insurance Act, 12 U.S.C. 1813, which is regulated by the Office of Thrift Supervision.
(f) Nature and form of reports. No later than April 30, 1999, every non-bank transfer agent required to file Part II of Form TA-Y2K (§ 249.619 of this chapter) pursuant to paragraph (b)(8) of this section shall file with its Form TA-Y2K an original and two copies of a report prepared by an independent public accountant regarding the non-bank transfer agent's process, as of March 15, 1999, for addressing Year 2000 Problems with the Commission's principal office in Washington, DC. The independent public accountant's report shall be prepared in accordance with standards that have been reviewed by the Commission and that have been issued by a national organization that is responsible for promulgating authoritative accounting and auditing standards.
§ 240.17Ad-19   Requirements for cancellation, processing, storage, transportation, and destruction or other disposition of securities certificates.
(a) Definitions. For purposes of this section:
(1) The terms cancelled or cancellation means the process in which a securities certificate:
(i) Is physically marked to clearly indicate that it no longer represents a claim against the issuer; and
(ii) Is voided on the records of the transfer agent.
(2) The term cancelled certificate facility means any location where securities certificates are cancelled and thereafter processed, stored, transported, destroyed or otherwise disposed of.
(3) The term certificate number means a unique identification or serial number that is assigned and affixed by an issuer or transfer agent to each securities certificate.
(4) The term controlled access means the practice of permitting the entry of only authorized personnel to areas where securities certificates are cancelled and thereafter processed, stored, transported, destroyed or otherwise disposed of.
(5) The term CUSIP number means the unique identification number that is assigned to each securities issue.
(6) The term destruction means the physical ruination of a securities certificate by a transfer agent as part of the certificate destruction procedures that make the reconstruction of the certificate impossible.
(7) The term otherwise disposed of means any disposition other than by destruction.
(8) The term securities certificate has the same meaning that it has in § 240.17f-1(a)(6).
(b) Required procedures for the cancellation, storage, transportation, destruction, or other disposition of securities certificates. Every transfer agent involved in the handling, processing, or storage of securities certificates shall establish and implement written procedures for the cancellation, storage, transportation, destruction, or other disposition of securities certificates. This requirement applies to any agent that the transfer agent uses to perform any of these activities.
(c) Written procedures. The written procedures required by paragraph (b) of this section at a minimum shall provide that:
(1) There is controlled access to any cancelled certificate facility;
(2) Each cancelled certificate be marked with the word “CANCELLED” by stamp or perforation on the face of the certificate unless the transfer agent has procedures adopted pursuant to this rule for the destruction of cancelled certificates within three business days of their cancellation;
(3) A record that is indexed and retrievable by CUSIP and certificate number that contains the CUSIP number, certificate number with any prefix or suffix, denomination, registration, issue date, and cancellation date of each cancelled certificate;
(4) A record that is indexed and retrievable by CUSIP and certificate number of each destroyed securities certificate or securities certificate otherwise disposed of, the records must contain for each destroyed or otherwise disposed of certificate the CUSIP number, certificate number with any prefix or suffix, denomination, registration, issue date, and cancellation date, and additionally for any certificate otherwise disposed of a record of how it was disposed of, the name and address of the party to whom it was disposed, and the date of disposition;
(5) The physical transportation of cancelled certificates be made in a secure manner and that the transfer agent maintain separately a record of the CUSIP number and certificate number of each certificate in transit;
(6) Authorized personnel of the transfer agent or its designee supervise and witness the intentional destruction of any cancelled certificate and retain copies of all records relating to certificates which were destroyed; and
(7) Reports to the Lost and Stolen Securities Program be effected in a timely and complete manner, as provided in § 240.17f-1 of any cancelled certificate that is lost, stolen, missing, or counterfeit.
(d) Recordkeeping. Every transfer agent subject to this section shall maintain records that demonstrate compliance with the requirements set forth in this section and that describe the transfer agent's methodology for complying with this section for three years, the first year in an easily accessible place.
(e) Exemptive authority. Upon written application or upon its own motion, the Commission may grant an exemption from any of the provisions of this section, either unconditionally or on specific terms and conditions, to any transfer agent or any class of transfer agents and to any securities certificate or any class of securities certificates.
§ 240.17Ad-20   Issuer restrictions or prohibitions on ownership by securities intermediaries.
(a) Except as provided in paragraph (c) of this section, no registered transfer agent shall transfer any equity security registered pursuant to section 12 or any equity security that subjects an issuer to reporting under section 15(d) of the Act (15 U.S.C. 78 l or 15 U.S.C. 78o(d)) if such security is subject to any restriction or prohibition on transfer to or from a securities intermediary in its capacity as such.
(b) The term securities intermediary means a clearing agency registered under section 17A of the Act (15 U.S.C. 78q-1) or a person, including a bank, broker, or dealer, that in the ordinary course of its business maintains securities accounts for others in its capacity as such.
(c) The provisions of this section shall not apply to any equity security issued by a partnership as defined in rule 901(b) of Regulation S-K (§ 229.901(b) of this chapter).
§ 240.17Ad-21T   Operational capability in a Year 2000 environment.
(a) This section applies to every registered non-bank transfer agent that uses computers in the conduct of its business as a transfer agent.
(b)(1) You have a material Year 2000 problem if, at any time on or after August 31, 1999:
(i) Any of your mission critical computer systems incorrectly identifies any date in the Year 1999 or the Year 2000, and
(ii) The error impairs or, if uncorrected, is likely to impair, any of your mission critical systems under your control.
(2) You will be presumed to have a material Year 2000 problem if, at any time on or after August 31, 1999, you:
(i) Do not have written procedures reasonably designed to identify, assess, and remediate any material Year 2000 problems in your mission critical systems under your control;
(ii) Have not verified your Year 2000 remediation efforts through reasonable internal testing of your mission critical systems under your control and reasonable testing of your external links under your control; or
(iii) Have not remediated all exceptions related to your mission critical systems contained in any independent public accountant's report prepared on your behalf pursuant to § 240.17Ad-18(f).
(c) If you have or are presumed to have a material Year 2000 problem, you must immediately notify the Commission and your issuers of the problem. You must send this notice to the Commission by overnight delivery to the Division of Market Regulation, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-6628 Attention: Y2K Compliance.
(d)(1) If you are a registered non-bank transfer agent that has or is presumed to have a material Year 2000 problem, you may not, on or after August 31, 1999, engage in any transfer agent function, including:
(i) Countersigning such securities upon issuance;
(ii) Monitoring the issuance of such securities with a view to preventing unauthorized issuance;
(iii) Registering the transfer of such securities;
(iv) Exchanging or converting such securities; or
(v) Transferring record ownership of securities by bookkeeping entry without physical issuance of securities certificates.
(2) Notwithstanding paragraph (d)(1) of this section, you may continue to engage in transfer agent functions:
(i) Until December 1, 1999, if you have submitted a certificate to the Commission in compliance with paragraph (e) of this section; or
(ii) Solely to the extent necessary to effect an orderly cessation or transfer of these functions.
(e)(1)(i) If you are a registered non-bank transfer agent that has or is presumed to have a material Year 2000 problem, you may, in addition to providing the Commission the notice required by paragraph (c) of this section, provide the Commission and your issuers a certificate signed by your chief executive officer (or an individual with similar authority) stating:
(A) You are in the process of remediating your material Year 2000 problem;
(B) You have scheduled testing of your affected mission critical systems to verify that the material Year 2000 problem has been remediated, and specify the testing dates;
(C) The date by which you anticipate completing remediation of the material Year 2000 problem in your mission critical systems; and
(D) Based on inquiries and to the best of the chief executive officer's knowledge, you do not anticipate that the existence of the material Year 2000 problem in your mission critical systems will impair your ability, depending on the nature of your business, to assure the prompt and accurate transfer and processing of securities, the maintenance of master securityholder files, or the production and retention of required records; and you anticipate that the steps referred to in paragraphs (e)(1)(i)(A) through (C) of this section will result in remedying the material Year 2000 problem on or before November 15, 1999.
(ii) If the information contained in any certificate provided to the Commission pursuant to paragraph (e) of this section is or becomes misleading or inaccurate for any reason, you must promptly file an updated certificate correcting such information. In addition to the information contained in the certificate, you may provide the Commission with any other information necessary to establish that your mission critical systems will not have material Year 2000 problems on or after November 15, 1999.
(2) If you have submitted a certificate pursuant to paragraph (e)(1) of this section, you must submit a certificate to the Commission and your issuers signed by your chief executive officer (or an individual with similar authority) on or before November 15, 1999, stating that, based on inquiries and to the best of the chief executive officer's knowledge, you have remediated your Year 2000 problem or that you will cease operations. This certificate must be sent to the Commission by overnight delivery to the Division of Market Regulation, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-6628 Attention: Y2K Compliance.
(f) Notwithstanding paragraph (d)(2) of this section, you must comply with the requirements of paragraph (d)(1) of this section if you have been so ordered by the Commission or by a court.
(g) Beginning August 31, 1999, and ending March 31, 2000, you must make backup records for all master securityholder files at the close of each business day and must preserve these backup records for a rolling five business day period in a manner that will allow for the transfer and conversion of the records to a successor transfer agent. If you have a material Year 2000 problem, you must preserve for at least one year the five day backup records immediately preceding the day the problem was discovered. In addition, you must make at the close of business on December 27 through 31, 1999, a backup copy for all master securityholder files and preserve these records for at least one year. Such backup records must permit the timely restoration of such systems to their condition existing prior to experiencing the material Year 2000 problem. Copies of the backup records must be kept in an easily accessible place but must not be located with or held in the same computer system as the primary records, and you must be able to immediately produce or reproduce them. You must furnish promptly to a representative of the Commission such legible, true, and complete copies of those records, as may be requested.
(h) For the purposes of this section:
(1) The term mission critical system means any system that is necessary, depending on the nature of your business, to assure the prompt and accurate transfer and processing of securities, the maintenance of master securityholder files, and the production and retention of required records as described in paragraph (d) of this section;
(2) The term customer includes an issuer, transfer agent, or other person for which you provide transfer agent services;
(3) The term registered non-bank transfer agent means a transfer agent, whose appropriate regulatory agency is the Commission and not the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, or the Federal Deposit Insurance Corporation; and
(4) The term master securityholder file has the same definition as defined in § 240.17Ad-9(b).
(i) This temporary section will expire on July 1, 2001.
§ 240.17ad-22   Standards for clearing agencies.
(a) Definitions. For purposes of this section:
Affiliated counterparty means any counterparty which meets the following criteria:
(i) The counterparty is either a bank (as defined in 15 U.S.C. 78c(6)), broker (as defined in 15 U.S.C. 78c(4)), dealer (as defined in 15 U.S.C. 78c(5)), or futures commission merchant (as defined in 7 U.S.C. 1a(28)), or any entity regulated as a bank, broker, dealer, or futures commission merchant in its home jurisdiction;
(ii) The counterparty holds, directly or indirectly, a majority ownership interest in the direct participant, or the direct participant, directly or indirectly, holds a majority ownership interest in the counterparty, or a third party, directly or indirectly, holds a majority ownership interest in both the direct participant and the counterparty; and
(iii) The counterparty, direct participant, or third party referenced in paragraph (ii) of this definition as holding the majority ownership interest would be required to report its financial statements on a consolidated basis under U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of the majority-owned party or of both majority-owned parties.
Backtesting means an ex-post comparison of actual outcomes with expected outcomes derived from the use of margin models.
Central bank means a reserve bank or monetary authority of a central government (including the Board of Governors of the Federal Reserve System or any of the Federal Reserve Banks) and the Bank for International Settlements.
Central counterparty means a clearing agency that interposes itself between the counterparties to securities transactions, acting functionally as the buyer to every seller and the seller to every buyer.
Central securities depository means a clearing agency that is a securities depository as described in Section 3(a)(23)(A) of the Act (15 U.S.C. 78c(a)(23)(A)).
Clearing agency involved in activities with a more complex risk profile means a clearing agency registered with the Commission under Section 17A of the Act (15 U.S.C. 78q-1) that:
(i) Provides central counterparty services for security-based swaps;
(ii) Has been determined by the Commission to be involved in activities with a more complex risk profile at the time of its initial registration; or
(iii) Is subsequently determined by the Commission to be involved in activities with a more complex risk profile pursuant to § 240.17Ab2-2(b).
Covered clearing agency means a registered clearing agency that provides the services of a central counterparty or central securities depository.
Designated clearing agency means a clearing agency registered with the Commission under Section 17A of the Exchange Act (15 U.S.C. 78q-1) that is designated systemically important by the Financial Stability Oversight Council pursuant to the Payment, Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5461 et seq. ) and for which the Commission is the supervisory agency as defined in Section 803(8) of the Payment, Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5461 et seq. ).
Eligible secondary market transaction refers to a secondary market transaction in U.S. Treasury securities of a type accepted for clearing by a registered covered clearing agency that is:
(i) A repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant; or
(ii) A purchase or sale, between a direct participant and:
(A) Any counterparty, if the direct participant of the covered clearing agency brings together multiple buyers and sellers using a trading facility (such as a limit order book) and is a counterparty to both the buyer and seller in two separate transactions; or
(B) Registered broker-dealer, government securities broker, or government securities dealer; except that:
(iii) Any purchase or sale transaction in U.S. Treasury securities or repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a central bank, a sovereign entity, an international financial institution, or a natural person shall be excluded from the definition set forth in this section of an eligible secondary market transaction;
(iv) Any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a covered clearing agency providing central counterparty services or a derivatives clearing organization ( see 7 U.S.C. 7a-1 and 17 CFR 39.3), or is regulated as a central counterparty in its home jurisdiction, shall be excluded from the definition set forth in this section of an eligible secondary market transaction;
(v) Any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a state or local government shall be excluded from the definition set forth in this section of an eligible secondary market transaction;
(vi) Any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities entered into between a direct participant and an affiliated counterparty shall be excluded from the definition set forth in this section of an eligible secondary market transaction, provided that the affiliated counterparty submit for clearance and settlement all other repurchase or reverse repurchase agreements collateralized by U.S. Treasury securities to which the affiliate is a party.
Financial market utility has the same meaning as defined in Section 803(6) of the Payment, Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5462(6)).
International financial institution means the African Development Bank; African Development Fund; Asian Development Bank; Banco Centroamericano de Integración Económica; Bank for Economic Cooperation and Development in the Middle East and North Africa; Caribbean Development Bank; Corporación Andina de Fomento; Council of Europe Development Bank; European Bank for Reconstruction and Development; European Investment Bank; European Investment Fund; European Stability Mechanism; Inter-American Development Bank; Inter-American Investment Corporation; International Bank for Reconstruction and Development; International Development Association; International Finance Corporation; International Monetary Fund; Islamic Development Bank; Multilateral Investment Guarantee Agency; Nordic Investment Bank; North American Development Bank; and any other entity that provides financing for national or regional development in which the U.S. Government is a shareholder or contributing member.
Link means, for purposes of paragraph (e)(20) of this section, a set of contractual and operational arrangements between two or more clearing agencies, financial market utilities, or trading markets that connect them directly or indirectly for the purposes of participating in settlement, cross margining, expanding their services to additional instruments or participants, or for any other purposes material to their business.
Model validation means an evaluation of the performance of each material risk management model used by a covered clearing agency (and the related parameters and assumptions associated with such models), including initial margin models, liquidity risk models, and models used to generate clearing or guaranty fund requirements, performed by a qualified person who is free from influence from the persons responsible for the development or operation of the models or policies being validated.
Net capital as used in paragraph (b)(7) of this section means net capital as defined in § 240.15c3-1 for broker-dealers or any similar risk adjusted capital calculation for all other prospective clearing members.
Normal market conditions as used in paragraphs (b)(1) and (2) of this section means conditions in which the expected movement of the price of cleared securities would produce changes in a clearing agency's exposures to its participants that would be expected to breach margin requirements or other risk control mechanisms only one percent of the time.
Participant family means that if a participant directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, another participant then the affiliated participants shall be collectively deemed to be a single participant family for purposes of paragraphs (b)(3), (d)(14), (e)(4), and (e)(7) of this section.
Potential future exposure means the maximum exposure estimated to occur at a future point in time with an established single-tailed confidence level of at least 99 percent with respect to the estimated distribution of future exposure.
