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October 27, 2010 

Ms. Elizabeth M. Murphy 

Secretary 

Securities and Exchange Commission 

100 F Street, N.E. 

Washington, DC 20549-1090 

Mr. David A. Stawick 

Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington DC 20581 

Dear Ms. Murphy and Mr. Stawick: 

The Capital Steering Committee (the “Committee”) of the Securities Industry and Financial 

Markets Association (“SIFMA”)1

 appreciates the opportunity to provide to the Commodity 

Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC” 

and, together with the CFTC, the “Commissions”) comments on capital adequacy and customer 

protection issues raised by Title VII of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (“Dodd-Frank”). We particularly appreciate the opportunity to comment prior to 

proposed rulemaking by the Commissions in these important areas. 

Many of the financial institutions represented by the Committee’s membership conduct securities 

and futures businesses through entities registered with both Commissions. Further, many of the 

financial institutions represented on the Committee offer clients over-the-counter (“OTC”) 

derivative products through broker-dealers (“BDs”), futures commission merchants (“FCMs”) 

and affiliates of BDs and FCMs subject to the supervision or oversight of other regulatory bodies. 

The current expectation among our members is that these financial institutions will register with 

the Commissions as “swap dealers” and “security-based swap dealers” (collectively, “Swap 

Dealers”) for their dealing activities in swaps and security-based swaps (collectively, “Swaps”), 

respectively. 

In this letter, we discuss a number of our questions and concerns regarding capital adequacy and 

customer protection issues under Dodd-Frank. In particular, these questions and concerns relate 

to: 

 implementation and transition; 

 structural issues; 

 capital requirements; 

 segregation/customer protection requirements; 

 margin requirements; and 

 treatment of existing transactions. 

                                                           

1

 SIFMA brings together the shared interests of hundreds of securities firms, banks and asset managers. 

SIFMA’s mission is to support a strong financial industry, investor opportunity, capital formation, job 

creation and economic growth, while building trust and confidence in the financial markets. SIFMA, with 

offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets 

Association. For more information, visit www.sifma.org. 
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Implementation and Transition

In implementing Dodd-Frank, we encourage the Commissions to harmonize and make consistent 

their rules and regulations. The Committee believes that consistent sets of regulations would 

facilitate more efficient and sound Swaps markets. 

Further, the Committee believes that a diverse population of firms will register as Swap Dealers. 

The population will include at least several large financial institutions with BDs currently 

applying the SEC’s model-based alternative net capital standard. The population will also 

include small and large BDs operating under the SEC’s basic methodology for computing capital 

requirements and some dealers yet to be formed. Many of these future Swap Dealers are (or will 

be) subsidiaries of holding companies subject to consolidated supervision – some by domestic 

regulatory bodies and some by foreign regulatory bodies. 

Given the enormity of the tasks firms face in establishing Swap Dealers and registering with the 

Commissions, the Committee would ask the Commissions to be flexible in their approach for the 

approval of applications – recognizing where possible the broader regulatory experiences of 

applicants. 

Structural Issues

Financial institutions have started to explore the entity structure through which they will engage 

in Swap activities upon implementation of Dodd-Frank. The Committee has identified two 

structural issues that are critical to its members’ evaluations of approaches for complying with 

Dodd-Frank: 1) the registration of full-service BDs and FCMs as Swap Dealers and 2) the 

clearing arrangements for standalone Swap Dealers not currently registered as BDs or FCMs. 

The Committee recommends that the Commissions allow firms maximum flexibility in 

determining their organizational structures to allow for the efficient use of existing operational 

and systems capabilities. 

The Committee believes that, to the extent possible, the Commissions’ rules should accommodate 

arrangements whereby Swap activities can be combined with non-Swap activities in a registered 

BD and FCM. Combining these activities within a single entity would allow a BD or an FCM to 

avoid unnecessarily limiting the range of products available to clients and to achieve operational 

and funding efficiencies. As a result, the Committee recommends that the Commissions enable 

full-service BDs and FCMs to register as Swap Dealers. Further, the Committee assumes that the 

Commissions will permit a single entity to register as both a security-based swap dealer and a 

swap dealer. We believe this is necessary to avoid fragmentation into separate entities 

transactions that are currently conducted as a single business. 

