Document ID: SEC-2019-1217-0001
Agency: sec
Document Type: Rule
Title: Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers
Posted Date: 2019-08-22T04:00Z

[Federal Register Volume 84, Number 163 (Thursday, August 22, 2019)]
[Rules and Regulations]
[Pages 43872-44077]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-13609]

[[Page 43871]]

Vol. 84

Thursday,

No. 163

August 22, 2019

Part II

 Securities and Exchange Commission

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17 CFR Parts 200 and 240

 Capital, Margin, and Segregation Requirements for Security-Based Swap 
Dealers and Major Security-Based Swap Participants and Capital and 
Segregation Requirements for Broker-Dealers; Final Rule

  Federal Register / Vol. 84 , No. 163 / Thursday, August 22, 2019 / 
Rules and Regulations  

[[Page 43872]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200 and 240

[Release No. 34-86175; File No. S7-08-12]
RIN 3235-AL12

Capital, Margin, and Segregation Requirements for Security-Based 
Swap Dealers and Major Security-Based Swap Participants and Capital and 
Segregation Requirements for Broker-Dealers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act''), the Securities and 
Exchange Commission (``Commission''), pursuant to the Securities 
Exchange Act of 1934 (``Exchange Act''), is adopting capital and margin 
requirements for security-based swap dealers (``SBSDs'') and major 
security-based swap participants (``MSBSPs''), segregation requirements 
for SBSDs, and notification requirements with respect to segregation 
for SBSDs and MSBSPs. The Commission also is increasing the minimum net 
capital requirements for broker-dealers authorized to use internal 
models to compute net capital (``ANC broker-dealers''), and prescribing 
certain capital and segregation requirements for broker-dealers that 
are not SBSDs to the extent they engage in security-based swap and swap 
activity. The Commission also is making substituted compliance 
available with respect to capital and margin requirements under Section 
15F of the Exchange Act and the rules thereunder and adopting a rule 
that specifies when a foreign SBSD or foreign MSBSP need not comply 
with the segregation requirements of Section 3E of the Exchange Act and 
the rules thereunder.

DATES: 
    Effective date: October 21, 2019.
    Compliance date: The compliance date is discussed in section III.B 
of this release.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at 
(202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 
551-5522; Raymond Lombardo, Assistant Director, at 202-551-5755; Sheila 
Dombal Swartz, Senior Special Counsel, at (202) 551-5545; Timothy C. 
Fox, Branch Chief, at (202) 551-5687; Valentina Minak Deng, Special 
Counsel, at (202) 551-5778; Rose Russo Wells, Senior Counsel, at (202) 
551-5527; or Nina Kostyukovsky, Special Counsel, at (202) 551-8833, 
Division of Trading and Markets, Securities and Exchange Commission, 
100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Introduction
    A. Background
    B. Overview of the New Requirements
    1. Capital Requirements
    2. Margin Requirements for Non-Cleared Security-Based Swaps
    3. Segregation Requirements
    4. Alternative Compliance Mechanism
    5. Cross-Border Application
II. Final Rules and Rule Amendments
    A. Capital
    1. Introduction
    2. Capital Rules for Nonbank SBSDs
    3. Capital Rules for Nonbank MSBSPs
    4. OTC Derivatives Dealers
    B. Margin
    1. Introduction
    2. Margin Requirements for Nonbank SBSDs and Nonbank MSBSPs
    C. Segregation
    1. Background
    2. Exemption
    3. Segregation Requirements for Security-Based Swaps
    D. Alternative Compliance Mechanism
    E. Cross-Border Application of Capital, Margin, and Segregation 
Requirements
    1. Capital and Margin Requirements
    2. Segregation Requirements
    F. Delegation of Authority
III. Explanation of Dates
    A. Effective Date
    B. Compliance Dates
    C. Effect on Existing Commission Exemptive Relief
    D. Application to Substituted Compliance
IV. Paperwork Reduction Act
    A. Summary of Collections of Information Under the Rules and 
Rule Amendments
    1. Rule 18a-1 and Amendments to Rule 15c3-1
    2. Rule 18a-2
    3. Rule 18a-3
    4. Rule 18a-4 and Amendments to Rule 15c3-3
    5. Rule 18a-10
    6. Amendments to Rule 3a71-6
    B. Use of Information
    C. Respondents
    D. Total Initial and Annual Recordkeeping and Reporting Burden
    1. Rule 18a-1 and Amendments to Rule 15c3-1
    2. Rule 18a-2
    3. Rule 18a-3
    4. Rule 18a-4 and Amendments to Rule 15c3-3
    5. Rule 18a-10
    6. Rule 3a71-6
    E. Collection of Information Is Mandatory
    F. Confidentiality
    G. Retention Period for Recordkeeping Requirements
V. Other Matters
VI. Economic Analysis
    A. Baseline
    1. Market Participants
    2. Counterparty Credit Risk Mitigation
    3. Global Regulatory Efforts
    4. Capital Regulation
    5. Margin Regulation
    6. Segregation
    7. Historical Pricing Data
    B. Analysis of the Final Rules and Alternatives
    1. The Capital Rules for Nonbank SBSDs--Rules 15c3-1 and 18a-1
    2. The Capital Rule for Nonbank MSBSPs--Rule 18a-2
    3. The Margin Rule--Rule 18a-3
    4. The Segregation Rules--Rules 15c3-3 and 18a-4
    5. Cross-Border Application
    6. Rule 18a-10
    C. Implementation Costs
    D. Effects on Efficiency, Competition, and Capital Formation
    1. Efficiency and Capital Formation
    2. Competition
VII. Regulatory Flexibility Act Certification
VIII. Statutory Basis

I. Introduction

A. Background

    Title VII of the Dodd-Frank Act (``Title VII'') established a new 
regulatory framework for the U.S. over-the-counter (``OTC'') 
derivatives markets.\1\ Section 764 of the Dodd-Frank Act added Section 
15F to the Exchange Act.\2\ Section 15F(e)(1)(B) of the Exchange Act 
provides that the Commission shall prescribe capital and margin 
requirements for SBSDs and

[[Page 43873]]

MSBSPs that do not have a prudential regulator (respectively, ``nonbank 
SBSDs'' and ``nonbank MSBSPs'').\3\ Section 763 of the Dodd-Frank Act 
added Section 3E to the Exchange Act.\4\ Section 3E provides the 
Commission with the authority to establish segregation requirements for 
SBSDs and MSBSPs.\5\ The Commission also has separate and independent 
authority under Section 15 of the Exchange Act to prescribe capital and 
segregation requirements for broker-dealers.\6\
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    \1\ See Public Law 111-203, 701 through 774. The Dodd-Frank Act 
assigns primary responsibility for the oversight of the U.S. OTC 
derivatives markets to the Commission and the Commodity Futures 
Trading Commission (``CFTC''). The Commission has oversight 
authority with respect to a ``security-based swap'' as defined in 
Section 3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)), 
including to implement a registration and oversight program for a 
``security-based swap dealer'' as defined in Section 3(a)(71) of the 
Exchange Act (15 U.S.C. 78c(a)(71)) and a ``major security-based 
swap participant'' as defined in Section 3(a)(67) of the Exchange 
Act (15 U.S.C. 78c(a)(67)). The CFTC has oversight authority with 
respect to a ``swap'' as defined in Section 1(a)(47) of the 
Commodity Exchange Act (``CEA'') (7 U.S.C. 1(a)(47)), including to 
implement a registration and oversight program for a ``swap dealer'' 
as defined in Section 1(a)(49) of the CEA (7 U.S.C. 1(a)(49)) and a 
``major swap participant'' as defined in Section 1(a)(33) of the CEA 
(7 U.S.C. 1(a)(33)). The Commission and the CFTC jointly have 
adopted rules to further define those terms. See Further Definition 
of ``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap 
Agreement''; Mixed Swaps; Security-Based Swap Agreement 
Recordkeeping, Exchange Act Release No. 67453 (July 18, 2012), 77 FR 
48208 (Aug. 13, 2012) (``Product Definitions Adopting Release''); 
Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant'', Exchange Act 
Release No. 66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012) 
(``Entity Definitions Adopting Release'').
    \2\ 15 U.S.C. 78o-10 (``Section 15F of the Exchange Act'' or 
``Section 15F'').
    \3\ Specifically, Section 15F(e)(1)(B) of the Exchange Act 
provides that each registered SBSD and MSBSP for which there is not 
a prudential regulator shall meet such minimum capital requirements 
and minimum initial and variation margin requirements as the 
Commission shall by rule or regulation prescribe. The term 
``prudential regulator'' is defined in Section 1(a)(39) of the CEA 
(7 U.S.C. 1(a)(39)) and that definition is incorporated by reference 
in Section 3(a)(74) of the Exchange Act. Pursuant to the definition, 
the Board of Governors of the Federal Reserve System (``Federal 
Reserve''), the Office of the Comptroller of the Currency (``OCC''), 
the Federal Deposit Insurance Corporation (``FDIC''), the Farm 
Credit Administration, or the Federal Housing Finance Agency 
(collectively, the ``prudential regulators'') is the ``prudential 
regulator'' of an SBSD, MSBSP, swap participant, or major swap 
participant if the entity is directly supervised by that agency.
    \4\ 15 U.S.C. 78c-5 (``Section 3E of the Exchange Act'' or 
``Section 3E'').
    \5\ Section 3E of the Exchange Act does not distinguish between 
bank and nonbank SBSDs and MSBSPs, and, consequently, provides the 
Commission with the authority to establish segregation requirements 
for SBSDs and MSBSPs (whether or not they have a prudential 
regulator).
    \6\ Section 771 of the Dodd-Frank Act states that unless 
otherwise provided by its terms, its provisions relating to the 
regulation of the security-based swap market do not divest any 
appropriate Federal banking agency, the Commission, the CFTC, or any 
other Federal or State agency, of any authority derived from any 
other provision of applicable law. In addition, Section 15F(e)(3)(B) 
of the Exchange Act provides that nothing in Section 15F ``shall 
limit, or be construed to limit, the authority'' of the Commission 
``to set financial responsibility rules for a broker or dealer . . . 
in accordance with Section 15(c)(3).''
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    Section 4s(e)(1)(B) of the CEA provides that the CFTC shall 
prescribe capital and margin requirements for swap dealers and major 
swap participants for which there is not a prudential regulator 
(``nonbank swap dealers'' and ``nonbank swap participants'').\7\ 
Section 15F(e)(1)(A) of the Exchange Act provides that the prudential 
regulators shall prescribe capital and margin requirements for SBSDs 
and MSBSPs that have a prudential regulator (respectively, ``bank 
SBSDs'' and ``bank MSBSPs''). Section 4s(e)(1)(A) of the CEA provides 
that the prudential regulators shall prescribe capital and margin 
requirements for swap dealers and major swap participants for which 
there is a prudential regulator (respectively, ``bank swap dealers'' 
and ``bank swap participants'').\8\ The prudential regulators have 
adopted capital and margin requirements for bank SBSDs and MSBSPs and 
for bank swap dealers and major swap participants.\9\ The CFTC has 
adopted margin requirements and proposed capital requirements for 
nonbank swap dealers and major swap participants.\10\ The CFTC also has 
adopted segregation requirements for cleared and non-cleared swaps.\11\
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    \7\ See 7 U.S.C. 6s(e)(1)(B).
    \8\ See 7 U.S.C. 6s(e)(1)(A).
    \9\ See Margin and Capital Requirements for Covered Swap 
Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential Regulator Margin 
and Capital Adopting Release''). The prudential regulators, as part 
of their margin requirements for non-cleared security-based swaps, 
adopted a segregation requirement for collateral received as margin.
    \10\ See Margin Requirements for Uncleared Swaps for Swap 
Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) 
(``CFTC Margin Adopting Release''); Capital Requirements of Swap 
Dealers and Major Swap Participants, 81 FR 91252 (Dec. 16, 2016) 
(``CFTC Capital Proposing Release'').
    \11\ See Protection of Cleared Swaps Customer Contracts and 
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions, 77 FR 6336 (Feb. 7, 2012); Protection of Collateral of 
Counterparties to Uncleared Swaps; Treatment of Securities in a 
Portfolio Margining Account in a Commodity Broker Bankruptcy, 78 FR 
66621 (Nov. 6, 2013); Segregation of Assets Held as Collateral in 
Uncleared Swap Transactions, 84 FR 12894 (Apr. 3, 2019).
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    In October 2012, the Commission proposed: (1) Capital and margin 
requirements for nonbank SBSDs and MSBSPs, segregation requirements for 
SBSDs, and notification requirements relating to segregation for SBSDs 
and MSBSPs; and (2) raising the minimum net capital requirements and 
establishing liquidity requirements for ANC broker-dealers.\12\ The 
Commission received a number of comment letters in response to the 2012 
proposals.\13\ In May 2013, the Commission proposed provisions 
regarding the cross-border treatment of security-based swap capital, 
margin, and segregation requirements.\14\ The Commission received 
comments on these proposals as well.\15\ In 2014, the Commission 
proposed an additional capital requirement for nonbank SBSDs that was 
inadvertently omitted from the 2012 proposals.\16\
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    \12\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071, (Oct. 18, 2012), 77 FR 70214 (Nov. 23, 2012) 
(``Capital, Margin, and Segregation Proposing Release'').
    \13\ The comment letters are available at https://www.sec.gov/comments/s7-08-12/s70812.shtml.
    \14\ See Cross-Border Security-Based Swap Activities; Re-
Proposal of Regulation SBSR and Certain Rules and Forms Relating to 
the Registration of Security-Based Swap Dealers and Major Security-
Based Swap Participants, Exchange Act Release No. 69490 (May 1, 
2013), 78 FR 30968 (May 23, 2013) (``Cross-Border Proposing 
Release'').
    \15\ The comment letters are available at https://www.sec.gov/comments/s7-02-13/s70213.shtml.
    \16\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers; Capital Rule for Certain Security-Based Swap 
Dealers, Exchange Act Release No. 71958 (Apr. 17, 2014), 79 FR 
25194, 25254 (May 2, 2014). The Commission received one comment 
addressing this proposal. See Letter from Suzanne H. Shatto (July 9, 
2014) (``Shatto Letter''), available at https://www.sec.gov/comments/s7-05-14/s70514.shtml.
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    Finally, in 2018, the Commission reopened the comment period and 
requested additional comment on the proposed rules and amendments 
(including potential modifications to proposed rule language).\17\ Some 
commenters supported the reopening of the comment period as a means to 
help ensure that the final rules reflect current market conditions.\18\ 
One commenter stated that the publication of the potential 
modifications to the proposed rule language provided important 
transparency in the development of this rulemaking.\19\ Other 
commenters stated that the Commission did not provide them with an 
adequate basis upon which to comment, and argued that it was not 
possible to fully assess the potential modifications to the proposed 
rules without a full re-proposal.\20\ The Commission disagrees. The 
potential modifications to the proposed rule language published in the 
release described how the rule text proposed in 2012 could be changed, 
including specific potential rule language. This approach provided the 
public with a meaningful opportunity to comment on potential 
modifications to the proposed rule text.
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    \17\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 84409 (Oct. 11, 2018), 83 FR 53007 (Oct. 19, 2018) 
(``Capital, Margin, and Segregation Comment Reopening'').
    \18\ See Letter from Stephen John Berger, Managing Director, 
Government & Regulatory Policy, Citadel Securities (Nov. 19, 2018) 
(``Citadel 11/19/2018 Letter''); Letter from Bridget Polichene, 
Chief Executive Officer, Institute of International Bankers (Nov. 
19, 2018) (``IIB 11/19/2018 Letter'').
    \19\ See Letter from Sebastian Crapanzano and Soo-Mi Lee, 
Managing Directors, Morgan Stanley (Nov. 19, 2018) (``Morgan Stanley 
11/19/2018 Letter'').
    \20\ See, e.g., Letter from Carl B. Wilkerson, Vice President 
and Chief Counsel, Securities, American Council of Life Insurers 
(Nov. 19, 2018) (``American Council of Life Insurers 11/19/18 
Letter''); Letter from Dennis M. Kelleher, President and Chief 
Executive Officer, Better Markets, Inc. (Nov. 19, 2018) (``Better 
Markets 11/19/2018 Letter''); Letter from Susan M. Olson, General 
Counsel, Investment Company Institute (Nov. 19, 2018) (``ICI 11/19/
2018 Letter'').
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    Today, the Commission is amending existing rules and adopting new 
rules. In particular, the Commission is amending existing rules 17 CFR 
240.15c3-1 (``Rule 15c3-1''), 17 CFR

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240.15c3-1a (``Rule 15c3-1a''), 17 CFR 240.15c3-1b (``Rule 15c3-1b''), 
17 CFR 240.15c3-1d (``Rule 15c3-1d''), 17 CFR 240.15c3-1e (``Rule 15c3-
1e''), 17 CFR 240.15c3-3 (``Rule 15c3-3'') and adopting new Rules 15c3-
3b, 18a-1, 18a-1a, 18a1b, 18a1c, 18a-1d, 18a-2, 18a-3, 18a-4, 18a-4a, 
and 18a-10. The amendments and new rules establish capital and margin 
requirements for nonbank SBSDs, including for: (1) Broker-dealers that 
are registered as SBSDs (``broker-dealer SBSDs''); \21\ (2) broker-
dealers that are registered as MSBSPs (``broker-dealer MSBSPs''); (3) 
nonbank SBSDs that are not registered as broker-dealers (``stand-alone 
SBSDs''); and (4) nonbank MSBSPs that are not registered as broker-
dealers (``stand-alone MSBSPs''). They also establish segregation 
requirements for SBSDs and notification requirements with respect to 
segregation for SBSDs and MSBSPs. Further, the amendments provide that 
a nonbank SBSD that is also registered as an OTC derivatives dealer is 
subject to Rules 18a-1, 18a-1a, 18a-1b, 18a-1c, and 18a-1d rather than 
Rule 15c3-1 and its appendices.
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    \21\ The term ``broker-dealer'' when used in this release 
generally does not refer to an OTC derivatives dealer See 17 CFR 
240.3b-12 (``Rule 3b-12'') (defining the term ``OTC derivatives 
dealer''). Instead, this class of dealer is referred to as an ``OTC 
derivatives dealer'' and, except when discussing the alternative 
compliance mechanism of Rule 18a-10, the term ``stand-alone SBSD'' 
includes a nonbank SBSD that is also registered as an OTC 
derivatives dealer. The alternative compliance mechanism is 
discussed below in sections I.B.4., II.D., IV.A.6., IV.D.6., and 
VI.B.1. of this release, among other sections. As discussed below, 
the alternative compliance mechanism is not available to nonbank 
SBSDs that are registered as either a broker-dealer or an OTC 
derivatives dealer. Consequently, the term ``stand-alone SBSD,'' in 
the context of discussing the alternative compliance mechanism, 
refers to a stand-alone SBSD that is not also registered as an OTC 
derivatives dealer.
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    The rule amendments also increase the minimum tentative net capital 
and net capital requirements for ANC broker-dealers. In addition to the 
new requirements for ANC broker-dealers, some of the amendments to 
Rules 15c3-1 and 15c3-3 apply to broker-dealers that are not registered 
as an SBSD or MSBSP (``stand-alone broker-dealers'') to the extent they 
engage in security-based swap activities.
    Additionally, the Commission is amending its existing cross-border 
rule to provide a mechanism to seek substituted compliance with respect 
to the capital and margin requirements for foreign nonbank SBSDs and 
MSBSPs and providing guidance on how it will evaluate requests for 
substituted compliance.\22\ The Commission is adopting rule-based 
requirements that address the application of the segregation 
requirements to cross-border security-based swap transactions.
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    \22\ 17 CFR 240.3a71-6 (``Rule 3a71-6'').
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    The Commission also is amending its rules governing the delegation 
of authority to provide the staff with delegated authority to take 
certain actions with respect to some of the requirements.
    The Commission is not adopting the proposed liquidity stress test 
requirements at this time.\23\ Instead, the Commission continues to 
consider the comments received on those proposals.
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    \23\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70252-54.
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    The Commission staff consulted with the CFTC and the prudential 
regulators in drafting the final rules and amendments.
    Finally, the Commission recognizes that the firms subject to the 
requirements being adopted today are operating in a market that 
continues to experience significant changes in response to market and 
regulatory developments. Given the global nature of the security-based 
swap and swap markets, the regulatory landscape will continue to shift 
as U.S. and foreign regulators continue to implement and/or modify 
relevant regulatory frameworks that apply to participants in these 
markets and to their transactions. For example, the CFTC has proposed 
but not yet finalized its own capital requirements that will apply to 
swap dealers, some of which will also likely be registered with the 
Commission as SBSDs. The Commission intends to monitor these 
developments during the period before the compliance date for these 
rules and may consider modifications to the requirements that it is 
adopting today as circumstances dictate, such as the need to further 
harmonize with other regulators to minimize the risk of unnecessary 
market fragmentation, or to address other market developments.\24\
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    \24\ The compliance date for the amendments and rules being 
adopted today is discussed below in section III.B. of this release.
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    In addition, the Commission intends to monitor the impact of the 
capital, margin, and segregation requirements being adopted today using 
data about the security-based swap and swap activities of stand-alone 
broker-dealers and SBSDs once they are subject to these requirements. 
The data will include the capital they maintain, the liquidity they 
maintain, the leverage they employ, the scale of their security-based 
swap and swap activities, the types and amounts of collateral they hold 
to address credit exposures, and the risk management controls they 
establish. The Commission may consider modifications to the 
requirements in light of these data.

B. Overview of the New Requirements

1. Capital Requirements
a. SBSDs
    Broker-dealer SBSDs will be subject to the pre-existing 
requirements of Rule 15c3-1, as amended, to account for security-based 
swap and swap activities. Stand-alone SBSDs (including firms also 
registered as OTC derivatives dealers) will be subject to Rule 18a-1. 
Rule 18a-1 is structured similarly to Rule 15c3-1 and contains many 
provisions that correspond to those in Rule 15c3-1, as amended.
    These rules prescribe minimum net capital requirements for nonbank 
SBSDs that are the greater of a fixed-dollar amount and an amount 
derived by applying a financial ratio. A broker-dealer SBSD must be an 
ANC broker-dealer (``ANC broker-dealer SBSD'') in order to use models 
to calculate market and credit risk charges in lieu of applying 
standardized deductions (also known as haircuts) for certain approved 
positions. An ANC broker-dealer, including an ANC broker-dealer SBSD, 
will be subject to a minimum fixed-dollar tentative net capital 
requirement of $5 billion and a minimum fixed-dollar net capital 
requirement of $1 billion. Stand-alone SBSDs that use models will be 
subject to a minimum fixed-dollar tentative net capital requirement of 
$100 million and a minimum fixed-dollar net capital requirement of $20 
million. Broker-dealer and stand-alone SBSDs not authorized to use 
models will be subject to a fixed-dollar minimum net capital 
requirement of $20 million but will not be subject to a fixed-dollar 
tentative net capital requirement.
    The financial ratio-derived minimum net capital requirement 
applicable to an ANC broker-dealer, including an ANC broker-dealer 
SBSD, and a broker-dealer SBSD not authorized to use models will be the 
amount computed using one of the two pre-existing (i.e., were part of 
the rule before today's amendments) financial ratios in Rule 15c3-1 
plus an amount computed using a new financial ratio tailored 
specifically to the firm's security-based swap activities. This new 
financial ratio requirement is 2% of an amount determined by 
calculating the firm's exposures to its security-based swap customers 
(``2% margin factor''). A stand-alone SBSD will be subject to the 2% 
margin factor but will not be subject to either of the pre-existing 
financial ratios in Rule 15c3-1. The 2% margin factor multiplier will 
remain at 2% for 3 years after the compliance date of the

[[Page 43875]]

rule. After 3 years, the multiplier could increase to not more than 4% 
by Commission order, and after 5 years the multiplier could increase to 
not more than 8% by Commission order if the Commission had previously 
issued an order raising the multiplier to 4% or less. The final rules 
further provide that the Commission will consider the capital and 
leverage levels of the firms subject to these requirements as well as 
the risks of their security-based swap positions and will provide 
notice before issuing an order raising the multiplier. This approach 
will enable the Commission to analyze the impact of the new 
requirement.
    The following table summarizes the minimum net capital requirements 
applicable to nonbank SBSDs as of the compliance date of the rule.

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                                                                                        Net capital
       Type of registrant                Rule            Tentative net   ---------------------------------------
                                                            capital          Fixed-dollar       Financial ratio
----------------------------------------------------------------------------------------------------------------
Stand-alone SBSD (not using       18a-1.............  N/A...............  $20 million.......  2% margin factor.
 internal models).
Stand-alone SBSD (using internal  18a-1.............  $100 million......  20 million........  2% margin factor.
 models)\1\.
Broker-dealer SBSD..............  15c3-1............  N/A...............  20 million........  2% margin factor +
(not using internal models).....                                                               Rule 15c3-1
                                                                                               ratio.
Broker-dealer SBSD (using         15c3-1............  $5 billion........  1 billion.........  2% margin factor +
 internal models).                                                                             Rule 15c3-1
                                                                                               ratio.
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\1\ Includes a stand-alone SBSD that also is an OTC derivatives dealer.

    Nonbank SBSDs will compute net capital by first determining their 
net worth under U.S. generally accepted accounting principles 
(``GAAP''). Next, the firms will need to deduct illiquid assets and 
take other deductions from net worth, and may add qualified 
subordinated loans. The deductions will be the same as required under 
the pre-existing requirements of Rule 15c3-1.
    In addition, the Commission is prescribing new deductions tailored 
specifically to security-based swaps and swaps. For example, stand-
alone broker-dealers and nonbank SBSDs will be required to take a 
deduction for under-margined accounts because of a failure to collect 
margin required under Commission, CFTC, clearing agency, derivatives 
clearing organization (``DCO''), or designated examining authority 
(``DEA'') rules (i.e., a failure to collect margin when there is no 
exception from collecting margin). Nonbank SBSDs also will be required 
to take deductions when they elect not to collect margin pursuant to 
exceptions in the margin rules of the Commission and the CFTC for non-
cleared security-based swaps and swaps, respectively. These deductions 
for electing not to collect margin must equal 100% of the amount of 
margin that would have been required to be collected from the security-
based swap or swap counterparty in the absence of an exception (i.e., 
the size of the deduction will be computed using the standardized or 
model-based approach prescribed in the margin rules of the Commission 
or the CFTC, as applicable). These deductions can be reduced by the 
value of collateral held in the account after applying applicable 
haircuts to the value of the collateral. In addition, as discussed 
below, nonbank SBSDs authorized to use models may take credit risk 
charges instead of these deductions for electing not to collect margin 
under exceptions in the margin rules of the Commission and the CFTC for 
non-cleared security-based swaps and swaps.
    After taking these deductions and making other adjustments to net 
worth, the amount remaining is defined as ``tentative net capital.'' 
The final steps a stand-alone broker-dealer or nonbank SBSD will need 
to take in computing net capital are: (1) To deduct haircuts 
(standardized or model-based) on their proprietary securities and 
commodity positions; and (2) for firms authorized to use models, to 
deduct credit risk charges computed using credit risk models.
    The haircuts for proprietary securities and commodity positions 
will be determined using standardized or model-based haircuts. The 
standardized haircuts for positions--other than security-based swaps 
and swaps--generally are the pre-existing standardized haircuts 
required by Rule 15c3-1. With respect to security-based swaps and 
swaps, the Commission is prescribing standardized haircuts tailored to 
those instruments. In the case of a cleared security-based swap or 
swap, the standardized haircut is the applicable clearing agency or DCO 
margin requirement. For a non-cleared credit default swap (``CDS''), 
the standardized haircut is set forth in two grids (one for security-
based swaps and one for swaps) in which the amount of the deduction is 
based on two variables: the length of time to maturity of the CDS 
contract and the amount of the current offered basis point spread on 
the CDS. For other types of non-cleared security-based swaps and swaps, 
the standardized haircut generally is the percentage deduction of the 
standardized haircut that applies to the underlying or referenced 
position multiplied by the notional amount of the security-based swap 
or swap.
    Instead of applying these standardized haircuts, stand-alone 
broker-dealers and nonbank SBSDs may apply to the Commission to use a 
model to calculate market and credit risk charges (model-based 
haircuts) for their positions, including derivatives instruments such 
as security-based swaps and swaps. The application and approval process 
will be similar to the process used for stand-alone broker-dealers 
applying to the Commission for authorization to use models under the 
pre-existing provisions of Rules 15c3-1 and 15c3-1e (i.e., stand-alone 
broker-dealers applying to become ANC broker-dealers). If approved, the 
firm may compute market risk charges for certain of its proprietary 
positions using a model.
    In addition, an ANC broker-dealer (including an ANC broker-dealer 
SBSD) and a stand-alone SBSD approved to use models for capital 
purposes can apply a credit risk charge with respect to 
uncollateralized exposures arising from derivatives instruments, 
including exposures arising from not collecting variation and/or 
initial margin pursuant to exceptions in the non-cleared security-based 
swap and swap margin rules of the Commission and CFTC, respectively. 
Consequently, these credit risk charges may be taken instead of the 
deductions described above when a nonbank SBSD does not collect 
variation and/or initial margin pursuant to exceptions in these margin 
rules.
    In applying the credit risk charges, an ANC broker-dealer 
(including an ANC broker-dealer SBSD) is subject to a portfolio 
concentration charge that has a threshold equal to 10% of the firm's 
tentative net capital. Under the portfolio

[[Page 43876]]

concentration charge, the application of the credit risk charges to 
uncollateralized current exposure across all counterparties arising 
from derivatives transactions is limited to an amount of the current 
exposure equal to no more than 10% of the firm's tentative net capital. 
The firm must take a charge equal to 100% of the amount of the firm's 
aggregate current exposure in excess of 10% of its tentative net 
capital. Uncollateralized potential future exposures arising from 
electing not to collect initial margin pursuant to exceptions in the 
margin rules of the Commission and the CFTC are not subject to this 
portfolio concentration charge. In addition, a stand-alone SBSD, 
including an SBSD operating as an OTC derivatives dealer, is not 
subject to a portfolio concentration charge with respect to 
uncollateralized current exposure. However, all these entities (i.e., 
ANC broker-dealers, ANC broker-dealer SBSDs, stand-alone SBSDs, and 
stand-alone SBSDs that also are registered as OTC derivatives dealers) 
are subject to a concentration charge for large exposures to single a 
counterparty that is calculated using the existing methodology in Rule 
15c3-1e.\25\
---------------------------------------------------------------------------

    \25\ Stand-alone SBSDs (including firms that also are registered 
as OTC derivatives dealers) are subject to Rule 18a-1, which 
includes a counterparty concentration charge that parallels the 
existing charge in Rule 15c3-1e.
---------------------------------------------------------------------------

    The following table summarizes the entities that are subject to the 
portfolio concentration charge and/or the counterparty concentration 
charge.

----------------------------------------------------------------------------------------------------------------
 Entity type  (must be approved to use     10% TNC portfolio concentration        Counterparty  concentration
                models)                                 charge                              charge
----------------------------------------------------------------------------------------------------------------
ANC broker-dealer......................  Yes................................  Yes.
ANC broker-dealer SBSD.................  Yes................................  Yes.
Stand-alone SBSD.......................  No.................................  Yes.
Stand-alone SBSD/OTC derivatives dealer  No.................................  Yes.
----------------------------------------------------------------------------------------------------------------

    Nonbank SBSDs also must comply with Rule 15c3-4. This rule will 
require them to establish, document, and maintain a system of internal 
risk management controls to assist in managing the risks associated 
with their business activities, including market, credit, leverage, 
liquidity, legal, and operational risks.
b. MSBSPs
    Rule 18a-2 prescribes the capital requirements for stand-alone 
MSBSPs.\26\ Under this rule, stand-alone MSBSPs must at all times have 
and maintain positive tangible net worth. The term ``tangible net 
worth'' is defined to mean the stand-alone MSBSP's net worth as 
determined in accordance with GAAP, excluding goodwill and other 
intangible assets. All MSBSPs must comply with Rule 15c3-4 with respect 
to their security-based swap and swap activities.
---------------------------------------------------------------------------

    \26\ A broker-dealer MSBSP will be subject to Rule 15c3-1.
---------------------------------------------------------------------------

2. Margin Requirements for Non-Cleared Security-Based Swaps
a. SBSDs
    Rule 18a-3 prescribes margin requirements for nonbank SBSDs with 
respect to non-cleared security-based swaps. The rule requires a 
nonbank SBSD to perform two calculations with respect to each account 
of a counterparty as of the close of business each day: (1) The amount 
of current exposure in the account of the counterparty (also known as 
variation margin); and (2) the initial margin amount for the account of 
the counterparty (also known as potential future exposure or initial 
margin). Variation margin is calculated by marking the position to 
market. Initial margin must be calculated by applying the standardized 
haircuts prescribed in Rule 15c3-1 or 18a-1 (as applicable). However, a 
nonbank SBSD may apply to the Commission for authorization to use a 
model (including an industry standard model) to calculate initial 
margin. Broker-dealer SBSDs must use the standardized haircuts (which 
include the option to use the more risk sensitive methodology in Rule 
15c3-1a) to compute initial margin for non-cleared equity security-
based swaps (even if the firm is approved to use a model to calculate 
initial margin). Stand-alone SBSDs (including firms registered as OTC 
derivatives dealers) may use a model to calculate initial margin for 
non-cleared equity security-based swaps (and potentially equity swaps 
if portfolio margining is implemented by the Commission and the CFTC), 
provided the account of the counterparty does not hold equity security 
positions other than equity security-based swaps (and potentially 
equity swaps).
    Rule 18a-3 requires a nonbank SBSD to collect collateral from a 
counterparty to cover a variation and/or initial margin requirement. 
The rule also requires the nonbank SBSD to deliver collateral to the 
counterparty to cover a variation margin requirement. The collateral 
must be collected or delivered by the close of business on the next 
business day following the day of the calculation, except that the 
collateral can be collected or delivered by the close of business on 
the second business day following the day of the calculation if the 
counterparty is located in another country and more than 4 time zones 
away. Further, collateral to meet a margin requirement must consist of 
cash, securities, money market instruments, a major foreign currency, 
the settlement currency of the non-cleared security-based swap, or 
gold. The fair market value of collateral used to meet a margin 
requirement must be reduced by the standardized haircuts in Rule 15c3-1 
or 18a-1 (as applicable), or the nonbank SBSD can elect to apply the 
standardized haircuts prescribed in the CFTC's margin rules. The value 
of the collateral must meet or exceed the margin requirement after 
applying the standardized haircuts. In addition, collateral being used 
to meet a margin requirement must meet conditions specified in the 
rule, including, for example, that it must have a ready market, be 
readily transferable, and not consist of securities issued by the 
nonbank SBSD or the counterparty.
    There are exceptions in Rule 18a-3 to the requirements to collect 
initial and/or variation margin and to deliver variation margin. A 
nonbank SBSD need not collect variation or initial margin from (or 
deliver variation margin to) a counterparty that is a commercial end 
user, the Bank for International Settlements (``BIS''), the European 
Stability Mechanism, or a multilateral development bank identified in 
the rule. Similarly, a nonbank SBSD need not collect variation or 
initial margin (or deliver variation margin) with respect to a legacy 
account (i.e., an account holding security-based swaps entered into 
prior to the compliance date of the rule). Further, a nonbank SBSD need 
not collect initial margin from a

[[Page 43877]]

counterparty that is a financial market intermediary (i.e., an SBSD, a 
swap dealer, a broker-dealer, a futures commission merchant (``FCM''), 
a bank, a foreign broker-dealer, or a foreign bank) or an affiliate. A 
nonbank SBSD also need not hold initial margin directly if the 
counterparty delivers the initial margin to an independent third-party 
custodian. Further, a nonbank SBSD need not collect initial margin from 
a counterparty that is a sovereign entity if the nonbank SBSD has 
determined that the counterparty has only a minimal amount of credit 
risk.
    The rule also has a threshold exception to the initial margin 
requirement. Under this exception, a nonbank SBSD need not collect 
initial margin to the extent that the initial margin amount when 
aggregated with other security-based swap and swap exposures of the 
nonbank SBSD and its affiliates to the counterparty and its affiliates 
does not exceed $50 million. The rule also would permit a nonbank SBSD 
to defer collecting initial margin from a counterparty for two months 
after the month in which the counterparty does not qualify for the $50 
million threshold exception for the first time. Finally, the rule has a 
minimum transfer amount exception of $500,000. Under this exception, if 
the combined amount of margin required to be collected from or 
delivered to a counterparty is equal to or less than $500,000, the 
nonbank SBSD need not collect or deliver the margin. If the initial and 
variation margin requirements collectively or individually exceed 
$500,000, collateral equal to the full amount of the margin requirement 
must be collected or delivered.
    The following table summarizes the exceptions in Rule 18a-3 from 
collecting initial and/or variation margin and from delivering 
variation margin.

----------------------------------------------------------------------------------------------------------------
                                           Status of exception to collecting margin
              Exception               --------------------------------------------------  Status of exception to
                                                  VM                       IM                 delivering VM
----------------------------------------------------------------------------------------------------------------
Commercial End User..................  Need Not Collect.......  Need Not Collect.......  Need Not Deliver.
BIS or European Stability Mechanism..  Need Not Collect.......  Need Not Collect.......  Need Not Deliver.
Multilateral Development Bank........  Need Not Collect.......  Need Not Collect.......  Need Not Deliver.
Financial Market Intermediary........  Must Collect...........  Need Not Collect.......  Must Deliver.
Affiliate............................  Must Collect...........  Need Not Collect.......  Must Deliver.
Sovereign with Minimal Credit Risk...  Must Collect...........  Need Not Collect.......  Must Deliver.
Legacy Account.......................  Need Not Collect.......  Need Not Collect.......  Need Not Deliver.
IM Below $50 Million Threshold.......  Must Collect...........  Need Not Collect.......  Must Deliver.
Minimum Transfer Amount..............  Need Not Collect.......  Need Not Collect.......  Need Not Deliver.
----------------------------------------------------------------------------------------------------------------

    Finally, nonbank SBSDs must monitor the risk of each account, and 
establish, maintain, and document procedures and guidelines for 
monitoring the risk.
MSBSPs
    Rule 18a-3 also prescribes margin requirements for nonbank MSBSPs 
with respect to non-cleared security-based swaps. The rule requires a 
nonbank MSBSP to calculate variation margin for the account of each 
counterparty as of the close of each business day. The rule requires 
the nonbank MSBSP to collect collateral from (or deliver collateral to) 
a counterparty to cover a variation margin requirement. The collateral 
must be collected or delivered by the close of business on the next 
business day following the day of the calculation, except that the 
collateral can be collected or delivered by the close of business on 
the second business day following the day of the calculation if the 
counterparty is located in another country and more than 4 time zones 
away. Further, the variation margin must consist of cash, securities, 
money market instruments, a major foreign currency, the security of 
settlement of the non-cleared security-based swap, or gold. The rule 
has an exception pursuant to which the nonbank MSBSP need not collect 
variation margin if the counterparty is a commercial end user, the BIS, 
the European Stability Mechanism, or one of the multilateral 
development banks identified in the rule (there is no exception from 
delivering variation margin to these types of counterparties). The rule 
also has an exception pursuant to which the nonbank MSBSP need not 
collect or deliver variation margin with respect to a legacy account. 
Finally, there is a $500,000 minimum transfer amount exception to the 
collection and delivery requirements for nonbank MSBSPs.
3. Segregation Requirements
    Section 3E(b) of the Exchange Act provides that, for cleared 
security-based swaps, the money, securities, and property of a 
security-based swap customer shall be separately accounted for and 
shall not be commingled with the funds of the broker, dealer, or SBSD 
or used to margin, secure, or guarantee any trades or contracts of any 
security-based swap customer or person other than the person for whom 
the money, securities, or property are held. However, Section 3E(c)(1) 
of the Exchange Act also provides, that for cleared security-based 
swaps, customers' money, securities, and property may, for convenience, 
be commingled and deposited in the same one or more accounts with any 
bank, trust company, or clearing agency. Section 3E(c)(2) further 
provides that, notwithstanding Section 3E(b), in accordance with such 
terms and conditions as the Commission may prescribe by rule, 
regulation, or order, any money, securities, or property of the 
security-based swaps customer of a broker, dealer, or security-based 
swap dealer described in Section 3E(b) may be commingled and deposited 
as provided in Section 3E with any other money, securities, or property 
received by the broker, dealer, or security-based swap dealer and 
required by the Commission to be separately accounted for and treated 
and dealt with as belonging to the security-based swaps customer of the 
broker, dealer, or security-based swap dealer.
    Section 3E(f) of the Exchange Act establishes a program by which a 
counterparty to non-cleared security-based swaps with an SBSD or MSBSP 
can elect to have initial margin held at an independent third-party 
custodian (``individual segregation''). Section 3E(f)(4) provides that 
if the counterparty does not choose to require segregation of funds or 
other property (i.e., waives segregation), the SBSD or MSBSP shall send 
a report to the counterparty on a quarterly basis stating that the 
firm's back office procedures relating to margin and collateral 
requirements are in compliance with the agreement of the 
counterparties. The statutory provisions of Sections 3E(b) and (f) are 
self-executing.
    The Commission is adopting segregation rules pursuant to which 
money, securities, and property of a

[[Page 43878]]

security-based swap customer relating to cleared and non-cleared 
security-based swaps must be segregated but can be commingled with 
money, securities, or property of other customers (``omnibus 
segregation''). The omnibus segregation requirements for stand-alone 
broker-dealers and broker-dealer SBSDs are codified in amendments to 
Rule 15c3-3. The omnibus segregation requirements for stand-alone SBSDs 
(including firms registered as OTC derivatives dealers) and bank SBSDs 
are codified in Rule 18a-4.
    The omnibus segregation requirements are mandatory with respect to 
money, securities, or other property relating to cleared security-based 
swaps that is held by a stand-alone broker-dealer or SBSD (i.e., 
customers cannot waive segregation). With respect to non-cleared 
security-based swap transactions, the omnibus segregation requirements 
are an alternative to the statutory provisions discussed above pursuant 
to which a counterparty can elect to have initial margin individually 
segregated or to waive segregation. However, under the final omnibus 
segregation rules for stand-alone broker-dealers and broker-dealer 
SBSDs codified in Rule 15c3-3, counterparties that are not an affiliate 
of the firm cannot waive segregation. Affiliated counterparties of a 
stand-alone broker-dealer or broker-dealer SBSD can waive segregation. 
Under Section 3E(f) of the Exchange Act and Rule 18a-4, all 
counterparties (affiliated and non-affiliated) to a non-cleared 
security-based swap transaction with a stand-alone or bank SBSD can 
waive segregation. The omnibus segregation requirements are the 
``default'' requirement if the counterparty does not elect individual 
segregation or to waive segregation (in the cases where a counterparty 
is permitted to waive segregation). Rule 18a-4 also has exceptions 
pursuant to which a foreign stand-alone or bank SBSD or MSBSP need not 
comply with the segregation requirements (including the omnibus 
segregation requirements) for certain transactions.
    Under the omnibus segregation requirements, an SBSD or stand-alone 
broker-dealer must maintain possession or control over excess 
securities collateral carried for the accounts of security-based swap 
customers. Generally, excess securities collateral means securities and 
money market instruments that are not being used to meet a variation 
margin requirement of the counterparty. In the context of security-
based swap transactions, excess securities collateral means collateral 
delivered to the SBSD or stand-alone broker-dealer to meet an initial 
margin requirement of the counterparty as well as collateral held by 
the SBSD or stand-alone broker-dealer in excess of any applicable 
initial margin requirement (and that is not being used to meet a 
variation margin requirement). There are two exceptions under which 
excess securities collateral can be held in a manner that is not in the 
possession or control of the SBSD or stand-alone broker-dealer: (1) It 
is being used to meet a margin requirement of a clearing agency 
resulting from a cleared security-based swap transaction of the 
security-based swap customer; or (2) it is being used to meet a margin 
requirement of an SBSD resulting from the first SBSD or stand-alone 
broker-dealer entering into a non-cleared security-based swap 
transaction with the SBSD to offset the risk of a non-cleared security-
based swap transaction between the first SBSD or broker-dealer and the 
security-based swap customer.
    Under the omnibus segregation requirements, an SBSD or stand-alone 
broker-dealer must maintain a security-based swap customer reserve 
account to segregate cash and/or qualified securities in an amount 
equal to the net cash owed to security-based swap customers. The SBSD 
or stand-alone broker-dealer must at all times maintain, through 
deposits into the account, cash and/or qualified securities in amounts 
computed weekly in accordance with the formula set forth in Rules 15c3-
3b or 18a-4a. In the case of a broker-dealer SBSD or stand-alone 
broker-dealer, this account must be separate from the reserve accounts 
the firm maintains for ``traditional'' securities customers and other 
broker-dealers under pre-existing requirements of Rule 15c3-3.
    The formula in Rules 15c3-3b and 18a-4a is modeled on the pre-
existing reserve formula in Exhibit A to Rule 15c3-3 (``Rule 15c3-
3a''). The security-based swap customer reserve formula requires the 
SBSD or stand-alone broker-dealer to add up various credit items 
(amounts owed to security-based swap customers) and debit items 
(amounts owed by security-based swap customers). If, under the formula, 
credit items exceed debit items, the SBSD or stand-alone broker-dealer 
must maintain cash and/or qualified securities in that net amount in 
the security-based swap customer reserve account. For purposes of the 
security-based swap reserve account requirement, qualified securities 
are: (1) Obligations of the United States; (2) obligations fully 
guaranteed as to principal and interest by the United States; and (3) 
subject to certain conditions and limitations, general obligations of 
any state or a political subdivision of a state that are not traded 
flat and are not in default, are part of an initial offering of $500 
million or greater, and are issued by an issuer that has published 
audited financial statements within 120 days of its most recent fiscal 
year end.
    With respect to non-cleared security-based swaps, Section 
3E(f)(1)(A) of the Exchange Act provides that an SBSD and an MSBSP 
shall be required to notify a counterparty of the SBSD or MSBSP at the 
beginning of a non-cleared security-based swap transaction that the 
counterparty has the right to require the segregation of the funds or 
other property supplied to margin, guarantee, or secure the obligations 
of the counterparty. SBSDs and MSBSPs must provide this notice in 
writing to a duly authorized individual prior to the execution of the 
first non-cleared security-based swap transaction with the counterparty 
occurring after the compliance date of the rule. SBSDs also must obtain 
subordination agreements from a counterparty that affirmatively elects 
to have initial margin held at a third-party custodian or that waives 
segregation. Finally, a stand-alone or bank SBSD will be exempt from 
the requirements of Rule 18a-4 if the firm meets certain conditions, 
including that the firm: (1) Does not clear security-based swap 
transactions for other persons; (2) provides notice to the counterparty 
regarding the right to segregate initial margin at an independent 
third-party custodian; (3) discloses to the counterparty in writing 
that any collateral received by the SBSD will not be subject to a 
segregation requirement; and (4) discloses to the counterparty how a 
claim of the counterparty for the collateral would be treated in a 
bankruptcy or other formal liquidation proceeding of the SBSD.
4. Alternative Compliance Mechanism
    The Commission is adopting an alternative compliance mechanism in 
Rule 18a-10 pursuant to which a stand-alone SBSD that is registered as 
a swap dealer and predominantly engages in a swaps business may elect 
to comply with the capital, margin, and segregation requirements of the 
CEA and the CFTC's rules in lieu of complying with Rules 18a-1, 18a-3, 
and 18a-4. In order to qualify to operate pursuant to Rule 18a-10, the 
stand-alone SBSD cannot be registered as a broker-dealer or an OTC 
derivatives dealer. Moreover, in addition to other conditions, the 
aggregate gross notional amount of the firm's security-based swap 
positions must not exceed the lesser of a maximum fixed-dollar amount 
or 10% of the combined

[[Page 43879]]

aggregate gross notional amount of the firm's security-based swap and 
swap positions. The maximum fixed-dollar amount is set at a 
transitional level of $250 billion for the first 3 years after the 
compliance date of the rule and then drops to $50 billion thereafter 
unless the Commission issues an order: (1) Maintaining the $250 billion 
maximum fixed-dollar amount for an additional period of time or 
indefinitely; or (2) lowering the maximum fixed-dollar amount to an 
amount between $250 billion and $50 billion. The final rule further 
provides that the Commission will consider the levels of security-based 
swap activity of the stand-alone SBSDs operating under the alternative 
compliance mechanism and provide notice before issuing such an order.
5. Cross-Border Application
    As adopted, the Commission is treating capital and margin 
requirements under Section 15F(e) of the Exchange Act and Rules 18a-1, 
18a-2, and 18a-3 thereunder as entity-level requirements that are 
applicable to the entirety of the business of an SBSD or MSBSP. Foreign 
SBSDs and MSBSPs have the potential to avail themselves of substituted 
compliance to satisfy the capital and margin requirements under Section 
15F of the Exchange Act and Rules 18a-1 and 18a-2, and 18a-3 
thereunder. The segregation requirements are deemed transaction-level 
requirements and substituted compliance is not available for them. 
However, Rule 18a-4 has exceptions pursuant to which a foreign stand-
alone or bank SBSD or MSBSP need not comply with the segregation 
requirements for certain transactions. There are no exceptions from the 
segregation requirements for cross-border transactions of a stand-alone 
broker-dealer or a broker-dealer SBSD or MSBSP.

II. Final Rules and Rule Amendments

A. Capital

1. Introduction
    The Commission is adopting capital requirements for nonbank SBSDs 
and MSBSPs pursuant to Sections 15 and 15F of the Exchange Act. More 
specifically, the Commission is adopting amendments to Rule 15c3-1 and 
certain of its appendices to address broker-dealer SBSDs and the 
security-based swap activities of stand-alone broker-dealers. In 
addition, the Commission is adopting Rule 18a-1, Rules 18a-1a, 18a-1b, 
18a-1c and 18a-1d to establish capital requirements for stand-alone 
SBSDs, including for stand-alone SBSDs that are also registered as OTC 
derivatives dealers. Rule 18a-1 and its related rules are structured 
similarly to Rule 15c3-1 and its appendices and contain many provisions 
that correspond to those in Rule 15c3-1 and its appendices.\27\
---------------------------------------------------------------------------

    \27\ Rule 18a-1a, Rule18a-1b, Rule 18a-1c, and Rule 18a-1d 
correspond to the following appendices to Rule 15c3-1: Rule 15c3-1a 
(Options); Rule 15c3-1b (Adjustments to net worth and aggregate 
indebtedness for certain commodities transactions); 17 CFR 240.15c3-
1c (``Rule 15c3-1c'') (Consolidated computations of net capital and 
aggregate indebtedness for certain subsidiaries and affiliates); and 
Rule 15c3-1d (Satisfactory subordination agreements).
---------------------------------------------------------------------------

    As discussed in the proposing release, Rule 15c3-1 imposes a net 
liquid assets test that is designed to promote liquidity within broker-
dealers.\28\ For example, paragraph (c)(2)(iv) of Rule 15c3-1 does not 
permit most unsecured receivables to count as allowable net capital. 
This aspect of the rule severely limits the ability of broker-dealers 
to engage in activities that generate unsecured receivables (e.g., as 
unsecured lending). The rule also does not permit fixed assets or other 
illiquid assets to count as allowable net capital, which creates 
disincentives for broker-dealers to own real estate and other fixed 
assets that cannot be readily converted into cash. For these reasons, 
Rule 15c3-1 incentivizes broker-dealers to confine their business 
activities and devote capital to activities such as underwriting, 
market making, and advising on and facilitating customer securities 
transactions.
---------------------------------------------------------------------------

    \28\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70217-20.
---------------------------------------------------------------------------

    Rule 15c3-1 permits a broker-dealer to engage in activities that 
are part of conducting a securities business (e.g., taking securities 
positions) but in a manner that leaves the firm holding at all times 
more than one dollar of highly liquid assets for each dollar of 
unsubordinated liabilities (e.g., money owed to customers, 
counterparties, and creditors). The objective of Rule 15c3-1 is to 
require a broker-dealer to maintain sufficient liquid assets to meet 
all liabilities, including obligations to customers, counterparties, 
and other creditors and to have adequate additional resources to wind-
down its business in an orderly manner without the need for a formal 
proceeding if the firm fails financially.\29\ The business of trading 
securities is one in which success, both for the firms and the 
investing public, is strongly dependent upon confidence, continuity, 
and commitment.\30\ Generally, almost all trading-related liabilities 
are payable upon demand and represent a major portion of the firm's 
liabilities. Emphasis on liquidity helps to ensure that the liquidation 
of a firm will not result in excessive delay in repayment of the firm's 
obligations to customers, broker-dealers, and other creditors and 
therefore assures the continued liquidity of the securities markets. 
Rule 15c3-1 has been the capital standard for broker-dealers since 
1975. Generally, the rule has promoted the maintenance of prudent 
levels of capital.\31\
---------------------------------------------------------------------------

    \29\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb. 
6, 1997), 62 FR 6474, 6475 (Feb. 12, 1997) (``Rule 15c3-1 requires 
registered broker-dealers to maintain sufficient liquid assets to 
enable those firms that fall below the minimum net capital 
requirements to liquidate in an orderly fashion without the need for 
a formal proceeding.'').
    \30\ See Net Capital Rule, Exchange Act Release No. 27249 (Sept. 
15, 1989), 54 FR 40395, 40396 (Oct. 2, 1989).
    \31\ See Securities Investor Protection Corporation (``SIPC''), 
Annual Report (2018), available at https://www.sipc.org/media/annual-reports/2018-annual-report.pdf. SIPC's 2018 annual report 
states that the annual average of new broker-dealer liquidations 
under the Securities Investor Protection Act of 1970 (``SIPA'') for 
the last 10-year period was 0.8 firms per year. It also states that 
there have been 330 broker-dealers liquidated in a SIPA proceeding 
since SIPC's inception in 1970, which amounts to less than 1% of 
approximately 40,000 broker-dealers that have been SIPC members 
during that time period. Moreover, it states that over that time 
period the value of cash and securities of SIPA liquidated broker-
dealers returned to customers totaled approximately $139.8 billion 
and, of that amount, approximately $138.9 billion came from the 
estates of the failed broker-dealers, and approximately $1 billion 
came from the SIPC fund. It further states that, of the 
approximately 770,400 claims satisfied in completed or substantially 
completed cases as of December 31, 2018, a total of 356 were for 
cash and securities whose value was greater than limits of 
protection afforded by SIPA.
---------------------------------------------------------------------------

    Some commenters supported the Commission's proposal to model the 
nonbank SBSD capital requirements on the broker-dealer capital 
requirements. A commenter stated that separate standards for stand-
alone broker-dealers and nonbank SBSDs would complicate the regulatory 
framework.\32\ A second commenter argued that there should be no 
difference in the manner in which capital standards are applied to 
nonbank SBSDs, regardless of whether they are registered as broker-
dealers or are affiliated with a bank holding company.\33\ A third 
commenter expressed general support for the approach.\34\
---------------------------------------------------------------------------

    \32\ See Letter from Dennis M. Kelleher, President and Chief 
Executive Officer, Better Markets, Inc. (Feb. 22, 2013) (``Better 
Markets 2/22/2013 Letter''); Letter from Dennis M. Kelleher, 
President and Chief Executive Officer, Better Markets, Inc. (July 
22, 2013) (``Better Markets 7/22/2013 Letter'').
    \33\ See Letter from Kurt N. Schacht, Managing Director, and 
Beth Kaiser, Director, CFA Institute (Feb. 22, 2013) (``CFA 
Institute Letter'').
    \34\ See Letter from Thomas G. McCabe, Chief Operating Officer, 
OneChicago, LLC (Feb. 19, 2013) (``OneChicago 2/19/2013 Letter'').
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    Other commenters expressed concerns with regard to the proposed

[[Page 43880]]

approach or encouraged the Commission to harmonize its final rules with 
those of international standard setters and domestic regulators that 
have finalized capital and margin requirements.\35\ A commenter stated 
that the Commission's proposed approach would result in very different 
capital requirements for nonbank SBSDs as compared to nonbank swap 
dealers subject to CFTC oversight, and that this could potentially 
prevent entities from dually registering as nonbank SBSDs and swap 
dealers.\36\ The commenter also stated that requiring a multi-
registered entity--such as an entity registered as a broker-dealer, 
FCM, SBSD, and swap dealer--to calculate regulatory capital under the 
rules of both the Commission and the CFTC and adhere to the greater 
minimum requirement would provide a strong disincentive to seeking the 
operational and risk management efficiencies of a consolidated business 
entity, and would be anticompetitive.
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    \35\ See Letter from Tom Quaadman, Executive Vice President, 
Center for Capital Markets Competitiveness, U.S. Chamber of Commerce 
(Nov. 19, 2018) (``Center for Capital Markets Competitiveness, 
Chamber of Commerce 11/19/2018 Letter''); Citadel 11/19/2018 Letter; 
Letter from Walt L. Lukken, President and Chief Executive Officer, 
Futures Industry Association (Nov. 19, 2018) (``FIA 11/19/2018 
Letter''); ICI 11/19/2018 Letter; Letter from Laura Harper Powell, 
Associate General Counsel, Managed Funds Association, and Adam 
Jacobs-Dean, Managing Director, Global Head of Markets Regulation, 
Alternative Investment Management Association (Nov. 19, 2018) 
(``MFA/AIMA 11/19/2018 Letter''); Adam Hopkins, Managing Director, 
Legal Department, Mizuho Capital Markets LLC, Marcy S. Cohen, 
General Counsel and Managing Director, ING Capital Markets LLC, and 
Michael Baudo, President and CEO, ING Capital Markets LLC (Nov. 16, 
2018) (``Mizuho/ING Letter''); Letter from Sebastian Crapanzano and 
Soo-Mi Lee, Managing Directors, Morgan Stanley (Feb. 22, 2013) 
(``Morgan Stanley 2/22/2013 Letter'').
    \36\ See Letter from Richard M. Whiting, Executive Director and 
General Counsel, The Financial Services Roundtable (Feb. 22, 2013) 
(``Financial Services Roundtable Letter'').
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    Several commenters encouraged the Commission and CFTC to harmonize 
their proposed capital rules.\37\ A commenter suggested that the 
Commission coordinate with the CFTC and, as appropriate, the prudential 
regulators to assure that each agency's respective capital rules are 
harmonized and do not have the unintended effect of impairing the 
ability of broker-dealers that are dually registered as FCMs to provide 
clearing services for security-based swaps and swaps.\38\ Another 
commenter was concerned that the proposed capital requirements for 
nonbank SBSDs were not comparable to those proposed by other U.S. 
regulators and that modeling the proposed rules on the broker-dealer 
capital standard was not appropriate.\39\ This commenter argued that 
the bank capital standard is risk-based, whereas the broker-dealer 
capital standard is transaction volume-based, and that SBSDs and swap 
dealers operate in the same markets with the same counterparties and 
should be subject to comparable capital requirements. Commenters also 
referenced Section 15F(e)(3)(D)(ii) of the Exchange Act, which provides 
that the Commission, the prudential regulators, and the CFTC ``shall, 
to the maximum extent practicable, establish and maintain comparable 
minimum capital requirements. . . .'' \40\ One commenter argued that 
divergence of bank and nonbank regulation is leading to some migration 
of risk to nonbank broker-dealers.\41\ A commenter suggested that to 
avoid undermining the de minimis exception for SBSDs or inhibiting 
hedging activities by broker-dealers not registered as SBSDs, the 
Commission should limit the application of the proposed amendments to 
Rule 15c3-1 to broker-dealers that register as SBSDs.\42\ Another 
commenter stated that a positive tangible net worth test would be more 
appropriate for nonbank SBSDs.\43\
---------------------------------------------------------------------------

    \37\ See Citadel 11/19/18 Letter; Financial Services Roundtable 
Letter; FIA 11/19/2018 Letter; Morgan Stanley 11/19/2018 Letter.
    \38\ See FIA 11/19/2018 Letter.
    \39\ See Morgan Stanley 2/22/2013 Letter.
    \40\ See Letter from Robert Pickel, Chief Executive Officer, 
International Swaps and Derivatives Association (``ISDA'') (Feb. 5, 
2014) (``ISDA 2/5/2014 Letter''); Morgan Stanley 2/22/2013 Letter.
    \41\ See Letter from Robert Rutkowski (Nov. 20, 2018) 
(``Rutkowski 11/20/2018 Letter'').
    \42\ See Letter from Kenneth E. Bentsen, Jr., President and CEO, 
Securities Industry and Financial Markets Association (Nov. 19, 
2018) (``SIFMA 11/19/2018 Letter''); Morgan Stanley 11/19/2018 
Letter.
    \43\ See Letter from David T. McIndoe, Alexander S. Holtan, and 
Cheryl I. Aaron, Counsels, Sutherland Asbill & Brennan LLP on behalf 
of The Commercial Energy Working Group (Feb. 14, 2013) (``Sutherland 
Letter'').
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    The Commission has made two significant modifications to the final 
capital rules for nonbank SBSDs that should mitigate some of these 
concerns raised by commenters. First, as discussed below in section 
II.A.2.b.v. of this release, the Commission has modified Rule 18a-1 so 
that it no longer contains a portfolio concentration charge that is 
triggered when the aggregate current exposure of the stand-alone SBSD 
to its derivatives counterparties exceeds 50% of the firm's tentative 
net capital.\44\ This means that stand-alone SBSDs that have been 
authorized to use models will not be subject to this limit on applying 
the credit risk charges to uncollateralized current exposures related 
to derivatives transactions. This includes uncollateralized current 
exposures arising from electing not to collect variation margin for 
non-cleared security-based swap and swap transactions under exceptions 
in the margin rules of the Commission and the CFTC. The credit risk 
charges are based on the creditworthiness of the counterparty and can 
result in charges that are substantially lower than deducting 100% of 
the amount of the uncollateralized current exposure.\45\ This approach 
to addressing credit risk arising from uncollateralized current 
exposures related to derivatives transactions is generally consistent 
with the treatment of such exposures under the capital rules for 
banking institutions.\46\
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    \44\ See paragraph (e)(2) of Rule 18a-1, as adopted. See also 
Capital, Margin, and Segregation Proposing Release, 77 FR at 70244 
(proposing a portfolio concentration charge in Rule 18a-1 for stand-
alone SBSDs).
    \45\ See paragraph (e)(2) of Rule 18a-1, as adopted.
    \46\ See OTC Derivatives Dealers, Exchange Act Release No. 40594 
(Oct. 23, 1998), 63 FR 59362, 59384-87 (Nov. 3, 1998) (``[T]he Board 
of Governors of the Federal Reserve System, the Office of the 
Comptroller of the Currency, and the Federal Deposit Insurance 
Corporation (collectively, the ``U.S. Banking Agencies'') have 
adopted rules implementing the Capital Accord for U.S. banks and 
bank holding companies. Appendix F is generally consistent with the 
U.S. Banking Agencies' rules, and incorporates the qualitative and 
quantitative conditions imposed on-banking institutions.''). The use 
of models to compute market risk charges in lieu of the standardized 
haircuts (as nonbank SBSDs will be permitted to do under Rules 15c3-
1 and 18a-1) also is generally consistent with the capital rules for 
banking institutions. Id. See also section VI.A.4.b. of this release 
(discussing bank capital regulations).
---------------------------------------------------------------------------

    The second significant modification is an alternative compliance 
mechanism. As discussed below in section II.D. of this release, the 
alternative compliance mechanism will permit a stand-alone SBSD that is 
registered as a swap dealer and that predominantly engages in a swaps 
business to comply with the capital, margin, and segregation 
requirements of the CEA and the CFTC's rules in lieu of complying with 
the Commission's capital, margin, and segregation requirements.\47\ The 
CFTC's proposed capital rules for swap dealers that are FCMs would 
retain the existing capital framework for FCMs, which imposes a net 
liquid assets test similar to the existing capital requirements for 
stand-alone broker-dealers.\48\ However, under the CFTC's proposed 
capital rules, swap dealers that are not FCMs would have the option of 
complying with: (1) A capital standard based on the capital rules for 
banks; (2) a capital standard based on the Commission's capital 
requirements in Rule 18a-1; or

[[Page 43881]]

(3) if the swap dealer is predominantly engaged in non-financial 
activities, a capital standard based on a tangible net worth 
requirement.
---------------------------------------------------------------------------

    \47\ See Rule 18a-10, as adopted.
    \48\ See CFTC Capital Proposing Release, 81 FR 91252.
---------------------------------------------------------------------------

    The Commission acknowledges that under these two modifications a 
stand-alone SBSD will be subject to: (1) A capital standard that is 
less rigid than Rule 15c3-1 in terms of imposing a net liquid assets 
test (in the case of firms that will comply with Rule 18a-1); or (2) a 
capital standard that potentially does not impose a net liquid assets 
test (in the case of firms that will operate under the alternative 
compliance mechanism and, therefore, comply with the CFTC's capital 
rules). This will decrease the liquidity of these firms and therefore 
decrease their self-sufficiency. As a result, the risk that a stand-
alone SBSD may not be able to self-liquidate in an orderly manner will 
be increased.
    However, stand-alone SBSDs will engage in a more limited business 
than stand-alone broker-dealers and broker-dealer SBSDs. Thus, they 
will be less significant participants in the overall securities 
markets. For example, they will not be dealers in the cash securities 
markets or the markets for listed options and they will not maintain 
custody of cash or securities for retail investors in those markets. 
Given their limited role, the Commission believes that it is 
appropriate to more closely align the requirements for stand-alone 
SBSDs with the requirements of the CFTC and the prudential regulators. 
These modifications to more closely harmonize the rules are designed to 
address the concerns of commenters noted above about the potential 
consequences of imposing different capital standards. They also take 
into account Section 15F(e)(3)(D)(ii) of the Exchange Act, which 
provides that the Commission, the prudential regulators, and the CFTC 
``shall, to the maximum extent practicable, establish and maintain 
comparable minimum capital requirements . . .''
    Notwithstanding the modification to Rule 18a-1 described above, the 
rule continues to be modeled in large part on the broker-dealer capital 
rule. For example, as is the case with Rule 15c3-1, most unsecured 
receivables (aside from uncollateralized current exposures relating to 
derivatives transactions) will not count as allowable capital. 
Moreover, fixed assets and other illiquid assets will not count as 
allowable capital. Consequently, stand-alone SBSDs subject to Rule 18a-
1 (i.e., firms that do not operate under the alternative compliance 
mechanism) will remain subject to certain requirements modeled on 
requirements of Rule 15c3-1 that are designed to promote their 
liquidity.
    Additionally, broker-dealer SBSDs will be subject to Rule 15c3-1 
and the stricter (as compared to Rule 18a-1) net liquid assets test it 
imposes. For example, as discussed below in section II.A.2.b.v. of this 
release, Rule 15c3-1e, as amended, modifies the existing portfolio 
concentration charge so that it equals 10% of an ANC broker-dealer's 
tentative net capital (a reduction from 50% of the firm's tentative net 
capital).\49\ Thus, the ability of these firms to apply the credit risk 
charges to uncollateralized current exposures arising from derivatives 
transactions will be more restricted. In addition, as discussed below, 
broker-dealer and stand-alone SBSDs will be subject to a 100% capital 
charge for initial margin they post to counterparties because, for 
example, the counterparty is subject to the margin rules of the CFTC or 
the prudential regulators.
---------------------------------------------------------------------------

    \49\ See paragraph (c)(3) of Rule 15c3-1e, as adopted.
---------------------------------------------------------------------------

    Consequently, while the two modifications discussed above with 
respect to stand-alone SBSDs should mitigate commenters' concerns, 
there likely will be significant differences between the capital 
requirements for nonbank SBSDs and the capital requirements for bank 
SBSDs and bank and nonbank swap dealers. In this regard, the Commission 
has balanced the concerns raised by commenters about inconsistent 
requirements with the objective of promoting the liquidity of nonbank 
SBSDs. The Commission believes that the broker-dealer capital standard 
is the most appropriate alternative for nonbank SBSDs, given the nature 
of their business activities and the Commission's experience 
administering the standard with respect to broker-dealers. The 
objective of the broker-dealer capital standard is to protect customers 
and counterparties and to mitigate the consequences of a firm's failure 
by promoting the ability of these entities to absorb financial shocks 
and, if necessary, to self-liquidate in an orderly manner.
    Moreover, certain operational, policy, and legal differences 
support the distinction between nonbank SBSDs and bank SBSDs. First, 
based on the Commission staff's understanding of the activities of 
nonbank dealers in the OTC derivatives markets, nonbank SBSDs are 
expected to engage in a securities business with respect to security-
based swaps that is more similar to the dealer activities of broker-
dealers than to the activities of banks, which--unlike broker-dealers--
are in the business of making loans and taking deposits. Similar to 
stand-alone broker-dealers, nonbank SBSDs will not be lending or 
deposit-taking institutions and will focus their activities on dealing 
in securities (i.e., security-based swaps).
    Second, existing capital standards for banks and broker-dealers 
reflect, in part, differences in their funding models and access to 
certain types of financial support. Those same differences also will 
exist between bank SBSDs and nonbank SBSDs. For example, in general, 
banks obtain much of their funding through customer deposits (a 
relatively inexpensive source of funding) and can obtain liquidity 
through the Federal Reserve's discount window. Broker-dealers do not--
and nonbank SBSDs will not--have access to these sources of funding and 
liquidity. Consequently, in the Commission's judgment, the broker-
dealer capital standard is the appropriate standard for nonbank SBSDs 
because it is designed to promote a firm's liquidity and self-
sufficiency (in other words, to account for the lack of inexpensive 
funding sources that are available to banks, such as deposits and 
central bank support).
    The rules governing ANC broker-dealers and OTC derivatives dealers 
currently contain provisions designed to address dealing in OTC 
derivatives by broker-dealers and, therefore, to some extent are 
tailored to address security-based swap activities of broker-dealers. 
However, as discussed below, the amendments to Rule 15c3-1 are designed 
to more specifically address the risks of security-based swaps and 
swaps and the potential for the increased involvement of broker-dealers 
in these markets.\50\ Moreover, most stand-alone broker-dealers are not 
subject to Rules 15c3-1e and 15c3-1f and thus will need to take 
standardized haircuts in calculating their net capital. Therefore, in 
response to comments, the Commission believes it is appropriate for the 
amendments to Rule 15c3-1 to apply to broker-dealers irrespective of 
whether they are registered as SBSDs. This approach will establish 
requirements (such as standardized haircuts for security-based swaps) 
that are specifically tailored to security-based swap activities across 
all broker-dealers (i.e., broker-dealer SBSDs and stand-alone broker-
dealers that engage in a de minimis level of security-based swap 
activities).
---------------------------------------------------------------------------

    \50\ See Alternative Net Capital Requirements for Broker-Dealers 
That Are Part of Consolidated Supervised Entities, Exchange Act 
Release No. 49830 (June 8, 2004), 69 FR 34428 (June 21, 2004); OTC 
Derivatives Dealers, 63 FR 59362.
---------------------------------------------------------------------------

    The Commission disagrees with the comment that the broker-dealer 
capital standard is not risk-based. The ratio-

[[Page 43882]]

based minimum net capital requirement being adopted today is tied 
directly to the risk of the firm's customer exposures. Further, the 
standardized and model-based haircuts that will be used by nonbank 
SBSDs are tied directly to the market and credit risk of the firm's 
positions.
    For these reasons, Rules 15c3-1, as amended, and 18a-1, as adopted, 
establish capital requirements for nonbank SBSDs that differ from the 
capital requirements adopted by the prudential regulators and certain 
of the capital requirements the CFTC proposed for nonbank swap 
dealers.\51\ The Commission considered these alternative approaches in 
light of Section 15F(e)(3)(D)(ii) of the Exchange Act, which provides--
as discussed above--that the Commission, prudential regulators, and the 
CFTC to the maximum extent practicable, establish and maintain 
comparable minimum capital requirements. However, as discussed above, 
the Commission believes that the capital requirements for nonbank SBSDs 
should take into account key differences between banks (which are 
lending institutions) and nonbank SBSDs (which will focus primarily on 
securities activities). Therefore, the Commission does not believe it 
would be appropriate to model the Commission's capital requirements for 
nonbank SBSDs on the bank capital standard.\52\
---------------------------------------------------------------------------

    \51\ As noted above, the prudential regulators similarly adopted 
capital standards for bank SBSDs based on the capital standards for 
banks. See Prudential Regulator Margin and Capital Adopting Release, 
80 FR at 74889. As discussed above, the CFTC has proposed different 
capital standards for nonbank swap dealers depending on whether the 
registrant is an FCM and whether the registrant is predominantly 
engaged in non-financial activities. See CFTC Capital Proposing 
Release, 81 FR 91252.
    \52\ As discussed above and in section II.D. of this release, 
stand-alone SBSDs (excluding firms registered as OTC derivatives 
dealers) will be able to operate pursuant to the alternative 
compliance mechanism of Rule 18a-10 if they meet the conditions in 
the rule. Stand-alone SBSDs operating pursuant to this mechanism 
will be permitted to comply with the capital, margin, and 
segregation requirements of the CEA and the CFTC's rules instead of 
the capital, margin, and segregation requirements of Rules 18a-1, 
18a-3, and 18a-4. As noted above, the CFTC's proposed capital rule 
for swap dealers included an option for certain firms to adhere to a 
bank-like capital standard. As discussed below in section II.D. of 
this release, the Commission believes stand-alone SBSDs that meet 
the conditions of Rule 18a-10 should be permitted to adhere to 
capital, margin, and segregation requirements of the CEA and the 
CFTC's rules (which, potentially, could include a bank-like capital 
standard) because, among other reasons, they will be predominantly 
engaging in a swaps business and, therefore, the CFTC will have a 
heightened regulatory interest in these firms as compared to the 
Commission's regulatory interest.
---------------------------------------------------------------------------

    Further, the Commission does not believe it is necessary to apply a 
tangible net worth test to nonbank SBSDs, as suggested by a commenter. 
The CFTC proposed a tangible net worth requirement for swap dealers 
that are predominately engaged in non-financial activities (e.g., 
agriculture or energy) because of the potential that some of these 
entities may need to register as swap dealers due to their use of swaps 
as part of their non-financial activities.\53\ The application of a 
broker-dealer-based or a bank-based capital approach to entities 
engaged in non-financial activities could result in inappropriate 
capital requirements that would not be proportionate to the risk 
associated with these types of firms. The Commission does not believe 
that entities predominantly engaged in non-financial activities are 
likely to deal in security-based swaps to an extent that would trigger 
registration with the Commission because, for example, the swap market 
is significantly larger than the security-based swap market and has 
many more active participants that are non-financial entities.\54\ 
Moreover, a tangible net worth standard would not promote liquidity, as 
it treats all tangible assets equally, and therefore could incentivize 
a firm to hold illiquid but higher yielding assets.
---------------------------------------------------------------------------

    \53\ See CFTC Capital Proposing Release, 81 FR at 91264-65.
    \54\ See BIS, OTC derivatives statistics at end December 2018 
(May 2019). The BIS statistical releases cited in this release are 
available at https://www.bis.org/list/statistics/index.htm.
---------------------------------------------------------------------------