Qualifying liquid resources means, for any covered clearing agency, the following, in each relevant currency:
(i) Cash held either at the central bank of issue or at creditworthy commercial banks;
(ii) Assets that are readily available and convertible into cash through prearranged funding arrangements, such as:
(A) Committed arrangements without material adverse change provisions, including:
( 1 ) Lines of credit;
( 2 ) Foreign exchange swaps; and
( 3 ) Repurchase agreements; or
(B) Other prearranged funding arrangements determined to be highly reliable even in extreme but plausible market conditions by the board of directors of the covered clearing agency following a review conducted for this purpose not less than annually; and
(iii) Other assets that are readily available and eligible for pledging to (or conducting other appropriate forms of transactions with) a relevant central bank, if the covered clearing agency has access to routine credit at such central bank in a jurisdiction that permits said pledges or other transactions by the covered clearing agency.
Security-based swap means a security-based swap as defined in Section 3(a)(68) of the Act (15 U.S.C. 78c(a)(68)).
Sensitivity analysis means an analysis that involves analyzing the sensitivity of a model to its assumptions, parameters, and inputs that:
(i) Considers the impact on the model of both moderate and extreme changes in a wide range of inputs, parameters, and assumptions, including correlations of price movements or returns if relevant, which reflect a variety of historical and hypothetical market conditions;
(ii) Uses actual portfolios and, where applicable, hypothetical portfolios that reflect the characteristics of proprietary positions and customer positions;
(iii) Considers the most volatile relevant periods, where practical, that have been experienced by the markets served by the clearing agency; and
(iv) Tests the sensitivity of the model to stressed market conditions, including the market conditions that may ensue after the default of a member and other extreme but plausible conditions as defined in a covered clearing agency's risk policies.
Sovereign entity means a central government (including the U.S. Government), or an agency, department, or ministry of a central government.
State or local government means a state or any political subdivision thereof, or an agency or instrumentality of a State or any political subdivision thereof, but shall not include any pension or retirement plan established and maintained by a State, its political subdivisions, or any agency or instrumentality of a State or its political subdivisions, for the benefit of its employees.
Stress testing means the estimation of credit or liquidity exposures that would result from the realization of potential stress scenarios, such as extreme price changes, multiple defaults, or changes in other valuation inputs and assumptions.
Systemically important in multiple jurisdictions means, with respect to a covered clearing agency, a covered clearing agency that has been determined by the Commission to be systemically important in more than one jurisdiction pursuant to § 240.17Ab2-2.
Transparent means, for the purposes of paragraphs (e)(1), (2), and (10) of this section, to the extent consistent with other statutory and Commission requirements on confidentiality and disclosure, that documentation required under paragraphs (e)(1), (2), and (10) is disclosed to the Commission and, as appropriate, to other relevant authorities, to clearing members and to customers of clearing members, to the owners of the covered clearing agency, and to the public.
U.S. Treasury security means any security issued by the U.S. Department of the Treasury.
(b) A registered clearing agency that performs central counterparty services shall establish, implement, maintain and enforce written policies and procedures reasonably designed to:
(1) Measure its credit exposures to its participants at least once a day and limit its exposures to potential losses from defaults by its participants under normal market conditions so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control.
(2) Use margin requirements to limit its credit exposures to participants under normal market conditions and use risk-based models and parameters to set margin requirements and review such margin requirements and the related risk-based models and parameters at least monthly.
(3) Maintain sufficient financial resources to withstand, at a minimum, a default by the participant family to which it has the largest exposure in extreme but plausible market conditions; provided that a registered clearing agency acting as a central counterparty for security-based swaps shall maintain additional financial resources sufficient to withstand, at a minimum, a default by the two participant families to which it has the largest exposures in extreme but plausible market conditions, in its capacity as a central counterparty for security-based swaps. Such policies and procedures may provide that the additional financial resources may be maintained by the security-based swap clearing agency generally or in separately maintained funds.
(4) Provide for an annual model validation consisting of evaluating the performance of the clearing agency's margin models and the related parameters and assumptions associated with such models by a qualified person who is free from influence from the persons responsible for the development or operation of the models being validated.
(5) Provide the opportunity for a person that does not perform any dealer or security-based swap dealer services to obtain membership on fair and reasonable terms at the clearing agency to clear securities for itself or on behalf of other persons.
(6) Have membership standards that do not require that participants maintain a portfolio of any minimum size or that participants maintain a minimum transaction volume.
(7) Provide a person that maintains net capital equal to or greater than $50 million with the ability to obtain membership at the clearing agency, provided that such persons are able to comply with other reasonable membership standards, with any net capital requirements being scalable so that they are proportional to the risks posed by the participant's activities to the clearing agency; provided, however, that the clearing agency may provide for a higher net capital requirement as a condition for membership at the clearing agency if the clearing agency demonstrates to the Commission that such a requirement is necessary to mitigate risks that could not otherwise be effectively managed by other measures and the Commission approves the higher net capital requirement as part of a rule filing or clearing agency registration application.
(c) Record of financial resources and annual audited financial statements. (1) Each fiscal quarter (based on calculations made as of the last business day of the clearing agency's fiscal quarter), or at any time upon Commission request, a registered clearing agency that performs central counterparty services shall calculate and maintain a record, in accordance with § 240.17a-1 of this chapter, of the financial and qualifying liquid resources necessary to meet the requirements, as applicable, of paragraphs (b)(3), (e)(4), and (e)(7) of this section, and sufficient documentation to explain the methodology it uses to compute such financial resources or qualifying liquid resources requirement.
(2) Within 60 days after the end of its fiscal year, each registered clearing agency shall post on its Web site its annual audited financial statements. Such financial statements shall:
(i) Include, for the clearing agency and its subsidiaries, consolidated balance sheets as of the end of the two most recent fiscal years and statements of income, changes in stockholders' equity and other comprehensive income and cash flows for each of the two most recent fiscal years;
(ii) Be prepared in accordance with U.S. generally accepted accounting principles, except that for a clearing agency that is a corporation or other organization incorporated or organized under the laws of any foreign country the consolidated financial statements may be prepared in accordance with U.S. generally accepted accounting principles or International Financial Reporting Standards as issued by the International Accounting Standards Board;
(iii) Be audited in accordance with standards of the Public Company Accounting Oversight Board by a registered public accounting firm that is qualified and independent in accordance with 17 CFR 210.2-01; and
(iv) Include a report of the registered public accounting firm that complies with paragraphs (a) through (d) of 17 CFR 210.2-02.
(d) Each registered clearing agency that is not a covered clearing agency shall establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable:
(1) Provide for a well-founded, transparent, and enforceable legal framework for each aspect of its activities in all relevant jurisdictions.
(2) Require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency; have procedures in place to monitor that participation requirements are met on an ongoing basis; and have participation requirements that are objective and publicly disclosed, and permit fair and open access.
(3) Hold assets in a manner that minimizes risk of loss or of delay in its access to them; and invest assets in instruments with minimal credit, market and liquidity risks.
(4) Identify sources of operational risk and minimize them through the development of appropriate systems, controls, and procedures; implement systems that are reliable, resilient and secure, and have adequate, scalable capacity; and have business continuity plans that allow for timely recovery of operations and fulfillment of a clearing agency's obligations.
(5) Employ money settlement arrangements that eliminate or strictly limit the clearing agency's settlement bank risks, that is, its credit and liquidity risks from the use of banks to effect money settlements with its participants; and require funds transfers to the clearing agency to be final when effected.
(6) Be cost-effective in meeting the requirements of participants while maintaining safe and secure operations.
(7) Evaluate the potential sources of risks that can arise when the clearing agency establishes links either cross-border or domestically to clear or settle trades, and ensure that the risks are managed prudently on an ongoing basis.
(8) Have governance arrangements that are clear and transparent to fulfill the public interest requirements in Section 17A of the Act (15 U.S.C. 78q-1) applicable to clearing agencies, to support the objectives of owners and participants, and to promote the effectiveness of the clearing agency's risk management procedures.
(9) Provide market participants with sufficient information for them to identify and evaluate the risks and costs associated with using its services.
(10) Immobilize or dematerialize securities certificates and transfer them by book entry to the greatest extent possible when the clearing agency provides central securities depository services.
(11) Make key aspects of the clearing agency's default procedures publicly available and establish default procedures that ensure that the clearing agency can take timely action to contain losses and liquidity pressures and to continue meeting its obligations in the event of a participant default.
(12) Ensure that final settlement occurs no later than the end of the settlement day; and require that intraday or real-time finality be provided where necessary to reduce risks.
(13) Eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.
(14) Institute risk controls, including collateral requirements and limits to cover the clearing agency's credit exposure to each participant family exposure fully, that ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle when the clearing agency provides central securities depository services and extends intraday credit to participants.
(15) State to its participants the clearing agency's obligations with respect to physical deliveries and identify and manage the risks from these obligations.
(e) Each covered clearing agency shall establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable:
(1) Provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.
(2) Provide for governance arrangements that:
(i) Are clear and transparent;
(ii) Clearly prioritize the safety and efficiency of the covered clearing agency;
(iii) Support the public interest requirements in Section 17A of the Act (15 U.S.C. 78q-1) applicable to clearing agencies, and the objectives of owners and participants;
(iv) Establish that the board of directors and senior management have appropriate experience and skills to discharge their duties and responsibilities;
(v) Specify clear and direct lines of responsibility; and
(vi) Consider the interests of participants' customers, securities issuers and holders, and other relevant stakeholders of the covered clearing agency.
(3) Maintain a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, general business, investment, custody, and other risks that arise in or are borne by the covered clearing agency, which:
(i) Includes risk management policies, procedures, and systems designed to identify, measure, monitor, and manage the range of risks that arise in or are borne by the covered clearing agency, that are subject to review on a specified periodic basis and approved by the board of directors annually;
(ii) Includes plans for the recovery and orderly wind-down of the covered clearing agency necessitated by credit losses, liquidity shortfalls, losses from general business risk, or any other losses;
(iii) Provides risk management and internal audit personnel with sufficient authority, resources, independence from management, and access to the board of directors;
(iv) Provides risk management and internal audit personnel with a direct reporting line to, and oversight by, a risk management committee and an independent audit committee of the board of directors, respectively; and
(v) Provides for an independent audit committee.
(4) Effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by:
(i) Maintaining sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence;
(ii) To the extent not already maintained pursuant to paragraph (e)(4)(i) of this section, for a covered clearing agency providing central counterparty services that is either systemically important in multiple jurisdictions or a clearing agency involved in activities with a more complex risk profile, maintaining additional financial resources at the minimum to enable it to cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the two participant families that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions;
(iii) To the extent not already maintained pursuant to paragraph (e)(4)(i) of this section, for a covered clearing agency not subject to paragraph (e)(4)(ii) of this section, maintaining additional financial resources at the minimum to enable it to cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions;
(iv) Including prefunded financial resources, exclusive of assessments for additional guaranty fund contributions or other resources that are not prefunded, when calculating the financial resources available to meet the standards under paragraphs (e)(4)(i) through (iii) of this section, as applicable;
(v) Maintaining the financial resources required under paragraphs (e)(4)(ii) and (iii) of this section, as applicable, in combined or separately maintained clearing or guaranty funds;
(vi) Testing the sufficiency of its total financial resources available to meet the minimum financial resource requirements under paragraphs (e)(4)(i) through (iii) of this section, as applicable, by:
(A) Conducting stress testing of its total financial resources once each day using standard predetermined parameters and assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis of the existing stress testing scenarios, models, and underlying parameters and assumptions, and considering modifications to ensure they are appropriate for determining the covered clearing agency's required level of default protection in light of current and evolving market conditions;
(C) Conducting a comprehensive analysis of stress testing scenarios, models, and underlying parameters and assumptions more frequently than monthly when the products cleared or markets served display high volatility or become less liquid, or when the size or concentration of positions held by the covered clearing agency's participants increases significantly; and
(D) Reporting the results of its analyses under paragraphs (e)(4)(vi)(B) and (C) of this section to appropriate decision makers at the covered clearing agency, including but not limited to, its risk management committee or board of directors, and using these results to evaluate the adequacy of and adjust its margin methodology, model parameters, models used to generate clearing or guaranty fund requirements, and any other relevant aspects of its credit risk management framework, in supporting compliance with the minimum financial resources requirements set forth in paragraphs (e)(4)(i) through (iii) of this section;
(vii) Performing a model validation for its credit risk models not less than annually or more frequently as may be contemplated by the covered clearing agency's risk management framework established pursuant to paragraph (e)(3) of this section;
(viii) Addressing allocation of credit losses the covered clearing agency may face if its collateral and other resources are insufficient to fully cover its credit exposures, including the repayment of any funds the covered clearing agency may borrow from liquidity providers; and
(ix) Describing the covered clearing agency's process to replenish any financial resources it may use following a default or other event in which use of such resources is contemplated.
(5) Limit the assets it accepts as collateral to those with low credit, liquidity, and market risks, and set and enforce appropriately conservative haircuts and concentration limits if the covered clearing agency requires collateral to manage its or its participants' credit exposure; and require a review of the sufficiency of its collateral haircuts and concentration limits to be performed not less than annually.
(6) Cover, if the covered clearing agency provides central counterparty services, its credit exposures to its participants by establishing a risk-based margin system that, at a minimum:
(i) Considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market, and, if the covered clearing agency provides central counterparty services for U.S. Treasury securities, calculates, collects, and holds margin amounts from a direct participant for its proprietary positions in Treasury securities separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency's payment, clearing, or settlement facilities;
(ii)(A) Marks participant positions to market and collects margin (including variation margin or equivalent charges if relevant) at least daily;
(B) Monitors intraday exposures on an ongoing basis;
(C) Includes the authority and operational capacity to make intraday margin calls, as frequently as circumstances warrant, including the following circumstances:
( 1 ) When risk thresholds specified by the covered clearing agency are breached; or
( 2 ) When the products cleared or markets served display elevated volatility; and
(D) Documents when the covered clearing agency determines not to make an intraday call pursuant to its written policies and procedures required under paragraph (e)(6)(ii)(C) of this section;
(iii) Calculates margin sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default;
(iv)(A) Uses reliable sources of timely price data and other substantive inputs;
(B) Uses procedures (and, with respect to price data, sound valuation models) for addressing circumstances in which price data or other substantive inputs are not readily available or reliable, to ensure that the covered clearing agency can continue to meet its obligations under this section; and
(C) Such procedures under paragraph (e)(6)(iv)(B) of this section must include either:
( 1 ) The use of price data or substantive inputs from an alternate source; or
( 2 ) If it does not use an alternate source, the use of a risk-based margin system that does not rely on substantive inputs that are unavailable or unreliable;
(v) Uses an appropriate method for measuring credit exposure that accounts for relevant product risk factors and portfolio effects across products;
(vi) Is monitored by management on an ongoing basis and is regularly reviewed, tested, and verified by:
(A) Conducting backtests of its margin model at least once each day using standard predetermined parameters and assumptions;
(B) Conducting a sensitivity analysis of its margin model and a review of its parameters and assumptions for backtesting on at least a monthly basis, and considering modifications to ensure the backtesting practices are appropriate for determining the adequacy of the covered clearing agency's margin resources;
(C) Conducting a sensitivity analysis of its margin model and a review of its parameters and assumptions for backtesting more frequently than monthly during periods of time when the products cleared or markets served display high volatility or become less liquid, or when the size or concentration of positions held by the covered clearing agency's participants increases or decreases significantly; and
(D) Reporting the results of its analyses under paragraphs (e)(6)(vi)(B) and (C) of this section to appropriate decision makers at the covered clearing agency, including but not limited to, its risk management committee or board of directors, and using these results to evaluate the adequacy of and adjust its margin methodology, model parameters, and any other relevant aspects of its credit risk management framework; and
(vii) Requires a model validation for the covered clearing agency's margin system and related models to be performed not less than annually, or more frequently as may be contemplated by the covered clearing agency's risk management framework established pursuant to paragraph (e)(3) of this section.