In addition, the Committee recommends that the Commissions permit standalone Swap Dealers to 

choose to (i) establish and maintain clearance and settlement capabilities for principal 

transactions; (ii) establish and maintain clearance and settlement capabilities for principal and 

agency transactions (in which case, the CFTC would require the standalone Swap Dealer to 

register as an FCM); or (iii) clear principal and/or agency transactions through an affiliated or an 

unaffiliated BD or FCM. 

The Committee would note that a number of factors, including those mentioned above, will 

influence decisions as to the structuring or restructuring of financial institutions to comply with 

Dodd-Frank. Among other factors are the structures of central clearance facilities and the basis 

upon which these facilities will assign responsibility and liability in the event of default. 
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Capital Requirements

Introduction

The Committee met with representatives of the SEC’s Division of Trading and Markets (the 

“Division”) on September 8, 2010, and, in response to that discussion, the Committee would offer 

the following comments regarding the determination of capital requirements for the market and 

credit exposures associated with principal and agency positions in Swaps. The Division indicated 

that the Commissions may rely upon the structures of SEC Rule 15c3-1 (Net Capital 

Requirements for Brokers or Dealers) and CFTC Rule 1.17 (Minimum Financial Requirements 

for Futures Commission Merchants and Introducing Brokers). We note the Commissions have 

treated the two rules as interdependent for many years. 

The Committee is aware of efforts within the broader regulatory community to revise capital 

adequacy standards and related regulations. The Committee would appreciate the opportunity to 

discuss with the Commissions the degree to which these revised standards may be relevant to and 

appropriate for Swaps and Swap Dealers once the standards are in final form and once we and the 

Commissions have reviewed the computational methods used. 

Principal Positions

During the course of the September 8th meeting, the Committee and the Division discussed the 

merits of the Commissions relying upon the computational approach of Appendix E of SEC Rule 

15c3-1 for assessing the market risks associated with principal positions in Swaps. A number of 

Committee members have experience with Appendix E and believe the model-based 

computational approach within Appendix E has several positive attributes. First, the approach 

recognizes hedges in the computation of capital charges as a function of the statistical correlation 

of price movements between instruments. The approach provides incentives for effective 

hedging. Second, to recognize the characteristics and risks associated with individual instrument 

types, Appendix E allows for add-ons to bring capital charges to levels the SEC views as 

commensurate with identified risks. 

Additionally, Appendix E provides that the SEC may allow a BD to utilize a scenario analysis for 

computing capital requirements for instruments for which model-based computations plus addons are not adequate to capture market risks. The scenario analyses must reflect “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 over the 

four years preceding calculation of the greatest loss.” Finally, in concept and in application, 

Appendix E’s computational methodology – including reliance upon add-ons and scenario 

analyses to align capital charges and risks – is broadly consistent with methodologies relied upon 

by other domestic and international regulators. 

 

The Committee would note that the reporting provisions of Dodd-Frank should make prices for 

derivative products more available and the pricing of derivative products more transparent and 

that the greater availability of pricing information facilitates the application of models in the 

computation of capital requirements. 
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Minimum Capital Requirements and Early Warning Levels 

The Committee believes that caution should be exercised before applying the Commissions’ 

current approaches for establishing minimum capital requirements for BDs and FCMs to the 

Swaps market. Currently, the Commissions apply percentages to amounts representing the sum 

total of client exposures to derive minimum net capital requirements and early warning levels. To 

our knowledge, the Commissions have yet to collect data that would allow for an evaluation of 

the appropriateness of current methodologies for computing minimum capital requirements or 

provide a basis for the derivation of other methodologies. The evaluation of data is particularly 

important because the size of the markets for Swaps suggests that the application to Swaps of the 

existing methodologies pertaining to futures positions and securities margin accounts could 

produce minimum capital requirements and early warning levels disproportionately large in 

relation to the risks and liquidity requirements associated with these businesses. The Committee 

would be glad to provide the Commissions with data the Commissions would find helpful in their 

efforts to test or establish minimum capital requirement computation methodologies. 