    Based on staff experience, it is expected that financial 
institutions will comprise a large segment of the security-based swap 
market as is currently the case and that these entities are more likely 
to have affiliates dedicated to OTC derivatives trading and affiliates 
that are broker-dealers registered with the Commission. Consequently, 
these affiliates--because their capital structures are geared towards 
securities trading or because they already are broker-dealers--will not 
face the types of practical issues that non-financial entities would 
face if they had to adhere to a capital standard modeled on the broker-
dealer capital standard. In addition, many broker-dealers currently are 
affiliates of bank holding companies. Consequently, these broker-
dealers are subject to Rule 15c3-1, while their parent and bank 
affiliates are subject to bank capital standards. For these reasons, 
the Commission does not believe it is necessary to adopt a different 
capital standard to accommodate entities that are predominantly engaged 
in non-financial activities as was proposed by the CFTC.\55\
---------------------------------------------------------------------------

    \55\ As discussed above and in section II.D. of this release, 
stand-alone SBSDs (excluding firms registered as OTC derivatives 
dealers) will be able to adhere to the capital, margin, and 
segregation requirements of the CEA and the CFTC's rules instead of 
Rules 18a-1, 18a-3, and 18a-4 if they meet the conditions in Rule 
18a-10. As noted above, the CFTC's proposed capital rule for swap 
dealers included an option for certain firms to adhere to a tangible 
net worth capital standard. As also noted above, the Commission does 
not expect that entities predominantly engaged in non-financial 
activities are likely to register as SBSDs. Accordingly, it is 
unlikely that stand-alone SBSDs adhering to CFTC requirements in 
accordance with Rule 18a-10 will be subject to the CFTC's tangible 
net worth capital standard. To the extent that they are, however, 
the Commission believes stand-alone SBSDs that meet the conditions 
of Rule 18a-10 should be permitted to adhere to capital, margin, and 
segregation requirements of the CEA and the CFTC's rules (which, 
potentially, could include a tangible net worth capital standard) 
because, among other reasons, they will be predominantly engaging in 
a swaps business and, therefore, the CFTC will have a heightened 
regulatory interest in these firms as compared to the Commission's 
regulatory interest.
---------------------------------------------------------------------------

    The Commission acknowledges that not adopting the CFTC's proposed 
alternative-capital-standards approach could require nonbank SBSDs that 
are also registered with the CFTC as swap dealers to, in some cases, 
perform two different capital calculations. This could cause some firms 
to separate their nonbank SBSDs and their nonbank swap dealers into 
separate entities. For nonbank SBSDs that are predominantly swap 
dealers, the alternative compliance mechanism will avoid this outcome. 
In addition, the modification to Rule 18a-1 more closely aligns the 
treatment of uncollateralized current exposures arising from 
derivatives transactions with the treatment of such exposures under the 
bank capital rules. The Commission, however, does not believe it would 
be appropriate to further address this potential consequence by 
modifying its proposed capital requirements for nonbank SBSDs to permit 
firms to apply a bank capital standard or tangible net worth test for 
the reasons discussed above.
    In response to commenters' requests that the Commission and CFTC 
work together and harmonize their respective capital rules, as 
appropriate, Commission staff has consulted with the CFTC, among 
others, in drafting the proposals and the amendments and rules being 
adopted today, and as discussed further below, has sought to make the 
Commission's capital rule more consistent with the CFTC's proposed 
capital rules, as appropriate.
    For these reasons, the Commission is modeling the capital 
requirements for nonbank SBSDs on the broker-dealer capital standard in 
Rule 15c3-1, as

[[Page 43883]]

proposed, but with the two significant modifications discussed above 
with respect to the capital requirements for stand-alone SBSDs.
    The Commission is adopting a positive tangible net worth capital 
standard for stand-alone MSBSPs pursuant to Section 15F of the Exchange 
Act. As discussed in more detail below, the Commission did not receive 
comments that specifically objected to this standard for these 
entities.
2. Capital Rules for Nonbank SBSDs
a. Computing Required Minimum Net Capital
    Rule 15c3-1 requires a broker-dealer to maintain a minimum level of 
net capital (meaning highly liquid capital) at all times. Paragraph (a) 
of the rule requires the broker-dealer to perform two calculations: (1) 
A computation of the minimum amount of net capital the broker-dealer 
must maintain; and (2) a computation of the amount of net capital the 
broker-dealer is maintaining. The minimum net capital requirement is 
the greater of a fixed-dollar amount specified in the rule and an 
amount determined by applying one of two financial ratios: The 15-to-1 
aggregate indebtedness to net capital ratio (``15-to-1 ratio'') or the 
2% of aggregate debit items ratio (``2% debit item ratio''). The 
Commission proposed that nonbank SBSDs be subject to similarly 
structured minimum net capital requirements that varied depending on 
the type of entity. More specifically, proposed Rule 18a-1 required a 
stand-alone SBSD not authorized to use internal models when computing 
net capital to maintain minimum net capital of not less than the 
greater of $20 million or 8% of the firm's ``risk margin amount'' as 
that term was defined in the rule.\56\ The risk margin amount was 
calculated as the sum of:
---------------------------------------------------------------------------

    \56\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70221-24.
---------------------------------------------------------------------------

     The greater of: (1) The total margin required to be 
delivered by the stand-alone SBSD with respect to security-based swap 
transactions cleared for security-based swap customers at a clearing 
agency: Or (2) the amount of the deductions that would apply to the 
cleared security-based swap positions of the security-based swap 
customers pursuant to proposed Rule 18a-1; and
     The total initial margin calculated by the stand-alone 
SBSD with respect to non-cleared security-based swaps pursuant to 
proposed Rule 18a-3.
    The total of these two amounts--i.e., the risk margin amount--would 
be multiplied by 8% to determine the ratio-based minimum net capital 
requirement (``8% margin factor''). In the 2018 comment reopening, the 
Commission asked whether the input to the risk margin amount for 
cleared security-based swaps should be determined solely by the total 
initial margin required to be delivered by the nonbank SBSD with 
respect to transactions cleared for security-based swap customers at a 
clearing agency.\57\
---------------------------------------------------------------------------

    \57\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53009. The release also sought comment and supporting data on 
the potential minimum net capital amounts that would be required of 
nonbank SBSDs. Id.
---------------------------------------------------------------------------

    Proposed Rule 18a-1 permitted a stand-alone SBSD to apply to the 
Commission to use model-based haircuts.\58\ The rule required a stand-
alone SBSD authorized to use models to maintain: (1) Minimum tentative 
net capital of not less than $100 million; and (2) minimum net capital 
of not less than the greater of $20 million or the 8% margin 
factor.\59\ The proposed rule defined ``tentative net capital'' to 
mean, in pertinent part, the amount of net capital maintained by the 
nonbank SBSD before deducting haircuts (standardized or model-based) 
with respect to the firm's proprietary positions and, for firms 
authorized to use models, before deducting the credit risk charges 
discussed below in section II.A.2.b.v. of this release. The minimum 
tentative net capital requirement was designed to account for the fact 
that model-based haircuts, while more risk sensitive than standardized 
haircuts, tend to substantially reduce the amount of the deductions to 
tentative net capital in comparison to the standardized haircuts. It 
also was designed to account for the fact that models may miscalculate 
risks or not capture all risks (e.g., extraordinary losses or decreases 
in liquidity during times of stress that are not incorporated into the 
models).
---------------------------------------------------------------------------

    \58\ Capital, Margin, and Segregation Proposing Release, 77 FR 
at 70226-27, 70237-40.
    \59\ 77 FR at 70221-24.
---------------------------------------------------------------------------

    The proposed amendments to Rule 15c3-1 established minimum net 
capital requirements for a broker-dealer SBSD not authorized to use 
model-based haircuts.\60\ The proposed amendments required these 
entities to maintain minimum net capital equal of the greater of $20 
million or the sum of: (1) The 8% margin factor; and (2) the amount of 
the financial ratio requirement that applied to the broker-dealer under 
pre-existing requirements in Rule 15c3-1 (i.e., either the 15-to-1 
ratio or 2% debit item ratio).
---------------------------------------------------------------------------

    \60\ 77 FR at 70225-26.
---------------------------------------------------------------------------

    Under Rule 15c3-1e, a broker-dealer must apply to the Commission 
for authorization to use the alternative net capital (ANC) computation 
that permits models to be used to compute haircuts and credit risk 
charges. Broker-dealers with that authorization--ANC broker-dealers--
are subject to minimum net capital requirements specific to these 
entities. In particular, before today's amendments, paragraph (a)(7)(i) 
of Rule 15c3-1 required an ANC broker-dealer to maintain minimum 
tentative net capital of at least $1 billion and minimum net capital of 
at least $500 million. In addition, paragraph (a)(7)(ii) of Rule 15c3-1 
required an ANC broker-dealer to provide the Commission with an ``early 
warning'' notice when its tentative net capital fell below $5 billion.
    As proposed, a broker-dealer SBSD authorized to use models was 
subject to the minimum net capital requirements for an ANC broker-
dealer, which the Commission proposed increasing.\61\ Consequently, 
under the proposed amendments to Rule 15c3-1, an ANC broker-dealer, 
including an ANC broker-dealer SBSD, was required to maintain: (1) 
Tentative net capital of not less than $5 billion; and (2) net capital 
of not less than the greater of $1 billion, or the amount of the 15-to-
1 ratio or 2% debit item ratio (as applicable) plus the 8% margin 
factor. The Commission also proposed increasing the early warning 
notification requirement for ANC broker-dealers from $5 billion to $6 
billion.
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    \61\ 77 FR at 70227-29.
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    The Commission explained in the proposing release that while 
raising the tentative net capital requirement under Rule 15c3-1 from $1 
billion to $5 billion would be a significant increase, the existing 
early warning notice requirement for ANC broker-dealers was $5 
billion.\62\ This $5 billion ``early warning'' threshold acted as a de 
facto minimum tentative net capital requirement since ANC broker-
dealers seek to maintain sufficient levels of tentative net capital to 
avoid the necessity of providing this regulatory notice. Accordingly, 
the objective in raising the minimum capital requirements for ANC 
broker-dealers was not to require the existing ANC broker-dealers to 
increase their current capital levels (as they already maintained 
tentative net capital in excess of $5 billion).\63\ Rather, the goal

[[Page 43884]]

was to establish new higher minimum requirements designed to ensure 
that the ANC broker-dealers continue to maintain high capital levels 
and that any new ANC broker-dealer entrants maintain capital levels 
commensurate with their peers.
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    \62\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70228.
    \63\ The ANC broker-dealers continue to maintain tentative net 
capital in excess of the proposed $6 billion early warning level. 
See also section VI of this release (discussing costs and benefits 
of the increases in the capital requirements for ANC broker-
dealers).
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Comments and Final Fixed-Dollar Minimum Net Capital Requirements
    Some commenters expressed support for the proposed fixed-dollar 
minimum tentative net capital and net capital requirements. A commenter 
stated that the requirements were consistent with pre-existing 
requirements and practices for OTC derivatives dealers and ANC broker-
dealers that have not proven to produce significant disparities with 
other capital regimes.\64\ A second commenter stated that the proposal 
to require an ANC broker-dealer to provide notification to the 
Commission if the firm's tentative net capital fell below $6 billion 
would improve the Commission's monitoring of these key market 
participants.\65\
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    \64\ See Letter from Kenneth E. Bentsen, Jr., Executive Vice 
President, Securities Industry and Financial Markets Association 
(Feb. 22, 2013) (``SIFMA 2/22/2013 Letter'').
    \65\ See Letter from Stuart J. Kaswell, Executive Vice 
President, Managing Director, and General Counsel, Managed Funds 
Association (Feb. 22, 2013) (``MFA 2/22/2013 Letter'').
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    One commenter asked the Commission to reconsider the proposed $100 
million minimum fixed-dollar tentative net capital requirement for 
stand-alone SBSDs authorized to use models, particularly for a nonbank 
SBSD that trades only in cleared security-based swaps.\66\ The 
commenter stated that dealing in cleared security-based swaps should 
not implicate the same concerns about the use of models that led to the 
establishment of a higher threshold for other Commission registrants. 
The Commission believes that the same risks exist with respect to the 
use of models whether an SBSD is trading cleared or non-cleared 
security-based swaps. In particular, the minimum tentative net capital 
requirement is designed to address the possibility that the model might 
miscalculate risk irrespective of the relative level of risk of the 
positions (e.g., cleared versus non-cleared security-based swaps) being 
input into the model.
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    \66\ See Letter from Stephen John Berger, Managing Director, 
Government & Regulatory Policy, Citadel Securities (May 15, 2017) 
(``Citadel 5/15/2017 Letter'').
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    For these reasons, the Commission is adopting the proposed minimum 
fixed-dollar tentative net capital and net capital requirements as 
proposed as well as the $6 billion early warning notification 
requirement as proposed.\67\ Consequently, under the final rules: (1) A 
stand-alone SBSD not approved to use internal models has a $20 million 
fixed-dollar minimum net capital requirement; \68\ (2) a stand-alone 
SBSD authorized to use internal models (including a firm registered as 
an OTC derivatives dealer) has a $100 million fixed-dollar minimum 
tentative net capital requirement and a $20 million fixed-dollar 
minimum net capital requirement; \69\ (3) a broker-dealer SBSD not 
authorized to use internal models has a $20 million fixed-dollar 
minimum net capital requirement; \70\ and (4) an ANC broker-dealer, 
including an ANC broker-dealer SBSD, has a $6 billion fixed-dollar 
early warning notification requirement, a $5 billion fixed-dollar 
minimum tentative net capital requirement, and a $1 billion fixed-
dollar minimum net capital requirement.\71\
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    \67\ See paragraphs (a)(7)(i) and (a)(10)(i) of Rule 15c3-1, as 
amended; paragraphs (a)(1) and (2) of Rule 18a-1, as adopted. In the 
final rule, the Commission made non-substantive amendments to the 
term of ``tentative net capital'' in Rule 18a-1, as adopted, to 
align the language more closely to the definition in Rule 15c3-1. 
See paragraph (c)(5) of Rule 18a-1, as adopted.
    \68\ See paragraph (a)(1) of Rule 18a-1, as adopted.
    \69\ See paragraph (a)(2) of Rule 18a-1, as adopted.
    \70\ See paragraph (a)(10)(i) of Rule 15c3-1, as amended.
    \71\ See paragraph (a)(7)(i) and (ii) of Rule 15c3-1, as 
amended.
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Comments and Final Ratio-Based Minimum Net Capital Requirements
    As noted above, the Commission proposed a ratio-based minimum net 
capital requirement that for a broker-dealer SBSD was the 15-to-1 ratio 
or 2% debit item ratio (as applicable) plus the proposed 8% margin 
factor, and for a stand-alone SBSD was only the proposed 8% margin 
factor.\72\ Commenters raised concerns about the proposed 8% margin 
factor. One commenter suggested that the Commission require broker-
dealer SBSDs to comply with a ratio that is modeled on the 2% debit 
item ratio in Rule 15c3-1.\73\ Another commenter stated that a minimum 
capital requirement that is scalable to the volume, size, and risk of a 
nonbank SBSD's activities would be consistent with the safety and 
soundness standards mandated by the Dodd-Frank Act and the Basel 
Accords and would be comparable to the requirements established by the 
CFTC and the prudential regulators.\74\ The commenter, however, 
expressed concerns that the proposed 8% margin factor was not 
appropriately risk-based.\75\
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    \72\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70225-26.
    \73\ See SIFMA 11/19/18 Letter. This commenter suggested that 
the Commission not apply the proposed 8% margin factor to full-
purpose broker-dealers, and modify the customer reserve requirements 
to include security-based swap credits and debits, thereby covering 
security-based swaps in the existing 2% debit item ratio, under 
existing Rule 15c3-1. For stand-alone SBSDs, the commenter 
recommended replacing the proposed 8% margin factor with a 2% 
minimum capital requirement, based on a calculation consistent with 
the proposed risk margin amount.
    \74\ See SIFMA 2/22/2013 Letter.
    \75\ The commenter suggested two approaches: one for nonbank 
SBSDs authorized to use models and one for nonbank SBSDs not 
authorized to use models. Under the first approach, the risk margin 
amount would be a percent of the firm's aggregate model-based 
haircuts. The second approach was a credit quality adjusted version 
of the proposed 8% margin factor.
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    A commenter suggested that, if the proposed 8% margin factor is 
adopted, the Commission should exclude security-based swaps that are 
portfolio margined with swaps or futures in a CFTC-supervised 
account.\76\ Another commenter believed that a broker-dealer dually 
registered as an FCM should be subject to a single risk margin amount 
calculated pursuant to the CFTC's rules, since the CFTC's proposed 
calculation incorporates both security-based swaps and swaps.\77\ A 
commenter suggested modifying the proposed definition of ``risk margin 
amount'' to reflect the lower risk associated with central clearing by 
ensuring that capital requirements for cleared security-based swaps are 
lower than the requirements for equivalent non-cleared security-based 
swaps.\78\
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    \76\ See SIFMA 11/19/18 Letter.
    \77\ See Morgan Stanley 11/19/2018 Letter. This commenter also 
argued that a stand-alone broker-dealer should not be subject to the 
proposed 8% margin factor minimum ratio requirement. Stand-alone 
broker-dealers--other than ANC broker-dealers--do not have to 
incorporate the 2% margin factor into their net capital calculation 
under Rule 15c3-1, as amended.
    \78\ See MFA 2/22/2013 Letter. See also Letter from Thomas G. 
McCabe, Chief Regulatory Officer, OneChicago (Nov. 19, 2018) 
(``OneChicago 11/19/2018 Letter'').
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    Commenters also addressed the modifications to the proposed rule 
text in the 2018 comment reopening pursuant to which the input for 
cleared security-based swaps in the risk margin amount would be 
determined solely by reference to the amount of initial margin required 
by clearing agencies (i.e., not be the greater of those amounts or the 
amount of the haircuts that would apply to the cleared security-based 
swap positions). Some commenters supported the potential rule language 
modifications.\79\ Other commenters

[[Page 43885]]

opposed them.\80\ One commenter opposing the modifications stated that 
the ``greater of'' provision creates a backstop to protect against the 
possibility that varying margin requirements across clearing agencies 
and over time could be insufficient to reflect the true risk to a 
nonbank SBSD arising from its customers' positions.\81\ Another 
commenter stated that eliminating the haircut requirement may 
incentivize clearing agencies to compete on the basis of margin 
requirements.\82\
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    \79\ See ICI 11/19/18 Letter; MFA/AIMA 11/19/2019 Letter; SIFMA 
11/19/2018 Letter.
    \80\ See Letter from Americans for Financial Reform (Nov. 19, 
2018) (``Americans for Financial Reform Education Fund Letter''); 
Better Markets 11/19/2018 Letter; Rutkowski 11/20/2018 Letter.
    \81\ See Better Markets 11/19/2018 Letter.
    \82\ See Americans for Financial Reform Education Fund Letter. 
See also Rutkowski 11/20/2018 Letter.
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    The Commission continues to believe a margin factor ratio is the 
right approach to setting a scalable minimum net capital requirement. 
The calculation is based on the initial margin required to be posted by 
an ANC broker-dealer or nonbank SBSD to a clearing agency for cleared 
security-based swaps and on the initial margin calculated by a nonbank 
SBSD for a counterparty for non-cleared security-based swaps.\83\ 
Margin requirements generally are scaled to the risk of the positions, 
with riskier positions requiring higher levels of margin. Therefore, 
the amount of the ratio-based minimum net capital requirement will be 
linked to the volume, size, and risk of the firm's cleared and non-
cleared security-based swap transactions.
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    \83\ An ANC broker-dealer will not be subject to the final 
margin rule for non-cleared security-based swaps if it is not also 
registered as an SBSD. Therefore, its calculation of the 2% margin 
factor will only account for cleared security-based swaps.
---------------------------------------------------------------------------

    However, in response to comments raising concerns about the 
potential impact of the proposed 8% margin factor, the Commission 
believes it would be appropriate to adopt, at least initially, a lower 
margin factor and create a process through which the percent multiplier 
can potentially (but not necessarily) be increased over time (i.e., 
starting at 2% and potentially transitioning from 2% to 8% or less over 
the course of at least 5 years). Initially using a 2% multiplier could 
provide ANC broker-dealers and nonbank SBSDs with time to adjust to the 
requirement if it incrementally increases. The final rule sets strict 
limits in terms of how quickly the multiplier can be raised and the 
amount by which it can be raised through the process in the rule 
because market participants should know when a potential increase in 
the multiplier using the process could first occur and how much the 
multiplier could be increased at that time or thereafter. The 
Commission's objective is to establish an efficient and flexible 
process, while providing market participants with notice about the 
potential timing and magnitude of an increase so that they can make 
informed decisions about how to structure their businesses.
    Consequently, under the process set forth in the final rules, the 
percent multiplier will be 2% for at least 3 years after the compliance 
date of the rule.\84\ After 3 years, the multiplier could increase to 
not more than 4% by Commission order, and after 5 years the multiplier 
could increase to not more than 8% by Commission order if the 
Commission had previously issued an order raising the multiplier to 4% 
or less. The process sets an upper limit for the multiplier of 8% (the 
day-1 multiplier under the proposed rules) and requires the issuance of 
two successive orders to raise the multiplier to as much as 8% (or an 
amount between 4% and 8%). The first order can be issued no earlier 
than 3 years after the compliance date of the rules, and the second 
order can be issued no earlier than 5 years after the compliance date.
---------------------------------------------------------------------------

    \84\ As discussed below in section II.D. of this release, Rule 
18a-10 contains a process through which the maximum fixed-dollar 
amount is set at a transitional level of $250 billion for the first 
3 years after the compliance date of the rule and then drops to $50 
billion thereafter unless the Commission issues an order: (1) 
Maintaining the $250 billion maximum fixed-dollar amount for an 
additional period of time or indefinitely; or (2) lowering the 
maximum fixed-dollar amount to an amount between $250 billion and 
$50 billion.
---------------------------------------------------------------------------

    The process in the final rules provides that, before issuing an 
order to raise the multiplier, the Commission will consider the capital 
and leverage levels of the firms subject to the ratio-based minimum net 
capital requirement as well as the risks of their security-based swap 
positions. After the rule is adopted, the Commission will gather data 
on how the ratio-based minimum net capital requirement using the 2% 
multiplier (``2% margin factor'') compares to the levels of excess net 
capital these firms maintain, the risks of their security-based swap 
positions, and the leverage they employ.\85\ This information will 
assist the Commission in analyzing whether the ratio-based minimum net 
capital requirement is operating in practice as the Commission intends 
(i.e., a requirement that sets a prudent level of minimum net capital 
given the volume, size, and risk of the firm's security-based swap 
positions). In determining whether to issue an order raising the 
multiplier, the Commission may also consider, for example, whether 
further data is necessary to analyze the appropriate level of the 
ratio-based minimum net capital requirement.
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    \85\ See section VI of this release (providing analysis of 
initial margin estimated for inter-dealer CDS positions, and using 
this to provide a range of estimates for the potential costs of 
complying with the 2% margin factor requirement, under certain 
assumptions).
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    Finally, the process in the final rules provides that the 
Commission will publish notice of the potential change to the 
multiplier and subsequently issue an order regarding the change. The 
Commission intends to provide such notice sufficiently in advance of 
the order for the public to be aware of the potential change.
    As discussed above, a commenter suggested that broker-dealer SBSDs 
should be subject to a ratio that is modeled on the 2% debit item ratio 
in Rule 15c3-1. The Commission does not believe there is a compelling 
reason to adopt a different standard for broker-dealer SBSDs. The 
standard being adopted today is based on initial margin calculations 
for cleared and non-cleared security-based swaps. Modeling a 
requirement on the 2% debit item ratio would require a calculation 
based on the segregation requirements for security-based swaps. This 
could result in firms with similar risk profiles in terms of their 
customers' security-based swap positions having different minimum net 
capital requirements because for stand-alone SBSDs the requirement 
would be based on margin calculations and for ANC broker-dealers and 
broker-dealer SBSDs the requirement would be based on segregation 
requirements. The Commission believes the more prudent approach is to 
require all firms subject to this requirement to comply with the same 
standard in order to avoid the potential competitive impacts of 
imposing different standards, particularly when the rationale for 
applying the different standard advocated by the commenter is not 
grounded in promoting the safety and soundness of the firms.
    Similarly, the Commission is not establishing two alternative 
methods for calculating the 2% margin factor--one for firms that use 
models and the other for firms that do not use models--as suggested by 
the commenter. To a certain extent, the 2% margin factor calculation by 
a nonbank SBSD authorized to use models to calculate initial margin 
requirements for non-cleared security-based swap transactions will be 
more risk sensitive than the calculation by nonbank SBSDs that will use 
the standardized approach to calculate initial margin (i.e., the 
standardized haircuts). Models generally are more risk sensitive and 
therefore will result in lower initial

[[Page 43886]]

margin requirements than approaches using standardized haircuts. Thus, 
the firms that use models to calculate initial margin for non-cleared 
security-based swaps generally will employ a more risk-sensitive 
approach when calculating the 2% margin factor than firms that do not 
use models. Further, the Commission believes that most nonbank SBSDs 
will use models to calculate initial margin to the extent permitted 
under the final margin rules.
    Moreover, a standard based on a firm's aggregate model-based 
haircuts--the commenter's first suggested alternative--could result in 
a substantially lower minimum net capital requirement. The Commission's 
approach requires the firm to calculate the risk margin amount using 
the initial margin amount calculated for each counterparty's cleared 
and non-cleared security-based swap positions. The commenter's 
alternative of using the model-based haircut calculations would net 
proprietary positions resulting in a lower minimum net capital 
requirement. The Commission believes the more prudent approach is to 
base the minimum net capital requirement on the margin calculations for 
each counterparty's security-based swap positions. For similar reasons, 
the Commission believes nonbank SBSDs not authorized to use models 
should base the calculation of the risk margin amount on the 
standardized margin calculations for their counterparties (rather than 
the standardized haircut calculation that can be taken for proprietary 
positions, which permits certain netting of long and short positions). 
This will be simpler and more consistent with the requirements of Rule 
18a-3, as adopted, than the commenter's suggested credit quality 
approach for nonbank SBSDs that do not use models.
    Moreover, as discussed below in section II.A.2.b.v. of this 
release, the final capital rules for ANC broker-dealers and nonbank 
SBSDs broaden the application of the credit risk charges as compared to 
the proposed rules. This should significantly reduce the amount of net 
capital an ANC broker-dealer or nonbank SBSD will need to maintain with 
respect to its security-based swap positions (as compared to the 
treatment of these positions under the proposed rules).\86\ Therefore, 
the Commission believes that largely retaining the proposed approaches 
to calculating the risk margin amount (and, therefore, the 2% margin 
factor) is an appropriate trade-off to reducing the application of the 
capital deductions in lieu of margin.
---------------------------------------------------------------------------

    \86\ See SIFMA 2/22/2013 Letter (raising concerns that the 
proposed 8% margin factor and the capital charges in lieu of margin 
could result in duplicative charges).
---------------------------------------------------------------------------

    In response to comments that the Commission exclude security-based 
swaps that are being portfolio margined under a CFTC-supervised 
account, the Commission will need to coordinate with the CFTC to 
implement portfolio margining.\87\ A part of any such coordination 
would be to resolve the question of how to incorporate accounts that 
are portfolio margined into the minimum net capital requirements under 
the capital rules of the Commission and the CFTC.
---------------------------------------------------------------------------

    \87\ See, e.g., Order Granting Conditional Exemption Under the 
Securities Exchange Act of 1934 in Connection with Portfolio 
Margining of Swaps and Security-Based Swaps, Exchange Act Release 
No. 68433 (Dec. 14, 2012), 77 FR 75211 (Dec. 19, 2012).
---------------------------------------------------------------------------

    In response to comments, the Commission does not believe it would 
be appropriate to treat cleared security-based swaps more favorably 
than non-cleared security-based swaps for purposes of calculating the 
2% margin factor. The 2% margin factor is consistent with an existing 
requirement in the CFTC's net capital rule for FCMs.\88\ Currently, 
FCMs must maintain adjusted net capital in excess of 8% of the risk 
margin on futures, foreign futures, and cleared swaps positions carried 
in customer and noncustomer accounts. Moreover, the CFTC has proposed a 
similar requirement for swap dealers and major swap participants 
registered as FCMs.\89\ The CFTC's proposed minimum capital requirement 
is 8% of the initial margin for non-cleared swap and security-based 
swap positions, and the total initial margin the firm is required to 
post to a clearing agency or broker-dealer for cleared swap and 
security-based swap positions. Thus, the CFTC's proposed rule does not 
treat cleared positions more favorably than non-cleared positions (both 
are based on initial margin calculations).
---------------------------------------------------------------------------

    \88\ See 17 CFR 1.17(a)(1)(i)(B) and (b)(8).
    \89\ See CFTC Capital Proposing Release, 81 FR at 91266.
---------------------------------------------------------------------------

    However, in response to comments, the Commission has modified the 
final rule so that for cleared security-based swaps the calculation of 
the risk margin amount is based on the initial margin required to be 
posted to a clearing agency rather than the greater of that amount or 
the haircuts that would apply to the positions (as was proposed).\90\ 
Thus, for purposes of the 2% margin factor, the risk of cleared 
security-based swaps is measured by the amount of initial margin the 
clearing agency's margin rule requires. This more closely aligns the 
Commission's rule with the CFTC's proposed rule (as requested by 
commenters).
---------------------------------------------------------------------------

    \90\ See paragraph (c)(17) of Rule 15c3-1, as amended; paragraph 
(c)(6) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    In response to commenters who opposed this modification, the 
Commission recognizes that it will eliminate a component of the 
proposed rule that was designed to address the potential that clearing 
agencies might set margin requirements that were lower than the 
applicable haircuts that would apply to the positions. However, 
retaining the requirement could have created a disincentive to clear 
security-based swap transactions. Moreover, eliminating it will 
simplify the calculation and more closely align the requirement with 
the CFTC's proposed capital rule. The Commission has weighed these 
competing considerations and believes that the modification is 
appropriate.
    The Commission does not believe further modifications to 
distinguish the risk of cleared security-based swaps from non-cleared 
security-based swaps are necessary. Cleared security-based swaps 
generally will be less complex than non-cleared security-based swaps. 
Further, cleared security-based swaps will be more liquid than non-
cleared security-based swaps in terms of how long it will take to close 
them out. These attributes may factor into the margin calculations of 
the clearing agencies and, consequently, into the risk margin amount. 
Therefore, the potentially lower risk characteristics of cleared 
security-based swaps as compared to non-cleared security-based swaps 
could be incorporated into the 2% margin factor by virtue of relying 
solely on the clearing agency margin requirements.
    For these reasons, the Commission is adopting the 2% margin factor 
with modifications to the term ``risk margin amount'' and the potential 
phase-in of the percent multiplier, as discussed above.\91\ Stand-alone 
SBSDs will need to calculate the 2% margin factor to determine their 
ratio-based minimum net capital requirement. ANC broker-dealers and 
broker-dealer SBSDs will need to calculate the 2% margin factor and the 
15-to-1 ratio or 2% debit item ratio (as applicable) to determine their 
ratio-based minimum net capital requirement.
---------------------------------------------------------------------------

    \91\ See paragraphs (a)(7)(i) and (a)(10)(i) of Rule 15c3-1, as 
amended; paragraphs (a)(1) and (2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

b. Computing Net Capital
    The Commission proposed the net liquid assets test embodied in Rule 
15c3-1 as the regulatory capital

[[Page 43887]]

standard for all nonbank SBSDs. The standard (maintaining net liquid 
assets) is imposed through the computation requirements set forth in 
paragraph (c)(2) of Rule 15c3-1, which defines the term ``net 
capital.'' The first step in a net capital calculation is to compute 
the broker-dealer's net worth under GAAP. Next, the broker-dealer must 
make certain adjustments to its net worth. These adjustments are 
designed to leave the firm in a position in which each dollar of 
unsubordinated liabilities is matched by more than a dollar of highly 
liquid assets.\92\ There are fourteen categories of net worth 
adjustments, including adjustments resulting from the application of 
standardized or model-based haircuts.\93\ The Commission proposed that 
a broker-dealer SBSD compute net capital pursuant to the pre-existing 
provisions in paragraph (c)(2) of Rule 15c3-1, as proposed to be 
amended, to account for security-based swap and swap activities, and 
that stand-alone SBSDs compute net capital in a similar manner pursuant 
to proposed Rule 18a-1.\94\
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    \92\ See, e.g., Net Capital Requirements for Brokers and 
Dealers, 54 FR at 315 (``The [net capital] rule's design is that 
broker-dealers maintain liquid assets in sufficient amounts to 
enable them to satisfy promptly their liabilities. The rule 
accomplishes this by requiring broker-dealers to maintain liquid 
assets in excess of their liabilities to protect against potential 
market and credit risks.'') (footnote omitted).
    \93\ See paragraphs (c)(2)(i) through (xiv) of Rule 15c3-1.
    \94\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70230-56.
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i. Deduction for Posting Initial Margin
    If a stand-alone broker-dealer or nonbank SBSD delivers initial 
margin to a counterparty, it must take a deduction from net worth in 
the amount of the posted collateral.\95\ The Commission recognizes that 
the imposition of this deduction could increase transaction costs for 
stand-alone broker-dealers and nonbank SBSDs.\96\ Consequently, the 
Commission sought comment on whether it should provide a means for a 
firm to post initial margin to counterparties without incurring the 
deduction with respect to Rules 15c3-1 and 18a-1, under specified 
conditions. The potential conditions included that the initial margin 
requirement is funded by a fully executed written loan agreement with 
an affiliate of the firm and that the lender waives re-payment of the 
loan until the initial margin is returned to the firm.\97\
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    \95\ 17 CFR 15c3-1(c)(2)(iv).
    \96\ See section VI of this release (discussing costs and 
benefits of the rules and amendments).
    \97\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53012.
---------------------------------------------------------------------------

    Several commenters expressed support for this general approach but 
suggested modifications. A commenter supported requiring no deduction 
if the posted initial margin is: (1) Subject to an agreement that 
satisfies the specified conditions, or (2) maintained at a third-party 
custodian in accordance with the recommendations the Basel Committee on 
Banking Supervision (``BCBS'') and the Board of the International 
Organization of Securities Commissions (``IOSCO'') made with respect to 
margin requirements for non-cleared derivatives (``BCBS/IOSCO 
Paper'').\98\ Another commenter supported the policy behind the 
Commission's approach recognizing the role of an SBSD as a subsidiary 
of a larger banking organization, but recommended that the Commission 
evaluate whether inter-company liquidity and funding arrangements and 
loss absorbing capacity mandated by resolution planning guidance should 
be recognized as a second alternative to deductions for initial margin 
posted away.\99\ This commenter also encouraged the Commission to 
reconcile its guidance with the CFTC's proposed capital rules, which do 
not require initial margin posted to a third-party custodian to be 
deducted from net worth in computing capital.\100\ Finally, a commenter 
raised concerns regarding the potential guidance suggesting that the 
effect of the conditions would be to reduce the amount of capital SBSDs 
are required to hold, increasing risk.\101\
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    \98\ See SIFMA 11/19/2018 Letter. See also BCBS and IOSCO, 
Margin Requirements for Non-centrally Cleared Derivatives (Mar. 
2015), available at http://www.bis.org/bcbs/publ/d317.pdf.
    \99\ See Morgan Stanley 11/19/2018 Letter.
    \100\ See Morgan Stanley 11/19/2018 Letter. In the case of a 
dually-registered SBSD/swap dealer, the commenter encouraged the 
Commission to defer to the CFTC's proposed treatment for swap 
initial margin.
    \101\ See Better Markets 11/19/2018 Letter.
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    The Commission is providing the following interpretive guidance as 
to how a stand-alone broker-dealer or nonbank SBSD can avoid taking a 
deduction from net worth when it posts initial margin to a third party. 
Under the guidance, initial margin provided by a stand-alone broker-
dealer or nonbank SBSD to a counterparty need not be deducted from net 
worth when computing net capital if:
     The initial margin requirement is funded by a fully 
executed written loan agreement with an affiliate of the stand-alone 
broker-dealer or nonbank SBSD;
     The loan agreement provides that the lender waives re-
payment of the loan until the initial margin is returned to the stand-
alone broker-dealer or nonbank SBSD; and
     The liability of the stand-alone broker-dealer or the 
nonbank SBSD to the lender can be fully satisfied by delivering the 
collateral serving as initial margin to the lender.\102\
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    \102\ Although not binding, the staff of the Division of Trading 
and Markets issued a no-action letter (in the context of margin 
collateral posted by a stand-alone broker-dealer to a swap dealer or 
other counterparty for a non-cleared swap) that stated that the 
staff would not recommend enforcement action to the Commission if 
the stand-alone broker-dealer did not deduct from net worth when 
computing net capital initial margin provided to a counterparty, if 
certain conditions were met. See Letter from Michael A. Macchiaroli, 
Associate Director, Division of Trading and Markets, Commission, to 
Kris Dailey, Vice President, Risk Oversight and Regulation, FINRA 
(Aug. 19, 2016) (``Staff Letter''). See also Capital, Margin, and 
Segregation Comment Reopening, 83 FR at 53012, n.38 (discussing the 
conditions in the Staff Letter).
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    Stand-alone broker-dealers and nonbank SBSDs may apply this 
guidance to security-based swap and swap transactions.\103\ In response 
to comments, the Commission does not believe this interpretive guidance 
will increase risk to a stand-alone broker-dealer or nonbank SBSD 
because the conditions require that an affiliate fund the initial 
margin requirement, resulting in no decrease to the capital of the 
broker-dealer or nonbank SBSD. In contrast, these conditions may 
decrease risks to a stand-alone broker-dealer or nonbank SBSD by making 
additional capital available to the firm for liquidity or other 
purposes, given that it will not need to use its own capital to fund 
the initial margin requirement of the counterparty. Further, the 
Commission does not believe that initial margin posted by a stand-alone 
broker-dealer or nonbank SBSD with respect to a swap transaction should 
be exempt from the firm's net capital requirements, since collateral 
posted away from the firm would not be available for other purposes, 
and, therefore, the firm's liquidity would be reduced. Finally, in 
response to comments, the Commission does not believe it would be 
appropriate at this time to permit a stand-alone broker-dealer or 
nonbank SBSD to look to collateral held by an affiliate as part of 
resolution planning as a means for the firm to avoid taking a deduction 
for initial margin posted to a counterparty. The collateral held by the 
affiliate may not be available to the stand-alone

[[Page 43888]]

broker-dealer or nonbank SBSD, particularly in a time of market stress 
when it is most needed.
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    \103\ This guidance is not relevant to margin collateral posted 
to a clearing agency for a cleared security-based swap or a DCO for 
a cleared swap. Under the final capital rules, stand-alone broker-
dealers and nonbank SBSDs may treat margin collateral posted to a 
clearing agency for cleared security-based swaps or to a DCO for 
cleared swaps as a ``clearing deposit'' and, therefore, not deduct 
the value of the collateral from net worth when computing net 
capital. See paragraph (c)(2)(iv)(E)(3) of Rule 15c3-1, as amended; 
paragraph (c)(1)(iii) of Rule 18a-1, as adopted.
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ii. Deductions for not Collecting Margin
    The pre-existing provisions of paragraph (c)(2)(xii) of Rule 15c3-1 
require a broker-dealer to take a deduction from net worth for under-
margined accounts. The Commission proposed to amend Rule 15c3-1 to 
require a stand-alone broker-dealer or broker-dealer SBSD to take a 
deduction from net worth for the amount of cash required in the account 
of each security-based swap customer to meet a margin requirement of a 
clearing agency, DEA (such as FINRA), or the Commission to which the 
firm was subject, after application of calls for margin, marks to the 
market, or other required deposits which are outstanding one business 
day or less.\104\ Proposed Rule 18a-1 had an analogous provision, 
although it did not refer to margin requirements of DEAs because stand-
alone SBSDs will not be members of self-regulatory organizations 
(``SROs'') and therefore will not have a DEA.
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    \104\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70245, 70331.
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    These proposed under-margined account provisions required a stand-
alone broker-dealer or nonbank SBSD to take a deduction from net worth 
when a customer or security-based swap customer did not meet a margin 
requirement of a clearing agency, DEA, or the Commission pursuant to a 
rule that applied to the stand-alone broker-dealer or nonbank SBSD 
after one business day from the date the margin requirement arises. The 
proposed deductions were designed to address the risk to stand-alone 
broker-dealers and nonbank SBSDs that arises from not collecting 
collateral to cover their exposures to counterparties. The Commission 
asked whether the deductions should also be extended to failing to 
collect margin required under margin rules for swap transactions that 
apply to a stand-alone broker-dealer or nonbank SBSD.\105\
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    \105\ See 77 FR at 70247.
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    The Commission also proposed deductions from net worth to address 
situations in which an account of a security-based swap customer is 
meeting all applicable margin requirements, but the margin requirements 
result in the collection of an amount of collateral that is 
insufficient to address the risk of the positions in the account.\106\ 
The proposals separately addressed cleared and non-cleared security-
based swaps.
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    \106\ See 77 FR at 7045-47.
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    For cleared security-based swaps, the Commission proposed a 
deduction that applied if a nonbank SBSD collects margin from a 
counterparty in an amount that is less than the deduction that would 
apply to the security-based swap if it was a proprietary position of 
the nonbank SBSD (i.e., the collected margin was less than the amount 
of the standardized or model-based haircuts, as applicable). This 
proposed requirement was designed to account for the risk of the 
counterparty defaulting by requiring the nonbank SBSD to maintain 
capital in the place of collateral in an amount that is no less than 
required for a proprietary position. It also was designed to ensure 
that there is a standard minimum coverage for exposure to cleared 
security-based swap counterparties apart from the individual clearing 
agency margin requirements, which could vary among clearing agencies 
and over time. In the 2018 comment reopening, the Commission asked 
whether this proposed rule should be modified to include a risk-based 
threshold under which the deduction need not be taken, and provided 
modified rule text to apply the deduction to cleared swap 
transactions.\107\
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    \107\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53009. More specifically, the Commission requested comment on 
whether the rule should provide that the deduction need not be taken 
if the difference between the clearing agency margin amount and the 
haircut is less than 1% (or some other amount) of the SBSD's 
tentative net capital, and less than 10% (or some other amount) of 
the counterparty's net worth, and the aggregate difference across 
all counterparties is less than 25% (or some other amount) of the 
counterparty's tentative net capital.
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    For non-cleared security-based swaps, the Commission proposed 
requirements that imposed deductions to address 3 exceptions in the 
nonbank SBSD margin requirements of proposed Rule 18a-3. Under these 3 
exceptions, a nonbank SBSD would not be required to collect (or, in one 
case, hold) variation and/or initial margin from certain types of 
counterparties. Consequently, the Commission proposed deductions to 
serve as an alternative to collecting margin.
    The first proposed deduction applied when a nonbank SBSD does not 
collect sufficient margin under an exception in proposed Rule 18a-3 for 
counterparties that are commercial end users. The second proposed 
deduction applied when the nonbank SBSD does not hold initial margin 
under an exception in proposed Rule 18a-3 for counterparties requiring 
that the collateral be segregated pursuant to Section 3E(f) of the 
Exchange Act. Section 3E(f) of the Exchange Act, among other things, 
provides that the collateral must be carried by an independent third-
party custodian. Collateral held in this manner would not be in the 
physical possession or control of the nonbank SBSD, nor would it be 
capable of being liquidated promptly by the nonbank SBSD without the 
intervention of another party. Consequently, it would not meet the 
collateral requirements in proposed Rule 18a-3. The third proposed 
deduction applied when a nonbank SBSD does not collect sufficient 
margin under an exception in proposed Rule 18a-3 for legacy accounts 
(i.e., accounts holding security-based swap transactions entered into 
prior to the effective date of the rule). The Commission also sought 
comment on whether there should be deductions in lieu of margin for 
non-cleared swaps with commercial end users and counterparties that 
elect to have initial margin held at a third-party custodian as well as 
for non-cleared swaps in legacy accounts.\108\
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    \108\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70247-48.
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    In the 2018 comment reopening, the Commission provided potential 
rule language that would establish deductions in lieu of margin for 
non-cleared security-based swaps and swaps.\109\ The amount of the 
deduction for non-cleared security-based swaps would be the initial 
margin calculated pursuant to proposed Rule 18a-3 (i.e., using the 
standardized haircuts in the nonbank SBSD capital rules or a margin 
model). The amount of the deduction for non-cleared swaps would be the 
standardized haircuts in the nonbank SBSD capital rules or the amount 
calculated using a margin model approved for purposes of proposed Rule 
18a-3.
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    \109\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53012.
---------------------------------------------------------------------------

    The Commission also asked in the 2018 comment reopening whether 
there should be an exception to taking the deduction for initial margin 
collateral held by an independent third-party custodian pursuant to 
Section 3E(f) of the Exchange Act or Section 4s(l) of the CEA under 
conditions that promote the SBSD's ability to promptly access the 
collateral if needed.\110\ Specifically, the Commission sought comment 
on whether there should be such an exception under the following 
conditions: (1) The custodian is a bank; (2) the nonbank SBSD enters 
into an agreement with the custodian and the counterparty that provides 
the nonbank

[[Page 43889]]

SBSD with the same control over the collateral as would be the case if 
the nonbank SBSD controlled the collateral directly; and (3) an opinion 
of counsel deems the agreement enforceable. In addition, the Commission 
stated it was considering providing guidance on ways a nonbank SBSD 
could structure the account control agreement to meet a requirement 
that the nonbank SBSD have the same control over the collateral as 
would be the case if the nonbank SBSD controlled the collateral 
directly.\111\
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    \110\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53011-12.
    \111\ The Commission asked commenters to address whether the 
agreement between the nonbank SBSD, counterparty, and third party 
should: (1) Provide that the collateral will be released promptly 
and directed in accordance with the instructions of the nonbank SBSD 
upon the receipt of an effective notice from the nonbank SBSD; (2) 
provide that when the counterparty provides an effective notice to 
access the collateral the nonbank SBSD will have sufficient time to 
challenge the notice in good faith and that the collateral will not 
be released until a prior agreed-upon condition among the three 
parties has occurred; and (3) give priority to an effective notice 
from the nonbank SBSD over an effective notice from the 
counterparty, as well as priority to the nonbank SBSD's instruction 
about how to transfer collateral in the event the custodian 
terminates the account control agreement.
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Comments and Final Requirements for Deductions for Under-Margined 
Accounts
    As noted above, the Commission proposed a deduction from net worth 
for failing to collect margin required by a rule of a clearing agency, 
DEA, or the Commission that applied to the stand-alone broker-dealer or 
nonbank SBSD.\112\ A commenter urged the Commission to permit firms a 
one-day grace period before the deduction would apply in the case of an 
under-margined account of an affiliate if the affiliate is subject to 
U.S. or comparable non-U.S. prudential regulation.\113\ The commenter 
stated that applying an immediate deduction with respect to a security-
based swap transaction with a regulated affiliate before there is 
operationally a means for transferring collateral to the SBSD would 
only serve to undermine beneficial risk management activities within a 
corporate group.
---------------------------------------------------------------------------

    \112\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70245.
    \113\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to the comment, the final margin rule being adopted 
today provides a nonbank SBSD or MSBSP an additional day (i.e., two 
business days) to collect required margin from a counterparty 
(including variation margin due from an affiliate) if the counterparty 
is located in a different country and more than 4 time zones away.\114\ 
In addition, the exceptions for when nonbank SBSDs need not collect 
initial margin from a counterparty have been expanded.\115\ For 
example, the financial market intermediary exception has been expanded 
so that it not only applies to counterparties that are SBSDs but also 
to other types of financial market intermediaries, including foreign 
and domestic banks and broker-dealers.\116\ There also is an exception 
from collecting initial margin from affiliates.\117\ In addition, the 
final margin rule includes an initial margin exception when the 
aggregate credit exposure of the nonbank SBSD and its affiliates to the 
counterparty and its affiliates is $50 million or less.\118\ These 
modifications to the final margin rule should substantially mitigate 
the commenter's concerns, given that in many instances there will be no 
requirement to collect initial margin, and the timeframe for collecting 
margin has been lengthened for counterparties located in other 
countries when they are more than 4 time zones away.
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    \114\ See paragraphs (c)(1)(iii) and (c)(2)(ii) of Rule 18a-3, 
as adopted. These and other provisions related to the margin rule 
are discussed in more detail in section II.B.2. below. In addition, 
a conforming change was made in paragraph (c)(1)(iii)(B) of Rule 
18a-1, as adopted, to replace the phrase ``one business day'' with 
``the required time frame to collect the margin, marks to the 
market, or other required deposit.'' See paragraph (c)(1)(iii)(B) of 
Rule 18a-1, as adopted.
    \115\ See paragraph (c)(1)(iii) of Rule 18a-3, as adopted.
    \116\ See paragraph (c)(1)(iii)(B) of Rule 18a-3, as adopted.
    \117\ See paragraph (c)(1)(iii)(G) of Rule 18a-3, as adopted.
    \118\ See paragraph (c)(1)(iii)(H) of Rule 18a-3, as adopted.
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    Nonetheless, when margin is required by a rule that applies to an 
entity, it should be collected promptly.\119\ Margin is designed to 
protect the stand-alone broker-dealer or nonbank SBSD from the 
consequences of the counterparty defaulting on its obligations. This 
deduction for failing to collect required margin will serve as an 
incentive for stand-alone broker-dealers and nonbank SBSDs to have a 
well-functioning margin collection system, and the capital needed to 
take the deduction will protect them from the consequences of the 
counterparty's default.
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    \119\ A stand-alone broker-dealer will not be subject to the 
Commission's final margin rule for non-cleared security-based swaps 
(Rule 18a-3). Therefore, the firm will not be required to take a 
capital deduction for failing to collect margin under this rule.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the deduction 
for under-margined accounts with the modification to include a 
deduction for failing to collect required margin with respect to swap 
transactions.\120\ In addition, as discussed above, the Commission has 
modified Rule 18a-3 to permit an extra business day to collect margin 
from a counterparty that is located in another country and more than 4 
time zones away. Further, it is possible that other margin requirements 
for security-based swaps and swaps may provide more than one business 
day to collect required margin.\121\ Therefore, the final rules have 
been modified to provide that the deduction for uncollected margin can 
be reduced by 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.\122\ As proposed, the rules provided that the deduction could 
be reduced by calls for margin, marks to the market, or other required 
deposits which are outstanding one business day or less. Consequently, 
under the final rules, if the firm has sent the counterparty a margin 
call within the required time frame for collecting the margin, a stand-
alone broker-dealer or nonbank SBSD can reduce the deduction for 
required margin that has not been collected from a counterparty by the 
amount of that call. If the counterparty does not post the margin 
within that time frame, the deduction must be taken.
---------------------------------------------------------------------------

    \120\ See paragraph (c)(2)(xii)(B) of Rule 15c3-1, as amended; 
paragraph (c)(1)(viii) of Rule 18a-1, as adopted.
    \121\ See CFTC Margin Adopting Release, 81 FR at 649-650; 
Prudential Regulator Margin and Capital Adopting Release, 80 FR at 
74864-65 (discussing collection of margin timing requirements, 
including when counterparties are located in different time zones).
    \122\ See paragraph (c)(2)(xii)(B) of Rule 15c3-1, as amended; 
paragraph (c)(1)(viii) of Rule 18a-1, as adopted.
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Comments and Final Requirements for Deductions In Lieu of Margin for 
Cleared Transactions
    As noted above, the Commission proposed a deduction from net worth 
that applied if a nonbank SBSD collects margin from a counterparty for 
a cleared security-based swap in an amount that is less than the 
deduction that would apply to the security-based swap if it was a 
proprietary position of the nonbank SBSD.\123\ In the 2018 comment 
reopening, the Commission asked whether this proposal should be 
modified to include a risk-based threshold under which the proposed 
deduction need not be taken.\124\
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    \123\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70245-46.
    \124\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53009.
---------------------------------------------------------------------------

    A commenter stated that the requirement to take a deduction in lieu

[[Page 43890]]

of margin with respect to cleared security-based swaps would ``harm 
customers because it would provide an incentive for the collection of 
margin by SBSDs beyond the amount determined by the clearing agency.'' 
\125\ The commenter recommended that the Commission eliminate this 
proposed deduction. Several commenters stated that the Commission 
should address any concerns regarding clearing agency minimum margin 
requirements directly through its regulation of clearing agencies.\126\ 
One commenter stated that the deduction could drive business to firms 
willing to incur the deduction instead of collecting sufficient 
margin.\127\ The commenter believed that this would provide an 
advantage to the largest clearing firms possessing the greatest amount 
of excess net capital, thereby exacerbating concentration in the market 
for clearing services. Another commenter stated that a low margin level 
for cleared swaps should not be viewed as a deficiency of clearing 
models but as an advantage of central clearing.\128\ This commenter 
stated that a threshold such as the one described in the 2018 comment 
reopening would not address the commenter's concerns and that the 
proposed deduction should be eliminated. Another commenter recommended 
that the Commission impose the cleared security-based swap deduction 
only to the extent it exceeds 1% of the SBSD's tentative net capital, 
consistent with the Commission's CDS portfolio margin exemption.\129\ 
One commenter opposed the inclusion of a potential threshold in the 
final rule, believing it would reduce capital requirements and increase 
risk.\130\ Some commenters opposed applying the proposed deduction to 
cleared swaps, arguing it would interfere with the CFTC's comprehensive 
regulation of cleared swaps margin requirements.\131\ A commenter noted 
that client clearing markets in the United States are, in their current 
composition, dominated by CFTC-regulated swaps and believed that 
integration of Commission net capital rules with CFTC net capital rules 
is particularly important in the case of client clearing.\132\
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    \125\ See SIFMA 2/22/2013 Letter.
    \126\ See Morgan Stanley 11/19/2018 Letter; OneChicago 11/19/
2018 Letter; SIFMA 2/22/2013 Letter; SIFMA 11/19/2018 Letter.
    \127\ See SIFMA 11/19/2018 Letter.
    \128\ See OneChicago 11/19/2018 Letter.
    \129\ See SIFMA 11/19/2018 Letter. This commenter argued that 
the 25% aggregate tentative net capital threshold is unnecessary.
    \130\ See Better Markets 11/19/2018 Letter.
    \131\ See Morgan Stanley 11/19/2018 Letter; SIFMA 11/19/2018 
Letter.
    \132\ See Morgan Stanley 11/19/2018 Letter.
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    The Commission is persuaded by commenters that the proposed 
deduction could provide an unintended advantage to the largest clearing 
firms and that potential issues regarding clearing agency and DCO 
minimum margin requirements may be addressed through direct regulation 
of clearing agencies and DCOs. Therefore, the Commission is eliminating 
the proposed deduction from the final rules. The CFTC did not propose a 
similar deduction related to clearing agency margin requirements. 
Therefore, eliminating this deduction from the final rules may result 
in the two agencies having more closely aligned capital requirements.
    In response to comments that elimination of the proposed deduction 
will decrease capital requirements and increase risk, the Commission 
believes that existing requirements for clearing agencies and DCOs as 
well as the risk management requirements for nonbank SBSDs being 
adopted today will address the potential risk of a counterparty 
defaulting on a requirement to post margin for a cleared security-based 
swap or swap transaction. For example, since the issuance of the 
proposing release in 2012, the Commission has enhanced its clearing 
agency standards. More specifically, in 2016, the Commission adopted 
final rules to establish enhanced standards for the operation and 
governance of registered clearing agencies that meet the definition of 
``covered clearing agency.'' \133\ Under these rules, a covered 
clearing agency that provides central clearing services must establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to, as applicable, cover its credit exposures to 
its participants by establishing a risk-based margin system that meets 
certain minimum standards prescribed in the rule.\134\ The CFTC also 
has adopted enhanced requirements for systemically important DCOs.\135\ 
In addition, nonbank SBSDs must establish and maintain a risk 
management control system that complies with Rule 15c3-4. This rule 
requires that the system address various risks, including credit risk. 
Consequently, nonbank SBSDs will need to have risk management systems 
designed to mitigate the risk of a counterparty defaulting on a 
requirement to post margin for a cleared security-based swap or swap 
transaction.
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    \133\ See Standards for Covered Clearing Agencies, Exchange Act 
Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016).
    \134\ 17 CFR 240.17Ad-22(e)(6).
    \135\ See Enhanced Risk Management Standards for Systemically 
Important Derivatives Clearing Organizations, 78 FR 49663 (Aug. 15, 
2013); Derivatives Clearing Organizations and International 
Standards, 78 FR 72476 (Dec. 2, 2013).
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    For the foregoing reasons, the Commission believes it is 
appropriate to eliminate from the final rules the deductions related to 
the margin requirements for cleared security-based swap and swap 
transactions.
Comments and Final Requirements for Deductions In Lieu of Margin for 
Non-Cleared Transactions
    As noted above, the Commission proposed deductions from net worth 
in lieu of margin for non-cleared security-based swaps, and sought 
comment on whether these proposed deductions should be expanded to 
include non-cleared swaps.\136\ In the 2018 comment reopening, the 
Commission provided potential rule language that would establish 
deductions in lieu of margin for non-cleared security-based swaps and 
swaps.\137\ The amount of the deduction for non-cleared security-based 
swaps would be the initial margin calculated pursuant to proposed Rule 
18a-3 (i.e., using the standardized haircuts in the nonbank SBSD 
capital rules or a margin model approved for the purposes of Rule 18a-
3). The amount of the deduction for non-cleared swaps would be the 
standardized haircuts in the nonbank SBSD capital rules or the amount 
calculated using a margin model approved for the purposes of proposed 
Rule 18a-3.
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    \136\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70246-47.
    \137\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53012.
---------------------------------------------------------------------------

    Comments on these matters generally fell into one of 3 categories: 
(1) Comments requesting or supporting the ability to apply credit risk 
charges instead of these deductions for a broader range of 
counterparties than only commercial end users; (2) comments objecting 
to the deduction when counterparties elect to have initial margin held 
at a third-party custodian and suggesting modifications to the 
potential exception to avoid the deduction; and (3) comments objecting 
to the deduction for legacy accounts and requesting the ability to use 
credit risk charges for these accounts.
    As discussed in more detail below, the Commission is adopting the 
proposed deductions in lieu of margin for non-cleared security-based 
swap and swap transactions, but with two significant modifications that 
are designed to address the concerns raised by commenters. First, as 
discussed

[[Page 43891]]

below in section II.A.2.b.v. of this release, the Commission has 
expanded the circumstances under which a nonbank SBSD authorized to use 
models may apply credit risk charges instead of taking the deduction in 
lieu of margin.\138\ Under the final rules, the credit risk charges may 
be applied when the nonbank SBSD does not collect variation or initial 
margin subject to any exception in Rule 18a-3 or the margin rules of 
the CFTC with respect to non-cleared security-based swap and swap 
transactions, respectively. However, an ANC broker-dealer SBSD is 
subject to a portfolio concentration charge with respect to 
uncollateralized current exposure (including current exposure resulting 
from not collecting variation margin) equal to 10% of the firm's 
tentative net capital.\139\ A stand-alone SBSD is not subject to a 
portfolio concentration charge.\140\
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    \138\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph 
(a)(2) of Rule 18a-1, as adopted. See Capital, Margin, and 
Segregation Comment Reopening, 83 FR at 53010-11 (soliciting comment 
on potential rule language that would modify the proposal in this 
manner).
    \139\ ANC broker-dealers that are not registered as SBSDs and 
other types of stand-alone broker-dealers will not be subject to the 
capital deductions in lieu of margin for non-cleared security-based 
swaps resulting from electing not to collect margin under Rule 18a-3 
because they are not subject to the rule (i.e., the rule only 
applies to nonbank SBSDs). As discussed above, they will be subject 
to the capital deductions for under-margined accounts with respect 
to margin requirements for security-based swaps and swaps that apply 
to them (e.g., margin requirements of DEAs, clearing agencies, or 
DCOs). While ANC broker-dealers (i.e., firms not registered as 
SBSDs) are not subject to Rule 18a-3 and the associated capital 
deductions in lieu of collecting margin under that rule, they may 
engage in OTC derivatives transactions that result in 
uncollateralized credit exposures to the counterparties. If so, they 
can apply credit risk charges to the exposures rather than take a 
100% deduction for the exposure as discussed below in section 
II.A.2.b.v. of this release. However, as discussed in that section 
of this release, they are subject to the portfolio concentration 
charge.
    \140\ As discussed below in section II.A.2.b.v. of this release, 
proposed Rule 18a-1 would have established a portfolio concentration 
charge for stand-alone SBSDs equal to 50% of their tentative net 
capital. The final rule does not include that provision.
---------------------------------------------------------------------------

    Second, the Commission has added a provision in the final rule that 
allows a nonbank SBSD to treat initial margin with respect to a non-
cleared security-based swap or swap held at a third-party custodian as 
if the collateral were delivered to the nonbank SBSD and, thereby, 
avoid taking the deduction for failing to hold the collateral 
directly.\141\ This modification should help mitigate concerns raised 
by commenters about the impact the deduction would have on nonbank 
SBSDs and their counterparties. Further, it responds to commenters who 
suggested that third-party custodial arrangements could be structured 
to provide the nonbank SBSD with sufficient control over the collateral 
to address the Commission's concern that the nonbank SBSD would not be 
able to promptly liquidate collateral in the event of the 
counterparty's default. As discussed in more detail below, the final 
rule is designed so that existing custodial agreements established 
pursuant to the margin rules of the CFTC and the prudential regulators 
should meet the conditions of the exception.
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    \141\ See paragraph (c)(2)(xv)(C) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C) of Rule 18a-1, as adopted. See also Capital, 
Margin, and Segregation Comment Reopening, 83 FR at 53011-12 
(soliciting comment on potential rule language that would establish 
a means to avoid taking the deduction for failing to hold the 
collateral directly).
---------------------------------------------------------------------------

    The Commission--as indicated above--has also modified the final 
requirements so that the deductions will apply to uncollected margin 
with respect to non-cleared swap transactions (in addition to non-
cleared security-based swap transactions).\142\ A commenter objected to 
applying the deductions in lieu of margin to non-cleared swaps 
transactions because, in the commenter's view, it would interfere with 
policy choices of the CFTC such as that agency's requirement that 
initial margin be held at a third-party custodian.\143\ The commenter 
also objected to calculating the amount of the deduction using the 
standardized haircuts in the nonbank SBSD capital rules or a model 
approved for purposes of Rule 18a-3. The commenter recommended that the 
deduction be calculated using the methods for calculating initial 
margin prescribed in the CFTC's rules.
---------------------------------------------------------------------------

    \142\ See paragraph (c)(2)(xv)(B) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(B) of Rule 18a-1, as adopted.
    \143\ See SIFMA 11/19/18 Letter.
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    In response to the commenter's concerns about applying the 
deductions with respect to non-cleared swaps, the failure to collect 
sufficient margin from a counterparty with respect to a swap 
transaction exposes the nonbank SBSD to the same credit risk that 
arises from failing to collect sufficient margin with respect to a 
security-based swap transaction. The deduction in lieu of margin is 
designed to address this risk by requiring the nonbank SBSD to hold 
capital (instead of collateral) to protect itself from the consequences 
of the default of the counterparty. Applying the deduction in lieu of 
margin to non-cleared swap transactions is designed to promote the 
safety and soundness of the nonbank SBSD.\144\ Moreover, as discussed 
below, the Commission has modified the exception from taking the 
deduction when a counterparty's initial margin is held at a third-party 
custodian (including initial margin for non-cleared swap transactions) 
in a manner that is designed to accommodate custodial arrangements 
entered into pursuant to the CFTC's margin rules. In addition, as 
discussed below in section II.A.2.b.v. of this release, the ability to 
use credit risk charges has been expanded to swap transactions.
---------------------------------------------------------------------------

    \144\ See Section 15F(e)(3) of the Exchange Act (providing in 
pertinent part that the capital requirements shall ``help ensure the 
safety and soundness of'' nonbank SBSDs).
---------------------------------------------------------------------------

    The Commission is persuaded by the commenter's second point that 
the amount of the deduction should be calculated using the methods for 
calculating initial margin prescribed in the CFTC's margin rules. 
Consequently, unlike the potential rule language in the 2018 comment 
reopening, the amount of the deduction is calculated using the 
methodology required by the margin rules for non-cleared swaps adopted 
by the CFTC. For example, if the CFTC has approved the firm's use of a 
margin model, the firm can use the model to calculate the amount of the 
deduction in lieu of margin.
    Under the final rules, a nonbank SBSD must deduct from net worth 
when computing net capital unsecured receivables, including receivables 
arising from not collecting variation margin under an exception in the 
margin rule for non-cleared security-based swaps.\145\ The final rules 
also require a nonbank SBSD to deduct the initial margin amount for 
non-cleared security-based swaps calculated under Rule 18a-3 with 
respect to a counterparty or account, less the margin value of 
collateral held in the account.\146\ Consequently, if the nonbank SBSD 
does not collect and hold variation and/or initial margin for an 
account pursuant to an exception in Rule 18a-3, the nonbank SBSD will 
be required to take a 100% deduction for the uncollateralized amount of 
the exposure. For uncollected variation margin, the amount of the 
exposure is the mark-to-market value of the security-based swap; for 
initial margin, the amount of the exposure is the initial margin amount 
calculated pursuant to Rule 18a-3. However, as discussed below in 
section II.A.2.b.v. of this release, an ANC broker-dealer SBSD and 
stand-alone SBSD authorized to use models can apply a credit risk model 
to

[[Page 43892]]

these exposures instead of taking these deductions.
---------------------------------------------------------------------------

    \145\ See paragraph (c)(2)(iv) of Rule 15c3-1; paragraph 
(c)(1)(iii) of Rule 18a-1, as adopted.
    \146\ See paragraph (c)(2)(xv)(A) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(A) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    With respect to swaps, the final rules provide that a nonbank SBSD 
must deduct from net worth when computing net capital unsecured 
receivables, including receivables arising from not collecting 
variation margin under an exception in the non-cleared swaps margin 
rules of the CFTC.\147\ The final rules also require a nonbank SBSD to 
deduct initial margin amounts calculated pursuant to the margin rules 
of the CFTC, less the margin value of collateral held in the account of 
a swap counterparty at the SBSD.\148\ Consequently, if the nonbank SBSD 
does not collect and hold variation and/or initial margin for an 
account pursuant to an exception in the CFTC's margin rules, the 
nonbank SBSD will be required to take a 100% deduction for the 
uncollateralized amount of the exposure. For uncollected variation 
margin, the amount of the exposure is the mark-to-market value of the 
swap; for uncollected initial margin, the amount of the exposure is the 
initial margin amount calculated pursuant to the CFTC's margin rules. 
However, as discussed below in section II.A.2.b.v. of this release, an 
ANC broker-dealer and nonbank SBSD authorized to use models can apply a 
credit risk model to these exposures instead of taking these 
deductions.
---------------------------------------------------------------------------

    \147\ See paragraph (c)(2)(iv) of Rule 15c3-1; paragraph 
(c)(1)(iii) of Rule 18a-1, as adopted. In order to further harmonize 
the Commission's capital rules with the CFTC's proposed capital 
rules, stand-alone broker-dealers and nonbank SBSDs need not deduct 
unsecured receivables from registered FCMs resulting from cleared 
swap transactions in computing net capital. See paragraph 
(a)(3)(iii)(C) of Rule 15c3-1b, as amended; paragraph (a)(2)(iii)(C) 
of Rule 18a-1b, as adopted.
    \148\ See paragraph (c)(2)(xv)(B) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(B) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Deductions related to margin held at third-party custodians. In 
terms of the deductions related to counterparties that elect to have 
initial margin held at a third-party custodian, commenters stated that 
it would discourage the use of third-party custodians, which security-
based swap customers have a right to elect under Section 3E(f) of the 
Exchange Act.\149\ They also claimed that the deduction would result in 
substantial costs to the affected nonbank SBSD, which would be passed 
on to the security-based swap customer. A commenter noted that other 
regulators have finalized or proposed swap capital rules that do not 
include a special deduction for initial margin held at a third-party 
custodian.\150\
---------------------------------------------------------------------------

    \149\ See, e.g., Letter from American Benefits Council, 
Committee on Investment of Employee Benefit Assets, European 
Federation for Retirement Provision, the European Association of 
Paritarian Institutions, the National Coordinating Committee for 
Multiemployer Plans, and the Pension Investment Association of 
Canada (May 19, 2014) (``American Benefits Council, et al. 5/19/2014 
Letter''); Letter from Karrie McMillan, General Counsel, Investment 
Company Institute (Feb. 4, 2013) (``ICI 2/4/2013 Letter''); Letter 
from David W. Blass, General Counsel, Investment Company Institute 
(Nov. 24, 2014) (``ICI 11/24/2014 Letter''); ICI 11/19/2018 Letter; 
Letter from Tim Buckley, Managing Director and Chief Investment 
Officer, and John Hollyer, Principal and Head of Risk Management and 
Strategy Analysis, Vanguard (May 27, 2014) (``Vanguard Letter'').
    \150\ See Letter from Stuart J. Kaswell, Executive Vice 
President & Managing Director, General Counsel, Managed Funds 
Association (May 18, 2017) (``MFA 5/18/2017 Letter'').
---------------------------------------------------------------------------

    Various commenters stated that a nonbank SBSD will have legal 
``control'' over collateral pledged to it and held at a third-party 
custodian when the parties properly structure a custodial 
agreement.\151\ Some of these commenters also stated that properly 
structured tri-party account control agreements could address the 
Commission's concern about the nonbank SBSD's lack of control over 
initial margin held at a third-party custodian.\152\ Some commenters 
argued that even though physical control is lacking under tri-party 
custodial arrangements, legal control of the securities collateral, 
under properly structured tri-party custodial arrangements, exists 
pursuant to Article 8 of the Uniform Commercial Code.\153\ Commenters 
noted that pledgors, secured parties, and securities intermediaries 
typically memorialize the pledge of securities and grant ``control'' of 
the securities to the secured party through a tri-party account control 
agreement.\154\ A commenter noted that courts have recognized the 
legitimacy of account control agreements and enforced them in 
accordance with their terms.\155\ Finally, another commenter suggested 
that the account control agreement should provide the nonbank SBSD with 
legal control over, and access to, the counterparty's initial margin in 
the event of enforcement of the firm's rights against such initial 
margin.\156\
---------------------------------------------------------------------------

    \151\ See Letter from Adam Jacobs, Director, Head of Markets 
Regulation, Alternative Investment Management Association (Mar. 17, 
2014) (``AIMA 3/17/2014 Letter''); Letter from Karrie McMillan, 
General Counsel, Investment Company Institute (Dec. 5, 2013) (``ICI 
12/5/2013 Letter''); ICI 11/19/2018 Letter; Letter from Institute of 
International Bankers and Securities Industry and Financial Markets 
Association (June 21, 2018) (``IIB/SIFMA Letter''); Letter from 
Stuart J. Kaswell, Executive Vice President, Managing Director, and 
General Counsel, Managed Funds Association (Feb. 24, 2013) (``MFA 2/
24/2014 Letter'').
    \152\ See ICI 12/5/2013 Letter; MFA 2/22/2013 Letter; MFA 2/24/
2014 Letter.
    \153\ See American Benefits Council, et al. 5/19/2014 Letter; 
ICI 12/5/2013 Letter; ICI 11/19/2018 Letter; MFA 2/22/2013 Letter.
    \154\ See ICI 12/5/2013 Letter; MFA 2/22/2013 Letter; MFA 2/24/
2014 Letter.
    \155\ See ICI 12/5/2013 Letter (citing Scher Law Firm v. DB 
Partners I LLC, 27 Misc.3d 1230(A), 911 N.Y.S.2d 696 (Kings County 
2010) and SIPC v. Lehman Brothers, Inc., 433 B.R. 127 (Bankr. 
S.D.N.Y. 2010)).
    \156\ See MFA/AIMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    As noted above, the Commission asked in the 2018 comment reopening 
whether there should be an exception to the deduction when collateral 
is held by an independent third-party custodian as initial margin 
pursuant to Section 3E(f) of the Exchange Act or Section 4s(l) of the 
CEA.\157\ The Commission asked whether the capital charge should be 
avoided in these circumstances if: (1) The independent third-party 
custodian is a bank as defined in Section 3(a)(6) of the Exchange Act 
that is not affiliated with the counterparty; (2) the firm, 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 
provides the firm with the same control over the collateral as would be 
the case if the firm controlled the collateral directly; and (3) the 
firm obtains a written opinion from outside counsel that the account 
control agreement is legally valid, binding, and enforceable in all 
material respects, including in the event of bankruptcy, insolvency, or 
a similar proceeding.
---------------------------------------------------------------------------

    \157\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53011.
---------------------------------------------------------------------------

    As a preliminary matter, two commenters addressed the potential 
rule language in the preface to the exception that stated that it could 
apply with respect to collateral held by an independent third-party 
custodian as initial margin pursuant to Section 3E(f) of the Exchange 
Act or Section 4s(l) of the CEA.\158\ One of these commenters noted 
that the CFTC and the prudential regulators adopted their margin rules 
pursuant to Section 4s(e) of the CEA and Section 15F(e) of the Exchange 
Act, respectively.\159\ The commenter further noted that the margin 
rules of the CFTC and the prudential regulators require that initial 
margin be segregated at a third-party custodian. Consequently, the 
commenter was concerned that initial margin held at a third-party 
custodian pursuant to those margin rules would not qualify for the 
exception. The commenter also noted that foreign regulators' rules 
could require that

[[Page 43893]]

initial margin collateral be held at a third-party custodian.
---------------------------------------------------------------------------

    \158\ See Morgan Stanley 11/19/2018 Letter; SIFMA 11/19/2018 
Letter.
    \159\ SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The margin rules of the CFTC and the prudential regulators require 
initial margin to be held at a third-party custodian and prescribe 
specific requirements for the custodial arrangements as well as 
requirements to document agreements with counterparties governing the 
exchange of margin.\160\ The margin rules of other jurisdictions could 
have similar requirements. In the specific context of this exception 
from taking a deduction, the reason why the collateral is held at a 
third-party custodian is less important than taking the necessary steps 
to enter into a custodial arrangement that meets the conditions 
discussed below for qualifying for the exception. The conditions are 
designed to provide the nonbank SBSD, as the secured party, with prompt 
access to the collateral held at the third-party custodian when the 
collateral is needed to protect the nonbank SBSD against the 
consequences of the counterparty's default. The fact that the 
collateral is held at the third-party custodian at the election of the 
counterparty or because a domestic or foreign law requires it to be 
held at the custodian should not be dispositive as to whether a given 
custodial arrangement can qualify for this exception.
---------------------------------------------------------------------------

    \160\ See CFTC Margin Adopting Release, 81 FR at 670-73, 702-3 
(adopting 17 CFR 23.157 and 17 CFR 23.158); Prudential Regulator 
Margin and Capital Adopting Release, 80 FR at 74873-75, 74886-87, 
74905, 74908-09.
---------------------------------------------------------------------------

    Moreover, the second and third conditions discussed below are 
designed to ensure that the custodial agreement legally provides the 
nonbank SBSD with the right to promptly access the collateral if 
necessary. These conditions therefore will address any concerns 
regarding potential interference with that right. For these reasons, 
the Commission agrees with the commenters that the preface to the 
exception need not limit the legal bases for why the collateral is 
being held at a third-party custodian. Consequently, the final rules do 
not reference Section 3E(f) of the Exchange Act or Section 4s(l) of the 
CEA in the preface to the exception. \161\
---------------------------------------------------------------------------

    \161\ See paragraph (c)(2)(xv)(C) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C) of Rule 18a-1, as adopted. The phrase 
``pursuant to section 3E(f) of the Act or section 4s(l) of the 
Commodity Exchange Act'' in the preface to each paragraph included 
in the 2018 comment reopening is not included in the final rules.
---------------------------------------------------------------------------