(7) Effectively measure, monitor, and manage the liquidity risk that arises in or is borne by the covered clearing agency, including measuring, monitoring, and managing its settlement and funding flows on an ongoing and timely basis, and its use of intraday liquidity by, at a minimum, doing the following:
(i) Maintaining sufficient liquid resources at the minimum in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the participant family that would generate the largest aggregate payment obligation for the covered clearing agency in extreme but plausible market conditions;
(ii) Holding qualifying liquid resources sufficient to meet the minimum liquidity resource requirement under paragraph (e)(7)(i) of this section in each relevant currency for which the covered clearing agency has payment obligations owed to clearing members;
(iii) Using the access to accounts and services at a Federal Reserve Bank, pursuant to Section 806(a) of the Payment, Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5465(a)), or other relevant central bank, when available and where determined to be practical by the board of directors of the covered clearing agency, to enhance its management of liquidity risk;
(iv) Undertaking due diligence to confirm that it has a reasonable basis to believe each of its liquidity providers, whether or not such liquidity provider is a clearing member, has:
(A) Sufficient information to understand and manage the liquidity provider's liquidity risks; and
(B) The capacity to perform as required under its commitments to provide liquidity to the covered clearing agency;
(v) Maintaining and testing with each liquidity provider, to the extent practicable, the covered clearing agency's procedures and operational capacity for accessing each type of relevant liquidity resource under paragraph (e)(7)(i) of this section at least annually;
(vi) Determining the amount and regularly testing the sufficiency of the liquid resources held for purposes of meeting the minimum liquid resource requirement under paragraph (e)(7)(i) of this section by, at a minimum:
(A) Conducting stress testing of its liquidity resources at least once each day using standard and predetermined parameters and assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis of the existing stress testing scenarios, models, and underlying parameters and assumptions used in evaluating liquidity needs and resources, and considering modifications to ensure they are appropriate for determining the clearing agency's identified liquidity needs and resources in light of current and evolving market conditions;
(C) Conducting a comprehensive analysis of the scenarios, models, and underlying parameters and assumptions used in evaluating liquidity needs and resources more frequently than monthly when the products cleared or markets served display high volatility or become less liquid, when the size or concentration of positions held by the clearing agency's participants increases significantly, or in other appropriate circumstances described in such policies and procedures; and
(D) Reporting the results of its analyses under paragraphs (e)(7)(vi)(B) and (C) of this section to appropriate decision makers at the covered clearing agency, including but not limited to, its risk management committee or board of directors, and using these results to evaluate the adequacy of and adjust its liquidity risk management methodology, model parameters, and any other relevant aspects of its liquidity risk management framework;
(vii) Performing a model validation of its liquidity risk models not less than annually or more frequently as may be contemplated by the covered clearing agency's risk management framework established pursuant to paragraph (e)(3) of this section;
(viii) Addressing foreseeable liquidity shortfalls that would not be covered by the covered clearing agency's liquid resources and seek to avoid unwinding, revoking, or delaying the same-day settlement of payment obligations;
(ix) Describing the covered clearing agency's process to replenish any liquid resources that the clearing agency may employ during a stress event; and
(x) Undertaking an analysis at least once a year that evaluates the feasibility of maintaining sufficient liquid resources at a minimum in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the two participant families that would potentially cause the largest aggregate payment obligation for the covered clearing agency in extreme but plausible market conditions if the covered clearing agency provides central counterparty services and is either systemically important in multiple jurisdictions or a clearing agency involved in activities with a more complex risk profile.
(8) Define the point at which settlement is final to be no later than the end of the day on which the payment or obligation is due and, where necessary or appropriate, intraday or in real time.
(9) Conduct its money settlements in central bank money, where available and determined to be practical by the board of directors of the covered clearing agency, and minimize and manage credit and liquidity risk arising from conducting its money settlements in commercial bank money if central bank money is not used by the covered clearing agency.
(10) Establish and maintain transparent written standards that state its obligations with respect to the delivery of physical instruments, and establish and maintain operational practices that identify, monitor, and manage the risks associated with such physical deliveries.
(11) When the covered clearing agency provides central securities depository services:
(i) Maintain securities in an immobilized or dematerialized form for their transfer by book entry, ensure the integrity of securities issues, and minimize and manage the risks associated with the safekeeping and transfer of securities;
(ii) Implement internal auditing and other controls to safeguard the rights of securities issuers and holders and prevent the unauthorized creation or deletion of securities, and conduct periodic and at least daily reconciliation of securities issues it maintains; and
(iii) Protect assets against custody risk through appropriate rules and procedures consistent with relevant laws, rules, and regulations in jurisdictions where it operates.
(12) Eliminate principal risk by conditioning the final settlement of one obligation upon the final settlement of the other, regardless of whether the covered clearing agency settles on a gross or net basis and when finality occurs if the covered clearing agency settles transactions that involve the settlement of two linked obligations.
(13) Ensure the covered clearing agency has the authority and operational capacity to take timely action to contain losses and liquidity demands and continue to meet its obligations by, at a minimum, requiring the covered clearing agency's participants and, when practicable, other stakeholders to participate in the testing and review of its default procedures, including any close-out procedures, at least annually and following material changes thereto.
(14) Enable, when the covered clearing agency provides central counterparty services for security-based swaps or engages in activities that the Commission has determined to have a more complex risk profile, the segregation and portability of positions of a participant's customers and the collateral provided to the covered clearing agency with respect to those positions and effectively protect such positions and related collateral from the default or insolvency of that participant.
(15) Identify, monitor, and manage the covered clearing agency's general business risk and hold sufficient liquid net assets funded by equity to cover potential general business losses so that the covered clearing agency can continue operations and services as a going concern if those losses materialize, including by:
(i) Determining the amount of liquid net assets funded by equity based upon its general business risk profile and the length of time required to achieve a recovery or orderly wind-down, as appropriate, of its critical operations and services if such action is taken;
(ii) Holding liquid net assets funded by equity equal to the greater of either (x) six months of the covered clearing agency's current operating expenses, or (y) the amount determined by the board of directors to be sufficient to ensure a recovery or orderly wind-down of critical operations and services of the covered clearing agency, as contemplated by the plans established under paragraph (e)(3)(ii) of this section, and which:
(A) Shall be in addition to resources held to cover participant defaults or other risks covered under the credit risk standard in paragraph (b)(3) or paragraphs (e)(4)(i) through (iii) of this section, as applicable, and the liquidity risk standard in paragraphs (e)(7)(i) and (ii) of this section; and
(B) Shall be of high quality and sufficiently liquid to allow the covered clearing agency to meet its current and projected operating expenses under a range of scenarios, including in adverse market conditions; and
(iii) Maintaining a viable plan, approved by the board of directors and updated at least annually, for raising additional equity should its equity fall close to or below the amount required under paragraph (e)(15)(ii) of this section.
(16) Safeguard the covered clearing agency's own and its participants' assets, minimize the risk of loss and delay in access to these assets, and invest such assets in instruments with minimal credit, market, and liquidity risks.
(17) Manage the covered clearing agency's operational risks by:
(i) Identifying the plausible sources of operational risk, both internal and external, and mitigating their impact through the use of appropriate systems, policies, procedures, and controls;
(ii) Ensuring that systems have a high degree of security, resiliency, operational reliability, and adequate, scalable capacity; and
(iii) Establishing and maintaining a business continuity plan that addresses events posing a significant risk of disrupting operations.
(18) Establish objective, risk-based, and publicly disclosed criteria for participation, which:
(i) Permit fair and open access by direct and, where relevant, indirect participants and other financial market utilities;
(ii) Require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency;
(iii) Monitor compliance with such participation requirements on an ongoing basis; and
(iv) When the covered clearing agency provides central counterparty services for transactions in U.S. Treasury securities,
(A) Require that any direct participant of such covered clearing agency submit for clearance and settlement all of the eligible secondary market transactions to which such direct participant is a counterparty;
(B) Identify and monitor its direct participants' submission of transactions for clearing as required in paragraph (e)(18)(iv)(A) of this section, including how the covered clearing agency would address a failure to submit transactions in accordance with paragraph (e)(18)(iv)(A) of this section; and
(C) Ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such covered clearing agency reviews annually.
(19) Identify, monitor, and manage the material risks to the covered clearing agency arising from arrangements in which firms that are indirect participants in the covered clearing agency rely on the services provided by direct participants to access the covered clearing agency's payment, clearing, or settlement facilities.
(20) Identify, monitor, and manage risks related to any link the covered clearing agency establishes with one or more other clearing agencies, financial market utilities, or trading markets.
(21) Be efficient and effective in meeting the requirements of its participants and the markets it serves, and have the covered clearing agency's management regularly review the efficiency and effectiveness of its:
(i) Clearing and settlement arrangements;
(ii) Operating structure, including risk management policies, procedures, and systems;
(iii) Scope of products cleared or settled; and
(iv) Use of technology and communication procedures.
(22) Use, or at a minimum accommodate, relevant internationally accepted communication procedures and standards in order to facilitate efficient payment, clearing, and settlement.
(23) Provide for the following:
(i) Publicly disclosing all relevant rules and material procedures, including key aspects of its default rules and procedures;
(ii) Providing sufficient information to enable participants to identify and evaluate the risks, fees, and other material costs they incur by participating in the covered clearing agency;
(iii) Publicly disclosing relevant basic data on transaction volume and values;
(iv) A comprehensive public disclosure that describes its material rules, policies, and procedures regarding its legal, governance, risk management, and operating framework, accurate in all material respects at the time of publication, that includes:
(A) Executive summary. An executive summary of the key points from paragraphs (e)(23)(iv)(B), (C), and (D) of this section;
(B) Summary of material changes since the last update of the disclosure. A summary of the material changes since the last update of paragraph (e)(23)(iv)(C) or (D) of this section;
(C) General background on the covered clearing agency. A description of:
( 1 ) The covered clearing agency's function and the markets it serves;
( 2 ) Basic data and performance statistics on the covered clearing agency's services and operations, such as basic volume and value statistics by product type, average aggregate intraday exposures to its participants, and statistics on the covered clearing agency's operational reliability; and
( 3 ) The covered clearing agency's general organization, legal and regulatory framework, and system design and operations; and
(D) Standard-by-standard summary narrative. A comprehensive narrative disclosure for each applicable standard set forth in paragraphs (e)(1) through (23) of this section with sufficient detail and context to enable a reader to understand the covered clearing agency's approach to controlling the risks and addressing the requirements in each standard; and
(v) Updating the public disclosure under paragraph (e)(23)(iv) of this section every two years, or more frequently following changes to its system or the environment in which it operates to the extent necessary to ensure statements previously provided under paragraph (e)(23)(iv) of this section remain accurate in all material respects.
(f) For purposes of enforcing the Payment, Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5461 et seq. ), a designated clearing agency for which the Commission acts as supervisory agency shall be subject to, and the Commission shall have the authority under, the provisions of paragraphs (b) through (n) of Section 8 of the Federal Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the same extent as if such designated clearing agency were an insured depository institution and the Commission were the appropriate Federal banking agency for such insured depository institution.
§ 240.17Ad-24   Exemption from clearing agency definition for certain registered security-based swap dealers, registered security-based swap execution facilities, and entities engaging in dealing activity in security-based swaps that are eligible for an exception under § 240.3a71-2(a) (or subject to the period set forth in § 240.3a71-2(b)).
A registered security-based swap dealer, a registered security-based swap execution facility, or an entity engaging in dealing activity in security-based swaps that is eligible for an exception under § 240.3a71-2(a) (or subject to the period set forth in § 240.3a71-2(b)) shall be exempt from inclusion in the term “clearing agency,” as defined in section 3(a)(23)(A) of the Act, where such registered security-based swap dealer, registered security-based swap execution facility, or entity engaging in dealing activity in security-based swaps that is eligible for an exception under § 240.3a71-2(a) (or subject to the period set forth in § 240.3a71-2(b)) would be deemed to be a clearing agency solely by reason of:
(a) Functions performed by such institution as part of customary dealing activities or providing facilities for comparison of data respecting the terms of settlement of securities transactions effected on such registered security-based swap execution facility, respectively; or
(b) Acting on behalf of a clearing agency or participant therein in connection with the furnishing by the clearing agency of services to its participants or the use of services of the clearing agency by its participants.
§ 240.17ad-25   Clearing agency boards of directors and conflicts of interest.
(a) Definitions. All terms used in this section have the same meaning as in the Securities Exchange Act of 1934, and unless the context otherwise requires, the following definitions apply for purposes of this section:
Affiliate means a person that directly or indirectly controls, is controlled by, or is under common control with the registered clearing agency.
Board of directors means the board of directors or equivalent governing body of the registered clearing agency.
Director means a member of the board of directors or equivalent governing body of the registered clearing agency.
Family member means any child, stepchild, grandchild, parent, stepparent, grandparent, spouse, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, including adoptive relationships, any person (other than a tenant or employee) sharing a household with the director or a nominee for director, a trust in which these persons (or the director or a nominee for director) have more than 50 percent of the beneficial interest, a foundation in which these persons (or the director or a nominee for director) control the management of assets, and any other entity in which these persons (or the director or a nominee for director) own more than 50 percent of the voting interests.
Independent director means a director of the registered clearing agency who has no material relationship with the registered clearing agency or any affiliate thereof.
Material relationship means a relationship, whether compensatory or otherwise, that exists or existed during a lookback period of one year from the initial determination in paragraph (b)(2) and that reasonably could affect the independent judgment or decision-making of the director.
Service provider for core services means any person that, through a written services provider agreement for services provided to or on behalf of the registered clearing agency, on an ongoing basis, directly supports the delivery of clearance or settlement functionality or any other purposes material to the business of the registered clearing agency.
(b) Composition of the board of directors. (1) A majority of the members of the board of directors of a registered clearing agency must be independent directors, unless a majority of the voting interests issued as of the immediately prior record date are directly or indirectly held by participants, in which case at least 34 percent of the members of the board of directors must be independent directors.
(2) Each registered clearing agency shall broadly consider all the relevant facts and circumstances, including under paragraph (g) of this section, on an ongoing basis, to affirmatively determine that a director does not have a material relationship with the registered clearing agency or an affiliate of the registered clearing agency, and is not precluded from being an independent director under paragraph (f) of this section. In making such determination, a registered clearing agency must:
(i) Identify the relationships between a director and the registered clearing agency or any affiliate thereof and any circumstances under paragraph (f) of this section;
(ii) Evaluate whether any relationship is likely to impair the independence of the director in performing the duties of director; and
(iii) Document the evaluation and determination in writing.
(c) Nominating committee. (1) Each registered clearing agency must establish a nominating committee and a written evaluation process whereby such nominating committee shall evaluate nominees for serving as directors and evaluate the independence of nominees and directors.
(2) A majority of the directors serving on the nominating committee must be independent directors, and the chair of the nominating committee must be an independent director.
(3) The fitness standards for serving as a director shall be specified by the nominating committee, documented in writing, and approved by the board of directors. Such fitness standards must be consistent with the requirements of this section and include that the individual is not subject to any statutory disqualification as defined under Section 3(a)(39) of the Act.
(4) The nominating committee must document the outcome of the written evaluation process consistent with the fitness standards required under paragraph (c)(3) of this section. Such process shall:
(i) Take into account each nominee's expertise, availability, and integrity, and demonstrate that the board of directors, taken as a whole, has a diversity of skills, knowledge, experience, and perspectives;
(ii) Demonstrate that the nominating committee has considered whether a particular nominee would complement the other board members, such that, if elected, the board of directors, taken as a whole, would represent the views of the owners and participants, including a selection of directors that reflects the range of different business strategies, models, and sizes across participants, as well as the range of customers and clients the participants serve;
(iii) Demonstrate that the nominating committee considered the views of other stakeholders who may be affected by the decisions of the registered clearing agency, including transfer agents, settlement banks, nostro agents, liquidity providers, technology or other service providers; and
(iv) Identify whether each nominee or director would meet the definition of independent director in paragraphs (a) and (f) of this section, and whether each such nominee or director has a known material relationship with the registered clearing agency or any affiliate thereof, an owner, a participant, or a representative of another stakeholder of the registered clearing agency described in paragraph (c)(4)(iii) of this section.
(d) Risk management committee. (1) Each registered clearing agency must establish a risk management committee (or committees) of the board to assist the board of directors in overseeing the risk management of the registered clearing agency. The membership of each risk management committee must be re-evaluated annually and at all times include representatives from the owners and participants of the registered clearing agency.
(2) In the performance of its duties, the risk management committee must be able to provide a risk-based, independent, and informed opinion on all matters presented to the committee for consideration in a manner that supports the overall risk management, safety and efficiency of the registered clearing agency.
(e) Committees generally. If any committee has the authority to act on behalf of the board of directors, the composition of that committee must have at least the same percentage of independent directors as is required for the board of directors, as set forth in paragraph (b)(1) of this section.