Margin Deficiencies 

The Committee understands that the Commissions are considering imposing capital charges in 

cases where margin calls for Swaps are not met on T + 1. This timeframe is significantly shorter 

than the timeframe currently in place with respect to futures and securities accounts. The 

Committee understands that the Commissions are considering a shortened timeframe in 

recognition of potential difficulties in covering exposures associated with instruments less liquid 

than common stocks or listed futures contracts. The Committee appreciates that the shortened 

time period may help identify potential credit problems at an early stage and will cause Swap 

Dealers to allocate capital to these businesses to allow for operational issues and delays. 

The Committee has two observations. First, the Committee believes the Commissions should 

recognize the abbreviated timeframe as a factor in differentiating minimum capital requirements 

for Swaps and Swap Dealers from the current minimum capital requirements applicable to BDs 

and FCMs. Second, the Committee would recommend that the Commissions reconsider the 

shortened timeframe with respect to those Swaps for which there is a liquid market or for which 

an effective hedge is readily available. 

Segregation/Customer Protection Requirements

Introduction 

Dodd-Frank requires the Commissions to develop rules for the segregation of client assets 

collateralizing Swaps. With reference to existing relationships between clients and FCMs and 

FCMs and clearing facilities, the Committee would expect that the segregation of margin posted 

with respect to centrally cleared Swaps would be achieved through the deposits of customer 

assets in designated accounts at the clearinghouses. 

To date, Committee members have received little information regarding the Commissions’ views 

toward segregation requirements for uncleared Swaps. We understand that clients may elect to 

require Swap Dealers to segregate client assets representing initial margin supporting uncleared 

Swaps with an independent third party custodian. We believe Dodd-Frank implies Congressional 

intent that segregation not be required for uncleared Swaps for variation margin or for initial 

margin where the customer does not elect segregation. The Committee is not aware of an 

industry-wide standard for third-party custody of margin, and third-party arrangements raise 
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additional risks for Swap Dealers (e.g., prior liens by third-party custodians and questionable 

perfection of Swap Dealers’ security interests). Therefore, to facilitate firms’ efforts to establish 

the infrastructure necessary to comply with Dodd-Frank, the Committee would recommend that 

the Commissions provide industry members with their views regarding the treatment of collateral 

supporting uncleared Swaps at an early date. 

The Committee further recommends that the Commissions consider the suggestions set out in the 

ISDA Pre-Proposal Letter to the CFTC dated October 8, 2010, specifically the recommendations 

that (i) rules allow the parties to choose to segregate collateral with a third-party custodian under 

either a tri-party or a bilateral custody arrangement; (ii) rules clarify that the notice required 

(under Section 4s(l)(1)(A) of the Commodity Exchange Act) to be given by a Swap Dealer or a 

major swap/security-based swap participant to its counterparty regarding the counterparty’s right 

to require segregation need only be given once, rather than on entry into every uncleared swap; 

and (iii) the Commissions engage in close collaboration to avoid inconsistent requirements for 

transactions typically governed by a common agreement. 

Operational Risk and Funding Inefficiencies 

While neither Commission has offered formal guidance with respect to the relationship of 

existing customer protection regimes to customer protection regimes for Swaps, the Committee’s 

understanding of the Commissions’ views is that the current regimes and the Swap regimes will 

be separate and distinct. For example, the Committee’s current understanding is that collateral 

posted in support of a security-based swap would not be protected under the Securities Investor 

Protection Act (“SIPA”), as security-based swaps have not been added to the definition of 

“security” in SIPA. Further, to our knowledge, the CFTC has yet to indicate formally whether 

collateral posted in support of a swap would fall within its own existing customer protection 

regulations. The Committee believes that separate customer protection regimes for Swaps, in 

combination with the existing regimes for the segregation and protection of customers’ assets, 

will complicate greatly the movement and control of customers’ other assets and, as a result, 

contribute to operational risk and funding inefficiencies. As a result, the Committee recommends 

including Swaps in existing customer protection regimes to the extent possible. 