    Commenters addressed the first potential condition set forth in the 
2018 comment reopening that the independent third-party custodian be a 
bank as defined in Section 3(a)(6) of the Exchange Act that is not 
affiliated with the counterparty. One commenter stated that the 
condition that the custodian be an unaffiliated bank is reasonable and 
practical.\162\ Other commenters suggested that the Commission expand 
the range of permissible custodians to include U.S. securities 
depositories and clearing agencies, foreign banks, and foreign 
securities depositories.\163\ The Commission also received comments 
prior to the 2018 comment reopening that are relevant to this potential 
condition. Two commenters supported allowing the collateral to be held 
at an affiliate of the nonbank SBSD.\164\ One commenter suggested that 
the third-party custodian must be a legal entity that is separate from 
both the nonbank SBSD and the counterparty (but not necessarily 
unaffiliated with the nonbank SBSD or counterparty).\165\ This 
commenter stated that this position would appropriately recognize well 
established, ordinary course custody and trading practices of market 
participants, including registered funds.
---------------------------------------------------------------------------

    \162\ See MFA/AIMA 11/19/2018 Letter.
    \163\ See IIB 11/19/2018 Letter; SIFMA 11/19/2018 Letter.
    \164\ See MFA 2/22/2013 Letter; SIFMA 2/22/2013 Letter.
    \165\ See ICI 11/24/2014 Letter.
---------------------------------------------------------------------------

    The Commission agrees with commenters that it would be appropriate 
to recognize third-party custodians that are not a bank. In the U.S., 
clearing organizations and depositories registered with the Commission 
or the CFTC could serve as custodians. As these entities are subject to 
oversight and regulation, the Commission does not believe the rule 
should exclude them from serving as custodians. In addition, if foreign 
securities or currencies are used as collateral to meet an initial 
margin requirement, it may be impractical to have them held at a U.S. 
custodian. Accordingly, the Commission believes it would be appropriate 
to recognize a foreign bank, clearing organization, or depository that 
is supervised (i.e., subject to oversight by a government authority) if 
the collateral consists of foreign securities or currencies and the 
custodian customarily maintains custody of such foreign securities or 
currencies. For these reasons, the final rules recognize domestic and 
foreign banks, custodians, and depositories, subject to the conditions 
discussed above.
    The Commission also agrees with commenters that the final rules 
should permit the third-party custodian to be an affiliate of the 
nonbank SBSD (but not the counterparty). In particular, an affiliate 
may be less likely to interfere with the legal right of the nonbank 
SBSD to exercise control over the collateral in the event of a default 
of the counterparty. Consequently, the final rules permit the custodian 
to be an affiliate of the nonbank SBSD but not the counterparty.\166\
---------------------------------------------------------------------------

    \166\ See paragraph (c)(2)(xv)(C)(1) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(1) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Commenters addressed the second potential condition set forth in 
the 2018 comment reopening that the firm, the independent third-party 
custodian, and the counterparty that delivered the collateral to the 
custodian must have executed an account control agreement that provides 
the firm with the same control over the collateral as would be the case 
if the firm controlled the collateral directly. Commenters generally 
supported the view that a nonbank SBSD, as the secured party, should 
have prompt access to the collateral held at the third-party 
custodian.\167\ However, a commenter objected to the ``same control'' 
language and argued it could be read to mean that nonbank SBSDs would 
be allowed to re-hypothecate and use collateral posted to a third-party 
custodian.\168\ Another commenter argued that collateral covered by an 
agreement meeting the conditions of the exception would no longer be 
segregated in any meaningful sense, and may violate the plain language 
of the Dodd-Frank Act that initial margin be segregated for the benefit 
of the counterparty.\169\ A commenter argued that this type of

[[Page 43894]]

provision would be costly, operationally burdensome, and inconsistent 
with current market practices for third-party custodial 
arrangements.\170\
---------------------------------------------------------------------------

    \167\ See, e.g., Letter from Carl B. Wilkerson, Vice President 
and Chief Counsel, American Council of Life Insurers (Feb. 22, 2013) 
(``American Council of Life Insurers 2/22/2013 Letter''); Letter 
from Adam Jacobs, Director of Markets Regulation, Alternative 
Investment Management Association (Feb. 22, 2013) (``AIMA 2/22/2013 
Letter''); ICI 12/5/2013 Letter; Letter from Robert Pickel, Chief 
Executive Officer, International Swaps and Derivatives Association 
(Jan. 23, 2013) (``ISDA 1/23/13 Letter''); MFA 2/24/2014 Letter; 
SIFMA 2/22/2013 Letter.
    \168\ See ICI 11/19/2018 Letter.
    \169\ See Better Markets 11/19/2018 Letter. In response to the 
ICI 11/19/2018 Letter and the Better Markets 11/19/2018 Letter, the 
potential rule language in the 2018 comment reopening with respect 
to a custodial arrangement that provided the nonbank SBSD with the 
``same control'' over the collateral was not intended to interfere 
with the fundamental purpose of having collateral held at a third-
party custodian: To keep it segregated and bankruptcy remote from 
the secured party. Instead, it was designed to promote the ability 
of the nonbank SBSD to access the collateral if the counterparty 
defaulted. Consequently, it was not intended to permit the nonbank 
SBSD to re-hypothecate the collateral or undermine the 
counterparty's statutory right to elect to have initial margin held 
at a third-party custodian. In any event, as discussed below, the 
Commission is not adopting the ``same control'' standard and, 
therefore, these commenters' concerns about that standard have been 
addressed.
    \170\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission agrees with commenters that the ``same control'' 
standard could create practical obstacles that would make it difficult 
to execute an account control agreement that would be sufficient to 
avoid the deduction when initial margin is held by a third-party 
custodian. Moreover, meeting the standard could have required the re-
drafting of existing agreements that are in place in accordance with 
the third-party custodian and documentation requirements of the CFTC 
and the prudential regulators. Doing so would be a costly and 
burdensome process. At the same time, the Commission also agrees with 
commenters that the account control agreement should provide the 
nonbank SBSD, as the secured party, with the right to promptly access 
the collateral held at the third-party custodian if necessary.
    The Commission has balanced these considerations in crafting final 
rules. In this regard, the Commission believes it would be appropriate 
to adopt final rules that align more closely with the third-party 
custodian requirements of the CFTC and the prudential regulators. 
Consequently, the final rules provide that the account control 
agreement must be 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.\171\ The rules further provide that the agreement 
must provide the nonbank SBSD with the right to access the collateral 
to satisfy the counterparty's obligations to the nonbank arising from 
transactions in the account of the counterparty.\172\ This is the 
fundamental purpose of the agreements and should not raise the same 
practical issues as the ``same control'' standard. At the same time, it 
is designed to require an agreement that achieves this fundamental 
purpose and by doing so will provide the nonbank SBSD, as the secured 
party, with prompt access to the collateral held at the third-party 
custodian when the collateral is needed to protect the nonbank SBSD 
against the consequences of the counterparty's default. While the 
provision requires an agreement, the Commission has crafted it with the 
objective that existing agreements with counterparties entered into for 
the purposes of the third-party custodian and documentation rules of 
the CFTC and the prudential regulators will suffice.
---------------------------------------------------------------------------

    \171\ See paragraph (c)(2)(xv)(C)(2) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(2) of Rule 18a-1, as adopted. See also CFTC 
Margin Adopting Release, 81 FR at 670-71, 702-3 (adopting 17 CFR 
23.157, which provides that the custodial agreement must be 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); Prudential Regulator Margin 
and Capital Adopting Release, 80 FR at 74873-75, 74905 (adopting 
rules requiring that a custodial agreement must be 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).
    \172\ See paragraph (c)(2)(xv)(C)(2) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Commenters addressed the third potential condition set forth in the 
2018 comment reopening that the firm obtain a written opinion from 
outside counsel that the account control agreement is legally valid, 
binding, and enforceable in all material respects, including in the 
event of bankruptcy, insolvency, or a similar proceeding. Some 
commenters opposed the requirement for an opinion of outside legal 
counsel on the basis of cost and impracticability, arguing it is 
inconsistent with market practice and operationally burdensome to 
implement.\173\ One commenter stated that the requirement was 
unnecessary because existing account control agreements and laws 
provide substantial protections.\174\ Another commenter suggested that 
the Commission consider alternatives to the requirement, such as 
permitting a nonbank SBSD to recognize initial margin so long as it has 
a well-founded basis to conclude that the collateral arrangement is 
enforceable.\175\
---------------------------------------------------------------------------

    \173\ See ICI 11/19/2018 Letter; MFA/AIMA 11/19/2018 Letter; 
Letter from Jason Silverstein, Esq., Managing Director, Asset 
Management Group & Associate General Counsel, Securities Industry 
and Financial Markets Association, and Andrew Ruggiero Senior 
Associate, Asset Management Group, Securities Industry and Financial 
Markets Association (Nov. 19, 2018) (``SIFMA AMG 11/19/2018 
Letter'').
    \174\ See ICI 11/19/2018 Letter.
    \175\ See SIFMA 11/19/2018 Letter. This commenter also requested 
that the Commission clarify that industry opinions regarding classes 
of agreements would satisfy a potential requirement for an opinion.
---------------------------------------------------------------------------

    The Commission acknowledges that requiring a formal written legal 
opinion by outside counsel could be a costly burden and, on further 
consideration, may not be necessary. At the same time, the Commission 
believes the nonbank SBSD should take steps to analyze whether the 
custodial agreement will provide the firm, as the secured party, with 
the right to access the collateral to satisfy the counterparty's 
obligations to the firm arising from transactions in the account of the 
counterparty. In other words, the firm should analyze whether a tri-
party custodial agreement intended to provide this right 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. The Commission's view that this analysis should be performed 
is consistent with the views of the CFTC and the prudential regulators. 
In particular, those agencies, in explaining the requirements of their 
rules governing tri-party custodial agreements, stated that the secured 
party would need to conduct a sufficient legal review to conclude with 
a well-founded basis that, in the event of a legal challenge, including 
one resulting from the default or from the receivership, 
conservatorship, insolvency, liquidation, or similar proceedings of the 
custodian or counterparty, the relevant court or administrative 
authorities would find the custodial agreement to be legal, valid, 
binding, and enforceable under the law.\176\
---------------------------------------------------------------------------

    \176\ See CFTC Margin Adopting Release, 81 FR at 670-71; 
Prudential Regulator Margin and Capital Adopting Release, 80 FR at 
74873-75.
---------------------------------------------------------------------------

    The Commission has balanced the cost and potential practical 
difficulties in obtaining a written opinion of outside legal counsel 
with the need for the nonbank SBSD to enter into a tri-party custodial 
agreement that will operate as intended under the relevant laws. The 
Commission has concluded that a written legal opinion of outside 
counsel is not the only way to provide assurance that the tri-party 
custodial agreement will operate as intended. For example, the nonbank 
SBSD could perform its own legal analysis rather than pay outside 
counsel to provide the legal opinion or be a member of a competent 
industry association that makes legal analysis available to its 
members. Therefore, the final rules do not require the nonbank SBSD to 
obtain a legal opinion of outside counsel. Instead, the rules require 
the firm to maintain 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.\177\ Among other things, the documentation could be a 
written

[[Page 43895]]

opinion of outside legal counsel, reflect the firm's own ``in-house'' 
legal research, or be the research of a competent industry association. 
The documentation will reflect how the firm analyzed the legality of 
the account control agreement.
---------------------------------------------------------------------------

    \177\ See paragraph (c)(2)(xv)(C)(3) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(3) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Legacy accounts. In terms of the deductions related to legacy 
accounts, one commenter stated that ``the costs of this requirement 
will ultimately flow back to the counterparties, penalizing all 
counterparties who trade with any affected [nonbank SBSD]'' and that 
``the retroactive effect of such a requirement--which effectively 
requires [nonbank SBSDs] to revise the price terms of pre-effective 
[security-based swaps]--is contrary to the prospective nature of the 
rest of Dodd-Frank's Title VII.'' \178\ A second commenter argued that 
the deduction is inconsistent with how dealers currently do business, 
as they do not typically collect margin from certain credit-worthy 
counterparties.\179\ Commenters stated that the legacy account 
deduction is inconsistent with the proposed capital regimes of the CFTC 
and the prudential regulators.\180\ A commenter argued that this 
inconsistency could result in regulatory arbitrage.\181\ Commenters 
indicated that the proposed legacy account deduction would unfairly 
penalize nonbank SBSDs and their customers.\182\ A commenter stated 
that the deduction would negatively affect the pricing and liquidity of 
transactions with counterparties.\183\ Commenters also argued that the 
proposed deduction could lead some market participants that cannot 
afford the costs to exit the market or cease engaging in new security-
based swaps activity.\184\
---------------------------------------------------------------------------

    \178\ See Letter from Douglas M. Hodge, Managing Director and 
Chief Operating Officer, Pacific Investment Management Company LLC 
(Feb. 21, 2013) (``PIMCO Letter'').
    \179\ See Letter from Sebastian Crapanzano and Soo-Mi Lee, 
Managing Directors, Morgan Stanley (Oct. 29, 2014) (``Morgan Stanley 
10/29/2014 Letter'').
    \180\ See Morgan Stanley 2/22/13 Letter; SIFMA 2/22/2013 Letter.
    \181\ See Financial Services Roundtable Letter.
    \182\ See PIMCO Letter; SIFMA 2/22/2013 Letter.
    \183\ See Morgan Stanley 2/22/13 Letter.
    \184\ See Financial Services Roundtable Letter; Morgan Stanley 
2/22/13 Letter.
---------------------------------------------------------------------------

    In response to the comment that the deduction in lieu of margin 
related to legacy accounts is contrary to the prospective nature of 
Title VII of the Dodd-Frank Act and will require re-pricing of existing 
security-based swaps,\185\ the legacy account exception is designed to 
address the impracticality of renegotiating contracts governing 
security-based swap transactions that predate the compliance date of 
Rule 18a-3.\186\ Further, as discussed below in section II.A.2.b.v. of 
this release, the ability to apply the credit risk charges has been 
expanded to exposures arising from electing not to collect variation or 
initial margin with respect to legacy accounts. This should help to 
mitigate the concern of this commenter and others that the 100% 
deduction could cause nonbank SBSDs to pass the costs of the capital 
requirement to counterparties. This also should help to mitigate 
concerns of commenters who argued that the 100% deduction was 
inconsistent with the capital requirements of other regulators. As one 
commenter stated, applying a credit risk charge for a nonbank SBSD's 
legacy account positions would more closely align the Commission's 
capital standards with the approaches of the CFTC and the prudential 
regulators.\187\
---------------------------------------------------------------------------

    \185\ See PIMCO Letter.
    \186\ See section II.B.2.b.i. of this release (discussing the 
legacy account exception).
    \187\ See Morgan Stanley 10/29/14 Letter; Morgan Stanley 11/19/
2018 Letter.
---------------------------------------------------------------------------

    The Commission acknowledges that, even with the modification 
expanding the application of the credit risk charge, the final rule 
will result in costs to nonbank SBSDs as well as to their security-
based swap and swap counterparties. However, the Commission has sought 
to strike an appropriate balance between addressing the concerns of 
commenters and promulgating a final rule that promotes the safety and 
soundness of nonbank SBSDs.\188\ The Commission believes it has 
achieved this objective by taking a measured approach to modifying the 
rule to reduce the impact of the deductions for uncollected variation 
and initial margin.
---------------------------------------------------------------------------

    \188\ See Better Markets 11/19/2018 Letter. See also section VI 
of this release (discussing costs and benefits of final rules).
---------------------------------------------------------------------------

iii. Standardized Haircuts
    The final step in the process of computing net capital under Rule 
15c3-1 is to apply the standardized or model-based haircuts to the 
firm's proprietary positions, thereby reducing the firm's tentative net 
capital amount to an amount that constitutes the firm's net 
capital.\189\ Most stand-alone broker-dealers use the standardized 
haircuts, which are prescribed in Rules 15c3-1, 15c3-1a, and 15c3-1b. 
ANC broker-dealers may apply model-based haircuts to positions for 
which they have been authorized to use models pursuant to Rule 15c3-1e. 
For all other types of positions, they must use the standardized 
haircuts.
---------------------------------------------------------------------------

    \189\ See, e.g., Uniform Net Capital Rule, Exchange Act Release 
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts] 
are intended to enable net capital computations to reflect the 
market risk inherent in the positioning of the particular types of 
securities enumerated in [the rule]''); Net Capital Rule, 50 FR 
42961 (``These percentage deductions, or `haircuts', take into 
account elements of market and credit risk that the broker-dealer is 
exposed to when holding a particular position.''); Net Capital Rule, 
62 FR 67996 (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against 
adverse market movements and other risks faced by the firms, 
including liquidity and operational risks.'') (footnote omitted).
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    The pre-existing provisions of paragraph (c)(2)(vi) of Rule 15c3-1 
prescribe standardized haircuts for marketable securities and money 
market instruments. The amounts of the standardized haircuts are based 
on the type of security or money market instrument and, in the case of 
certain debt instruments, the time-to-maturity of the bond. Broker-
dealer SBSDs will be subject to these pre-existing standardized haircut 
provisions in paragraph (c)(2)(vi) of Rule 15c3-1. Proposed Rule 18a-1 
required stand-alone SBSDs to apply the pre-existing standardized 
haircuts in paragraph (c)(2)(vi) of Rule 15c3-1 by cross-referencing 
that paragraph.\190\ The pre-existing provisions of Rules 15c3-1a and 
15c3-1b prescribe standardized haircuts for equity option positions and 
commodities positions, respectively. The provisions in Rule 15c3-1b 
incorporate deductions in the CFTC's capital rule for FCMs.\191\ 
Broker-dealer SBSDs will be subject to the pre-existing standardized 
haircut provisions in Rules 15c3-1a and 15c3-1b. The Commission 
proposed Rules 18a-1a and 18a-1b to prescribe standardized haircuts for 
stand-alone SBSDs modeled on the pre-existing requirements in Rules 
15c3-1a and 15c3-1b, respectively.\192\
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    \190\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70231, n.146.
    \191\ See 17 CFR 1.17 (prescribing standardized haircuts for 
commodities positions of FCMs) (``Rule 1.17'').
    \192\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70231-37, 70248-50.
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    However, the pre-existing provisions of Rule 15c3-1 and Rule 15c3-
1b did not prescribe standardized haircuts tailored specifically for 
security-based swaps and swaps.\193\ Consequently, the Commission 
proposed amending paragraph (c)(2)(vi) of Rule 15c3-1 and Rule 15c3-1b 
to establish standardized

[[Page 43896]]

haircuts for security-based swaps and swaps that would apply to stand-
alone broker-dealers and broker-dealer SBSDs.\194\ The Commission 
proposed parallel standardized deductions tailored for security-based 
swaps and swaps in proposed Rules 18a-1 and 18a-1b, respectively, that 
would apply to stand-alone SBSDs.
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    \193\ Because there were no specific standardized haircuts for 
security-based swaps, a stand-alone broker-dealer was required to 
apply a deduction based on the existing provisions (e.g., the 
catchall provisions in the rule). For certain types of OTC 
derivatives, the deduction has been the notional amount of the 
derivative multiplied by the deduction that would apply to the 
underlying instrument referenced by the derivative. See Net Capital 
Rule, Exchange Act Release No. 32256 (May 6, 1993), 58 FR 27486, 
27490 (May 10, 1993).
    \194\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70231-37, 70248-50.
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    The proposed standardized haircut for a CDS was determined using 
one of two maturity grids: One for a CDS that is a security-based swap 
and the other for a CDS that is a swap.\195\ The proposed grids 
prescribed standardized haircuts based on two variables: The length of 
time to maturity of the CDS and the amount of the current offered basis 
point spread on the CDS. The standardized haircut for an unhedged short 
position in a CDS (i.e., selling protection) was the applicable 
percentage specified in the grid. The deduction for an unhedged long 
position in a CDS (i.e., buying protection) was 50% of the applicable 
deduction specified in the grid. The amount of the deductions in the 
maturity grid for a CDS that was a swap were one-third less than the 
comparable deductions in the maturity grid for a CDS that was a 
security-based swap. The proposed rules provided for reduced grid-
derived deductions based on netting positions.
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    \195\ See 77 FR at 70232-34, 70248-49.
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    For a security-based swap that is not a CDS, the proposed 
standardized haircuts required multiplying the notional amount of the 
security-based swap by the amount of the standardized haircut percent 
that applied to the underlying position pursuant to the pre-existing 
provisions of Rule 15c3-1.\196\ For example, paragraph (c)(2)(vi)(J) of 
Rule 15c3-1 prescribes a standardized haircut for an exchange traded 
equity security equal to 15% of the mark-to-market value of the 
security. Consequently, the standardized haircut for a security-based 
swap referencing an exchange traded equity security was a deduction 
equal to the notional amount of the security-based swap multiplied by 
15%. The same approach applied to a security-based swap (other than a 
CDS) referencing a debt instrument. For example, paragraph 
(c)(2)(vi)(F)(1)(v) of Rule 15c3-1 prescribes a 7% standardized haircut 
for a corporate bond that has a maturity of five years, is not traded 
flat or in default as to principal or interest, and has a minimal 
amount of credit risk. Therefore, the proposed standardized haircut for 
a security-based swap referencing such a bond was a deduction equal to 
the notional amount of the security-based swap multiplied by 7%.
---------------------------------------------------------------------------

    \196\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70234-36.
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    For a swap that is not a CDS or interest rate swap, the Commission 
proposed a similar approach that required multiplying the notional 
amount of the swap by a certain percent.\197\ To determine the 
applicable percent, the Commission proposed a hierarchy approach. Under 
this approach, if the pre-existing provisions of Rule 15c3-1 prescribed 
a standardized haircut for the type of asset, obligation, or event 
underlying the swap, the percent deduction of the Rule 15c3-1 
standardized haircut applied. For example, if the swap referenced an 
equity security index, the pre-existing standardized haircut in Rule 
15c3-1 applicable to baskets of securities and equity index exchange 
traded funds applied. If the pre-existing provisions of Rule 15c3-1 did 
not prescribe a standardized haircut for the type of asset, obligation, 
or event underlying the swap but the pre-existing provisions in Rule 
15c3-1b did, the percent deduction in the Rule 15c3-1b standardized 
haircut applied. This would be the case if the swap referenced a type 
of commodity for which CFTC Rule 1.17 prescribes a standardized 
haircut, and the Rule 1.17 haircut is incorporated into Rule 15c3-1b. 
Finally, if neither Rules 15c3-1 nor 15c3-1b prescribed a standardized 
haircut for the type of asset, obligation, or event underlying the swap 
but Rule 1.17 did, the percent deduction in the Rule 1.17 standardized 
deduction applied. This could be the case, for example, if the swap was 
a type of swap for which the CFTC had prescribed a specific 
standardized haircut.
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    \197\ See 77 FR at 70249-50.
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    For interest rate swaps, the Commission proposed a similar 
standardized haircut approach that required multiplying the notional 
amount of the swap by a certain percent.\198\ The percent was 
determined by referencing the standardized haircuts in Rule 15c3-1 for 
U.S. government securities with comparable maturities to the swap's 
maturity. However, the proposed haircut for interest rate swaps had a 
floor of 1% (whereas U.S. government securities with a maturity of less 
than 9 months are subject to haircuts of \3/4\ of 1%, \1/2\ of 1%, or 
0% depending on the time to maturity). This 1% floor was designed to 
account for potential differences between the movement of interest 
rates on U.S. government securities and interest rates upon which swap 
payments are based.
---------------------------------------------------------------------------

    \198\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70249.
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    Under the proposed standardized haircuts for a security-based swap 
that is not a CDS, stand-alone broker-dealers and nonbank SBSDs were 
permitted to recognize portfolio offsets.\199\ In particular, these 
entities were permitted to include an equity security-based swap in a 
portfolio of related equity positions (e.g., long and short cash and 
options positions involving the same security) under the pre-existing 
provisions of Rule 15c3-1a, which produces a single haircut for a 
portfolio of equity options and related positions.\200\ Similarly, they 
were permitted to treat a debt security-based swap and an interest rate 
swap in the same manner as debt instruments are treated in pre-existing 
debt-maturity grids in Rule 15c3-1 in terms of allowing offsets between 
long and short positions where the instruments are in the same maturity 
categories, subcategories, and in some cases, adjacent categories.
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    \199\ See 77 FR at 70235-36, 70249.
    \200\ Specifically, the Commission proposed amending paragraph 
(a)(4) of Rule 15c3-1a to include equity security-based swaps within 
the definition of underlying instrument. This would allow these 
positions to be included in portfolios of equity positions involving 
the same equity security. In addition, the Commission proposed 
including security futures within the definition of the term 
underlying instrument to permit these positions to be included in 
portfolios of positions involving the same underlying security.
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Comments and Final Requirements for Standardized Haircuts
    A commenter stated that, based on its estimates, the standardized 
haircuts in the proposed CDS maturity grids would be significantly 
greater than the capital charges that would apply to the same positions 
using an internal model.\201\ The commenter stated that the Commission 
should conduct further review of empirical data regarding the 
historical market volatility and losses given default associated with 
CDS positions and modify the proposed standardized haircuts. This 
commenter argued that excessive standardized haircuts may 
disproportionately affect smaller and mid-size firms.\202\ The 
commenter further stated that these types of firms may be limiting 
their security-based swaps business so they will not be required to 
register as a nonbank SBSD or may try to develop internal models to 
avoid having to use the standardized haircuts.
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    \201\ See SIFMA 2/22/2013 Letter.
    \202\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to these comments, the economic analysis performed for 
these

[[Page 43897]]

final rules determined that the standardized haircuts being adopted 
today generally were not set at the most conservative level. As stated 
in the analysis, the Commission believes that, in general, haircuts are 
intended to strike a balance between being sufficiently conservative to 
cover losses in most cases, including stressed market conditions, and 
being sufficiently nimble to allow nonbank SBSDs to operate efficiently 
in all market conditions. Based on the results of the analysis, the 
Commission believes the standardized haircuts in the final rules take 
into account this tradeoff.\203\
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    \203\ See section VI of this release.
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    Nonetheless, the Commission recognizes that the standardized 
haircuts for non-cleared security-based swaps are less risk-sensitive 
than the model-based haircuts and, therefore, in many cases will be 
greater than the model-based haircuts. This difference in the 
deductions that result from applying standardized haircuts as opposed 
to model-based haircuts is part of the pre-existing provisions of Rule 
15c3-1. The rule has permitted ANC broker-dealers and OTC derivatives 
dealers to apply model-based haircuts, whereas all other broker-dealers 
must apply the standardized haircuts. These differences are why broker-
dealers applying the model-based haircuts are subject to higher capital 
standards, including minimum tentative net capital requirements.\204\ 
These additional and higher capital requirements account for the 
generally lower deductions that result from applying model-based 
haircuts as opposed to standardized haircuts. Because nonbank SBSDs 
that do not use model-based haircuts will not be subject to these 
additional or higher capital requirements, the Commission believes that 
it is an appropriate trade-off that they will employ the less risk-
sensitive standardized haircuts. Further, the Commission believes that 
most nonbank SBSDs will seek approval to use model-based haircuts.
---------------------------------------------------------------------------

    \204\ See OTC Derivatives Dealers, 63 FR at 5938; Alternative 
Net Capital Requirements for Broker-Dealers That Are Part of 
Consolidated Supervised Entities, 69 FR at 34431.
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    The standardized haircuts are designed to account for more than 
just market and credit risk--they also are intended to address other 
risks such as operational, leverage, and liquidity risks.\205\ The 
standardized haircuts are intended to account for more risks because 
the firms that will use them, as discussed above, are subject to lower 
minimum net capital requirements.
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    \205\ See Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities, 69 FR at 
34431 (``The current haircut structure [use of the standardized 
haircuts] seeks to ensure that broker-dealers maintain a sufficient 
capital base to account for operational, leverage, and liquidity 
risk, in addition to market and credit risk.'').
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    Commenters also recommended that for cleared security-based swaps, 
the Commission apply a standardized haircut based on the initial margin 
requirement of the clearing agency, similar to the treatment of futures 
in Rule 15c3-1b.\206\ A commenter stated that the clearing agencies use 
risk-based models to calculate initial margin and, therefore, relying 
on their margin calculations would allow firms that do not use models 
to indirectly get the benefit of a more risk-sensitive approach.\207\
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    \206\ See Citadel 5/15/2017 Letter; Citadel 11/19/2018 Letter; 
SIFMA 2/22/2013 Letter.
    \207\ See SIFMA 2/22/2013 Letter.
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    The Commission is persuaded that it would be appropriate to 
establish standardized haircuts for cleared security-based swaps and 
swaps that are determined using the margin requirements of the clearing 
agency or DCO where the position is cleared. Consequently, the 
Commission is modifying the proposed standardized haircut requirements 
for cleared security-based swaps and swaps to require that the amount 
of the deduction will be the amount of margin required by the clearing 
agency or DCO where the position is cleared.\208\ This will align the 
treatment of these cleared products with the treatment of futures 
products. It also will establish standardized haircuts that potentially 
are more risk sensitive, as suggested by the commenter. This will 
benefit stand-alone broker-dealers and nonbank SBSDs that have not been 
authorized to use models to determine market risk charges for their 
security-based swap and swap positions.
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    \208\ See paragraph (c)(2)(vi)(O) of Rule 15c3-1, as amended; 
paragraph (b)(1) of Rule 15c3-1b, as amended; paragraph 
(c)(1)(vi)(A) of Rule 18a-1, as adopted; paragraph (b)(1) of Rule 
18a-1b, as adopted. In the final rule, paragraph (c)(2)(vi)(O) of 
Rule 15c3-1, as proposed, is being re-designated paragraph 
(c)(2)(vi)(P) of Rule 15c3-1, as adopted. In addition, references to 
``(c)(2)(vi)(O)'' have been replaced with references to 
``(c)(2)(vi)(P)'' in paragraph (c)(2)(vi)(P) of Rule 15c3-1, as 
amended; the word ``non-cleared'' has been inserted before the term 
``security-based swap''; and the title has been modified to read 
``Non-cleared security-based swaps.'' Conforming changes have been 
made to Appendix B to Rule 15c3-1, as amended, Rule 18a-1, as 
adopted, and Rule 18a-1b, as adopted. Paragraph (c)(2)(vi)(O) of 
Rule 15c3-1, as amended, will state: ``Cleared security-based swaps. 
In the case of a cleared security-based swap held in a proprietary 
account of the broker or dealer, deducting the amount of the 
applicable margin requirement of the clearing agency or, if the 
security-based swap references an equity security, the broker or 
dealer may take a deduction using the method specified in Sec.  
240.15c3-1a.'' Conforming rule text modifications were made to 
Appendix B to Rule 15c3-1, as amended, Rule 18a-1, as adopted, and 
Rule 18a-1b, as adopted.
---------------------------------------------------------------------------

    A commenter supported the Commission's proposal to allow 
standardized haircuts for portfolios of equity security-based swaps and 
related equity positions using the methodology in Rule 15c3-1a.\209\ 
The commenter believed this would allow stand-alone broker-dealers and 
nonbank SBSDs to employ a more risk-sensitive approach to computing net 
capital than if a position were treated in isolation. The Commission 
agrees with the commenter's reasoning and continues to believe that 
cleared equity security-based swaps should be permitted to be included 
in the portfolios of equity positions for purposes of Rules 15c3-1a and 
18a-1a and that this treatment should be extended to cleared equity-
based swaps. Therefore, the Commission is modifying the requirement to 
permit equity-based swaps (in addition to equity security-based swaps) 
to be included as related or underlying instruments for purposes of 
Rules 15c3-1a and 18a-1a.\210\ Further, as discussed above, the 
standardized haircut for cleared security-based swaps and swaps being 
adopted today is determined using the margin requirements of the 
clearing agency or DCO where the position is cleared. However, as an 
alternative to that standardized haircut, a stand-alone broker-dealer 
and nonbank SBSD can use the methodology prescribed in Rules 15c3-1a 
and 18a-1a to derive a portfolio-based standardized haircut for cleared 
security-based swaps that reference an equity security or narrow-based 
equity index and swaps that reference a broad-based equity index.\211\
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    \209\ See SIFMA 2/22/2013 Letter.
    \210\ See paragraphs (a)(3) and (4) of Rule 15c3-1a, as amended; 
paragraphs (a)(3) and (4) of Rule 18a-1a, as adopted.
    \211\ See paragraph (c)(2)(vi)(O) of Rule 15c3-1, as amended; 
paragraph (b)(1) of Rule 15c3-1b, as amended; paragraph 
(c)(1)(vi)(A) of Rule 18a-1, as adopted; paragraph (b)(1) of Rule 
18a-1b, as adopted.
---------------------------------------------------------------------------

    A commenter opposed the 1% minimum standardized haircut for 
interest rate swaps as being too severe.\212\ Based on its analysis of 
sample positions, this commenter believed that the proposed 
standardized haircut calculations that include the 1% minimum haircut 
would result in market risk charges that are nearly 35 times higher 
than charges without the 1% minimum.\213\ The Commission is persuaded 
that the proposed 1% minimum haircut was too conservative,

[[Page 43898]]

particularly when applied to tightly hedged positions such as those in 
the commenter's examples. As discussed above, the standardized haircut 
for cleared swaps, including interest rate swaps, being adopted today 
is determined by the margin required by the DCO where the position is 
cleared. Therefore, the 1% minimum standardized haircut for cleared 
security-based swaps is being eliminated.
---------------------------------------------------------------------------

    \212\ See SIFMA 2/22/2013 Letter.
    \213\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    However, the Commission continues to believe that a minimum haircut 
should be applied to non-cleared interest rate swaps. Under the final 
rules being adopted today, the standardized haircuts for non-cleared 
interest rate swaps are determined using the maturity grid for U.S. 
government securities in paragraph (c)(2)(vi)(A) of Rule 15c3-1.\214\ 
Moreover, the standardized haircuts for non-cleared security-based 
swaps and swaps (other than CDS) being adopted today permit a stand-
alone broker-dealer and nonbank SBSD to reduce the deduction by an 
amount equal to any reduction recognized for a comparable long or short 
position in the reference security under the standardized haircuts in 
Rule 15c3-1.\215\ The standardized haircuts in paragraph (c)(2)(vi)(A) 
of Rule 15c3-1 permit a stand-alone broker-dealer to take a capital 
charge on the net long or short position in U.S. government securities 
that are in the same maturity categories in the rule. This treatment 
will apply to interest rate swaps. Therefore, if a stand-alone broker-
dealer or nonbank SBSD has long and short positions in interest rate 
swaps, the amount of the standardized haircut applied to these 
positions could be greatly reduced and could potentially be 0% for 
positions that are tightly hedged. This could permit the firm to 
substantially leverage its interest rate swaps and hold little or no 
capital against them. Further, potential differences between the 
movement of interest rates on U.S. government securities and interest 
rates upon which swap payments are based could impose a level of 
additional risk even to tightly hedged interest rate positions.
---------------------------------------------------------------------------

    \214\ See paragraph (b)(2)(ii)(A)(3) of Rule 15c3-1b, as 
amended; paragraph (b)(2)(ii)(A)(3) of Rule 18a-1b, as adopted.
    \215\ See paragraph (c)(2)(vi)(P)(2) of Rule 15c3-1, as amended; 
paragraph (b)(2)(ii)(B) of Rule 15c3-1b, as amended; paragraph 
(c)(1)(vi)(B)(2) of Rule 18a-1, as adopted; paragraph (b)(2)(ii)(B) 
of Rule 18a-1b, as adopted.
---------------------------------------------------------------------------

    For these reasons, the Commission believes that a minimum 
standardized haircut for non-cleared interest rate swaps is 
appropriate. However, the Commission is persuaded by the commenter that 
the proposed 1% minimum haircut was too conservative. Therefore, the 
Commission is modifying the standardized haircut for non-cleared 
interest rate swaps so that it can be no less than \1/8\ of 1% of a 
long position that is netted against a short position in the case of a 
non-cleared swap with a maturity of 3 months or more.\216\ The 
standardized haircuts in paragraph (c)(2)(vi)(A) of Rule 15c3-1 require 
a 0% haircut for the unhedged amount of U.S. government securities that 
have a maturity of less than 3 months. Therefore, the standardized 
haircuts for interest rate swaps will treat hedged and unhedged 
positions with maturities of less than 3 months identically in that 
there will be no haircut required to be applied to the positions.
    The next lowest standardized haircut in paragraph (c)(2)(vi)(A) of 
Rule 15c3-1 applies to unhedged positions with a maturity of 3 months 
but less than 6 months. For these positions, the haircut is \1/2\ of 
1%. Therefore, the minimum standardized haircut for hedged interest 
rate swaps with a maturity of 3 months or more (i.e., \1/8\ of 1%) will 
be one-quarter of the standardized haircut for unhedged positions with 
a maturity 3 months but less than 6 months. The Commission believes 
this modified minimum haircut for interest rate swaps strikes an 
appropriate balance in terms of addressing commenters' concerns that 
the 1% minimum was too conservative and the prudential concern with 
permitting a stand-alone broker-dealer or nonbank SBSD to substantially 
leverage its non-cleared interest rate swaps positions.
---------------------------------------------------------------------------

    \216\ See paragraph (b)(2)(ii)(A)(3) of Rule 15c3-1b, as 
amended; paragraph (b)(2)(ii)(A)(3) of Rule 18a-1b, as adopted.
---------------------------------------------------------------------------

    Another commenter stated that the Commission appears to have 
proposed different and substantially higher haircuts for cleared swaps 
regulated by the CFTC, such as cleared interest rate swaps and cleared 
index CDS, than those proposed under the CFTC's rules.\217\ This 
commenter stated that dual registrants should not be subject to 
conflicting requirements for the same instrument and urged the 
Commission to work with the CFTC to harmonize applicable requirements 
for cleared swaps that are regulated by the CFTC. The commenter also 
noted that increasing harmonization will promote the portfolio 
margining of cleared security-based swaps and swaps. The CFTC has not 
finalized its capital rules under Title VII of the Dodd-Frank Act; 
however, as discussed above, the Commission has modified the 
standardized haircuts for cleared CDS and interest rate swaps so that 
the deduction equals the margin requirement of the clearing agency or 
DCO where the positions are cleared. This should alleviate the 
commenter's concerns about the magnitude of the standardized haircuts 
for cleared swaps. In terms of harmonizing the Commission's 
standardized haircuts with the CFTC's standardized haircuts, the 
Commission intends to continue coordinating with the CFTC as that 
agency finalizes its capital requirements under Title VII of the Dodd-
Frank Act.
---------------------------------------------------------------------------

    \217\ See Citadel 5/15/2017 Letter.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the 
standardized haircuts for security-based swaps and swaps with the 
modifications discussed above and with certain non-substantive 
modifications to conform the final rule text in Rule 15c3-1, as 
amended, and Rule 18a-1, as adopted.\218\
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    \218\ See paragraphs (c)(2)(vi)(O) and (P) of Rule 15c3-1, as 
amended; Rule 15c3-1a, as amended; Rule 15c3-1b as amended; 
paragraph (c)(1)(vi) of Rule 18a-1, as adopted; Rule 18a-1a, as 
adopted; Rule 18a-1b, as adopted. In addition to the changes 
discussed above, the Commission has made some non-substantive 
modifications to the final rule text for the standardized haircuts 
for non-cleared CDS that are security-based swaps or swaps in order 
to conform the final rule text in Rule 18a-1, as adopted, and Rule 
18a-1b, as adopted, with the final rule text in Rule 15c3-1, as 
amended, and Rule 15c3-1b, as amended. The standardized haircuts for 
these positions were designed to be consistent in both rules. See 
Capital, Margin, and Segregation Proposing Release, 77 FR at 70233-
34. In the proposing release, however, there were some inadvertent 
differences in the proposed rule texts which have been corrected in 
the final rules.
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iv. Model-Based Haircuts
    The Commission proposed to allow nonbank SBSDs to apply model-based 
haircuts.\219\ Broker-dealer SBSDs that were not already ANC broker-
dealers needed Commission authorization to use model-based haircuts and 
were subject to the requirements governing the use of models by ANC 
broker-dealers (i.e., they would need to operate as an ANC broker-
dealer SBSD). Stand-alone SBSDs similarly needed Commission 
authorization to apply model-based haircuts and were subject to 
requirements governing the use of them modeled on the requirements for 
ANC broker-dealers.
---------------------------------------------------------------------------

    \219\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70237-40.
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    Under the proposals, nonbank SBSDs seeking authorization to use 
model-based haircuts needed to submit an application to the Commission 
(``ANC application'').\220\ The pre-existing provisions of paragraphs 
(a)(1) through (a)(3) of Rule 15c3-1e set forth in detail the 
information that must be submitted

[[Page 43899]]

by a stand-alone broker-dealer in an ANC application. The pre-existing 
provisions of paragraph (a)(4) provide that the Commission may request 
that the applicant supplement the ANC application with other 
information. The pre-existing provisions of paragraph (a)(5) prescribe 
when an ANC application is deemed filed with the Commission and 
provides that the application and all submissions in connection with it 
are accorded confidential treatment to the extent permitted by law. The 
pre-existing provisions of paragraph (a)(6) provide that if any 
information in an ANC application is found to be or becomes inaccurate 
before the Commission approves the application, the stand-alone broker-
dealer must notify the Commission promptly and provide the Commission 
with a description of the circumstances in which the information was 
inaccurate along with updated, accurate information. The pre-existing 
provisions of paragraph (a)(7) provide that the Commission may approve, 
in whole or in part, an ANC application or an amendment to the 
application, 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. 
A broker-dealer SBSD seeking authorization to use internal models would 
be subject to these pre-existing application requirements in paragraph 
(a) of Rule 15c3-1e. A stand-alone SBSD seeking authorization to use 
internal models would be subject to similar application requirements in 
proposed Rule 18a-1.
---------------------------------------------------------------------------

    \220\ See 77 FR at 70237-39.
---------------------------------------------------------------------------

    As part of the ANC application approval process, the Commission 
staff reviews the operation of the stand-alone broker-dealer's model, 
including a review of associated risk management controls and the use 
of stress tests, scenario analyses, and back-testing. As part of this 
process, the applicant provides information designed to demonstrate to 
the Commission staff that the model reliably accounts for the risks 
that are specific to the types of positions the firm intends to include 
in the model computations. During the review, the Commission staff 
assesses the quality, rigor, and adequacy of the technical components 
of the model and of related governance processes around the use of the 
model as well as the firm's risk management policies, procedures, and 
controls. Under the proposals, nonbank SBSDs seeking authorization to 
use internal models would be subject to similar reviews during the 
application process.\221\
---------------------------------------------------------------------------

    \221\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70239.
---------------------------------------------------------------------------

    The pre-existing provisions of paragraph (a)(8) of Rule 15c3-1e 
require an ANC broker-dealer to amend its ANC application and submit it 
to the Commission for approval before materially changing its model or 
its internal risk management control system. Further, the pre-existing 
provisions of paragraph (a)(10) require an ANC broker-dealer to notify 
the Commission 45 days before the firm ceases to use internal models to 
compute net capital. Finally, the pre-existing provisions of paragraph 
(a)(11) provide that the Commission, by order, can revoke an ANC 
broker-dealer's exemption that allows it to use internal models if the 
Commission finds that the ANC broker-dealer's use of models is no 
longer necessary or appropriate in the public interest or for the 
protection of investors. In this case, the firm would need to revert to 
applying the standardized haircuts for all positions. Under the 
proposal, an ANC broker-dealer SBSD would be subject to these pre-
existing application requirements in paragraph (a) of Rule 15c3-1e. A 
stand-alone SBSD authorized to use internal models would have been 
subject to similar application requirements in proposed Rule 18a-
1.\222\
---------------------------------------------------------------------------

    \222\ Id.
---------------------------------------------------------------------------

    The pre-existing provisions of paragraph (d)(1) of Rule 15c3-1e 
require an ANC broker-dealer to comply with qualitative requirements 
that specify among other things that: (1) The model must be integrated 
into the ANC broker-dealer's daily internal risk management system; (2) 
the model must be reviewed periodically by the firm's internal audit 
staff, and annually by an independent public accounting firm; and (3) 
the measure computed by the model must be multiplied by a factor of at 
least 3 but potentially a greater amount based on the number of 
exceptions to the measure resulting from quarterly back-testing 
exercises.\223\ The pre-existing provisions of paragraph (d)(2) 
prescribe quantitative requirements that specify that the model must, 
among other things: (1) Use a 99%, one-tailed confidence level with 
price changes equivalent to a 10-business-day movement in rates and 
prices; \224\ (2) use an effective historical observation period of at 
least one year; (3) use historical data sets that are updated at least 
monthly and are reassessed whenever market prices or volatilities 
change significantly; and (4) take into account and incorporate all 
significant, identifiable market risk factors applicable to positions 
of the ANC broker-dealer, including risks arising from non-linear price 
characteristics, empirical correlations within and across risk factors, 
spread risk, and specific risk for individual positions. An ANC broker-
dealer SBSD would be subject to these pre-existing qualitative and 
quantitative requirements in paragraph (d) of Rule 15c3-1e. A stand-
alone SBSD authorized to use internal models would have been subject to 
similar qualitative and quantitative requirements in proposed Rule 18a-
1.\225\
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    \223\ A back-testing exception occurs when the ANC broker-
dealer's actual one-day loss exceeds the amount estimated by its 
model.
    \224\ This means the potential loss measure produced by the 
model is a loss that the portfolio could experience if it were held 
for 10 trading days and that this potential loss amount would be 
exceeded only once every 100 trading days.
    \225\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70239.
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    The pre-existing provisions of paragraph (b) of Rule 15c3-1e 
prescribe the model-based haircuts an ANC broker-dealer must deduct 
from tentative net capital in lieu of the standardized haircuts. This 
deduction is an amount equal to the sum of four charges: (1) A 
portfolio market risk charge for all positions that are included in the 
ANC broker-dealer's models (i.e., the amount measured by the model 
multiplied by a factor of at least 3); \226\ (2) a ``specific risk'' 
charge for positions where specific risk was not captured in the model; 
\227\ (3) a charge for positions not included in the model where the 
ANC broker-dealer is approved to use scenario analysis; and (4) a 
charge for all other positions that is determined using the 
standardized haircuts. An ANC broker-dealer SBSD would be subject to 
these pre-existing model-based haircut requirements in paragraph (b) of 
Rule 15c3-1e. A stand-alone SBSD authorized to use internal models 
would have been subject to similar requirements in proposed Rule 18a-
1.\228\
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    \226\ This charge is designed to address the risk that the value 
of a portfolio of trading book assets will decline as a result of a 
broad move in market prices or interest rates.
    \227\ This charge is designed to address the risk that the value 
of an individual position would decline for reasons unrelated to a 
broad movement of market prices or interest rates.
    \228\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70239-40.
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    Finally, ANC broker-dealers are subject to ongoing supervision with 
respect to their internal risk management, including their use of 
models. In this regard, the Commission staff meets regularly with 
senior risk managers at each ANC broker-dealer to

[[Page 43900]]

review the risk analytics prepared for the firm's senior management. 
These reviews focus on the performance of the risk measurement 
infrastructure, including statistical models, risk governance issues 
such as modifications to and breaches of risk limits, and the 
management of outsized risk exposures. In addition, Commission staff 
and personnel from an ANC broker-dealer hold regular meetings 
(scheduled and ad hoc) focused on financial results, the management of 
the firm's balance sheet, and, in particular, the liquidity of the 
firm's balance sheet.\229\ The Commission staff also monitors the 
performance of the ANC broker-dealer's internal models through regular 
submissions of reported model changes by the firms and quarterly 
discussions with the firm's quantitative modeling personnel. Material 
changes to the internal models used to determine regulatory capital 
require advance notification, Commission staff review, and pre-approval 
before implementation. Stand-alone SBSDs authorized to use model-based 
haircuts would be subject to similar monitoring and reviews.
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    \229\ In addition to regularly scheduled meetings, 
communications with ANC broker-dealers may increase in frequency, 
dependent on existing market conditions, and, at times, may involve 
daily, weekly, or other ad hoc calls or meetings.
---------------------------------------------------------------------------

Comments and Final Requirements for Model-Based Haircuts

    A commenter expressed support for the Commission's proposal that 
nonbank SBSDs be authorized to use model-based haircuts for proprietary 
securities positions, including security-based swap positions, in lieu 
of standardized haircuts, subject to application to, and approval by, 
the Commission and satisfaction of the qualitative and quantitative 
requirements set forth in Rule 15c3-1e.\230\ However, other commenters 
raised concerns about permitting nonbank SBSDs to use model-based 
haircuts. A commenter stated that model-based haircuts should be 
``floored'' at a level set by a standardized approach.\231\ This 
commenter also stated that the Commission's continued reliance on 
model-based haircuts would represent a step away from the evolving 
practice of prudential regulators. This commenter and others also 
generally argued that the failure by significant market participants to 
accurately measure risk using models in the run-up to and during the 
2008 financial crisis demonstrated that such models do not successfully 
measure risk and do not enable firms to make optimal judgments about 
risk.\232\ One of these commenters argued that the firms using models 
are the most systemically risky and have a financial incentive to keep 
the measures low.\233\ Other commenters argued that models can be 
manipulated and create perverse incentives for risk management staff to 
minimize capital charges.\234\ A commenter indicated that it will be 
difficult for Commission staff to examine, duplicate, and back-test 
model estimates.\235\ A second commenter believed models tend to fail 
during volatile market conditions particularly during a crisis.\236\ 
Another commenter, in light of various reforms by banking regulators, 
urged the Commission to place more limitations on ANC broker-dealers 
because they use internal models to determine capital charges.\237\
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    \230\ See SIFMA 2/22/2013 Letter.
    \231\ See Letter from Americans for Financial Reform (Feb. 22, 
2013) (``Americans for Financial Reform Letter'').
    \232\ See Americans for Financial Reform Letter; Better Markets 
7/22/2013 Letter; CFA Institute Letter; Letter from Sheila C. Bair, 
Systemic Risk Council (Jan. 24, 2013) (``Systemic Risk Council 
Letter''). See also Letter from Lisa A. Rutherford (Jan. 22, 2013) 
(``Rutherford Letter'').
    \233\ See Better Markets 7/22/2013 Letter.
    \234\ See CFA Institute Letter; Systemic Risk Council Letter.
    \235\ See Better Markets 7/22/2013 Letter.
    \236\ See Letter from Matthew Shaw (Feb. 22, 2013) (``Shaw 
Letter'').
    \237\ See Americans for Financial Reform Education Fund Letter.
---------------------------------------------------------------------------

    Commenters also argued that allowing the use of models for capital 
purposes can create competitive advantages for larger firms that are 
able to reduce their capital requirements through internal modeling 
relative to smaller firms that are engaged in similar activities but 
are subject to different capital requirements.\238\ A commenter stated 
that allowing the use of models will incentivize firms to organize 
themselves in ways that reduce their capital requirements and increase 
their leverage in order to enhance return on capital.\239\ This 
commenter also stated that capital requirements should be the same 
regardless of firms' activities and that the only reason for different 
treatment should be the aggregate exposures taken by individual firms.
---------------------------------------------------------------------------

    \238\ See CFA Institute Letter; Systemic Risk Council Letter.
    \239\ See CFA Institute Letter.
---------------------------------------------------------------------------

    The Commission continues to believe that the capital rules for ANC 
broker-dealers and nonbank SBSDs should permit these entities to use 
model-based haircuts. Models are used by financial institutions to 
manage risk and, therefore, permitting their use will allow firms to 
integrate their risk management processes with their capital 
computations.
    The Commission, however, acknowledges the concerns raised by 
commenters about the efficacy of models, particularly in times of 
market stress. In response to these concerns and the comment that ANC 
broker-dealers should be subject to more limitations, ANC broker-
dealers and nonbank SBSDs using models will be subject to higher 
minimum capital requirements as well as the Commission's ongoing 
monitoring of their use of models. In particular, the minimum tentative 
net capital requirements that apply to ANC broker-dealers (which are 
being substantially increased by today's amendments) and stand-alone 
SBSDs authorized to use model-based haircuts are designed to address 
the concerns raised by commenters that the models may fail to 
accurately measure risk, firms may calibrate the models to keep values 
low, firms might manipulate models, and models may fail during volatile 
market conditions. More specifically, tentative net capital is the 
amount of a firm's net capital before applying the haircuts.
    Today's amendments and new rules will require ANC broker-dealers 
(including ANC broker-dealer SBSDs) to maintain at least $5 billion in 
tentative net capital and subject them to a minimum fixed-dollar net 
capital requirement of $1 billion. Stand-alone SBSDs authorized to use 
models will be required to maintain at least $100 million in tentative 
net capital and will be subject to a minimum fixed-dollar net capital 
requirement of $20 million. Consequently, for each type of nonbank 
SBSD, the fixed-dollar minimum tentative net capital requirement is 
five times the fixed-dollar minimum net capital requirement. Thus, 
nonbank SBSDs that use models will need to maintain minimum tentative 
net capital in an amount that far exceeds their minimum fixed-dollar 
net capital requirement. The larger tentative net capital requirement 
is designed to address the risk associated with using model-based 
haircuts. To the extent a nonbank SBSD's model fails to accurately 
calculate the risk of its positions, the tentative net capital 
requirement will serve as a buffer to account for the difference 
between the calculated haircut amount and the actual risk of the 
positions. Further, the Commission's ongoing supervision of the firms' 
use of models as well as the qualitative and quantitative requirements 
governing the use of models (e.g., backtesting) provide additional 
checks on the use of models that are designed to address the risks

[[Page 43901]]

identified by the commenters. Finally, ANC broker-dealers and nonbank 
SBSDs are subject to Rule 15c3-4, which requires them to establish, 
document, and maintain a system of internal risk management controls to 
assist in managing the risks associated with their business activities, 
including market, credit, leverage, liquidity, legal, and operational 
risks.
    Although one commenter stated that the Commission's continued 
reliance on internal models would represent a step away from the 
evolving practice of prudential regulators, this has not been the case. 
Financial supervisors and regulators, in the United States and 
elsewhere, have continued to permit the use of internal models as a 
component of establishing and measuring capital requirements for 
financial market participants, including with respect to bank SBSDs and 
bank swap dealers. Similarly, the CFTC has proposed to allow nonbank 
swap dealers to use models. The Commission's final rules and amendments 
will promote consistency with these other rules. For these reasons, the 
Commission is adopting the provisions relating to the use of model-
based haircuts substantially as proposed.\240\
---------------------------------------------------------------------------

    \240\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph 
(a) of Rule 15c3-1e, as amended; paragraphs (a)(2), (d), and (e)(1) 
of Rule 18a-1, as adopted. The Commission also is modifying the 
credit risk charges in the final rule in paragraph (a)(7) of Rule 
15c3-1, as amended and paragraph (a)(2) of Rule 18a-1, as adopted. 
These changes are discussed in the next section. The Commission also 
is making some non-substantive changes in paragraph (d)(9)(iii) of 
Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Finally, a commenter recommended that the Commission adopt an 
expedited review and approval process for models that have been 
approved and are subject to periodic assessment by the Federal Reserve 
or a qualifying foreign regulator.\241\ This commenter suggested that 
if the Commission has previously approved a model for use by one 
registrant, the Commission should automatically approve the use of that 
model by an affiliate subject to the same risk management program as 
the affiliate whose model was previously approved. Other commenters 
recommended that the Commission permit a nonbank SBSD to use internal 
credit risk models approved by other regulators, and that the 
Commission generally defer to the other regulator's ongoing oversight 
of the model (including model governance).\242\ Another commenter 
supported a provisional approval process for internal capital 
models.\243\
---------------------------------------------------------------------------

    \241\ See SIFMA 2/22/2013 Letter; SIFMA 11/19/2018 Letter.
    \242\ See ING/Mizuho Letter; IIB 11/19/2018 Letter.
    \243\ See Citadel 5/15/2017 Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission encourages 
prospective registrants to reach out to the Commission staff as early 
as possible in advance of the registration compliance date to begin the 
model approval process. The staff will work diligently to review the 
models before the firm must register as an SBSD. However, the 
Commission acknowledges the possibility that it may not be able to make 
a determination regarding a firm's model before it is required to 
register as an SBSD. Consequently, the Commission is modifying Rule 
15c3-1e and Rule 18a-1 to provide that the Commission may approve, 
subject to any condition or limitations that the Commission may 
require, the temporary use of a provisional model by an ANC broker-
dealer, including an ANC broker-dealer SBSD, or a stand-alone SBSD for 
the purposes of computing net capital if the model had been approved by 
certain other supervisors.\244\ Further, as discussed below in section 
II.B.2.a.i. of this release, the Commission also may approve, subject 
to any condition or limitations that the Commission may require, the 
temporary use of a provisional model by a nonbank SBSD for the purposes 
of calculating initial margin pursuant to the requirements of Rule 18a-
3, as adopted.
---------------------------------------------------------------------------

    \244\ See paragraph (a)(7)(ii) of Rule 15c3-1e, as amended; 
paragraph (d)(5)(ii) of Rule 18a-1, as adopted. As a result of this 
modification, paragraph (a)(7) of Rule 15c3-1e has been re-
designated paragraph (a)(7)(i) of Rule 15c3-1e, as amended, and 
paragraph (d)(5) of Rule 18a-1, as proposed, has been re-designated 
paragraph (d)(5)(i) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    To qualify, the firm must have a complete application pending for 
approval to use a model.\245\ The requirement that a complete 
application be pending is designed to limit the amount of time that the 
firm uses the provisional model and incentivize firms to promptly file 
applications for model approval.
---------------------------------------------------------------------------

    \245\ See paragraph (a)(7)(ii)(A) of Rule 15c3-1e, as amended; 
paragraph (d)(5)(ii)(A) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    In addition, to be approved by the Commission, the use of the 
provisional model must have been approved by a prudential regulator, 
the CFTC, a CFTC-registered futures association, a foreign financial 
regulatory authority that administers capital and/or margin 
requirements that the Commission has found are eligible for substituted 
compliance, or 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 the 
final rules.\246\ This condition is designed to ensure that the 
provisional model has been approved by a financial regulator that is 
administering a program for approving and monitoring the use of models 
that is consistent with the Commission's program, including with 
respect to the qualitative and quantitative requirements for models in 
the final rules being adopted today.
---------------------------------------------------------------------------

    \246\ See paragraph (a)(7)(ii)(B) of Rule 15c3-1e, as amended; 
paragraph (d)(5)(ii)(B) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

v. Credit Risk Models
    The pre-existing provisions of paragraph (a)(7) of Rule 15c3-1 and 
paragraph (c) of Rule 15c3-1e permit an ANC broker-dealer to treat 
uncollateralized current exposure to a counterparty arising from 
derivatives transactions as part of its tentative net capital instead 
of deducting 100% of the value of the unsecured receivable (as is 
required with respect to most unsecured receivables under Rule 15c3-
1).\247\ These provisions further require the ANC broker-dealer to take 
a credit risk charge to tentative net capital (along with the market 
risk charges--the model-based haircuts--discussed above in section 
II.A.2.b.iv. of this release) to compute its net capital. The credit 
risk charge typically will be significantly less than the 100% 
deduction to net worth that would have otherwise applied to the 
unsecured receivable since the credit risk charge is a percentage of 
the amount of the receivable. The pre-existing provisions of paragraph 
(c) of Rule 15c3-1e prescribe the method for calculating credit risk 
charges (``ANC credit risk model''). In particular, the credit risk 
charge is the sum of 3 calculated amounts: (1) A counterparty exposure 
charge; (2) a concentration charge if the current exposure to a single 
counterparty exceeds certain thresholds; and (3) a portfolio 
concentration charge if the aggregate current exposure to all 
counterparties exceeds 50% of the firm's tentative net capital.
---------------------------------------------------------------------------

    \247\ See paragraph (c)(15) of Rule 15c3-1 (defining the term 
``tentative net capital'').
---------------------------------------------------------------------------

    The capital rules governing OTC derivatives dealers similarly 
permit them to include uncollateralized current exposures to a 
counterparty arising from derivatives transactions in their tentative 
net capital, and require them to take a credit risk charge to tentative 
net capital with respect to these exposures to compute net 
capital.\248\

[[Page 43902]]

Paragraph (d) of Rule 15c3-1f prescribes the method for computing the 
credit risk charges for OTC derivatives dealers (``OTCDD credit risk 
model''). The OTCDD credit risk model is similar to the ANC credit risk 
model except that the former does not include a portfolio concentration 
charge.\249\
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    \248\ See paragraphs (a)(5) and (c)(15) of Rule 15c3-1; 17 CFR 
240.15c3-1f (``Rule 15c3-1f'').
    \249\ See paragraph (d) of Rule 15c3-1f.
---------------------------------------------------------------------------

    Commission staff reviews an ANC broker-dealer's use of the ANC 
credit risk model as part of the overall review of the firm's ANC 
application and monitors the firm's use of the model thereafter. 
Moreover, the process is subject to the pre-existing provisions of 
paragraphs (a)(8), (a)(10), and (a)(11) of Rule 15c3-1e, which provide, 
respectively, that: (1) An ANC broker-dealer must amend and submit to 
the Commission for approval its ANC application before materially 
changing its ANC credit risk model; (2) an ANC broker-dealer must 
notify the Commission 45 days before it ceases using its ANC credit 
risk model; and (3) the Commission, by order, can revoke an ANC broker-
dealer's ability to use the ANC credit risk model. Commission staff 
also reviews and monitors an OTC derivatives dealer's use of its OTCDD 
credit risk model.\250\
---------------------------------------------------------------------------

    \250\ See paragraph (a) of Rule 15c3-1f.
---------------------------------------------------------------------------

    Under the pre-existing provisions of Rule 15c3-1e, an ANC broker-
dealer approved to use an ANC credit risk model can apply the model to 
unsecured receivables arising from OTC derivatives instruments from all 
types of counterparties. The Commission proposed to narrow this 
treatment so that ANC broker-dealers could apply the ANC credit risk 
model to unsecured receivables arising exclusively from security-based 
swap transactions with commercial end users (i.e., unsecured 
receivables arising from other types of derivative transactions were 
subject to the 100% deduction from net worth).\251\
---------------------------------------------------------------------------

    \251\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70240-44.
---------------------------------------------------------------------------

    The Commission proposed that stand-alone SBSDs authorized to use 
models also could apply a credit risk model to unsecured receivables 
arising from security-based swap transactions with commercial end 
users.\252\ The proposed credit risk model for stand-alone SBSDs was 
modeled on the ANC credit risk model (as opposed to the OTCDD credit 
risk model). Consequently, the credit risk model for stand-alone SBSDs 
included a portfolio concentration charge if aggregate current 
exposures to all counterparties exceeded 50% of the firm's tentative 
net capital.
---------------------------------------------------------------------------

    \252\ See 77 FR at 70240-44.
---------------------------------------------------------------------------

    In the 2018 comment reopening, the Commission asked whether the 
final rules should cap the ability of ANC broker-dealers and stand-
alone SBSDs authorized to use models to apply the credit risk models to 
uncollateralized current exposures arising from security-based swap and 
swap transactions with commercial end users. The Commission asked 
whether this cap should equal 10% of the firm's tentative net 
capital.\253\ In addition, the Commission asked whether the use of the 
credit risk models by ANC broker-dealers and stand-alone SBSDs should 
be expanded to apply to uncollateralized potential exposures to 
counterparties arising from electing not to collect initial margin for 
non-cleared security-based swap and swap transactions pursuant to 
exceptions in the margin rules of the Commission and the CFTC. This 
treatment would be an alternative to taking the 100% deduction to net 
worth in lieu of collecting initial margin.
---------------------------------------------------------------------------

    \253\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53010-11.
---------------------------------------------------------------------------

Comments and Final Requirements for Using Credit Risk Models
    A commenter urged the Commission not to limit the circumstances in 
which the credit risk models could be used.\254\ The commenter stated 
that uncollateralized receivables arising from a counterparty failing 
to post margin typically result from operational issues that are 
temporary in nature (i.e., that are addressed in a matter of days) and 
are liquidated if they last for longer periods of time. The commenter 
stated that a credit risk charge adequately addresses the risks of 
under-collateralized positions during the interim period before margin 
is posted and that ``a punitive 100% deduction is unnecessary.'' The 
commenter also stated that requiring a nonbank SBSD to hold additional 
capital for each dollar of margin it did not collect from a non-
financial entity for a swap would effectively undermine an exception 
proposed by the CFTC, which the commenter indicated would deter the 
dual registration of nonbank SBSDs as swap dealers. The commenter also 
requested that the Commission permit ANC broker-dealers and stand-alone 
SBSDs authorized to use models to apply a counterparty credit risk 
charge in lieu of a 100% deduction for security-based swaps and swaps 
with sovereigns, central banks, supranational institutions, and 
affiliates to the extent that an exception to applicable margin 
requirements applies. Similarly, another commenter recommended that the 
Commission calibrate the capital charges so that they do not make 
compliance with other regulators' margin rules punitive.\255\
---------------------------------------------------------------------------

    \254\ See SIFMA 2/22/2013 Letter.
    \255\ See Memorandum from Richard Gabbert, Counsel to 
Commissioner Hester M. Peirce, regarding an April 24, 2018 meeting 
with representatives of Citigroup (April 26, 2018) (``Citigroup 4/
24/2018 Meeting'').
---------------------------------------------------------------------------

    A commenter stated that ANC broker-dealers and stand-alone SBSDs 
should be permitted to apply the credit risk models to uncollateralized 
exposures to multilateral development banks in which the U.S. is a 
member.\256\ This commenter stated that the Commission's proposal to 
limit use of the models to commercial end users is unwarranted, on 
either risk-based or policy grounds. A commenter stated that requiring 
a 100% deduction for unsecured receivables from commercial end users 
with respect to swap transactions (as compared to security-based swap 
transactions for which the credit risk models would apply) will make it 
difficult, if not impossible, to maintain a dually-registered nonbank 
SBSD and swap dealer.\257\ Another commenter urged the Commission to 
modify its proposal to avoid the pass-through of costs to commercial 
end users that the commenter argued would result if SBSDs are required 
to hold capital to cover unsecured credit exposures to them.\258\ This 
commenter also recommended that the Commission allow nonbank SBSDs and 
nonbank MSBSPs that are not approved to use internal models to take the 
credit risk charge (i.e., not limit its use to ANC broker-dealers and 
stand-alone SBSDs authorized to use models). One commenter suggested 
that the Commission substitute a credit risk charge or a credit 
concentration charge in place of the 100% charge for legacy accounts, 
with an exception permitting SBSDs to exclude any currently non-cleared 
positions for which a clearing agency has made an application to the 
Commission to accept for clearing.\259\
---------------------------------------------------------------------------

    \256\ See Letter from Anne-Marie Leroy, Senior Vice President 
and Group General Counsel, and David Harris, Acting Vice President 
and General Counsel, The World Bank (Feb. 21, 2013) (``World Bank 
Letter'').
    \257\ See Financial Services Roundtable Letter.
    \258\ See Sutherland Letter.
    \259\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to the 2018 comment reopening, a commenter expressed 
support for expanding the use of credit risk models to uncollected 
initial margin from legacy accounts.\260\ This commenter argued that 
this would be comparable to capital rules for bank SBSDs. Similarly, a 
commenter supported expanding the use of credit

[[Page 43903]]

risk models, noting that it would be consistent with the Basel capital 
standards as well as the manner in which the current net capital rule 
applies to ANC broker-dealers.\261\ Conversely, a commenter opposed 
expanding the use of credit risk models.\262\
---------------------------------------------------------------------------

    \260\ See Morgan Stanley 11/19/2018 Letter.
    \261\ See SIFMA 11/19/2018 Letter.
    \262\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    Finally, a commenter raised concerns about the potential rule 
language in the 2018 comment reopening because it narrowed the ability 
to use credit risk models for transactions in security-based swaps and 
swaps.\263\ The commenter noted that the current capital rules permit 
ANC broker-dealers to use the ANC credit risk models with respect to 
derivatives instruments, which encompass--among other things--OTC 
options that are not security-based swaps or swaps.
---------------------------------------------------------------------------

    \263\ See Morgan Stanley 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission is persuaded that the 
ability to apply the credit risk models should not be narrowed as 
proposed in 2012 (i.e., to exposures arising from uncollected variation 
and initial margin from commercial end users). The Commission believes 
the better approach is to maintain the existing provision in Rule 15c3-
1 that permits an ANC broker-dealer to apply the ANC credit risk model 
to credit exposures arising from all derivatives transactions. The 
Commission further believes that Rule 18a-1 should permit stand-alone 
SBSDs authorized to use models to similarly apply the credit risk 
model. Consequently, under the final rules, the credit risk models can 
be applied to uncollateralized current exposures to counterparties 
arising from all derivatives instruments, including such exposures 
arising from not collecting variation margin from counterparties 
pursuant to exceptions in the margin rules of the Commission and the 
CFTC.\264\
---------------------------------------------------------------------------

    \264\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph 
(a)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    The final rules also permit use of the credit risk models instead 
of taking the 100% deductions to net worth for electing not to collect 
initial margin for non-cleared security-based swaps and swaps pursuant 
to exceptions in the margin rules of the Commission and the CFTC, 
respectively. This broader application of the credit risk models with 
respect to security-based swap and swap transactions--which will reduce 
the amount of the capital charges--should mitigate concerns raised by 
commenters about the impact that the 100% deductions to net worth would 
have on nonbank SBSDs and their counterparties. It also responds to 
commenters who requested that the ability to use the credit risk models 
be expanded to a broader range of transactions. In addition, the 
broader application of credit risk models should mitigate the concerns 
raised by commenters that applying the 100% deduction to net worth with 
respect to swap transactions would make it difficult, if not 
impossible, to maintain an entity dually-registered as a nonbank SBSD 
and swap dealer.
    As noted above, the 2018 comment reopening described a potential 
cap equal to 10% of the firm's tentative net capital that would limit 
the firm's ability to apply the credit risk models to uncollateralized 
current exposures arising from electing not to collect variation 
margin.\265\ Under this potential threshold, a firm would need to take 
a capital charge equal to the aggregate amount of uncollateralized 
current exposures that exceeded 10% of the firm's tentative net 
capital.
---------------------------------------------------------------------------

    \265\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53010.
---------------------------------------------------------------------------

    Commenters addressed this potential cap. One commenter recommended 
that rather than an aggregate cap, the Commission adopt a counterparty-
by-counterparty threshold equal to 1% of the firm's tentative net 
capital.\266\ In the alternative, this commenter suggested using a 20% 
cap, if the Commission deemed it necessary to impose an aggregate 
limit. Another commenter suggested that the Commission not adopt the 
10% cap and instead rely on the existing portfolio concentration charge 
in Rule 15c3-1e that is part of the credit risk model used to calculate 
the credit risk charges.\267\
---------------------------------------------------------------------------

    \266\ See Morgan Stanley 11/19/2018 Letter.
    \267\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to the comments, the 10% cap was designed to limit the 
amount of a firm's capital base that is comprised of unsecured 
receivables. These assets generally are illiquid and cannot be readily 
converted to cash, particularly in a time of market stress. Permitting 
additional unsecured receivables to be allowable assets for capital 
purposes (in the form of either a higher aggregate cap or alternative 
thresholds) could substantially impair the firm's liquidity and ability 
to withstand a financial shock. Moreover, as discussed above, the 
Commission is broadening the application of the credit risk models to 
all types of counterparties and transactions that are subject to 
exceptions in the margin rules for non-cleared security-based swaps and 
swaps.
    For these reasons, the Commission believes it is an appropriate and 
prudent measure to adopt the 10% cap for ANC broker-dealers, including 
ANC broker-dealer SBSDs. These firms engage in a wide range of 
securities activities beyond dealing in security-based swaps, including 
maintaining custody of securities and cash for retail customers. They 
are significant participants in the securities markets and, 
accordingly, the Commission believes it is appropriate to adopt rules 
that promote their safety and soundness by limiting the amount of 
unsecured receivables that can be part of their regulatory capital. 
Thus, the Commission does not believe increasing the 10% cap to a 20% 
cap would be appropriate.
    Consequently, under the final rule, these firms are subject to a 
portfolio concentration charge equal to 100% of the amount of the 
firm's aggregate current exposure to all counterparties in excess of 
10% of the firm's tentative net capital.\268\ Thus, unsecured 
receivables arising from electing not to collect variation margin are 
included in the portfolio concentration charge. The charge does not 
include potential future exposure arising from electing not to collect 
initial margin.
---------------------------------------------------------------------------

    \268\ See paragraph (c)(3) of Rule 15c3-1e, as amended.
---------------------------------------------------------------------------

    In response to comments, the Commission has reconsidered the 
proposed portfolio concentration charge for stand-alone SBSDs 
(including stand-alone SBSDs registered as OTC derivatives 
dealers).\269\ These firms will engage in a much more limited 
securities business as compared to ANC broker-dealers, including ANC 
broker-dealer SBSDs. Consequently, they will be a less significant 
participant in the broader securities market. Moreover, under existing 
requirements, OTC derivatives dealers are not subject to a portfolio 
concentration charge.\270\ Therefore, not including a portfolio 
concentration charge for stand-alone SBSDs will more closely align the 
credit risk model for these firms with the OTCDD credit risk model. The 
Commission believes this is appropriate as both types of entities are 
limited in the activities they can engage in as compared to ANC broker-
dealers. Further, as discussed above in section II.A.4. of this 
release, a stand-alone SBSD that also is registered as an OTC 
derivatives dealer will be subject to

[[Page 43904]]

Rules 18a-1, 18a-1a, 18a-1b, 18a-1c and 18a-1d rather than Rule 15c3-1 
and its appendices (and, in particular, Rule 15c3-1f). Consequently, 
not including a portfolio concentration charge in Rule 18a-1 will avoid 
having two different standards: one for OTC derivatives dealers that 
also are SBSDs and the other for OTC derivatives dealers that are not 
SBSDs. For these reasons, the credit risk model for stand-alone SBSDs 
in Rule 18a-1 has been modified from the proposal to eliminate the 
portfolio concentration charge.\271\
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    \269\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70244 (proposing a portfolio concentration charge in Rule 18a-
1 for stand-alone SBSDs).
    \270\ See paragraph (c) of Rule 15c3-1f.
    \271\ See paragraph (e)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    In addition to the foregoing modifications to the credit risk 
models for ANC broker-dealers and stand-alone SBSDs, the Commission is 
making an additional modification to the term ``collateral'' as defined 
in the rules for purposes of the models.\272\ In particular, the 
existing definition in Rule 15c3-1e and the proposed definition in Rule 
18a-1 provided that in applying the credit risk model the fair market 
value of collateral pledged by the counterparty could be taken into 
account if, among other conditions, the firm maintains possession or 
control of the collateral.\273\ Consequently, under the existing and 
proposed rules, collateral held at a third-party custodian could not be 
taken into account because it was not in the possession or control of 
the firm.
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    \272\ See paragraph (c)(4)(v) of Rule 15c3-1e, as amended; 
paragraph (e)(2)(iii)(E) of Rule 18a-1, as adopted.
    \273\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70243.
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    As discussed above in section II.A.2.b.ii. of this release, the 
Commission believes it would be appropriate to recognize a broader 
range of custodians for purposes of the exception to taking the 
deduction to net worth when initial margin is held at a third-party 
custodian. Consequently, the Commission modified that provision so 
that, for purposes of the exception, a stand-alone broker-dealer or 
nonbank SBSD could recognize collateral held at a bank as defined in 
Section 3(a)(6) of the Exchange 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.\274\ The Commission 
believes the same types of custodians should be recognized for purposes 
of the credit risk models and accordingly is modifying the definitions 
of ``collateral'' in Rules 15c3-1e, as amended, and 18a-1, as adopted, 
to permit an ANC broker-dealer or nonbank SBSD to take into account 
collateral held at a third-party custodian that is one of these 
entities, subject to the same conditions with respect to foreign 
securities and currencies.\275\
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    \274\ See paragraph (c)(2)(xv)(C)(1) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(1) of Rule 18a-1, as adopted.
    \275\ See paragraph (c)(4)(v)(B)(2) of Rule 15c3-1e, as amended; 
paragraph (e)(2)(iii)(E)(2) of Rule 18a-1, as adopted. As part of 
this modification, paragraph (c)(4)(v)(B) was re-designated 
paragraph (c)(4)(v)(B)(1) and the phrase ``and may be liquidated 
promptly by the firm without intervention by any other party'' was 
added before the semicolon. This rule text was moved from paragraph 
(c)(4)(v)(D) of Rule 15c3-1e, because this provision is not 
applicable to the third-party custodial provisions in paragraph 
(c)(4)(v)(B)(2). As a result, paragraph (c)(4)(v)(D) of Rule 15c3-1e 
was deleted and the remaining subparagraphs re-numbered. Conforming 
changes also were made to paragraph (e)(2)(iii) of Rule 18a-1, as 
amended.
---------------------------------------------------------------------------