(f) Circumstances that preclude directors from being independent directors. In addition to how the definition of independent director set forth in this section is applied by a registered clearing agency, the following circumstances preclude a director from being an independent director, subject to a lookback period of one year (counting back from making the initial determination in paragraph (b)(2) of this section) applying to paragraphs (f)(2) through (6) of this section:
(1) The director is subject to rules, policies, or procedures by the registered clearing agency that may undermine the director's ability to operate unimpeded, such as removal by less than a majority vote of shares that are entitled to vote in such director's election;
(2) The director, or a family member, has an employment relationship with or otherwise receives compensation other than as a director from the registered clearing agency or any affiliate thereof, or the holder of a controlling voting interest of the registered clearing agency;
(3) The director, or a family member, is receiving payments from the registered clearing agency, or any affiliate thereof, or the holder of a controlling voting interest of the registered clearing agency, that reasonably could affect the independent judgment or decision-making of the director, other than the following:
(i) Compensation for services as a director on the board of directors or a committee thereof; or
(ii) Pension and other forms of deferred compensation for prior services not contingent on continued service;
(4) The director, or a family member, is a partner in, or controlling shareholder of, any organization to or from which the registered clearing agency, or any affiliate thereof, or the holder of a controlling voting interest of the registered clearing agency, is making or receiving payments for property or services, other than the following:
(i) Payments arising solely from investments in the securities of the registered clearing agency, or affiliate thereof; or
(ii) Payments under non-discretionary charitable contribution matching programs;
(5) The director, or a family member, is employed as an executive officer of another entity where any executive officers of the registered clearing agency serve on that entity's compensation committee; or
(6) The director, or a family member, is a partner of the outside auditor of the registered clearing agency, or any affiliate thereof, or an employee of the outside auditor who is working on the audit of the registered clearing agency, or any affiliate thereof.
(g) Conflicts of interest. Each registered clearing agency must establish, implement, maintain, and enforce written policies and procedures reasonably designed to:
(1) Identify and document existing or potential conflicts of interest in the decision-making process of the clearing agency involving directors or senior managers of the registered clearing agency; and
(2) Mitigate or eliminate and document the mitigation or elimination of such conflicts of interest.
(h) Obligation of directors to report conflicts. Each registered clearing agency must establish, implement, maintain, and enforce written policies and procedures reasonably designed to require a director to document and inform the registered clearing agency promptly of the existence of any relationship or interest that reasonably could affect the independent judgment or decision-making of the director.
(i) Management of risks from relationships with service providers for core services. Each registered clearing agency must establish, implement, maintain, and enforce written policies and procedures reasonably designed to:
(1) Require senior management to evaluate and document the risks related to an agreement with a service provider for core services, including under changes to circumstances and potential disruptions, and whether the risks can be managed in a manner consistent with the clearing agency's risk management framework;
(2) Require senior management to submit to the board of directors for review and approval any agreement that would establish a relationship with a service provider for core services, along with the risk evaluation required in paragraph (i)(1) of this section;
(3) Require senior management to be responsible for establishing the policies and procedures that govern relationships and manage risks related to such agreements with service providers for core services and require the board of directors to be responsible for reviewing and approving such policies and procedures; and
(4) Require senior management to perform ongoing monitoring of the relationship, and report to the board of directors for its evaluation of any action taken by senior management to remedy significant deterioration in performance or address changing risks or material issues identified through such monitoring; or if the risks or issues cannot be remedied, require senior management to assess and document weaknesses or deficiencies in the relationship with the service provider for submission to the board of directors.
(j) Obligation of board of directors to solicit and consider viewpoints of participants and other relevant stakeholders. Each registered clearing agency must establish, implement, maintain, and enforce written policies and procedures reasonably designed to require the board of directors to solicit, consider, and document its consideration of the views of participants and other relevant stakeholders of the registered clearing agency regarding material developments in its risk management and operations on a recurring basis.
§ 240.17ad-26   Recovery and orderly wind-down plans of covered clearing agencies.
(a) The plans for the recovery and orderly wind-down of the covered clearing agency referenced in § 240.17ad-22(e)(3)(ii) must:
(1) Identify and describe the covered clearing agency's core payment, clearing, and settlement services and address how the covered clearing agency would continue to provide such core services in the event of a recovery and during an orderly wind-down, including by:
(i) Identifying the staffing roles necessary to support such core services; and
(ii) Analyzing how such staffing roles necessary to support such core services would continue in the event of a recovery and during an orderly wind-down;
(2)(i) Identify and describe any service providers for core services, specifying which core services each service provider supports; and
(ii) Address how the covered clearing agency would ensure that service providers for core services would continue to perform in the event of a recovery and during an orderly wind-down, including consideration of its written agreements with such service providers and whether the obligations under those written agreements are subject to alteration or termination as a result of initiation of the recovery and orderly wind-down plan;
(3) Identify and describe scenarios that may potentially prevent the covered clearing agency from being able to provide its core services identified in paragraph (a)(1) of this section as a going concern, including uncovered credit losses (as described in § 240.17ad-22(e)(4)(viii)), uncovered liquidity shortfalls (as described in § 240.17ad-22(e)(7)(viii)), and general business losses (as described in § 240.17ad-22(e)(15));
(4) Identify and describe criteria that could trigger the covered clearing agency's implementation of the recovery and orderly wind-down plans and the process that the covered clearing agency uses to monitor and determine whether the criteria have been met, including the governance arrangements applicable to such process;
(5) Identify and describe the rules, policies, procedures, and any other tools or resources on which the covered clearing agency would rely in a recovery or orderly wind-down;
(6) Address how the rules, policies, procedures, and any other tools or resources identified in paragraph (a)(5) of this section would ensure timely implementation of the recovery and orderly wind-down plan;
(7) Require the covered clearing agency to inform the Commission as soon as practicable when the covered clearing agency is considering implementing a recovery or orderly wind-down;
(8) Include procedures for testing the covered clearing agency's ability to implement the recovery and orderly wind-down plans at least every 12 months, including by:
(i) Requiring the covered clearing agency's participants and, when practicable, other stakeholders to participate in the testing of its plans;
(ii) Requiring that such testing be in addition to testing pursuant to § 240.17ad-22(e)(13);
(iii) Providing for reporting the results of such testing to the covered clearing agency's board of directors and senior management; and
(iv) Specifying the procedures for, as appropriate, amending the plans to address the results of such testing; and
(9) Include procedures requiring review and approval of the plans by the board of directors of the covered clearing agency at least every 12 months or following material changes to the covered clearing agency's operations that would significantly affect the viability or execution of the plans, with such review informed, as appropriate, by the covered clearing agency's testing of the plans.
(b) All terms used in this section have the same meaning as in the Securities Exchange Act of 1934, and unless the context otherwise requires, the following definitions apply for purposes of this section:
Affiliate means a person that directly or indirectly controls, is controlled by, or is under common control with the covered clearing agency.
Orderly wind-down means the actions of a covered clearing agency to effect the permanent cessation, sale, or transfer of one or more of its core services, as identified by the covered clearing agency pursuant to paragraph (a)(1) of this section, in a manner that would not increase the risk of significant liquidity, credit, or operational problems spreading among financial institutions or markets and thereby threaten the stability of the U.S. financial system.
Recovery means the actions of a covered clearing agency, consistent with its rules, procedures, and other ex ante contractual arrangements, to address any uncovered loss, liquidity shortfall, or capital inadequacy, whether arising from participant default or other causes (such as business, operational, or other structural weaknesses), including actions to replenish any depleted prefunded financial resources and liquidity arrangements, as necessary to maintain the covered clearing agency's viability as a going concern and to continue its provision of core services, as identified by the covered clearing agency pursuant to paragraph (a)(1) of this section.
Service provider for core services means any person, including an affiliate or a third party, that, through a written agreement for services provided to or on behalf of the covered clearing agency, on an ongoing basis, directly supports the delivery of core services, as identified by the covered clearing agency pursuant to paragraph (a)(1) of this section.
§ 240.17Ad-27   Straight-through processing by clearing agencies that provide a central matching service.
(a) A clearing agency that provides a central matching service must establish, implement, maintain, and enforce written policies and procedures reasonably designed to facilitate straight-through processing of securities transactions at the clearing agency.
(b) A clearing agency that provides a central matching service must submit to the Commission every twelve months a report that includes the following:
(1) A summary of the clearing agency's policies and procedures required under paragraph (a) of this section, current as of the last day of the twelve-month period covered by the report required under paragraph (b) of this section;
(2) A qualitative description of the clearing agency's progress in facilitating straight-through processing during the twelve-month period covered by the report required under paragraph (b) of this section;
(3) A quantitative presentation of data that includes:
(i) The total number of trades submitted to the clearing agency for processing;
(ii) The total number of allocations submitted to the clearing agency;
(iii) The total number of confirmations submitted to the clearing agency, as well as the total number of confirmations cancelled by a user;
(iv) The percentage of confirmations submitted to the clearing agency that are affirmed on trade date, specifying to the extent practicable the relevant timeframe in which the affirmation is processed on trade date;
(v) The percentage of allocations and confirmations submitted to the clearing agency that are matched and automatically confirmed through the clearing agency's services; and
(vi) Metrics concerning the use of manual and automated processes by the clearing agency's users with respect to its services that may be used to assess progress in facilitating straight-through processing.
(4) Each of the data sets required under paragraph (b)(3) of this section shall be:
(i) Organized on a month-by-month basis, beginning with January of each year, for the twelve months covered by the report required under paragraph (b) of this section;
(ii) Separated, where applicable, between the use of central matching and electronic trade confirmation services offered by the clearing agency;
(iii) Separated, as appropriate, by asset class;
(iv) Separated by type of user; and
(v) Presented on an anonymized and aggregated basis.
(5) A qualitative description of the actions the clearing agency intends to take to further facilitate straight-through processing of securities transactions at the clearing agency during the twelve-month period that follows the period covered by the report required under paragraph (b) of this section.
(c) Each report required under paragraph (b) of this section must be filed within 60 days of the end of the twelve-month period covered by the report required under paragraph (b) of this section, and the twelve-month period covered by each report shall commence on January 1 of the calendar year.
(d) The report required under paragraph (b) of this section must be filed electronically on EDGAR and must be provided in an Interactive Data File in accordance with § 232.405 of this chapter (Rule 405 of Regulation S-T) and the EDGAR Filer Manual.
§ 240.18a-1   Net capital requirements for security-based swap dealers for which there is not a prudential regulator.
Sections 240.18a-1, 240.18a-1a, 240.18a-1b, 240.18a-1c, and 240.18a-1d apply to a security-based swap dealer registered under section 15F of the Act (15 U.S.C. 78 o -10), including a security-based swap dealer that is an OTC derivatives dealer as that term is defined in § 240.3b-12. A security-based swap dealer registered under section 15F of the Act (15 U.S.C. 78 o -10) that is also a broker or dealer registered under section 15 of the Act (15 U.S.C. 78o), other than an OTC derivatives dealer, is subject to the net capital requirements in § 240.15c3-1 and its appendices. A security-based swap dealer registered under section 15F of the Act that has a prudential regulator is not subject to § 240.18a-1, 240.18a-1a, 240.18a-1b, 240.18a-1c, and 240.18a-1d.
(a) Minimum requirements. Every registered security-based swap dealer must at all times have and maintain net capital no less than the greater of the highest minimum requirements applicable to its business under paragraph (a)(1) or (2) of this section, and tentative net capital no less than the minimum requirement under paragraph (a)(2) of this section.
(1)(i) A security-based swap dealer must at all times maintain net capital of not less than the greater of $20 million or:
(A) Two percent of the risk margin amount; or
(B) Four percent or less of the risk margin amount if the Commission issues an order raising the requirement to four percent or less on or after the third anniversary of this section's compliance date; or
(C) Eight percent or less of the risk margin amount if the Commission issues an order raising the requirement to eight percent or less on or after the fifth anniversary of this section's compliance date and the Commission had previously issued an order raising the requirement under paragraph (a)(1)(ii) of this section;
(ii) If, after considering the capital and leverage levels of security-based swap dealers subject to this paragraph (a)(1), as well as the risks of their security-based swap positions, the Commission determines that it may be appropriate to change the percentage pursuant to paragraph (a)(1)(i)(B) or (C) of this section, the Commission will publish a notice of the potential change and subsequently will issue an order regarding any such change.
(2) In accordance with paragraph (d) of this section, the Commission may approve, in whole or in part, an application or an amendment to an application by a security-based swap dealer to calculate net capital using the market risk standards of paragraph (d) to compute a deduction for market risk on some or all of its positions, instead of the provisions of paragraphs (c)(1)(iv), (vi), and (vii) of this section, and § 240.18a-1b, and using the credit risk standards of paragraph (d) to compute a deduction for credit risk on certain credit exposures arising from transactions in derivatives instruments, instead of the provisions of paragraphs (c)(1)(iii) and (c)(1)(ix)(A) and (B) of this section, subject to any conditions or limitations on the security-based swap dealer the Commission may require as necessary or appropriate in the public interest or for the protection of investors. A security-based swap dealer that has been approved to calculate its net capital under paragraph (d) of this section must at all times maintain tentative net capital of not less than $100 million and net capital of not less than the greater of $20 million or:
(i)(A) Two percent of the risk margin amount;
(B) Four percent or less of the risk margin amount if the Commission issues an order raising the requirement to four percent or less on or after the third anniversary of this section's compliance date; or
(C) Eight percent or less of the risk margin amount if the Commission issues an order raising the requirement to eight percent or less on or after the fifth anniversary of this section's compliance date and the Commission had previously issued an order raising the requirement under paragraph (a)(2)(ii) of this section;
(ii) If, after considering the capital and leverage levels of security-based swap dealers subject to this paragraph (a)(2), as well as the risks of their security-based swap positions, the Commission determines that it may be appropriate to change the percentage pursuant to paragraph (a)(2)(i)(B) or (C) of this section, the Commission will publish a notice of the potential change and subsequently will issue an order regarding any such change; and
(b) A security-based swap dealer must at all times maintain net capital in addition to the amounts required under paragraph (a)(1) or (2) of this section, as applicable, in an amount equal to 10 percent of:
(1) The excess of the market value of United States Treasury Bills, Bonds and Notes subject to reverse repurchase agreements with any one party over 105 percent of the contract prices (including accrued interest) for reverse repurchase agreements with that party;
(2) The excess of the market value of securities issued or guaranteed as to principal or interest by an agency of the United States or mortgage related securities as defined in section 3(a)(41) of the Act subject to reverse repurchase agreements with any one party over 110 percent of the contract prices (including accrued interest) for reverse repurchase agreements with that party; and
(3) The excess of the market value of other securities subject to reverse repurchase agreements with any one party over 120 percent of the contract prices (including accrued interest) for reverse repurchase agreements with that party.
(c) Definitions. For purpose of this section:
(1) Net capital. The term net capital shall be deemed to mean the net worth of a security-based swap dealer, adjusted by:
(i) Adjustments to net worth related to unrealized profit or loss and deferred tax provisions.
(A) Adding unrealized profits (or deducting unrealized losses) in the accounts of the security-based swap dealer;
(B)( 1 ) In determining net worth, all long and all short positions in listed options shall be marked to their market value and all long and all short securities and commodities positions shall be marked to their market value.
( 2 ) In determining net worth, the value attributed to any unlisted option shall be the difference between the option's exercise value and the market value of the underlying security. In the case of an unlisted call, if the market value of the underlying security is less than the exercise value of such call it shall be given no value and in the case of an unlisted put if the market value of the underlying security is more than the exercise value of the unlisted put it shall be given no value.
(C) Adding to net worth the lesser of any deferred income tax liability related to the items in paragraphs (c)(1)(i)(C)( 1 ) through ( 3 ) of this section, or the sum of paragraphs (c)(1)(i)(C)( 1 ), ( 2 ), and ( 3 ) of this section;
( 1 ) The aggregate amount resulting from applying to the amount of the deductions computed in accordance with paragraphs (c)(1)(vi) and (vii) of this section and Appendices A and B, §§ 240.18a-1a and 240.18a-1b, the appropriate Federal and State tax rate(s) applicable to any unrealized gain on the asset on which the deduction was computed;
( 2 ) Any deferred tax liability related to income accrued which is directly related to an asset otherwise deducted pursuant to this section;
( 3 ) Any deferred tax liability related to unrealized appreciation in value of any asset(s) which has been otherwise deducted from net worth in accordance with the provisions of this section; and
(D) Adding, in the case of future income tax benefits arising as a result of unrealized losses, the amount of such benefits not to exceed the amount of income tax liabilities accrued on the books and records of the security-based swap dealer, but only to the extent such benefits could have been applied to reduce accrued tax liabilities on the date of the capital computation, had the related unrealized losses been realized on that date.