Portfolio Margining 

Separate systems of segregation and customer protection for Swaps could also interfere with 

portfolio margining. Dodd-Frank provides the basis for the Commissions to expand the 

framework within which customers and other clients carrying positions in products regulated by 

both Commissions could avail themselves of the benefits of portfolio margining. The Committee 

believes that broad application of portfolio margining would allow U.S. investors to hedge market 

and credit risk more efficiently and effectively. Further, the broader application of portfolio 

margining in the U.S. would provide investors in the U.S. advantages available in some foreign 

jurisdictions. However, a dichotomy in segregation and customer protection regimes, as 

discussed above, would greatly complicate, if not prevent, the expansion of portfolio margining 

opportunities for U.S. investors. For this reason also, the Committee would urge the 

Commissions to include Swaps in the existing customer protection regimes to the extent possible. 

Margin Requirements

Dodd-Frank requires the Commissions to supervise or set margin requirements for cleared and 

uncleared Swaps entered into by Swap Dealers and major swap/security-based swap participants. 

As mentioned above, Dodd-Frank allows latitude for the Commissions to expand the framework 
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within which BDs and FCMs could offer portfolio margining capabilities to clients. Portfolio 

margining affords clients the opportunity to reduce margin requirements by hedging risks within 

a portfolio. For example, a client could reduce the risk of holding a position in a given common 

stock by entering into a security-based swap on that common stock. As a result, less margin 

should be required of the customer. 

In a hedged portfolio, therefore, a Swap Dealer may obtain less overall margin from a client than 

a clearinghouse would require the Swap Dealer to post to the clearinghouse with respect to the 

customer’s Swap position if not taking into consideration other positions of the client. To address 

this potential disparity in margin and to facilitate the development of portfolio margining, the 

Committee would recommend that Swap Dealers be permitted to meet the margin requirements 

of clearinghouses through the rehypothecation of collateral deposited by clients in support of 

Swaps, as long as the Swap Dealer reflects such rehypothecation in computing customer reserve 

requirements. 

Treatment of Existing Transactions

Many BDs, FCMs and affiliates of BDs and FCMs hold positions in OTC derivative transactions 

that, upon effectiveness of Title VII, will be Swaps. Firms executed these transactions under 

agreements stipulating collateral requirements and rehypothecation rights that may be 

inconsistent with requirements under regulations to be imposed by the Commissions in 

implementing Dodd-Frank. To avoid potential cash flow and operational issues, the Committee 

recommends that the Commissions permit financial institutions flexibility in the transition to the 

regimes currently under development. Given the size, complexity and maturity structures of 

existing OTC derivatives books, firms will need adequate time to address clients’ concerns and 

trading exposures and Swap Dealers’ funding, capital and operational constraints. The 

documentation and re-documentation of clients’ accounts and transaction agreements in and of 

itself is a task of significant dimension. Additionally, the Committee recommends that the 

Commissions permit Swap Dealers to address clients’ concerns on a client-by-client basis to 

allow financial institutions to align actions taken with clients’ needs and circumstances. 

 * * * 

The Committee thanks the Commissions for the opportunity to comment in advance of their 

rulemaking on capital adequacy and customer protection issues raised by Dodd-Frank. The 

Committee’s members would appreciate the opportunity to further comment on these topics, as 

well as other related rulemakings the Commissions will undertake under Title VII of the DoddFrank Act. If you have any questions, please do not hesitate Kyle Brandon of SIFMA at 212-

313-1280 or the undersigned at 202-962-7400. 

Respectfully submitted, 

Kenneth E. Bentsen, Jr. 

Executive Vice President 

Public Policy and Advocacy 

SIFMA