    A commenter urged the Commission to modify the proposed application 
of the credit risk models to avoid the pass-through of costs to 
commercial end users that the commenter argued would result if nonbank 
SBSDs are required to hold capital to cover unsecured credit exposures 
to these counterparties.\276\ The commenter recommended that the 
Commission allow nonbank SBSDs not authorized to compute model-based 
haircuts to use the credit risk models (i.e., not limit the use of 
credit risk models to ANC broker-dealers and stand-alone SBSDs 
authorized to use models). Another commenter suggested that nonbank 
SBSDs that have not been approved to use models for capital purposes 
also be allowed to compute credit risk charges for uncollected initial 
margin by multiplying the exposure by 8% and a credit-risk-weight 
factor.\277\
---------------------------------------------------------------------------

    \276\ See Sutherland Letter.
    \277\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response, the Commission does not believe it would be 
appropriate to permit stand-alone SBSDs that are not authorized to use 
models to apply model-derived credit risk charges. First, the credit 
risk models used by ANC broker-dealers and nonbank SBSDs require a 
calculation of maximum potential exposure to the counterparty 
multiplied by a back-testing-determined factor.\278\ The maximum 
potential exposure amount is a charge to address potential future 
exposure and is calculated using the firm's market risk model (i.e., 
the model to calculate model-based haircuts) as applied to the 
counterparty's positions after giving effect to a netting agreement 
with the counterparty, taking into account collateral received from the 
counterparty, and taking into account the current replacement value of 
the counterparty's positions. Second, ANC broker-dealers and stand-
alone SBSDs authorized to use models are subject to higher minimum 
tentative net capital and net capital requirements. These enhanced 
minimum capital requirements are designed to account for the lower 
deductions that result from using models. Nonbank SBSDs that have not 
been authorized to use models will not be subject to these additional 
requirements. Moreover, as a practical matter, the Commission expects 
that most nonbank SBSDs will apply to use models.
---------------------------------------------------------------------------

    \278\ See paragraph (c)(4)(i) and Rule 15c3-1e, as amended; 
paragraph (e)(2)(iii)(A) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    A commenter argued that adopting an exception from collecting 
initial margin from another SBSD for a non-cleared security-based swap 
transaction without imposing a deduction from net worth would be 
inappropriate.\279\ The commenter argued that these counterparties 
could default, which, in turn, could increase systemic risk. In 
response, as discussed above in section II.A.2.b.ii. of this release, 
the final rules require a nonbank SBSD to take a deduction in lieu of 
margin when it does not collect initial margin from a counterparty, 
including an SBSD. The capital charge is designed to achieve the same 
objective as collecting margin (i.e., protect the nonbank SBSD from the 
consequences of the counterparty's default). Moreover, a nonbank SBSD 
will be required to collect variation margin from other financial 
market intermediaries such as SBSDs.
---------------------------------------------------------------------------

    \279\ See OneChicago 2/19/2013 Letter.
---------------------------------------------------------------------------

    A commenter stated that uncollateralized receivables arising from a 
counterparty failing to post margin typically result from operational 
issues that are temporary in nature (i.e., that are addressed in a 
matter of days) and are liquidated if they last for longer periods of 
time.\280\ Consequently, the commenter requested that the Commission 
expand the use of credit risk models to instances when the nonbank SBSD 
does not collect required margin (i.e., as distinct from when the SBSD 
elects not collect margin pursuant to an exception in the margin 
rules). As discussed above in section II.A.2.b.ii. of this release with 
respect to under-margined accounts, when margin is required it should 
be collected promptly, as it is designed to protect the nonbank SBSD 
from the consequences of the counterparty defaulting on its 
obligations. The 100% deduction from net worth for failing to collect 
required margin will serve as an incentive for nonbank SBSDs to have a 
well-

[[Page 43905]]

functioning margin collection system and the capital needed to take the 
deduction will protect the nonbank SBSD from the consequences of the 
counterparty's default. However, the final margin rule being adopted 
today provides a nonbank SBSD or MSBSP an additional day to collect 
required margin from a counterparty (including variation margin due 
from an affiliate) if the counterparty is located in a different 
country and is more than 4 time zones away.\281\ This should mitigate 
the commenter's concern about having to take a deduction when required 
margin is not collected in a timely manner.
---------------------------------------------------------------------------

    \280\ See SIFMA 2/22/2013 Letter.
    \281\ See paragraphs (c)(1)(iii) and (c)(2)(ii) of Rule 18a-3, 
as adopted. These and other provisions related to the margin rule 
are discussed in more detail in section II.B.2. of this release.
---------------------------------------------------------------------------

    Finally, a commenter requested that the Commission permit a nonbank 
SBSD to substitute the credit risk charge that would apply to a 
transaction with a counterparty with the credit risk charge that would 
apply to a transaction with a different counterparty that hedges the 
transaction with the first counterparty, as permitted under bank 
capital rules under certain conditions.\282\ The commenter cited a bank 
regulation that permits this shifting of credit risk charges.\283\ The 
bank regulation cited in support of this comment is integrated into the 
broader set of bank capital regulations. The commenter did not describe 
why such a provision would be appropriate for a nonbank or which bank 
regulations would need to be codified into the ANC broker-dealer and 
nonbank SBSD capital rules to prudently and effectively implement it. 
Consequently, the Commission is not incorporating such a provision into 
the ANC broker-dealer and nonbank SBSD capital rules.\284\
---------------------------------------------------------------------------

    \282\ See SIFMA 11/19/2018 Letter.
    \283\ 12 CFR 217.36.
    \284\ See also section II.A.1. of this release (discussing why 
the Commission does not believe it would be appropriate to apply a 
bank capital standard to a nonbank SBSD).
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting final rules 
that permit ANC broker-dealers and stand-alone SBSDs authorized to use 
credit risk models to apply the credit risk charges with the 
modifications discussed above.\285\ The Commission also is adopting 
final rules regarding the operation of the credit risk models with the 
modifications discussed above.\286\
---------------------------------------------------------------------------

    \285\ See paragraph (a)(7) of Rule 15c3-1, as amended; paragraph 
(a)(2) of Rule 18a-1, as adopted.
    \286\ See paragraph (c) of Rule 15c3-1e, as amended; paragraph 
(e)(2) to Rule 18a-1, as adopted. The following non-substantive 
changes are being made. First, ``%'' is replaced with ``percent'' in 
paragraph (e)(2) of Rule 18a-1, as adopted, to improve internal 
consistency in the rule. Second, ``paragraphs (c)(1)(iv), (vi), and 
(vii) of this section'' are replaced with ``paragraphs (c)(1)(iv), 
(vi), and (vii) of this section, and Sec.  240.18a-1b,'' in 
paragraph (d)(1) of Rule 18a-1, as adopted. Third, ``ten business 
day'' is replaced with ``ten-business day'' in paragraph 
(d)(9)(i)(C)(5)(i) of Rule 18a-1, as adopted. Fourth, ``paragraphs 
(c)(1)(iii), (iv), (vii), or (viii)'' is replaced with ``paragraphs 
(c)(1)(iii), (iv), (vi), (vii),'' in paragraph (d)(9)(iii) of Rule 
18a-1, as adopted.
---------------------------------------------------------------------------

c. Risk Management
    ANC broker-dealers and OTC derivatives dealers are subject to a 
risk management rule.\287\ Rule 15c3-4 requires these firms to, among 
other things, establish, document, and maintain a system of internal 
risk management controls to assist in managing the risks associated 
with their business activities, including market, credit, leverage, 
liquidity, legal, and operational risks. The Commission proposed that 
nonbank SBSDs be required to comply with Rule 15c3-4 to promote the 
establishment of effective risk management control systems by these 
firms.\288\
---------------------------------------------------------------------------

    \287\ See 17 CFR 240.15c3-4 (``Rule 15c3-4''); paragraph 
(a)(7)(iii) of Rule 15c3-1.
    \288\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70250-70251.
---------------------------------------------------------------------------

    Commenters expressed support for the Commission's proposal.\289\ A 
commenter stated that requiring nonbank SBSDs to comply with Rule 15c3-
4 ``will better enable nonbank SBSDs to identify and mitigate and 
manage the risks they are facing.'' \290\ A second commenter stated 
that Rule 15c3-4 should already contemplate the unique needs of a 
dealer in derivatives.\291\ The Commission is adopting, as proposed, 
the requirement that nonbank SBSDs comply with Rule 15c3-4.\292\
---------------------------------------------------------------------------

    \289\ See Letter from Chris Barnard (Dec. 4, 2012) (``Barnard 
Letter''); Financial Services Roundtable Letter.
    \290\ See Barnard Letter.
    \291\ See Financial Services Roundtable Letter.
    \292\ See paragraph (a)(10)(ii) of Rule 15c3-1, as amended 
(which applies Rule 15c3-4 to broker-dealer SBSDs not authorized to 
use model-based haircuts); paragraph (f) of Rule 18a-1, as adopted 
(which applies Rule 15c3-4 to stand-alone SBSDs). In the final rule, 
paragraph (g) of Rule 18a-1, as proposed to be adopted, was re-
designated paragraph (f). See paragraph (f) of Rule 18a-1, as 
adopted. See also paragraph (a)(7)(iii) of Rule 15c3-1 (which 
applies Rule 15c3-4 to ANC broker-dealers, including ANC broker-
dealer SBSDs).
---------------------------------------------------------------------------

d. Other Rule 15c3-1 Provisions Incorporated Into Rule 18a-1
i. Debt-Equity Ratio Requirements
    Paragraph (d) of Rule 15c3-1 sets limits on the amount of a stand-
alone broker-dealer's outstanding subordinated loans. The debt-to-
equity limits are designed to ensure that a stand-alone broker-dealer 
has a base of permanent capital in addition to any subordinated loans, 
which--as discussed above--are permitted to be added back to net worth 
when computing net capital. Paragraph (h) of proposed Rule 18a-1 
contained parallel debt-to-equity limits.\293\ The Commission did not 
receive comments concerning the debt-to-equity limits in proposed Rule 
18a-1 and for the reasons discussed in the proposing release is 
adopting them as proposed.\294\
---------------------------------------------------------------------------

    \293\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70254-55.
    \294\ See paragraph (g) of Rule 18a-1, as adopted. The debt-
equity ratio requirements were set forth in re-designated paragraph 
(g) of Rule 18a-1, as adopted, and conforming changes were made to 
applicable cross-references in the rule.
---------------------------------------------------------------------------

ii. Capital Withdrawal Requirements
    Paragraph (e)(1) of Rule 15c3-1 requires that a stand-alone broker-
dealer provide notice when it seeks to withdraw capital in an amount 
that exceeds certain thresholds. Paragraph (e)(2) of Rule 15c3-1 
permits the Commission to issue an order temporarily restricting a 
stand-alone broker-dealer from withdrawing capital or making loans or 
advances to stockholders, insiders, and affiliates under certain 
circumstances. The Commission proposed parallel requirements for stand-
alone SBSDs.\295\ The Commission did not receive comments concerning 
the proposed capital withdrawal requirements for stand-alone SBSDs and 
for the reasons discussed in the proposing release is adopting them as 
proposed.\296\
---------------------------------------------------------------------------

    \295\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70254-55.
    \296\ See paragraph (h) of Rule 18a-1, as adopted. The capital 
withdrawal requirements were set forth in re-designated paragraph 
(h) of Rule 18a-1, as adopted, and conforming changes were made to 
applicable cross-references in the rule.
---------------------------------------------------------------------------

iii. Appendix C
    Appendix C to Rule 15c3-1 requires a stand-alone broker-dealer in 
computing its net capital and aggregate indebtedness to consolidate, in 
a single computation, assets and liabilities of any subsidiary or 
affiliate for which it guarantees, endorses, or assumes, directly or 
indirectly, obligations or liabilities.\297\ The assets and liabilities 
of a subsidiary or affiliate whose liabilities and obligations have not 
been guaranteed, endorsed, or assumed directly or indirectly by the 
stand-alone broker-dealer may also be consolidated. Subject to certain 
conditions in Appendix C to Rule 15c3-1, a stand-alone broker-dealer 
may receive flow-through net capital benefits because the consolidation 
may serve to increase the firm's net capital and thereby assist it in

[[Page 43906]]

meeting the minimum requirements of Rule 15c3-1. However, based on 
Commission staff experience and information from an SRO, very few 
stand-alone broker-dealers consolidate subsidiaries or affiliates to 
obtain the flow-through capital benefits permitted under Appendix C to 
Rule 15c3-1.
---------------------------------------------------------------------------

    \297\ See Rule 15c3-1c.
---------------------------------------------------------------------------

    Consequently, the Commission proposed a parallel requirement for a 
stand-alone SBSD to include in its net capital computation all 
liabilities or obligations of a subsidiary or affiliate of the stand-
alone SBSD that the SBSD guarantees, endorses, or assumes either 
directly or indirectly, but the Commission did not propose parallel 
provisions permitting flow-through capital benefits.\298\ The 
Commission did not receive comments on this proposed consolidation 
requirement and for the reasons discussed in the proposing release is 
adopting it as proposed.\299\
---------------------------------------------------------------------------

    \298\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70255.
    \299\ See Rule 18a-1c, as adopted.
---------------------------------------------------------------------------

iv. Appendix D
    Paragraph (c)(2)(ii) of Rule 15c3-1 permits a stand-alone broker-
dealer when computing net capital to exclude liabilities that are 
subordinated to the claims of creditors pursuant to a satisfactory 
subordination agreement. Excluding these liabilities has the effect of 
increasing the firm's net capital. Appendix D to Rule 15c3-1 (Rule 
15c3-1d) sets forth minimum and non-exclusive requirements for 
satisfactory subordination agreements.\300\ There are two types of 
subordination agreements under Rule 15c3-1d: (1) A subordinated loan 
agreement, which is used when a third party lends cash to a stand-alone 
broker-dealer;\301\ and (2) a secured demand note agreement, which is a 
promissory note in which a third party agrees to give cash to a stand-
alone broker-dealer on demand during the term of the note and provides 
cash or securities to the broker-dealer as collateral.\302\ Based on 
Commission staff experience, stand-alone broker-dealers infrequently 
utilize secured demand notes as a source of capital, and the amounts of 
these notes are relatively small in size.
---------------------------------------------------------------------------

    \300\ See 17 CFR 240.15c3-1d (``Rule 15c3-1d'').
    \301\ See paragraph (a)(2)(ii) of Rule 15c3-1d.
    \302\ See paragraph (a)(2)(v)(A) of Rule 15c3-1d.
---------------------------------------------------------------------------

    Certain of the provisions in Rule 15c3-1d are tied to the minimum 
net capital requirements of stand-alone broker-dealers. Consequently, 
the Commission proposed amendments to the rule to reflect the proposed 
minimum net capital requirements of broker-dealer SBSDs so that they 
could realize the net capital benefits of qualified subordination 
agreements.\303\ The Commission also included parallel provisions in 
proposed Rules 18a-1 and 18a-1d so that stand-alone SBSDs could realize 
the net capital benefits of qualified subordination agreements.\304\ 
However, because stand-alone broker-dealers rarely use secured demand 
notes, the proposed provisions for stand-alone SBSDs did not include 
this option for entering into a qualified subordinated agreement. The 
Commission did not receive comments on the proposed amendments to Rule 
15c3-1d or the proposed parallel provisions for stand-alone SBSDs and 
for the reasons discussed in the proposing release is adopting them 
with certain non-substantive modifications.\305\
---------------------------------------------------------------------------

    \303\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70256, n. 460.
    \304\ See 77 FR at 70255-70256.
    \305\ See Rule 15c3-1d, as amended; paragraph (c)(1)(ii) of Rule 
18a-1, as adopted; Rule 18a-1d, as adopted. The final rules are 
modified in the following non-substantive ways. The proposed rule 
text in Rule 15c3-1d is modified to refer generically to minimum 
capital requirements, rather than specific numbers and percentages, 
to account for the additional financial ratios that broker-dealer 
SBSDs are subject to under Rule 15c3-1. The term ``%'' is replaced 
with ``percent'' to improve internal consistency in paragraphs 
(b)(7), (b)(8)(i), (b)(10)(ii)(B), and (c)(5)(B) of Rule 15c3-1d, as 
amended, and in paragraphs (b)(6), (b)(7), (b)(9)(ii)(A), (c)(2), 
and (c)(4) of Rule 18a-1, as adopted. The headers ``(i)'' and 
``(ii)'' are removed in paragraph (b)(1) of Rule 18a-1d, as adopted. 
The semicolon at the end of paragraph is replaced with a period in 
paragraph (c)(2) of Rule 15c3-1d, as amended, and paragraph (b)(5) 
of Rule 18a-1d, as adopted. The phrase ``Sec.  240.18a-1 and Sec.  
240.18a-1d'' is replaced with ``Sec. Sec.  18a-1 and 18a-1d'' in 
paragraphs (b)(8)(i) and (c)(1) of Rule 18a-1d, as adopted. 
Semicolons are added at the end of paragraphs (b)(9)(D) and (D)(1) 
of Rule 18a-1d, as adopted. The phrase ``[C]lause (i) of paragraph 
(b)(8)'' is replaced with ``paragraph (b)(8)(i) of this section'' in 
paragraph (b)(9)(ii)(D) of Rule 18a-1d, as adopted.
---------------------------------------------------------------------------

v. Capital Charge for Unresolved Securities Differences
    Paragraph (c)(2)(v) of Rule 15c3-1 requires a stand-alone broker-
dealer to take a capital charge for short securities differences that 
are unresolved for seven days or longer and for long securities 
differences where the securities have been sold before they are 
adequately resolved. These capital charges were inadvertently omitted 
from the text of Rule 18a-1 when it was proposed and, consequently, the 
Commission proposed to include them in the rule when proposing the 
recordkeeping and reporting rules for SBSDs and MSBSPs.\306\ The 
Commission received one comment, which addressed concerns regarding 
short sale buy-in requirements that are beyond the scope of this 
rulemaking.\307\ For the reasons discussed in the proposing release, 
the Commission is adopting the capital charges as proposed with minor 
non-substantive changes.\308\
---------------------------------------------------------------------------

    \306\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers; Capital Rule for Certain Security-Based Swap 
Dealers, 79 FR at 25254.
    \307\ See Shatto Letter.
    \308\ See paragraph (c)(1)(x)(A) through (C) of Rule 18a-1, as 
adopted. In the final rule, the Commission replaced the phrase 
``broker or dealer'' with ``security-based swap dealer'' in 
paragraph (c)(1)(x)(B) and the term ``designated examining authority 
for a broker or dealer'' with ``Commission'' in paragraph 
(c)(1)(x)(C).
---------------------------------------------------------------------------

3. Capital Rules for Nonbank MSBSPs
    The Commission proposed Rule 18a-2 to establish capital 
requirements for nonbank MSBSPs.\309\ Under the proposal, nonbank 
MSBSPs were required at all times to have and maintain positive 
tangible net worth. The Commission proposed a tangible net worth 
standard, rather than the net liquid assets test in Rule 15c3-1, 
because the entities that may need to register as nonbank MSBSPs may 
engage in a diverse range of business activities different from, and 
broader than, the securities activities conducted by stand-alone 
broker-dealers or SBSDs. As proposed, the term ``tangible net worth'' 
was defined to mean the nonbank MSBSP's net worth as determined in 
accordance with GAAP, excluding goodwill and other intangible assets. 
Consequently, the definition of ``tangible net worth'' allowed nonbank 
MSBSPs to include as regulatory capital assets that would be deducted 
from net worth under Rule 15c3-1, such as property, plant, equipment, 
and unsecured receivables. At the same time, it would require the 
deduction of goodwill and other intangible assets.
---------------------------------------------------------------------------

    \309\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70256-57.
---------------------------------------------------------------------------

    The Commission also proposed that nonbank MSBSPs must comply with 
Rule 15c3-4 with respect to their security-based swap and swap 
activities. Requiring nonbank MSBSPs to be subject to Rule 15c3-4 was 
intended to promote sound risk management practices with respect to the 
risks associated with OTC derivatives.
    Commenters expressed support for the Commission's proposed 
requirements for nonbank MSBSPs.\310\ A commenter stated that the 
positive tangible net worth test is more appropriate than the net 
liquid assets test particularly for entities that have never been 
prudentially regulated before.\311\ Another commenter supported ``the 
proposed requirement

[[Page 43907]]

that MSBSPs maintain a positive tangible net worth.'' \312\ However, 
the commenter also stated that the proposed rule ``should recognize and 
respect state insurance regulators' role in ensuring the capital 
adequacy of financial guaranty insurers, and should accordingly 
recognize that, in the case of a financial guaranty insurer, any 
positive tangible net worth requirement should be satisfied if an 
insurer maintains the minimum statutory capital and complies with the 
investment requirements under applicable insurance law.'' \313\ This 
commenter also stated that, to the extent that financial guaranty 
insurers use affiliates to write CDS that they in turn insure, and 
insofar as such affiliates are designated as MSBSPs, the positive 
tangible net worth test should refer back to the financial guaranty 
insurer itself, as that is the entity that the CDS counterparties look 
to for paying the affiliates' obligations under the insured CDS.
---------------------------------------------------------------------------

    \310\ See Barnard Letter; Sutherland Letter.
    \311\ See Sutherland Letter.
    \312\ See Letter from Bruce E. Stern, Chairman, Association of 
Financial Guaranty Insurers (Feb. 15, 2013) (``AFGI 2/15/2013 
Letter''). See also Letter from Bruce E. Stern, Chairman, 
Association of Financial Guaranty Insurers (July 22, 2013) (``AFGI 
7/22/2013 Letter'').
    \313\ See AFGI 2/15/2013 Letter.
---------------------------------------------------------------------------

    With respect to the Commission's proposal that nonbank MSBSPs 
comply with Rule 15c3-4, the commenter stated that it recognized the 
need for nonbank MSBSPs to maintain strong internal risk controls, but 
cautioned the Commission against imposing unnecessarily burdensome, 
duplicative, and costly risk management controls on financial guaranty 
insurers. This commenter also stated that financial guaranty insurers 
that are determined to be MSBSPs should be able to establish compliance 
with Rule 15c3-4 by virtue of compliance with the New York Department 
of Financial Services Circular Letter No. 14, which calls for the 
establishment of comprehensive internal risk management controls.
    The Commission has considered the comments on its proposed 
requirements for nonbank MSBSPs and is adopting the requirements 
substantially as proposed.\314\ The requirement that nonbank MSBSPs at 
all times have and maintain positive tangible net worth is intended to 
be a less rigorous requirement than the net liquid assets test 
applicable to stand-alone broker-dealers and nonbank SBSDs. It will 
provide a workable standard for entities that engage in a diverse range 
of business activities that differ from, and are broader than, the 
securities activities conducted by stand-alone broker-dealers or SBSDs.
---------------------------------------------------------------------------

    \314\ See Rule 18a-2, as adopted. The Commission modified 
paragraph (a) of the rule to provide that the tangible net worth 
requirement does not apply to a broker-dealer MSBSP. However, a 
broker-dealer MSBSP will be required to comply with Rule 15c3-4. See 
paragraph (c) of Rule 18a-2, as adopted.
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    In response to the comment that the rule should recognize and 
respect existing state insurance law capital adequacy standards, the 
commenter supported the proposed tangible net worth requirement for 
nonbank MSBSPs.\315\ The final rule imposes a relatively simple capital 
standard--the requirement to maintain positive tangible net worth 
(i.e., positive net worth after deducting intangible assets). This 
should not impose a significant burden on nonbank MSBSPs, including 
firms that also are subject to capital requirements under state 
insurance laws. If it is possible that a nonbank MSBSP's capital 
position could drop below a positive tangible net worth but at the same 
time still comply with a state insurance law capital requirement, the 
Commission believes the rule's positive tangible net worth standard 
should be the binding constraint with respect to the nonbank MSBSP's 
activities as an MSBSP. The Commission does not believe it would be 
appropriate to permit a nonbank MSBSP to continue to operate as an 
MSBSP if it cannot meet the capital requirement of the positive 
tangible net worth test. In such a case, the firm's precarious capital 
position would pose a significant risk to its security-based swap 
counterparties.
---------------------------------------------------------------------------

    \315\ See AFGI 2/15/2013 Letter (``We support the proposed 
requirement that MSBSPs maintain a positive tangible net worth.'').
---------------------------------------------------------------------------

    In response to the comment about nonbank MSBSPs with CDS insured by 
an affiliate, the commenter did not identify an alternative capital 
standard that should apply to such nonbank MSBSPs. If the commenter was 
suggesting that these nonbank MSBSPs should be subject to a lesser 
requirement than the positive tangible net worth standard, the 
Commission disagrees. As discussed above, the Commission believes this 
standard will not impose a substantial burden on nonbank MSBSPs. 
Further, to the extent the affiliate insuring the CDS fails, the 
nonbank MSBSP will need to rely on its own financial resources.
    The Commission also is adopting, as proposed, the requirement that 
MSBSPs comply with Rule 15c3-4.\316\ Although a commenter cautioned the 
Commission against imposing unnecessarily burdensome, duplicative, and 
costly risk management controls on financial guaranty insurers, the 
Commission believes that establishing and maintaining a strong risk 
management control system that complies with Rule 15c3-4 is necessary 
for entities engaged in a security-based swaps business. Participants 
in the securities markets are exposed to various risks, including 
market, credit, leverage, liquidity, legal, and operational risk. Risk 
management controls promote the stability of the firm and, 
consequently, the stability of the marketplace. A firm that adopts and 
follows appropriate risk management controls reduces its risk of 
significant loss, which also reduces the risk of spreading the losses 
to other market participants or throughout the financial markets as a 
whole. Moreover, to the extent an entity, such as a financial guaranty 
insurer, complies with existing risk management requirements applicable 
to its business, the entity will likely have in place some, if not 
many, of the required risk management controls. Thus, the incremental 
burdens and costs associated with complying with Rule 15c3-4 should not 
be great.
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    \316\ See paragraph (c) of Rule 18a-2, as adopted.
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4. OTC Derivatives Dealers
    OTC derivatives dealers are limited purpose broker-dealers that are 
authorized to trade in OTC derivatives (including a broader range of 
derivatives than security-based swaps) and to use models to calculate 
net capital. They are required to maintain minimum tentative net 
capital of $100 million and minimum net capital of $20 million.\317\ 
OTC derivatives dealers also are subject to Rule 15c3-4.
---------------------------------------------------------------------------

    \317\ See paragraph (a)(5) of Rule 15c3-1, as amended.
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    A commenter stated that OTC derivatives dealers will register as 
nonbank SBSDs in order to conduct an integrated equity derivatives 
business (i.e., trade in equity security-based swaps and equity OTC 
options).\318\ The commenter requested that the Commission modify its 
framework for OTC derivatives dealers to allow them to register as 
nonbank SBSDs. The commenter further stated that the Commission should 
permit an OTC derivatives dealer that is dually registered as a nonbank 
SBSD to deal in OTC options and qualifying forward contracts, subject 
to the rules applicable to the nonbank SBSD.
---------------------------------------------------------------------------

    \318\ See SIFMA 2/22/2013 Letter.
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    The Commission agrees with the commenter that entities may seek to 
deal in a broader range of OTC derivatives that are securities other 
than dealing in just security-based swaps. In order to engage in this 
broader securities activity, the entity would need to register as a 
broker-dealer. The capital

[[Page 43908]]

rules the Commission is adopting today address entities that will 
register as broker-dealer SBSDs. In response to the comments, the 
Commission believes it would be appropriate to also adopt final rules 
to address OTC derivatives dealers that will register as nonbank SBSDs. 
Accordingly, the final rules provide that an OTC derivatives dealer 
that is registered as a nonbank SBSD must comply with Rule 18a-1, as 
adopted, and Rules 18a-1a, 18a-1b, 18a-1c and 18a-1d instead of Rule 
15c3-1 and its appendices.\319\ This will simplify the capital rules 
for such an entity by requiring the firm to comply with a single set of 
requirements.
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    \319\ See paragraph (a)(5)(ii) of Rule 15c3-1, as amended; 
undesignated introductory paragraph to Rule 18a-1, as adopted 
(stating that the rule applies to stand-alone SBSDs registered as 
OTC derivatives dealers).
---------------------------------------------------------------------------

    Moreover, the provisions of Rule 18a-1 and related rules are 
similar to the provisions of Rule 15c3-1 and its appendices. For 
example, the minimum fixed-dollar capital requirements in both sets of 
rules are $100 million in tentative net capital and $20 million in net 
capital. Both sets of rules permit the firms to compute net capital 
using models. In addition, as discussed above in section II.A.2.b.v. of 
this release, the methodology for computing the credit risk charges in 
Rule 18a-1 does not include the proposed portfolio concentration 
charge. As a result of this modification, both sets of rules are 
consistent in that they do not require this charge. Stand-alone SBSDs 
and OTC derivatives dealers also are both subject to Rule 15c3-4. For 
these reasons, the Commission believes a stand-alone SBSD should be 
able to efficiently incorporate its activities as an OTC derivatives 
dealer into its capital and risk management requirements under Rule 
18a-1, as adopted.

B. Margin

1. Introduction
    The Commission is adopting Rule 18a-3 pursuant to Section 15F of 
the Exchange Act to establish margin requirements for nonbank SBSDs and 
MSBSPs with respect to non-cleared security-based swaps. The Commission 
modeled Rule 18a-3 on the margin rules applicable to stand-alone 
broker-dealers (the ``broker-dealer margin rules'').\320\ A commenter 
supported the Commission's decision to base its proposal on the 
existing margin rules for stand-alone broker-dealers, noting that it is 
critically important that the Commission maintain a level playing field 
for similar financial instruments.\321\
---------------------------------------------------------------------------

    \320\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70259.
    \321\ See OneChicago 2/19/2013 Letter.
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    A number of commenters raised concerns about the Commission's 
decision to model proposed Rule 18a-3 on the broker-dealer margin rules 
to the extent that doing so resulted in inconsistencies with the margin 
rules of the CFTC and the prudential regulators as well as with the 
recommendations in the BCBS/IOSCO Paper.\322\ A commenter argued that 
the broker-dealer margin rules are not consistent with the restrictions 
on re-hypothecation recommended by the BCBS/IOSCO Paper.\323\ This 
commenter stated that the Commission needed to tailor its margin 
requirements to the realities of the security-based swap and swap 
markets.
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    \322\ The CFTC and the prudential regulators incorporated the 
recommendations in the BCBS/IOSCO Paper into their final margin 
rules for non-cleared security-based swaps and/or swaps. See CFTC 
Margin Adopting Release, 81 FR 636; Prudential Regulator Margin and 
Capital Adopting Release, 80 FR 74840.
    \323\ See Letter from Paul Schott Stevens, President and CEO, 
Investment Company Institute (May 11, 2015) (``ICI 5/11/2015 
Letter'').
---------------------------------------------------------------------------

    Another commenter appreciated that the Commission largely modeled 
its proposed margin rules on the broker-dealer margin rules in an 
effort to promote consistency with existing rules, but suggested that 
the Commission more closely conform its final rules to the 
recommendations in the final BCBS/IOSCO Paper to promote the 
comparability of margin requirements among jurisdictions.\324\ A second 
commenter noted that material differences and inconsistencies between 
the proposal and domestic and international standards could cause a 
need for separate documentation and tri-party arrangements for 
security-based swaps and swaps, which could lead to separate margin 
calls and different netting sets.\325\
---------------------------------------------------------------------------

    \324\ See MFA 2/22/2013 Letter.
    \325\ See SIFMA AMG 11/19/2018 Letter.
---------------------------------------------------------------------------

    A commenter suggested that the Commission coordinate its margin 
rules with the CFTC and the prudential regulators and raised a concern 
that the cumulative effects of multiple regulations potentially could 
tie up significant amounts of financial resources.\326\ Other 
commenters recommended re-proposing the margin rule after publication 
of the final recommendations of the BCBS/IOSCO Paper, as well as 
coordinating and harmonizing with the margin rules of the CFTC and 
other foreign and domestic regulators.\327\ A commenter argued that 
inconsistent rules potentially could be incompatible in practice and 
that international adoption of the recommended standards in the BCBS/
IOSCO Paper will prevent regulatory arbitrage and lead to a more level 
playing field between competitors in different jurisdictions.\328\ 
Other commenters argued that the Commission should more closely align 
its margin requirements to the recommended standards in the BCBS/IOSCO 
Paper to promote more comparable margin requirements across 
jurisdictions.\329\ One commenter argued that several components of the 
proposed margin rules differ from the recommended framework in the 
BCBS/IOSCO Paper and would generally make nonbank SBSDs uncompetitive 
with bank SBSDs and foreign SBSDs.\330\ The commenter argued that the 
Commission could best address these differences by permitting OTC 
derivatives dealers and stand-alone SBSDs to collect and maintain 
margin in a manner consistent with the recommendations in the BCBS/
IOSCO Paper.
---------------------------------------------------------------------------

    \326\ See Financial Services Roundtable Letter.
    \327\ See, e.g., Letter from William J. Harrington (Nov. 19, 
2018) (``Harrington 11/19/2018 Letter''); ICI 1/23/2013 Letter; ICI 
11/19/2018 Letter; ISDA 1/23/13 Letter; Morgan Stanley 10/29/2014 
Letter; PIMCO Letter; SIFMA AMG 11/19/2018 Letter. The CFTC and the 
prudential regulators re-proposed their margin rules after 
publication of the BCBS/IOSCO Paper. See Margin Requirements for 
Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 FR 
59898 (Oct. 3, 2014); Margin and Capital Requirements for Covered 
Swap Entities, 79 FR 57348 (Sept. 24, 2014). As noted above, these 
agencies incorporated the recommendations of the BCBS/IOSCO Paper 
into their final margin rules. The Commission reopened the comment 
period for the proposed capital, margin, and segregation 
requirements in October 2018--well after the final recommendations 
of the BCBS/IOSCO Paper. In reopening the comment period, the 
Commission asked specific questions about potential rule language 
that would modify rule text in the proposed margin rule. See 
Capital, Margin, and Segregation Comment Reopening.
    \328\ See ISDA 2/5/2014 Letter.
    \329\ See American Council of Life Insurers 2/22/2013 Letter; 
American Council of Life Insurers 11/19/2018 Letter; Letter from Dan 
Waters, Managing Director, ICI Global (Nov. 24, 2014) (``ICI Global 
11/24/2014 Letter''); MFA 2/22/2013 Letter; Letter from Christopher 
A. Klem, Leigh R. Fraser, and Molly Moore, Ropes & Gray LLP (Jan. 
22, 2013) (``Ropes & Gray Letter''); SIFMA 11/19/2018 Letter.
    \330\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Section 15F(e)(3)(D) of the Exchange Act requires that, to the 
maximum extent practicable, the Commission, the CFTC, and the 
prudential regulators shall establish and maintain comparable minimum 
initial and variation margin requirements for SBSDs and MSBSPs. In 
response to the comments above, the Commission has modified the 
proposal to more closely align the final rule with the margin rules of 
the CFTC and the prudential regulators and, in doing so,

[[Page 43909]]

the recommendations in the IOSCO/BCBS Paper. As discussed in more 
detail below, these modifications to harmonize the final rule include:
     An extra day to collect margin in the event a counterparty 
is located in a different country and more than 4 time zones away;
     A requirement that SBSDs post variation margin to most 
counterparties;
     An exception pursuant to which a nonbank SBSD need not 
collect initial margin to the extent that the initial margin amount 
when aggregated with other security-based swap and swap exposures of 
the nonbank SBSD and its affiliates to the counterparty and its 
affiliates does not exceed a fixed-dollar $50 million threshold;
     An exception pursuant to which a nonbank SBSD need not 
collect initial margin from a counterparty that is an affiliate of the 
nonbank SBSD;
     An exception pursuant to which a nonbank SBSD need not 
collect variation or initial margin from a counterparty that is the 
BIS, the European Stability Mechanism, or certain multilateral 
development banks;
     An exception pursuant to which a nonbank SBSD need not 
collect initial margin from a counterparty that is a sovereign entity 
with minimal credit risk;
     An option for nonbank SBSDs to use models to calculate 
initial margin that are different from the models they use to calculate 
capital charges;
     An option for nonbank SBSDs to use models developed by 
third parties (which will permit the use of an industry standard model 
such as ISDA's SIMMTM model); \331\
---------------------------------------------------------------------------

    \331\ Information about ISDA's SIMMTM model is 
available at https://www.isda.org/category/margin/isda-simm/.
---------------------------------------------------------------------------

     An option for stand-alone SBSDs to use a model to 
calculate initial margin for equity security-based swaps subject to 
certain conditions;
     An option for nonbank SBSDs to collect and deliver 
collateral that is eligible under the CFTC's margin rules; and
     An option for nonbank SBSDs to use the standardized 
haircuts prescribed in the CFTC's margin rule to determine deductions 
for collateral received or delivered as margin.
    While differences remain, the Commission believes the final nonbank 
SBSD margin rule for non-cleared security-based swaps is largely 
comparable to the margin rules of the CFTC and the prudential 
regulators. The main differences are that the Commission's rule:
     Does not require (but permits) nonbank SBSDs to collect 
initial margin from counterparties that are financial market 
intermediaries such as SBSDs, swap dealers, FCMs, and domestic and 
foreign broker-dealers and banks;
     Does not require (but permits) nonbank SBSDs to post 
initial margin to a counterparty;
     Does not contain the exceptions from the requirement to 
collect margin for counterparties such as financial end users that do 
not have material exposures to security-based swaps and swaps; and
     Does not require (but permits) initial margin to be held 
at a third-party custodian.
    These differences between the Commission's final rule and the 
margin rules of the CFTC and the prudential regulators reflect the 
Commission's judgment of how ``to help ensure the safety and 
soundness'' of nonbank SBSDs and MSBSPs as required by Section 
15F(e)(3)(i) of the Exchange Act. The Commission has sought to strike 
an appropriate balance between addressing the concerns of commenters 
and promulgating a final margin rule that promotes the safety and 
soundness of nonbank SBSDs.\332\ For these reasons, the Commission is 
adopting a final rule--Rule 18a-3--that is modeled on the broker-dealer 
margin rule but with the significant modifications noted above. These 
modifications further harmonize the rule with the final margin rules of 
the CFTC and the prudential regulators. In particular, and as discussed 
in more detail below, these changes are intended, in part, to permit 
firms that are registered as SBSDs and swap dealers to collect initial 
margin and collect and deliver variation margin in a manner consistent 
with current practices under the CFTC's margin rules, which should in 
turn reduce operational burdens that would arise due to differences in 
these requirements.\333\ Moreover, while paragraphs (c)(4) and (5) of 
Rule 18a-3, as adopted, respectively require netting and collateral 
agreements to be in place,\334\ the rule does not impose a specific 
margin documentation requirement as do the margin rules of the CFTC and 
the prudential regulators.\335\ Consequently, an existing netting or 
collateral agreement with a counterparty that was entered into by the 
nonbank SBSD in order to comply with the margin documentation 
requirements of the CFTC or the prudential regulators will suffice for 
the purposes of Rule 18a-3, as adopted, if the agreement meets the 
requirements of paragraph (c)(4) or (5), as applicable.
---------------------------------------------------------------------------

    \332\ See Section VI of this release (discussing benefits and 
costs of the final margin requirements).
    \333\ Furthermore, although Rule 18a-3 does not mandate that 
SBSDs deliver initial margin to their counterparties (or to deliver 
or collect initial margin from financial market intermediaries) as 
the CFTC's margin rules do, nothing in Rule 18a-3 prohibits nonbank 
SBSDs from delivering initial margin to these counterparties or 
collecting initial margin from or posting initial margin to 
financial market intermediaries. In addition, as above in section 
II.A.2.b.i. of this release, the Commission is providing guidance 
that would permit nonbank SBSDs to post initial margin to 
counterparties without taking a capital charge pursuant to certain 
conditions.
    \334\ See paragraph (c)(4) of Rule 18a-3, as adopted (providing 
that a nonbank SBSD or MSBSP may take into account the fair market 
value of collateral delivered by a counterparty, provided the 
collateral is subject to an agreement between the SBSD or the MSBSP 
and the counterparty that is legally enforceable by the SBSD or 
MSBSP against the counterparty and any other parties to the 
agreement); paragraph (c)(5) of Rule 18a-3, as adopted (prescribing 
requirements for qualified netting agreements).
    \335\ See 17 CFR 23.159 (CFTC rule requiring that margin 
documentation: (1) Specify the methods, procedures, rules, inputs, 
and data sources to be used for determining the value of non-cleared 
swaps for purposes of calculating variation margin; (2) describe the 
methods, procedures, rules, inputs, and data sources to be used to 
calculate initial margin for non-cleared swaps entered into between 
the covered swap entity and the counterparty; and (3) specify the 
procedures by which any disputes concerning the valuation of non-
cleared swaps, or the valuation of assets collected or posted as 
initial margin or variation margin may be resolved); see also CFTC 
Margin Adopting Release, 81 FR at 672-73, 702-3; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74886-87, 
74908-909.
---------------------------------------------------------------------------

2. Margin Requirements for Nonbank SBSDs and Nonbank MSBSPs
a. Daily Calculations
i. Nonbank SBSDs
    Proposed Rule 18a-3 required a nonbank SBSD to perform two 
calculations for the account of each counterparty: (1) The amount of 
equity in the account (variation margin); and (2) the initial margin 
amount for the account.\336\ The term ``equity'' was defined to mean 
the total current fair market value of securities positions in an 
account of a counterparty (excluding the time value of an over-the-
counter option), plus any credit balance and less any debit balance in 
the account after applying a qualifying netting agreement with respect 
to gross derivatives payables and receivables meeting the requirements 
of the rule. As indicated by the definition, the Commission proposed 
that the nonbank SBSD could offset payables and receivables relating to 
derivatives in the account by applying a qualifying netting agreement 
with the counterparty. Proposed Rule 18a-3 set forth the requirements 
for a netting agreement to qualify for this treatment. The equity in 
the account was the amount that resulted after

[[Page 43910]]

marking-to-market the securities positions and adding the credit 
balance or subtracting the debit balance (including giving effect to 
qualifying netting agreements). An account with negative equity was 
subject to a variation margin requirement unless an exception from 
collecting collateral to cover the negative equity (i.e., the nonbank 
SBSD's current exposure) applied.
---------------------------------------------------------------------------

    \336\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70260-62.
---------------------------------------------------------------------------

    The proposed rule set forth a standardized and a model-based 
approach for calculating initial margin.\337\ The rule divided 
security-based swaps into two classes for purposes of the standardized 
approach: (1) CDS; and (2) all other security-based swaps. In both 
cases, the initial margin amount was to be calculated using the 
standardized haircuts in the proposed capital rules for nonbank SBSDs.
---------------------------------------------------------------------------

    \337\ See 77 FR at 70261.
---------------------------------------------------------------------------

    Proposed Rule 18a-3 provided that, if the nonbank SBSD was 
authorized to use model-based haircuts, the firm could use them to 
calculate initial margin for security-based swaps for which the firm 
had been approved to apply such haircuts.\338\ However, model-based 
haircuts could not be used to calculate initial margin for equity 
security-based swaps. Initial margin for equity security-based swaps 
needed to be calculated using standardized haircuts in order to be 
consistent with SRO margin rules for cash equity positions. 
Consequently, a nonbank SBSD authorized to use model-based haircuts for 
certain types of debt security-based swaps could use these haircuts to 
calculate initial margin for the same types of positions. For all other 
positions, a nonbank SBSD needed to use the standardized haircuts. 
Nonbank SBSDs not authorized to use model-based haircuts needed to use 
the standardized haircuts to calculate initial margin for all types of 
positions.
---------------------------------------------------------------------------

    \338\ In the 2018 comment reopening, the Commission also sought 
comment on whether the margin rule should permit nonbank SBSDs to 
apply to use models other than proprietary capital models to compute 
initial margin, including applying to use an industry standard 
model. Capital, Margin, and Segregation Comment Reopening, 83 FR at 
53013.
---------------------------------------------------------------------------

    Finally, proposed Rule 18a-3 required a nonbank SBSD to increase 
the frequency of the variation and initial margin calculations (i.e., 
perform intra-day calculations) during periods of extreme volatility 
and for accounts with concentrated positions.\339\
---------------------------------------------------------------------------

    \339\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70260.
---------------------------------------------------------------------------

Comments and Final Requirements To Calculate Variation Margin
    A commenter sought clarification as to whether the mark-to-market 
value of security-based swap positions would only be counted in the 
definition of ``equity'' as part of the credit balance or the debit 
balance, as appropriate.\340\ This commenter believed the absence of 
credit and debit balance definitions created a potential issue that the 
mark-to-market value of non-cleared security-based swap positions would 
be double counted in the calculation of the equity in a counterparty's 
account. In response, a nonbank SBSD should only include the mark-to-
market value of a security-based swap once when calculating equity in 
determining the variation margin requirement.
---------------------------------------------------------------------------

    \340\ See SIFMA 2/22/13 Letter.
---------------------------------------------------------------------------

    Another commenter stated that counterparties should be permitted to 
reference third parties for dispute resolution, valuations, and inputs 
in relation to their account equity variation margin calculations.\341\ 
In response, the Commission agrees that price and valuation information 
from third parties can be useful in validating the nonbank SBSD's 
variation margin calculations and in the dispute resolution process.
---------------------------------------------------------------------------

    \341\ See Letter from Kevin Gould, President, Markit (Feb. 22, 
2013) (``Markit Letter'').
---------------------------------------------------------------------------

    The Commission is adopting the requirement to calculate variation 
margin for the account of a counterparty on a daily basis, with certain 
non-substantive modifications to the rule, in response to comments and 
to use terms that are more commonly used in the security-based swap 
market.\342\ In the final rule, the Commission has deleted the term 
``equity'' and the definitions of ``positive equity'' and ``negative 
equity'' and has included the phrase ``current exposure'' without 
defining it.\343\ The phrase ``current exposure'' is used more commonly 
in the non-cleared security-based swap market when describing 
uncollateralized mark-to-market gains or losses.
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    \342\ See paragraph (c)(1)(i)(A) of Rule 18a-3, as adopted.
    \343\ See paragraph (c)(1)(i)(A) of Rule 18a-3, as adopted. The 
Commission also proposed to define the term ``positive equity'' to 
mean equity of greater than $0 and ``negative equity'' to mean 
equity of less than $0. The Commission received no comments on these 
proposed definitions. However, the Commission is deleting them in 
the final rule because the term equity is no longer being defined. 
In addition, paragraph (b)(1) of proposed Rule 18a-3 defined the 
term ``account'' for purposes of the daily calculations of variation 
and initial margin to mean an account carried by a nonbank SBSD or 
MSBSP for a counterparty that holds non-cleared security-based 
swaps. The Commission did not receive any comments on this 
definition. However, the Commission is modifying the definition to 
move the clause ``for a counterparty'' to the end of the definition 
to clarify that the nonbank SBSD holds non-cleared security-based 
swaps for a counterparty, and to add the term ``one or more'' before 
the phrase ``non-cleared security-based swaps.'' Furthermore, 
paragraph (b)(3) of proposed Rule 18a-3 defined the term 
``counterparty'' to mean a person with whom the nonbank SBSD or 
MSBSP has entered into a non-cleared security-based swap 
transaction. The Commission received no comments on this definition 
and is adopting it as proposed.
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Comments and Final Requirements To Calculate Initial Margin Using the 
Standardized Approach
    Commenters argued that the standardized approach to calculating 
initial margin was too conservative and not sufficiently risk 
sensitive.\344\ A commenter stated that the standardized approach would 
result in excessive margin requirements because the standardized 
haircuts in the capital rules were applied to gross notional amounts 
and only permitted limited netting.\345\ This commenter also argued 
that it was unclear how the proposed grids applied to more complex 
products.
---------------------------------------------------------------------------

    \344\ See ISDA 1/23/2013 Letter; Markit Letter.
    \345\ See ISDA 1/23/2013 Letter.
---------------------------------------------------------------------------

    In response to these concerns, nonbank SBSDs may seek authorization 
to calculate initial margin using the model-based approach. Based on 
staff experience and the ongoing implementation of margin rules for 
non-cleared security-based swaps and swaps by other regulators and 
market participants, the Commission believes that most nonbank SBSDs 
will seek authorization to use a model. The availability of an initial 
margin model and the widespread use of initial margin models by 
industry participants should alleviate commenters' concerns that using 
standardized haircuts to calculate initial margin will lead to 
excessive initial margin requirements. While the Commission agrees that 
standardized haircuts likely will lead to more conservative 
requirements in contrast to the model-based initial margin 
calculations, the Commission does not believe these requirements will 
be excessive. The standardized haircuts have been used by stand-alone 
broker-dealers for many years. Moreover, as discussed below, the 
Commission is modifying the proposal to add a threshold under which 
initial margin need not be collected. This should mitigate the concern 
raised by the commenter with regard to using the standardized haircuts 
to calculate initial margin. Finally, the ability to use the simpler 
standardized haircuts for initial margin calculations may be preferable 
for nonbank SBSDs that occasionally trade in non-cleared security-based 
swaps but not in a substantial enough

[[Page 43911]]

volume to justify the initial and ongoing systems and personnel costs 
that may be associated with the implementation and operation of an 
initial margin model.
    Commenters argued that nonbank SBSDs should be permitted to use 
approaches other than the standardized approach to calculate initial 
margin for equity security-based swaps.\346\ One commenter stated that 
the standardized haircuts in the capital rules that would be used to 
calculate initial margin for equity security-based swaps--including the 
more risk sensitive standardized haircut approach in Rule 15c3-1a and 
proposed Rule 18a-1a (``Appendix A methodology'')--are inadequate and 
inefficient for a proper initial margin calculation and do not 
sufficiently recognize portfolio margining. This commenter argued that 
the Appendix A methodology does not incorporate critical factors such 
as volatility, and, as a result, initial margin on equity security-
based swaps would likely be insufficient in times of market stress (in 
contrast to a model-based approach). Finally, this commenter stated 
that requiring the Appendix A methodology for non-cleared equity 
security-based swaps would place U.S.-based nonbank SBSDs at a 
competitive disadvantage in the market because no other jurisdiction 
(or other U.S. regulator) has proposed to prohibit the use of models 
for specific asset classes.\347\ Another commenter similarly raised 
concerns that applying the Appendix A methodology (as compared to a 
model) would result in initial margin requirements that are 
substantially less sensitive to the economic risks of a security-based 
swap portfolio, and suggested that the Commission permit a nonbank SBSD 
to use a model to calculate initial margin for equity security-based 
swaps.\348\ Several other commenters endorsed the use of models to 
compute initial margin for equity security-based swaps.\349\
---------------------------------------------------------------------------

    \346\ See ISDA 1/23/2013 Letter; SIFMA 2/22/2013 Letter; SIFMA 
11/19/2018 Letter.
    \347\ See ISDA 1/23/2013 Letter.
    \348\ See SIFMA 2/22/2013 Letter.
    \349\ See Center for Capital Markets Competitiveness, Chamber of 
Commerce 11/19/2018 Letter; Letter from Scott O'Malia, Chief 
Executive Officer, International Swaps and Derivatives Association 
(Nov. 19, 2018) (``ISDA 11/19/2018''); OneChicago 11/19/2018 Letter; 
SIFMA AMG 2/22/2013 Letter; SIFMA 11/19/2018 Letter. One commenter 
suggested that the Commission permit stand-alone SBSDs and SBSDs 
dually-registered as OTC derivatives dealers to calculate initial 
margin for equity security-based swaps using an industry standard 
model such as SIMMTM. See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission continues to believe it is important to maintain 
parity between the margin requirements in the cash equity markets and 
the margin requirements for equity security-based swaps. The only 
method currently available to portfolio margin positions in the cash 
equity markets is the Appendix A methodology.\350\ Consequently, the 
Commission is adopting the requirement to use the standardized approach 
to calculate initial margin for non-cleared equity security-based 
swaps, but with a modification to address commenters' concerns.\351\ In 
particular, the Commission is modifying the margin rule to permit a 
stand-alone SBSD to use a model to calculate initial margin for non-
cleared equity security-based swaps, provided the account does not hold 
equity security positions other than equity security-based swaps and 
equity swaps (e.g., the account cannot hold long and short positions, 
options, or single stock futures).\352\ The Commission believes 
permitting the model-based approach under these limited circumstances 
strikes an appropriate balance in terms of addressing commenters' 
concerns and maintaining regulatory parity between the cash equity 
market and the equity security-based swap market. Moreover, a nonbank 
stand-alone SBSD could seek authorization to use a model to portfolio 
margin equity security-based swaps with equity swaps. Similarly, as 
discussed above in relation to the standardized haircuts, the 
Commission modified the Appendix A methodology from the proposal to 
permit equity swaps to be included in a portfolio of equity products. 
The ability to use the model-based approach for equity security-based 
swaps (and potentially equity swaps) and the modification to the 
Appendix A methodology will facilitate portfolio margining of equity 
security-based swaps and equity swaps, though the Commission and the 
CFTC will need to coordinate further to implement this type of 
portfolio margining.\353\
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    \350\ See FINRA Rule 4210(g).
    \351\ See paragraph (d)(1) of Rule 18a-3, as adopted. In the 
final rule, the Commission replaced the term ``margin'' with the 
term ``initial margin amount'' and replaced the phrase ``of positive 
equity in an account of a counterparty'' with the phrase 
``calculated pursuant to paragraph (d) of this section.'' See 
paragraph (b)(4) of Rule 18a-3, as adopted. These are non-
substantive changes to conform the rule text to changes made to 
other paragraphs of the final rule. In addition, in the final rule 
the Commission deleted the phrase ``calculated pursuant to paragraph 
(d)(2) of this section'' from paragraph (c)(1)(i)(B) of the rule, 
because the phrase, as modified, was moved to paragraph (b)(4) of 
the rule to define the term ``initial margin amount.''
    \352\ See paragraph (d)(2)(ii) of Rule 18a-3, as adopted. See 
also Capital, Margin, and Segregation Comment Reopening, 83 FR at 
53015-16. In the reopening, the potential modifications to the rule 
contained the phrase ``provided, however, the account of the 
counterparty subject to the requirements of this paragraph may not 
hold equity securities or listed options.'' 83 FR at 53016. The 
final rule contains the phrase ``provided, however, the account of 
the counterparty subject to the requirements of this paragraph may 
not hold equity security positions other than equity security-based 
swaps and equity swaps.'' The final rule clarifies that the account 
of a counterparty utilizing this paragraph may not hold equity 
security positions other than equity security-based swaps and equity 
swaps.
    \353\ See, e.g., Order Granting Conditional Exemption Under the 
Securities Exchange Act of 1934 in Connection with Portfolio 
Margining of Swaps and Security-Based Swaps, 77 FR 75211.
---------------------------------------------------------------------------

Comments and Final Requirements To Calculate Initial Margin Using the 
Model-Based Approach
    Comments addressing the model-based approach to calculating initial 
margin generally fell into one of two broad categories: (1) Comments 
raising concerns about the risks of using models; and (2) comments 
supporting the use of models but suggesting modifications to the 
proposal or seeking clarifications as to how the proposal would work in 
practice.
    In terms of concerns about the risks of models, one commenter 
argued that using models for capital and margin calculations likely 
will make capital and margin more pro-cyclical because market data used 
in the models will show less risk during strong periods of the economic 
cycle and more risk during downturns.\354\ This commenter recommended, 
among other things, that if internal models continue to be used, they 
should be ``floored'' at the level set by standardized approaches 
(e.g., those used in bank capital regimes), and that the Commission 
should continue with a review of the implications of the use of 
internal models. Another commenter stated that netting derivatives 
exposures (a component of model-based initial margin calculations) when 
calculating potential losses is an unsound risk management 
practice.\355\ According to the commenter, even if two positions appear 
to offset one another, liquidity conditions, replacement costs, and 
counterparty credit risk may vary considerably.
---------------------------------------------------------------------------

    \354\ See Americans for Financial Reform Letter.
    \355\ See Better Markets 1/22/2013 Letter; Better Markets 7/22/
2013 Letter.
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    The Commission acknowledges the concerns expressed by commenters 
about the efficacy of models, particularly in times of market stress. 
The Commission nonetheless believes it is appropriate to permit firms 
to employ a model to calculate initial margin. The Commission's 
supervision of the firms' use of models as well as the conditions that 
will be imposed governing their use will provide checks that are 
designed to address the risks identified by the

[[Page 43912]]

commenters, such as the potential for firms to manipulate their 
collateral needs. In addition, the CFTC, the prudential regulators, and 
foreign financial regulators permit the use of internal models to 
calculate initial margin. Permitting nonbank SBSDs to use models for 
this purpose will further harmonize the Commission's margin rule with 
the rules of domestic and foreign regulators and, therefore, minimize 
potential competitive impacts of imposing different requirements.
    Commenters supporting the use of models commented on the proposed 
requirement that the initial margin model needed to be the same model 
used by the nonbank SBSD to calculate haircuts for purposes of the 
proposed capital rules. These commenters supported the Commission's 
potential modification to permit nonbank SBSDs to use models other than 
proprietary capital models to compute initial margin, including an 
industry standard model.\356\ A commenter stated that the rule should 
provide a nonbank SBSD with the option to choose between internal and 
third-party models to avoid an uneven playing field among 
counterparties, noting that not all entities have sufficient resources 
to develop internal models.\357\ This commenter argued that permitting 
a nonbank SBSD to use a third-party model would reduce the time and 
resources needed for the Commission to authorize the use of the model. 
A second commenter requested that nonbank SBSDs be permitted to use an 
industry standard model to compute initial margin and argued that such 
a model would result in efficiency, transparency, and consistency in 
the marketplace.\358\ Other commenters generally supported the use of 
an industry standard model to compute initial margin.\359\
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    \356\ See Center for Capital Markets Competitiveness, Chamber of 
Commerce 11/19/2018 Letter; ISDA 11/19/2018 Letter; MFA/AIMA 11/19/
2018 Letter; SIFMA 11/19/2018 Letter.
    \357\ See Markit Letter.
    \358\ See SIFMA 3/12/2014 Letter; SIFMA 11/19/2018 Letter.
    \359\ See Center for Capital Markets Competitiveness, Chamber of 
Commerce 11/19/2018 Letter; MFA/AIMA 11/19/2018 Letter; SIFMA 11/19/
2018 Letter.
---------------------------------------------------------------------------

    Making a similar point about the benefits of model transparency, a 
commenter suggested that internal models should be available to 
counterparties upon request.\360\ Similarly, commenters suggested that 
the ability of a counterparty to replicate a firm's initial margin 
model should be a condition of the Commission's approval of the model, 
or that the calculation of initial margin should be independently 
verifiable.\361\ A commenter argued that external models, in some 
cases, are preferable to internal models because there is less 
potential for firms to manipulate their collateral needs.\362\ The 
commenter also supported the use of pre-approved clearing agency and 
DCO models as one input in the calculation of initial margin for non-
cleared positions, but cautioned that additional inputs should be 
required. The commenter opposed the use of vendor-supplied models for 
the calculation of margin due to concerns that vendors may develop 
models that would help firms minimize required margin.
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    \360\ See Sutherland Letter.
    \361\ See MFA 2/22/2013 Letter; MFA/AIMA 11/19/2018 Letter; 
Letter from Timothy W. Cameron, Managing Director, and Matthew J. 
Nevins, Managing Director and Associate General Counsel, Securities 
Industry and Financial Markets Association Asset Management Group 
(Feb. 22, 2013) (``SIFMA AMG 2/22/2013 Letter'').
    \362\ See CFA Institute Letter.
---------------------------------------------------------------------------

    Commenters also addressed the potential offsets that could be 
permitted with respect to the model-based initial margin calculations. 
A commenter argued that netting should be limited to exactly offsetting 
positions and that positions that are potentially correlated due to, 
for example, long and short positions in the same broad industry should 
not be permitted to be offset.\363\ On the other hand, another 
commenter requested that counterparties be permitted to use a broader 
product set to calculate initial margin than the set required by each 
counterparty's applicable regulation.\364\ The commenter stated that 
this broader product set potentially could include a wide set of 
bilaterally traded products, even if such products are not swaps or 
derivatives. Other commenters asked the Commission to clarify whether 
cleared and non-cleared security-based swaps could be offset.\365\ A 
commenter stated that if U.S. registrants must structure their 
activities so as to margin non-centrally cleared security-based swaps 
and swaps separately from other non-centrally cleared derivatives, they 
would be at a significant competitive disadvantage to foreign 
competitors.\366\ Another commenter encouraged the Commission to 
consider allowing participants to calculate the risk of positions 
within broad asset classes and then sum the risk calculations for each 
asset class.\367\ A commenter also stated that it is essential that 
national supervisors provide consistent and more comprehensive guidance 
regarding model inputs (including baseline stress scenarios) and the 
adjustment of model inputs.\368\ Commenters supported the cross-
margining of security-based swaps with other products under a single 
cross-product netting agreement, as well as the portfolio margining of 
cleared security-based swaps and swaps.\369\
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    \363\ See Americans for Financial Reform Letter.
    \364\ See Letter from Mary P. Johannes, Senior Director and Head 
of ISDA WGMR Initiative, International Swaps and Derivatives 
Association (May 15, 2015) (``ISDA 5/15/2015 Letter'').
    \365\ See, e.g., AIMA 2/22/2013 Letter; Letter from American 
Benefits Council, Committee on Investment of Employee Benefit 
Assets, European Federation for Retirement Provision, the European 
Association of Paritarian Institutions, the National Coordinating 
Committee for Multiemployer Plans, and the Pension Investment 
Association of Canada (Jan. 29, 2013) (``American Benefits Council, 
et al. 1/29/2013 Letter''); ISDA 2/5/2014 Letter; MFA 2/22/2013 
Letter; Ropes & Gray Letter; SIFMA 2/22/2013 Letter.
    \366\ See Letter from Kenneth E. Bentsen, Jr., President and 
Chief Executive Officer, Securities Industry and Financial Markets 
Association (Mar. 12, 2014) (``SIFMA 3/12/2014 Letter'').
    \367\ See ISDA 2/5/2014 Letter.
    \368\ See SIFMA 3/12/14 Letter.
    \369\ See FIA 11/19/2018 Letter; MFA/AIMA 11/19/20178 Letter; 
OneChicago 11/19/2018 Letter; SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Commenters also requested that the Commission facilitate portfolio 
margining.\370\ A commenter supported the Commission's proposal to 
allow portfolio margining between cash market securities and security-
based swaps, and encouraged the Commission to work with other 
regulators to make such an approach as expansive as possible.\371\ 
Other commenters encouraged the Commission to permit a nonbank SBSD 
(including a broker-dealer SBSD) to portfolio margin non-cleared 
security-based swaps with non-cleared swaps in accordance with the 
CFTC's margin and segregation rules, subject to appropriate conditions 
(including appropriately calibrated capital charges and waiver of 
customer protection rules).\372\ Another commenter argued that the 
CFTC, in turn, should expand its existing relief allowing a swap dealer 
to collect and post margin on a portfolio basis for swaps and security-
based swaps under the CFTC's margin rules by reciprocally allowing a 
dually registered swap dealer and nonbank SBSD to portfolio margin 
security-based swaps and swaps under the Commission's margin 
rules.\373\ One commenter suggested that the Commission clarify that 
the portfolio margining of cleared and non-cleared

[[Page 43913]]

security-based swaps and swaps should be permitted and encouraged the 
Commission to coordinate with the CFTC to determine appropriate 
conditions for enhanced portfolio margining.\374\
---------------------------------------------------------------------------

    \370\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53014-16. See also Center for Capital Markets Competitiveness, 
Chamber of Commerce 11/19/2018 Letter; ICI 11/19/2018 Letter; ISDA 
11/19/2018 Letter; SIFMA 11/19/2018 Letter.
    \371\ See Financial Services Roundtable Letter.
    \372\ See Citigroup 4/24/2018 Meeting; IIB/SIFMA Letter.
    \373\ See IIB/SIFMA Letter; see also CFTC Letter 16-71 (Aug. 23, 
2016).
    \374\ See MFA/AIMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    To expedite the approval process, some commenters suggested that 
the Commission permit the use of initial margin models approved by 
other domestic and foreign regulators, or a model already approved for 
a firm's parent company.\375\ One commenter suggested that the 
Commission provisionally approve proprietary models used by nonbank 
SBSDs when the margin rules first become effective subject to further 
Commission review.\376\ The commenter argued that such a process would 
prevent those firms whose models were reviewed earlier from having an 
unfair market advantage over those firms that are positioned later in 
the Commission's review schedule.
---------------------------------------------------------------------------

    \375\ See IIB11/19/2018 Letter; ISDA 1/23/2013 Letter; SIFMA 3/
12/2014 Letter.
    \376\ See ISDA 1/23/2013 Letter.
---------------------------------------------------------------------------

    Other commenters argued that the Commission should restrict the use 
of portfolio margining to ensure greater security for market 
participants, or stated that the Commission did not provide an 
explanation as to how the Commission would oversee portfolio margin 
models.\377\
---------------------------------------------------------------------------

    \377\ See Americans for Financial Reform Education Fund Letter; 
Better Markets 11/19/2018 Letter; Rutkowski 11/20/2018 Letter. 
Another commenter opposed the portfolio margining of swaps with flip 
clauses, walkaway clauses, or similar provisions. See Harrington 11/
19/2018 Letter.
---------------------------------------------------------------------------

    In response to comments, the Commission made the following 
modifications to the proposed model-based approach to calculating 
initial margin: (1) Nonbank SBSDs may use a model other than their 
capital model; (2) the final rule provides more clarity as to the 
offsets permitted of an initial margin model; (3) the final rule 
permits stand-alone SBSDs to use a model to portfolio margin equity 
security-based swaps and will permit these entities to include equity 
swaps in the portfolio, subject to further coordination with the CFTC; 
and (4) as discussed above in section II.A.2.b.iv. of this release, the 
final capital rule provides that the Commission may approve the 
temporary use of a provisional model by a nonbank SBSD for the purposes 
of calculating initial margin if the model had been approved by certain 
other supervisors.
    As indicated, the final rule does not limit a nonbank SBSD to using 
its capital model to calculate initial margin.\378\ For example, after 
the Commission proposed Rule 18a-3, the CFTC and the prudential 
regulators adopted final margin rules permitting the use of a model to 
calculate initial margin subject to the approval of the CFTC or a 
firm's prudential regulator.\379\ The first compliance date for these 
rules for both variation and initial margin was September 1, 2016 for 
the largest firms.\380\ The Commission understands that the firms 
subject to these final rules have widely adopted the use of an industry 
standard model to compute initial margin.\381\ Based on these 
developments, the Commission believes that most nonbank SBSDs likely 
will apply to the Commission to use the industry standard model to 
compute initial margin. The final rule permits the use of such a model, 
subject to approval by the Commission.
---------------------------------------------------------------------------

    \378\ See paragraph (d)(2) of Rule 18a-3, as adopted. See 
Capital, Margin, and Segregation Comment Reopening, 83 FR at 53012-
13 (soliciting comment on potential rule language that would modify 
the proposal in this manner).
    \379\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74876; CFTC Margin Adopting Release, 81 FR at 654.
    \380\ See, e.g., Prudential Regulator Margin and Capital 
Adopting Release, 80 FR at 74849-74851; CFTC Margin Adopting 
Release, 81 FR at 674-677. Variation margin requirements have been 
implemented pursuant to these rules, while initial margin 
requirements are being phased in through September 1, 2020.
    \381\ See, e.g., ISDA, ISDA SIMM\TM\ Deployed Today; New 
Industry Standard for Calculating Initial Margin Widely Adopted by 
Market Participants (Sept. 1, 2016), available at https://www.isda.org/2016/09/01/isda-simm-deployed-today-new-industry-standard-for-calculating-initial-margin-widely-adopted-by-market-participants/.
---------------------------------------------------------------------------

    The Commission believes that the ability to use an initial margin 
model (other than the firm's capital model)--including the industry 
standard model that has been widely adopted by market participants--
will mitigate many of the concerns raised by commenters. Counterparties 
will be better able to replicate the initial margin calculations of the 
nonbank SBSDs with whom they transact. Giving counterparties the 
ability to meaningfully estimate potential future initial margin calls 
will allow them to prepare for contingencies and minimize the risk of 
their failure to meet a margin call. This increased transparency will 
benefit the nonbank SBSD and the counterparty. Consequently, widespread 
use of an industry standard model to calculate initial margin may 
increase transparency and decrease margin disputes. This should 
mitigate commenters' concerns regarding the transparency of a nonbank 
SBSD's proprietary model used to calculate initial margin, as the 
Commission believes that most nonbank SBSDs likely will apply to the 
Commission to use the industry standard model to compute initial 
margin.
    The Commission acknowledges that some nonbank SBSDs may choose to 
use models other than the industry standard model. However, the 
anticipated widespread use of the industry standard model will provide 
counterparties with the option of taking their business to nonbank 
SBSDs that use this model to the extent they are concerned about a lack 
of transparency with respect to other models used by nonbank SBSDs. 
Moreover, this could incentivize firms that use other models to make 
them more transparent to market participants.
    The final rule also provides that the initial margin model must use 
a 99%, one-tailed confidence level with price changes equivalent to a 
10 business-day movement in rates and prices, and must use risk factors 
sufficient to cover all the material price risks inherent in the 
positions for which the initial margin amount is being calculated, 
including foreign exchange or interest rate risk, credit risk, equity 
risk, and commodity risk, as appropriate.\382\ Several commenters 
opposed a 10 business-day movement in rates and prices as part of the 
quantitative requirements for using a model and recommended that the 
Commission reduce the close-out period to 3 or 5 days.\383\ One of 
these commenters argued that a 10-day period substantially overstates 
the risk of many non-cleared security-based swaps and will create 
unnecessarily high initial margin requirements.\384\ Other commenters 
recommended that the Commission establish a more flexible, risk-
specific approach to determine and adjust the appropriate liquidation 
time horizon by product type or asset class.\385\
---------------------------------------------------------------------------

    \382\ See paragraph (d)(2) of Rule 18a-3, as adopted. This 
approach is consistent with the final margin rules of the CFTC and 
the prudential regulators. See Prudential Regulator Margin and 
Capital Adopting Release, 80 FR at 74906; CFTC Margin Adopting 
Release, 81 FR at 699.
    \383\ See American Benefits Council, et al. 1/29/2013 Letter; 
MFA 2/22/2013 Letter; PIMCO Letter; SIFMA AMG 2/22/2013 Letter.
    \384\ See American Benefits Council, et al. 1/29/2013 Letter.
    \385\ See MFA 2/22/2013 Letter; MFA/AIMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission believes the prudent approach is to retain the 
proposed 10 business-day period in the final requirements governing the 
use of models to calculate initial margin.\386\ The 10-day standard has 
been part of the quantitative requirements for broker-dealers in 
calculating model-based haircuts under the net capital rule since

[[Page 43914]]

the rule permitted the use of models. The Commission does not believe 
it would be appropriate to have a less conservative standard for 
calculating initial margin (which is designed to account for the risk 
of the counterparty's positions) than for calculating model-based 
haircuts under Rule 15c3-1e, as amended, and Rule 18a-1, as adopted 
(which is designed to account for the risk of the nonbank SBSD's own 
positions). Further, the Commission does not believe that a period of 
less than 10 business days--such as the 3 to 5 business-day period 
typically used by clearing agencies and DCOs--would be appropriate 
given that non-cleared security-based swaps may be, in some cases, less 
liquid than cleared security-based swaps in terms of how long it would 
take to close them out. Moreover, the initial margin model requirements 
of the CFTC and the prudential regulators mandate a 10-day standard 
and, therefore, the Commission's rule is harmonized with their 
rules.\387\
---------------------------------------------------------------------------

    \386\ See paragraph (d)(2) of Rule 18a-3, as adopted.
    \387\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74875; CFTC Margin Adopting Release, 81 FR at 653. 
See also BCBS/IOSCO Paper at 12.
---------------------------------------------------------------------------

    The final rule provides more clarity as to the offsets permitted in 
calculating initial margin using a model. In particular, it provides 
that an initial margin model must use risk factors sufficient to cover 
all the material price risks inherent in the positions for which the 
initial margin is being calculated, including foreign exchange or 
interest rate risk, credit risk, equity risk, and commodity risk, as 
appropriate.\388\ The final rule also provides that empirical 
correlations may be recognized by the model within each broad risk 
category, but not across broad risk categories. This means that each 
non-cleared security-based swap and related position must be assigned 
to a single risk category for purposes of calculating initial margin. 
Thus, the initial margin calculation can offset cleared and non-cleared 
security-based swaps (in answer to the question raised by some 
commenters) to the extent they are within the same asset class.\389\
---------------------------------------------------------------------------

    \388\ See paragraph (d)(2) of Rule 18a-3, as adopted. Although 
the final rule uses the term ``risk factors,'' the approach of 
assigning each non-cleared security-based swap to a specific risk 
factor category is sometimes referred to by market participants as 
the ``asset class approach.''
    \389\ However, the clearing agency's margin requirement for the 
cleared security-based swaps in a portfolio likely will permit 
offsets only for positions it clears.
---------------------------------------------------------------------------

    The presence of any common risks or risk factors across asset 
classes (e.g., credit, commodity, and interest rate risks) cannot be 
recognized for initial margin purposes. This approach is designed to 
help ensure a conservative and robust margin regime that potentially 
reduces counterparty exposures to offset the greater risk to the 
nonbank SBSD and the financial system arising from the use of non-
cleared security-based swaps.\390\ Margin calculations that limit 
correlations to asset classes generally will result in more 
conservative initial margin amounts than calculations that permit 
offsets across different asset classes. Finally, this approach is 
consistent with the final margin rules adopted by the CFTC and the 
prudential regulators, and with the industry standard model being used 
today to comply with the margin rules of the CFTC and the prudential 
regulators.\391\
---------------------------------------------------------------------------