(E) Adding to net worth any actual tax liability related to income accrued which is directly related to an asset otherwise deducted pursuant to this section.
(ii) Subordinated liabilities. Excluding liabilities of the security-based swap dealer that are subordinated to the claims of creditors pursuant to a satisfactory subordinated loan agreement, as defined in § 240.18a-1d.
(iii) Assets not readily convertible into cash. Deducting fixed assets and assets which cannot be readily converted into cash, including, among other things:
(A) Fixed assets and prepaid items. Real estate; furniture and fixtures; exchange memberships; prepaid rent, insurance and other expenses; goodwill; organization expenses;
(B) Certain unsecured and partly secured receivables. All unsecured advances and loans; deficits in customers' and non-customers' unsecured and partly secured notes; deficits in customers' and non-customers' unsecured and partly secured accounts after application of calls for margin, marks to the market or other required deposits that are outstanding for more than the required time frame to collect the margin, marks to the market, or other required deposits; and the market value of stock loaned in excess of the value of any collateral received therefore.
(C) Insurance claims. Insurance claims that, after seven (7) business days from the date the loss giving rise to the claim is discovered, are not covered by an opinion of outside counsel that the claim is valid and is covered by insurance policies presently in effect; insurance claims that after twenty (20) business days from the date the loss giving rise to the claim is discovered and that are accompanied by an opinion of outside counsel described above, have not been acknowledged in writing by the insurance carrier as due and payable; and insurance claims acknowledged in writing by the carrier as due and payable outstanding longer than twenty (20) business days from the date they are so acknowledged by the carrier; and
(D) Other deductions. All other unsecured receivables; all assets doubtful of collection less any reserves established therefore; the amount by which the market value of securities failed to receive outstanding longer than thirty (30) calendar days exceeds the contract value of such fails to receive, and the funds on deposit in a “segregated trust account” in accordance with 17 CFR 270.27d-1 under the Investment Company Act of 1940, but only to the extent that the amount on deposit in such segregated trust account exceeds the amount of liability reserves established and maintained for refunds of charges required by sections 27(d) and 27(f) of the Investment Company Act of 1940; Provided, That any amount deposited in the “special reserve account for the exclusive benefit of the security-based swap customers” established pursuant to § 240.18a-4 and clearing deposits shall not be so deducted.
(E) Repurchase agreements. ( 1 ) For purposes of this paragraph:
( i ) The term reverse repurchase agreement deficit shall mean the difference between the contract price for resale of the securities under a reverse repurchase agreement and the market value of those securities (if less than the contract price).
( ii ) The term repurchase agreement deficit shall mean the difference between the market value of securities subject to the repurchase agreement and the contract price for repurchase of the securities (if less than the market value of the securities).
( iii ) As used in this paragraph (c)(1)(iii)(E)( 1 ), the term contract price shall include accrued interest.
( iv ) Reverse repurchase agreement deficits and the repurchase agreement deficits where the counterparty is the Federal Reserve Bank of New York shall be disregarded.
( 2 )( i ) In the case of a reverse repurchase agreement, the deduction shall be equal to the reverse repurchase agreement deficit.
( ii ) In determining the required deductions under paragraph (c)(1)(iii)(E)( 2 )( i ) of this section, the security-based swap dealer may reduce the reverse repurchase agreement deficit by: Any margin or other deposits held by the security-based swap dealer on account of the reverse repurchase agreement; any excess market value of the securities over the contract price for resale of those securities under any other reverse repurchase agreement with the same party; the difference between the contract price for resale and the market value of securities subject to repurchase agreements with the same party (if the market value of those securities is less than the contract price); and calls for margin, marks to the market, or other required deposits that are outstanding one business day or less.
( 3 ) In the case of repurchase agreements, the deduction shall be:
( i ) The excess of the repurchase agreement deficit over 5 percent of the contract price for resale of United States Treasury Bills, Notes and Bonds, 10 percent of the contract price for the resale of securities issued or guaranteed as to principal or interest by an agency of the United States or mortgage related securities as defined in section 3(a)(41) of the Act and 20 percent of the contract price for the resale of other securities; and
( ii ) The excess of the aggregate repurchase agreement deficits with any one party over 25 percent of the security-based swap dealer's net capital before the application of paragraphs (c)(1)(vi) and (vii) of this section (less any deduction taken with respect to repurchase agreements with that party under paragraph (c)(1)(iii)(E)( 3 )( i ) of this section) or, if greater; the excess of the aggregate repurchase agreement deficits over 300 percent of the security-based swap dealer's net capital before the application of paragraphs (c)(1)(vi) and (vii) of this section.
( iii ) In determining the required deduction under paragraphs (c)(1)(iii)(E)( 3 )( i ) and ( ii ) of this section, the security-based swap dealer may reduce a repurchase agreement by any margin or other deposits held by the security-based swap dealer on account of a reverse repurchase agreement with the same party to the extent not otherwise used to reduce a reverse repurchase agreement deficit; the difference between the contract price and the market value of securities subject to other repurchase agreements with the same party (if the market value of those securities is less than the contract price) not otherwise used to reduce a reverse repurchase agreement deficit; and calls for margin, marks to the market, or other required deposits that are outstanding one business day or less to the extent not otherwise used to reduce a reverse repurchase agreement deficit.
(F) Securities borrowed. One percent of the market value of securities borrowed collateralized by an irrevocable letter of credit.
(G) Affiliate receivables and collateral. Any receivable from an affiliate of the security-based swap dealer (not otherwise deducted from net worth) and the market value of any collateral given to an affiliate (not otherwise deducted from net worth) to secure a liability over the amount of the liability of the security-based swap dealer unless the books and records of the affiliate are made available for examination when requested by the representatives of the Commission in order to demonstrate the validity of the receivable or payable. The provisions of this subsection shall not apply where the affiliate is a registered security-based swap dealer, registered broker or dealer, registered government securities broker or dealer, bank as defined in section 3(a)(6) of the Act, insurance company as defined in section 3(a)(19) of the Act, investment company registered under the Investment Company Act of 1940, federally insured savings and loan association, or futures commission merchant or swap dealer registered pursuant to the Commodity Exchange Act.
(iv) Non-marketable securities. Deducting 100 percent of the carrying value in the case of securities or evidence of indebtedness in the proprietary or other accounts of the security-based swap dealer, for which there is no ready market, as defined in paragraph (c)(4) of this section, and securities, in the proprietary or other accounts of the security-based swap dealer, that cannot be publicly offered or sold because of statutory, regulatory or contractual arrangements or other restrictions.
(v) Deducting from the contract value of each failed to deliver contract that is outstanding five business days or longer (21 business days or longer in the case of municipal securities) the percentages of the market value of the underlying security that would be required by application of the deduction required by paragraph (c)(1)(vii) of this section. Such deduction, however, shall be increased by any excess of the contract price of the failed to deliver contract over the market value of the underlying security or reduced by any excess of the market value of the underlying security over the contract value of the failed to deliver contract, but not to exceed the amount of such deduction. The Commission may, upon application of the security-based swap dealer, extend for a period up to 5 business days, any period herein specified when it is satisfied that the extension is warranted. The Commission upon expiration of the extension may extend for one additional period of up to 5 business days, any period herein specified when it is satisfied that the extension is warranted.
(vi)(A) Cleared security-based swaps. In the case of a cleared security-based swap held in a proprietary account of the security-based swap dealer, deducting the amount of the applicable margin requirement of the clearing agency or, if the security-based swap references an equity security, the security-based swap dealer may take a deduction using the method specified in § 240.18a-1a.
(B) Non-cleared security-based swaps —( 1 ) Credit default swaps —( i ) Short positions (selling protection). In the case of a non-cleared security-based swap that is a short credit default swap, deducting the percentage of the notional amount based upon the current basis point spread of the credit default swap and the maturity of the credit default swap in accordance with table 1 to § 240.18a-1(c)(1)(vi)(B)( 1 )( i ):
Table 1 to § 240.18a-1(c)(1)(vi)(B)( 1 )( i )
( ii ) Long positions (purchasing protection). In the case of a non-cleared security-based swap that is a long credit default swap, deducting 50 percent of the deduction that would be required by paragraph (c)(1)(vi)(B)( 1 )( i ) of this section if the non-cleared security-based swap was a short credit default swap, each such deduction not to exceed the current market value of the long position.
( iii ) Long and short credit default swaps. In the case of non-cleared security-based swaps that are long and short credit default swaps referencing the same entity (in the case of non-cleared credit default swap security-based swaps referencing a corporate entity) or obligation (in the case of non-cleared credit default swap security-based swaps referencing an asset-backed security), that have the same credit events which would trigger payment by the seller of protection, that have the same basket of obligations which would determine the amount of payment by the seller of protection upon the occurrence of a credit event, that are in the same or adjacent spread category, and that are in the same or adjacent maturity category and have a maturity date within three months of the other maturity category, deducting the percentage of the notional amount specified in the higher maturity category under paragraph (c)(1)(vi)(B)( 1 )( i ) or ( ii ) on the excess of the long or short position. In the case of non-cleared security-based swaps that are long and short credit default swaps referencing corporate entities in the same industry sector and the same spread and maturity categories prescribed in paragraph (c)(1)(vi)(B)( 1 )( i ) of this section, deducting 50 percent of the amount required by paragraph (c)(1)(vi)(B)( 1 )( i ) of this section on the short position plus the deduction required by paragraph (c)(1)(vi)(B)( 1 )( ii ) of this section on the excess long position, if any. For the purposes of this section, the security-based swap dealer must use an industry sector classification system that is reasonable in terms of grouping types of companies with similar business activities and risk characteristics and the security-based swap dealer must document the industry sector classification system used pursuant to this section.
( iv ) Long security and long credit default swap. In the case of a non-cleared security-based swap that is a long credit default swap referencing a debt security and the security-based swap dealer is long the same debt security, deducting 50 percent of the amount specified in § 240.15c3-1(c)(2)(vi) or (vii) for the debt security, provided that the security-based swap dealer can deliver the debt security to satisfy the obligation of the security-based swap dealer on the credit default swap.
( v ) Short security and short credit default swap. In the case of a non-cleared security-based swap that is a short credit default swap referencing a debt security or a corporate entity, and the security-based swap dealer is short the debt security or a debt security issued by the corporate entity, deducting the amount specified in § 240.15c3-1(c)(2)(vi) or (vii) for the debt security. In the case of a non-cleared security-based swap that is a short credit default swap referencing an asset-backed security and the security-based swap dealer is short the asset-backed security, deducting the amount specified in § 240.15c3-1(c)(2)(vi) or (vii) for the asset-backed security.
( 2 ) All other security-based swaps. In the case of a non-cleared security-based swap that is not a credit default swap, deducting the amount calculated by multiplying the notional amount of the security-based swap and the percentage specified in § 240.15c3-1(c)(2)(vi) applicable to the reference security. A security-based swap dealer may reduce the deduction under this paragraph (c)(1)(vi)(B)( 2 ) by an amount equal to any reduction recognized for a comparable long or short position in the reference security under § 240.15c3-1(c)(2)(vi) and, in the case of a security-based swap referencing an equity security, the method specified in § 240.18a-1a.
(vii) All other securities, money market instruments or options. Deducting the percentages specified in § 240.15c3-1(c)(2)(vi) of the market value of all securities, money market instruments, and options in the proprietary accounts of the security-based swap dealer.
(viii) Deduction from net worth for certain undermargined accounts. Deducting the amount of cash required in the account of each security-based swap and swap customer to meet the margin requirements of a clearing agency, the Commission, derivatives clearing organization, or the Commodity Futures Trading Commission, as applicable, after application of calls for margin, marks to the market, or other required deposits which are outstanding within the required time frame to collect the margin, mark to the market, or other required deposits.
(ix) Deduction from net worth in lieu of collecting collateral for non-cleared security-based swap and swap transactions —(A) Security-based swaps. Deducting the initial margin amount calculated pursuant to § 240.18a-3(c)(1)(i)(B) for the account of a counterparty at the security-based swap dealer that is subject to a margin exception set forth in § 240.18a-3(c)(1)(iii), less the margin value of collateral held in the account.
(B) Swaps. Deducting the initial margin amount calculated pursuant to the margin rules of the Commodity Futures Trading Commission in the account of a counterparty at the security-based swap dealer that is subject to a margin exception in those rules, less the margin value of collateral held in the account.
(C) Treatment of collateral held at a third-party custodian. For the purposes of the deductions required pursuant to paragraphs (c)(1)(ix)(A) and (B) of this section, collateral held by an independent third-party custodian as initial margin may be treated as collateral held in the account of the counterparty at the security-based swap dealer if:
( 1 ) The independent third-party custodian is a bank as defined in section 3(a)(6) of the Act or a registered U.S. clearing organization or depository that is not affiliated with the counterparty or, if the collateral consists of foreign securities or currencies, a supervised foreign bank, clearing organization, or depository that is not affiliated with the counterparty and that customarily maintains custody of such foreign securities or currencies;
( 2 ) The security-based swap dealer, the independent third-party custodian, and the counterparty that delivered the collateral to the custodian have executed an account control agreement governing the terms under which the custodian holds and releases collateral pledged by the counterparty as initial margin that is a legal, valid, binding, and enforceable agreement under the laws of all relevant jurisdictions, including in the event of bankruptcy, insolvency, or a similar proceeding of any of the parties to the agreement, and that provides the security-based swap dealer with the right to access the collateral to satisfy the counterparty's obligations to the security-based swap dealer arising from transactions in the account of the counterparty; and
( 3 ) The security-based swap dealer maintains written documentation of its analysis that in the event of a legal challenge the relevant court or administrative authorities would find the account control agreement to be legal, valid, binding, and enforceable under the applicable law, including in the event of the receivership, conservatorship, insolvency, liquidation, or a similar proceeding of any of the parties to the agreement.
(x)(A) Deducting the market value of all short securities differences (which shall include securities positions reflected on the securities record which are not susceptible to either count or confirmation) unresolved after discovery in accordance with the schedule in table 2 to § 240.18a-1(c)(1)(x)(A):
Table 2 to § 240.18a-1( c )(1)( x )(A)
1 Percentage of market value of short securities differences.
(B) Deducting the market value of any long securities differences, where such securities have been sold by the security-based swap dealer before they are adequately resolved, less any reserves established therefor;
(C) The Commission may extend the periods in paragraph (c)(1)(x)(A) of this section for up to 10 business days if it finds that exceptional circumstances warrant an extension.
(2) The term exempted securities shall mean those securities deemed exempted securities by section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) and the rules thereunder.
(3) Customer. The term customer shall mean any person from whom, or on whose behalf, a security-based swap dealer has received, acquired or holds funds or securities for the account of such person, but shall not include a security-based swap dealer, a broker or dealer, a registered municipal securities dealer, or a general, special or limited partner or director or officer of the security-based swap dealer, or any person to the extent that such person has a claim for property or funds which by contract, agreement, or understanding, or by operation of law, is part of the capital of the security-based swap dealer.
(4) Ready market. The term ready market shall include a recognized established securities market in which there exist independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined for a particular security almost instantaneously and where payment will be received in settlement of a sale at such price within a relatively short time conforming to trade custom.
(5) The term tentative net capital means the net capital of the security-based swap dealer before deducting the haircuts computed pursuant to paragraphs (c)(1)(vi) and (vii) of this section and the charges on inventory computed pursuant to § 240.18a-1b. However, for purposes of paragraph (a)(2) of this section, the term tentative net capital means the net capital of the security-based swap dealer before deductions for market and credit risk computed pursuant to paragraph (d) of this section or paragraphs (c)(1)(vi) and (vii) of this section, if applicable, and increased by the balance sheet value (including counterparty net exposure) resulting from transactions in derivative instruments which would otherwise be deducted pursuant to paragraph (c)(1)(iii) of this section. Tentative net capital shall include securities for which there is no ready market, as defined in paragraph (c)(4) of this section, if the use of mathematical models has been approved for purposes of calculating deductions from net capital for those securities pursuant to paragraph (d) of this section.
(6) The term risk margin amount means the sum of:
(i) The total initial margin required to be maintained by the security-based swap dealer at each clearing agency with respect to security-based swap transactions cleared for security-based swap customers; and
(ii) The total initial margin amount calculated by the security-based swap dealer with respect to non-cleared security-based swaps pursuant to § 240.18a-3(c)(1)(i)(B).
(d) Application to use models to compute deductions for market and credit risk. (1) A security-based swap dealer may apply to the Commission for authorization to compute deductions for market risk under this paragraph (d) in lieu of computing deductions pursuant to paragraphs (c)(1)(iv), (vi), and (vii) of this section, and § 240.18a-1b, and to compute deductions for credit risk pursuant to this paragraph (d) on credit exposures arising from transactions in derivatives instruments (if this paragraph (d) is used to calculate deductions for market risk on these instruments) in lieu of computing deductions pursuant to paragraphs (c)(1)(iii) and (c)(1)(ix)(A) and (B) of this section:
(i) A security-based swap dealer shall submit the following information to the Commission with its application:
(A) An executive summary of the information provided to the Commission with its application and an identification of the ultimate holding company of the security-based swap dealer;
(B) A comprehensive description of the internal risk management control system of the security-based swap dealer and how that system satisfies the requirements set forth in § 240.15c3-4;
(C) A list of the categories of positions that the security-based swap dealer holds in its proprietary accounts and a brief description of the methods that the security-based swap dealer will use to calculate deductions for market and credit risk on those categories of positions;
(D) A description of the mathematical models to be used to price positions and to compute deductions for market risk, including those portions of the deductions attributable to specific risk, if applicable, and deductions for credit risk; a description of the creation, use, and maintenance of the mathematical models; a description of the security-based swap dealer's internal risk management controls over those models, including a description of each category of persons who may input data into the models; if a mathematical model incorporates empirical correlations across risk categories, a description of the process for measuring correlations; a description of the backtesting procedures the security-based swap dealer will use to backtest the mathematical models used to calculate maximum potential exposure; a description of how each mathematical model satisfies the applicable qualitative and quantitative requirements set forth in this paragraph (d); and a statement describing the extent to which each mathematical model used to compute deductions for market risk and credit risk will be used as part of the risk analyses and reports presented to senior management;
(E) If the security-based swap dealer is applying to the Commission for approval to use scenario analysis to calculate deductions for market risk for certain positions, a list of those types of positions, a description of how those deductions will be calculated using scenario analysis, and an explanation of why each scenario analysis is appropriate to calculate deductions for market risk on those types of positions;
(F) A description of how the security-based swap dealer will calculate current exposure;
(G) A description of how the security-based swap dealer will determine internal credit ratings of counterparties and internal credit risk weights of counterparties, if applicable;
(H) For each instance in which a mathematical model to be used by the security-based swap dealer to calculate a deduction for market risk or to calculate maximum potential exposure for a particular product or counterparty differs from the mathematical model used by the ultimate holding company to calculate an allowance for market risk or to calculate maximum potential exposure for that same product or counterparty, a description of the difference(s) between the mathematical models; and
(I) Sample risk reports that are provided to management at the security-based swap dealer who are responsible for managing the security-based swap dealer's risk.
(ii) [Reserved].
(2) The application of the security-based swap dealer shall be supplemented by other information relating to the internal risk management control system, mathematical models, and financial position of the security-based swap dealer that the Commission may request to complete its review of the application;
(3) The application shall be considered filed when received at the Commission's principal office in Washington, DC. A person who files an application pursuant to this section for which it seeks confidential treatment may clearly mark each page or segregable portion of each page with the words “Confidential Treatment Requested.” All information submitted in connection with the application will be accorded confidential treatment, to the extent permitted by law;
(4) If any of the information filed with the Commission as part of the application of the security-based swap dealer is found to be or becomes inaccurate before the Commission approves the application, the security-based swap dealer must notify the Commission promptly and provide the Commission with a description of the circumstances in which the information was found to be or has become inaccurate along with updated, accurate information;
(5)(i) The Commission may approve the application or an amendment to the application, in whole or in part, subject to any conditions or limitations the Commission may require if the Commission finds the approval to be necessary or appropriate in the public interest or for the protection of investors, after determining, among other things, whether the security-based swap dealer has met the requirements of this paragraph (d) and is in compliance with other applicable rules promulgated under the Act;
(ii) The Commission may approve the temporary use of a provisional model in whole or in part, subject to any conditions or limitations the Commission may require, if:
(A) The security-based swap dealer has a complete application pending under this section;
(B) The use of the provisional model has been approved by:
( 1 ) A prudential regulator;
( 2 ) The Commodity Futures Trading Commission or a futures association registered with the Commodity Futures Trading Commission under section 17 of the Commodity Exchange Act;
( 3 ) A foreign financial regulatory authority that administers a foreign financial regulatory system with capital requirements that the Commission has found are eligible for substituted compliance under § 240.3a71-6 if the provisional model is used for the purposes of calculating net capital;
( 4 ) A foreign financial regulatory authority that administers a foreign financial regulatory system with margin requirements that the Commission has found are eligible for substituted compliance under § 240.3a71-6 if the provisional model is used for the purposes of calculating initial margin pursuant to § 240.18a-3; or
( 5 ) Any other foreign supervisory authority that the Commission finds has approved and monitored the use of the provisional model through a process comparable to the process set forth in this section.
(6) A security-based swap dealer shall amend its application to calculate certain deductions for market and credit risk under this paragraph (d) and submit the amendment to the Commission for approval before it may change materially a mathematical model used to calculate market or credit risk or before it may change materially its internal risk management control system;
(7) As a condition for the security-based swap dealer to compute deductions for market and credit risk under this paragraph (d), the security-based swap dealer agrees that:
(i) It will notify the Commission 45 days before it ceases to compute deductions for market and credit risk under this paragraph (d); and
(ii) The Commission may determine by order that the notice will become effective after a shorter or longer period of time if the security-based swap dealer consents or if the Commission determines that a shorter or longer period of time is necessary or appropriate in the public interest or for the protection of investors; and
(8) Notwithstanding paragraph (d)(7) of this section, the Commission, by order, may revoke a security-based swap dealer's exemption that allows it to use the market risk standards of this paragraph (d) to calculate deductions for market risk, and the exemption to use the credit risk standards of this paragraph (d) to calculate deductions for credit risk on certain credit exposures arising from transactions in derivatives instruments if the Commission finds that such exemption is no longer necessary or appropriate in the public interest or for the protection of investors. In making its finding, the Commission will consider the compliance history of the security-based swap dealer related to its use of models, the financial and operational strength of the security-based swap dealer and its ultimate holding company, and the security-based swap dealer's compliance with its internal risk management controls.
(9) To be approved, each value-at-risk (“VaR”) model must meet the following minimum qualitative and quantitative requirements:
(i) Qualitative requirements. (A) The VaR model used to calculate market or credit risk for a position must be integrated into the daily internal risk management system of the security-based swap dealer;
(B) The VaR model must be reviewed both periodically and annually. The periodic review may be conducted by the security-based swap dealer's internal audit staff, but the annual review must be conducted by a registered public accounting firm, as that term is defined in section 2(a)(12) of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq. ); and
(C) For purposes of computing market risk, the security-based swap dealer must determine the appropriate multiplication factor as follows:
( 1 ) Beginning three months after the security-based swap dealer begins using the VaR model to calculate market risk, the security-based swap dealer must conduct backtesting of the model by comparing its actual daily net trading profit or loss with the corresponding VaR measure generated by the VaR model, using a 99 percent, one-tailed confidence level with price changes equivalent to a one business-day movement in rates and prices, for each of the past 250 business days, or other period as may be appropriate for the first year of its use;
( 2 ) On the last business day of each quarter, the security-based swap dealer must identify the number of backtesting exceptions of the VaR model, that is, the number of business days in the past 250 business days, or other period as may be appropriate for the first year of its use, for which the actual net trading loss, if any, exceeds the corresponding VaR measure; and
( 3 ) The security-based swap dealer must use the multiplication factor indicated in table 3 to § 240.18a-1(d)(9)(i)(C)( 3 ) in determining its market risk until it obtains the next quarter's backtesting results;
Table 3 to § 240.18 a -1( d )(9)( i )(C)( 3 )—Multiplication Factor Based on the Number of Backtesting Exceptions of the V a R model
( 4 ) For purposes of incorporating specific risk into a VaR model, a security-based swap dealer must demonstrate that it has methodologies in place to capture liquidity, event, and default risk adequately for each position. Furthermore, the models used to calculate deductions for specific risk must:
( i ) Explain the historical price variation in the portfolio;
( ii ) Capture concentration (magnitude and changes in composition);
( iii ) Be robust to an adverse environment;
( iv ) Capture name-related basis risk;
( v ) Capture event risk; and
( vi ) Be validated through backtesting.
( 5 ) For purposes of computing the credit equivalent amount of the security-based swap dealer's exposures to a counterparty, the security-based swap dealer must determine the appropriate multiplication factor as follows:
( i ) Beginning three months after it begins using the VaR model to calculate maximum potential exposure, the security-based swap dealer must conduct backtesting of the model by comparing, for at least 80 counterparties with widely varying types and sizes of positions with the firm, the ten-business day change in its current exposure to the counterparty based on its positions held at the beginning of the ten-business day period with the corresponding ten-business day maximum potential exposure for the counterparty generated by the VaR model;
( ii ) As of the last business day of each quarter, the security-based swap dealer must identify the number of backtesting exceptions of the VaR model, that is, the number of ten-business day periods in the past 250 business days, or other period as may be appropriate for the first year of its use, for which the change in current exposure to a counterparty exceeds the corresponding maximum potential exposure; and
( iii ) The security-based swap dealer will propose, as part of its application, a schedule of multiplication factors, which must be approved by the Commission based on the number of backtesting exceptions of the VaR model. The security-based swap dealer must use the multiplication factor indicated in the approved schedule in determining the credit equivalent amount of its exposures to a counterparty until it obtains the next quarter's backtesting results, unless the Commission determines, based on, among other relevant factors, a review of the security-based swap dealer's internal risk management control system, including a review of the VaR model, that a different adjustment or other action is appropriate.
(ii) Quantitative requirements. (A) For purposes of determining market risk, the VaR model must use a 99 percent, one-tailed confidence level with price changes equivalent to a ten business-day movement in rates and prices;
(B) For purposes of determining maximum potential exposure, the VaR model must use a 99 percent, one-tailed confidence level with price changes equivalent to a one-year movement in rates and prices; or based on a review of the security-based swap dealer's procedures for managing collateral and if the collateral is marked to market daily and the security-based swap dealer has the ability to call for additional collateral daily, the Commission may approve a time horizon of not less than ten business days;
(C) The VaR model must use an effective historical observation period of at least one year. The security-based swap dealer must consider the effects of market stress in its construction of the model. Historical data sets must be updated at least monthly and reassessed whenever market prices or volatilities change significantly; and
(D) The VaR model must take into account and incorporate all significant, identifiable market risk factors applicable to positions in the accounts of the security-based swap dealer, including:
( 1 ) Risks arising from the non-linear price characteristics of derivatives and the sensitivity of the market value of those positions to changes in the volatility of the derivatives' underlying rates and prices;
( 2 ) Empirical correlations with and across risk factors or, alternatively, risk factors sufficient to cover all the market risk inherent in the positions in the proprietary or other trading accounts of the security-based swap dealer, including interest rate risk, equity price risk, foreign exchange risk, and commodity price risk;
( 3 ) Spread risk, where applicable, and segments of the yield curve sufficient to capture differences in volatility and imperfect correlation of rates along the yield curve for securities and derivatives that are sensitive to different interest rates; and
( 4 ) Specific risk for individual positions:
(iii) Additional conditions. As a condition for the security-based swap dealer to use this paragraph (d) to calculate certain of its capital charges, the Commission may impose additional conditions on the security-based swap dealer, which may include, but are not limited to restricting the security-based swap dealer's business on a product-specific, category-specific, or general basis; submitting to the Commission a plan to increase the security-based swap dealer's net capital or tentative net capital; filing more frequent reports with the Commission; modifying the security-based swap dealer's internal risk management control procedures; or computing the security-based swap dealer's deductions for market and credit risk in accordance with paragraphs (c)(1)(iii), (iv), (vi), (vii), and (c)(1)(ix)(A) and (B), as appropriate, and § 240.18a-1b, as appropriate. If the Commission finds it is necessary or appropriate in the public interest or for the protection of investors, the Commission may impose additional conditions on the security-based swap dealer, if:
(A) The security-based swap dealer fails to meet the reporting requirements set forth in § 240.18a-7;
(B) Any event specified in § 240.18a-8 occurs;
(C) There is a material deficiency in the internal risk management control system or in the mathematical models used to price securities or to calculate deductions for market and credit risk or allowances for market and credit risk, as applicable, of the security-based swap dealer;
(D) The security-based swap dealer fails to comply with this paragraph (d); or
(E) The Commission finds that imposition of other conditions is necessary or appropriate in the public interest or for the protection of investors.
(e) Models to compute deductions for market risk and credit risk —(1) Market risk. A security-based swap dealer whose application, including amendments, has been approved under paragraph (d) of this section, shall compute a deduction for market risk in an amount equal to the sum of the following:
(i) For positions for which the Commission has approved the security-based swap dealer's use of VaR models, the VaR of the positions multiplied by the appropriate multiplication factor determined according to paragraph (d) of this section, except that the initial multiplication factor shall be three, unless the Commission determines, based on a review of the security-based swap dealer's application or an amendment to the application under paragraph (d) of this section, including a review of its internal risk management control system and practices and VaR models, that another multiplication factor is appropriate;
(ii) For positions for which the VaR model does not incorporate specific risk, a deduction for specific risk to be determined by the Commission based on a review of the security-based swap dealer's application or an amendment to the application under paragraph (d) of this section and the positions involved;
(iii) For positions for which the Commission has approved the security-based swap dealer's application to use scenario analysis, the greatest loss resulting from a range of adverse movements in relevant risk factors, prices, or spreads designed to represent a negative movement greater than, or equal to, the worst ten-day movement of the four years preceding calculation of the greatest loss, or some multiple of the greatest loss based on the liquidity of the positions subject to scenario analysis. If historical data is insufficient, the deduction shall be the largest loss within a three standard deviation movement in those risk factors, prices, or spreads over a ten-day period, multiplied by an appropriate liquidity adjustment factor. Irrespective of the deduction otherwise indicated under scenario analysis, the resulting deduction for market risk must be at least $25 per 100 share equivalent contract for equity positions, or one-half of one percent of the face value of the contract for all other types of contracts, even if the scenario analysis indicates a lower amount. A qualifying scenario must include the following:
(A) A set of pricing equations for the positions based on, for example, arbitrage relations, statistical analysis, historic relationships, merger evaluations, or fundamental valuation of an offering of securities;
(B) Auxiliary relationships mapping risk factors to prices; and
(C) Data demonstrating the effectiveness of the scenario in capturing market risk, including specific risk; and
(iv) For all remaining positions, the deductions specified in § 240.15c3-1(c)(2)(vi), § 240.15c3-1(c)(2)(vii), and applicable appendices to § 240.15c3-1.