    \390\ See Section 15F(e)(3)(A) of the Exchange Act.
    \391\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74876 (``Each derivative contract must be assigned 
to a single asset class in accordance with the classifications in 
the final rule (i.e., foreign exchange or interest rate, commodity, 
credit, and equity)''); CFTC Margin Adopting Release, 81 FR at 657-
58 (``The final rule does not permit an initial margin model to 
reflect offsetting exposures, diversification, or other hedging 
benefits across broad risk categories. Hence, the margin 
calculations for derivatives in distinct product-based asset 
classes, such as equity and credit, must be performed separately 
without regard to derivatives contracts in other asset classes. Each 
derivatives contract must be assigned to a single asset class. . 
.''). See also BCBS/IOSCO Paper at 12-13.
---------------------------------------------------------------------------

    The final rule permits stand-alone SBSDs to use a model to 
calculate initial margin for equity security-based swaps and will 
permit these entities to include equity swaps in the portfolio, subject 
to further coordination with the CFTC.\392\ Under the final rule, these 
entities are not required to use the standardized approach to calculate 
initial margin for equity security-based swaps. However, the account of 
a counterparty for which the stand-alone SBSD provides model-based 
portfolio margining may not hold equity security positions other than 
equity security-based swaps and equity swaps. Therefore, cash market 
positions such as long and short equity positions, listed options 
positions, and single stock futures positions cannot be held in the 
accounts or otherwise included in the portfolio margin calculations. 
This is designed to ensure that a stand-alone SBSD cannot provide more 
favorable treatment for these types of equity positions than a stand-
alone or ANC broker-dealer that is subject to the margin requirements 
of the Federal Reserve's Regulation T and the margin rules of the SROs.
---------------------------------------------------------------------------

    \392\ See paragraph (d)(2) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    A commenter requested that qualified netting agreements be 
permitted in calculating initial margin.\393\ Other commenters argued 
that effective netting agreements lower systemic risk by reducing both 
the aggregate requirement to deliver margin and trading costs for 
market participants.\394\ A commenter stated that netting, among other 
things, is an important tool for the reduction of counterparty credit 
risk.\395\ Another commenter supported the Commission's proposal to 
permit certain netting under a qualified netting agreement to determine 
margin requirements, stating that netting obligations under derivatives 
and other trading positions reduces counterparty credit risk and allows 
market participants to make the most efficient use of their 
capital.\396\ Finally, a commenter stated that differences in the 
security-based swap and swap margin rules may fragment the market by 
causing firms to engage only in a security-based swaps business through 
a Commission-regulated nonbank SBSD.\397\ The commenter stated that, 
upon the insolvency of a nonbank SBSD and an affiliated swap dealer, a 
counterparty would likely be unable to close out and net security-based 
swaps entered into with the nonbank SBSD with swaps entered into with 
the swap dealer because the entities are not the same. This commenter 
also believed that the Commission's proposals may undermine the 
mutuality of obligations for close-out netting, stating that the 
Commission appeared to treat a nonbank SBSD as an agent of the 
counterparty rather than a direct counterparty, which may cause a 
bankruptcy court to reject attempts by a counterparty to close out 
derivatives positions with the debtor.
---------------------------------------------------------------------------

    \393\ See MFA 2/22/2013 Letter.
    \394\ See AIMA 2/22/2013 Letter; MFA 2/22/2013 Letter.
    \395\ See MFA 2/22/2013 Letter.
    \396\ See Sutherland Letter.
    \397\ See ICI 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response, the Commission has modified the rule to clarify that 
qualified netting agreements may be used in the calculation of initial 
margin (in addition to variation margin).\398\ Generally, industry 
practice is to use netting in variation and initial margin 
calculations. Further, the Commission believes that in most cases a 
counterparty entering into a non-cleared security-based swap 
transaction with a nonbank SBSD will be a direct counterparty of the 
nonbank SBSD. In response to the comment regarding potential 
fragmentation of the market

[[Page 43915]]

and the proposed rule's effects on close-out netting, as discussed 
above, the Commission believes the final margin rule for non-cleared 
security-based swaps is largely comparable to the final margin rules of 
the CFTC and the prudential regulators.\399\ In addition, as discussed 
above, the Commission has modified the final rules to facilitate the 
portfolio margining of security-based swaps and swaps, subject to 
further coordination with the CFTC.\400\ For example, the Commission 
modified Rules 15c3-1a and 18a-1a to permit swaps to be included in the 
Appendix A methodology, which can be used by broker-dealer SBSDs to 
calculate initial margin.\401\ Moreover, the Commission modified 
paragraph (d)(2) of Rule 18a-3 to permit stand-alone SBSDs to use a 
model to portfolio margin equity security-based swaps with equity 
swaps, subject to certain conditions. The Commission believes that 
these modifications will provide a means for market participants to 
conduct security-based swap and swap activity in the same legal entity 
without incurring significant additional operational or compliance 
costs.
---------------------------------------------------------------------------

    \398\ Specifically, the Commission has modified paragraph (c)(5) 
in the final rule to delete the ``(A)'' from the reference to 
paragraph (c)(1)(i)(A) (as a result, paragraph (c)(5), governing the 
use of netting agreements, now refers to the variation and 
initiation margin calculations as opposed to just the variation 
margin calculation).
    \399\ See section II.B.1. of this release (summarizing 
similarities and differences between the Commission's final margin 
rules for non-cleared security-based swaps and the final margin 
rules of the CFTC and the prudential regulators).
    \400\ See also Order Granting Conditional Exemption Under the 
Securities Exchange Act of 1934 in Connection with Portfolio 
Margining of Swaps and Security-Based Swaps, 77 FR 75211.
    \401\ See also section II.A.2.b.iii. of this release (discussing 
adding swaps to the Appendix A methodology for purposes of the 
standardized haircuts).
---------------------------------------------------------------------------

    A commenter stated that the Commission's potential modification of 
the proposed rules to permit the use of an industry standard model 
provides too little information concerning the parameters that would be 
required for such models and the process for nonbank SBSDs to approve, 
establish, maintain, review, and validate margin models.\402\ In 
response, the final rule provides that a nonbank SBSD seeking approval 
to use a model (including an industry standard model) to calculate 
initial margin will be subject to the application process in Rule 15c3-
1e, as amended, or paragraph (d) of Rule 18a-1, as adopted, as 
applicable, governing the use of model-based haircuts.\403\ As part of 
the application process, the Commission staff will review whether the 
model meets the qualitative and quantitative requirements of Rule 18a-
3. Therefore, a nonbank SBSD will need to submit sufficient information 
to allow the Commission to make a determination regarding the 
performance of the nonbank SBSD's initial margin model. The use of 
internal models, industry standard models, or other models to calculate 
initial margin by nonbank SBSDs will be subject to the same application 
and approval process under the final rule. The application process and 
any condition imposed in connection with Commission approval of the use 
of the model should mitigate the risk that nonbank SBSDs will compete 
by implementing lower initial margin levels and should also help ensure 
that initial margin levels are set at sufficiently prudent levels to 
reduce risk to the firm and, more generally, systemic risk.
---------------------------------------------------------------------------

    \402\ See Better Markets 11/19/2018 Letter.
    \403\ If a nonbank SBSD's model is approved for use to compute 
initial margin under paragraph (d) of Rule 18a-3, the performance of 
the model would be subject to ongoing regulatory supervision, and 
the nonbank SBSD will need to submit an amendment to the Commission 
for approval before materially changing its model. See, e.g., Rule 
15c3-1e, as amended; paragraph (d) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    If an industry standard model is widely used by nonbank SBSDs, 
concerns about competing through lower margin requirements should be 
further mitigated. However, the Commission reiterates that each nonbank 
SBSD individually must receive approval from the Commission to use an 
initial margin model, including an industry standard model, because, 
among other things, each firm must submit a comprehensive description 
of its internal risk management control system and how that system 
satisfies the requirements set forth in Rule 15c3-4. Thus, any approval 
by the Commission for a particular nonbank SBSD to use a specific model 
to calculate initial margin will not be deemed approval for another 
nonbank SBSD to use the same model.
    As noted above, some commenters made suggestions about how to 
expedite the model approval process.\404\ In response to these 
comments, the Commission recognizes that the timing of such approvals 
could raise competitive issues if one nonbank SBSD is authorized to use 
a model before one or more other firms. Timing issues may also arise 
with respect to the review and approval process if multiple firms 
simultaneously apply to the Commission for approval to use a model. The 
Commission is sensitive to these issues and, similar to the capital 
model approval process, encourages all firms that intend to register as 
nonbank SBSDs and seek model approval to begin working with the staff 
as far in advance of their targeted registration date as is feasible. 
However, as discussed above with respect to capital models, the 
Commission acknowledges the possibility that it may not be able to make 
a determination regarding a firm's margin model before it is required 
to register as an SBSD. Consequently, the Commission is modifying Rule 
15c3-1e and Rule 18a-1 to provide that the Commission may approve the 
temporary use of a provisional model by a nonbank SBSD for the purposes 
of calculating initial margin if the model had been approved by certain 
other supervisors.
---------------------------------------------------------------------------

    \404\ See IIB11/19/2018 Letter; ISDA 1/23/2013 Letter; SIFMA 3/
12/2014 Letter.
---------------------------------------------------------------------------

    Two commenters suggested the Commission allow market participants 
to delegate the duty to run a model to a counterparty or third party 
noting that it is an accepted market practice for a counterparty to 
agree that a dealer will make determinations for a security-based swap 
in the dealer's capacity as calculation agent.\405\ In response to this 
comment, a nonbank SBSD could enter into a commercial arrangement to 
serve as a third-party calculation agent for entities that are not 
required to calculate initial margin pursuant to Rule 18a-3, as 
adopted. In addition, a nonbank SBSD's model can use third-party inputs 
(e.g., price calculations). However, a nonbank SBSD retains 
responsibility for the model-based initial margin calculations required 
by Rule 18a-3, as adopted. As discussed above, paragraph (c)(1)(i) of 
Rule 18a-3, as adopted, requires a nonbank SBSD to calculate an initial 
margin amount for each counterparty as of the close of each business 
day. Under paragraph (d) of Rule 18a-3, the nonbank SBSD must use the 
standardized or model-based approach, as applicable, to calculate the 
initial margin amount. The fact that a nonbank SBSD uses a model to 
perform the calculation and that the model uses third-party inputs does 
not eliminate or diminish the firm's underlying obligation under the 
rule to calculate an initial margin amount for each counterparty as of 
the close of each business day. In light of the comment and the 
Commission's response that third-party inputs may be used, the 
Commission believes it would be appropriate to make explicit in the 
rule that the nonbank SBSD retains responsibility for model-based 
initial margin calculations. Accordingly, the Commission is modifying 
the proposed rule text to make this clear.\406\
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    \405\ See ISDA 2/5/2014 Letter; Markit Letter.
    \406\ See paragraph (d)(2)(i) of Rule 18a-3, as adopted. In the 
final rule, the Commission inserted the phrase ``and be responsible 
for'' after the phrase ``authorization to use.''
---------------------------------------------------------------------------

    In summary, the Commission is adopting the model-based approach to 
calculating initial margin, with the

[[Page 43916]]

modifications discussed above. The final rule will require a nonbank 
SBSD to calculate with respect to each account of a counterparty as of 
the close of each business day: (1) The amount of the current exposure 
in the account; and (2) the initial margin amount for the account.\407\ 
As discussed above, in response to comments, the Commission modified 
paragraph (d) of Rule 18a-3 to establish a margin model authorization 
process that is distinct from the net capital rule model authorization 
process. This modification will provide flexibility to allow nonbank 
SBSDs that do not use a model for purposes of the net capital rule to 
seek authorization to use a model for purposes of the margin rule.\408\ 
It also will permit firms to use an industry standard model such as the 
model currently being used to comply with the margin rules of the CFTC 
and the prudential regulators.
---------------------------------------------------------------------------

    \407\ See paragraph (c)(1)(i) to Rule 18a-3, as adopted.
    \408\ See paragraph (d)(2) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

Comments and Final Requirements To Increase the Frequency of the 
Calculations
    Two commenters supported the proposed requirement to perform more 
frequent calculations under specified conditions.\409\ Another 
commenter requested that the Commission clarify that the requirement 
for a nonbank SBSD to perform calculations more frequently in specified 
circumstances does not give rise to a regulatory requirement for the 
nonbank SBSD to collect intra-day margin from its counterparties.\410\ 
The commenter argued that requiring a nonbank SBSD to collect margin 
more frequently than daily would be operationally difficult and 
contrary to current market practice.
---------------------------------------------------------------------------

    \409\ See Better Markets 7/22/2013 Letter; Markit Letter.
    \410\ See SIFMA AMG 2/22/2013 Letter.
---------------------------------------------------------------------------

    The Commission is adopting the requirement to increase the 
frequency of the required calculations during periods of extreme 
volatility and for accounts with concentrated positions, as proposed, 
with some non-substantive modifications.\411\ In response to the 
comment about collecting margin intra-day, the Commission clarifies 
that the rule does not require a nonbank SBSD to collect intra-day 
margin, although it may choose to do so (such as through a house margin 
requirement). In addition, more frequent calculations are only required 
during periods of extreme volatility and for accounts with concentrated 
positions. However, nonbank SBSDs are subject to Rule 15c3-4, which 
requires, among other things, that they have a system of internal 
controls to assist in managing the risks associated with their business 
activities, including credit risk. In designing a system of internal 
controls pursuant to Rule 15c3-4, a nonbank SBSD generally should 
consider whether there are circumstances where the collection of intra-
day margin in times of volatility and for accounts with concentrated 
positions would be necessary to effectively manage credit risk. In 
addition, a nonbank SBSD generally should consider these factors in its 
risk monitoring procedures required under paragraph (e)(7) of Rule 18a-
3, as adopted, which is discussed below.
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    \411\ See paragraph (c)(6) to Rule 18a-3, as adopted. Paragraph 
(c)(7) of Rule 18a-3, as proposed to be adopted, was re-designated 
paragraph (c)(6) in the final rule due to non-substantive amendments 
made to the minimum transfer amount language.
---------------------------------------------------------------------------

ii. Nonbank MSBSPs
    As proposed, Rule 18a-3 required nonbank MSBSPs to collect 
collateral from counterparties to which the nonbank MSBSP has current 
exposure and provide collateral to counterparties that have current 
exposure to the nonbank MSBSP.\412\ Consequently, a nonbank MSBSP 
needed to calculate as of the close of business each day the amount of 
equity in each account of a counterparty. Consistent with the proposal 
for nonbank SBSDs, a nonbank MSBSP was required to increase the 
frequency of its calculations during periods of extreme volatility and 
for accounts with concentrated positions.
---------------------------------------------------------------------------

    \412\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70262-63.
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    A commenter stated that it believed that nonbank MSBSPs should be 
required to calculate initial margin for each counterparty and collect 
or post initial margin because doing so would allow nonbank MSBSPs to 
better measure and understand their aggregate counterparty risk.\413\ 
The commenter believed that nonbank MSBSPs should have the personnel 
necessary to operate daily initial margin programs. Another commenter, 
who supported bilateral margining for both variation and initial 
margin, stated that not requiring the bilateral exchange of initial 
margin is inconsistent with the BCBS/IOSCO Paper and the re-proposals 
of the CFTC and the prudential regulators.\414\ A commenter supported 
the proposal that nonbank MSBSPs should not have to collect initial 
margin.\415\ Another commenter stated that MSBSPs should be provided 
flexibility as to whether and to what extent they should be required to 
pledge initial margin to financial firms.\416\
---------------------------------------------------------------------------

    \413\ See CFA Institute Letter.
    \414\ See ICI 5/11/2015 Letter.
    \415\ See Financial Services Roundtable Letter.
    \416\ See American Council of Life Insurers 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to comments that nonbank MSBSPs should calculate and 
collect and post initial margin, the margin requirements for nonbank 
MSBSPs are designed to ``neutralize'' the credit risk between a nonbank 
MSBSP and its counterparty. This requirement is intended to account for 
the fact that nonbank MSBSPs will be subject to less stringent capital 
requirements than nonbank SBSDs. Consequently, in the case of a nonbank 
MSBSP, the Commission believes it is more prudent to not require the 
firm to collect initial margin from counterparties, as doing so would 
increase the counterparties' exposures to the nonbank MSBSP. Therefore, 
the Commission is not adopting requirements for nonbank MSBSPs to 
calculate and post or deliver initial margin.
    The Commission acknowledges that the final rule, in this case, is 
not consistent with the final margin rules of the CFTC and the 
prudential regulators, which generally require nonbank major swap 
participants, bank MSBSPs, and bank major swap participants to collect 
and post initial margin from and to specified counterparties.\417\ 
However, the Commission believes that minimizing a counterparty 
exposure to a nonbank MSBSP by not requiring it to deliver initial 
margin is prudent, as these firms will not be subject to as robust a 
capital framework as SBSDs or bank MSBSPs. Similarly, the Commission 
believes it is prudent to limit the exposure of the nonbank MSBSP to 
the counterparty by not requiring it to post initial margin, as the 
counterparty may not be subject to any capital requirement. While the 
final rule does not impose a requirement to post or deliver initial 
margin, nonbank MSBSPs and their counterparties are permitted to agree 
to the exchange of initial margin. For these reasons, the Commission is 
adopting paragraph (c)(2)(i) of Rule 18a-3 substantially as 
proposed.\418\
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    \417\ See also BCBS/IOSCO Paper at 5 (``All financial firms and 
systemically important non-financial entities (``covered entities'') 
that engage in non-centrally cleared derivatives must exchange 
initial and variation margin as appropriate to the counterparty 
risks posed by such transactions.'').
    \418\ See paragraph (c)(2)(i) of Rule 18a-3, as adopted. In the 
final rule, the Commission made several non-substantive 
modifications. The word ``equity'' was replaced with the phrase 
``the current exposure.'' The phrase ``with respect to each account 
of a counterparty'' was inserted before the word ``calculate'' and 
the word ``the'' replaced the word ``each'' to conform the language 
in the paragraph more closely with the language in paragraph 
(c)(1)(i) of the final rule.

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[[Page 43917]]

b. Account Equity Requirements
i. Nonbank SBSDs
    As discussed above, a nonbank SBSD must calculate variation and 
initial margin amounts with respect to the account of a counterparty as 
of the close of each business day. Proposed Rule 18a-3: (1) Required a 
nonbank SBSD to collect margin from the counterparty unless an 
exception applied; (2) set forth the time frame for when that 
collateral needed to be collected; (3) prescribed the types of assets 
that could serve as eligible collateral; (4) prescribed additional 
requirements for the collateral; (5) prescribed when collateral must be 
liquidated; and (6) set forth certain exceptions to collecting the 
collateral.\419\
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    \419\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70263-69.
---------------------------------------------------------------------------

    More specifically, proposed Rule 18a-3 required that a nonbank SBSD 
collect from the counterparty by noon of the following business day 
cash, securities, and/or money market instruments in an amount at least 
equal to the ``negative equity'' (current exposure) in the account plus 
the initial margin amount unless an exception applied. Assets other 
than cash, securities, and/or money market instruments were not 
eligible collateral. The proposed rule further provided that the fair 
market value of securities and money market instruments (``securities 
collateral'') held in the account of a counterparty needed to be 
reduced by the amount of the standardized haircuts the nonbank SBSD 
would apply to the positions pursuant to the proposed capital rules for 
the purpose of determining whether the level of equity in the account 
met the minimum margin requirements. Securities collateral with no 
``ready market'' or that could not be publicly offered or sold because 
of statutory, regulatory, or contractual arrangements or other 
restrictions effectively could not serve as collateral because it would 
be subject to a 100% deduction pursuant to the standardized haircuts in 
the proposed capital rules, which were to be used to take the 
collateral deductions for the purposes of proposed Rule 18a-3.
    In addition, proposed Rule 18a-3 contained certain additional 
requirements for cash and securities to be eligible as collateral. 
These requirements were designed to ensure that the collateral was of 
stable and predictable value, not linked to the value of the 
transaction in any way, and capable of being sold quickly and easily if 
the need arose. The requirements included that the collateral was: (1) 
Subject to the physical possession or control of the nonbank SBSD; (2) 
liquid and transferable; (3) capable of being liquidated promptly 
without the intervention of a third party; (4) subject to a legally 
enforceable collateral agreement, (5) not securities issued by the 
counterparty or a party related to the counterparty or the nonbank 
SBSD; and (6) a type of financial instrument for which the nonbank SBSD 
could apply model-based haircuts if the nonbank SBSD was authorized to 
use such haircuts. Proposed Rule 18a-3 also required a nonbank SBSD to 
take prompt steps to liquidate collateral consisting of securities 
collateral to the extent necessary to eliminate the account equity 
deficiency.
    The Commission proposed five exceptions to the account equity 
requirements. The first applied to counterparties that were commercial 
end users. The second applied to counterparties that were nonbank 
SBSDs. The third applied to counterparties that were not commercial end 
users and that required their collateral to be segregated pursuant to 
Section 3E(f) of the Exchange Act. The fourth proposed exception 
applied to accounts of counterparties that were not commercial end 
users and that held legacy non-cleared security-based swaps. The fifth 
provided for a $100,000 minimum transfer amount with respect to a 
particular counterparty.
Comments and Final Requirements Regarding the Collection and Posting of 
Margin
    As noted above, proposed Rule 18a-3 required a nonbank SBSD to 
collect margin from the counterparty by noon of the next business day 
unless an exception applied.\420\ Generally, the comments on this 
aspect of the proposal fell into two categories: (1) Comments 
requesting that nonbank SBSDs be required to deliver margin (in 
addition to collecting it); and (2) comments requesting that the 
required time frame for collecting margin be lengthened.
---------------------------------------------------------------------------

    \420\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70264.
---------------------------------------------------------------------------

    In terms of requiring nonbank SBSDs to deliver margin, commenters 
stated that doing so would promote consistency with the recommendations 
in the BCBS/IOSCO Paper.\421\ Commenters also argued that bilateral 
margining would help to reduce systemic risk.\422\ A commenter argued 
that not requiring a nonbank SBSD to post margin could create an 
incentive to avoid clearing security-based swaps counter to the Dodd-
Frank Act's objective of promoting central clearing.\423\ One commenter 
stated that the Commission did not adequately consider the potential 
for one-way margining to harm investors and the security-based swap 
market.\424\ This commenter argued that making two-way margining 
mandatory would provide important risk mitigation benefits to the 
markets, and protect counterparties of all sizes, not just those large 
enough to negotiate for two-way margining.\425\ Some commenters 
suggested that the rule should permit the counterparty to require the 
nonbank SBSD to deliver margin at the counterparty's discretion.\426\ 
Another commenter stated that nonbank SBSDs and financial end users 
should have the flexibility to determine whether nonbank SBSDs should 
be required to post initial margin to financial end users.\427\
---------------------------------------------------------------------------

    \421\ See AIMA 2/22/2013 Letter; ICI 2/4/2013 Letter.
    \422\ See American Council of Life Insurers 11/19/2018 Letter; 
ICI 2/4/2013 Letter; ICI 5/11/2015 Letter; ICI 11/19/2018 Letter; 
SIFMA AMG 11/19/2018 Letter.
    \423\ See PIMCO Letter.
    \424\ See ICI 11/19/2018 Letter.
    \425\ See ICI 11/19/2018 Letter.
    \426\ See PIMCO Letter; SIFMA AMG 2/22/2013 Letter.
    \427\ See American Council of Life Insurers 2/22/2013 Letter; 
American Council of Life Insurers 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission is persuaded that 
requiring nonbank SBSDs to deliver variation margin to counterparties 
would provide an important protection to the counterparties by reducing 
their uncollateralized current exposure to SBSDs. The Commission also 
believes it would be appropriate to require nonbank SBSDs to deliver 
variation margin to counterparties in order to further harmonize Rule 
18a-3 with the margin rules of the CFTC and the prudential 
regulators.\428\ For these reasons, the Commission has modified the 
final rule to require a nonbank SBSD to deliver variation margin to a 
counterparty unless an exception applies. However, as discussed below, 
the nonbank SBSD is not required to collect or deliver variation or 
collect initial margin from a commercial end user, a security-based 
swap legacy account, or a counterparty that is the BIS, the European 
Stability Mechanism, or one of the multilateral development banks 
identified in the rule.\429\
---------------------------------------------------------------------------

    \428\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74903; CFTC Margin Adopting Release, 80 FR at 698.
    \429\ See paragraphs (c)(1)(ii)(A)(2) and (c)(1)(iii) of Rule 
18a-3, as adopted. The Commission also made some non-substantive 
changes to paragraph (c)(1)(ii) to accommodate the new requirement. 
In the final rule, paragraph (c)(1)(ii)(A) of Rule 18a-3, as 
proposed to be adopted, was re-designated paragraph 
(c)(1)(ii)(A)(1).

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[[Page 43918]]

    The Commission does not believe it would be appropriate to require 
nonbank SBSDs to deliver initial margin and, therefore, the final rule 
does not require it. Requiring nonbank SBSDs to deliver initial margin 
could impact the liquidity of these firms. Delivering initial margin 
would prevent this capital of the nonbank SBSD from being immediately 
available to the firm to meet liquidity needs. If the delivering SBSD 
is undergoing financial stress or the markets more generally are in a 
period of financial turmoil, a nonbank SBSD may need to liquidate 
assets to raise funds and reduce its leverage. Assets in the control of 
a counterparty would not be available for this purpose. For these 
reasons, under the net capital rule, most unsecured receivables must be 
deducted from net worth when the nonbank SBSD computes net capital. The 
final rule, however, does not prohibit a nonbank SBSD from delivering 
initial margin. For example, a nonbank SBSD and its counterparty can 
agree to commercial terms pursuant to which the nonbank SBSD will post 
initial margin to the counterparty.
    In terms of lengthening the time frame for collecting margin, a 
commenter requested flexibility for nonbank SBSDs to collect initial 
margin on a different schedule and frequency than variation 
margin.\430\ A second commenter sought clarification concerning how 
often initial margin needed to be collected and noted that the overall 
initial margin amount for a portfolio could change even if no new 
transactions occur because existing transactions may mature or 
significant market moves may impact values.\431\ A third commenter 
suggested that the Commission require nonbank SBSDs to begin collecting 
initial margin on a weekly basis and phase in more frequent 
collections.\432\ Another commenter recommended that consistent with 
the CFTC's and prudential regulators' margin rules, the Commission 
should require an SBSD to collect margin by the end of the business day 
following the day of execution and at the end of each business day 
thereafter, with appropriate adjustments to address operational 
difficulties associated with parties located in different time 
zones.\433\
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    \430\ See ISDA 1/23/2013 Letter; ISDA 2/5/2014 Letter.
    \431\ See Markit Letter.
    \432\ See SIFMA 3/12/2014 Letter.
    \433\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Other commenters recommended a longer time period than one business 
day to collect margin, citing cross-border transactions as possibly 
requiring more time.\434\ One commenter stated that the time zone 
differences between the Unites States and certain jurisdictions will 
cause major operational challenges, and could lead to delayed payments, 
disputes, and broadly greater operational risk.\435\ Another commenter 
noted that the settlement and delivery periods for securities to be 
posted as collateral are longer than the time period for collection 
under the proposed rule, particularly in a cross-border context.\436\ A 
commenter stated that the proposed one business-day requirement did not 
reflect the operational realities of security-based swap trading, 
payment, and collateral transfer processes.\437\ The commenter argued 
that the need for additional time was especially critical with respect 
to transactions with counterparties in countries such as Japan and 
Australia.
---------------------------------------------------------------------------

    \434\ See American Benefits Council, et al. 1/29/2013 Letter; 
Letter from Angus D.W. Martowardojo, Governor of Bank Indonesia and 
Chairman of the Executives Meeting of East Asia-Pacific Central 
Banks (Aug. 31, 2016) (``EMEAP Letter''); Letter from Mary P. 
Johannes, Senior Director and Head of ISDA WGMR Initiative, 
International Swaps and Derivatives Association (Aug. 7, 2015) 
(``ISDA 8/7/2015 Letter''); Letter from Mary P. Johannes, Senior 
Director and Head of ISDA WGMR Initiative, International Swaps and 
Derivatives Association (Sept. 24, 2015) (``ISDA 9/24/2015 
Letter''); SIFMA AMG 2/22/2013 Letter.
    \435\ See EMEAP Letter.
    \436\ See ISDA 8/7/2015 Letter.
    \437\ See SIFMA AMG 2/22/2013 Letter.
---------------------------------------------------------------------------

    The Commission recognizes that it will take time for nonbank SBSDs 
to implement processes to collect variation and initial margin on a 
daily basis if the entity is not currently collecting margin at this 
frequency. The Commission, therefore, is establishing compliance and 
effective dates discussed below in section III.B. of this release 
designed to give nonbank SBSDs and their counterparties a reasonable 
period of time to implement the operational, legal, and other changes 
necessary to come into compliance with requirements to collect and 
deliver margin on a daily basis.
    In terms of lengthening the period to collect or deliver margin 
beyond one business day, promptly obtaining collateral to cover credit 
risk exposures is vitally important to promoting the financial 
responsibility of nonbank SBSDs and protecting their counterparties. 
Collateral protects the nonbank SBSD from consequences of the 
counterparty's default and the counterparty from the consequences of 
the nonbank SBSD's default. However, the Commission is modifying the 
next-day collection requirement in two ways that should mitigate the 
concerns of commenters. First, the Commission is lengthening time for 
nonbank SBSDs and MSBSPs to collect or post required margin from noon 
to the close of business on the next business day.\438\ Second, the 
Commission is lengthening from one to two business days the time frame 
in which the nonbank SBSD or MSBSP must collect or deliver required 
margin if the counterparty is located in another country and more than 
4 time zones away. These changes should mitigate the concerns of 
commenters about cross-border transactions.
---------------------------------------------------------------------------

    \438\ See paragraphs (c)(1)(ii) and (c)(2)(ii) of Rule 18a-3, as 
adopted.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the proposed 
requirements to collect variation and initial margin with the 
modifications discussed above and with certain other non-substantive 
modifications.\439\
---------------------------------------------------------------------------

    \439\ See paragraphs (c)(1)(ii) and (c)(1)(iii) of Rule 18a-3, 
as adopted. References to cash, securities and/or money market 
instruments were deleted throughout the rule text and replaced with 
the term ``collateral'' as a result of other modifications to the 
rule to expand the types of collateral permitted under the rule. The 
defined term ``non-cleared security-based swap'' in paragraph (b)(5) 
of Rule 18a-3, as adopted, is modified to add the phrase ``submitted 
to and'' before the word ``cleared,'' and to add the phrase ``or by 
a clearing agency that the Commission has exempted from registration 
by rule or order pursuant to section 17A of the Act (15 U.S.C. 78q-
1)'' before the ``.''. The language regarding exemption from 
registration was added to the final rule to align the definition 
more closely with the definitions used in the margin rules of the 
CFTC and prudential regulators.
---------------------------------------------------------------------------

Comments and Final Requirements for Collateral and Taking Deductions on 
Collateral
    As noted above, proposed Rule 18a-3 permitted cash, securities, and 
money market instruments to serve as collateral to meet variation and 
initial margin requirements and, if securities or money market 
instruments were used, required the nonbank SBSD to apply the 
standardized haircuts in the capital rules to the collateral when 
computing the equity in the account.\440\ Generally, comments 
addressing these requirements fell into two categories: (1) Comments 
requesting that the scope of assets qualifying as collateral be 
broadened, or modified to conform with requirements of the prudential 
regulators, the CFTC, or the recommendations in the BCBS/IOSCO Paper; 
and (2) comments requesting that the deductions to securities or money 
market instruments serving as collateral be calculated using methods 
other than

[[Page 43919]]

the standardized haircuts in the capital rules.
---------------------------------------------------------------------------

    \440\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70264.
---------------------------------------------------------------------------

    In terms of the scope of eligible collateral, commenters supported 
the broad categories of securities and money market instruments that 
qualified under the proposal, but asked that the final rule be more 
consistent with the recommendations in the BCBS/IOSCO Paper or the 
rules of the CFTC and the prudential regulators.\441\ A commenter 
stated that the Commission should define the term ``eligible 
collateral,'' preferably by adopting the CFTC's ``forms of margin'' 
approach.\442\ A second commenter recommended that the Commission 
carefully parallel the collateral approach recommended in the BCBS/
IOSCO Paper.\443\ This commenter noted that the examples of collateral 
listed in the BCBS/IOSCO Paper were not exhaustive. Another commenter 
suggested that regulators and market participants develop a set of 
consistent definitions for the categories of eligible collateral.\444\
---------------------------------------------------------------------------

    \441\ See American Council of Life Insurers 2/22/2013 Letter; 
American Council of Life Insurers 11/19/2018 Letter; CFA Institute 
Letter; MFA 2/22/2013 Letter; SIFMA AMG 11/19/2018; SIFMA 3/12/2014 
Letter; SIFMA 11/19/2019 Letter.
    \442\ See MFA 2/22/2013 Letter.
    \443\ See American Council of Life Insurers 2/22/2013 Letter; 
American Council of Life Insurers 11/19/2018 Letter.
    \444\ See SIFMA 3/12/2014 Letter.
---------------------------------------------------------------------------

    In response to these comments, the BCBS/IOSCO Paper recommends that 
national supervisors develop their own list of collateral assets, 
taking into account the conditions of their own markets, and based on 
the key principle that assets should be highly liquid and should, after 
accounting for an appropriate haircut, be able to hold their value in a 
time of financial stress.\445\ The examples of collateral in the BCBS/
IOSCO Paper are: (1) Cash; (2) high-quality government and central bank 
securities; (3) high-quality corporate bonds; (4) high-quality covered 
bonds; (5) equities included in major stock indices; and (6) gold.\446\ 
Eligible securities collateral under the margin rules of the CFTC and 
the prudential regulators includes: (1) U.S. Treasury securities; (2) 
certain securities guaranteed by the U.S.; (3) certain securities 
issued or guaranteed by the European Central Bank, a sovereign entity, 
or the BIS; (4) certain corporate debt securities; (5) certain equity 
securities contained in major indices; and (6) certain redeemable 
government bond funds.\447\ Under the Commission's proposed margin 
rule, these types of securities would be permitted as collateral if 
they had a ready market. The margin rules of the CFTC and the 
prudential regulators also permit major foreign currencies, the 
currency of settlement for the security-based swap, and gold to serve 
as collateral. The Commission's proposed rule permitted ``cash'' but 
did not permit foreign currencies to serve as collateral, and the 
proposed rule did not permit gold to serve as collateral.
---------------------------------------------------------------------------

    \445\ See BCBS/IOSCO Paper at 16.
    \446\ Id. at 17-18.
    \447\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74870; CFTC Margin Adopting Release, 81 FR at 701-
2.
---------------------------------------------------------------------------

    The Commission is modifying proposed Rule 18a-3 in response to 
commenters' concerns about the rule excluding collateral types that are 
permitted by the CFTC and the prudential regulators. Consequently, the 
final rule permits cash, securities, money market instruments, a major 
foreign currency, the settlement currency of the non-cleared security-
based swap, or gold to serve as eligible collateral.\448\ This will 
avoid the operational burdens of having different sets of collateral 
that may be used with respect to a counterparty depending on whether 
the nonbank SBSD is entering into a security-based swap (subject to the 
Commission's rule) or a swap (subject to the CFTC's rule) with the 
counterparty. It also will avoid potential unintended competitive 
effects of having different sets of collateral for non-cleared 
security-based swaps under the margin rules for nonbank SBSDs and bank 
SBSDs. Finally, by giving the option of aligning with the requirements 
of the CFTC and the prudential regulators, the final rule should avoid 
the necessity of amending existing collateral agreements that may 
specifically reference the forms of margin permitted by those 
requirements.
---------------------------------------------------------------------------

    \448\ See paragraph (c)(4)(i)(C) of Rule 18a-3, as adopted. The 
additional collateral requirements in the final rule are discussed 
below.
---------------------------------------------------------------------------

    Commenters requested that certain types of assets be permitted to 
serve as collateral when dealing with commercial end users and special 
purpose vehicles.\449\ One commenter requested that the Commission 
expand the collateral permitted under the rule to include shares of 
affiliated registered funds or clarify that a fund of funds could post 
shares of an affiliated registered fund to meet a margin requirement 
under the rule.\450\ Another commenter requested that the Commission 
adopt a definition of collateral that includes U.S. government money 
market funds.\451\ In response to these comments, the final rule does 
not specifically exclude any type of security provided it has a ready 
market, is readily transferable, and does not consist of securities 
and/or money market instruments issued by the counterparty or a party 
related to the nonbank SBSD or MSBSP, or the counterparty.\452\ 
Generally, U.S. government money market funds should be able to serve 
as collateral under these conditions.
---------------------------------------------------------------------------

    \449\ See Financial Services Roundtable Letter; MFA 2/22/2013 
Letter; Sutherland Letter.
    \450\ See ICI 11/19/2018 Letter.
    \451\ See Letter from Lee A. Pickard, Esq., Pickard, Djinis and 
Pisarri, on behalf of Federated Investors, Inc. (Nov. 15, 2018) 
(``Federated 11/15/2018 Letter'').
    \452\ See paragraph (c)(4) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    In terms of applying the standardized haircuts in the nonbank SBSD 
capital rules to securities and money market instruments serving as 
collateral, a commenter advocated aligning with the prudential 
regulators' proposed rules for ease of application and consistency of 
treatment across instruments, as well as to minimize the opportunity 
for regulatory arbitrage.\453\ Comments received after the CFTC and the 
prudential regulators adopted their final margin rules supported 
aligning the haircuts in the Commission's margin rule with the 
standardized haircuts adopted by the CFTC and the prudential 
regulators.\454\
---------------------------------------------------------------------------

    \453\ See PIMCO Letter.
    \454\ See American Council of Life Insurers 11/19/2018 Letter; 
SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The haircuts in proposed Rule 18a-3 (i.e., the standardized 
haircuts in the proposed nonbank SBSD capital rules) and the haircuts 
in the margin rules of the CFTC and the prudential regulators (which 
are based on the recommended standardized haircuts in the BCBS/IOSCO 
Paper) are largely comparable.\455\ However, the Commission also 
recognizes that there are differences. For example, the Commission's 
standardized haircuts in some cases are more risk sensitive than those 
required by final margin rules of the CFTC and the prudential 
regulators.\456\
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    \455\ See, e.g., paragraph (c)(2)(vi)(J) of Rule 15c3-1, as 
amended (prescribing a haircut of 15% for equity securities), and 
BCBS/IOSCO Paper, Appendix B, at 27 (prescribing a haircut of 15% 
for equities included in major stock indices). See also paragraph 
(c)(2)(vi)(A)(1) of Rule 15c3-1, as amended (prescribing a haircut 
of 0.5% for securities issued or guaranteed by the United States or 
any agency thereof with 3 months but less than 6 months to 
maturity), and BCBS/IOSCO Paper, Appendix B, at 27 (prescribing a 
haircut of 0.5% for high quality government and central bank 
securities: Residual maturity less than one year).
    \456\ See, e.g., paragraph (c)(2)(vi)(A)(1) of Rule 15c3-1, as 
amended (prescribing a range of four haircuts of 0% to 1% for 
securities issued or guaranteed by the United States or any agency 
thereof with less than 12 months to maturity), and BCBS/IOSCO Paper, 
Appendix B, at 27 (prescribing a haircut of 0.5% for high-quality 
and central bank securities: Residual maturity less than one year); 
see also paragraph (c)(2)(vi)(F)(1) of Rule 15c3-1, as amended 
(prescribing a range of three haircuts of 3% to 6% for 
nonconvertible debt securities that mature in more than one year but 
less than five years), and BCBS/IOSCO Paper, Appendix B, at 27 
(prescribing a haircut of 4% for high-quality corporate/covered 
bonds: Residual maturity greater than one year and less than five 
years). The prudential regulators' and CFTC's final margin rules 
each prescribe a collateral haircut schedule that is generally 
consistent with the BCBS/IOSCO Paper. See Prudential Regulator 
Margin and Capital Adopting Release, 80 FR at 74910; CFTC Margin 
Adopting Release, 81 FR at 702.

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

[[Page 43920]]

    At the same time, the Commission believes it would be appropriate 
to provide nonbank SBSDs the option either to use the standardized 
haircuts in the nonbank SBSD capital rules as proposed or to use the 
collateral haircuts in the CFTC's margin rules. Consequently, the final 
margin rule provides nonbank SBSDs with the option of choosing to use 
the standardized haircuts in the capital rules or the standardized 
haircuts in the CFTC's margin rules.\457\ The final rule further 
provides that if the nonbank SBSD uses the CFTC's standardized haircuts 
it must apply them consistently with respect to the counterparty.\458\ 
This requirement is designed to prevent a nonbank SBSD from ``cherry 
picking'' either the nonbank SBSD capital haircuts or the CFTC haircuts 
at different points in time depending on which set provides the more 
advantageous haircut.
---------------------------------------------------------------------------

    \457\ See paragraph (c)(3) of Rule 18a-3, as adopted.
    \458\ See paragraph (c)(3)(ii) of Rule 18a-3, as adopted. In the 
final rule, paragraph (c)(3) of Rule 18a-3, as proposed, is re-
designated paragraph (c)(3)(i) of Rule 18a-3, as adopted, and a new 
subparagraph (c)(3)(ii) is added to read: ``(ii) Notwithstanding 
paragraph (c)(3)(i) of this section, the fair market value of assets 
delivered as collateral by a counterparty or the security-based swap 
dealer may be reduced by the amount of the standardized deductions 
prescribed in 17 CFR 23.156 if the security-based swap dealer 
applies these standardized deductions consistently with respect to 
the particular counterparty.''
---------------------------------------------------------------------------

    Similar to aligning the sets of eligible collateral, giving the 
option of aligning the collateral haircuts with the CFTC's collateral 
haircuts will allow a firm to avoid the operational burdens of having 
different haircut requirements with respect to a counterparty depending 
on whether the nonbank SBSD is entering into a security-based swap 
(subject to the Commission's rule) or a swap (subject to the CFTC's 
rule) with the counterparty. This option also will avoid potential 
unintended competitive effects of having different sets of collateral 
for non-cleared security-based swaps under the margin rules for nonbank 
SBSDs and bank SBSDs. Finally, by aligning with the requirements of the 
CFTC and the prudential regulators, the final rule should reduce the 
likelihood that SBSDs will seek to amend existing collateral agreements 
that may specifically reference the haircuts in the margin rules of the 
CFTC or prudential regulators.\459\
---------------------------------------------------------------------------

    \459\ As discussed above in section II.B.1. of this release, 
while paragraphs (c)(4) and (5) of Rule 18a-3, as adopted, 
respectively require netting and collateral agreements to be in 
place, the rule does not impose a specific margin documentation 
requirement as do the margin rules of the CFTC and the prudential 
regulators.
---------------------------------------------------------------------------

    With respect to the proposed collateral haircuts, a commenter 
suggested that the deductions applicable to high-grade corporate debt 
or liquid structured credit instruments be calculated using the option-
adjusted spread (``OAS'').\460\ A second commenter noted that the BCBS/
IOSCO Paper provides that the haircuts can be determined by a model 
that is approved by a regulator, in addition to a standardized schedule 
set forth in the BCBS/IOSCO Paper.\461\ In response to these comments, 
the Commission believes that the simpler and more transparent approach 
of using the standardized haircuts will establish appropriately 
conservative discounts on eligible collateral. Moreover, using models 
to determine haircuts on collateral would not be consistent with the 
final rules of the CFTC and the prudential regulators.\462\
---------------------------------------------------------------------------

    \460\ See PIMCO Letter. The commenter stated that OAS generally 
measures a debt instrument's risk premium over benchmark rates 
covering a variety of risks and net of any embedded options in the 
instrument. See id. (citing Frank J. Fabozzi, The Handbook of Fixed 
Income Securities, at 908-909 (7th ed. 2005)).
    \461\ See ISDA 1/23/2013 Letter; ISDA 2/5/2014 Letter. See also 
BCBS/IOSCO Paper at 17-19, Appendix B.
    \462\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74872; CFTC Margin Adopting Release, 81 FR at 702.
---------------------------------------------------------------------------

    Finally, a commenter recommended that the Commission apply a 100% 
haircut to a structured product, asset-backed security, re-packaged 
note, combination security, and any other complex instrument.\463\ In 
response, the final margin rule requires margin collateral to have a 
ready market.\464\ This is designed to exclude collateral that cannot 
be promptly liquidated.
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    \463\ See Letter from William J. Harrington (Nov. 19, 2018) 
(``Harrington 11/19/2018 Letter'').
    \464\ See paragraph (c)(4)(i)(A) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    A nonbank SBSD must apply the collateral haircuts to collateral 
used to meet a variation margin requirement and an initial margin 
requirement as was proposed.\465\ However, the Commission is making a 
conforming modification to require a nonbank SBSD to apply the 
deductions prescribed in paragraph (c)(3)(i) or (ii) of Rule 18a-3 to 
variation margin that the firm delivers to a counterparty to meet a 
variation margin requirement. As discussed above, the final rule now 
requires nonbank SBSDs to deliver variation margin to counterparties, 
and applying the haircuts to collateral used for this purpose will 
serve the same purpose of determining whether the level of equity in 
the account met the minimum margin requirements, as applying them to 
collateral collected by the nonbank SBSD. In addition, applying a 
haircut to collateral delivered by the nonbank SBSD to a counterparty 
is consistent with the requirements of the CFTC and the prudential 
regulators.
---------------------------------------------------------------------------

    \465\ See paragraph (c)(3) of Rule 18a-3, as adopted. In 
addition to the changes to the final rule described above to permit 
the use of the CFTC collateral haircut schedule, in the final rule, 
the Commission inserted the word ``standardized'' before the word 
``deductions'' and deleted the phrase ``determining whether the 
level of equity in the account meets the requirements of'' to 
clarify that only the use of standardized haircuts is permitted and 
to make a conforming change as a result of changes made to the 
definitions in paragraph (b) of the final rule. In the final rule, 
the Commission also deleted the phrase ``securities and money market 
instruments held in the account of'' and replaced it with 
``collateral delivered by'' to clarify that the collateral in the 
account was delivered by a counterparty to the nonbank SBSD. 
Further, in the final rule, the title of the paragraphs reads: 
``Deductions for collateral'' as a conforming change. In addition, 
the phrase ``securities and money market instruments'' has been 
replaced with the term ``collateral'' to conform to changes made to 
other parts of the rule. Finally, the phrase ``or security-based 
swap dealer'' is being added after the phrase ``collateral delivered 
by a counterparty.'' These changes conform the modification to the 
final rule requiring nonbank SBSDs to apply the standardized 
haircuts to collateral they deliver to counterparties to meet a 
variation margin requirement.
---------------------------------------------------------------------------

Comments and Final Requirements Regarding Additional Collateral and 
Liquidation Requirements
    As noted above, proposed Rule 18a-3 prescribed additional 
requirements for collateral (e.g., it must be liquid and transferable) 
and required the prompt liquidation of the collateral to eliminate a 
margin deficiency.\466\ A commenter requested that only ``excess 
securities collateral'' as defined in proposed Rule 18a-4 for purposes 
of the segregation requirements be subject to the possession or control 
requirement in proposed Rule 18a-3.\467\ The commenter noted that the 
proposed segregation requirements only required excess securities 
collateral to be in the SBSD's possession or control. Thus, the 
commenter argued that imposing a

[[Page 43921]]

possession or control requirement on a broader range of collateral 
could impose ``serious'' funding costs on SBSDs by requiring them to 
fund initial and variation margin payments for offsetting transactions 
through their own resources rather than through the collateral posted 
by security-based swap customers in accordance with proposed Rule 18a-
3. Another commenter requested that the Commission amend paragraph 
(c)(4)(i) of proposed Rule 18a-3 to recognize initial margin collateral 
that is held at an independent third-party custodian as being in the 
control of the nonbank SBSD.\468\
---------------------------------------------------------------------------

    \466\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 7064-65.
    \467\ See SIFMA 2/22/2013 Letter.
    \468\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission did not intend the possession or control requirement 
in proposed Rule 18a-3 to conflict with the proposed possession or 
control requirement in Rule 18a-4. More specifically, under Rule 18a-4, 
as proposed, a nonbank SBSD could re-hypothecate collateral received as 
initial margin pursuant to Rule 18a-3 in limited circumstances and 
subject to certain conditions. The Commission clarifies that under Rule 
18a-3, as adopted, initial margin that is held at a clearing agency to 
meet a margin requirement of the customer is in the control of the 
nonbank SBSD for purposes of the rule. Additionally, as discussed above 
in sections II.A.2.b.ii. and II.A.2.b.v. of this release, the 
Commission has adopted final capital rules for stand-alone broker-
dealers and nonbank SBSDs that permit them to recognize collateral held 
at a third-party custodian for purposes of: (1) The exception from 
taking the capital charge when initial margin is held at a third-party 
custodian; \469\ and (2) computing credit risk charges.\470\ In each 
case, the collateral can be recognized if the custodian is a bank as 
defined in Section 3(a)(6) of the Exchange 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.
---------------------------------------------------------------------------

    \469\ See paragraph (c)(2)(xv)(C)(1) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(1) of Rule 18a-1, as adopted.
    \470\ See paragraph (c)(4)(v)(B) of Rule 15c3-1e, as amended; 
paragraph (e)(2)(iii)(E)(2) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    The Commission believes collateral held at a third-party custodian 
also should be recognized for the purposes of determining the account 
equity requirements in Rule 18a-3. Consequently, the Commission is 
modifying paragraph (c)(4) in the final rule to provide that the 
collateral must be either: (1) Subject to the physical possession or 
control of the nonbank SBSD or MSBSP and may be liquidated promptly by 
the firm without intervention by any other party (as was proposed); or 
(2) carried by an independent third-party custodian that is a bank as 
defined in Section 3(a)(6) of the Exchange 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.\471\ This will address the second commenter's concern about 
recognizing collateral that is held at a third-party custodian.
---------------------------------------------------------------------------

    \471\ See paragraph (c)(4)(ii)(A) and (B) of Rule 18a-3, as 
adopted.
---------------------------------------------------------------------------

    As discussed above, the Commission has modified proposed Rule 18a-3 
to provide a nonbank SBSD with the option to use the collateral 
haircuts required by the CFTC's rules.\472\ In light of this 
modification, the Commission is modifying the final margin rule to 
explicitly require that the collateral have a ready market.\473\ The 
requirement that the collateral have a ready market was incorporated 
into the proposed rule because, as discussed above, the nonbank SBSD 
was required to use the standardized haircuts in the proposed capital 
rules for purposes of the collateral deductions. The proposed nonbank 
SBSD capital rules required the firm to take a 100% deduction for a 
security or money market instrument that does not have a ready market 
(as do the final capital rules). Consequently, by incorporating those 
standardized haircuts into proposed Rule 18a-3, a nonbank SBSD would 
need to deduct 100% of the value of a security or money market 
instrument it received as margin if the security or money market 
instrument did not have a ready market. In other words, the security or 
money market instrument would have no collateral value for purposes of 
meeting the account equity requirements in proposed Rule 18a-3. The 
Commission's modification will retain the proposed requirement that 
collateral without a ready market has no collateral value and, in 
particular, will apply that requirement when the standardized haircuts 
of the CFTC are used, as they do not explicitly impose a ready market 
test. However, the CFTC, in describing its requirements for collateral, 
stated that margin assets should share the following fundamental 
characteristics: They ``should be liquid and, with haircuts, hold their 
value in times of financial stress.'' \474\ The CFTC further stated in 
describing collateral permitted under its rule that it consists of 
``assets for which there are deep and liquid markets and, therefore, 
assets that can be readily valued and easily liquidated.'' The 
Commission believes that modifying the final rule to make explicit that 
the ready market test applies when the CFTC's standardized haircuts are 
used is consistent with these statements by the CFTC about collateral 
permitted under its margin rule.
---------------------------------------------------------------------------

    \472\ See paragraph (c)(4)(i)(C) of Rule 18a-3, as adopted.
    \473\ See paragraph (c)(4)(i)(A) of Rule 18a-3, as adopted. The 
modification replaces paragraph (4)(i) of proposed Rule 18a-3 (which 
provided that ``The collateral is liquid and transferable'') with 
paragraph (4)(i)(A) of Rule 18a-3, as adopted (which provides that 
the collateral ``Has a ready market'') and paragraph (4)(i)(B) of 
Rule 18a-3, as adopted (which provides that the collateral ``Is 
readily transferable'').
    \474\ See CFTC Margin Adopting Release, 81 FR at 665.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the proposed 
collateral requirements with the modifications discussed above and 
certain additional non-substantive modifications.\475\
---------------------------------------------------------------------------

    \475\ See paragraph (c)(4) of Rule 18a-3, as adopted. As a 
consequence of the modifications discussed above, paragraph 
(c)(4)(i) is re-designated paragraph (c)(4)(i)(A) through (E), 
paragraph (c)(4)(ii) is re-designated paragraph (c)(4)(ii)(A) and 
(B), and paragraphs (c)(4)(iii), (iv), and (v) are deleted. The 
Commission made the following additional non-substantive 
modifications to paragraph (c)(4) of Rule 18a-3, as adopted: (1) The 
phrase ``A security-based swap dealer and'' in the preface of the 
paragraph (c)(4) is changed to ``A security-based swap dealer or''; 
(2) the phrases ``cash and,'' ``securities and money market 
instruments,'' and ``delivered as collateral'' in the preface to 
paragraph (c)(4) are deleted and replaced with the phrase 
``collateral delivered''; (3) the phrase ``The collateral is subject 
to the physical possession or control of the security-based swap 
dealer or the major security-based swap participant'' is deleted 
from paragraph (c)(4)(i) and replaced with the phrase ``The 
collateral:,'' and the phrase ``Subject to the physical possession 
or control of the security-based swap dealer or the major security-
based swap participant'' is added to re-designated paragraph 
(c)(4)(ii)(A); (4) the phrase ``The collateral does not consist of 
securities and/or money market instruments issued by the 
counterparty or a party related to the security-based swap dealer, 
the major security-based swap participant, or to the counterparty.'' 
is deleted along in paragraph (c)(4)(v) and the phrase ``Does not 
consist of securities and/or money market instruments issued by the 
counterparty or a party related to the security-based swap dealer, 
the major security-based swap participant, or the counterparty; 
and'' is added to new paragraph (c)(4)(i)(D); (5) the phrase ``The 
collateral agreement between the security-based swap dealer or the 
major security-based swap participant and the counterparty is 
legally enforceable by the security-based swap dealer or the major 
security-based swap participant against the counterparty and any 
other parties to the agreement; and'' is deleted in paragraph 
(c)(4)(iv) and the phrase ``Is subject to an agreement between the 
security-based swap dealer or the major security-based swap 
participant and the counterparty that is legally enforceable by the 
security-based swap dealer or the major security-based swap 
participant against the counterparty and any other parties to the 
agreement; and'' is added to re-designated paragraph (c)(4)(i)(E); 
(6) the phrase ``The collateral is liquid and transferable'' is 
deleted from paragraph (c)(4)(ii) and replaced with the phrase ``The 
collateral is either''; and (7) the phrase ``The collateral may be 
liquidated promptly by the security-based swap dealer or the major 
security-based swap participant without intervention by any other 
party''; is deleted from paragraph (c)(4)(iii) and the phrase ``and 
may be liquidated promptly by the security-based swap dealer or the 
major security-based swap participant without intervention by any 
other party; or'' is added to re-designated paragraph (c)(4)(ii)(A) 
after the phrase ``Subject to the physical possession or control of 
the security-based swap dealer or the major security-based swap 
participant.''

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

[[Page 43922]]

    Finally, the Commission did not receive any comments addressing the 
prompt liquidation requirement and is adopting it with several non-
substantive modifications.\476\
---------------------------------------------------------------------------

    \476\ See paragraph (c)(7) of Rule 18a-3, as adopted. This 
paragraph was re-numbered in the final rule as a result of changes 
made to other paragraphs in the rule. In the final rule, the word 
``and'' was replaced with ``or'' between the phrase ``A security-
based swap dealer'' and the phrase ``major security-based swap 
participant''; the phrase ``securities and money market 
instruments'' was replaced with the word ``positions''; and the 
phrase ``account equity'' was replaced with the word ``margin'' in 
two places. These changes to the rule were non-substantive 
amendments to conform the final rule text with changes made to other 
parts of the rule.
---------------------------------------------------------------------------

Comments and Final Requirements Regarding Exceptions to Collecting 
Margin
    Commercial End Users. As noted above, the Commission proposed five 
exceptions to the account equity requirements, and the first exception 
applied to counterparties that are commercial end users.\477\ This 
exception provided that a nonbank SBSD need not collect variation or 
initial margin from a counterparty that was a commercial end user. A 
commenter opposed any exceptions in the rule, stating that failing to 
collect and deliver margin contributed significantly to the 2008 
financial crisis.\478\ Another commenter argued that commercial end 
users carry market risk and can default on their obligations to the 
nonbank SBSD, which may then be faced with liquidity challenges.\479\ 
This commenter stated that the lack of margin from these market 
participants can be a source of systemic risk that can ``ripple through 
the financial market ecosystem.''
---------------------------------------------------------------------------

    \477\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70265-66.
    \478\ See CFA Institute Letter.
    \479\ See OneChicago 2/19/2013 Letter.
---------------------------------------------------------------------------

    After Rule 18a-3 was proposed, the Terrorism Risk Insurance Program 
Reauthorization Act of 2015 (``TRIPRA'') was enacted.\480\ Title III of 
TRIPRA amended Section 15F(e) of the Exchange Act to provide that the 
requirements of Section 15F(e)(2)(B)(ii) (which requires the Commission 
to adopt margin requirements for nonbank SBSDs with respect to non-
cleared security-based swaps) shall not apply to a security-based swap 
in which a counterparty qualifies for an exception under Section 
3C(g)(1) of the Exchange Act or that satisfies the criteria in Section 
3C(g)(4) of the Exchange Act (the exceptions from mandatory clearing 
for commercial end users). Consequently, Congress mandated an exception 
for commercial end users from the Commission's margin rules for non-
cleared security-based swaps.\481\ While the statutory provision 
establishes a commercial end user exception, defining the term 
``commercial end user'' will serve an important purpose. In particular, 
the definition will implement the statutory provision and serve as a 
cross-reference for the term ``commercial end user,'' which is 
referenced in other parts of the Commission's rules. Consequently, the 
Commission is adopting the exception and related definition with 
modifications to conform the definition to the statutory text.\482\ In 
the final rule, the term ``commercial end user'' is defined to mean a 
counterparty that qualifies for an exception from clearing under 
section 3C(g)(1) of the Exchange Act and implementing regulations or 
satisfies the criteria in Section 3C(g)(4) of the Exchange Act and 
implementing regulations.\483\
---------------------------------------------------------------------------

    \480\ See Public Law 114-1, 129 Stat. 3 (2015).
    \481\ Section 3C(g) of the Exchange Act provides that the 
Commission shall consider whether to exempt small banks, savings 
associations, Farm Credit System institutions, and credit unions 
with total assets of $10 billion or less. 15 U.S.C. 78c-3(g)(3)(B). 
If the Commission implements an exclusion for such entities from 
clearing, those entities would be encompassed within the definition 
of commercial end user under the rule. See End-User Exception to 
Mandatory Clearing of Security-Based Swaps; Proposed Rule, Exchange 
Act Release No. 63556 (Dec. 15, 2010), 75 FR 79992 (Dec. 21, 2010).
    \482\ See paragraphs (b)(2) and (c)(1)(iii)(A) of Rule 18a-3, as 
adopted.
    \483\ See paragraph (b)(2) of Rule 18a-3, as adopted. This 
language is consistent with the final rule adopted by the prudential 
regulators to implement Title III of TRIPRA and the CFTC's final 
margin rule. See Margin and Capital Requirements for Covered Swap 
Entities, 81 FR 50605 (Aug. 2, 2016); CFTC Margin Adopting Release, 
81 FR at 677-79.
---------------------------------------------------------------------------

    In response to the concerns raised by the commenters regarding the 
exception, a nonbank SBSD will be required to take a capital deduction 
in lieu of margin or credit risk charge if it does not collect margin 
from a commercial end user counterparty. The capital deduction or 
charge is intended to require a nonbank SBSD to set aside net capital 
to address the risks that would be mitigated through the collection of 
initial margin.\484\ The set-aside net capital will serve as an 
alternative to obtaining collateral for this purpose. Consequently, the 
final capital rules and amendments work in tandem with the margin rules 
to require capital deductions or credit risk charges that will require 
nonbank SBSDs to allocate capital against the market and credit 
exposures resulting from transactions with commercial end users, which 
may not be fully collateralized.
---------------------------------------------------------------------------

    \484\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70245.
---------------------------------------------------------------------------

    In addition, as discussed below, a nonbank SBSD will be required to 
establish, maintain, and document procedures and guidelines for 
monitoring the risk of accounts holding non-cleared security-based 
swaps. Among other things, a nonbank SBSD will be required to have 
procedures and guidelines for determining, approving, and periodically 
reviewing credit limits for each counterparty to a non-cleared 
security-based swap.\485\ Consequently, nonbank SBSDs that do not 
collect variation and/or initial margin from a commercial end user will 
need to establish a credit limit for the end user and periodically 
review the credit limit in accordance with their risk monitoring 
guidelines.\486\ The final rule also does not prohibit a nonbank SBSD 
from requiring a commercial end user to post variation and initial 
margin under its own house margin requirements.
---------------------------------------------------------------------------

    \485\ See paragraph (e)(2) of Rule 18a-3, as adopted.
    \486\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74848-49 (``Finally, the Agencies note that the 
exception or exemption of a transaction from the margin requirements 
in no way prohibits a covered swap entity from requiring initial 
and/or variation margin on such transactions but does not impose 
initial or variation margin requirements as a regulatory matter.''); 
see also CFTC Margin Adopting Release, 81 FR at 648 (``The 
Commission has other requirements [17 CFR 23.600 (Risk Management 
Program for swap dealers and major swap participants)] that should 
address the monitoring of risk exposures for those entities'').
---------------------------------------------------------------------------

    Financial Market Intermediaries. The second exception to collecting 
margin applied when the counterparty was another SBSD.\487\ More 
specifically, the Commission proposed two alternatives with respect to 
SBSD counterparties. Under the first alternative, a nonbank SBSD would 
need to collect variation margin but not initial margin from the other 
SBSD (``Alternative A''). Under the second alternative, a nonbank SBSD 
would be required to collect variation and initial margin from the 
other SBSD

[[Page 43923]]

and the initial margin needed to be held at a third-party custodian 
(``Alternative B'').\488\
---------------------------------------------------------------------------

    \487\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70267-68.
    \488\ Alternative B would not be an exception to the account 
equity requirements in Rule 18a-3 because it would require the 
nonbank SBSD to collect variation and initial margin from another 
SBSD. However, the proposed exception related to how the collateral 
must be held--at an independent third-party custodian on behalf of 
the counterparty--and, therefore, not in the possession or control 
of the nonbank SBSD.
---------------------------------------------------------------------------

    Some commenters supported Alternative A. One of these commenters 
argued that the requirement to collect initial margin from other SBSDs 
under Alternative B would severely curtail the use of non-cleared 
security-based swaps for hedging.\489\ The commenter argued that this 
result would disrupt key financial services, such as those that 
facilitate the availability of home loans and corporate finance. The 
commenter argued that the requirement to collect initial margin from 
another SBSD would have detrimental pro-cyclical effects because it 
would increase collateral demands in times of market stress. A second 
commenter believed that Alternative B could limit credit availability, 
be destabilizing, and have undesirable pro-cyclical effects.\490\ While 
generally supporting harmonization of the Commission's margin rules 
with the recommendations of the BCBS/IOSCO Paper, this commenter 
supported Alternative A. The commenter stated that harmonization in 
this case is not appropriate because it would put stress on the funding 
models of U.S. nonbank SBSDs if they were required to post initial 
margin to other SBSDs.\491\ A third commenter argued that the proposal 
to require the exchange of large amounts of liquid initial margin come 
at a time when other regulators and regulations are also focusing on 
and imposing new requirements with respect to liquidity in the 
financial sector.\492\ This commenter urged the Commission to evaluate 
initial margin requirements in light of the changing financial 
regulatory environment and to establish regulations that will support 
capital growth and customer protection while minimizing systemic risk. 
Some commenters also supported expanding the Alternative A approach so 
that nonbank SBSDs would not be required to collect initial margin from 
swap dealers, stand-alone broker-dealers, banks, foreign banks, and 
foreign broker-dealers.\493\
---------------------------------------------------------------------------

    \489\ See ISDA 1/23/2013 Letter.
    \490\ See SIFMA 2/22/2013 Letter.
    \491\ See SIFMA Letter 11/19/2018. See also ISDA 11/19/2018 
Letter.
    \492\ See Financial Services Roundtable Letter. See also Letter 
from Robert Rozell (Nov. 8, 2018) (``Rozell Letter'').
    \493\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR 53013-14; SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Other commenters supported Alternative B, arguing that it was more 
consistent with the intent of the Dodd-Frank Act and that Alternative A 
would permit an inappropriate build-up of systemic risk within the 
financial system.\494\ One commenter argued that the Commission should 
not be swayed by claims that Alternative B would make it difficult for 
nonbank SBSDs to hedge transactions, or that it would shrink the size 
of the global security-based swap market.\495\ Another commenter argued 
that it would be inappropriate to allow a nonbank SBSD to have non-
cleared security-based swap exposure to another SBSD without any 
requirement to collect initial margin or to take a capital charge to 
address the risk of the non-cleared security-based swap.\496\ Some 
commenters noted that the CFTC and the prudential regulators require 
the exchange of initial margin between SBSDs and swap dealers, and the 
Commission should do so as well in order to harmonize its rules with 
the rules of the CFTC and the prudential regulators.\497\ One commenter 
argued that a lack of harmonization would reduce the likelihood of 
achieving substituted compliance determinations.\498\ Finally, a 
commenter responding to the 2018 comment reopening argued that the 
proposed rule text modifications were made despite the fact that 
insufficient margin and capital were two of the triggers of the 
financial crisis.\499\
---------------------------------------------------------------------------

    \494\ See Americans for Financial Reform Education Fund Letter; 
Barnard Letter; Citadel 11/19/2018 Letter; Letter from Jeffrey P. 
Mahoney, General Counsel, Council of Institutional Investors (Nov. 
8, 2018) (``Council of Institutional Investors Letter'').
    \495\ See Americans for Financial Reform Letter.
    \496\ See OneChicago 2/19/2013 Letter.
    \497\ See Americans for Financial Reform Education Fund Letter; 
Citadel 11/19/2018 Letter; Rutkowski Letter.
    \498\ See Citadel 11/19/2018 Letter.
    \499\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    In the Commission's judgment, Alternative A is the prudent approach 
because it will promote the liquidity of nonbank SBSDs by not requiring 
them to deliver initial margin to other SBSDs. As discussed above, 
delivering initial margin would prevent this capital of the nonbank 
SBSD from being immediately available to be used by the firm. If the 
delivering SBSD is undergoing financial stress or the markets more 
generally are in a period of financial turmoil, a nonbank SBSD may need 
to liquidate assets to raise funds and reduce its leverage. However, if 
assets are in the control of another SBSD, they would not be available 
for this purpose. For these reasons, the nonbank SBSD capital rule 
treats most unsecured receivables as assets that must be deducted from 
net worth when the firm computes net capital.
    In addition, the Commission believes that nonbank SBSDs serve an 
important function in the non-cleared security-based swap market by 
providing liquidity to market participants and by performing important 
market making functions. Thus, the Commission believes its margin rule 
for non-cleared security-based swaps should promote the liquidity of 
these entities, which, in turn, will help ensure their safety and 
soundness. Further, the Commission believes these considerations 
support expanding the exception beyond SBSD counterparties to include 
other financial market intermediary counterparties such as swap 
dealers, FCMs, stand-alone broker-dealers, banks, foreign banks, and 
foreign broker-dealers.\500\ The Commission believes it is appropriate 
to expand the list given their importance to the securities markets, 
the liquidity impact on these entities if they are required to post 
initial margin, and the fact that these entities will be subject to a 
regulatory capital standard that would incentivize them to 
collateralize exposures to their security-based swap counterparties.
---------------------------------------------------------------------------

    \500\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53013-14 (soliciting comment on whether the dealer to dealer 
initial margin exception should be expanded to other types of 
financial market intermediaries).
---------------------------------------------------------------------------

    A nonbank SBSD will be required to take a capital deduction in lieu 
of margin or credit risk charge if it does not collect initial margin 
from a counterparty that is a financial market intermediary. As 
discussed above, the capital deduction or credit risk charge is 
intended to require a nonbank SBSD to set aside net capital to address 
the risks that are mitigated through the collection of initial margin. 
Furthermore, the nonbank SBSD will be required to establish, maintain, 
and document procedures and guidelines for monitoring the risk of 
accounts holding non-cleared security-based swaps.\501\ These include 
procedures for determining, approving, and periodically reviewing 
credit limits for each counterparty. Consequently, a nonbank SBSD will 
need to establish credit limits for each counterparty to a non-cleared 
security-based swap, including counterparties that are financial market 
intermediaries.
---------------------------------------------------------------------------

    \501\ See paragraph (e) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    While Alternative A is not consistent with the final rules of the 
CFTC and the

[[Page 43924]]

prudential regulators, the rule does not prohibit nonbank SBSDs from 
collecting initial margin from another financial intermediary as a 
house margin requirement or by agreement. In addition, the adoption of 
Alternative A as one requirement in the margin rule should not 
negatively affect potential substituted compliance determinations 
because the Commission expects regulators will focus on regulatory 
outcomes as a whole rather than on requirement-by-requirement 
similarity.\502\ Finally, the adoption of Alternative A with 
modifications discussed above should alleviate commenters' concerns 
that imposing initial margin requirements would severely curtail the 
use of non-cleared security-based swaps for hedging.
---------------------------------------------------------------------------

    \502\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR at 30078-
30079.
---------------------------------------------------------------------------

    For these reasons, the Commission is adopting Alternative A with 
the modifications discussed above.\503\
---------------------------------------------------------------------------

    \503\ See paragraph (c)(1)(iii)(B) of Rule 18a-3, as adopted. 
The text of the final rule is modified to add swap dealers, broker-
dealers, FCMs, banks, foreign banks, and foreign broker-dealers to 
the list of counterparties covered by the exception.
---------------------------------------------------------------------------

    Counterparties that Use Third-Party Custodians. The third proposed 
exception applied to counterparties that are not commercial end users 
and that elect to have their initial margin segregated pursuant to 
Section 3E(f) of the Exchange Act.\504\ Among other things, Section 
3E(f) provides that a counterparty may elect to have its initial margin 
segregated in an account carried by an independent third-party 
custodian. Under the proposed exception, the nonbank SBSD did not need 
to directly hold the initial margin required from the counterparty. 
This accommodated the counterparty's right under Section 3E(f) to elect 
to have the third-party custodian hold the initial margin. The 
Commission did not receive any comments specifically addressing this 
provision but is modifying it to remove the reference to Section 3E(f) 
to address the potential that the initial margin might be held at a 
third-party custodian pursuant to other provisions. For the foregoing 
reasons, the Commission is adopting this exception with the 
modification described above and certain non-substantive 
modifications.\505\
---------------------------------------------------------------------------

    \504\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70268-69.
    \505\ In the final rule, this exception is contained in 
paragraph (c)(1)(iii)(C) of Rule 18a-3, as adopted. This paragraph 
states ``The requirements of paragraph (c)(1)(ii)(B) of this section 
do not apply to an account of a counterparty that delivers the 
collateral to meet the initial margin amount to an independent 
third-party custodian.''
---------------------------------------------------------------------------

    Legacy Accounts. The fourth proposed exception applied to accounts 
of counterparties that are not commercial end users and that hold 
legacy non-cleared security-based swaps.\506\ Under this proposed 
exception, the nonbank SBSD did not need to collect variation or 
initial margin from the counterparty.
---------------------------------------------------------------------------

    \506\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70269.
---------------------------------------------------------------------------

    Some commenters expressed support for this exception. One of these 
commenters suggested that the Commission except legacy transactions, 
unless both counterparties agree that margin should be exchanged.\507\ 
A second commenter suggested that legacy trades be excepted unless the 
nonbank SBSD includes them in a netting set with new transactions.\508\ 
Some commenters also provided suggestions as to what should be deemed a 
legacy transaction, citing novated contracts and existing legacy 
security-based swaps that have been modified for loss mitigation 
purposes, or contracts that have been amended to replace references to 
the London Inter-bank Offered Rate (``LIBOR'').\509\ Commenters also 
requested clarification as to whether the legacy account exception for 
nonbank SBSDs applies to both variation and initial margin or to 
initial margin only.\510\ A commenter argued that initial margin 
requirements should not apply to legacy security-based swaps, but that 
the exception should only apply until the legacy contracts expire or 
are revised.\511\ This commenter further argued that the exception 
should not apply to variation margin because, without this type of 
protection, counterparties are exposed to potential losses as a 
consequence of the default of trading partners.
---------------------------------------------------------------------------

    \507\ See PIMCO Letter.
    \508\ See SIFMA 3/12/2014 Letter.
    \509\ See Letter from the Alternative Reference Rates Committee 
(Jul. 12, 2018) (``ARRC Letter''); AFGI 2/15/2013 Letter; SIFMA 2/
22/2013 Letter.
    \510\ See Financial Services Roundtable Letter; ISDA 1/23/2013 
Letter.
    \511\ See CFA Institute Letter.
---------------------------------------------------------------------------

    The Commission is adopting the proposed exception for accounts 
holding legacy security-based swaps \512\ with a modification to make 
explicit that the exception applies to variation and initial margin in 
response to comments seeking clarification on that point.\513\ Under 
the final rule, nonbank SBSDs can collect variation or initial margin 
with respect to legacy transactions pursuant to house requirements or 
agreement.
---------------------------------------------------------------------------

    \512\ See paragraph (c)(1)(iii)(D) of Rule 18a-3, as adopted. In 
the final rule, the Commission modified the defined term ``security-
based swap legacy account'' by replacing the word ``effective'' in 
two places with the word ``compliance.'' See paragraph (b)(6) of 
Rule 18a-3, as adopted. The Commission made these modifications to 
link the legacy account exception to the compliance date of Rule 
18a-3 (i.e., the date when nonbank SBSDs must begin complying with 
the rules) as opposed to the effective date, which will occur before 
these entities are required to register as SBSDs and comply with the 
rule. The term security-based swap legacy account was re-designated 
subparagraph (b)(6) of the rule due to non-substantive changes made 
to other parts of the rule. Finally, the phrase ``one or more'' was 
inserted after the phrase ``is used to hold.''
    \513\ See paragraph (c)(1)(iii)(D) of Rule 18a-3, as adopted. 
See also See Capital, Margin, and Segregation Proposing Release, 77 
FR 70269. The Commission's intent was to propose an exception that 
applied to both variation and initial margin. See Capital, Margin, 
and Segregation Proposing Release, 77 FR at 70269 (``Under the 
fourth exception to the account equity requirements in proposed Rule 
18a-3, a nonbank SBSD would not be required to collect cash, 
securities, and/or money market instruments to cover the negative 
equity (current exposure) or margin amount (potential future 
exposure) in a security-based swap legacy account.''). The proposed 
rule text, however, inadvertently limited the exception to the 
collection of initial margin. In the final rule, the Commission also 
deleted the phrase ``of a counterparty that is not a commercial end 
user'' from this subsection because it is redundant, as commercial 
end users are subject to an exception from the rule under paragraph 
(c)(1)(iii)(A) of Rule 18a-3. Finally, the word ``legacy'' was moved 
to before the word ``account'' to conform the language with the 
definition of security-based swap legacy account in paragraph (b)(6) 
of the rule. See paragraph (c)(1)(iii)(D) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    With regard to the comment that counterparties should be required 
to post variation margin since they may be exposed to potential losses, 
a nonbank SBSD will be required to take a capital deduction in lieu of 
margin or credit risk charge if it does not collect variation and/or 
initial margin with respect to a legacy account. Furthermore, the 
nonbank SBSD will be required to establish, maintain, and document 
procedures and guidelines for monitoring the risk of legacy accounts. 
With respect to the comment about the effect of the replacement of 
references to LIBOR in security-based swap contracts, the Commission 
intends to consult and coordinate with other regulators on this 
question.
    Minimum Transfer Amount. The fifth exception established a minimum 
transfer amount.\514\ Under this provision, a nonbank SBSD was not 
required to collect margin if the total amount of the requirement was 
equal to or less than $100,000. If this amount was exceeded, the 
nonbank SBSD needed to collect margin to cover the entire amount of the 
requirement, not just the amount that exceeded $100,000.
---------------------------------------------------------------------------