(2) Credit risk. A security-based swap dealer whose application, including amendments, has been approved under paragraph (d) of this section may compute a deduction for credit risk on transactions in derivatives instruments (if this paragraph (e) is used to calculate a deduction for market risk on those positions) in an amount equal to the sum of the following:
(i) Counterparty exposure charge. A counterparty exposure charge in an amount equal to the sum of the following:
(A) The net replacement value in the account of each counterparty that is insolvent, or in bankruptcy, or that has senior unsecured long-term debt in default; and
(B) For a counterparty not otherwise described in paragraph (e)(2)(i)(A) of this section, the credit equivalent amount of the security-based swap dealer's exposure to the counterparty, as defined in paragraph (e)(2)(iii)(A) of this section, multiplied by the credit risk weight of the counterparty, as determined in accordance with paragraph (e)(2)(iii)(F) of this section, multiplied by eight percent; and
(ii) Counterparty concentration charge. A concentration charge by counterparty in an amount equal to the sum of the following:
(A) For each counterparty with a credit risk weight of 20 percent or less, 5 percent of the amount of the current exposure to the counterparty in excess of 5 percent of the tentative net capital of the security-based swap dealer;
(B) For each counterparty with a credit risk weight of greater than 20 percent but less than 50 percent, 20 percent of the amount of the current exposure to the counterparty in excess of 5 percent of the tentative net capital of the security-based swap dealer; and
(C) For each counterparty with a credit risk weight of greater than 50 percent, 50 percent of the amount of the current exposure to the counterparty in excess of 5 percent of the tentative net capital of the security-based swap dealer;
(iii) Terms. (A) The credit equivalent amount of the security-based swap dealer's exposure to a counterparty is the sum of the security-based swap dealer's maximum potential exposure to the counterparty, as defined in paragraph (e)(2)(iii)(B) of this section, multiplied by the appropriate multiplication factor, and the security-based swap dealer's current exposure to the counterparty, as defined in paragraph (e)(2)(iii)(C) of this section. The security-based swap dealer must use the multiplication factor determined according to paragraph (d)(9)(i)(C)( 5 ) of this section, except that the initial multiplication factor shall be one, unless the Commission determines, based on a review of the security-based swap dealer's application or an amendment to the application approved under paragraph (d) of this section, including a review of its internal risk management control system and practices and VaR models, that another multiplication factor is appropriate;
(B) The maximum potential exposure is the VaR of the counterparty's positions with the security-based swap dealer, after applying netting agreements with the counterparty meeting the requirements of paragraph (e)(2)(iii)(D) of this section, taking into account the value of collateral from the counterparty held by the security-based swap dealer in accordance with paragraph (e)(2)(iii)(E) of this section, and taking into account the current replacement value of the counterparty's positions with the security-based swap dealer;
(C) The current exposure of the security-based swap dealer to a counterparty is the current replacement value of the counterparty's positions with the security-based swap dealer, after applying netting agreements with the counterparty meeting the requirements of paragraph (e)(2)(iii)(D) of this section and taking into account the value of collateral from the counterparty held by the security-based swap dealer in accordance with paragraph (e)(2)(iii)(E) of this section;
(D) Netting agreements. A security-based swap dealer may include the effect of a netting agreement that allows the security-based swap dealer to net gross receivables from and gross payables to a counterparty upon default of the counterparty if:
( 1 ) The netting agreement is legally enforceable in each relevant jurisdiction, including in insolvency proceedings;
( 2 ) The gross receivables and gross payables that are subject to the netting agreement with a counterparty can be determined at any time; and
( 3 ) For internal risk management purposes, the security-based swap dealer monitors and controls its exposure to the counterparty on a net basis;
(E) Collateral. When calculating maximum potential exposure and current exposure to a counterparty, the fair market value of collateral pledged and held may be taken into account provided:
( 1 ) The collateral is marked to market each day and is subject to a daily margin maintenance requirement;
( 2 )( i ) The collateral is subject to the security-based swap dealer's physical possession or control and may be liquidated promptly by the firm without intervention by any other party; or
( ii ) The collateral is held by an independent third-party custodian that is a bank as defined in section 3(a)(6) of the Act or a registered U.S. clearing organization or depository that is not affiliated with the counterparty or, if the collateral consists of foreign securities or currencies, a supervised foreign bank, clearing organization, or depository that is not affiliated with the counterparty and that customarily maintains custody of such foreign securities or currencies;
( 3 ) The collateral is liquid and transferable;
( 4 ) The collateral agreement is legally enforceable by the security-based swap dealer against the counterparty and any other parties to the agreement;
( 5 ) The collateral does not consist of securities issued by the counterparty or a party related to the security-based swap dealer or to the counterparty;
( 6 ) The Commission has approved the security-based swap dealer's use of a VaR model to calculate deductions for market risk for the type of collateral in accordance with paragraph (d) of this section; and
( 7 ) The collateral is not used in determining the credit rating of the counterparty;
(F) Credit risk weights of counterparties. A security-based swap dealer that computes its deductions for credit risk pursuant to this paragraph (e)(2) shall apply a credit risk weight for transactions with a counterparty of either 20 percent, 50 percent, or 150 percent based on an internal credit rating the security-based swap dealer determines for the counterparty.
( 1 ) As part of its initial application or in an amendment, the security-based swap dealer may request Commission approval to apply a credit risk weight of either 20 percent, 50 percent, or 150 percent based on internal calculations of credit ratings, including internal estimates of the maturity adjustment. Based on the strength of the security-based swap dealer's internal credit risk management system, the Commission may approve the application. The security-based swap dealer must make and keep current a record of the basis for the credit risk weight of each counterparty;
( 2 ) As part of its initial application or in an amendment, the security-based swap dealer may request Commission approval to determine credit risk weights based on internal calculations, including internal estimates of the maturity adjustment. Based on the strength of the security-based swap dealer's internal credit risk management system, the Commission may approve the application. The security-based swap dealer must make and keep current a record of the basis for the credit risk weight of each counterparty; and
( 3 ) As part of its initial application or in an amendment, the security-based swap dealer may request Commission approval to reduce deductions for credit risk through the use of credit derivatives.
(f) Internal risk management control systems. A security-based swap dealer must comply with § 240.15c3-4 as if it were an OTC derivatives dealer with respect to all of its business activities, except that § 240.15c3-4(c)(5)(xiii) and (xiv) and (d)(8) and (9) shall not apply.
(g) Debt-equity requirements. No security-based swap dealer shall permit the total of outstanding principal amounts of its satisfactory subordination agreements (other than such agreements which qualify under this paragraph (g) as equity capital) to exceed 70 percent of its debt-equity total, as hereinafter defined, for a period in excess of 90 days or for such longer period which the Commission may, upon application of the security-based swap dealer, grant in the public interest or for the protection of investors. In the case of a corporation, the debt-equity total shall be the sum of its outstanding principal amounts of satisfactory subordination agreements, par or stated value of capital stock, paid in capital in excess of par, retained earnings, unrealized profit and loss or other capital accounts. In the case of a partnership, the debt-equity total shall be the sum of its outstanding principal amounts of satisfactory subordination agreements, capital accounts of partners (exclusive of such partners' securities accounts) subject to the provisions of paragraph (h) of this section, and unrealized profit and loss. Provided, however, that a satisfactory subordinated loan agreement entered into by a partner or stockholder which has an initial term of at least three years and has a remaining term of not less than 12 months shall be considered equity for the purposes of this paragraph (g) if:
(1) It does not have any of the provisions for accelerated maturity provided for by paragraph (b)(8)(i) or (b)(9)(i) or (ii) of § 240.18a-1d and is maintained as capital subject to the provisions restricting the withdrawal thereof required by paragraph (h) of this section; or
(2) The partnership agreement provides that capital contributed pursuant to a satisfactory subordination agreement as defined in § 240.18a-1d shall in all respects be partnership capital subject to the provisions restricting the withdrawal thereof required by paragraph (h) of this section.
(h) Provisions relating to the withdrawal of equity capital —(1) Notice provisions relating to limitations on the withdrawal of equity capital. No equity capital of the security-based swap dealer or a subsidiary or affiliate consolidated pursuant to § 240.18a-1c may be withdrawn by action of a stockholder or a partner or by redemption or repurchase of shares of stock by any of the consolidated entities or through the payment of dividends or any similar distribution, nor may any unsecured advance or loan be made to a stockholder, partner, employee or affiliate without written notice given in accordance with paragraph (h)(1)(iv) of this section:
(i) Two business days prior to any withdrawals, advances or loans if those withdrawals, advances or loans on a net basis exceed in the aggregate in any 30 calendar day period, 30 percent of the security-based swap dealer's excess net capital. A security-based swap dealer, in an emergency situation, may make withdrawals, advances or loans that on a net basis exceed 30 percent of the security-based swap dealer's excess net capital in any 30 calendar day period without giving the advance notice required by this paragraph, with the prior approval of the Commission. Where a security-based swap dealer makes a withdrawal with the consent of the Commission, it shall in any event comply with paragraph (h)(1)(ii) of this section; or
(ii) Two business days after any withdrawals, advances or loans if those withdrawals, advances or loans on a net basis exceed in the aggregate in any 30 calendar day period, 20 percent of the security-based swap dealer's excess net capital.
(iii) This paragraph (h)(1) does not apply to:
(A) Securities or commodities transactions in the ordinary course of business between a security-based swap dealer and an affiliate where the security-based swap dealer makes payment to or on behalf of such affiliate for such transaction and then receives payment from such affiliate for the securities or commodities transaction within two business days from the date of the transaction; or
(B) Withdrawals, advances or loans which in the aggregate in any thirty calendar day period, on a net basis, equal $500,000 or less.
(iv) Each required notice shall be effective when received by the Commission in Washington, DC, the regional office of the Commission for the region in which the security-based swap dealer has its principal place of business, and the Commodity Futures Trading Commission if such security-based swap dealer is registered with that Commission.
(2) Limitations on withdrawal of equity capital. No equity capital of the security-based swap dealer or a subsidiary or affiliate consolidated pursuant to § 240.18a-1c may be withdrawn by action of a stockholder or a partner or by redemption or repurchase of shares of stock by any of the consolidated entities or through the payment of dividends or any similar distribution, nor may any unsecured advance or loan be made to a stockholder, partner, employee or affiliate, if after giving effect thereto and to any other such withdrawals, advances or loans and any Payments of Payments Obligations (as defined in § 240.18a-1d) under satisfactory subordinated loan agreements which are scheduled to occur within 180 days following such withdrawal, advance or loan if:
(i) The security-based swap dealer's net capital would be less than 120 percent of the minimum dollar amount required by paragraph (a) of this section; or
(ii) The total outstanding principal amounts of satisfactory subordinated loan agreements of the security-based swap dealer and any subsidiaries or affiliates consolidated pursuant to § 240.18a-1c (other than such agreements which qualify as equity under paragraph (g) of this section) would exceed 70 percent of the debt-equity total as defined in paragraph (g) of this section.
(3) Temporary restrictions on withdrawal of net capital. (i) The Commission may by order restrict, for a period up to twenty business days, any withdrawal by the security-based swap dealer of equity capital or unsecured loan or advance to a stockholder, partner, member, employee or affiliate under such terms and conditions as the Commission deems necessary or appropriate in the public interest or consistent with the protection of investors if the Commission, based on the information available, concludes that such withdrawal, advance or loan may be detrimental to the financial integrity of the security-based swap dealer, or may unduly jeopardize the security-based swap dealer's ability to repay its customer claims or other liabilities which may cause a significant impact on the markets or expose the customers or creditors of the security-based swap dealer to loss.
(ii) An order temporarily prohibiting the withdrawal of capital shall be rescinded if the Commission determines that the restriction on capital withdrawal should not remain in effect. A hearing on an order temporarily prohibiting withdrawal of capital will be held within two business days from the date of the request in writing by the security-based swap dealer.
(4) Miscellaneous provisions. (i) Excess net capital is that amount in excess of the amount required under paragraph (a) of this section. For the purposes of paragraphs (h)(1) and (2) of this section, a security-based swap dealer may use the amount of excess net capital and deductions required under paragraphs (c)(1)(vi) and (vii) and § 240.18a-1a reported in its most recently required filed Part II of Form X-17A-5 for the purposes of calculating the effect of a projected withdrawal, advance or loan relative to excess net capital or deductions. The security-based swap dealer must assure itself that the excess net capital or the deductions reported on the most recently required filed Part II of Form X-17A-5 have not materially changed since the time such report was filed.
(ii) The term equity capital includes capital contributions by partners, par or stated value of capital stock, paid-in capital in excess of par, retained earnings or other capital accounts. The term equity capital does not include securities in the securities accounts of partners and balances in limited partners' capital accounts in excess of their stated capital contributions.
(iii) Paragraphs (h)(1) and (2) of this section shall not preclude a security-based swap dealer from making required tax payments or preclude the payment to partners of reasonable compensation, and such payments shall not be included in the calculation of withdrawals, advances, or loans for purposes of paragraphs (h)(1) and (2) of this section.
(iv) For the purpose of this paragraph (h), any transactions between a security-based swap dealer and a stockholder, partner, employee or affiliate that results in a diminution of the security-based swap dealer's net capital shall be deemed to be an advance or loan of net capital.
§ 240.18a-1a   Options.
(a)(1) Definitions. The term unlisted option means any option not included in the definition of listed option provided in § 240.15c3-1(c)(2)(x).
(2) The term option series refers to listed option contracts of the same type (either a call or a put) and exercise style, covering the same underlying security with the same exercise price, expiration date, and number of underlying units.
(3) The term related instrument within an option class or product group refers to futures contracts, options on futures contracts, security-based swaps on a narrow-based security index, and swaps covering the same underlying instrument. In relation to options on foreign currencies, a related instrument within an option class also shall include forward contracts on the same underlying currency.
(4) The term underlying instrument refers to long and short positions, as appropriate, covering the same foreign currency, the same security, security future, or security-based swap other than a security-based swap on a narrow-based security index, or a security which is exchangeable for or convertible into the underlying security within a period of 90 days. If the exchange or conversion requires the payment of money or results in a loss upon conversion at the time when the security is deemed an underlying instrument for purposes of this Appendix A, the broker or dealer will deduct from net worth the full amount of the conversion loss. The term underlying instrument shall not be deemed to include securities options, futures contracts, options on futures contracts, security-based swaps on a narrow-based security index, qualified stock baskets, unlisted instruments, or swaps.
(5) The term options class refers to all options contracts covering the same underlying instrument.
(6) The term product group refers to two or more option classes, related instruments, underlying instruments, and qualified stock baskets in the same portfolio type (see paragraph (b)(1)(ii) of this section) for which it has been determined that a percentage of offsetting profits may be applied to losses at the same valuation point.
(b) The deduction under this Appendix A must equal the sum of the deductions specified in paragraph (b)(1)(iv)(C) of this section.
(1)(i) Definitions. (A) The terms theoretical gains and losses mean the gain and loss in the value of individual option series, the value of underlying instruments, related instruments, and qualified stock baskets within that option's class, at 10 equidistant intervals (valuation points) ranging from an assumed movement (both up and down) in the current market value of the underlying instrument equal to the percentage corresponding to the deductions otherwise required under § 240.15c3-1 for the underlying instrument (see paragraph (b)(1)(iii) of this section). Theoretical gains and losses shall be calculated using a theoretical options pricing model that satisfies the criteria set forth in paragraph (b)(1)(i)(B) of this section.
(B) The term theoretical options pricing model means any mathematical model, other than a security-based swap dealer's proprietary model, the use of which has been approved by the Commission. Any such model shall calculate theoretical gains and losses as described in paragraph (b)(1)(i)(A) of this section for all series and issues of equity, index and foreign currency options and related instruments, and shall be made available equally and on the same terms to all security-based swap dealers. Its procedures shall include the arrangement of the vendor to supply accurate and timely data to each security-based swap dealer with respect to its services, and the fees for distribution of the services. The data provided to security-based swap dealers shall also contain the minimum requirements set forth in paragraphs (b)(1)(iv)(C) of this section and the product group offsets set forth in paragraphs (b)(1)(iv)(B) of this section. At a minimum, the model shall consider the following factors in pricing the option:
( 1 ) The current spot price of the underlying asset;
( 2 ) The exercise price of the option;
( 3 ) The remaining time until the option's expiration;
( 4 ) The volatility of the underlying asset;
( 5 ) Any cash flows associated with ownership of the underlying asset that can reasonably be expected to occur during the remaining life of the option; and
( 6 ) The current term structure of interest rates.
(C) The term major market foreign currency means the currency of a sovereign nation for which there is a substantial inter-bank forward currency market.
(D) The term qualified stock basket means a set or basket of stock positions which represents no less than 50 percent of the capitalization for a high-capitalization or non-high-capitalization diversified market index, or, in the case of a narrow-based index, no less than 95 percent of the capitalization for such narrow-based index.
(ii) With respect to positions involving listed options in its proprietary or other account, the security-based swap dealer shall group long and short positions into the following portfolio types:
(A) Equity options on the same underlying instrument and positions in that underlying instrument;
(B) Options on the same major market foreign currency, positions in that major market foreign currency, and related instruments within those options' classes;
(C) High-capitalization diversified market index options, related instruments within the option's class, and qualified stock baskets in the same index;
(D) Non-high-capitalization diversified index options, related instruments within the index option's class, and qualified stock baskets in the same index; and
(E) Narrow-based index options, related instruments within the index option's class, and qualified stock baskets in the same index.