    \514\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70272.
---------------------------------------------------------------------------

    Several commenters supported this exception, or supported 
increasing it to amounts that ranged from $250,000 to

[[Page 43925]]

$500,000.\515\ Commenters also asked the Commission to clarify whether 
the proposed minimum transfer amount applies to both initial and 
variation margin, and recommended that different jurisdictions use the 
same currency to designate thresholds.\516\ A commenter also supported 
consistent minimum transfer amounts across domestic regulators.\517\ 
The CFTC and the prudential regulators adopted a minimum transfer 
amount of $500,000.\518\ One commenter opposed a minimum transfer 
amount for variation margin.\519\
---------------------------------------------------------------------------

    \515\ See American Council of Life Insurers 2/22/2013 Letter; 
American Council of Life Insurers, et al. 1/29/2013 Letter; ICI 11/
19/2018 Letter; ISDA 11/19/2018 Letter; Markit Letter; SIFMA AMG 2/
22/2013 Letter; SIFMA AMG 11/19/2018 Letter; SIFMA 3/12/14 Letter; 
SIFMA 11/19/2018 Letter.
    \516\ See ISDA 2/5/2014 Letter; SIFMA 3/12/14 Letter.
    \517\ See American Council of Life Insurers 2/22/2013 Letter.
    \518\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74903; CFTC Margin Adopting Release, 81 FR at 697. 
See also BCBS/IOSCO Paper at 10 (recommending a minimum transfer 
amount of [euro]500,000).
    \519\ See Harrington 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission agrees with commenters that the minimum transfer 
amount should be increased to $500,000. This will reduce operational 
burdens for nonbank SBSDs and their counterparties by not requiring 
them to transfer small amounts of collateral on a daily basis. It also 
will align the rule with the minimum transfer amount adopted by the 
CFTC and the prudential regulators and, thereby, reduce potential 
operational burdens and competitive impacts that could result from 
inconsistent requirements.
    In response to the commenter concerned about applying the minimum 
transfer amount to variation margin, a nonbank SBSD will be required to 
take a capital deduction in lieu of margin or credit risk charge if it 
does not collect variation and/or initial margin pursuant to the 
minimum transfer amount exception.
    For these reasons, the Commission is adopting the minimum transfer 
amount exception with an increase to $500,000, and with minor 
modifications.\520\
---------------------------------------------------------------------------

    \520\ See paragraph (c)(1)(iii)(I) and (c)(2)(iii)(D) of Rule 
18a-3, as adopted. In the final rule the minimum transfer amount 
paragraph was moved to the exceptions section of the rule as a non-
substantive change to facilitate cross-references to the capital 
rules related to capital charges in lieu of margin and credit risk 
charges. This modification also will improve the overall consistency 
and structure of the margin rule. Therefore, the exception appears 
twice in the final rule text, rather than once, as proposed, with 
references to both nonbank SBSDs and MSBSPs. See paragraph 
(c)(1)(iii)(I) and (c)(2)(iii)(D) of Rule 18a-3, as adopted. 
Finally, the phrase ``cash, securities, and money market 
instruments'' has been replaced with the term ``collateral'' as a 
result of changes made to other paragraphs of the rule.
---------------------------------------------------------------------------

    The Commission also clarifies that the minimum transfer amount 
applies to both initial and variation margin. Thus, required initial 
and variation margin need not be collected if the combined requirements 
are below $500,000. However, if the $500,000 level is exceeded, the 
entire amount must be collected (i.e., not the just amount that exceeds 
$500,000). Finally, in response to a comment, nonbank SBSDs may 
negotiate a lower ``house'' minimum transfer amount with their 
counterparties.
    Initial Margin Threshold. The CFTC and the prudential regulators 
have adopted a fixed-dollar $50 million threshold under which initial 
margin need not be collected.\521\ The CFTC defines its initial margin 
threshold amount to mean an aggregate credit exposure of $50 million 
resulting from all non-cleared swaps of a swap dealer and its 
affiliates with a counterparty and its affiliates.\522\ The prudential 
regulators adopted a similar threshold, except that it covers aggregate 
credit exposure resulting from all non-cleared security-based swaps and 
swaps.\523\
---------------------------------------------------------------------------

    \521\ See CFTC Margin Adopting Release, 81 FR at 652; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74863; see 
also BCBS/IOSCO Paper, principle 2.1 (providing that covered 
entities must exchange initial margin with a threshold not to exceed 
[euro]50 million).
    \522\ See CFTC Margin Adopting Release, 81 FR at 697.
    \523\ Prudential Regulator Margin and Capital Adopting Release, 
80 FR at 74901.
---------------------------------------------------------------------------

    Some commenters requested that the Commission adopt a threshold 
consistent with the thresholds adopted by the CFTC and the prudential 
regulators, and with the recommendations in the BCBS/IOSCO Paper.\524\ 
A commenter stated that initial margin thresholds can be a useful means 
for reducing the aggregate liquidity impact of mandatory initial margin 
requirements while still protecting an SBSD from large uncollateralized 
potential future exposures to counterparties.\525\ Another commenter 
suggested that if pension plans are subject to initial margin 
requirements, then dealers should be able to set initial margin 
thresholds for them on a case-by-case basis.\526\ A third commenter 
suggested that low-risk financial end users should be allowed an 
uncollateralized threshold of $100 million.\527\ Other commenters 
raised concerns about the consequences of breaching the threshold and 
noted that doing so would trigger the need to execute agreements to 
address the posting of initial margin.\528\
---------------------------------------------------------------------------

    \524\ See, e.g., ICI 5/11/2015 Letter; Ropes & Gray Letter; 
SIFMA 3/12/2014 Letter.
    \525\ See SIFMA 2/22/2013 Letter.
    \526\ See American Benefits Council Letter, et al., 1/29/2013 
Letter.
    \527\ See PIMCO Letter.
    \528\ See Letter from Scott O'Malia, Chief Executive Officer, 
International Swaps and Derivatives Association, Kenneth E. Bentsen, 
Jr., President & CEO, Securities Industry and Financial Markets 
Association, Ananda Radhakrishnan, Vice President, Center for Bank 
Derivatives Policy, American Bankers Association, James Kemp, 
Managing Director, Global Foreign Exchange Division, GFMA, and 
Briget Polichene, Chief Executive Officer, Institute of 
International Bankers (Sept. 12, 2018) (``ISDA, SIFMA, ABA, et al. 
9/12/18 Letter'').
---------------------------------------------------------------------------

    In the 2018 comment reopening, the Commission asked whether it 
would be appropriate to establish a risk-based threshold where, for 
example, a nonbank SBSD would not be required to collect initial margin 
to the extent the amount does not exceed the lesser of: (1) 1% of the 
SBSD's tentative net capital; or (2) 10% of the net worth of the 
counterparty.\529\ The Commission stated that the purpose would be to 
establish a threshold that is scalable and has a more direct relation 
to the risk to the nonbank SBSD arising from its security-based swap 
activities. The Commission also stated that a fixed-dollar threshold, 
depending on the size and activities of the nonbank SBSD, could either 
be too large and, therefore, not adequately address the risk, or too 
small and, therefore, overcompensate for the risk.
---------------------------------------------------------------------------

    \529\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53013.
---------------------------------------------------------------------------

    In response to the potential risk-based threshold discussed in the 
comment period reopening, most commenters argued that the Commission 
should adopt a fixed-dollar $50 million threshold consistent with the 
final margin rules of the CFTC and the prudential regulators.\530\ A 
commenter suggested that this would result in benefits such as 
predictability and transparency.\531\ This commenter also argued that a 
threshold harmonized with that of other regulators would prevent 
opportunities for counterparties to engage in regulatory arbitrage, and 
recommended that any drawbacks (such as the threshold being too large 
in relation to a nonbank SBSD's net capital) be addressed through 
additional capital charges.\532\ A commenter raised concerns that a 
different threshold

[[Page 43926]]

would result in significant compliance challenges if trading desks that 
trade both security-based swaps and swaps were required to apply 
different standards to the same counterparty.\533\ Another commenter 
believed that a scalable threshold would cause significant operational 
challenges and inefficiencies by subjecting individual SBSDs to 
different thresholds for the collection of initial margin.\534\
---------------------------------------------------------------------------

    \530\ See Center for Capital Markets Competitiveness, Chamber of 
Commerce 11/19/2018 Letter; ICI 11/19/2018 Letter; ISDA 11/19/2018 
Letter.
    \531\ See SIFMA 11/19/2018 Letter. This commenter recommended 
that the Commission adopt a $50 million initial margin threshold, 
but recommended that the drawbacks of the fixed-dollar threshold 
could be addressed through additional capital charges, such as 
credit concentration capital charges.
    \532\ See SIFMA 11/19/2018 Letter.
    \533\ See ICI 11/19/2018 Letter.
    \534\ See ISDA 11/29/2018 Letter.
---------------------------------------------------------------------------

    Several commenters argued against including an initial margin 
threshold in the final rule. Two stated that there is no threshold in 
the margin rules for cleared security-based swaps, and establishing one 
for non-cleared security-based swaps would increase systemic risk.\535\ 
One commenter argued that the Commission did not explain its views on 
why a counterparty specific threshold (e.g., $50 million) should be 
rejected in favor of a measure that would be tied to a percentage of 
the nonbank SBSD's tentative net capital.\536\
---------------------------------------------------------------------------

    \535\ See Better Markets 11/19/2018 Letter; OneChicago 11/19/
2018 Letter.
    \536\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to comments, the Commission believes that it would be 
appropriate to establish a threshold that is more consistent with the 
thresholds adopted by the CFTC and the prudential regulators. This will 
eliminate potential competitive disparities and address operational 
concerns raised by commenters. For these reasons, the Commission is 
adopting a fixed-dollar $50 million initial margin threshold below 
which initial margin need not be collected.\537\ As discussed below, 
the threshold in the Commission's final margin rule is consistent with 
the threshold in the prudential regulators' margin rules.
---------------------------------------------------------------------------

    \537\ See paragraph (c)(1)(iii)(H)(1) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    Pursuant to the threshold, an SBSD need not collect the calculated 
amount of initial margin to the extent that the sum of that amount plus 
all other credit exposures resulting from non-cleared security-based 
swaps and swaps of the nonbank SBSD and its affiliates with the 
counterparty and its affiliates does not exceed $50 million. The 
threshold will be calculated across all non-cleared security-based 
swaps and swaps of the nonbank SBSD and its affiliates with the 
counterparty and its affiliates, with the exception that non-cleared 
security-based swap transactions with commercial end users and non-
cleared swap transactions that are exempted under Section 4s(e)(4) of 
the CEA need not be included in the calculation. The margin rules of 
the CFTC and the prudential regulators similarly exclude transactions 
with commercial end users from their respective fixed-dollar $50 
million thresholds. Moreover, as discussed above, the TRIPRA statute 
precludes the Commission from adopting margin requirements for 
commercial end users.
    The Commission's fixed-dollar $50 million threshold is consistent 
with the threshold established by the prudential regulators in that the 
calculation includes both non-cleared security-based swaps and swaps 
(in contrast to the CFTC's threshold, which includes only swaps in the 
calculation). Including both non-cleared security-based swaps and swaps 
in the calculation will result in a more prudent requirement that takes 
into account a broader range of exposures. Further, because bank SBSDs 
can deal in security-based swaps, aligning the nonbank SBSD threshold 
with the bank threshold will eliminate a potential competitive 
disparity between the two types of U.S. entities that deal in security-
based swaps. Also, if the calculation of the Commission's threshold 
were limited to security-based swaps, SBSDs and counterparties 
potentially would need to make 3 threshold calculations: One for the 
Commission's rule (security-based swaps only), one for the CFTC's rule 
(swaps only), and one for the prudential regulators' rule (security-
based swaps and swaps). By conforming to the prudential regulator's 
rule, SBSDs and counterparties need only make two calculations (the 
Commission/prudential regulator threshold and the CFTC threshold). 
Further, a counterparty that breaches the Commission's fixed-dollar $50 
million threshold will not necessarily breach the CFTC's fixed-dollar 
$50 million threshold exception given that the former calculation 
includes security-based swap and swap exposures and the latter includes 
only swap exposures.
    The Commission recognizes that a fixed-dollar threshold (as opposed 
to a scalable threshold) does not necessarily bear a relation to the 
financial condition of the nonbank SBSD and its counterparty. To 
address this issue, as discussed above, and as suggested by a 
commenter, a nonbank SBSD will be required to take a capital deduction 
in lieu of margin or a credit risk charge if it does not collect 
initial margin pursuant to the fixed-dollar $50 million threshold 
exception. Furthermore, the nonbank SBSD will be required to establish, 
maintain, and document procedures and guidelines for monitoring 
counterparty risk. Consequently, the Commission does not believe the 
fixed-dollar $50 million threshold exception will unduly increase 
systemic risk as suggested by a commenter. For these reasons, the 
Commission believes it is appropriate to adopt the exception to promote 
greater consistency with the margin requirements of the prudential 
regulators.
    Finally, commenters raised concerns about the consequences of 
breaching a fixed-dollar $50 million threshold and noted that doing so 
would trigger the need to execute agreements to address the posting of 
initial margin.\538\ The Commission recognizes that after a breach 
counterparties may need time to execute agreements, establish processes 
for exchanging initial margin, and take other steps to comply with the 
initial margin requirement.\539\ Therefore, the Commission is modifying 
the final rule to permit a nonbank SBSD to defer collecting the initial 
margin amount for up to two months following the month in which a 
counterparty no longer qualifies for the fixed-dollar $50 million 
threshold exception for the first time.\540\ This is designed to 
provide the counterparty with sufficient time to take the steps 
necessary to begin posting initial margin pursuant to the final rule.
---------------------------------------------------------------------------

    \538\ See ISDA, SIFMA, American Bankers Association, et al 9/12/
2018 Letter.
    \539\ As discussed above in section II.B.1. of this release, 
while paragraphs (c)(4) and (5) of Rule 18a-3, as adopted, 
respectively require netting and collateral agreements to be in 
place, the rule does not impose a specific margin documentation 
requirement as do the margin rules of the CFTC and the prudential 
regulators.
    \540\ See paragraph (c)(1)(iii)(H)(2) of Rule 18a-4, as adopted. 
Paragraph (c)(1)(iii)(H)(2) of the final rule states 
``Notwithstanding paragraph (c)(1)(iii)(H)(1) of this section, a 
security-based swap dealer may defer collecting the amount required 
under paragraph (c)(1)(ii)(B) of this section for up to two months 
following the month in which a counterparty no longer qualifies for 
this threshold exception for the first time.''
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    Affiliates. The margin rules of the CFTC and the prudential 
regulators have exceptions for counterparties that are affiliates.\541\ 
Some commenters requested that the Commission also adopt exceptions for 
affiliates.\542\ One

[[Page 43927]]

commenter stated that inter-affiliate transactions do not increase the 
overall risk profile or leverage of the SBSD.\543\ Another commenter 
noted that some affiliates enter into security-based swap transactions 
with their nonbank SBSD affiliates, either for individual hedging 
purposes or as part of the consolidated group's broader risk 
strategy.\544\
---------------------------------------------------------------------------

    \541\ See CFTC Margin Adopting Release, 81 FR at 673-674; 
Prudential Regulator Margin and Capital Adopting Release, 80 FR at 
74887-90.
    \542\ See Letter from Representative Ted Budd, Representative 
Patrick McHenry et. al. (May 14, 2019); Letter from John Court, 
Managing Director and Senior Associate General Counsel, The Clearing 
House, Cecelia A. Calaby, Executive Director and General Counsel, 
American Bankers Association Securities Association, and Jason 
Shafer, Vice President, American Bankers Association (Nov. 24, 2014) 
(``Clearing House 11/24/14 Letter''); Letter from John Court, 
Managing Director/Deputy General Counsel, The Clearing House, 
Cecelia A. Calaby, Senior Vice President, Office of Regulatory 
Policy, American Bankers Association and Executive Director and 
General Counsel, American Bankers Association Securities 
Association, and Kyle Brandon, Managing Director, Director of 
Research, SIFMA (June 1, 2015) (``Clearing House 6/1/15 Letter''); 
Letter from Coalition for Derivatives End-Users (Feb. 22, 2013) 
(``Coalition for Derivatives End-Users 2/22/2013 Letter''); 
Financial Services Roundtable Letter; ISDA 1/23/2013 Letter; ISDA 2/
5/2014 Letter; ISDA 11/19/2018 Letter; SIFMA 2/22/2013 Letter; SIFMA 
3/12/2014 Letter; SIFMA 11/19/2019 Letter. The Clearing House 
proposed two alternatives for initial margin: A requirement that a 
nonbank SBSD collect initial margin from less regulated affiliates 
and segregate it, and not collect (or post) initial margin from 
highly regulated affiliates. Variation margin would still be 
collected under this proposal. In lieu of these proposals, The 
Clearing House also proposed a pooled segregated collateral account 
held at the parent company level. See Clearing House 6/1/15 Letter. 
One commenter recommended that variation margin requirements apply 
to an inter-affiliate transaction only when an SBSD is transacting 
with an unregulated/non-prudentially supervised affiliate. See SIFMA 
2/22/2013 Letter. This commenter also recommended that the 
Commission should not require nonbank SBSDs to collect initial 
margin from affiliates that are subject to the same centralized risk 
management program as the nonbank SBSD. See SIFMA 11/19/2018 Letter.
    \543\ See ISDA 11/19/2018 Letter.
    \544\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Other commenters opposed an exception for affiliates.\545\ One of 
these commenters urged the Commission to impose strong margin 
requirements for security-based swaps between bank affiliates and other 
entities under the Commission's authority.\546\
---------------------------------------------------------------------------

    \545\ See CFA Institute Letter; Letter from Elijah E. Cummings, 
Ranking Member, Committee on Oversight and Government Reform and 
Elizabeth Warren, Ranking Member, Subcommittee on Economic Policy 
(Nov. 10, 2015) (``Cummings and Warren Letter'').
    \546\ See Cummings and Warren Letter.
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    The Commission is persuaded that there should an exception for 
affiliates in order to reduce potential competitive disparities, and to 
promote consistency with the margin requirements of the CFTC. 
Therefore, the Commission is modifying the final rule to establish an 
initial margin exception when the counterparty is an affiliate of the 
SBSD.\547\
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    \547\ See paragraph (c)(1)(iii)(G) of Rule 18a-3, as adopted. 
This paragraph in the final rule will read: [t]he requirements of 
paragraph (c)(1)(ii)(B) of this section do not apply to an account 
of a counterparty that is an affiliate of the security-based swap 
dealer.
---------------------------------------------------------------------------

    Although they will not be required to collect initial margin from 
affiliates, a nonbank SBSD must collect variation margin from them. In 
addition, as discussed above, a nonbank SBSD will be required to take a 
capital deduction in lieu of margin or credit risk charge if it does 
not collect initial margin from an affiliate. The nonbank SBSD also 
will be required to establish, maintain, and document procedures and 
guidelines for monitoring the risk of affiliates. Moreover, the final 
rule does not prohibit a nonbank SBSD from requiring an affiliate to 
post initial margin under its own house margin requirements.
    The BIS, European Stability Mechanism, Multilateral Development 
Banks, and Sovereigns. The margin rules of the CFTC and the prudential 
regulators have exceptions for counterparties that are not a financial 
end user as that term is defined in their rules.\548\ Their definitions 
of financial end user exclude the BIS, multilateral development banks, 
and sovereign entities.\549\
---------------------------------------------------------------------------

    \548\ See CFTC Margin Adopting Release, 81 FR at 642; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74855.
    \549\ See CFTC Margin Adopting Release, 81 FR at 642; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74855. See 
also BCBS/IOSCO Paper, paragraph 2(c) (recommending that margin 
standards should not be applied in such a way that would require 
sovereigns, central banks, multilateral development banks, or the 
BIS to either collect or post margin).
---------------------------------------------------------------------------

    Some commenters requested that the Commission adopt exceptions for 
these types of entities to be consistent with the margin rules of the 
CFTC and the prudential regulators, and with the recommendations in the 
BCBS/IOSCO Paper.\550\ One of these commenters argued that 
international consistency among covered entities subject to margin 
requirements, including the definition of public sector entities, is 
critical to competitive parity and comity.\551\ Another commenter 
argued that the approach to margin for foreign sovereign governments, 
central banks, and multilateral lending or development organizations 
should be determined through international consensus.\552\ A commenter 
recommended that the Commission adopt a definition of ``financial end 
user'' consistent with the margin rules of the CFTC and the prudential 
regulators, which--as noted above--results in exceptions for sovereign 
entities, multilateral development banks, and the BIS.\553\ The 
commenter argued that different treatment of these entities will create 
unnecessary competitive disparities.
---------------------------------------------------------------------------

    \550\ See Financial Services Roundtable Letter; SIFMA 2/22/2013 
Letter; SIFMA 3/12/2014 Letter; SIFMA 11/19/2018 Letter.
    \551\ See SIFMA 3/12/2014 Letter.
    \552\ See Financial Services Roundtable Letter.
    \553\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that there should be some exceptions 
for these types of entities in order to reduce potential competitive 
disparities. However, the Commission also believes that the exception 
for sovereign entities should be more limited, given the wide range of 
potential counterparties that would be within this category and their 
differing levels of creditworthiness. Limiting the exception for 
sovereign entities will help ensure the safety and soundness of nonbank 
SBSDs.
    For these reasons, the Commission is adopting an exception from 
collecting variation and initial margin if the counterparty is the BIS, 
the European Stability Mechanism, or one of a number of multilateral 
development banks identified in the rule.\554\ These multilateral 
development banks are the International Bank for Reconstruction and 
Development, the Multilateral Investment Guarantee Agency, the 
International Finance Corporation, the Inter-American Development Bank, 
the Asian Development Bank, the African Development Bank, the European 
Bank for Reconstruction and Development, the European Investment Bank, 
the European Investment Fund, the Nordic Investment Bank, the Caribbean 
Development Bank, the Islamic Development Bank, the Council of Europe 
Development Bank, and any other multilateral development bank that 
provides financing for national or regional development in which the 
U.S. government is a shareholder or contributing member. These specific 
counterparties also are not required to collect and/or post variation 
margin under the final margin rules of the CFTC and/or the prudential 
regulators.\555\ The Commission believes these counterparties pose 
minimal credit risk and, therefore, it is an appropriate trade-off to 
except them from the margin requirements (which are designed to protect 
the nonbank SBSD from counterparty risk) in order to eliminate the 
potential competitive disparities and operational burdens of treating 
them differently than under the rules of the CFTC and the prudential 
regulators.\556\
---------------------------------------------------------------------------

    \554\ See paragraph (c)(1)(iii)(E) of Rule 18a-3, as adopted.
    \555\ See CFTC Margin Adopting Release, 81 FR at 642; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74855. See 
also BCBS/IOSCO Paper at 10. The CFTC's approach generally treats 
the European Stability Mechanism consistent with the treatment of a 
multilateral development bank for purposes of the CFTC margin rule. 
See CFTC Letter No. 17-34 (Jul. 24, 2017).
    \556\ See CFTC Margin Adopting Release, 81 FR at 642; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74855.
---------------------------------------------------------------------------

    The exception for sovereign entities is more limited. Specifically, 
the final rule excepts a nonbank SBSD from collecting initial margin 
from a counterparty that is a sovereign entity if the nonbank SBSD has 
determined that the

[[Page 43928]]

counterparty has only a minimal amount of credit risk pursuant to 
policies and procedures or credit risk models established under 
applicable net capital rules for nonbank SBSDs.\557\ The final capital 
rules for nonbank SBSDs require these entities to have policies and 
procedures for assessing the creditworthiness of certain types of 
securities or money market instruments for purposes of applying 
standardized haircuts.\558\ The rules also require firms authorized to 
use models to compute haircuts to have a model for determining credit 
risk charges. The firms will need to use these policies and procedures 
or models (as applicable) to determine whether a sovereign entity has a 
minimal amount of credit risk in order to apply this exception. A 
sovereign entity that the nonbank SBSD has determined has a minimal 
amount of credit risk for purposes of the nonbank capital rules would 
qualify for the initial margin exception in Rule 18a-3.
---------------------------------------------------------------------------

    \557\ See paragraph (c)(1)(iii)(F) of Rule 18a-3, as adopted. 
The exception applies to a counterparty that is a central government 
(including the U.S. government) or an agency, department, ministry, 
or central bank of a central government if the security-based swap 
dealer has determined that the counterparty has only a minimal 
amount of credit risk pursuant to policies and procedures 
established pursuant to Rule 15c3-1 or 18a-1 (as applicable).
    \558\ See Removal of Certain References to Credit Ratings Under 
the Securities Exchange Act of 1934, Exchange Act Release No. 71194 
(Dec. 27, 2013), 79 FR 1522 (Jan. 8, 2014) (discussing the ``minimal 
amount of credit risk'' standard). See also paragraph (c)(2)(vi)(I) 
of Rule 15c3-1.
---------------------------------------------------------------------------

    Nonbank SBSDs must collect variation margin from and deliver 
variation margin to counterparties that are sovereign entities under 
the final rule. In contrast, the final margin rules of the CFTC and the 
prudential regulators do not require an SBSD or swap dealer to exchange 
variation margin with a counterparty that is a sovereign entity.\559\ 
Collecting variation margin from sovereign entity counterparties is an 
important means of managing credit exposure to these entities and 
limiting the amount of unsecured receivables that comprise the firm's 
capital. As discussed above, in contrast to the multilateral 
development banks identified in the rule, the Commission believes that 
the exception for sovereign entities should be more limited given the 
wide range of potential counterparties in this category and their 
differing levels of creditworthiness. Limiting the exception for 
sovereign entities and requiring that these counterparties post 
variation margin will help ensure the safety and soundness of nonbank 
SBSDs. Therefore, the Commission does not believe it is appropriate to 
except such counterparties from the variation margin requirements of 
the final rule.
---------------------------------------------------------------------------

    \559\ See CFTC Margin Adopting Release, 81 FR at 642; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR at 74855.
---------------------------------------------------------------------------

Requests for Other Exceptions
    Commenters suggested that the Commission except other 
counterparties from the margin requirements in Rule 18a-3. The proposed 
exceptions included: Pension plans; \560\ securitization and similar 
special purpose vehicles; \561\ state and municipal government 
entities; \562\ low risk financial end users; \563\ financial end users 
such as captive financial affiliates and mutual life insurance 
companies; \564\ emerging market counterparties that constitute only a 
certain percentage of a nonbank SBSD's volume; \565\ and counterparties 
trading non-cleared derivatives below a certain notional amount (e.g., 
financial end users without material swaps exposure).\566\ Other 
commenters suggested that the Commission adopt exceptions to the margin 
requirements recommended in the BCBS/IOSCO Paper, including for 
entities that have less than a specified gross notional amount of 
outstanding non-centrally cleared swaps.\567\
---------------------------------------------------------------------------

    \560\ See American Benefits Council, et al. 1/29/2013 Letter.
    \561\ See Financial Services Roundtable Letter; ISDA 1/23/2013 
Letter; ISDA 2/5/2014 Letter; SIFMA 2/22/2013 Letter; SIFMA 3/12/
2014 Letter.
    \562\ See Financial Services Roundtable Letter; ISDA 1/23/2013 
Letter.
    \563\ See SIFMA AMG 2/22/2013 Letter.
    \564\ See Coalition for Derivatives End-Users 2/22/2013 Letter.
    \565\ See SIFMA 3/12/2014 Letter.
    \566\ See ICI 11/19/2018 Letter; ISDA 11/19/2018 Letter; ISDA, 
SIFMA, American Bankers Association, et al. 9/12/18 Letter; SIFMA 
11/19/2018 Letter; SIFMA AMG 11/19/2018 Letter. These commenters 
generally supported that the Commission only require counterparties 
with ``material swaps exposure'' to post initial margin.
    \567\ See Financial Services Roundtable Letter; ISDA 2/5/2014 
Letter; Letter from Lutz-Christian Funke, Senior Vice President, and 
Frank Czichowski, Senior Vice President and Treasurer, KfW 
Bankengruppe (Dec. 19, 2012) (``KfW Bankengruppe Letter''); SIFMA 2/
22/2013 Letter; SIFMA 3/12/2014 Letter; World Bank Letter.
---------------------------------------------------------------------------

    A commenter opposed any exceptions, arguing that exceptions for 
certain market participants were a significant contributor to the 
systemic risk disruptions during the 2008 financial crisis.\568\ A 
commenter specifically opposed exceptions for asset-backed security 
issuers.\569\
---------------------------------------------------------------------------

    \568\ See CFA Institute Letter. This commenter specifically 
opposed exceptions for small banks, savings associations, farm 
credit system institutions, credit unions and foreign governments.
    \569\ See Letter from William J. Harrington (May 12, 2015) 
(``Harrington 5/12/2015 Letter'').
---------------------------------------------------------------------------

    The Commission does not believe it is necessary or prudent to 
establish special exceptions for these specific types of 
counterparties. The Commission acknowledges that not establishing 
special exceptions for some of these types of counterparties may lead 
to different margin requirements across both foreign and domestic 
regulators. On balance, however, the Commission believes that, given 
the funding profiles of nonbank SBSDs and the role of margin in 
promoting liquidity and self-sufficiency and managing credit exposure, 
the expansion of the exceptions in the manner suggested by commenters 
would not be prudent. The addition of the fixed-dollar $50 million 
threshold exception should provide relief to many of these 
counterparties from the requirement to deliver initial margin. 
Moreover, as discussed above, the Commission is providing SBSDs with a 
deferral period that should provide sufficient time for them and their 
counterparties to implement any documentation, custodial, or 
operational arrangements that they deem necessary to comply with Rule 
18a-3.\570\
---------------------------------------------------------------------------

    \570\ As discussed above, while paragraphs (c)(4) and (5) of 
Rule 18a-3, as adopted, respectively require netting and collateral 
agreements to be in place, the rule does not impose a specific 
margin documentation requirement as do the margin rules of the CFTC 
and the prudential regulators. Consequently, an existing netting or 
collateral agreement with a counterparty that was entered into by 
the nonbank SBSD in order to comply with the margin documentation 
requirements of the CFTC or the prudential regulators will suffice 
for the purposes of Rule 18a 3, as adopted, if the agreement meets 
the requirements of paragraph (c)(4) or (5), as applicable.
---------------------------------------------------------------------------

ii. Nonbank MSBSPs
    As discussed earlier, proposed Rule 18a-3 required a nonbank MSBSP 
to calculate as of the close of each business day the amount of equity 
in the account of each counterparty to a non-cleared security-based 
swap.\571\ By noon of the next business day, the nonbank MSBSP was 
required to either collect or deliver cash, securities, and/or money 
market instruments to the counterparty depending on whether there was 
negative or positive equity in the account of the counterparty.\572\ In 
other words, the nonbank MSBSP was required to either collect or 
deliver variation margin but not required to collect or deliver initial 
margin. The proposed rule did not require the nonbank MSBSP to apply 
the

[[Page 43929]]

standardized haircuts to securities or money market instruments when 
calculating the variation margin requirement for an account because the 
proposed capital rule for these entities did not use standardized 
haircuts (or model-based haircuts).
---------------------------------------------------------------------------

    \571\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70270-71.
    \572\ The nonbank MSBSP would need to deliver cash, securities, 
and/or money market instruments and, consequently, under the 
proposal, other types of assets would not be eligible as collateral.
---------------------------------------------------------------------------

    Under the proposal, a nonbank MSBSP was subject to certain of the 
account equity requirements that applied to nonbank SBSDs and were 
discussed above. First, the types of assets that could be used to meet 
the nonbank MSBSP's obligation to either collect or deliver variation 
margin were limited to cash, securities, or money market instruments. 
Second, the nonbank MSBSP was subject to the additional collateral 
requirements designed to ensure that the collateral was of stable and 
predictable value, not linked to the value of the transaction in any 
way, and capable of being sold quickly and easily if the need arises. 
Third, the nonbank MSBSP was subject to the requirement to take prompt 
steps to liquidate collateral consisting of securities or money market 
instruments to the extent necessary to eliminate an account equity 
deficiency (though the measure of a deficiency related solely to 
required variation margin, as these entities were not required to 
collect initial margin).
    Proposed Rule 18a-3 also provided exceptions under which a nonbank 
MSBSP was not required to collect and, in some cases, deliver variation 
margin. The first exception applied to counterparties that were 
commercial end users. Under this exception, the nonbank MSBSP was not 
required to collect variation margin from the commercial end user. The 
second exception applied to counterparties that were SBSDs. Under this 
exception, the nonbank MSBSP was not required to collect variation 
margin from the SBSD. However, under proposed Rule 18a-3, a nonbank 
SBSD was required to collect variation and initial margin from an 
MSBSP. The third exception applied to legacy accounts. Under this 
exception, the nonbank MSBSP was not required to collect or deliver 
variation margin with respect to positions in a legacy account. The 
fourth exception was the $100,000 minimum transfer amount provision. 
Under this exception, the nonbank MSBSP was not required to collect or 
deliver variation margin if the margin requirement was less than 
$100,000.
Comments and Final Account Equity Requirements for Nonbank MSBSPs
    A commenter stated that nonbank MSBSPs should be required to apply 
haircuts to the value of securities and money market instruments when 
determining whether the level of equity in the account meets the 
minimum requirement.\573\ Under the final rules being adopted today, 
nonbank MSBSPs are not subject to a capital standard that uses 
standardized or model based haircuts. Consequently, the Commission 
believes it would not be appropriate to require these firms to apply 
the standardized haircuts to the variation margin they receive from 
counterparties.
---------------------------------------------------------------------------

    \573\ See CFA Institute Letter.
---------------------------------------------------------------------------

    The Commission did not receive any specific comments on the 
commercial end user exception and is adopting it as proposed, with a 
non-substantive modification.\574\ As discussed above, however, the 
Commission modified the definition of ``commercial end user'' as a 
result of amendments to Section 15F(e) of the Exchange Act.
---------------------------------------------------------------------------

    \574\ See paragraph (c)(2)(iii)(A) of Rule 18a-3, as adopted. In 
the final rule, the phrase ``an account of'' was inserted before the 
phrase ``a counterparty'' to more closely align the text with 
paragraph (c)(1)(iii)(A) of the final rul.
---------------------------------------------------------------------------

    The Commission did not receive any specific comments on the 
exception for SBSD counterparties. The Commission, however, is removing 
this exception from the final rule because it is unnecessary. The final 
rule requires nonbank SBSDs to collect and post variation margin with 
respect to most counterparties including nonbank MSBSPs, and, 
consequently, a specific exception from collecting variation margin 
from nonbank SBSDs would be inconsistent with the requirement that they 
deliver variation margin to counterparties, including nonbank MSBSPs.
    Several commenters supported the Commission's proposed legacy 
account exception for nonbank MSBSPs.\575\ Commenters stated that 
applying the new rules to legacy accounts would be highly disruptive as 
the underlying agreements were negotiated based on the law in effect at 
the time of execution, and that, specifically, financial guarantee 
insurers are subject to extensive regulation by state insurance 
companies, and their security-based swap guarantees reflect the 
restrictions and obligations imposed by those regimes.\576\ The 
Commission is adopting the legacy account exception for nonbank MSBSPs 
substantially as proposed.\577\
---------------------------------------------------------------------------

    \575\ See AFGI 2/15/2013 Letter; AFGI 7/22/2013 Letter.
    \576\ See AFGI 2/15/2013 Letter; AFGI 7/22/2013 Letter.
    \577\ See paragraph (c)(2)(iii)(B) of Rule 18a-3, as adopted. In 
the final rule, the Commission deleted the phrase ``of a 
counterparty that is not a commercial end user'' from this paragraph 
because the phrase is redundant, as an exception for commercial end 
users is contained in paragraph (c)(2)(iii)(A) of Rule 18a-3, as 
adopted. The exception for legacy accounts has been re-designated 
paragraph (c)(2)(iii)(B) of Rule 18a-3, as adopted, since the 
exception for SBSDs was deleted from the final rule. Finally, the 
word ``legacy'' was moved to before the word ``account'' to align 
the phrase with the definition in paragraph (b)(6) of Rule 18a-3, as 
adopted.
---------------------------------------------------------------------------

    The Commission is making several conforming modifications to the 
account equity requirements for nonbank MSBSPs in light of 
modifications made to the account equity requirements for nonbank SBSDs 
discussed above in section II.B.2.i. of this release. First, the final 
rule provides that the nonbank MSBSP must collect or deliver variation 
margin by the close of business on the next business day following the 
day of the calculation, except that the collateral can be collected or 
delivered by the close of business on the second business day following 
the day of the calculation if the counterparty is located in another 
country and more than four time zones away.\578\ Second, the 
modifications to the collateral requirements in paragraph (c)(4) of 
Rule 18a-3, as adopted, apply to nonbank MSBSPs, including that the 
collateral to meet a margin requirement must consist of cash, 
securities, money market instruments, a major foreign currency, the 
security of settlement of the non-cleared security-based swap, or 
gold.\579\ Third, the final rule includes an exception from collecting 
variation margin if the counterparty is the BIS, the European Stability 
Mechanism, or one of the multilateral development banks identified in 
the rule (there is no exception from delivering variation margin to 
these types of counterparties).\580\ Fourth, the Commission is making 
the minimum transfer amount a specific exception to the account equity 
requirements for nonbank MSBSPs and raising the amount from $100,000 to 
$500,000.\581\
---------------------------------------------------------------------------

    \578\ See paragraph (c)(2)(ii) of Rule 18a-3, as adopted.
    \579\ See paragraph (c)(4) of Rule 18a-3, as adopted (applying 
its provisions to nonbank SBSDs and MSBSPs).
    \580\ See paragraph (c)(2)(iii)(C) of Rule 18a-3, as adopted.
    \581\ See paragraph (c)(2)(iii)(D) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    Finally, a commenter stated that commercial end users do not 
normally operate under the fiduciary obligations applicable to 
financial firms for the safekeeping of client funds and, therefore, are 
unequipped to handle collateral while a contract is open.\582\ 
Therefore, the commenter suggested that margin that a nonbank MSBSP is 
required to deliver to a commercial end user be held at a third-party 
custodian. In response, the final rules do not

[[Page 43930]]

prevent a nonbank MSBSP from entering into an agreement with a 
commercial end user under which variation margin required to be 
delivered to the commercial end user is held at a third-party 
custodian.
---------------------------------------------------------------------------

    \582\ See CFA Institute Letter.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the proposed 
account equity requirements for nonbank MSBSPs with the modifications 
discussed above.\583\
---------------------------------------------------------------------------

    \583\ See paragraphs (c)(2)(ii) and (iii) of Rule 18a-3, as 
adopted.
---------------------------------------------------------------------------

c. Risk Monitoring and Procedures
    Under proposed Rule 18a-3, a nonbank SBSD was required to monitor 
the risk of the positions in the account of each counterparty to a non-
cleared security-based swap and establish, maintain, and document 
procedures and guidelines for monitoring those risks.\584\ The nonbank 
SBSD also was also required to review, in accordance with written 
procedures, and at reasonable periodic intervals, its non-cleared 
security-based swap activities for consistency with the risk monitoring 
procedures and guidelines. The Commission did not receive any comments 
on these proposed requirements and for the reasons discussed in the 
proposing release is adopting them as proposed.\585\
---------------------------------------------------------------------------

    \584\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70272-70273.
    \585\ See paragraph (e) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

C. Segregation

1. Background
    The Commission is adopting security-based swap segregation 
requirements for SBSDs and stand-alone broker-dealers pursuant to 
Sections 3E and 15(c)(3) of the Exchange Act.\586\ Section 3E(b) of the 
Exchange Act provides that, for cleared security-based swaps, the 
money, securities, and property of a security-based swap customer shall 
be separately accounted for and shall not be commingled with the funds 
of the broker, dealer, or SBSD or used to margin, secure, or guarantee 
any trades or contracts of any security-based swap customer or person 
other than the person for whom the money, securities, or property are 
held. However, Section 3E(c)(1) of the Exchange Act also provides that, 
for cleared security-based swaps, customers' money, securities, and 
property may, for convenience, be commingled and deposited in the same 
one or more accounts with any bank, trust company, or clearing agency. 
Section 3E(c)(2) further provides that, notwithstanding Section 3E(b), 
in accordance with such terms and conditions as the Commission may 
prescribe by rule, regulation, or order, any money, securities, or 
property of the security-based swaps customer of a broker, dealer, or 
SBSD described in Section 3E(b) may be commingled and deposited as 
provided in Section 3E with any other money, securities, or property 
received by the broker, dealer, or SBSD and required by the Commission 
to be separately accounted for and treated and dealt with as belonging 
to the security-based swaps customer of the broker, dealer, or SBSD.
---------------------------------------------------------------------------

    \586\ Section 771 of the Dodd-Frank Act states that unless 
otherwise provided by its terms, its provisions relating to the 
regulation of the security-based swap market do not divest any 
appropriate Federal banking agency, the Commission, the CFTC, or any 
other Federal or State agency, of any authority derived from any 
other provision of applicable law.
---------------------------------------------------------------------------

    Section 3E(f) of the Exchange Act establishes a program by which a 
counterparty to non-cleared security-based swaps with an SBSD or MSBSP 
can elect to have initial margin held at an independent third-party 
custodian (individual segregation). Section 3E(f)(4) provides that if 
the counterparty does not choose to require segregation of funds or 
other property (i.e., waives segregation), the SBSD or MSBSP shall send 
a report to the counterparty on a quarterly basis stating that the 
firm's back office procedures relating to margin and collateral 
requirements are in compliance with the agreement of the 
counterparties. The statutory provisions of Sections 3E(b) and (f) are 
self-executing.
    Finally, Section 15(c)(3)(A) of the Exchange Act provides, in 
pertinent part, that no broker-dealer shall make use of the mails or 
any means or instrumentality of interstate commerce to effect any 
transaction in, or to induce or attempt to induce the purchase or sale 
of, any security (other than an exempted security (except a government 
security) or commercial paper, bankers' acceptances, or commercial 
bills) in contravention of such rules and regulations as the Commission 
shall prescribe as necessary or appropriate in the public interest or 
for the protection of investors to provide safeguards with respect to 
the financial responsibility and related practices of brokers-dealers 
including, but not limited to, the acceptance of custody and use of 
customers' securities and the carrying and use of customers' deposits 
or credit balances. The statute further provides, in pertinent part, 
that the rules and regulations shall require the maintenance of 
reserves with respect to customers' deposits or credit balances. The 
Commission adopted Rule 15c3-3 pursuant to this authority in Section 
15(c)(3)(A) of the Exchange Act.\587\
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    \587\ See Broker-Dealers; Maintenance of Certain Basic Reserves, 
Exchange Act Release No, 9856 (Nov. 29, 1972), 37 FR 25224, 25226 
(Nov. 29, 1972).
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    The Commission is adopting omnibus segregation requirements 
pursuant to which money, securities, and property of a security-based 
swap customer relating to cleared and non-cleared security-based swaps 
must be segregated but can be commingled with money, securities, or 
property of other customers. The omnibus segregation requirements for 
stand-alone SBSDs (including firms registered as OTC derivatives 
dealers) and bank SBSDs are codified in Rules 18a-4 and 18a-4a.\588\ 
The omnibus segregation requirements for stand-alone broker-dealers and 
broker-dealer SBSDs are codified in amendments to Rules 15c3-3 and 
15c3-3b.\589\
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    \588\ See Rule 18a-4, as adopted; Rule 18a-4a, as adopted. See 
also undesignated introductory paragraph to Rule 18a-4, as adopted 
(stating that the rule applies to stand-alone SBSDs registered as 
OTC derivatives dealers).
    \589\ See paragraph (p) of Rule 15c3-3, as amended; Rule 15c3-
3b, as adopted.
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    The omnibus segregation requirements are mandatory with respect to 
money, securities, or other property relating to cleared security-based 
swaps that is held by a stand-alone broker-dealer or SBSD (i.e., 
customers cannot waive segregation). With respect to non-cleared 
security-based swap transactions, the omnibus segregation requirements 
are an alternative to the statutory provisions discussed above pursuant 
to which a counterparty can elect to have initial margin individually 
segregated or to waive segregation. However, under the final omnibus 
segregation rules for stand-alone broker-dealers and broker-dealer 
SBSDs in Rule 15c3-3, counterparties that are not an affiliate of the 
firm cannot waive segregation. Affiliated counterparties of a stand-
alone broker-dealer or broker-dealer SBSD can waive segregation. Under 
Section 3E(f) of the Exchange Act and Rule 18a-4, all counterparties 
(affiliated and non-affiliated) to a non-cleared security-based swap 
transaction with a stand-alone or bank SBSD can waive segregation. The 
omnibus segregation requirements are the ``default'' requirement if the 
counterparty does not elect individual segregation or to waive 
segregation (in the cases where a counterparty is permitted to waive 
segregation). As discussed below in section II.E.2. of this release, 
Rule 18a-4 also has exceptions pursuant to which a foreign stand-alone 
or bank SBSD or MSBSP need not comply with the

[[Page 43931]]

segregation requirements (including the omnibus segregation 
requirements) for certain transactions.
    The omnibus segregation requirements do not apply to MSBSPs.\590\ 
However, if an MSBSP requires initial margin from a counterparty with 
respect to non-cleared security-based swaps, the counterparty can 
request that the collateral be held at a third-party custodian pursuant 
to Section 3E(f) of the Exchange Act.\591\
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    \590\ A broker-dealer dually registered as an MSBSP will be 
subject to the omnibus segregation requirements in Rule 15c3-3 by 
virtue of being a broker-dealer.
    \591\ See 15 U.S.C. 78c-5(f).
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    As proposed, the segregation requirements for all types of SBSDs 
would have been codified in Rules 18a-4 and 18a-4a. However, a 
commenter requested that Rule 15c3-3 be amended so that initial margin 
delivered to a stand-alone broker-dealer by a counterparty to a cleared 
security-based swap and which the stand-alone broker-dealer in turn 
delivers to a clearing agency could be treated under the proposed 
omnibus segregation requirements.\592\ In the 2018 comment reopening, 
the Commission asked whether omnibus segregation requirements parallel 
to those in proposed Rule 18a-4 should be codified in Rule 15c3-3, in 
which case they would apply to stand-alone broker-dealers and broker-
dealer SBSDs.\593\ One commenter argued that the Commission should 
apply the omnibus segregation requirements of Rule 15c3-3 to a broker-
dealer SBSD, but recommended a single possession or control requirement 
for all positions, including those that are portfolio margined.\594\ 
Another commenter supported the integration of security-based swap 
segregation requirements for stand-alone broker-dealers into Rule 15c3-
3, including the express recognition in Rule 15c3-3 of margin posted by 
a stand-alone broker-dealer to a clearing agency.\595\ Other commenters 
stated that the Commission should consider raising segregation 
requirements to achieve regulatory consistency, or harmonize rules with 
other regulators to avoid operational issues that could fragment the 
security-based swap market.\596\
---------------------------------------------------------------------------

    \592\ See Letter from Kathleen M. Cronin, Senior Managing 
Director, General Counsel, CME Group Inc. (Feb. 22, 2013) (``CME 
Letter'').
    \593\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53016.
    \594\ See SIFMA 11/19/2018 Letter.
    \595\ See FIA 11/19/2018 Letter.
    \596\ See Better Markets 11/19/2018 Letter; ISDA 11/19/2018 
Letter.
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    The Commission believes it is appropriate to codify the omnibus 
segregation requirements for stand-alone broker-dealers and broker-
dealer SBSDs in Rules 15c3-3 and 15c3-3b. Absent this modification, a 
stand-alone broker-dealer that engages in security-based swap activity 
would continue to be subject to the segregation requirements of Rules 
15c3-3 and 15c3-3a as they existed prior to today's amendments. 
However, as discussed in more detail below, these pre-existing 
requirements are not tailored to security-based swaps in the way that 
the omnibus segregation requirements are tailored. Consequently, by 
codifying the omnibus segregation requirements in Rules 15c3-3 and 
15c3-3b, stand-alone broker-dealers also will be subject to the 
tailored requirements and will meet their pre-existing segregation 
obligations through them. Furthermore, Section 3E(b) of the Exchange 
Act imposes self-executing segregation requirements on stand-alone 
broker-dealers (as well as SBSDs) that would place strict restrictions 
on, and not permit the commingling of, collateral for a cleared 
security-based swap unless the Commission, pursuant to Section 3E(c), 
permits it by rule, regulation, or order. The omnibus segregation 
requirements being adopted in Rules 15c3-3 and 15c3-3b will permit 
stand-alone broker-dealers to commingle this collateral and take other 
actions with respect to it that otherwise would have been prohibited. 
Thus, the Commission believes that stand-alone broker-dealers will 
benefit by being subject to more tailored and flexible segregation 
requirements.
    As discussed above, non-affiliated customers of a stand-alone 
broker-dealer or broker-dealer SBSD will not be permitted to waive 
segregation. Section 15(c)(3) of the Exchange Act does not have a 
provision that is analogous to Section 3E(f)(4), which provides that if 
the counterparty does not choose to require segregation of funds or 
other property with respect to non-cleared swaps, the SBSD or MSBSP 
shall send a report to the counterparty on a quarterly basis stating 
that the firm's back office procedures relating to margin and 
collateral requirements are in compliance with the agreement of the 
counterparties. Under Section 15(c)(3) of the Exchange Act and Rule 
15c3-3 thereunder, persons--other than affiliates--are not permitted to 
waive segregation. This reflects the important protection that 
segregation provides to customers. It also serves to promote the safety 
and soundness of stand-alone broker-dealers. Segregating securities and 
cash of customers makes these assets readily available to be returned 
to the customers and therefore makes it more likely that a stand-alone 
broker-dealer (and a broker-dealer SBSD) can meet its obligations to 
the customers. Thus, segregation protects customers and supports the 
liquidity of stand-alone broker-dealers (and will have the same effect 
on broker-dealer SBSDs). Moreover, segregation reduces the risk that 
customers will ``run'' on a stand-alone broker-dealer when it is 
experiencing financial difficulty or the securities markets are in 
turmoil (and will have the same effect on broker-dealer SBSDs). 
Customers whose assets are being segregated know that the assets are 
being protected. Conversely, persons whose assets are not being 
segregated may act precipitously to withdraw them from a firm if they 
perceive that the firm is experiencing financial difficulty or the 
markets are in turmoil. This could put severe liquidity pressure on the 
firm, particularly since the assets these persons are seeking to 
withdraw may not be readily available to the firm (e.g., they may be 
re-hypothecated or serving as collateral for loans to the broker-
dealer). Affiliates are less likely to create this ``run'' risk as they 
will have more information about the financial condition of the firm 
and their shared parent holding company.
    In addition, as discussed below, a number of commenters have raised 
questions about how claims would be handled in the liquidation of a 
broker-dealer SBSD. In addition, one commenter argued that stand-alone 
broker-dealers and broker-dealer SBSDs should be subject to a single 
set of omnibus segregation requirements for security-based swaps and 
related cash and all other types of securities and related cash.\597\ 
This commenter argued that separating security-based swap positions 
from all other security positions for purposes of the possession or 
control and reserve account requirements of the omnibus segregation 
rule could foster legal uncertainty in a SIPA liquidation. As discussed 
below in sections II.C.3.a. and II.C.3.b. of this release, the 
Commission does not believe at this time that security-based swaps 
should be combined with other types of securities positions for the 
purposes of the possession or control and reserve account 
calculations.\598\

[[Page 43932]]

However, the Commission does share the commenter's concern about taking 
steps to avoid legal uncertainty. In this regard, customers could be 
harmed in cases where a stand-alone broker-dealer or broker-dealer SBSD 
that holds cash and securities for persons who waived segregation with 
respect to their non-cleared security-based transactions, but did not 
(because they could not) waive segregation with respect to cash and 
securities that are not related to non-cleared security-based swap 
transactions. More specifically, there could be questions about the 
status of a particular person's claim in a liquidation proceeding and 
potentially result in the amount of cash and securities that were 
segregated by the stand-alone broker-dealer or broker-dealer SBSD being 
insufficient to satisfy the claims of all persons who a court 
ultimately determines are customers under SIPA and are entitled to a 
pro rata share of customer property.
---------------------------------------------------------------------------

    \597\ SIFMA 11/19/2018 Letter.
    \598\ Combining security-based swap transactions, particularly 
non-cleared security-based swap transactions, with other securities 
positions for purposes of the reserve account calculation would mean 
that credit items owed to retail customers could be used to fund 
debits relating to non-cleared security-based swap transactions. The 
Commission does not believe that retail customers should be subject 
to this risk.
---------------------------------------------------------------------------

    For these reasons, the omnibus segregation requirements are being 
codified in Rule 15c3-3 to apply to stand-alone broker-dealers and 
broker-dealer SBSDs with a limitation that non-affiliates cannot waive 
segregation with respect to non-cleared security-based swap 
transactions (in addition to not being able to waive segregation with 
respect to all other securities transactions). In order to implement 
this limitation, the Commission is modifying the subordination 
provisions in the final rule to provide that only an affiliate of the 
stand-alone broker-dealer or broker-dealer SBSD can waive segregation 
with respect to non-cleared security-based swap transactions. In 
particular, the Commission is modifying the definition of ``security-
based swap customer'' to provide that, with respect to persons who 
subordinate their claims, the term excludes an affiliate of the stand-
alone broker-dealer or broker-dealer SBSD.\599\ Thus, a person who is 
not an affiliate will be a ``security-based swap customer'' (regardless 
of whether the person attempts to subordinate) and therefore cash and 
securities of the customer related to non-cleared security-based swaps 
will be subject to the omnibus segregation requirements. The Commission 
is making a conforming amendment to the requirement that the stand-
alone broker-dealer or broker-dealer SBSD obtain a subordination 
agreement from a person who waives segregation with respect to non-
cleared security-based swaps to provide that the provision applies to 
affiliates that waive segregation because persons who are not 
affiliates cannot waive segregation.\600\
---------------------------------------------------------------------------

    \599\ See paragraph (p)(1)(vi) of Rule 15c3-3, as amended.
    \600\ See paragraph (p)(4)(ii)(B) of Rule 15c3-3, as amended.
---------------------------------------------------------------------------

    Commenters sought clarification on how customer collateral held by 
an SBSD as initial margin to secure a security-based swap would be 
treated in the event of the SBSD's insolvency.\601\ A commenter 
requested clarification on how counterparties to an entity that is both 
an SBSD and CFTC-regulated swap dealer would be treated in the event of 
the insolvency of the firm.\602\ The same commenter stated that it is 
unclear how claims of a security-based swap customer of a broker-dealer 
SBSD would be treated relative to the claims of other types of 
customers of the firm, including whether security-based swaps would be 
subject to SIPA protections.
---------------------------------------------------------------------------

    \601\ See, e.g., Letter from Angie Karna, Managing Director, 
Legal, Nomura Global Financial Products, Inc. (Sept. 10, 2014) 
(``Nomura Letter''); SIFMA AMG 2/22/2013 Letter.
    \602\ See SIFMA AMG 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to commenters' requests for clarification, Section 
3E(g) of the Exchange Act applies the customer protection elements of 
the stockbroker liquidation provisions to cleared security-based swaps 
and related collateral, and to collateral delivered as margin for non-
cleared security-based swaps if collateral is subject to a customer 
protection requirement under Section 15(c)(3) of the Exchange Act or a 
segregation requirement. The Dodd-Frank Act also amended the U.S. 
Bankruptcy Code, and the CFTC has promulgated rules to implement that 
amendment, to provide the protections of Subchapter IV of Chapter 7 of 
the Bankruptcy Code and CFTC Regulation Part 190 to collateral 
associated with cleared swaps.\603\ Finally, SIPA protects customers of 
SIPC-member broker-dealers. SIPA defines a ``customer'' as any person 
(including any person with whom the broker-dealer deals as principal or 
agent) who has a claim on account of securities received, acquired, or 
held by the broker-dealer in the ordinary course of its business as a 
broker-dealer from or for the securities accounts of such person for 
safekeeping, with a view to sale, to cover consummated sales, pursuant 
to purchases, as collateral, security, or for purposes of effecting 
transfer.\604\
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    \603\ See Protection of Cleared Swaps Customer Contracts and 
Collateral; Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 
7, 2012).
    \604\ See 15 U.S.C. 78lll(2).
---------------------------------------------------------------------------

    The omnibus segregation requirements will apply to stand-alone 
broker-dealers and broker-dealer SBSDs pursuant to new paragraph (p) of 
Rule 15c3-3, as discussed above. They also will apply to stand-alone 
and bank SBSDs if they elect to clear security-based swap transactions 
for other persons or otherwise do not meet the conditions of the 
exemption discussed below in section II.C.2. of this release. In this 
regard, Section 3E of the Exchange Act authorizes the Commission to 
promulgate segregation rules for all types of SBSDs. In contrast, 
Section 15F of the Exchange Act authorizes the prudential regulators to 
promulgate capital and margin rules for bank SBSDs. Further, the 
requirements of the prudential regulators with respect to segregating 
initial margin apply to non-cleared security-based swaps (i.e., they do 
not address cleared security-based swaps). As discussed above, with 
respect to cleared security-based swaps, Section 3E(b) of the Exchange 
Act imposes self-executing segregation requirements on stand-alone 
broker-dealers and SBSDs that place strict restrictions on, and do not 
permit the commingling of, collateral for a cleared security-based swap 
unless the Commission, pursuant to Section 3E(c), permits it by rule, 
regulation, or order. Therefore, the Commission believes the statute 
itself imposes strict segregation requirements on bank SBSDs with 
respect to cleared security-based swaps in the absence of Commission 
rulemaking. The Commission's omnibus segregation requirements implement 
Section 3E(c) in a manner that is designed to protect security-based 
swap customers, but in a tailored way that will permit stand-alone 
broker-dealers and SBSDs to commingle collateral with respect to 
cleared security-based swaps and take other actions with respect to the 
collateral that otherwise would have been prohibited. Consequently, 
bank SBSDs (along with nonbank SBSDs and stand-alone broker-dealers) 
will benefit from the flexibility offered by the omnibus segregation 
requirements to the extent they elect to clear security-based swap 
transactions for other persons. However, as noted above and discussed 
below in section II.C.2. of this release, stand-alone and bank SBSDs 
will be exempt from the omnibus segregation requirements of Rule 18a-4 
under certain conditions, including that they do not clear security-
based swaps for other persons.\605\ The Commission expects that bank 
SBSDs will operate under this exemption, because in order to clear 
swaps for other persons they would need to be registered as an FCM, 
which would subject them to CFTC capital requirements in addition to 
the

[[Page 43933]]

capital requirements imposed by their prudential regulator.
---------------------------------------------------------------------------

    \605\ See paragraph (f) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    Commenters recommended that the Commission adopt individual 
segregation requirements for cleared security-based swaps. A commenter 
stated that the European Commission has finalized regulations mandating 
that central counterparties allow customers to choose between omnibus 
segregation and individual segregation for their cleared derivatives 
assets and positions.\606\ A second commenter stated that if the stand-
alone broker-dealer or SBSD defaults, any cleared security-based swap 
customer collateral that is individually segregated would likely be 
outside the estate of the stand-alone broker-dealer or SBSD for 
bankruptcy purposes, thereby facilitating customers' retrieval of their 
collateral.\607\ This commenter also indicated that cleared security-
based swap customers registered with the Commission under the 
Investment Company Act of 1940 may be precluded from having their 
collateral held at an SBSD that is not a bank. A third commenter argued 
that collateral posted as margin should be segregated by client, rather 
than on an omnibus basis.\608\ A number of these commenters advocated 
that the Commission modify its proposal for cleared security-based 
swaps to allow for the approach adopted by the CFTC, known as legal 
separation with operational comingling (``LSOC'').\609\ Under the 
CFTC's LSOC rules, the collateral of multiple cleared swap customers 
can be commingled in one account.\610\
---------------------------------------------------------------------------

    \606\ See MFA 2/22/2013 Letter (citing Regulation (EU) No. 648/
2012 of the European Parliament of the Council on OTC derivative 
transactions, central counterparties and trade repositories (July 4, 
2012)).
    \607\ See ICI 2/4/2013 Letter.
    \608\ See CFA Institute Letter.
    \609\ See AIMA 2/22/2013 Letter; MFA 2/22/2013 Letter; SIFMA AMG 
2/22/2013 Letter; Vanguard Letter.
    \610\ See Protection of Cleared Swaps Customer Contracts and 
Collateral; Commodity Broker Bankruptcy Provisions, 77 FR 6336.
---------------------------------------------------------------------------

    Implementing an individual segregation regime for cleared security-
based swaps, including an LSOC-like approach, would require 
implementing new rules governing the treatment of collateral held by 
clearing agencies. For example, under the CFTC's rules, the DCO and the 
FCM that is a member of the DCO must take certain steps to ensure that 
the collateral attributable to non-defaulting swap customers is not 
used to pay for obligations arising from other defaulting swap 
customers. Implementing such rules would be outside the scope of this 
rulemaking, which involves segregation requirements for SBSDs (not 
clearing agencies).
    A commenter requested clarification as to how property remaining in 
a portfolio margin account of a security-based swap customer should be 
treated when all the security-based swap positions in the account are 
temporarily closed out or expire before the customer enters into a new 
security-based swap transaction.\611\ As noted above, this commenter 
also argued that the Commission should apply the omnibus segregation 
requirements of Rule 15c3-3 to a broker-dealer SBSD, but recommended a 
single possession or control requirement for all positions, including 
those that are portfolio margined.\612\ As stated above, implementing 
portfolio margining will require further coordination with the CFTC. If 
the entity is a broker-dealer, the security-based swap customer could 
request that cash and securities in the security-based swap account be 
transferred to a traditional securities account, in which case it would 
be subject to the segregation requirements of Rules 15c3-3 and 15c3-3a 
that existed prior to today's amendments.\613\ A commenter argued that 
swaps should be permitted to be held in a security-based swap account 
to facilitate portfolio margining for related or offsetting positions 
in the account.\614\ As discussed above with respect to Rule 18a-3, the 
Commission has modified the rule to accommodate portfolio margining of 
security-based swaps and swaps.
---------------------------------------------------------------------------

    \611\ See SIFMA 2/22/2013 Letter.
    \612\ See SIFMA 11/19/2018 Letter.
    \613\ See paragraphs (a) and (o) of Rule 15c3-3; Rule 15c3-3a.
    \614\ See CFA Institute Letter.
---------------------------------------------------------------------------

    A commenter stated that if MSBSPs are not required to comply with 
the proposed omnibus segregation requirements, many firms will apply to 
register as MSBSPs as a way to circumvent them.\615\ The Commission 
does not agree. First, Section 3E(a) of the Exchange Act makes it 
unlawful for a person to accept any money, securities, or property (or 
to extend credit in lieu thereof) from, for, or on behalf of a 
security-based swap customer to margin, guarantee, or secure a cleared 
security-based swap unless the person is registered as a broker-dealer 
or an SBSD. This prohibition severely limits the activities a stand-
alone MSBSP can engage in with respect to effecting transactions for 
cleared security-based swap customers (as compared to the activities 
permitted of broker-dealers and SBSDs). Second, the omnibus segregation 
requirements as applied to non-cleared security-based swaps are 
designed to provide a third segregation option to security-based swap 
customers in addition to the statutory options of individual 
segregation or waiving segregation altogether. The Commission believes 
that SBSDs will favor having the ability to utilize this third option. 
Third, a firm with security-based swap activity exceeding the de 
minimis threshold must register as an SBSD.\616\ A firm that does not 
want to comply with the omnibus segregation requirements by virtue of 
being an SBSD will need to restrict its activities to stay below the de 
minimis threshold. For these reasons, the Commission does not believe 
firms will seek to register as MSBSPs to avoid the omnibus segregation 
requirements.
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    \615\ See CFA Institute Letter.
    \616\ See Section 3(a)(71) of the Exchange Act (defining the 
term ``security-based swap dealer''); Entity Definitions Adopting 
Release, 77 FR 30596; Registration Process for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 80 FR 48964.
---------------------------------------------------------------------------

    Moreover, MSBSPs will be subject to the self-executing segregation 
provisions in Section 3E(f) of the Exchange Act for collateral relating 
to non-cleared security-based swap transactions, and, consequently, 
their customers can request individual segregation. Therefore, an MSBSP 
will be subject to a rigorous statutory segregation requirement. 
Finally, the omnibus segregation requirements may not be practical for 
stand-alone MSBSPs, given the potentially wide range of business models 
under which they may operate, and the uncertain impact that 
requirements designed for broker-dealers could have on these commercial 
entities.
    For the reasons discussed above, the Commission is adopting the 
omnibus segregation requirements for SBSDs modeled on the segregation 
requirements for broker-dealers but, as discussed below, with an 
exemption for stand-alone and bank SBSDs if they meet the conditions in 
the final rule, including that they do not clear security-based swaps 
transactions for other persons.
2. Exemption
    In the 2018 comment reopening, the Commission asked whether there 
are aspects of the proposed omnibus segregation requirements where 
greater clarity regarding the operation of the rule would be 
helpful.\617\ One commenter supported the use of third-party custodians 
to avoid the omnibus

[[Page 43934]]

segregation requirements.\618\ Several commenters recommended that the 
Commission modify its final segregation requirements based on entity 
type and whether or not the entity offered counterparty clearing.\619\ 
More specifically, one commenter recommended that no customer 
protection and segregation requirements should apply to a stand-alone 
broker-dealer if it does not clear security-based swap 
transactions.\620\ Instead, the firm should be required to provide 
certain notices to customers: (1) Regarding their right to request that 
initial margin related to non-cleared security-based swaps be held at a 
third-party custodian; and (2) disclosing that the customer has no 
customer claim in the event of the SBSD's insolvency.\621\ Another 
commenter recommended that the Commission not impose the omnibus 
segregation requirements on bank SBSDs, foreign SBSDs, and stand-alone 
SBSDs.\622\ This commenter argued that the proposed omnibus segregation 
requirements could conflict with bank liquidation or resolution 
schemes, could cause jurisdictional disputes, and would not be 
consistent with the Exchange Act. In addition, this commenter argued 
that the omnibus segregation requirements would impair hedging and 
funding activities for stand-alone SBSDs. Another commenter was 
concerned about the application of omnibus segregation requirements to 
foreign SBSDs that are not registered broker-dealers.\623\ With respect 
to non-cleared security-based swaps, this commenter suggested that the 
proposed omnibus segregation requirements not apply at all.
---------------------------------------------------------------------------

    \617\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53016.
    \618\ See American Council of Life Insurers 11/19/2018 Letter.
    \619\ See Morgan Stanley 11/19/2018 Letter; SIFMA 11/19/2018 
Letter.
    \620\ See Morgan Stanley 11/19/2018 Letter.
    \621\ This commenter also recommended that if the Commission 
wants to ensure that non-cleared security-based swap counterparties 
can have their collateral protected at a Commission registrant, a 
more appropriate way to do so would be to permit a stand-alone SBSD 
to provide non-cleared security-based swap clients with the option 
of placing initial margin at a full-purpose broker-dealer affiliate. 
See Morgan Stanley 11/19/2018 Letter.
    \622\ See SIFMA 11/19/2018 Letter.
    \623\ See IIB 11/19/2018 Letter.
---------------------------------------------------------------------------

    These comments echoed comments the Commission previously received 
opposing the application of the omnibus segregation requirements to a 
bank. Commenters argued that imposing the omnibus segregation 
requirements on banks was unnecessary because rules of the prudential 
regulators require initial margin for non-cleared security-based swaps 
to be segregated at a third-party custodian.\624\ One of these 
commenters recommended that the Commission adopt an approach similar to 
that of the Department of Treasury, which exempts government securities 
dealers from customer protection requirements if the entity is a bank 
that meets certain conditions.\625\
---------------------------------------------------------------------------

    \624\ See Financial Services Roundtable Letter; SIFMA AMG 2/22/
2013 Letter.
    \625\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that it would be appropriate to exempt 
from the omnibus segregation requirements stand-alone and bank SBSDs 
that do not clear security-based swaps for other persons. As discussed 
above, the omnibus segregation requirements implement the provisions of 
Section 3E of the Exchange Act that require Commission rulemaking to 
permit SBSDs to commingle their customers' cleared security-based 
swaps. If the stand-alone or bank SBSD does not clear security-based 
swaps for other persons then there is no need for the omnibus 
segregation requirements with respect to those positions. Moreover, as 
discussed above, with respect to non-cleared security-based swaps, the 
omnibus segregation requirements provide an alternative to the 
statutory options available to counterparties to request individual 
segregation or to waive segregation. Thus, counterparties will have the 
option of protecting their initial margin for non-cleared security-
based swaps by exercising their statutory right to individual 
segregation.
    This modification from the proposed rule is designed to mitigate 
commenters' concerns that the proposed omnibus segregation requirements 
may conflict with bank liquidation or resolution schemes. In addition, 
as discussed above, Section 3E(g) of the Exchange Act applies the 
customer protection elements of the stockbroker liquidation provisions 
to cleared security-based swaps and related collateral, and to 
collateral delivered as initial margin for non-cleared security-based 
swaps if the collateral is subject to a customer protection requirement 
under Section 15(c)(3) of the Exchange Act or a segregation 
requirement. Consequently, a stand-alone SBSD that does not have 
cleared security-based swap customers and is not subject to a 
segregation requirement with respect to collateral for non-cleared 
security-based swaps will not implicate the stockbroker liquidation 
provisions.
    For the foregoing reasons, the final rule exempts stand-alone and 
bank SBSDs from the requirements of Rule 18a-4 if the SBSD meets 
certain conditions, including that the SBSD does not clear security-
based swap transactions for other persons, provides notice to the 
counterparty regarding the right to segregate initial margin at an 
independent third-party custodian, and discloses in writing that any 
collateral received by the SBSD for non-cleared security-based swaps 
will not be subject to a segregation requirement and regarding how a 
claim of the counterparty for the collateral would be treated in a 
bankruptcy or other formal liquidation proceeding of the SBSD.\626\
---------------------------------------------------------------------------

    \626\ See paragraph (f) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    Under the first condition, the stand-alone or bank SBSD must not: 
(1) Effect transactions in cleared security-based swaps for or on 
behalf of another person; (2) have any open transactions in cleared 
security-based swaps executed for or on behalf of another person; and 
(3) hold or control any money, securities, or other property to margin, 
guarantee, or secure a cleared security-based swap transaction executed 
for or on behalf of another person (including money, securities, or 
other property accruing to another person as a result of a cleared 
security-based swap transaction).\627\ For the reasons discussed above, 
this condition will ensure that the exemption is only available to 
stand-alone SBSDs or bank SBSDs that do not clear security-swaps for 
other persons.
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    \627\ See paragraph (f)(1) of Rule 18a-4, as adopted.
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    Under the second condition, the stand-alone or bank SBSD must 
provide the notice required pursuant to Section 3E(f)(1)(A) of the 
Exchange Act in writing to a duly authorized individual prior to the 
execution of the first non-cleared security-based swap transaction with 
the counterparty occurring after the compliance date of the rule.\628\ 
Section 3E(f)(1)(A) of the Exchange Act provides that an SBSD and an 
MSBSP shall be required to notify the counterparty at the ``beginning'' 
of a non-cleared security-based swap transaction about the right to 
require segregation of the funds or other property supplied to margin, 
guarantee, or secure the obligations of the counterparty.\629\ This 
condition will require a stand-alone or bank SBSD to provide the notice 
in writing to a counterparty prior to the execution of the first non-
cleared security-based swap transaction with the counterparty occurring 
after the compliance date.\630\ Consequently, the stand-alone or bank 
SBSD must give the notice in writing before the counterparty is 
required to