(iii) Before making the computation, each security-based swap dealer shall obtain the theoretical gains and losses for each option series and for the related and underlying instruments within those options' class in the proprietary or other accounts of that security-based swap dealer. For each option series, the theoretical options pricing model shall calculate theoretical prices at 10 equidistant valuation points within a range consisting of an increase or a decrease of the following percentages of the daily market price of the underlying instrument:
(A) +(−) 15 percent for equity securities with a ready market, narrow-based indexes, and non-high-capitalization diversified indexes;
(B) +(−) 6 percent for major market foreign currencies;
(C) +(−) 20 percent for all other currencies; and
(D) +(−)10 percent for high-capitalization diversified indexes.
(iv)(A) The security-based swap dealer shall multiply the corresponding theoretical gains and losses at each of the 10 equidistant valuation points by the number of positions held in a particular option series, the related instruments and qualified stock baskets within the option's class, and the positions in the same underlying instrument.
(B) In determining the aggregate profit or loss for each portfolio type, the security-based swap dealer will be allowed the following offsets in the following order, provided, that in the case of qualified stock baskets, the security-based swap dealer may elect to net individual stocks between qualified stock baskets and take the appropriate deduction on the remaining, if any, securities:
( 1 ) First, a security-based swap dealer is allowed the following offsets within an option's class:
( i ) Between options on the same underlying instrument, positions covering the same underlying instrument, and related instruments within the option's class, 100 percent of a position's gain shall offset another position's loss at the same valuation point;
( ii ) Between index options, related instruments within the option's class, and qualified stock baskets on the same index, 95 percent, or such other amount as designated by the Commission, of gains shall offset losses at the same valuation point;
( 2 ) Second, a security-based swap dealer is allowed the following offsets within an index product group:
( i ) Among positions involving different high-capitalization diversified index option classes within the same product group, 90 percent of the gain in a high-capitalization diversified market index option, related instruments, and qualified stock baskets within that index option's class shall offset the loss at the same valuation point in a different high-capitalization diversified market index option, related instruments, and qualified stock baskets within that index option's class;
( ii ) Among positions involving different non-high-capitalization diversified index option classes within the same product group, 75 percent of the gain in a non-high-capitalization diversified market index option, related instruments, and qualified stock baskets within that index option's class shall offset the loss at the same valuation point in another non-high-capitalization diversified market index option, related instruments, and qualified stock baskets within that index option's class or product group;
( iii ) Among positions involving different narrow-based index option classes within the same product group, 90 percent of the gain in a narrow-based market index option, related instruments, and qualified stock baskets within that index option's class shall offset the loss at the same valuation point in another narrow-based market index option, related instruments, and qualified stock baskets within that index option's class or product group;
( iv ) No qualified stock basket should offset another qualified stock basket; and
( 3 ) Third, a security-based swap dealer is allowed the following offsets between product groups: Among positions involving different diversified index product groups within the same market group, 50 percent of the gain in a diversified market index option, a related instrument, or a qualified stock basket within that index option's product group shall offset the loss at the same valuation point in another product group;
(C) For each portfolio type, the total deduction shall be the larger of:
( 1 ) The amount for any of the 10 equidistant valuation points representing the largest theoretical loss after applying the offsets provided in paragraph (b)(1)(iv)(B) if this section; or
( 2 ) A minimum charge equal to 25 percent times the multiplier for each equity and index option contract and each related instrument within the option's class or product group, or $25 for each option on a major market foreign currency with the minimum charge for futures contracts and options on futures contracts adjusted for contract size differentials, not to exceed market value in the case of long positions in options and options on futures contracts; plus
( 3 ) In the case of portfolio types involving index options and related instruments offset by a qualified stock basket, there will be a minimum charge of 5 percent of the market value of the qualified stock basket for high-capitalization diversified and narrow-based indexes;
( 4 ) In the case of portfolio types involving index options and related instruments offset by a qualified stock basket, there will be a minimum charge of 7 1/2 percent of the market value of the qualified stock basket for non-high-capitalization diversified indexes; and
( 5 ) In the case of portfolio types involving security futures and equity options on the same underlying instrument and positions in that underlying instrument, there will be a minimum charge of 25 percent times the multiplier for each security-future and equity option.
§ 240.18a-1b   Adjustments to net worth for certain commodities transactions.
(a) Every registered security-based swap dealer in computing net capital pursuant to § 240.18a-1 shall comply with the following:
(1) Where a security-based swap dealer has an asset or liability which is treated or defined in paragraph (c) of § 240.18a-1, the inclusion or exclusion of all or part of such asset or liability for net capital shall be in accordance with § 240.18a-1, except as specifically provided otherwise in this section. Where a commodity related asset or liability, including a swap-related asset or liability, is specifically treated or defined in 17 CFR 1.17 and is not generally or specifically treated or defined in § 240.18a-1 or this section, the inclusion or exclusion of all or part of such asset or liability for net capital shall be in accordance with 17 CFR 1.17.
(2) In computing net capital as defined in § 240.18a-1(c)(1), the net worth of a security-based swap dealer shall be adjusted as follows with respect to commodity-related transactions:
(i)(A) Unrealized profits shall be added and unrealized losses shall be deducted in the commodities accounts of the security-based swap dealer, including unrealized profits and losses on fixed price commitments and forward contracts; and
(B) The value attributed to any commodity option which is not traded on a contract market shall be the difference between the option's strike price and the market value for the physical or futures contract which is the subject of the option. In the case of a long call commodity option, if the market value for the physical or futures contract which is the subject of the option is less than the strike price of the option, it shall be given no value. In the case of a long put commodity option, if the market value for the physical commodity or futures contract which is the subject of the option is more than the striking price of the option, it shall be given no value.
(ii) Deduct any unsecured commodity futures or option account containing a ledger balance and open trades, the combination of which liquidates to a deficit or containing a debit ledger balance only: Provided, however, Deficits or debit ledger balances in unsecured customers', non-customers' and proprietary accounts, which are the subject of calls for margin or other required deposits need not be deducted until the close of business on the business day following the date on which such deficit or debit ledger balance originated;
(iii) Deduct all unsecured receivables, advances and loans except for:
(A) Management fees receivable from commodity pools outstanding no longer than thirty (30) days from the date they are due;
(B) Receivables from foreign clearing organizations;
(C) Receivables from registered futures commission merchants or brokers, resulting from cleared swap transactions or, commodity futures or option transactions, except those specifically excluded under paragraph (a)(2)(ii) of this section.
(iv) Deduct all inventories (including work in process, finished goods, raw materials and inventories held for resale) except for readily marketable spot commodities; or spot commodities which adequately collateralize indebtedness under 17 CFR 1.17(c)(7);
(v) Guarantee deposits with commodities clearing organizations are not required to be deducted from net worth;
(vi) Stock in commodities clearing organizations to the extent of its margin value is not required to be deducted from net worth;
(vii) Deduct from net worth the amount by which any advances paid by the security-based swap dealer on cash commodity contracts and used in computing net capital exceeds 95 percent of the market value of the commodities covered by such contracts.
(viii) Do not include equity in the commodity accounts of partners in net worth.
(ix) In the case of all inventory, fixed price commitments and forward contracts, except for inventory and forward contracts in the inter-bank market in those foreign currencies which are purchased or sold for further delivery on or subject to the rules of a contract market and covered by an open futures contract for which there will be no charge, deduct the applicable percentage of the net position specified below:
(A) Inventory which is currently registered as deliverable on a contract market and covered by an open futures contract or by a commodity option on a physical—No charge.
(B) Inventory which is covered by an open futures contract or commodity option—5 percent of the market value.
(C) Inventory which is not covered—20 percent of the market value.
(D) Fixed price commitments (open purchases and sales) and forward contracts which are covered by an open futures contract or commodity option—10 percent of the market value.
(E) Fixed price commitments (open purchases and sales) and forward contracts which are not covered by an open futures contract or commodity option—20 percent of the market value.
(x) Deduct for undermargined customer commodity futures accounts the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or, if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin, or other required deposits which are outstanding three business days or less. If there are no such maintenance margin requirements or clearing organization margin requirements on such accounts, then deduct the amount of funds required to provide margin equal to the amount necessary after application of calls for margin, or other required deposits outstanding three days or less to restore original margin when the original margin has been depleted by 50 percent or more. Provided, To the extent a deficit is deducted from net worth in accordance with paragraph (a)(2)(ii) of this section, such amount shall not also be deducted under this paragraph (a)(2)(x). In the event that an owner of a customer account has deposited an asset other than cash to margin, guarantee or secure his account, the value attributable to such asset for purposes of this paragraph shall be the lesser of the value attributable to such asset pursuant to the margin rules of the applicable board of trade, or the market value of such asset after application of the percentage deductions specified in paragraph (a)(2)(ix) of this section or, where appropriate, specified in § 240.18a-1(c)(1)(iv), (vi), or (vii) of this part;
(xi) Deduct for undermargined non-customer and omnibus commodity futures accounts the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or, if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin, or other required deposits which are outstanding two business days or less. If there are no such maintenance margin requirements or clearing organization margin requirements, then deduct the amount of funds required to provide margin equal to the amount necessary after application of calls for margin, or other required deposits outstanding two days or less to restore original margin when the original margin has been depleted by 50 percent or more. Provided, To the extent a deficit is deducted from net worth in accordance with paragraph (a)(2)(ii) of this section such amount shall not also be deducted under this paragraph (a)(2)(xi). In the event that an owner of a non-customer or omnibus account has deposited an asset other than cash to margin, guarantee or secure the account, the value attributable to such asset for purposes of this paragraph shall be the lesser of the value attributable to such asset pursuant to the margin rules of the applicable board of trade, or the market value of such asset after application of the percentage deductions specified in paragraph (a)(2)(ix) of this section or, where appropriate, specified in § 240.18a-1(c)(1)(iv), (vi), or (vii) of this part;
(xii) In the case of open futures contracts and granted (sold) commodity options held in proprietary accounts carried by the security-based swap dealer which are not covered by a position held by the security-based swap dealer or which are not the result of a “changer trade” made in accordance with the rules of a contract market, deduct:
(A) For a security-based swap dealer which is a clearing member of a contract market for the positions on such contract market cleared by such member, the applicable margin requirement of the applicable clearing organization;
(B) For a security-based swap dealer which is a member of a self-regulatory organization, 150 percent of the applicable maintenance margin requirement of the applicable board of trade or clearing organization, whichever is greater; or
(C) For all other security-based swap dealers, 200 percent of the applicable maintenance margin requirement of the applicable board of trade or clearing organization, whichever is greater; or
(D) For open contracts or granted (sold) commodity options for which there are no applicable maintenance margin requirements, 200 percent of the applicable initial margin requirement; Provided, the equity in any such proprietary account shall reduce the deduction required by this paragraph (a)(2)(xii) if such equity is not otherwise includable in net capital.
(xiii) In the case of a security-based swap dealer which is a purchaser of a commodity option which is traded on a contract market, the deduction shall be the same safety factor as if the security-based swap dealer were the grantor of such option in accordance with paragraph (a)(2)(xii) of this section, but in no event shall the safety factor be greater than the market value attributed to such option.
(xiv) In the case of a security-based swap dealer which is a purchaser of a commodity option not traded on a contract market which has value and such value is used to increase net capital, the deduction is ten percent of the market value of the physical or futures contract which is the subject of such option but in no event more than the value attributed to such option.
(xv) A loan or advance or any other form of receivable shall not be considered “secured” for the purposes of paragraph (a)(2) of this section unless the following conditions exist:
(A) The receivable is secured by readily marketable collateral which is otherwise unencumbered and which can be readily converted into cash: Provided, however, That the receivable will be considered secured only to the extent of the market value of such collateral after application of the percentage deductions specified in paragraph (a)(2)(ix) of this section; and
(B)( 1 ) The readily marketable collateral is in the possession or control of the security-based swap dealer; or
( 2 ) The security-based swap dealer has a legally enforceable, written security agreement, signed by the debtor, and has a perfected security interest in the readily marketable collateral within the meaning of the laws of the State in which the readily marketable collateral is located.
(xvi) The term cover for purposes of this section shall mean cover as defined in 17 CFR 1.17(j).
(xvii) The term customer for purposes of this section shall mean customer as defined in 17 CFR 1.17(b)(2). The term non-customer for purposes of this section shall mean non-customer as defined in 17 CFR 1.17(b)(4).
(b) Every registered security-based swap dealer in computing net capital pursuant to § 240.18a-1 shall comply with the following:
(1) Cleared swaps. In the case of a cleared swap held in a proprietary account of the security-based swap dealer, deducting the amount of the applicable margin requirement of the derivatives clearing organization or, if the swap references an equity security index, the security-based swap dealer may take a deduction using the method specified in § 240.18a-1a.
(2) Non-cleared swaps —(i) Credit default swaps referencing broad-based security indices. In the case of a non-cleared credit default swap for which the deductions in § 240.18a-1(e) do not apply:
(A) Short positions (selling protection). In the case of a non-cleared swap that is a short credit default swap referencing a broad-based security index, deducting the percentage of the notional amount based upon the current basis point spread of the credit default swap and the maturity of the credit default swap in accordance with table 1 to § 240.18a-1b(b)(2)(i)(A):
Table 1 to § 240.18 a -1 b ( b )(2)( i )(A)
(B) Long positions (purchasing protection). In the case of a non-cleared swap that is a long credit default swap referencing a broad-based security index, deducting 50 percent of the deduction that would be required by paragraph (b)(2)(i)(A) of this section if the non-cleared swap was a short credit default swap, each such deduction not to exceed the current market value of the long position.
(C) Long and short credit default swaps. In the case of non-cleared swaps that are long and short credit default swaps referencing the same broad-based security index, have the same credit events which would trigger payment by the seller of protection, have the same basket of obligations which would determine the amount of payment by the seller of protection upon the occurrence of a credit event, that are in the same or adjacent spread category, and that are in the same or adjacent maturity category and have a maturity date within three months of the other maturity category, deducting the percentage of the notional amount specified in the higher maturity category under paragraph (b)(2)(i)(A) or (B) of this section on the excess of the long or short position.
(D) Long basket of obligors and long credit default swap. In the case of a non-cleared swap that is a long credit default swap referencing a broad-based security index and the security-based swap dealer is long a basket of debt securities comprising all of the components of the security index, deducting 50 percent of the amount specified in § 240.15c3-1(c)(2)(vi) for the component securities, provided the security-based swap dealer can deliver the component securities to satisfy the obligation of the security-based swap dealer on the credit default swap.
(E) Short basket of obligors and short credit default swap. In the case of a non-cleared swap that is a short credit default swap referencing a broad-based security index and the security-based swap dealer is short a basket of debt securities comprising all of the components of the security index, deducting the amount specified in § 240.15c3-1(c)(2)(vi) for the component securities.
(ii) All other swaps. (A) In the case of any non-cleared swap that is not a credit default swap for which the deductions in § 240.18a-1(e) do not apply, deducting the amount calculated by multiplying the notional value of the swap by the percentage specified in:
( 1 ) Section 240.15c3-1 applicable to the reference asset if § 240.15c3-1 specifies a percentage deduction for the type of asset;
( 2 ) 17 CFR 1.17 applicable to the reference asset if 17 CFR 1.17 specifies a percentage deduction for the type of asset and § 240.15c3-1 does not specify a percentage deduction for the type of asset; or
( 3 ) In the case of a non-cleared interest rate swap, § 240.15c3-1(c)(2)(vi)(A) based on the maturity of the swap, provided that the percentage deduction must be no less than one eighth of 1 percent of the amount of a long position that is netted against a short position in the case of a non-cleared swap with a maturity of three months or more.
(B) A security-based swap dealer may reduce the deduction under paragraph (b)(2)(ii) of this section by an amount equal to any reduction recognized for a comparable long or short position in the reference asset or interest rate under 17 CFR 1.17 or § 240.15c3-1.
§ 240.18a-1c   Consolidated Computations of Net Capital for Certain Subsidiaries and Affiliates of Security-Based Swap Dealers.
Every security-based swap dealer in computing its net capital pursuant to § 240.18a-1 shall include in its computation all liabilities or obligations of a subsidiary or affiliate that the security-based swap dealer guarantees, endorses, or assumes either directly or indirectly.