[[Page 43935]]

deliver margin to the SBSD. This will give the counterparty an 
opportunity to determine whether to elect individual segregation or to 
waive segregation.
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    \628\ See paragraph (f)(2) of Rule 18a-4, as adopted.
    \629\ See 15 U.S.C. 78c-5(f)(1)(A).
    \630\ Compare paragraph (d)(1) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    Under the third condition, the stand-alone or bank SBSD must 
disclose in writing to a counterparty before engaging in the first non-
cleared security-based swap transaction with the counterparty that any 
margin collateral received and held by the SBSD will not be subject to 
a segregation requirement and how a claim of the counterparty for the 
collateral would be treated in a bankruptcy or other formal liquidation 
proceeding of the SBSD.\631\ This condition is designed to provide the 
counterparty with additional information to determine whether to elect 
individual segregation or to waive segregation by describing the 
potential consequences of waiving segregation.
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    \631\ See paragraph (f)(3) of Rule 18a-4, as adopted.
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3. Segregation Requirements for Security-Based Swaps
a. Possession or Control of Excess Securities Collateral
i. Requirement To Obtain Possession or Control
    Paragraph (b)(1) of Rule 15c3-3, as it existed before today's 
amendments, requires a stand-alone broker-dealer that carries customer 
securities and cash (``carrying broker-dealer'') to promptly obtain and 
thereafter maintain physical possession or control of all customer 
fully paid and excess margin securities. Fully paid and excess margin 
securities, as defined in paragraphs (a)(3) and (a)(5) of the rule, 
respectively, generally are securities the carrying broker-dealer is 
carrying for customers that are not being used as collateral arising 
from margin loans to the customer or to facilitate a customer's short 
sale of a security. Physical possession or control as used in paragraph 
(b)(1) of Rule 15c3-3 under these pre-existing requirements means the 
carrying broker-dealer cannot lend or hypothecate securities and must 
hold them itself or, as is more common, at a satisfactory control 
location.
    As part of the omnibus segregation requirements, the Commission 
proposed that SBSDs be required to promptly obtain and thereafter 
maintain physical possession or control of all excess securities 
collateral carried for the accounts of security-based swap 
customers.\632\ The Commission modeled these proposed requirements for 
SBSDs on the pre-existing requirements in paragraph (b)(1) of Rule 
15c3-3 and intended that physical possession or control have the same 
meaning in terms of prohibiting the SBSD from lending or hypothecating 
the excess securities collateral and requiring the SBSD to hold the 
collateral itself or in a satisfactory control location.
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    \632\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70278-82.
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    The term ``security-based swap customer'' was defined to mean any 
person from whom or on whose behalf the SBSD has received or acquired 
or holds funds or other property for the account of the person with 
respect to a cleared or non-cleared security-based swap transaction. 
The proposed definition excluded a person to the extent that person has 
a claim for funds or other property which by contract, agreement or 
understanding, or by operation of law, is part of the capital of the 
SBSD or is subordinated to all claims of security-based swap customers 
of the SBSD. The term ``excess securities collateral'' was defined to 
mean securities and money market instruments (``securities 
collateral'') carried for the account of a security-based swap customer 
that have a market value in excess of the current exposure of the SBSD 
to the customer. Thus, securities collateral held by the SBSD that was 
not being used to meet a variation margin requirement of the customer 
needed to be protected by maintaining physical possession or control of 
it. This would be the case with respect to securities collateral held 
by the SBSD to meet the customer's initial margin requirement or that 
had a value in excess of the initial margin requirement.
    The definition of excess securities collateral had two exclusions 
that permitted an SBSD to use, under certain narrowly prescribed 
circumstances, securities collateral of a security-based swap customer 
not being held to meet a variation margin requirement of the customer. 
Under the first exclusion, the SBSD could use the securities collateral 
to meet a margin requirement of a clearing agency resulting from a 
security-based swap transaction of the customer. This exclusion was 
designed to accommodate the margin requirements of clearing agencies, 
which will require SBSDs to deliver collateral to cover exposures 
arising from cleared security-based swaps of the SBSD's security-based 
swap customers. The exclusion required that the securities collateral 
be held in a qualified clearing agency account. The term ``qualified 
clearing agency account'' was defined to mean an account of the SBSD at 
a clearing agency that met certain conditions designed to ensure that 
the securities collateral was isolated from the proprietary assets of 
the SBSD and identified as property of the firm's security-based swap 
customers. Excluding the securities collateral from the definition of 
excess securities collateral meant it was not subject to the physical 
possession or control requirement. This allowed the clearing agency to 
hold the securities collateral against obligations of the SBSD's 
customers without the SBSD violating the physical possession or control 
requirement.\633\
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    \633\ As discussed below, under the proposed omnibus segregation 
requirements, the values of these security-based swap customer 
securities and money market instruments held by the clearing agency 
needed to be included in the reserve formula calculations.
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    Under the second exclusion from the definition of ``excess 
securities collateral,'' the SBSD could use securities collateral to 
meet a margin requirement of a second SBSD resulting from the first 
SBSD entering into a non-cleared security-based swap transaction with 
the second SBSD. However, the transaction with the second SBSD needed 
to be for the purpose of offsetting the risk of the non-cleared 
security-based swap transaction between the first SBSD and the 
security-based swap customer. This exclusion was designed to 
accommodate the practice of dealers in OTC derivatives transactions 
maintaining ``matched books'' of transactions in which an OTC 
derivatives transaction with a counterparty is hedged with an 
offsetting transaction with another dealer.
    The exclusion required that the securities collateral be held in a 
qualified registered security-based swap dealer account. The term 
``qualified registered security-based swap dealer account'' was defined 
to mean an account at a second unaffiliated SBSD that met certain 
conditions designed to ensure that the securities collateral provided 
to the second SBSD was isolated from the proprietary assets of the 
first SBSD and identified as property of the firm's security-based swap 
customers. Further, the account and the assets in the account could not 
be subject to any type of subordination agreement. This condition was 
designed to ensure that if the second SBSD fails, the first SBSD would 
be treated as a security-based swap customer in a liquidation 
proceeding and, therefore, accorded applicable protections under the 
bankruptcy laws. Thus, because the account was at a second SBSD, the 
second SBSD needed to treat the first SBSD as a customer and the first 
SBSD's account was subject to the proposed omnibus segregation 
requirements. Excluding the securities collateral from

[[Page 43936]]

the definition of ``excess securities collateral'' meant that the first 
SBSD did not have to hold them in accordance with the physical 
possession or control requirement. This allowed the first SBSD to 
finance customer transactions in non-cleared security-based swaps by 
using the customer's securities collateral to secure an offsetting 
transaction with a second SBSD.
Comments and Final Physical Possession or Control Requirements
    A commenter stated that the proposed use of market value rather 
than haircut value for the securities collateral posted in connection 
with non-cleared security-based swaps would require that an SBSD use 
its own resources to fund margin requirements.\634\ The Commission did 
not intend this result and is modifying the definition of ``excess 
securities collateral'' so that stand-alone broker-dealers or SBSDs may 
use securities collateral for non-cleared security-based swaps in an 
amount that equals the regulatory margin requirement of the SBSD with 
whom they are entering into a hedging transaction taking into account 
haircuts required by that regulatory requirement.\635\ For purposes of 
this modification, the Commission clarifies that ``regulatory margin 
requirement'' means the amount of initial margin the SBSD-hedging 
counterparty is required to collect from the stand-alone broker-dealer 
or SBSD and not any greater ``house'' margin amount the SBSD-hedging 
counterparty may require as a supplement to the regulatory requirement. 
If the SBSD-hedging counterparty imposes a supplemental ``house'' 
margin requirement, the stand-alone broker-dealer or SBSD cannot use 
the customer's securities collateral to meet the additional 
requirement. Securities collateral used in this manner will not be 
excluded from the definition of ``excess securities collateral'' and 
therefore must be in the physical possession or control of the stand-
alone broker-dealer or SBSD. Thus, the stand-alone broker-dealer or 
SBSD would need to fund the supplemental ``house'' margin requirement 
of the SBSD-hedging counterparty using proprietary cash or securities.
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    \634\ See SIFMA 2/22/2013 Letter.
    \635\ See paragraph (p)(1)(ii)(B) of Rule 15c3-3, as amended; 
paragraph (a)(2)(ii) of Rule 18a-4, as adopted.
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    In the 2018 comment reopening, the Commission asked whether it 
should modify the definition of ``excess securities collateral'' to 
account for the fact that the prudential regulators require initial 
margin to be held at a third-party custodian.\636\ As discussed above, 
the proposed second exclusion from the definition of ``excess 
securities collateral'' required that the securities collateral be held 
in a qualified registered security-based swap dealer account (i.e., an 
account at a second SBSD). Thus, the proposed definition of ``qualified 
registered security-based swap dealer account'' did not contemplate 
holding the securities collateral at a third-party custodian. Absent 
modification, the proposed rule would have created the unintended 
consequence of preventing an SBSD from posting a customer's securities 
collateral to a third-party custodian in accordance with the 
requirements of the prudential regulators. Thus, the SBSD would have 
been required to use proprietary securities or cash to enter into a 
hedging transaction with a bank SBSD.
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    \636\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53016-17.
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    Consequently, in the 2018 comment reopening, the Commission asked 
whether the definition of ``excess securities collateral'' should 
exclude securities collateral held in a third-party custodial account, 
subject to the same limitations and conditions as apply to securities 
collateral re-hypothecated directly to a second SBSD. The Commission 
asked whether the term ``third-party custodial account'' should be 
defined to mean an account carried by an independent third-party 
custodian that meets the following conditions:
     It is established for the purposes of meeting regulatory 
margin requirements of another SBSD;
     The account is carried by a bank under Section 3(a)(6) of 
the Exchange Act;
     The account is designated for and on behalf of the SBSD 
for the benefit of its security-based swap customers and the account is 
subject to a written acknowledgement by the bank provided to and 
retained by the SBSD that the funds and other property held in the 
account are being held by the bank for the exclusive benefit of the 
security-based swap customers of the SBSD and are being kept separate 
from any other accounts maintained by the SBSD with the bank; and
     The account is subject to a written contract between the 
SBSD and the bank which provides that the funds and other property in 
the account shall at no time be used directly or indirectly as security 
for a loan or other extension of credit to the SBSD by the bank and 
shall be subject to no right, charge, security interest, lien, or claim 
of any kind in favor of the bank or any person claiming through the 
bank.
    The conditions in the definition of ``third-party custodial 
account'' in the 2018 comment reopening were designed to ensure that 
securities collateral posted to the custodian is isolated from the 
proprietary assets of the SBSD and identified as property of its 
security-based swap customers.\637\ The objective was to facilitate the 
prompt return of the securities collateral to the customers if the SBSD 
fails.
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    \637\ Capital, Margin, and Segregation Comment Reopening, 83 FR 
at 53016-17.
---------------------------------------------------------------------------

    As discussed above, commenters suggested that the Commission 
recognize a broader range of custodians for purposes of the provisions 
in the final capital rules that permit stand-alone broker-dealers and 
nonbank SBSDs to avoid taking a capital charge when initial margin is 
held at a third-party custodian.\638\ These same commenters similarly 
suggested that the definition of ``third-party custodial account'' for 
purposes of the segregation rules include a broader range of 
custodians. One of these commenters suggested that the definition of 
``third-party custodial account'' for purposes of the segregation rules 
be modified to include domestic clearing agencies and 
depositories.\639\ The second commenter suggested that the definition 
include foreign banks.\640\
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    \638\ See IIB 11/19/2018 Letter; SIFMA 11/19/2018 Letter. The 
provisions in the final capital rules that permit broker-dealers and 
nonbank SBSDs to avoid taking a capital charge when initial margin 
is held at a third-party custodian are discussed above in section 
II.A.2. of this release.
    \639\ See SIFMA 11/19/2018 Letter.
    \640\ See IIB 11/19/2018 Letter.
---------------------------------------------------------------------------

    For the reasons discussed above, the final segregation rules being 
adopted today modify the proposed definition of ``excess securities 
collateral'' to exclude securities collateral held in a ``third-party 
custodial account'' as that term is defined in the rules.\641\ The 
final segregation rules also incorporate the definition of ``third-
party custodial account'' that was included in the 2018 comment 
reopening but with the modifications suggested by the commenters to 
broaden the definition to include domestic clearing organizations and 
depositories and foreign supervised banks, clearing organizations, and 
depositories.\642\ As a result of these modifications, the definition 
of ``third-party custodial account'' in the final segregation rules 
means, among other

[[Page 43937]]

conditions, an account carried by a bank as defined in Section 3(a)(6) 
of the Exchange Act or a registered U.S. clearing organization or 
depository or, if the collateral to be held in the account consists of 
foreign securities or currencies, a supervised foreign bank, clearing 
organization, or depository that customarily maintains custody of such 
foreign securities or currencies. Thus, the definition includes the 
same types of custodians as are permitted by the final capital rules 
for purposes of the exception from taking the capital charge when 
initial margin is held at a third-party custodian \643\ and computing 
credit risk charges.\644\ These same types of custodians also are 
permitted by Rule 18a-3 for the purposes of calculating the account 
equity requirements.\645\
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    \641\ See paragraph (p)(1)(ii)(B) of Rule 15c3-3, as amended; 
paragraph (a)(2)(ii) of Rule 18a-4, as adopted.
    \642\ See paragraph (p)(1)(viii) of Rule 15c3-3, as amended; 
paragraph (a)(10) of Rule 18a-4, as adopted.
    \643\ See paragraph (c)(2)(xv)(C)(1) of Rule 15c3-1, as amended; 
paragraph (c)(1)(ix)(C)(1) of Rule 18a-1, as adopted. The exception 
is discussed above in section II.A.2.b.ii. of this release.
    \644\ See paragraph (c)(4)(v)(B) of Rule 15c3-1e, as amended; 
paragraph (e)(2)(iii)(E)(2) of Rule 18a-1, as adopted. The 
computation is discussed in section II.A.2.b.v. of this release.
    \645\ See paragraph (c)(4)(ii)(A) and (B) of Rule 18a-3, as 
adopted. This provision is discussed in section II.B.2.b.i. of this 
release.
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    In addition to these modifications, the Commission believes it is 
appropriate to modify the proposed definition of ``qualified registered 
security-based swap dealer account'' to remove the limitation that the 
account be held at an unaffiliated SBSD. This limitation would have had 
the unintended consequence of impeding a financial institution from 
centralizing its risk management of security-based swaps in a central 
booking entity through affiliate transactions or of transferring risk 
from one affiliate to another to manage the risk of the position in the 
jurisdiction where the underlying security is traded, for example. 
Therefore, the Commission is not adopting the affiliate limitation in 
the final rule.\646\
---------------------------------------------------------------------------

    \646\ See paragraph (p)(1)(iv) of Rule 15c3-3, as amended; 
paragraph (a)(6) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission is adopting the proposed 
physical possession or control requirements with the modifications 
discussed above and certain other non-substantive modifications.\647\
---------------------------------------------------------------------------

    \647\ See paragraph (p)(2)(i) of Rule 15c3-3, as amended; 
paragraph (b)(1) of Rule 18a-4, as adopted. Conforming changes are 
made to reflect the phrase ``special account for the exclusive 
benefit of security-based swap dealer customers'' in the definition 
of qualified registered security-based swap dealer account is 
changed to ``special reserve account for the exclusive benefit of 
security-based swap customers.'' See paragraphs (c)(2)(iv)(E)(1), 
(p)(1)(iv), (p)(1)(vii), (p)(1)(vii)(A), (p)(3), (p)(3)(i), 
(p)(3)(i)(B), (p)(3)(i)(C), (p)(3)(iii), and (p)(3)(iv) of Rule 
15c3-3, as amended, paragraph (c)(1)(iii)(D) of Rule 18a-1, as 
adopted, and paragraphs (c), (c)(1), (c)(1)(ii), (c)(1)(iii), 
(c)(3), (c)(4), and (e)(1)(i) of Rule 18a-4, as adopted. In 
addition, the definition of qualified clearing agency account in the 
two rules is modified to align them more closely with the language 
used in Section 3E(b) of the Exchange Act, which addresses the 
segregation of cleared security-based swaps. The revised language 
replaces the phrase ``established to hold funds and other property 
in order to purchase, margin, guarantee, secure, adjust, or settle 
clear security based swaps'' with the phrase ``that holds funds and 
other property in order to margin, guarantee, or secure cleared 
security-based swap transactions.''
---------------------------------------------------------------------------

    A commenter urged the Commission to conform its proposal to the 
recommendations in the BCBS/IOSCO Paper with respect to re-
hypothecation of collateral for non-cleared security-based swaps, by 
limiting re-hypothecation of securities collateral to circumstances 
that facilitate hedging of derivatives transactions entered into with 
customers.\648\ The Commission agrees that securities collateral with 
respect to non-cleared security-based swaps should be re-hypothecated 
only in order to hedge a transaction with a security-based swap 
customer. Consequently, as discussed above, the final rules permit re-
hypothecation only for this purpose.
---------------------------------------------------------------------------

    \648\ See SIFMA 3/12/2014 Letter.
---------------------------------------------------------------------------

    A commenter questioned whether it was necessary for the Commission 
to promulgate a possession or control requirement for security-based 
swap customers that is separate from and in addition to the requirement 
for traditional securities customers under Rules 15c3-3 given the 
common insolvency treatment of securities and security-based swap 
customers.\649\ The commenter argued that requiring separate 
calculations could increase operational risk. In response, the 
possession or control requirement is tailored to security-based swaps 
activity. For example, the definition of excess securities collateral, 
which is tied to the security-based swap possession or control 
requirement, is different than the definitions of ``fully paid'' and 
excess margin securities, which are tied to the existing possession or 
control requirement in Rule 15c3-3. The Commission believes it is 
appropriate to have separate requirements to help ensure that stand-
alone and broker-dealer SBSDs appropriately account for excess 
securities collateral in the context of security-based swap activities 
and fully paid and excess margin securities in the context of 
traditional securities activities.
---------------------------------------------------------------------------

    \649\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    Commenters asked the Commission to permit re-hypothecation of 
securities collateral for non-cleared security-based swap transactions 
to entities other than other SBSDs.\650\ One of these commenters noted 
that SBSDs may use products such as cleared and non-cleared swaps, 
cleared security-based swaps, and futures to hedge security-based swap 
transactions.\651\ Conversely, another commenter opposed the re-
hypothecation of initial margin.\652\
---------------------------------------------------------------------------

    \650\ See ISDA 1/23/13 Letter; SIFMA 2/22/2013 Letter.
    \651\ See SIFMA 2/22/2013 Letter.
    \652\ See SIFMA AMG 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response, the exemption from Rule 18a-4 being adopted today will 
permit SBSDs that operate under the exemption to re-hypothecate initial 
margin collateral received from counterparties for non-cleared 
security-based swaps unless the counterparty elects to have the initial 
margin held at a third-party custodian. The Commission anticipates that 
most stand-alone and bank SBSDs will operate under this exemption 
because, for example, to clear swaps for others the firms would need to 
register with the CFTC as an FCM and be subject to the specific rules 
governing FCMs.
    If a stand-alone or bank SBSD does not operate under the exemption 
because it clears security-based swaps for others, the Commission 
believes the strict limits on re-hypothecation should apply. This type 
of firm will receive and hold initial margin for both cleared and non-
cleared security-based swaps. Securities and cash collateral held 
directly by the firm would be fungible and, therefore, the Commission 
believes it should be subject to the strict limitations of the omnibus 
segregation requirements in order to facilitate the prompt return of 
the collateral to cleared and non-cleared security-based swap customers 
of the SBSD.
    The Commission designed the hedging exception for non-cleared 
security-based swap collateral to accommodate a limited scenario: The 
industry practice of dealers in OTC derivatives maintaining ``matched 
books'' of transactions.\653\ The Commission does not believe it would 
be appropriate at this time to either broaden the exception to permit 
the securities collateral to be used in connection with other types of 
products, or to prohibit the re-hypothecation of initial margin. The 
second SBSD must treat the securities collateral it receives in the 
hedging transaction in accordance with the omnibus segregation 
requirements being adopted today for security-based swaps. This is 
designed to ensure that the securities collateral posted by the first 
SBSD to the second

[[Page 43938]]

SBSD remains within the omnibus segregation program.
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    \653\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70279.
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ii. Good Control Locations
    As discussed above, paragraph (b) of Rule 15c3-3, as it existed 
before today's amendments, requires a carrying broker-dealer to 
promptly obtain and thereafter maintain physical possession or control 
of a customer's fully paid and excess margin securities. The pre-
existing provisions of paragraph (c) of the rule identify locations 
that are deemed to be under the control of the carrying broker-dealer. 
As part of the omnibus segregation requirements, the Commission 
proposed five locations where an SBSD could hold excess securities 
collateral and be deemed in control of it.\654\ The Commission modeled 
these proposed requirements for SBSDs on the pre-existing requirements 
in paragraph (c) of Rule 15c3-3. The identification of these 
satisfactory control locations was designed to limit where the SBSD 
could hold excess securities collateral. The identified locations were 
places from which securities collateral can promptly be retrieved and 
returned to security-based swap customers. The Commission did not 
receive any comments addressing these specific provisions and for the 
reasons discussed in the proposing release is adopting them as 
substantially as proposed.\655\
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    \654\ See 77 FR at 70280-82.
    \655\ See paragraph (p)(2)(ii) of Rule 15c3-3, as amended; 
paragraph (b)(2) of Rule 18a-4, as adopted. For clarity, the phrase 
``security-based swap'' is inserted before the phrase ``customer 
securities'' in paragraph (b)(2)(v) of Rule 18a-4. The text of the 
parallel paragraph in Rule 15c3-3, as amended, reflects this 
modification. In the final rule, the phrase ``security-based swap'' 
was inserted before the word ``accounts'' in paragraph (b)(1) of the 
rule to clarify that the possession or control requirements apply 
only to security-based swap accounts. See also paragraph (p)(2)(i) 
of Rule 15c3-3, as amended.
---------------------------------------------------------------------------

iii. Steps To Obtain Possession or Control
    Paragraph (d) of Rule 15c3-3, as it existed before today's 
amendments, requires a carrying broker-dealer to determine each 
business day the quantity of fully paid and excess margin securities it 
has in its physical possession or control based on its books and 
records and the quantity of such securities it does not have in its 
possession or control. If a quantity of fully paid and excess margin 
securities is not in the carrying broker-dealer's physical possession 
or control, the firm must initiate steps to bring them within its 
physical possession or control.
    As a component of the omnibus segregation requirements, the 
Commission proposed to require that each business day an SBSD must 
determine from its books and records the quantity of excess securities 
collateral that the firm had in its physical possession or control as 
of the close of the previous business day and the quantity of excess 
securities collateral the firm did not have in its physical possession 
or control on that day.\656\ The SBSD also needed to take steps to 
retrieve excess securities collateral from certain specifically 
identified non-control locations if securities collateral of the same 
issue and class are at the locations. The Commission modeled these 
proposed requirements for SBSDs on the pre-existing requirements in 
paragraph (d) of Rule 15c3-3. The Commission did not receive any 
comments addressing these specific provisions and for the reasons 
discussed in the proposing release is adopting them with the certain 
amendments.\657\
---------------------------------------------------------------------------

    \656\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70281-82.
    \657\ For clarity, the phrase ``security-based swap'' is being 
inserted before ``customer securities'' in paragraph (b)(2)(v) of 
Rule 18a-4, as adopted. The text of paragraph (b)(3)(vii) of Rule 
18a-4, as adopted, is modified to align it with existing broker-
dealer possession or control requirements with respect to the 
allocation of a customers' fully paid and excess margin securities 
to short positions. See paragraph (d)(5) of Rule 15c3-3, as amended; 
Financial Responsibility Rules for Broker-Dealers, Exchange Act 
Release No. 70072 (July 30, 2013), 78 FR 51823, 51835-51836 (Aug. 
21, 2013) (explaining non-substantive amendments to the final rule 
with respect to the allocation of customers' fully paid and excess 
margin securities to short positions). In addition to the 
modifications discussed above, the Commission is adopting the 
following non-substantive changes to paragraph (b)(3)(vii) of Rule 
18a-4: (1) The phrase ``security-based swap dealer's'' is added 
before ``books or records''; (2) the phrase ``that allocate to a 
short position'' is added before ``of the security-based swap 
dealer''; (3) the phrase ``as a proprietary short position or as'' 
is replaced with ``or''; (4) the phrase ``more than 10 days business 
(or'' is replaced with ``for''; and (5) the phrase ``days if the 
security based swap dealer is a market maker in the securities'' is 
removed. The text of the parallel paragraphs of Rule 15c3-3, as 
amended, reflects these modifications to the proposed text in Rule 
18a-4.
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b. Security-Based Swap Customer Reserve Account
    Paragraph (e) of Rule 15c3-3, as it existed before today's 
amendments, requires a carrying broker-dealer to maintain a reserve of 
cash or qualified securities in an account at a bank that is at least 
equal in value to the net cash owed to customers, including cash 
obtained from the use of customer securities. The account must be 
titled ``Special Reserve Bank Account for the Exclusive Benefit of 
Customers.'' The amount of net cash owed to customers is computed 
pursuant to a formula set forth in Rule 15c3-3a. Under this formula, 
the carrying broker-dealer adds up customer credit items (e.g., cash in 
customer securities accounts and cash obtained through the use of 
customer margin securities) and then subtracts from that amount 
customer debit items (e.g., margin loans). If credit items exceed debit 
items, the net amount must be on deposit in the customer reserve 
account in the form of cash and/or qualified securities. The carrying 
broker-dealer cannot make a withdrawal from the customer reserve 
account until the next computation and even then only if the 
computation shows that the reserve requirement has decreased. The 
carrying broker-dealer must make a deposit into the customer reserve 
account if the computation shows an increase in the reserve 
requirement.
    As a component of the omnibus segregation requirements, the 
Commission proposed reserve account requirements for SBSDs that were 
modeled on the pre-existing requirements of paragraph (e) of Rule 15c3-
3 and Rule 15c3-3a.\658\ More specifically, proposed Rule 18a-4 
required an SBSD to maintain a special account for the exclusive 
benefit of security-based swap customers separate from any other bank 
account of the SBSD. The term ``special account for the exclusive 
benefit of security-based swap customers'' (``SBS Customer Reserve 
Account'') was defined to mean an account at a bank that is not the 
SBSD or an affiliate of the SBSD and that met certain conditions 
designed to ensure that cash and qualified securities deposited into 
the account were isolated from the proprietary assets of the SBSD and 
identified as property of the security-based swap customers.
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    \658\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70282-86.
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    The proposed rule provided that the SBSD must at all times maintain 
in an SBS Customer Reserve Account, through deposits into the account, 
cash and/or qualified securities in amounts computed daily in 
accordance with the formula set forth in proposed Rule 18a-4a. This 
formula required the SBSD to add up credit items and debit items. If, 
under the formula, the credit items exceeded the debit items, the SBSD 
would be required to maintain cash and/or qualified securities in that 
net amount in an SBS Customer Reserve Account. The credit and debit 
items identified in the proposed formula included the same credit and 
debit items in the Rule 15c3-3a formula. Further, the proposed formula 
identified two additional debit items: (1) Margin related to cleared 
security-based swap transactions in accounts carried for

[[Page 43939]]

security-based swap customers required and on deposit in a qualified 
clearing agency account at a clearing agency; and (2) margin related to 
non-cleared security-based swap transactions in accounts carried for 
security-based swap customers held in a qualified registered SBSD 
account at another SBSD. These items were designed to accommodate the 
two exclusions from the definition of ``excess securities collateral'' 
discussed above pursuant to which an SBSD could deliver a customer's 
collateral to a clearing agency to meet a margin requirement of the 
clearing agency or to a second SBSD to meet a regulatory margin 
requirement of the second SBSD. They also accommodated customer cash 
collateral delivered for this purpose. In either case, the debit items 
would offset related credit items in the formula.
    As proposed, if the total credits exceeded the total debits, the 
SBSD needed to maintain that net amount on deposit in a SBS Customer 
Reserve Account in the form of funds and/or qualified securities. The 
term ``qualified security'' as defined in proposed Rule 18a-4 meant: 
(1) Obligations of the United States; (2) obligations fully guaranteed 
as to principal and interest by the United States; and (3) general 
obligations of any State or a subdivision of a State that are not 
traded flat or are not in default, were part of an initial offering of 
$500 million or greater, and were issued by an issuer that has 
published audited financial statements within 120 days of its most 
recent fiscal year end. The proposed conditions for obligations of a 
State or subdivision of a State (``municipal securities'') were 
designed to help ensure that only securities that are likely to have 
significant issuer information available and that can be valued and 
liquidated quickly at current market values were used for this purpose.
    As discussed above, an SBSD was required to add up credit and debit 
items pursuant to the formula in proposed Rule 18a-4a. If, under the 
formula, the credit items exceeded the debit items, the SBSD was 
required to maintain cash and/or qualified securities in that net 
amount in the SBS Customer Reserve Account. Under the proposal, an SBSD 
was required to take certain deductions for purposes of this 
requirement. The amount of cash and/or qualified securities in the SBS 
Customer Reserve Account needed to equal or exceed the amount required 
pursuant to the formula in proposed Rule 18a-4a after applying the 
deductions.
    First, under the proposal, if municipal securities were held in the 
account, the SBSD was required to apply the standardized haircut 
specified in Rule 15c3-1 to the value of the municipal securities. 
Second, if municipal securities were held in the account, the SBSD 
needed to deduct the aggregate value of the municipal securities of a 
single issuer to the extent that value exceeded 2% of the amount 
required to be maintained in the SBS Customer Reserve Account. Third, 
if municipal securities were held in the account, the SBSD needed to 
deduct the aggregate value of all municipal securities to the extent 
that amount exceeded 10% of the amount required to be maintained in the 
SBS Customer Reserve Account. Fourth, the proposal required that the 
SBSD deduct the amount of funds held in an SBS Customer Reserve Account 
at a single bank to the extent that amount exceeded 10% of the equity 
capital of the bank as reported on its most recent Consolidated Report 
of Condition and Income (``Call Report''). This proposal was consistent 
with the proposed 2007 amendments to Rule 15c3-3 that were pending at 
the time.\659\
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    \659\ See Amendments to Financial Responsibility Rules for 
Broker-Dealers, Exchange Act Release No. 55431 (Mar. 9, 2007), 72 FR 
12862 (Mar. 19, 2007). See also Financial Responsibility Rules for 
Broker-Dealers, 78 FR at 51832-35.
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    The proposed rule also provided that it would be unlawful for an 
SBSD to accept or use credits identified in the items of the formula in 
proposed Rule 18a-4a except to establish debits for the specified 
purposes in the items of the formula. This provision would prohibit the 
SBSD from using customer cash and cash realized from the use of 
customer securities for purposes other than those identified in the 
debit items in the proposed formula. Thus, the SBSD would be prohibited 
from using customer cash to, for example, pay expenses.
    The proposed rule also provided that the computations necessary to 
determine the amount required to be maintained in the SBS Customer 
Reserve Account must be made daily as of the close of the previous 
business day and any deposit required to be made into the account must 
be made on the next business day following the computation no later 
than one hour after the opening of the bank that maintains the account. 
Further, the SBSD could make a withdrawal from the SBS Customer Reserve 
Account only if the amount remaining in the account after the 
withdrawal equaled or exceeded the amount required to be maintained in 
the account.
    Finally, the proposed rule required an SBSD to promptly deposit 
funds or qualified securities into an SBS Customer Reserve Account if 
the amount of funds and/or qualified securities held in one or more SBS 
Customer Reserve Accounts falls below the amount required to be 
maintained by the rule.
Comments and Final Reserve Account Requirements
    A commenter argued that a separate calculation for the SBS Customer 
Reserve Account is not necessary given the common insolvency treatment 
of securities customers and security-based swap customers.\660\ 
However, similar to the daily possession or control requirement 
calculation, the Commission believes it is appropriate as an initial 
matter to require separate reserve computations. First, broker-dealers 
historically have not engaged in significant amounts of security-based 
swap activities. Given the customer protection objectives of the 
reserve account requirements, the Commission believes the prudent 
approach is to require two reserve account calculations and accounts. 
Second, the SBS Customer Reserve Account requirements are tailored to 
security-based swap activities. For example, the SBS Customer Reserve 
Account formula has debit items relating to margin delivered to 
security-based swap clearing agencies and other SBSDs. The Commission 
believes it is appropriate to have separate requirements to help ensure 
that stand-alone and broker-dealer SBSDs appropriately account for 
debits and credits in the context of their security-based swap 
activities and in their traditional securities activities. Third, the 
definition of qualified securities for purposes of the SBS Customer 
Reserve Account requirement includes certain municipal securities; 
whereas the definition of qualified securities for purposes of the 
traditional securities reserve account requirement is limited to 
government securities.
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    \660\ See SIFMA 2/22/2013 Letter.
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    A commenter objected to the application of the SBS Customer Reserve 
Account requirements to bank SBSDs due to the existing customer 
protection requirements applicable to banks.\661\ The commenter argued 
that the SBS Customer Reserve Account calculation would be 
operationally intensive. In response, bank SBSDs are exempt from the 
final omnibus segregation requirements if they meet the conditions of 
the exemption, including not clearing security-based swap transactions 
for others.\662\ If a bank

[[Page 43940]]

SBSD is appropriately operating pursuant to the exemption, it will not 
be required to perform the SBS Customer Reserve Account calculation. To 
the extent a bank SBSD does not take advantage of the exemption, the 
Commission believes that the computation a bank SBSD will be required 
to perform will be less operationally complex because generally it 
should only involve cleared security-based swaps. The prudential 
regulators' margin rules for non-cleared security-based swaps 
applicable to banks require that initial margin be held at a third-
party custodian. Therefore, initial margin arising from non-cleared 
security-based swaps generally should not be a factor in the SBS 
Customer Reserve Account formula for these entities.
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    \661\ See SIFMA 2/22/2013 Letter.
    \662\ See paragraph (f) to Rule 18a-4, as adopted.
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    A commenter requested that the Commission require a weekly SBS 
Customer Reserve Account computation rather than a daily 
computation.\663\ The commenter stated that calculating the reserve 
account formula is an onerous process that is operationally intensive 
and requires a significant commitment of resources. The commenter 
further stated that the Commission can achieve its objective of 
decreasing liquidity pressures on SBSDs while limiting operational 
burdens by requiring weekly computations and permitting daily 
computations. The Commission acknowledges that a daily reserve 
calculation will increase operational burdens as compared to a weekly 
computation. Therefore, in response to comments, the Commission is 
modifying the final rules to require a weekly SBS Customer Reserve 
Account computation.\664\ The final rules further provide that stand-
alone broker-dealers or SBSDs may perform daily computations if they 
choose to do so.\665\ These modifications to the final rules align with 
the existing reserve account computation requirements in paragraph (e) 
of Rule 15c3-3.
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    \663\ See SIFMA 2/22/2013 Letter.
    \664\ See paragraphs (p)(3)(A) and (B) of Rule 15c3-3, as 
amended; paragraphs (c)(3)(i) and (ii) of Rule 18a-4, as adopted.
    \665\ See paragraph (p)(3)(B) of Rule 15c3-3, as amended; 
paragraph (c)(3)(ii) of Rule 18a-4, as adopted.
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    Another commenter asked the Commission to prohibit an SBSD from 
using funds in the SBS Customer Reserve Account held for one customer 
to extend credit to another customer.\666\ The SBS Customer Reserve 
Account deposit will equal or exceed the net monies owed to security-
based swap customers as calculated using the formula in Rules 15c3-3b 
and 18a-4a, as adopted. The logic behind the formula is that credits 
(monies owed to customers) are offset by debits (monies owed by 
customers) and, if there is a net amount of credits in excess of 
debits, that amount is reserved in the form of cash or qualified 
securities. Consequently, implementing the commenter's suggestion would 
not be consistent with the omnibus segregation requirements, which are 
designed to permit the commingling of customer assets in a safe manner.
---------------------------------------------------------------------------

    \666\ See ICI 2/4/2013 Letter.
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    A commenter requested that the Commission modify the definition of 
``qualified security'' in Rule 18a-4 to include U.S. government money 
market funds.\667\ In the proposal, the Commission sought to align the 
definition of qualified security in Rule 18a-4 with the existing 
definition of qualified security in Rule 15c3-3 with one exception: 
Namely, the Commission proposed that the Rule 18a-4 definition include 
certain municipal securities because Section 3E(d) of the Exchange Act 
provides that municipal securities are a ``permitted investment'' for 
purposes of the segregation requirements for cleared security-based 
swaps. There is no corresponding statutory requirement to permit 
municipal securities to be a ``permitted investment'' for purposes of 
the segregation requirements and implementing regulations under Section 
15(c)(3) of the Exchange Act applicable to stand-alone broker-dealers. 
While Section 3E(d) of the Exchange Act authorizes the Commission to 
expand the list of permitted investments for purposes of the omnibus 
segregation requirements for security-based swaps, the Commission 
believes the definitions in the two rules should be consistent and the 
types of securities permitted to be deposited into the customer reserve 
accounts required by each rule limited to the safest and most liquid 
securities.
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    \667\ See Federated 11/15/2018 Letter; Letter from Lee A. 
Pickard, Esq., Pickard, Djinis and Pisarri, on behalf of Federated 
Investors, Inc. (Dec. 7. 2018) (``Federated 12/7/2018 Letter'').
---------------------------------------------------------------------------

    In addition, the commenter stated that limiting instruments to be 
utilized by SBSDs under financial responsibility requirements will 
create pressure on regulated entities in search of those limited 
instruments to buy and sell on a continuous basis in their reserve 
accounts.\668\ The Commission disagrees. As discussed above, the final 
rule contains an exemption for stand-alone SBSDs from the omnibus 
segregation requirements of Rule 18a-4, as adopted, if certain 
conditions are met.\669\ This modification to the final rule will 
reduce the number of SBSDs subject to the omnibus segregation 
requirements in the final rules and reduce the amounts that will need 
to be deposited into these accounts. This modification as well as the 
availability of municipal securities as qualified securities under Rule 
18a-4, as adopted, should mitigate the commenter's concerns regarding 
the availability of qualified securities. For these reasons, the 
Commission is not modifying the proposal to permit U.S. government 
money market funds to serve as qualified securities as suggested by the 
commenter.
---------------------------------------------------------------------------

    \668\ See Federated 11/15/2018 Letter.
    \669\ See paragraph (f) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    A commenter urged the Commission to reconsider the provision in the 
proposed rule requiring the SBS Customer Reserve Accounts to be 
maintained at a bank that is not affiliated with the SBSD.\670\ The 
primary concern with permitting an affiliated bank to carry the SBS 
Customer Reserve Account is that the SBSD or stand-alone broker-dealer 
may not exercise due diligence with the same degree of impartiality and 
care when assessing the financial soundness of an affiliated bank as it 
would with an unaffiliated bank.\671\ The decision of the SBSD or 
stand-alone broker-dealer to hold cash in a reserve account at an 
affiliated bank may be driven in part by profit or for reasons based on 
the affiliation, regardless of any due diligence it may conduct or the 
overall safety and soundness of the bank.\672\ However, this concern 
largely pertains to cash deposits because they become part of the 
assets of the bank and can be used by the bank for any of its business 
activities.\673\ As discussed below, the concern about cash deposits is 
being addressed through a 100% deduction of cash held in an SBS 
Customer Reserve Account at an affiliated bank.\674\ Unlike cash, 
qualified securities deposited with a bank are held in a custodial 
capacity and, absent

[[Page 43941]]

an agreement between the bank and the depositor, cannot be used by the 
bank. Consequently, in response to the comment, the Commission is 
modifying the final rule from the proposal so that it no longer 
requires the SBS Customer Reserve Account to be maintained at an 
unaffiliated bank.\675\
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    \670\ See SIFMA 2/22/2013 Letter.
    \671\ See Financial Responsibility Rules for Broker-Dealers, 78 
FR at 51833.
    \672\ See id.
    \673\ See Federal Reserve, Division of Banking Supervision and 
Regulation, Commercial Bank Examination Manual, Section 3000.1, 
Deposit Accounts (stating that deposits are the primary funding 
source for most banks and that banks use deposits in a variety of 
ways, primarily to fund loans and investments), available at http://www.federalreserve.gov/boarddocs/supmanual/cbem/3000.pdf. See also 
OCC Banking Circular (BC-196), Securities Lending (May 7, 1985) 
(stating securities should be lent only pursuant to a written 
agreement between the lender institution and the owner of the 
securities specifically authorizing the institution to offer the 
securities for loan), available at http://www.occ.gov/static/news-issuances/bulletins/pre-1994/banking-circulars/bc-1985-196.pdf.
    \674\ See paragraph (p)(3)(i)(E) of Rule 15c3-3, as amended; 
paragraph (c)(1)(i)(E) of Rule 18a-4, adopted.
    \675\ To make this modification, the Commission revised the 
definition of ``special reserve account for the exclusive benefit of 
security-based swap customers'' to remove the provision requiring 
that the bank be unaffiliated. See paragraph (p)(1)(vii) of Rule 
15c3-3, as amended; paragraph (a)(9) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    The Commission also is modifying the final rules to require an SBSD 
to deduct 100% of the amount of cash held at an affiliated bank and to 
increase the deduction threshold for cash held at a non-affiliated bank 
from 10% to 15% of the bank's equity capital.\676\ These modifications 
more closely align the SBS Customer Reserve Account requirements with 
the pre-existing customer reserve account requirements for traditional 
securities.\677\ However, the Commission is adding an exception to the 
15% deduction to accommodate bank SBSDs that choose to maintain the SBS 
Customer Reserve Account themselves rather than at an affiliated or 
non-affiliated bank.\678\ Under the exception, they would not need to 
take the 15% deduction.
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    \676\ See paragraph (p)(3)(i)(D) of Rule 15c3-3, as amended; 
paragraph (c)(1)(D) of Rule 18a-4, as adopted. See also Capital, 
Margin, and Segregation Comment Reopening, 83 FR at 53017-18 
(soliciting comment on potential rule language that would modify the 
proposal in this manner).
    \677\ See 17 CFR 240.15c3-3(e)(5). See also Financial 
Responsibility Rules for Broker-Dealers, 78 FR at 51832-51833 
(explaining the rationale for permitting securities but not cash to 
be held at an affiliated bank).
    \678\ See paragraph (c)(1)(ii) of Rule 18a-4, as adopted. The 
final rule text of paragraph (c)(1)(ii) of Rule 18a-4, as adopted, 
states ``Exception. A security-based swap dealer for which there is 
a prudential regulator need not take the deduction specified in 
paragraph (c)(1)(i)(D) of this section if it maintains the special 
reserve account for the exclusive benefit of security-based swap 
customers itself rather than at an affiliated or non-affiliated 
bank.'' To add this exception, in the final rule, a ``(i)'' was 
inserted before the phrase ``In determining the amount maintained'' 
in paragraph (c)(1) of Rule 18a-1, as adopted, and paragraphs 
(c)(1)(i) through (iv) of Rule 18a-4, as proposed, were re-
designated paragraphs (c)(1)(i)(A) through (D) in Rule 18a-4, as 
adopted. A new subparagraph (c)(1)(i)(E) provides ``The total amount 
of cash deposited with an affiliated bank.'' The final phrasing of 
new subparagraph (c)(1)(i)(E) does not contain the phrase ``for a 
security-based swap dealer for which there is not a prudential 
regulator'' that was contained in the re-opening as a potential 
modification because it is redundant to the exception language in 
paragraph (c)(1)(ii) of Rule 18a-4, as adopted. See also Capital, 
Margin, and Segregation Comment Reopening, 83 FR at 53017-18 
(soliciting comment on potential rule language that would modify the 
proposal in this manner).
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    One commenter argued that these changes would lead to undue risk 
for SBSDs and their customers.\679\ The Commission does not agree. 
Increasing the deduction threshold from 10% to 15% aligns the threshold 
with the threshold in the pre-existing requirements for traditional 
securities under existing Rule 15c3-3. Further, the exemption from the 
requirements of Rule 18a-4 likely will appreciably reduce the amounts 
that will need to be deposited into the SBS Customer Reserve 
Accounts.\680\ For example, the Commission expects that the omnibus 
segregation requirements largely will apply to cleared security-based 
swaps transactions where a substantial portion of the initial margin 
received by the stand-alone broker-dealer or SBSD will be passed on to 
the clearing agency. Consequently, it will not need to be locked up in 
SBS Customer Reserve Accounts. Moreover, the Commission does not 
believe that increasing the threshold from 10% to 15% will unduly 
undermine the objective of addressing the risk that arises when a 
bank's deposit base is overly reliant on a single depositor. Finally, 
permitting a bank SBSD to maintain its own SBS Customer Reserve Account 
is designed to strike an appropriate balance in terms of achieving the 
objectives of the segregation rule, while providing the firm with 
sufficient flexibility in terms of locating its reserve account 
deposits. This scenario also does not raise the same concerns that 
arise when an SBSD uses a separate bank to maintain its SBS Customer 
Reserve Account. Moreover, the Commission expects that most bank SBSDs 
will operate under the exemption from the omnibus segregation 
requirements of Rule 18a-4. Therefore, the Commission does not believe 
these modifications to the final rule will lead to undue risks for 
SBSDs and their customers.
---------------------------------------------------------------------------

    \679\ See Better Markets 11/19/2018 Letter. See also Capital, 
Margin, and Segregation Comment Reopening, 83 FR at 53017-18.
    \680\ See paragraph (f) of Rule 18a-4.
---------------------------------------------------------------------------

    In addition, the Commission is making a conforming modification to 
the text of the debit item with respect to margin relating to non-
cleared security-based swaps. As discussed above, the definition of 
``excess securities collateral'' has been modified to account for the 
fact that the prudential regulators require initial margin collected by 
a bank SBSD to be held at a third-party custodian (rather than being 
held directly by the bank SBSD).\681\ The rule, as proposed, did not 
account for the possibility that a nonbank SBSD might pledge a 
customer's initial margin to a third-party custodian pursuant to the 
margin rules of the prudential regulators. The modification to the 
definition of ``excess securities collateral'' discussed above 
addresses this issue with respect to the possession or control 
requirement. The modification to the debit item with respect to margin 
relating to non-cleared security-based swap transactions will address 
this issue with respect to the SBS Customer Reserve Account 
requirement. Specifically, the Commission is modifying the debit item 
to include margin related to non-cleared security-based swap 
transactions in accounts carried for security-based swap customers 
required and held at a ``third-party custodial account'' as that term 
is defined in the rules.\682\ This will allow the SBSD to offset the 
corresponding credit item that results from using customer collateral 
to meet the margin requirement of another SBSD when the customer 
collateral is posted to a third-party custodian (rather than provided 
directly to the other SBSD).
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    \681\ See paragraph (p)(1)(ii)(B) of Rule 15c3-3, as amended; 
paragraph (a)(2)(ii) of Rule 18a-4, as adopted. See also 12 CFR 
45.7; 12 CFR 237.7; 12 CFR 624.7; 12 CFR 1221.7; 17 CFR 23.157.
    \682\ See Rule 15c3-3b, as adopted, Item 16; Rule 18a-4a, as 
adopted, Item 14. In addition, the Commission is deleting Items 3 
and 10 from Rule 18a-4a, as adopted, because that rule will be used 
by non-broker-dealer SBSDs. As discussed above, the security-based 
swap segregation requirements, including the SBS Reserve Account 
requirements, that apply to broker-dealers, including broker-dealer 
SBSDs, are being codified in Rule 15c3-3, as amended, and Exhibit B 
to Rule 15c3-3 (Rule 15c3-3b), as adopted. Items 3 and 10 relate to 
the broker-dealer margin account business with respect to securities 
other than security-based swaps. Consequently, these Line Items are 
not necessary for the security-based swap customer reserve formula 
that non-broker-dealer SBSDs will use to determine their SBS Reserve 
Account requirement and, therefore, are not included in the final 
rule. See Exhibit A to Rule 18a-4 (Rule 18a-4a), as adopted.
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    The Commission originally proposed that it would be unlawful for an 
SBSD to accept or use credits identified in the items of the formula 
set forth in Exhibit A to the proposed rule ``except to establish 
debits for the specified purposes in the items of the formula.'' \683\ 
This phrase in proposed Rule 18a-4 varied from the phrase in the 
parallel pre-existing requirement in Rule 15c3-3.\684\ The Commission 
did not intend to establish a different standard for SBSDs and is 
modifying the phrase as used in Rules 15c3-3, as amended, and 18a-4, as 
adopted, to align it with the pre-existing text.
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    \683\ See paragraph (c)(2) of Rule 18a-4, as proposed to be 
adopted.
    \684\ Compare 17 CFR 240.15c3-3(e)(2), with paragraph (c)(2) of 
Rule 18a-4, as proposed to be adopted.
---------------------------------------------------------------------------

    For these reasons, the Commission is adopting these provisions 
relating to the

[[Page 43942]]

SBS Customer Reserve Account with the modifications described 
above.\685\
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    \685\ See paragraph (p)(3) of Rule 15c3-3, as amended; paragraph 
(c) of Rule 18a-4, adopted. The following non-substantive 
modifications are being made. The phrase ``a political'' is added 
before the phrase ``subdivision of a state'' in the definition of 
qualified security in paragraphs (p)(1)(v)(C) and (p)(3)(i) of Rule 
15c3-3, as amended, and paragraphs (a)(7)(iii) and (c)(1) of Rule 
18a-4, as adopted because, under Section 3E(d) of the Exchange Act, 
``obligations . . . of any political subdivision of a State'' are 
``Permitted Investments.'' The phrase ``Consolidated Report of 
Condition and Income'' is replaced with the phrase ``Call Report or 
any successor form the bank is required to file by its appropriate 
federal banking agency (as defined by section 3 of the Federal 
Deposit Insurance Act)'' in paragraph (p)(3)(i)(D) of Rule 15c3-3, 
as amended, and paragraph (c)(1)(i)(D) of Rule 18a-4, as adopted. 
This modification uses the commonly known name of the report and 
accounts for the potential that bank regulators could change the 
form of the report in the future. The Commission replaced the phrase 
``It is unlawful for a security-based swap dealer'' in paragraph 
(c)(2) of Rule 18a-4, as proposed, with the phrase ``a security-
based swap dealer must not.'' See paragraph (p)(3)(ii) of Rule 15c3-
3, as amended (using the phrase ``a broker or dealer must not''). 
See also Amendments to Financial Responsibility Rules for Broker-
Dealers, 72 FR 12862; Financial Responsibility Rules for Broker-
Dealers, 78 FR at 51838 (similarly modifying the proposed amendments 
to Rule 15c3-3 to replace the phrase ``It shall be unlawful'' 
``because any violation of the rules and regulations promulgated 
under the Exchange Act is unlawful and therefore it is unnecessary 
to use this phrase in the final rule''). The Commission replaced the 
term ``funds'' in paragraph (c)(4) of Rule 18a-4, as proposed, with 
the term ``cash.'' See paragraph (p)(3)(iv) of Rule 15c3-3, as 
amended.
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c. Special Provisions for Non-Cleared Security-Based Swap 
Counterparties
i. Notice Requirement
    Section 3E(f)(1)(A) of the Exchange Act provides that an SBSD and 
an MSBSP shall be required to notify the counterparty at the 
``beginning'' of a non-cleared security-based swap transaction about 
the right to require segregation of the funds or other property 
supplied to margin, guarantee, or secure the obligations of the 
counterparty.\686\ To provide greater clarity as to the meaning of 
``beginning'' as used in the statute, proposed Rule 18a-4 required an 
SBSD or MSBSP to provide the notice in writing to a counterparty prior 
to the execution of the first non-cleared security-based swap 
transaction with the counterparty occurring after the effective date of 
the rule.\687\ Consequently, the notice needed to be given in writing 
before the counterparty was required to deliver margin to the SBSD or 
MSBSP. This gave the counterparty an opportunity to determine whether 
to elect individual segregation, waive segregation, or affirmatively or 
by default elect omnibus segregation.
---------------------------------------------------------------------------

    \686\ See 15 U.S.C. 78c-5(f)(1)(A).
    \687\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70287.
---------------------------------------------------------------------------

    A commenter recommended that the Commission clarify that the notice 
must be sent to the customer (or investment manager authorized to act 
on behalf of a customer) in accordance with mutually agreed terms by 
the parties, or absent such terms, to a person reasonably believed to 
be authorized to accept notices on behalf of a customer.\688\ The 
Commission agrees that the rule should provide more clarity and has 
modified the requirement to provide that the notice must be sent to a 
duly authorized individual. This person could be an individual that is 
mutually agreed to by the parties.
---------------------------------------------------------------------------

    \688\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    For these reasons, the Commission is adopting the proposed notice 
requirement with the modification described above.\689\ The 
notification provision in Rule 15c3-3 applies only to a broker-dealer 
SBSD or MSBSP because the notification requirements in Section 
3E(f)(1)(A) of the Exchange Act apply only to SBSDs and MSBSPs (and not 
to stand-alone broker-dealers).
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    \689\ See paragraph (p)(4)(i) of Rule 15c3-3, as amended; 
paragraph (d)(1) of Rule 18a-4, as adopted. A non-substantive 
modification is being made to replace the term ``effective date'' 
with the term ``compliance date'' because, as discussed below in 
section III of this release, the effective of the final notification 
rules will fall before the compliance date. The Commission intended 
the notification requirement to apply to transactions that occur on 
or after the date SBSDs and MSBSPs begin complying with the rule. 
Finally, the word ``swap'' is inserted before the word ``dealer.''
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ii. Subordination Agreements
    Proposed Rule 18a-4 required an SBSD to obtain agreements from 
counterparties that elect either individual segregation or waive 
segregation with respect to non-cleared security-based swaps under 
Section 3E(f) of the Exchange Act. In the agreements, the 
counterparties needed to subordinate all of their claims against the 
SBSD to the claims of security-based swap customers.\690\ By entering 
into subordination agreements, these counterparties would be excluded 
from the definition of security-based swap customer in proposed Rule 
18a-4.\691\ They also would not be entitled to share ratably with 
security-based swap customers in the fund of customer property held by 
the SBSD if it was subject to a bankruptcy proceeding.
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    \690\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70287-88. The proposed subordination requirements did not 
apply to MSBSPs because they would not have security-based swap 
customers.
    \691\ See paragraph (a)(6) of proposed Rule 18a-4.
---------------------------------------------------------------------------

    Under the proposal, an SBSD needed to obtain a conditional 
subordination agreement from a counterparty that elects individual 
segregation. The agreement was conditional because the subordination 
agreement would not be effective in a case where the counterparty's 
assets were included in the bankruptcy estate of the SBSD, 
notwithstanding that they had been held by a third-party custodian 
(rather than the SBSD). Specifically, the proposed rule provided that 
the counterparty must subordinate claims but only to the extent that 
funds or other property provided by the counterparty to the independent 
third-party custodian are not treated as customer property in a formal 
liquidation proceeding.
    An SBSD needed to obtain an unconditional subordination agreement 
from a counterparty that waives segregation altogether. By waiving 
individual and omnibus segregation, the counterparty agrees that cash, 
securities, and money market instruments delivered to the SBSD as 
initial margin can be used by the SBSD for any business purpose and 
need not be isolated from the proprietary assets of the SBSD. 
Therefore, these counterparties are foregoing the protections of 
segregation. As a consequence, they should not be entitled to a ratable 
share of the customer property of the SBSD in the event the SBSD is 
liquidated in a formal proceeding. If they were deemed security-based 
swap customers, they could have a pro rata priority claim on customer 
property. This could disadvantage the security-based swap customers 
that did not waive segregation by diminishing the amount of customer 
property available to be distributed to them.
    A commenter stated that the subordination agreement required of 
customers that elect individual segregation was not necessary because 
the initial margin provided by the customer was held at a third-party 
custodian and therefore would not become ``customer property'' held by 
the failed SBSD.\692\ The commenter argued that a ``legally unnecessary 
subordination agreement is prone to creating ambiguity, unforeseen 
consequences and complication . . . and runs contrary to the goal of 
investor protection . . . .'' The Commission disagrees. The 
subordination agreement is designed to reduce ambiguity, unforeseen 
consequences, and complications that may arise during an SBSD's 
liquidation by clarifying that the subordinating customers are not 
entitled

[[Page 43943]]

to a pro rata share of customer property from the liquidation. By 
entering into the subordination agreements, customers who elect 
individual segregation are affirmatively waiving their rights to make 
customer claims with respect to initial margin held by the third-party 
custodian. Their recourse is to the third-party custodian that is 
holding the collateral. Therefore, a properly designed and executed 
subordination agreement affirms the rights of customers that elect 
individual segregation as compared to the rights of customers whose 
assets are treated under the omnibus segregation requirements.
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    \692\ See Ropes & Gray Letter.
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    The Commission, however, is modifying the final subordination 
requirements for collateral held at a third-party custodian so that it 
is no longer are limited to funds or other property that is segregated 
pursuant to Section 3E(f) of the Exchange Act. As discussed above in 
section II.A.2.b.ii. of this release, a counterparty's collateral to 
meet a margin requirement of the nonbank SBSD may be held at a third-
party custodian pursuant to other laws. Consequently, the Commission is 
modifying the rule text to provide that the subordination agreement is 
required ``from a counterparty whose funds or other property to meet a 
margin requirement of the [nonbank SBSD] are held at a third-party 
custodian.'' \693\
---------------------------------------------------------------------------

    \693\ See paragraph (p)(4)(ii)(A) of Rule 15c3-3, as amended; 
paragraph (d)(2)(i) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    Another commenter stated that customers electing individual 
segregation should not be required to subordinate claims other than 
those with respect to such initial margin held by the third-party 
custodian.\694\ The commenter objected to the provision in the proposed 
rule requiring the customer to subordinate all of its claims against 
the SBSD to the claims of other security-based swap customers. The 
Commission agrees that the proposed text of the rule was ambiguous and 
could be read to mean the customer must subordinate claims to property 
that is held by the SBSD (as opposed to the third-party custodian). 
Therefore, the Commission is modifying the final rule from the proposal 
to clarify that the counterparty electing individual segregation must 
subordinate its claims against the SBSD only for the funds or other 
property held at the third-party custodian.\695\
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    \694\ See Financial Services Roundtable Letter.
    \695\ See paragraph (p)(4)(ii)(A) of Rule 15c3-3, as amended; 
paragraph (d)(2)(i) of Rule 18a-4, as adopted. The provision in 
paragraph (p) of Rule 15c3-3 provides that the counterparty's 
subordination also does not apply to the extent that the funds or 
other property provided by the counterparty are treated as customer 
property as defined in 15 U.S.C. 78lll(4) in a liquidation of the 
broker-dealer. See paragraph (p)(4)(ii)(A) of Rule 15c3-3, as 
amended. This clause is being added to account for the fact that 
broker-dealers are liquidated in SIPA proceedings.
---------------------------------------------------------------------------

    Because a counterparty will not subordinate all of its claims 
against a stand-alone broker-dealer or broker-dealer SBSD, the 
Commission is making conforming modifications to the final rule to 
specifically identify the two classes of carrying broker-dealer 
customers that must be accounted for in the subordination agreements. 
In particular, the Commission is adding the phrase ``(including PAB 
customers)'' following the term ``to the claims of customers'' in 
paragraph (p)(1)(vi) and paragraphs (p)(4)(ii)(A) and (B) of Rule 15c3-
3, as amended. PAB customers are other broker-dealers for whom the 
carrying broker-dealer is holding cash and/or securities.\696\ Under 
amendments to Rule 15c3-3 adopted after the rules in this release were 
proposed, a carrying broker-dealer must include (and thereby protect) 
the cash and securities it carries for other customers by including 
them in a PAB reserve account computation.\697\ Broker-dealer customers 
also have priority claims to cash and securities held at the carrying 
broker-dealer in a SIPA proceeding. Consequently, their status as a 
protected class of creditors must be accounted for in the provisions of 
the rule relating to subordination agreements.
---------------------------------------------------------------------------

    \696\ ``PAB'' is an acronym for proprietary accounts of broker-
dealers. See paragraph (a)(16) of Rule 15c3-3 (defining the term PAB 
account).
    \697\ Financial Responsibility Rules for Broker-Dealers, 78 FR 
at 51827-51832 (discussing PAB accounts); paragraph (e) of Rule 
15c3-3; Rule 15c3-3a. Consequently, this modification more closely 
aligns the segregation requirements with the pre-existing 
requirements for traditional securities under existing Rule 15c3-3, 
and would clarify that a security-based swap customer's 
subordination includes a subordination to the claims of PAB 
customers.
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    Finally, as discussed above, the Commission is making a conforming 
amendment to the requirement that the stand-alone broker-dealer or 
broker-dealer SBSD obtain a subordination agreement from a person who 
waives segregation with respect to non-cleared security-based swaps to 
provide that the provision applies to affiliates that waive segregation 
because persons who are not affiliates cannot waive segregation.\698\
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    \698\ See paragraph (p)(4)(ii)(B) of Rule 15c3-3, as amended.
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    For these reasons, the Commission is adopting the subordination 
requirements with the modifications discussed above.\699\
---------------------------------------------------------------------------

    \699\ See paragraph (p)(4)(ii) of Rule 15c3-3, as amended; 
paragraph (d)(2) of Rule 18a-4, as adopted. The Commission also made 
a non-substantive amendment to replace the phrase ``does not 
choose'' with ``affirmatively chooses not'' to clarify that the 
requirements related to the subordination agreements where a 
counterparty elects to have no segregation only apply when a 
counterparty affirmatively chooses to waive segregation. See 
paragraph (p)(4)(ii)(B) of Rule 15c3-3, as amended; paragraph 
(d)(2)(ii) of Rule 18a-4, as adopted.
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D. Alternative Compliance Mechanism

    As discussed throughout this release, commenters urged the 
Commission to harmonize the requirements being adopted today with 
requirements of the CFTC. Commenters sought harmonization with respect 
to the Commission's capital requirements,\700\ margin 
requirements,\701\ and segregation requirements.\702\ One commenter 
stated that ``[i]f the Commission and CFTC do not harmonize their 
capital rules, they should defer to the capital rules of one another in 
the case of'' an entity that is registered as an SBSD and a swap dealer 
and ``whose swaps or [security-based swaps] represent a de minimis 
portion of the [entity's] combined swap and [security-based swap] 
business.'' \703\ This commenter further stated that ``[i]n cases where 
the firm is predominantly engaged in swap activity, imposing different 
capital requirements would be inefficient.'' Another commenter stated 
that ``[i]f harmonization is not achievable, the rules should be 
coordinated so that [the Commission] defers to the capital and margin 
rules of the CFTC for an SBSD that is not a broker-dealer and whose 
[security-based swaps] constitute a very small proportion of its 
business (e.g., less than 10% of the notional amount of its outstanding 
combined swap and SBS positions).'' \704\
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    \700\ See, e.g., Citadel 11/19/18 Letter; Financial Services 
Roundtable Letter; FIA 11/19/2018 Letter; Morgan Stanley 11/19/2018 
Letter.
    \701\ See, e.g., American Council of Life Insurers 11/19/2018 
Letter; Citadel 11/19/2018 Letter; Financial Services Roundtable 
Letter; MFA 2/22/2013 Letter; SIFMA 11/19/2018 Letter.
    \702\ See, e.g., AIMA 2/22/2013 Letter; ISDA 11/19/2018 Letter; 
MFA 2/22/2013 Letter; SIFMA AMG 2/22/2013 Letter; Vanguard Letter.
    \703\ See SIFMA 11/19/2018 Letter.
    \704\ See Mizuho/ING Letter. See also Center for Capital Markets 
Competitiveness, US Chamber of Commerce 11/19/2019 Letter. This 
commenter supported a safe harbor that would allow firms to rely on 
their compliance with the rules of the Commission or the CFTC to 
satisfy comparable requirements set by the other agency.
---------------------------------------------------------------------------

    In response to these comments seeking harmonization, the final 
capital, margin, and segregation rules being adopted today have been 
modified from the proposed rules to achieve greater consistency with 
the requirements of the CFTC. However, as discussed throughout this 
release, there are differences between the approaches taken by the 
Commission and the CFTC.

[[Page 43944]]

Moreover, the Commission believes that some registered swap dealers (or 
entities that will register as swap dealers in the future) will need to 
also register as security-based swap dealers because their security-
based swaps business--while not a significant part of their overall 
business mix--exceeds the de minimis exception to the ``security-based 
swap dealer'' definition.\705\ In light of the differences between the 
rules of the Commission and the CFTC, the Commission believes it is 
appropriate to permit such firms to comply with the capital, margin, 
and segregation requirements of the CEA and the CFTC's rules, provided 
the firm's security-based swaps business is not a significant part of 
the security-based swap market and predominantly involves dealing in 
swaps as compared to security-based swaps. In this circumstance, the 
CFTC's regulatory interest in the firm will greatly exceed the 
Commission's regulatory interest given the relative size of its swaps 
business as compared to its security-based swaps business.\706\
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    \705\ See 17 CFR 240.3a71-2 (``Rule 3a71-2'').
    \706\ In situations under Rule 18a-10 where a stand-alone SBSD 
elects to meet its regulatory requirements by complying with the CEA 
and the CFTC's rules, because of the differences in the Commission's 
and the CFTC's rules, the Commission anticipates that its staff will 
work closely with the staffs of the CFTC and the National Futures 
Association.
---------------------------------------------------------------------------

    For these reasons, the Commission is adopting an alternative 
compliance mechanism in Rule 18a-10 pursuant to which a stand-alone 
SBSD that is registered as a swap dealer and predominantly engages in a 
swaps business may elect to comply with the capital, margin and 
segregation requirements of the CEA and the CFTC's rules in lieu of 
complying with the capital, margin, and segregation requirements in 
Rules 18a-1, 18a-3, and 18a-4.\707\ This will address the concern 
raised by the commenters that it would be inefficient to impose 
differing requirements on a firm that is predominantly a swap dealer.
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    \707\ The term ``stand-alone SBSD'' when used in this section 
II.D. of the release does not include a firm that is also registered 
as an OTC derivatives dealer. As discussed below, the alternative 
compliance mechanism is not available to a nonbank SBSD that is also 
registered as a broker-dealer, including a broker-dealer that is an 
OTC derivatives dealer. In theory, a bank SBSD could use the 
alternative compliance mechanism if it met the required conditions. 
However, these entities will be subject to the Commission's final 
segregation rule for stand-alone and bank SBSDs (Rule 18a-4), but 
not the Commission's final capital and margin rules. Moreover, as 
discussed above in section II.C.2. of this release, Rule 18a-4, as 
adopted, contains an exemption provision. The Commission expects 
bank SBSDs will take advantage of the exemption provision in the 
segregation rule rather than use the alternative compliance 
mechanism. The reason for this belief is that the exemption in Rule 
18a-4 does not place a limit on the size of the firm's security-
based swap business as a condition to qualify for the exemption, and 
it does not require firms to comply with requirements of the CEA and 
the CFTC's rules.
---------------------------------------------------------------------------

    A firm may elect to operate pursuant to Rule 18a-10 if it meets 
certain conditions. First, under paragraphs (a)(1) through (3) of Rule 
18a-10, the firm must be registered with the Commission as a stand-
alone SBSD (i.e., not also registered as a broker-dealer or an OTC 
derivatives dealer) and registered with the CFTC as a swap dealer. The 
Commission believes it is appropriate to permit stand-alone SBSDs--
which will not be integrated into the traditional securities markets to 
the same degree as stand-alone broker-dealers and broker-dealer SBSDs--
to comply with Rule 18a-10 because their securities activities will be 
limited to dealing in security-based swaps. The requirement to be 
registered with the CFTC is designed to ensure that the firm is subject 
to CFTC oversight given that it will be adhering to the CFTC's rules.
    Second, under paragraph (a)(4) of Rule 18a-10, the stand-alone SBSD 
must be exempt from the segregation requirements of Rule 18a-4. As 
discussed above in section II.C.2. of this release, the Commission has 
added a provision to Rule 18a-4 that will exempt a stand-alone or bank 
SBSD from the rule's omnibus segregation requirements if it meets 
certain conditions, including that it does not clear security-based 
swaps for other persons. Section 3E(g) of the Exchange Act applies the 
customer protection elements of the stockbroker liquidation provisions 
to cleared security-based swaps and related collateral, and to 
collateral delivered as initial margin for non-cleared security-based 
swaps if the collateral is subject to a customer protection requirement 
under Section 15(c)(3) of the Exchange Act or a segregation 
requirement. Consequently, a stand-alone SBSD that does not have 
cleared security-based swap customers and is not subject to a 
segregation requirement with respect to collateral for non-cleared 
security-based swaps will not implicate the stockbroker liquidation 
provisions. Given this result, the Commission believes it would be 
appropriate to permit the firm to comply with CEA and CFTC segregation 
requirements to the extent applicable in lieu of Rule 18a-4.
    Third, under paragraph (a)(5) of Rule 18a-10, the aggregate gross 
notional amount of the firm's outstanding security-based swap positions 
must not exceed the lesser of two thresholds as of the most recently 
ended quarter of the firm's fiscal year.\708\ The thresholds are: (1) 
The maximum fixed-dollar gross notional amount of open security-based 
swaps specified in paragraph (f) of the rule (``maximum fixed-dollar 
threshold''); and (2) 10% of the combined aggregate gross notional 
amount of the firm's open security-based swap and swap positions (``10% 
threshold'').
---------------------------------------------------------------------------

    \708\ The gross notional amount is based on the notional amounts 
of the firm's security-based swaps and swaps that are outstanding as 
of the quarter end. It is not based on transaction volume during the 
quarter.
---------------------------------------------------------------------------

    These thresholds are designed to limit the availability of the 
alternative compliance mechanism to firms whose security-based swaps 
business is not a significant part of the security-based swap market 
and that are predominately engaged in a swaps business as compared to a 
security-based swaps business. In this regard, the capital, margin, and 
segregation requirements being adopted today are designed to promote 
the safety and soundness of an SBSD and the ability of the Commission 
to oversee the firm and, thereby, protect the firm, its counterparties, 
and the integrity of the security-based swap market. Moreover, the 
security-based swap market and the broader securities markets (such as 
the cash markets for equity and fixed-income securities) are 
interrelated, given that economically similar instruments can be traded 
in both markets (e.g., an equity security in the cash market and a 
total return swap referencing that security in the security-based swap 
market). For these reasons, the Commission has a heightened regulatory 
interest in stand-alone SBSDs that will be significant participants in 
the security-based swap market. Therefore, in crafting the alternative 
compliance mechanism, the Commission sought to calibrate the maximum-
fixed-dollar and 10% thresholds to exclude stand-alone SBSDs that will 
be significant participants in this market.\709\
---------------------------------------------------------------------------

    \709\ See also section VI. of the release (providing an economic 
analysis of Rule 18a-10, as adopted, including the costs and 
benefits of the rule).
---------------------------------------------------------------------------

    The amount of the maximum fixed-dollar threshold is $250 billion 
for a transitional period of 3 years and then will drop to $50 billion 
(unless the Commission issues an order as discussed below). Based on 
current information about the security-based swap market and the 
participants and potential participants in that market, the Commission 
believes that a stand-alone SBSD with a gross notional amount of 
outstanding security-based swaps of no more than $50 billion will not 
be a

[[Page 43945]]

significant participant in the security-based swap market. However, as 
stated above in section I.A. of this release, the Commission recognizes 
that the firms subject to the capital, margin, and segregation 
requirements being adopted today are operating in a market that 
continues to experience significant changes in response to market and 
regulatory developments. For these reasons, the Commission believes it 
is appropriate to set a maximum fixed-dollar threshold that is well in 
excess of $50 billion for a transitional period of 3 years. Therefore, 
the maximum fixed-dollar threshold will be $250 billion for 3 years, 
starting on the compliance date for the capital, margin and segregation 
rules being adopted today. This transitional $250 billion threshold 
will provide a stand-alone SBSD operating under the alternative 
compliance mechanism (i.e., firms that are predominantly engaged in a 
swaps business) with a substantial amount of leeway to develop their 
security-based swaps business without managing the level of that 
business to the lower $50 billion threshold. If the security-based 
swaps business of these firms develops to a degree that the $50 billion 
threshold would require them to refrain from taking on additional 
business, the Commission can assess whether the amount of the 
additional business that causes them to exceed the threshold makes them 
a significant participant in the security-based swap market.
    The transitional period therefore will provide the Commission with 
the opportunity to evaluate the impact that the $50 billion threshold 
would have on firms operating pursuant to the alternative compliance 
mechanism before the threshold drops from $250 billion to $50 billion. 
Moreover, the final rule establishes a process through which the 
Commission, by order, can: (1) Maintain the maximum fixed-dollar amount 
at $250 billion for an additional period of time or indefinitely after 
the 3-year transition period ends; or (2) lower it to an amount that is 
less than $250 billion but greater than $50 billion.\710\ This process 
could provide firms operating under the alternative compliance 
mechanism with additional time to transition from the $250 billion 
threshold to the $50 billion threshold or another threshold.
---------------------------------------------------------------------------

    \710\ See paragraphs (f)(1)(i) and (ii) of Rule 18a-10, as 
adopted.
---------------------------------------------------------------------------

    The final rules provide that the Commission will issue an order 
after considering the levels of security-based swap activity of stand-
alone SBSDs operating under the alternative compliance mechanism. The 
Commission intends to analyze how significant these entities are to the 
security-based swap market and broader securities markets based on 
their levels of their security-based swap activity. The analysis will 
consider the firm's individual and collective impact on the security-
based swap market. Based on this analysis, the Commission could decide 
to take no action and let the $250 billion maximum fixed-dollar 
threshold transition to $50 billion on the 3-year anniversary of the 
compliance date for the capital, margin, and segregation rules being 
adopted today. Alternatively, the Commission could decide to reset the 
maximum fixed-dollar threshold to a level greater than $50 billion (but 
no more than $250 billion) or provide additional time for firms to 
transition from a $250 billion threshold to the $50 billion threshold.
    The process in the final rule provides that the Commission will 
publish notice of the potential change to the maximum fixed-dollar 
threshold (i.e., extending the $250 billion threshold for an additional 
period of time or indefinitely, or lowering it to a level between $250 
billion and $50 billion) and subsequently issue an order regarding the 
change. The Commission intends to provide such notice in sufficient 
time for the public to be aware of the potential change.
    In summary, the maximum fixed-dollar threshold sets an absolute 
limit on the availability of the alternative compliance mechanism 
irrespective of the size of the firm's swaps business as compared to 
its security-based swaps business. Thus, a firm potentially may not 
exceed the 10% threshold given the large size of its swaps business but 
could exceed the maximum fixed-dollar threshold because its security-
based swaps business is sufficiently large. This absolute limit is 
designed to exclude stand-alone SBSDs that are significant participants 
in the security-based swap market from qualifying for the alternative 
compliance mechanism.
    The 10% threshold establishes a limit on the ratio of the firm's 
security-based swaps business to its combined security-based swaps and 
swaps businesses. In crafting this threshold, the Commission sought to 
limit the availability of the alternative compliance mechanism to firms 
that are predominantly engaged in a swaps business as compared to a 
security-based swaps business. Consequently, if the firm's security-
based swap business does not exceed the maximum fixed-dollar threshold, 
it nonetheless may not qualify for the alternative compliance mechanism 
if its security-based swaps business exceeds the ratio set by the 10% 
threshold. This is designed to limit the alternative compliance 
mechanism to firms for which the CFTC (as opposed to the Commission) 
has a heightened regulatory interest.
    Under paragraph (a)(5) of Rule 18a-10, the firm must not exceed the 
lesser of these thresholds as of the most recently ended quarter of its 
fiscal year. This point-in-time requirement is designed to simplify the 
process for determining whether the firm meets the condition by 
aligning it with when the firm closes its books for financial 
recordkeeping and reporting purposes. A quarterly test (as opposed to 
an annual test) also is designed to ensure that a firm using the 
alternative compliance mechanism consistently limits its security-based 
swaps business in a manner that aligns with the Commission's objective: 
To provide this option only to firms that are not a significant part of 
the security-based swap market and predominantly deal in swaps as 
compared to security-based swaps. Moreover, a quarterly test (as 
opposed to a requirement to meet the threshold test at all times) is 
designed to limit the possibility that a firm operating pursuant to the 
alternative compliance mechanism inadvertently exceeds one of the 
thresholds for a brief period of time (particularly by an immaterial 
amount) and, as a consequence, can no longer use it.
    Paragraph (b) of Rule 18a-10 sets forth requirements for a firm 
that is operating pursuant to the rule. Paragraph (b)(1) provides that 
the firm must comply with the capital, margin, and segregation 
requirements of the CEA and the CFTC's rules applicable to swap dealers 
and treat security-based swaps and related collateral pursuant to those 
requirements to the extent the requirements do not specifically address 
security-based swaps and related collateral. Consequently, a firm that 
is subject to Rule 18a-10 must comply with applicable capital, margin, 
and segregation requirements of the CEA and the CFTC's rules and a 
failure to comply with one or more of those rules will constitute a 
failure to comply with Rule 18a-10. Moreover, the firm must treat 
security-based swaps and related collateral pursuant to the 
requirements of the CEA and the CFTC's rules even if the CEA and the 
CFTC's rules do not specifically address security-based swaps and 
related collateral. This provision is designed to ensure that security-
based swaps and related collateral do not fall into a ``regulatory 
gap'' with respect to a nonbank SBSD operating under the alternative 
compliance mechanism. Thus, if a capital, margin, or segregation

[[Page 43946]]

requirement applicable to a swap or collateral related to a swap is 
silent as to a security-based swap or collateral related to a security-
based swap, the nonbank SBSD must treat the security-based swap or 
collateral related to a security-based swap pursuant to the requirement 
applicable to the swap or collateral related to the swap.\711\
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    \711\ See, e.g., Letter from Eileen T. Flaherty, Director, 
Division of Swap Dealer and Intermediary Oversight, and Jeffrey M. 
Bandman, Acting Director, Division of Clearing and Risk, CFTC, to 
Mary P. Johannes, Senior Director, ISDA (Aug. 23, 2016) (providing 
no-action relief to swap dealers and major swap participants with 
respect to the CFTC's margin rules for non-cleared swaps pursuant to 
which these entities can portfolio margin non-cleared swaps with 
non-cleared security-based swaps, provided, among other conditions, 
the security-based swaps shall be treated as if they were swaps for 
all applicable provisions of the CFTC's margin rules).
---------------------------------------------------------------------------

    Paragraph (b)(2) of Rule 18a-10 requires the firm to provide a 
written disclosure to its counterparties after it begins operating 
pursuant to the rule. The disclosure must be provided before the first 
transaction with the counterparty after the firm begins operating 
pursuant to the rule. The disclosure must notify the counterparty that 
the firm is complying with the applicable capital, margin, and 
segregation requirements of the CEA and the CFTC's rules in lieu of 
complying with Rules 18a-1, 18a-3, and 18a-4. The disclosure 
requirement is designed to alert the counterparty that the firm is not 
complying with these Commission rules notwithstanding the fact that the 
firm is registered with the Commission as an SBSD. This will provide 
the counterparty with the opportunity to assess the implications of 
transacting with the SBSD under these circumstances.
    Paragraph (b)(3) of Rule 18a-10 requires the firm to immediately 
notify the Commission and the CFTC in writing if it fails to meet a 
condition in paragraph (a) of the rule. This notice--by immediately 
alerting the Commission and the CFTC of the firm's status--will provide 
the agencies with the opportunity to promptly evaluate the situation 
and coordinate any regulatory responses such as increased monitoring of 
the firm.
    Paragraph (c) of Rule 18a-10 addresses when a firm fails to comply 
with a condition in paragraph (a) of the rule and, therefore, no longer 
qualifies to operate pursuant to the rule. The paragraph provides that 
a firm in that circumstance must begin complying with Rules 18a-1, 18a-
3, and 18a-4 no later than either: (1) Two months after the end of the 
month in which the firm failed to meet the condition in paragraph (a); 
or (2) for a longer period of time as granted by the Commission by 
order subject to any conditions imposed by the Commission. This period 
of time to come into compliance with the Commission's rules 
(``compliance period'') is modeled on the de minimis exception to the 
``security-based swap dealer'' definition.\712\ Under paragraph (b) of 
Rule 3a71-2, an entity that no longer meets the requirements of the de 
minimis exception will be deemed to not be an SBSD until the earlier of 
the date on which it submits a complete application to register as an 
SBSD or two months after the end of the month in which the entity 
becomes no longer able to take advantage of the exception. The 
compliance period in Rule 18a-10 is designed to provide an SBSD with 
time to implement systems, controls, policies, and procedures and take 
other necessary steps to comply with Rules 18a-1, 18a-3, and 18a-4. The 
Commission, by order, can grant the SBSD additional time if necessary.
---------------------------------------------------------------------------

    \712\ See Rule 3a71-2.
---------------------------------------------------------------------------

    The conditions in paragraphs (a)(1) through (4) of Rule 18a-10 must 
be met at all times an SBSD is operating pursuant to the rule. 
Consequently, the compliance period will begin to run on the day of a 
month that the SBSD fails to meet a condition in paragraphs (a)(1) 
through (4). As discussed above, whether a firm meets the condition in 
paragraph (a)(5) of Rule 18a-10 will be determined as of the most 
recently ended quarter of the firm's fiscal year. Therefore, a firm 
could fail to meet this condition only on a day that is the end of one 
of its fiscal year quarters. If the firm fails to meet the condition on 
one of those days, the compliance period will begin to run on that day.
    Paragraph (d) of Rule 18a-10 addresses how a firm would elect to 
operate pursuant to the rule. Under paragraph (d)(1), a firm can make 
the election as part of the process of applying to register as an SBSD. 
In this case, the firm must provide written notice to the Commission 
and the CFTC during the registration process of its intent to operate 
pursuant to the rule. Upon being registered as an SBSD, the firm can 
begin complying with Rule 18a-10, provided it meets the conditions in 
paragraph (a) of the rule.
    Under paragraph (d)(2) of Rule 18a-10, an SBSD can make the 
election after the firm has been registered as an SBSD. In this case, 
the firm must provide written notice to the Commission and the CFTC of 
its intent to operate pursuant to the rule and continue to comply with 
Rules 18a-1, 18a-3, and 18a-4 for two months after the end of the month 
in which the firm provides the notice or for a shorter period of time 
as granted by the Commission by order subject to any conditions imposed 
by the Commission. The requirement that the firm continue complying 
with the Commission's rules for a period of time after making the 
election is designed to provide the Commission and the CFTC with an 
opportunity to examine the firm before it begins operating pursuant to 
the alternative compliance mechanism and to prepare for the firm no 
longer complying with the Commission's rules.
    As discussed above, paragraph (b)(3) requires a firm operating 
pursuant to the rule to immediately notify the Commission and the CFTC 
in writing if the SBSD fails to meet a condition in paragraph (a). 
Further, paragraphs (d)(1) and (2) require a firm to provide written 
notice to the Commission and the CFTC of its intent to operate pursuant 
to the rule. Paragraph (e) of Rule 18a-10 provides that the notices 
required by the rule must be sent by facsimile transmission to the 
principal office of the Commission and the regional office of the 
Commission for the region in which the security-based swap dealer has 
its principal place of business or an email address to be specified 
separately, and to the principal office of the CFTC in a manner 
consistent with the notification requirements of the CFTC.\713\ The 
paragraph also requires that notices include a brief summary of the 
reason for the notice and the contact information of an individual who 
can provide further information about the matter that is the subject of 
the notice. This will facilitate the ability of the Commission and the 
CFTC to follow-up with the firm and gather further information about 
the matter that triggered the notice requirement.
---------------------------------------------------------------------------

    \713\ See 17 CFR 240.17a-11 (requiring a similar process to 
provide notice to the Commission and the CFTC). See also Staff 
Guidance for Filing Broker-Dealer Notices, Statements, and Reports, 
available at https://www.sec.gov/divisions/marketreg/bdnotices.htm 
(providing a fax number that broker-dealers may use to send these 
notices).
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E. Cross-Border Application of Capital, Margin, and Segregation 
Requirements

1. Capital and Margin Requirements
    In 2013, the Commission preliminarily interpreted the Title VII 
requirements associated with registration to apply generally to the 
activities of registered entities. In reaching that preliminary 
conclusion, the Commission did not concur with the views of certain 
commenters that the Title VII requirements should not apply to the 
foreign security-based swap activities of registered entities, stating 
that such a view could be difficult to

[[Page 43947]]

reconcile with, among other things, the statutory language describing 
the requirements applicable to SBSDs.\714\
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    \714\ See Cross-Border Proposing Release, 78 FR at 30986.
---------------------------------------------------------------------------

a. Treatment of Cross-Border Transactions
    The Commission further preliminarily identified capital and margin 
requirements as entity-level requirements, rather than requirements 
specifically applicable to particular transactions. Entity-level 
requirements primarily address concerns relating to the entity as a 
whole, with a particular focus on safety and soundness of the entity to 
reduce systemic risk in the U.S. financial system. The Commission 
accordingly proposed to apply the entity-level requirements on a firm-
wide basis to address risks to the SBSD as a whole. The Commission did 
not propose any exception from the application of the entity-level 
requirements to SBSDs.\715\
---------------------------------------------------------------------------

    \715\ See 78 FR at 31011. The Commission similarly expressed the 
preliminary view that MSBSPs should be required to adhere to the 
entity-level requirements. See 78 FR at 31035.
---------------------------------------------------------------------------

    Commenters did not address the proposal to treat capital 
requirements as entity-level requirements. The Commission continues to 
believe these requirements must apply to the entity as a whole. In 
reaching this conclusion, the Commission recognizes that the objective 
of the capital rule for SBSDs is the same as the capital rule for 
broker-dealers--to ensure that the entity maintains at all times 
sufficient liquid assets to promptly satisfy its liabilities, and to 
provide a cushion of liquid assets in excess of liabilities to cover 
potential market, credit, and other risks.\716\ The tangible net worth 
standard applicable to nonbank MSBSPs is intended to be applied to the 
entity as a whole to ensure the MSBSP's solvency is based on tangible 
assets. Therefore, the Commission is also treating the nonbank MSBSP 
capital requirements as entity-level requirements.
---------------------------------------------------------------------------

    \716\ See Cross-Border Proposing Release, 78 FR at 31011.
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    With respect to margin, a commenter pointed out that ``the 
application and enforcement of margin requirements applies on a 
transaction-by-transaction basis and the calculation of margin depends 
on the circumstances of a particular [security-based swap].'' \717\ 
Another commenter opposed characterizing margin as an entity-level 
requirement due to a concern that doing so could result in a 
substituted compliance determination where firms could ``comply with 
only a comparable foreign regime in every circumstance, regardless of 
who they transact with or where the transactions occur.'' \718\ The 
commenter advocated that the Commission ``either treat margin as a 
transaction-level requirement or not permit substituted compliance in 
these transactions.'' A number of commenters requested that margin be 
treated as a transaction-level requirement for consistency with other 
domestic and foreign regulators.\719\ Some commenters also argued there 
could be costs and operational complications resulting from subjecting 
a foreign registrant to both Commission and home country margin 
requirements.\720\
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    \717\ See Letter from Kenneth E. Bentsen, Jr., President, SIFMA, 
Walt Lukken, President and Chief Executive Officer, Futures Industry 
Association, and Richard M. Whiting, Executive Officer and General 
Counsel, The Financial Services Roundtable (Aug. 21, 2013) (``SIFMA 
8/21/2013 Letter'').
    \718\ See Letter from Dennis M. Kelleher, President and Chief 
Executive Officer, Stephen W. Hall, Securities Specialist, and 
Katelynn O. Bradley, Attorney, Better Markets, Inc. (Aug. 21, 2013) 
(``Better Markets 8/21/2013 Letter'').
    \719\ See, e.g., Letter from Koichi Ishikura, Executive Chief of 
Operations for International Headquarters, Japan Securities Dealers 
Association (Aug. 21, 2013) (``Japan SDA Letter'') (urging the 
Commission and the CFTC to align their rules to avoid ``hamper[ing] 
efficient management of derivatives transactions'').
    \720\ See, e.g., Letter from Sarah A. Miller, Chief Executive 
Officer, Institute of International Bankers (Aug. 21, 2013) (``IIB 
8/21/2013 Letter'') (stating that it would be ``cost-intensive'' to 
``negotiate and execute separate credit support documentation, make 
separate margin calculations and have separate operational 
procedures across its swap and [security-based swap] 
transactions'').
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    Margin is designed to protect the nonbank SBSD or MSBSP from the 
consequences of a counterparty's default.\721\ Permitting different 
margin requirements based on the location of the counterparty is not 
consistent with this objective. Further, treating margin as a 
transaction-level requirement could cause those counterparties entering 
into transactions that constitute the U.S. business of a nonbank 
registrant to bear a greater burden in ensuring the safety and 
soundness of the nonbank registrant than counterparties that are part 
of the nonbank registrant's foreign business.\722\ The Commission also 
concludes that treating margin solely as a transaction-level 
requirement would not adequately further the objectives of using margin 
to ensure the safety and soundness of nonbank registrants because it 
could result in entities with global businesses collecting 
significantly less collateral than would otherwise be required to the 
extent that they are not required by local law to collect comparable 
margin from their counterparties. This potential outcome could increase 
the registrant's risk of failure if certain counterparties are not 
required to post margin, especially during a period when the market is 
already unstable.\723\
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    \721\ The Commission acknowledges that the requirement that 
nonbank SBSDs post variation margin to counterparties is primarily 
designed to protect the counterparty from the consequences of the 
nonbank SBSD's default. However, because the collection of variation 
and initial margin by the nonbank SBSD is critical to the safety and 
soundness of the nonbank SBSD, the Commission believes it 
appropriate to treat margin as an entity-level requirement even 
though the component of the rule requiring the nonbank SBSD to post 
variation margin is designed to protect the counterparty.
    \722\ See Section 15F(e)(3)(A) of the Exchange Act (providing 
that the Commission's statutorily mandated initial and variation 
margin requirements shall ``help ensure the safety and soundness'' 
of the SBSD or MSBSP).
    \723\ Prior to the financial crisis, the ability to enter into 
OTC derivatives transactions without having to deliver collateral 
allowed counterparties to enter into OTC derivatives transactions 
without the necessity of using capital to support the transactions. 
So, when ``trigger events'' occurred during the financial crisis, 
counterparties faced significant liquidity strains in seeking to 
meet the requirements to deliver collateral. As a result, some 
dealers experienced large uncollateralized exposures to 
counterparties experiencing financial difficulty, which, in turn, 
risked exacerbating the already severe market dislocation. See, 
e.g., Orice M. Williams, Director, Financial Markets and Community 
Investment, GAO, Systemic Risk: Regulatory Oversight and Recent 
Initiatives to Address Risk Posed by Credit Default Swaps, GAO-09-
397T (Mar. 2009); GAO, Financial Crisis: Review of Federal Reserve 
System Financial Assistance to American International Group, Inc., 
GAO-11-616 (Sept. 2011).
---------------------------------------------------------------------------

    In response to the comment that treating margin requirements as 
entity-level requirements would permit nonbank SBSDs in every 
circumstance to use foreign requirements to satisfy the margin 
requirements, the Commission intends to consider certain factors to 
mitigate this risk prior to making a substituted compliance 
determination. More specifically, the Commission intends to consider 
whether the foreign financial regulatory system requires registrants to 
adequately cover their current and potential future exposure to OTC 
derivatives counterparties, and ensures registrants' safety and 
soundness, in a manner comparable to the applicable provisions arising 
from the Exchange Act and its rules and regulations.\724\
---------------------------------------------------------------------------

    \724\ See paragraph (d)(5) of Rule 3a71-6, as amended.
---------------------------------------------------------------------------

    For all of these reasons, the Commission is treating the nonbank 
SBSD margin requirements as entity-level requirements. The margin 
requirements applicable to nonbank MSBSPs are intended to be applied to 
the entity as a whole for the same reasons the margin requirements for 
nonbank SBSDs are intended to apply to the entity as a whole. 
Therefore, the Commission is also treating the nonbank

[[Page 43948]]

MSBSP margin requirements as entity-level requirements.
    The Commission preliminarily identified the SBSD segregation 
requirements as transaction-level requirements.\725\ Consequently, 
proposed Rule 18a-4 contained provisions to address the application of 
the segregation requirements to cross-border security-based swap 
transactions of foreign SBSDs. The applicable segregation requirements 
are tailored depending on the type of registrant, security-based swap, 
and customer. The Commission did not receive comments specifically 
addressing this proposed treatment of segregation requirements. 
However, one commenter stated that it ``support[s] the Commission's 
overall proposal to distinguish between entity-level and transaction-
level requirements'' and that it ``generally support[s] the 
Commission's proposed cross-border application of segregation 
requirements to foreign SBSDs.'' \726\ The Commission continues to 
treat segregation requirements as transaction-level requirements.
---------------------------------------------------------------------------

    \725\ See Cross-Border Proposing Release, 78 FR at 31010-31011.
    \726\ See IIB 8/21/2013 Letter.
---------------------------------------------------------------------------

Amendments to the Substituted Compliance Rule
    The Commission proposed to make substituted compliance potentially 
available in connection with the requirements applicable to foreign 
SBSDs pursuant to Section 15F of the Exchange Act, other than the 
registration requirements. Because the capital and margin requirements 
were grounded in Section 15F, substituted compliance generally would 
have been available for those requirements under the proposal.\727\ 
Upon a Commission substituted compliance determination, a person would 
be able to satisfy relevant capital or margin requirements by 
substituting compliance with corresponding requirements under a foreign 
regulatory system.
---------------------------------------------------------------------------

    \727\ See Cross-Border Proposing Release, 78 FR at 31085.
---------------------------------------------------------------------------

    The Commission subsequently adopted Rule 3a71-6, which provides 
that substituted compliance is available with respect to the 
Commission's business conduct requirements, and (rather than addressing 
all requirements under Section 15F of the Exchange Act) reserved the 
issue as to whether substituted compliance also would be available in 
connection with other requirements under that statute.\728\ Rule 3a71-6 
was amended to make substituted compliance available with respect to 
the Commission's trade acknowledgment and verification 
requirements.\729\ Today the Commission is amending Rule 3a71-6 to make 
the nonbank SBSD and MSBSP capital and margin requirements available 
for substituted compliance determinations.
---------------------------------------------------------------------------

    \728\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, Exchange Release 
No. 77617 (Apr. 14, 2016). See Cross-Border Proposing Release, 78 FR 
at 31207.
    \729\ See Trade Acknowledgment and Verification of Security-
Based Swap Transactions, Exchange Act Release No. 78011 (June 8, 
2016), 81 FR 39808, 30143-44 (June 17, 2016).
---------------------------------------------------------------------------

    One commenter expressed concerns that there is no adequate legal or 
policy justification for allowing substituted compliance.\730\ In 
contrast to the implication of that comment, however, substituted 
compliance does not constitute exemptive relief and does not excuse 
registered SBSDs and MSBSPs from having to comply with the Commission's 
capital and margin requirements. Instead, substituted compliance 
provides an alternative method of satisfying those requirements under 
Title VII.
---------------------------------------------------------------------------

    \730\ See Better Markets 11/19/2018 Letter. See also Harrington 
11/19/2018 Letter.
---------------------------------------------------------------------------

i. Basis for Substituted Compliance in Connection With Capital and 
Margin Requirements
    In light of the global nature of the security-based swap market and 
the prevalence of cross-border transactions within that market, there 
is the potential that the application of the Title VII capital and 
margin requirements may duplicate or conflict with applicable foreign 
requirements, even when the two sets of requirements implement similar 
goals and lead to similar results. Such duplications or conflicts could 
disrupt existing business relationships, and, more generally, reduce 
competition and market efficiency.\731\
---------------------------------------------------------------------------

    \731\ See generally Business Conduct Standards for Security-
Based Swap Dealers and Major Security-Based Swap Participants, 81 FR 
at 30073-74 (addressing the basis for making substituted compliance 
available in the context of the business conduct requirements).
---------------------------------------------------------------------------

    To address those effects, the Commission concludes that under 
certain circumstances it may be appropriate to allow for the 
possibility of substituted compliance whereby foreign SBSDs and MSBSPs 
may satisfy Section 15F(e) of the Exchange Act and Rules 18a-1, 18a-2, 
and 18a-3 thereunder by complying with comparable foreign requirements. 
Allowing for the possibility of substituted compliance in this manner 
may help achieve the benefits of these capital and margin requirements 
in a way that helps avoid regulatory duplication or conflict and hence 
promotes market efficiency, enhances competition, and facilitates a 
well-functioning global security-based swap market. Accordingly, Rule 
3a71-6 is amended to identify Section 15F(e) of the Exchange Act and 
Rules 18a-1, 18a-2, and 18a-3 thereunder as being eligible for 
substituted compliance.\732\
---------------------------------------------------------------------------

    \732\ See paragraph (d) of Rule 3a71-6, as adopted. Paragraph 
(a)(1) of Rule 3a71-6 provides that the Commission may, 
conditionally or unconditionally, by order, make a determination 
with respect to a foreign financial regulatory system that 
compliance with specified requirements under that foreign financial 
system by a registered SBSD and/or registered MSBSP, or class 
thereof, may satisfy the corresponding requirements identified in 
paragraph (d) of the rule that would otherwise apply.
---------------------------------------------------------------------------

    A number of comments addressed substituted compliance as it 
specifically applies to the Commission's capital and margin 
requirements. One commenter generally asked the Commission to 
``recognize local margin requirements'' for foreign SBSDs,\733\ while 
other commenters requested that the Commission coordinate with the 
prudential regulators on substituted compliance determinations for 
capital and margin.\734\ Similarly, another commenter requested that 
the Commission jointly propose and adopt rules reflecting a harmonized 
and unified approach to the cross-border application of the security-
based swaps and swaps provisions of Title VII of the Dodd-Frank 
Act.\735\ While a joint rulemaking would present logistical challenges 
due to timing differences in agencies' implementation of cross-border 
regimes, the Commission staff has consulted and coordinated with the 
CFTC, the prudential regulators, and foreign regulatory authorities on 
the cross-border application of its rules, and plans to continue such 
consultation and coordination during the substituted compliance 
determination process.\736\
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    \733\ See ISDA 1/23/2013 Letter.
    \734\ See Center for Capital Markets Competitiveness, Chamber of 
Commerce 11/19/2018 Letter; ICI 11/19/2018 Letter; SIFMA 8/21/2013 
Letter.
    \735\ See Letter from Walt L. Lukken, President and Chief 
Executive Officer, Futures Industry Association (Nov. 29, 2018) 
(``FIA 11/29/2018 Letter'').
    \736\ Section 712(a)(2) of the Dodd-Frank Act provides in part 
that the Commission shall ``consult and coordinate to the extent 
possible with the [CFTC] and the prudential regulators for the 
purposes of assuring regulatory consistency and comparability, to 
the extent possible.''
---------------------------------------------------------------------------

    A few commenters sought blanket substituted compliance 
determinations that would automatically grant substituted compliance 
without requiring an independent comparability determination with 
respect to firms subject to foreign capital or margin requirements that 
are consistent with

[[Page 43949]]

certain international standards.\737\ In contrast, another commenter 
recommended that the Commission not consider consistency with the 
prudential regulators, international standards, and foreign regulators 
when making substituted compliance determinations.\738\ In response to 
these comments, the Commission believes it is appropriate to analyze 
directly a foreign jurisdiction's capital and margin requirements. In 
particular, jurisdictions may customize their capital and margin 
requirements to local markets and activities. In addition, Rule 3a71-6 
provides that the Commission's substituted compliance determination 
will take into consideration the effectiveness of the supervisory 
compliance program administered and the enforcement authority exercised 
by the foreign regulatory authority, which are expected to vary among 
foreign jurisdictions. Consequently, the analysis of any particular 
foreign jurisdiction's capital and margin requirements will be fact 
specific and therefore a ``blanket approach'' would not be appropriate.
---------------------------------------------------------------------------

    \737\ See, e.g., Citigroup 4/24/2018 Meeting; IIB/SIFMA Letter; 
IIB 11/19/2018 Letter; ISDA 11/19/2018 Letter; SIFMA 3/12/2014 
Letter; SIFMA 11/19/2018 Letter.
    \738\ See Harrington 11/19/2018 Letter.
---------------------------------------------------------------------------

    Another commenter sought an exemption for foreign firms with 
respect to the Commission's margin requirements (among other 
requirements) pursuant to which they could comply with local 
requirements that are not comparable to U.S. requirements, provided the 
aggregate notional value of swaps in the jurisdictions where this 
exemption is used does not exceed 15% of the firm's total swap 
activities.\739\ The Commission does not believe such an exemption 
would be appropriate because it could negatively impact the safety and 
soundness of the firm if the local requirements were less rigorous than 
the Commission's requirements.
---------------------------------------------------------------------------

    \739\ See SIFMA 8/21/2013 Letter.
---------------------------------------------------------------------------

ii. Comparability Criteria, and Consideration of Related Requirements
    The Commission will endeavor to take a holistic approach in 
determining the comparability of foreign requirements for substituted 
compliance purposes, focusing on regulatory outcomes as a whole rather 
than on requirement-by-requirement similarity.\740\ The Commission's 
comparability assessments associated with Section 15F(e) of the 
Exchange Act and Rules 18a-1, 18a-2, and 18a-3 thereunder accordingly 
will consider whether, in the Commission's view, the foreign regulatory 
system achieves regulatory outcomes that are comparable to the 
regulatory outcomes associated with the capital and margin 
requirements. More specifically, paragraph (a)(2)(i) of Rule 3a71-6 
provides that the Commission's substituted compliance determination 
will take into account factors that the Commission determines 
appropriate, such as, for example, ``the scope and objectives of the 
relevant foreign regulatory requirements . . . , as well as the 
effectiveness of the supervisory compliance program administered, and 
the enforcement authority exercised, by a foreign financial regulatory 
authority or authorities in such system to support its oversight of 
such foreign security-based swap entity (or class thereof) or of the 
activities of such security-based swap entity (or class thereof).''
---------------------------------------------------------------------------

    \740\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR at 30078-
79.
---------------------------------------------------------------------------

    In reviewing applications, the Commission may determine to conduct 
its comparability analyses regarding the capital and margin 
requirements in conjunction with comparability analyses regarding other 
Exchange Act requirements that promote risk management in connection 
with SBSDs and MSBSPs. Accordingly, depending on the applicable facts 
and circumstances, the comparability assessment associated with the 
capital and margin requirements may constitute part of a broader 
assessment of the foreign regulatory system's risk mitigation 
requirements, and the applicable comparability assessments may be 
conducted at the level of those risk mitigation requirements as a 
whole. Commenters generally requested additional guidance regarding the 
criteria the Commission would consider when making a substituted 
compliance determination.\741\ Such criteria have been set forth in the 
final rule as discussed below.
---------------------------------------------------------------------------

    \741\ See, e.g., Letter from Americans for Financial Reform 
(Aug. 22, 2013) (``Americans for Financial Reform 8/22/2013 
Letter''); Letter from Futures and Options Association (Aug. 21, 
2013) (``Futures and Options Association Letter''). See also 
Capital, Margin, and Segregation Comment Reopening, 83 FR at 53018-
19 (soliciting comment on potential rule language that would modify 
the proposal in this manner).
---------------------------------------------------------------------------

Comparability Criteria for Nonbank SBSD Capital Requirements
    Rule 3a71-6 provides that prior to making a substituted compliance 
determination regarding SBSD capital requirements, the Commission 
intends to consider (in addition to any conditions imposed), whether 
the capital requirements of the foreign financial regulatory system are 
designed to help ensure the safety and soundness of registrants \742\ 
in a manner that is comparable to the applicable provisions arising 
under the Exchange Act and its rules and regulations.\743\ Under this 
provision, the Commission would analyze whether the capital and other 
prudential requirements of the foreign jurisdiction from an outcome 
perspective help ensure the safety and soundness of the registrants in 
a manner that is comparable to the applicable provisions arising under 
the Exchange Act and its rules and regulations.
---------------------------------------------------------------------------

    \742\ See Section 15F(e)(3)(A) of the Exchange Act (providing 
that the capital requirements for SBSDs shall ``help ensure the 
safety and soundness'' of the SBSD).
    \743\ See paragraph (d)(4)(i) of Rule 3a71-6, as amended.
---------------------------------------------------------------------------

Comparability Criteria for Nonbank MSBSP Capital Requirements
    Nonbank MSBSPs are subject to a tangible net worth standard, rather 
than a net liquid assets test. This different standard recognizes that 
the entities required to register as nonbank MSBSPs may engage in a 
diverse range of business activities different from, and broader than, 
the securities activities conducted by stand-alone broker-dealers or 
nonbank SBSDs. In light of these considerations, Rule 3a71-6 provides 
that prior to making a substituted compliance determination regarding 
MSBSP capital requirements, the Commission intends to consider (in 
addition to any conditions imposed), whether the capital requirements 
of the foreign financial regulatory system are comparable to the 
applicable provisions arising under the Exchange Act and its rules and 
regulations.\744\
---------------------------------------------------------------------------

    \744\ See paragraph (d)(4)(ii) of Rule 3a71-6, as amended.
---------------------------------------------------------------------------

Comparability Criteria for Nonbank SBSD and MSBSP Margin Requirements
    Obtaining collateral is one of the ways OTC derivatives dealers 
manage their credit risk exposure to OTC derivatives counterparties. 
Prior to the financial crisis, in certain circumstances, counterparties 
were able to enter into OTC derivatives transactions without having to 
deliver collateral. When ``trigger events'' occurred during the 
financial crisis, those counterparties faced significant liquidity 
strains when they were required to deliver collateral.
    In light of these considerations, Rule 3a71-6 provides that prior 
to making a substituted compliance determination regarding SBSD margin 
requirements, the Commission intends to consider (in addition to any 
conditions imposed) whether the foreign financial regulatory

[[Page 43950]]

system requires registrants to adequately cover their current and 
future exposure to OTC derivatives counterparties,\745\ and ensures 
registrants' safety and soundness,\746\ in a manner comparable to the 
applicable provisions arising under the Exchange Act and its rules and 
regulations.\747\
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    \745\ See Section 15F(e)(3) of the Exchange Act (stating that 
the margin requirements adopted under Section 15F(e)(2) of the 
Exchange Act must, among other things, ``be appropriate for the risk 
associated with the non-cleared security-based swaps held as a 
[SBSD] or [MSBSP]'').
    \746\ See Section 15F(e)(3) of the Exchange Act (stating that 
the margin requirements adopted under Section 15F(e)(2) of the 
Exchange Act must, among other things, ``help ensure the safety and 
soundness of the [SBSD] or [MSBSP]'').
    \747\ See paragraph (d)(5)(i) of Rule 3a71-6, as amended.
---------------------------------------------------------------------------

    Similarly, Rule 3a71-6 provides that prior to making a substituted 
compliance determination regarding MSBSP margin requirements, the 
Commission intends to consider (in addition to any conditions imposed) 
whether the foreign financial regulatory system requires registrants to 
adequately cover their current exposure to OTC derivatives 
counterparties, and ensures registrants' safety and soundness, in a 
manner comparable to the applicable provisions arising under the 
Exchange Act and its rules and regulations.\748\
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    \748\ See paragraph (d)(5)(ii) of Rule 3a71-6, as amended.
---------------------------------------------------------------------------

2. Segregation Requirements
a. Treatment of Cross-Border Transactions
    As discussed above, the Commission proposed to treat the 
segregation requirements of Section 3E of the Exchange Act and proposed 
Rule 18a-4 as transaction-level requirements. Further, these 
requirements were not available for substituted compliance 
determinations. However, proposed Rule 18a-4 included provisions that 
addressed the applicability of these requirements with respect to 
different types of cross-border transactions.\749\ These provisions in 
proposed Rule 18a-4 applied to foreign SBSDs and MSBSPs that were not 
dually registered as broker-dealers. Consequently, a broker-dealer SBSD 
needed to treat cross-border transactions no differently than any other 
types of transactions for purposes of the segregation requirements in 
Section 3E of the Exchange Act and proposed Rule 18a-4.
---------------------------------------------------------------------------

    \749\ See Cross-Border Proposing Release, 78 FR at 31018-22.
---------------------------------------------------------------------------

    The cross-border provisions in proposed Rule 18a-4 for foreign 
stand-alone and bank SBSDs and MSBSPs distinguished between entities 
that were a U.S. branch or agency of a foreign bank, or neither of the 
above, and between cleared or non-cleared security-based swap 
transactions. The objective underlying these distinctions was to ensure 
that U.S. customers of a foreign stand-alone or bank SBSD or MSBSP were 
protected in the event the firm needed to be liquidated in a formal 
proceeding. Consequently, the differing treatment of cross-border 
transactions depending on these distinctions was tied to the applicable 
bankruptcy or liquidation laws that would apply to a failed foreign 
stand-alone or bank SBSD or MSBSP.
    A commenter expressed general support for the Commission's proposed 
cross-border treatment of segregation requirements for foreign SBSDs as 
``consistent with the objective of applying segregation requirements so 
they work in tandem with applicable insolvency laws.'' \750\ Another 
commenter believed the Commission intended to make segregation 
requirements eligible for substituted compliance, and asked the 
Commission to clarify this fact.\751\ The Commission is adopting the 
approach as proposed that segregation is a transaction-level (rather 
than entity-level) requirement, because the Commission believes 
transaction-based rules are the best mechanism for protecting U.S. 
customers, given that varying possible liquidation outcomes depending 
on the type of registrant, security-based swap, and customer involved.
---------------------------------------------------------------------------

    \750\ See IIB 8/21/2013 Letter.
    \751\ See SIFMA 8/21/2013 Letter. See also IIB 11/19/2018 Letter 
(requesting that in connection with collateral for cleared security-
based swaps, the Commission's segregation requirements should only 
apply to transactions with U.S. persons, and the foreign SBSD should 
be permitted to satisfy these requirements through substituted 
compliance.)
---------------------------------------------------------------------------

    Another commenter generally requested substituted compliance for 
all transaction-level requirements (which includes segregation 
requirements) to mitigate the risk of duplicative and/or conflicting 
regulatory requirements.\752\ The transaction-based approach to 
segregation considers the risk of duplicative and/or conflicting 
regulatory requirements, but without requiring a substituted compliance 
application to be submitted. Similarly, another commenter asked for an 
exemption from the Commission's omnibus segregation requirements for 
foreign SBSDs (including foreign bank SBSDs) ``whose segregation and 
custody of customer assets are subject to the supervision of a local 
regulatory authority,'' because an insolvent or liquidated foreign SBSD 
would be subject to banking regulations or home country law, rather 
than SIPA or the U.S. Bankruptcy Code's stockbroker liquidation 
provisions.\753\ However, the commenter's proposed approach does not 
consider that the Commission's approach is designed to protect U.S. 
customers of foreign SBSDs and MSBSPs.
---------------------------------------------------------------------------

    \752\ See, e.g., Letter from Stuart J. Kaswell, Executive Vice 
President & Managing Director, General Counsel, Managed Funds 
Association, and Adam Jacobs, Director, Head of Markets Regulation, 
Alternative Investment Management Association (Aug. 19, 2013) 
(``MFA/AIMA 8/19/2013 Letter'').
    \753\ See IIB 8/21/2013 Letter.
---------------------------------------------------------------------------

    The same commenter requested that the Commission follow the 
Department of Treasury's approach, which exempts banks from its 
government securities dealer customer protection requirements if they 
meet certain conditions and are subject to certain prudential regulator 
rules. More specifically, the commenter requested a blanket exemption 
from the Commission's omnibus segregation requirements for foreign 
SBSDs that are foreign banks with a U.S. branch because they would be 
liquidated under banking regulations instead of SIPA or the stockbroker 
liquidation provisions. In response, the Commission recognizes that a 
foreign SBSD that is not a registered broker-dealer but is a foreign 
bank may not be eligible to be liquidated pursuant to the stockbroker 
liquidation provisions, and as such, the foreign SBSD's insolvency 
proceeding would be administered under U.S. or foreign banking 
regulations. However, the Commission believes that due to existing 
ring-fencing laws, imposing segregation requirements on such a foreign 
SBSD with respect to certain security-based swap customers that are 
U.S. persons in all circumstances, and with respect to security-based 
swap customers regardless of U.S. person status when it receives funds 
or other property arising out of a transaction with a U.S. branch or 
agency of the foreign SBSD, will reduce the likelihood of U.S. 
counterparties incurring losses by helping identify customers' assets 
in an insolvency proceeding and would potentially minimize disruption 
to the U.S. security-based swap market.
    A commenter requested that foreign SBSDs be exempted from 
transaction-level requirements (including segregation) when transacting 
with foreign funds managed by U.S. asset managers, because transaction-
level requirements primarily focus on protecting counterparties by 
imposing certain obligations on both U.S. and foreign SBSDs.\754\ A 
second commenter

[[Page 43951]]

stated that collateral segregation and disclosure requirements should 
only apply to transactions with U.S. counterparties, so long as the 
firm maintains a separate account for collateral collected from U.S. 
persons as a way to protect U.S. counterparties in case of bankruptcy. 
The commenter also requested that foreign branches of U.S. banks which 
are not part of registered broker-dealers not be subject to segregation 
requirements when transacting with non-U.S. persons, to ``mitigate the 
competitive effects'' foreign branches may suffer relative to foreign 
SBSDs that are subject to segregation requirements in a narrower set of 
circumstances.
---------------------------------------------------------------------------

    \754\ See Letter from Karrie McMillan, General Counsel, 
Investment Company Institute, and Dan Waters, Managing Director, ICI 
Global (Aug. 21, 2013) (``ICI 8/21/2013 Letter'').
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    In response to these comments, granting these exemption requests 
would put U.S. customers' interests at risk in case of a foreign SBSD's 
bankruptcy. A primary purpose of the Commission's segregation 
requirements is to facilitate the prompt return of property to U.S. 
customers and security-based swap customers either before or during a 
liquidation if a registrant fails. The Commission is able to limit the 
segregation rules applicable to U.S. branches of foreign banks to a 
narrower set of transactions, because the applicable insolvency laws 
enable a ring-fencing mechanism by which regulators may ring fence 
creditor claims ``arising out of transactions had by them with'' the 
U.S. branches or agencies of the foreign bank.\755\
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    \755\ See 12 U.S.C. 3102(j).
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    For the foregoing reasons, the Commission--as discussed below--is 
adopting the substance of the proposed segregation cross-border 
provisions in paragraph (e) of Rule 18a-4, but--as discussed in the 
next section--the Commission is modifying the structure of the 
paragraph by re-organizing it and making other non-substantive 
modifications.
Final Cross-Border Provisions for Foreign Bank SBSDs
    A foreign bank SBSD that has a branch or agency in the United 
States should not be eligible to be a debtor under the U.S. stockbroker 
liquidation scheme.\756\ Instead, the foreign bank's U.S. branches and 
agencies would likely be liquidated under federal or state banking law 
which ``ring fences'' creditor claims ``arising out of transactions had 
by them with'' the U.S. branches or agencies.\757\ With respect to a 
foreign bank SBSD that has no branch or agency in the United States, 
such entities probably would not be liquidated in the United States for 
jurisdictional reasons. The treatment of U.S. customers in such a 
liquidation is unknown because it depends on the laws of the 
jurisdiction where the foreign SBSD is liquidated. However, many 
jurisdictions' laws provide for ring fencing similar to U.S. bank 
liquidation laws.
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    \756\ See 11 U.S.C. 109(b)(3)(B).
    \757\ See, e.g., 12 U.S.C. 3102(j)(2); NY Banking Law Sec.  
606(4)(a).
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    The proposed cross-border segregation provisions for foreign bank 
SBSDs were based on the understanding that ring fencing prioritized the 
claims of U.S. creditors above the claims of foreign creditors (rather 
than the actuality that both U.S. and foreign creditor claims arising 
out of a transaction with U.S. branches and agencies receive priority). 
Therefore, proposed Rule 18a-4 required a foreign bank SBSD with a U.S. 
branch to comply with the segregation requirements in Section 3E of the 
Exchange Act, and the rules and regulations thereunder (e.g., proposed 
Rule 18a-4), with respect to cleared and non-cleared security-based 
swap transactions only with U.S. persons. The proposed cross-border 
provisions did not expressly address a foreign bank SBSD that has no 
branch or agency in the United States.
    For the foregoing reasons, Rule 18a-4, as adopted, clarifies that 
the segregation requirements of Section 3E of the Exchange Act, and the 
rules and regulations thereunder, apply to a foreign bank SBSD (i.e., a 
foreign bank, savings bank, cooperative bank, savings and loan 
association, building and loan association, or credit union): (1) With 
respect to a security-based swap customer that is a U.S. person 
(regardless of which branch or agency the customer's transactions arise 
out of), and (2) with respect to a security-based swap customer that is 
not a U.S. person if the foreign bank SBSD holds funds or other 
property arising out of a transaction had by such person with a U.S. 
branch or agency of the foreign SBSD.\758\ Thus, the final cross-border 
provisions for foreign bank SBSDs expressly account for foreign bank 
SBSDs that do not have a U.S. branch and for foreign customers who 
transact with a U.S. branch of a foreign bank SBSD and, therefore, may 
be protected by U.S. ring fencing laws along with U.S. customers.
---------------------------------------------------------------------------

    \758\ See paragraph (e)(1)(i) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    The Commission also proposed that the foreign bank SBSD maintain a 
special account designated for the exclusive benefit of U.S. security-
based swap customers.\759\ However, this language is removed as 
extraneous text because Rule 18a-4, as adopted, already requires SBSDs 
to maintain a special reserve account for the exclusive benefit of 
security-based swap customers.\760\
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    \759\ See Cross-Border Proposing Release, 78 FR at 31022.
    \760\ See paragraph (c)(1) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

Final Cross-Border Provisions for Foreign Stand-Alone SBSDs
    A foreign stand-alone SBSD should be subject to the U.S. Bankruptcy 
Code's stockholder liquidation provisions. In particular, Section 3E(g) 
of the Exchange Act provides ``customer'' status under the stockbroker 
liquidation provisions to all counterparties to cleared security-based 
swaps, making no distinction between U.S. and non-U.S. customers or 
counterparties.\761\ If the Commission were to apply the segregation 
requirements only to assets of U.S. customers but not to assets of non-
U.S. customers, the amount of assets segregated (i.e., the assets of 
U.S. person customers) could be insufficient to satisfy the combined 
priority claims of both U.S. and non-U.S. customers in a stockbroker 
liquidation proceeding, potentially resulting in losses to U.S. 
customers. Therefore, proposed Rule 18a-4 required a foreign stand-
alone SBSD to comply with the segregation requirements of Section 3E of 
the Exchange Act, and the rules and regulations thereunder, with 
respect to assets received from both U.S. and non-U.S. persons if the 
foreign stand-alone SBSD received collateral from at least one U.S. 
person to secure cleared security-based swaps.
---------------------------------------------------------------------------

    \761\ See also 11 U.S.C. 741(2).
---------------------------------------------------------------------------

    Section 3E(g) of the Exchange Act also extends customer protection 
under the stockbroker liquidation provisions to collateral delivered as 
margin for non-cleared security-based swaps if the collateral is 
subject to a customer protection requirement under Section 15(c)(3) of 
the Exchange Act or a segregation requirement. Therefore, proposed Rule 
18a-4 required a foreign stand-alone SBSD to comply with the 
segregation requirements of Section 3E of the Exchange Act, and the 
rules and regulations thereunder, with respect to non-cleared security-
based swap transactions with U.S. persons (but not with non-U.S. 
persons). Under that approach, the collateral posted by U.S. person 
counterparties was subject to a segregation requirement and therefore 
these persons would have ``customer'' status under the stockbroker 
liquidation

[[Page 43952]]

provisions.\762\ Collateral posted by non-U.S. persons was not subject 
to a segregation requirement and, therefore, these persons would not 
have ``customer'' status.
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    \762\ Section 3E(g) of the Exchange Act provides that the term 
``customer,'' as defined in Section 741 of title 11 of the U.S. 
Code, excludes any person, to the extent that such person has a 
claim based on any open repurchase agreement, open reverse 
repurchase agreement, stock borrowed agreement, non-cleared option, 
or non-cleared security-based swap except to the extent of any 
margin delivered to or by the customer with respect to which there 
is a customer protection requirement under Section 15(c)(3) of the 
Exchange Act or a segregation requirement.
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    For these reasons, the Commission is adopting the substance of the 
proposed cross-border provisions for foreign stand-alone SBSDs.\763\ 
However, the Commission is making a clarifying modification to more 
clearly state that these provisions apply to a foreign SBSD that is not 
a broker-dealer and is not a foreign bank, savings bank, cooperative 
bank, savings and loan association, building and loan association, or 
credit union.\764\
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    \763\ See paragraph (e)(1)(ii) of Rule 18a-4, as adopted.
    \764\ Throughout paragraph (e) of Rule 18a-4, as adopted, the 
phrase ``foreign bank, foreign savings bank, foreign cooperative 
bank, foreign savings and loan association, foreign building and 
loan association, or foreign credit union'' parallels and is 
intended to have the same meeting as the phrase ``foreign bank, 
savings bank, cooperative bank, savings and loan association, 
building and loan association, or credit union'' in 11 U.S.C. 
109(b)(3)(B).
---------------------------------------------------------------------------

Final Cross-Border Provisions for Foreign MSBSPs
    The omnibus segregation requirements in Rule 18a-4 do not apply to 
MSBSPs. Consequently, if an MSBSP holds collateral for a security-based 
swap, it will be subject only to: (1) Paragraph (d) of Rule 18a-4, 
which requires an SBSD or MSBSP to provide notice of the customer's 
right to require segregation, and (2) Section 3E(f)(1)(B) of the 
Exchange Act, which provides that, if requested by the security-based 
swap customer, the MSBSP shall separately segregate the funds or other 
property for the benefit of the security-based swap customer. 
Consequently, proposed Rule 18a-4 excepted a foreign MSBSP that is not 
a broker-dealer from the segregation requirements in Section 3E of the 
Exchange Act and the disclosure requirements in paragraph (d) of Rule 
18a-4 with respect to assets received from a security-based swap 
customer that is not a U.S. person to secure security-based swaps.\765\ 
The Commission did not receive comment on this proposed exception and 
is adopting the substance of the proposal.\766\
---------------------------------------------------------------------------

    \765\ See Cross-Border Proposing Release, 78 FR at 31035.
    \766\ See paragraph (e)(2) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

b. Disclosure Requirements
    The Commission proposed disclosure requirements for foreign SBSDs 
because the treatment of security-swap customers in a liquidation 
proceeding may vary depending on the foreign SBSD's status and the 
insolvency laws applicable to the foreign SBSD. In particular, a 
foreign SBSD was required to disclose to a U.S. security-based swap 
customer--prior to accepting any assets from the person with respect to 
a security-based swap--the potential treatment of the assets segregated 
by the foreign SBSD pursuant to Section 3E of the Exchange Act, and the 
rules and regulations thereunder, in insolvency proceedings under U.S. 
bankruptcy law and applicable foreign insolvency laws.\767\ The intent 
was to require that a foreign SBSD disclose whether it could be subject 
to the stockbroker liquidation provisions in the U.S. Bankruptcy Code, 
whether the segregated funds or other property could be afforded 
customer property treatment under the U.S. bankruptcy law, and any 
other relevant considerations that may affect the treatment of the 
assets segregated under Section 3E of the Exchange Act in such foreign 
SBSD's insolvency proceedings. One commenter responded to the 
Commission's request for comment by opposing applying segregation-
related disclosure requirements to transactions with non-U.S. 
counterparties, because of the Commission's more limited interest in 
non-U.S. counterparties. The Commission agrees and is adopting its 
proposal to limit the disclosure requirement to counterparties that are 
U.S. persons.
---------------------------------------------------------------------------

    \767\ See Cross-Border Proposing Release, 78 FR at 31022.
---------------------------------------------------------------------------

    In addition, the Commission is modifying the rule text to clarify 
that the disclosures must be made in writing. As discussed above, the 
Commission intended that the matters to be disclosed would inform the 
counterparty about the application of U.S. bankruptcy and foreign 
insolvency laws to segregated funds or other property the SBSD will 
hold for the counterparty. The Commission does not believe that an SBSD 
could provide disclosure on these complex issues in a manner that, in 
fact, would inform the counterparty about them other than in writing. 
Therefore, the final rule explicitly provides that the disclosure must 
be in writing.
    For the foregoing reasons, the Commission is adopting the 
disclosure requirements with the modifications described above.\768\
---------------------------------------------------------------------------

    \768\ See paragraph (e)(3) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

c. Non-Substantive Modifications
    The Commission is making several organizational, clarifying, and 
non-substantive modifications to the proposed cross-border segregation 
rule text.
    Paragraph (e) of Rule 18a-4 now has a simplified organizational 
structure compared to paragraphs (e) and (f) of proposed Rule 18a-4. 
First, the rule text no longer explicitly states that a foreign broker-
dealer SBSD is subject to Section 3E of the Exchange Act and the 
Commission's security-based swap segregation requirements, even though 
broker-dealers continue to be subject to the segregation 
requirements.\769\ The Commission's security-based swap segregation 
requirements applicable to stand-alone broker-dealers are located in 
paragraph (p) of Rule 15c3-3.\770\ Thus, all broker-dealers registered 
with the Commission are subject to Rule 15c3-3, and there are no cross-
border exemptions from Rule 15c3-3, even if the broker-dealer is also a 
foreign SBSD or MSBSP. The proposed rule text was intended to identify 
exemptions from the Commission's security-based swap segregation rules. 
As a result, it is not necessary to explicitly state that broker-
dealers are subject to Rule 15c3-3 even if they are also foreign SBSDs 
or MSBSPs.
---------------------------------------------------------------------------

    \769\ See Cross-Border Proposing Release, 78 FR at 31020-21. As 
discussed below, the Commission is re-organizing paragraph (e) and 
making other non-substantive modifications to the paragraph.
    \770\ See Capital, Margin, and Segregation Comment Reopening, 83 
FR at 53016 (soliciting comment on potential rule language that 
would modify the proposal in this manner).
---------------------------------------------------------------------------

    Second, rather than categorizing the applicable rules by cleared 
and non-cleared security-based swaps, and then further subdividing them 
by entity type, the rule paragraphs are now categorized by entity type. 
In addition, instead of a single paragraph addressing the cross-border 
non-cleared security-based swap segregation treatment of all foreign 
SBSDs that are not broker-dealers, there are separate paragraphs 
addressing foreign SBSDs that are not broker-dealers and are not 
foreign banks, and foreign SBSDs that are not broker-dealers and are 
foreign banks. Since a foreign SBSD that is neither a broker-dealer nor 
a foreign bank is the only entity that must apply a different rule 
depending on whether the security-based swaps are cleared or non-
cleared, this is the only paragraph that requires

[[Page 43953]]

subparagraphs for cleared and non-cleared security-based swaps.\771\
---------------------------------------------------------------------------

    \771\ See paragraph (e)(1)(ii)(A) and (B) of Rule 18a-4, as 
adopted.
---------------------------------------------------------------------------

    Paragraph (e)(2) of Rule 18a-4, which prescribes the segregation 
requirements applicable to foreign MSBSPs, is now structured in the 
affirmative instead of the negative by identifying which requirements 
apply to foreign MSBSPs instead of identifying which requirements 
``shall not'' apply to foreign MSBSPs.\772\
---------------------------------------------------------------------------

    \772\ See paragraph (e)(2) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    The Commission is also making several changes to simplify and 
clarify the rule text. Instead of including a cross-reference to the 
rule defining ``foreign security-based swap dealer,'' ``foreign major 
security-based swap participant,'' and ``U.S. person'' each time these 
terms appear, definitions of these terms are added to the 
``Definitions'' section in Rule 18a-4.\773\ With respect to SBSDs, 
``counterparty'' is replaced with ``security-based swap customer'' for 
consistency with the rest of Rule 18a-4 which uses the defined term 
``security-based swap customer.'' To eliminate ambiguity about the term 
``registered'' SBSD, MSBSP, or broker-dealer, the rule text now 
clarifies that ``registered'' refers to an entity registered with the 
Commission by explicitly cross-referencing the section of the Exchange 
Act that the entity would register under (i.e., ``foreign [SBSD or 
MSBSP] registered under Section 15 of the Exchange Act (15 U.S.C. 78o-
10)'' or ``broker or dealer registered under Section 15 of the Exchange 
Act (15 U.S.C. 78o)'').
---------------------------------------------------------------------------

    \773\ See paragraphs (a)(3), (4), and (10) of Rule 18a-4, as 
adopted.
---------------------------------------------------------------------------

    Several simplifying changes are being made to the cross-border 
segregation rule text. Throughout the rule text, the phrase ``any 
assets received . . . to margin, guarantee, or secure a [cleared or 
non-cleared] security-based swap (including money, securities, or 
property accruing to such [U.S. person or non-U.S. person] counterparty 
as the result of such a security-based swap transaction)'' is 
simplified to better align with the language used in other rule text. 
Thus, paragraph (e)(1)(ii) of Rule 18a-4, as adopted, now references 
``funds or other property for [a or at least one] security-based swap 
customer that is a U.S. person with respect to a [cleared or non-
cleared] security-based swap transaction'' to parallel Rule 18a-4's 
definition of a security-based swap customer. For the same reason, 
paragraph (e)(3) of Rule 18a-4, as adopted, now references ``funds or 
other property'' instead of ``assets,'' references ``funds or other 
property received, acquired, or held for'' instead of ``assets 
collected from,'' and references ``receiving, acquiring, or holding 
funds or other property'' instead of ``accepting any assets.'' Finally, 
paragraph (e)(2) of Rule 18a-4, as adopted, now omits the reference to 
``assets . . . to margin, guarantee, or secure a security-based swap'' 
as extraneous.\774\
---------------------------------------------------------------------------

    \774\ Further, the phrase ``[S]ection 3E(f) of the Act (15 
U.S.C. 78c-5(f))'' is replaced with ``section 3E of the Act (15 
U.S.C. 78c-5)'' in paragraph (e)(2) of Rule 18a-4, as adopted, for 
consistency with the other subparagraphs under paragraph (e) of Rule 
18a-4, which reference Section 3E of the Exchange Act. In addition, 
the following stylistic, corrective, and punctuation changes are 
being made to improve the rule's readability: (1) Adding or 
elaborating on paragraph and subparagraph headings; (2) replacing 
``who'' with ``that'' in paragraphs (e)(1)(i) and (e)(3) of Rule 
18a-4; (3) replacing the word ``shall'' with the word ``must'' in 
paragraph (e)(3) of Rule 18a-4; (4) replacing ``the U.S. bankruptcy 
law'' with ``U.S. bankruptcy law'' in paragraph (e)(3) of Rule 18a-
4; and (5) replacing ``Section 3E of the Act'' and ``Section 3E of 
the Act, and the rules and regulations thereunder'' with ``section 
3E of the Act (15 U.S.C. 3E( ), and the rules and regulations 
thereunder,'' the second and third times it appears in paragraph 
(e)(3) for completeness and for consistency with the first reference 
to ``Section 3E of the Act (15 U.S.C. 78c-5), and the rules and 
regulations thereunder'' in the same paragraph.
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F. Delegation of Authority

    The Commission is amending its rules governing delegations of 
authority to the Director of the Division of Trading and Markets 
(``Division''). The amendments delegate authority to the Division with 
respect to requirements in Rules 18a-1 and 18a-4, and are modeled on 
preexisting delegations of authority with respect to requirements in 
parallel Rules 15c3-1 and 15c3-3 under 17 CFR 200.30-3 (``Rule 30-3''). 
The amendments also add additional delegations of authority with 
respect to Rule 18a-1d (Satisfactory Subordinated Loan Agreements), as 
well as to Appendix E to Rule 15c3-1 and paragraph (d) to Rule 18a-1 
with respect to the approval of the temporary use of a provisional 
model. These delegations are intended to permit Commission staff to 
perform functions under Rule 18a-1d for stand-alone SBSDs that are 
currently performed by a broker-dealer's DEA (i.e., FINRA) under 
Appendix D to Rule 15c3-1.\775\
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    \775\ The Commission is the examining authority for stand-alone 
SBSDs because they are not required to be a member of an SRO.
---------------------------------------------------------------------------

    The amendments to Rule 30-3 authorize the Director of the Division 
to: (1) Review amendments to applications of SBSDs filed pursuant to 
paragraph (d) of Rule 18a-1 and to approve such amendments, 
unconditionally or subject to specified terms and conditions; \776\ (2) 
impose additional conditions, pursuant to paragraph (d)(9)(iii) of Rule 
18a-1 on an SBSD that computes certain of its net capital deductions 
pursuant to paragraph (d) of Rule 18a-1; \777\ (3) require that an SBSD 
provide information to the Commission pursuant to paragraph (d)(2) of 
Rule 18a-1; \778\ (4) pursuant to Rule 15c3-3 and Rule 18a-4, find and 
designate as control locations for purposes of paragraph (p)(2)(ii)(E) 
of Rule 15c3-3, and paragraph (b)(2)(v) of Rule 18a-4, certain broker-
dealer and SBSD accounts which are adequate for the protection of 
customer securities; \779\ (5) pursuant to paragraph (b)(6) of Rule 
18a-1d, approve prepayment of a subordinated loan; \780\ (6) pursuant 
to paragraph (c)(4) of Rule 18a-1d, approve prepayment of a revolving 
subordinated loan agreement; \781\ (7) pursuant to paragraph (c)(5) of 
Appendix D to Rule 18a-1, examine any proposed subordinated loan 
agreement filed by a security-based swap dealer and find the agreement 
acceptable; \782\ (8) determine, pursuant Sec.  240.18a-1(d)(7)(ii), 
that the notice a security-based swap dealer must provide to the 
Commission pursuant to Sec.  240.18a-1(d)(7)(i) will become effective 
for a shorter or longer period of time; \783\ and (9) approve, pursuant 
to Sec.  240.15c3-1e(a)(7)(ii) and Sec.  240.18a-1(d)(5)(ii) of this 
chapter, the temporary use of a provisional model, in whole or in part, 
unconditionally or subject to any conditions or limitations.\784\ In 
addition, paragraph (a)(7)(i)'s cross-reference to Rule 15c3-1 is 
corrected to reference paragraph (a)(6)(iii)(B) instead of paragraph 
(a)(6)(iii)(E), and paragraph (a)(7)(iv)'s cross-reference to Rule 
15c3-1 is corrected to reference paragraph (a)(1)(ii) instead of 
paragraphs (f)(1)(i) and (ii).
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    \776\ See paragraph (a)(7)(vi)(A) of Rule 30-3, as amended.
    \777\ See paragraph (a)(7)(vi)(C) of Rule 30-3, as amended.
    \778\ See paragraph (a)(7)(vi)(D) of Rule 30-3, as amended.
    \779\ See paragraph (a)(10)(i) of Rule 30-3, as amended.
    \780\ See paragraph (a)(7)(vii)(A) of Rule 30-3, as amended.
    \781\ See paragraph (a)(7)(vii)(B) of Rule 30-3, as amended.
    \782\ See paragraph (a)(7)(vii)(C) of Rule 30-3, as amended.
    \783\ See paragraph (a)(7)(vi)(E) of Rule 30-3, as amended.
    \784\ See paragraph (a)(7)(vi)(F) of Rule 30-3, as amended.
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    These delegations of authority are intended to preserve Commission 
resources and increase the effectiveness and efficiency of the 
Commission's oversight of the financial responsibility rules for SBSDs 
being adopted today under the authority of the Dodd-Frank

[[Page 43954]]

Act. Nevertheless, the Division may submit matters to the Commission 
for its consideration, as it deems appropriate.
Administrative Law Matters
    The Commission finds, in accordance with the Administrative 
Procedure Act (``APA''),\785\ that these amendments relate solely to 
agency organization, procedure, or practice, and do not relate to a 
substantive rule. Accordingly, the provisions of the APA regarding 
notice of rulemaking, opportunity for public comment, and publication 
of the amendment prior to its effective date are not applicable. For 
the same reason, and because this amendment does not substantively 
affect the rights or obligations of non-agency parties, the provisions 
of the Small Business Regulatory Enforcement Fairness Act,\786\ are not 
applicable. Additionally, the provisions of the Regulatory Flexibility 
Act, which apply only when notice and comment are required by the APA 
or other law,\787\ are not applicable. Further, because this amendment 
imposes no new burdens on private persons, the Commission does not 
believe that the amendment will have any anti-competitive effects for 
purposes of Section 23(a)(2) of the Exchange Act.\788\ Finally, this 
amendment does not contain any collection of information requirements 
as defined by the Paperwork Reduction Act of 1980, as amended.
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    \785\ See 5 U.S.C. 553(b)(3)(A).
    \786\ See 5 U.S.C. 804(3)(C).
    \787\ See 5 U.S.C. 603.
    \788\ See 15 U.S.C. 78w(a)(2).
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III. Explanation of Dates

A. Effective Date

    These final rules will be effective 60 days after the date of this 
release's publication in the Federal Register.

B. Compliance Dates

    In the release establishing the registration process for SBSDs and 
MSBSPs, the Commission adopted a compliance date for SBSD and MSBSP 
registration requirements (the ``Registration Compliance Date'') that 
was tied to four then-pending rule sets.\789\ Two of those four rule 
sets have been adopted \790\ and the Commission is adopting today in 
this release one of the remaining two rule sets. The Commission 
believes it appropriate to set the Registration Compliance Date in this 
release rather than in final rules establishing recordkeeping and 
reporting requirements for SBSDs and MSBSPs.\791\ Accordingly, the 
Registration Compliance Date is 18 months after the later of: (1) The 
effective date of final rules establishing recordkeeping and reporting 
requirements for SBSDs and MSBSPs; or (2) the effective date of final 
rules addressing the cross-border application of certain security-based 
swap requirements.\792\ Similarly, the compliance date for the rule 
amendments and new rules being adopted in this release is 18 months 
after the later of: (1) The effective date of final rules establishing 
recordkeeping and reporting requirements for SBSDs and MSBSPs; or (2) 
the effective date of final rules addressing the cross-border 
application of certain security-based swap requirements. The Commission 
believes this extended compliance date addresses commenters' concerns 
about needing enough time to prepare for and come into compliance with 
the new requirements.\793\ In this regard, the Commission notes that 
commenters recommended a period of 18 to 24 months following adoption 
of final rules for firms to come into compliance.\794\ With respect to 
the capital requirements being adopted today, a commenter recommended 
that SBSD capital requirements take effect at the later of: (1) 2 years 
after the start of the margin implementation period; and (2) the 
effective date of the swaps push-out rule, and that, once in effect, 
SBSD capital standards be determined with reference to the transaction 
activity of counterparties subject to then-applicable initial margin 
requirements, taking into account the transition period in the BCBS/
IOSCO Paper.\795\ The compliance date being adopted today is a 
reasonable amount of time to come into compliance with the new 
requirements, given that it is triggered by the adoption of rules that 
were only recently proposed. Consequently, in practice, the compliance 
date will be more than 18 months from today's date.
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    \789\ The Registration Compliance Date was set as the later of: 
Six months after the date of publication in the Federal Register of 
final rules establishing capital, margin, and segregation 
requirements for SBSDs and MSBSPs; the compliance date of final 
rules establishing recordkeeping and reporting requirements for 
SBSDs and MSBSPs; the compliance date of final rules establishing 
business conduct requirements under Sections 15F(h) and 15F(k) of 
the Exchange Act; or the compliance date for final rules 
establishing a process for a registered SBSD or MSBSP to make an 
application to the Commission to allow an associated person who is 
subject to a statutory disqualification to effect or be involved in 
effecting security-based swaps on the SBSD or MSBSP's behalf. See 
Registration Process for Security-Based Swap Dealers and Major 
Security-Based Swap Participants; Final Rule, 80 FR at 48988.
    \790\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, Exchange Act 
Release No. 77617 (Apr. 14, 2016), 81 FR 29960, 30081 (May 13, 
2019); Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, Exchange Act Release No. 84858 (Dec. 19, 2018), 84 FR 
4906, 4920 (Feb. 19, 2019).
    \791\ The Registration Compliance Date is also the compliance 
date for final rules establishing business conduct requirements 
under Sections 15F(h) and 15F(k) of the Exchange Act and for 
acknowledgement and verification of security-based swap 
transactions. Rule of Practice 194 was effective on April 22, 2019.
    \792\ The Commission proposed these rules on May 10, 2019, which 
include rules and/or guidance regarding security-based swap 
transactions ``arranged, negotiated, or executed'' by personnel 
located in the United States, the cross-border scope of the SBSD de 
minimis exception, the certification and opinion of counsel 
requirement of Rule 15Fb2-1, the questionnaire and application 
requirement of Rule 18a-5, and the cross-border application of the 
statutory disqualification prohibition within Section 15F(b)(6) of 
the Exchange Act. See Proposed Guidance and Rule Amendments 
Addressing Cross-Border Application of Certain Security-Based Swap 
Requirements, Exchange Act Release No. 85823 (May 10, 2019), 84 FR 
24206 (May 24, 2019).
    \793\ See also Capital, Margin, and Segregation Comment 
Reopening, 83 FR at 53019 (soliciting comment on potential rule 
language that would modify the proposal in this manner).
    \794\ See, e.g., IIB 11/19/2018 Letter (18 months); Letter from 
Karrie McMillan, General Counsel, Investment Company Institute (Aug. 
13, 2012) (``ICI 8/13/2012 Letter'') (18-24 months); ICI 11/19/2018 
Letter (24 months); ISDA 11/19/2018 Letter (18 months); Mizuho/ING 
Letter (4 years); Morgan Stanley 11/19/2018 Letter (18 months); 
SIFMA 11/19/2018 Letter (18 months).
    \795\ See Morgan Stanley 10/29/2014 Letter.
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    Some commenters recommended that the Commission adopt a compliance 
date that is shorter than 18 months.\796\ The Commission agrees that 
the Title VII dealer regime should be stood up as expeditiously as 
possible but must balance that objective with the need to provide firms 
with a reasonable amount of time to adapt to the new regime. 
Specifically, firms need time to familiarize themselves with the 
requirements in the rules being adopted today and how they interact 
with other security-based swap rules. Firms also need to make and 
implement informed decisions about business structure and to develop 
and build compliance systems and controls.
---------------------------------------------------------------------------

    \796\ See, e.g., Better Markets 11/19/2018 Letter (6 months); 
Harrington 11/19/2018 Letter (1 month).
---------------------------------------------------------------------------

    Regarding the Commission's policy statement on the sequencing of 
final rules governing security-based swaps,\797\ commenters recommended 
establishing phase-in periods for each major new

[[Page 43955]]

requirement based on asset class and market participant type.\798\ 
Commenters also suggested imposing requirements on the relatively less 
complex, more standardized, more liquid products and on interdealer 
transactions before imposing requirements on more complex, less 
standardized and less liquid products or transactions involving end 
users and other smaller market participants.\799\ Another commenter 
suggested grouping rulemakings into two categories in terms of the 
applicable compliance date.\800\ Other commenters requested that the 
Commission delay the compliance date for the rules being adopted today 
until after SBSDs and MSBSPs are required to register with the 
Commission.\801\ In contrast, a commenter recommended that there should 
be a single compliance date with respect to the Commission's margin 
rules for all relevant market participants after a reasonable 
compliance period, arguing that a phased-in compliance schedule would 
create unfairly inconsistent treatment among market participants.\802\
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    \797\ See Statement of General Policy on the Sequencing of the 
Compliance Dates for Final Rules Applicable to Security-Based Swaps 
Adopted Pursuant to the Securities Exchange Act of 1934 and the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, Exchange 
Act Release No. 67177 (June 11, 2012), 77 FR 35625 (June 14, 2012). 
Comments on the Sequencing Policy Statement which are relevant to 
the Commission's capital, margin, and segregation requirements are 
available at http://www.sec.gov/comments/s7-05-12/s70512.shtml.
    \798\ See ICI 8/13/2012 Letter; Letter from Jeff Gooch, Chief 
Executive Officer, MarkitSERV (Aug. 13, 2012) (``MarkitSERV 
Letter''); Letter from Kenneth E. Bentsen, Jr., Executive Vice 
President, Public Policy and Advocacy, Securities Industry and 
Financial Markets Association (Aug. 13, 2012) (``SIFMA 8/13/2012 
Letter''); Letter from Douglas L. Friedman, General Counsel, 
Tradeweb Markets LLC (Sept. 5, 2012) (``Tradeweb Letter''), Appendix 
1 (supporting the CFTC's proposal to phase in compliance with 
clearing, trade execution and trade reporting requirements by class 
of market participant and asset class).
    \799\ See SIFMA 8/13/2012 Letter (recommending certain single-
name credit default swaps as examples of more liquid and 
standardized products and total return swaps on equity securities or 
loans as examples of less liquid and standardized products); ICI 8/
13/2012 Letter.
    \800\ See Letter from Chris Barnard (Aug. 13, 2012) (``Barnard 
8/13/2012 Letter'').
    \801\ See ISDA 11/19/2018 Letter.
    \802\ See MFA 2/22/2013 Letter.
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    The Commission does not believe it is necessary to phase in the 
capital, margin, and segregation requirements by asset or market 
participant type. The compliance date for the rules being adopted today 
will be more than 18 months from today's date. The Commission believes 
this will give entities adequate time to take the necessary steps to 
comply with the new requirements. The Commission also does not believe 
it would be appropriate to delay the compliance date for the 
Commission's capital, margin, and segregation rules beyond the date 
when SBSDs and MSBSPs must register with the Commission, because this 
would undermine the Commission's ability to effectively regulate and 
supervise these registrants.
    A variety of comments stated that the implementation of the margin 
rules must be delayed in relation to domestic and foreign regulators, 
international standard setters, and the development of market 
infrastructure.\803\ Several other jurisdictions and regulators, 
including the CFTC and the prudential regulators, have finalized margin 
requirements and certain entities are now subject to these 
requirements. Given this fact, coupled with a compliance date in excess 
of 18 months, the Commission believes the industry will have adequate 
time to come into compliance with the margin rules being adopted today.
---------------------------------------------------------------------------

    \803\ See Letter from Jason Shafer, Vice President/Senior 
Counsel, Center for Bank Derivatives Policy, American Bankers 
Association, and Cecilia Calaby, Executive Director and General 
Counsel, American Bankers Association Securities Association (July 
29, 2016) (``American Bankers Association Letter'') (asking U.S. 
regulators to synchronize their margin rules' effective dates with 
the European Union's schedule); ICI 11/24/2014 Letter (recommending 
coordinating a longer phase-in period for variation margin with the 
CFTC and the prudential regulators); IIB 11/19/2018 Letter 
(requesting a delay in the compliance date for margin rules if the 
compliance date falls before the final phase-in recommended by the 
BCBS and IOSCO); ISDA 2/5/2014 Letter (recommending a 2 year phase-
in after final margin rules are adopted in the U.S., Europe, and 
Japan); PIMCO Letter (generally); SIFMA 3/12/2014 Letter 
(recommending a 2 year phase-in after final margin rules are adopted 
in the U.S., Europe, and Japan).
---------------------------------------------------------------------------

    Several commenters addressed the timing of the implementation of 
the Commission's margin rules relative to its clearing rules. A 
commenter believed that the Commission should not implement the final 
margin rules until after relevant mandatory central clearing is fully 
implemented under the Dodd-Frank Act.\804\ Other commenters similarly 
suggested that the non-cleared margin rules should be implemented after 
clearing rules take effect.\805\ A commenter noted that mandatory 
clearing has not been phased in across market participants and that 
rules relating to margin for non-cleared transactions should not apply 
to a particular market participant until the mandatory clearing 
requirement applies to that participant.\806\
---------------------------------------------------------------------------

    \804\ See Sutherland Letter.
    \805\ See American Benefits Council, et al. 1/29/2013 Letter; 
ISDA 1/23/2013 Letter.
    \806\ See Letter from Kyle Brandon, Managing Director, Director 
of Research, Securities Industry and Financial Markets Association 
(Jan. 13, 2015) (``SIFMA 1/13/2015 Letter'') (``[P]hasing in 
uncleared [security-based swap] margin requirements too close in 
time to clearing determinations could lead to such margin 
requirements becoming effective for a certain class of [security-
based swap] before that class of [security-based swap] is required 
to be cleared--effectively forcing clearing before the class is 
ready, as the cost of engaging in uncleared [security-based swap] 
transactions would be greater.''); SIFMA 3/12/2014 Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission does not believe it 
would be appropriate to link the compliance date for the margin rules 
to the implementation of mandatory clearing. The margin rule applies to 
non-cleared security-based swaps and is designed to promote the safety 
and soundness of nonbank SBSDs and nonbank MSBSPs and to protect their 
counterparties. Therefore, the Commission believes the better approach 
is to make the compliance date of the margin rule the same as the 
Registration Compliance Date for SBSDs and MSBSPs. As discussed above, 
both of these compliance dates will be 18 months after the later of: 
(1) The effective date of final rules establishing recordkeeping and 
reporting requirements for SBSDs and MSBSPs; or (2) the effective date 
of final rules addressing the cross-border application of certain 
security-based swap requirements.
    Another commenter suggested that non-cleared security-based swap 
margin rules should become effective only after operational 
requirements for non-cleared margin can be met, and submitted models 
have been reviewed.\807\ A commenter recommended that the Commission 
adopt a compliance date that is at least 2 years from the effective 
date of a final capital rule to allow for sufficient time for the 
Commission or FINRA to approve internal models for capital 
purposes.\808\ As discussed above, the compliance date will be in 
excess of 18 months after these rules are adopted. This should provide 
sufficient time for the Commission to review the models of entities 
that will register as nonbank SBSDs and whose models have not already 
been approved. Moreover, as discussed above, the final capital rules 
provide that the Commission can approve the temporary use of a 
provisional model under certain conditions.\809\
---------------------------------------------------------------------------

    \807\ See SIFMA AMG 2/22/2013 Letter. See also Mizuho/ING Letter 
(requesting that capital requirements be phased in if the Commission 
does not plan to approve models already approved by certain other 
regulators).
    \808\ See Citadel 5/15/2017 Letter.
    \809\ See paragraph (a)(7)(ii) of Rule 15c3-1e, as amended; 
paragraph (d)(5)(ii) of Rule 18a-1, as adopted.
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C. Effect on Existing Commission Exemptive Relief

    Compliance with certain provisions of the Exchange Act and certain 
rules and regulations thereunder in connection with security-based swap 
transactions, positions and/or activity is currently subject to 
temporary exemptive relief granted by the Commission. The rules

[[Page 43956]]

the Commission is adopting and amending today relate to temporary 
exemptive relief for 3 key areas of requirements applicable to SBSDs 
and MSBSPs: (1) Financial responsibility-related requirements; (2) 
segregation requirements for non-cleared security-based swaps; and (3) 
requirements in connection with certain CDS portfolio margin programs.
    First, the Commission has provided limited exemptions for 
registered broker-dealers, subject to certain conditions and 
limitations, from the application of Sections 7 and 15(c)(3) of the 
Exchange Act, Rules 15c3-1, 15c3-3,\810\ and 15c3-4, and Regulation T 
in connection with security-based swaps, some of which exemptions were 
solely to the extent the provisions or rules did not apply to the 
broker-dealer's security-based swap positions or activities as of July 
15, 2011 (collectively, the ``Financial Responsibility Rule 
Exemptions'').\811\ In connection with this and other exemptive relief, 
the Commission also provided that, until such time as the underlying 
exemptive relief expires, no contract entered into on or after July 16, 
2011 shall be void or considered voidable by reason of Section 29(b) of 
the Exchange Act because any person that is a party to the contract 
violated a provision of the Exchange Act for which the Commission 
provided exemptive relief in the Exchange Act Exemptive Order 
(``Section 29(b) Exemption'').\812\ The Financial Responsibility Rule 
Exemptions are scheduled to expire on the compliance date for any final 
capital, margin, and segregation rules for SBSDs and MSBSPs.\813\ 
Accordingly, all of the Financial Responsibility Rule Exemptions, 
together with the portion of the Section 29(b) Exemption that relates 
to the Exchange Act provisions for which the Commission provided 
exemptive relief in the Financial Responsibility Rule Exemptions, will 
expire upon the compliance date set forth in section III.B. of this 
release.
---------------------------------------------------------------------------

    \810\ The exemption from Rule 15c3-3 was not available for 
activities and positions of a registered broker-dealer related to 
cleared security-based swaps to the extent that the registered 
broker-dealer is a member of a clearing agency that functions as a 
central counterparty for security-based swaps, and holds customer 
funds or securities in connection with cleared security-based swaps.
    \811\ See Order Granting Temporary Exemptions under the 
Securities Exchange Act of 1934 in Connection with the Pending 
Revision of the Definition of ``Security'' to Encompass Security-
Based Swaps, and Request for Comment, Exchange Act Release No. 64795 
(July 1, 2011), 76 FR 39927 (July 7, 2011) (``Exchange Act Exemptive 
Order'')
    \812\ See Exchange Act Exemptive Order at 39940.
    \813\ The Financial Responsibility Rule Exemptions originally 
were set to expire on the compliance date for final rules further 
defining the terms ``security-based swap'' and ``eligible contract 
participant.'' See Exchange Act Exemptive Order at 39938-39. In the 
final rules further defining the term ``security-based swap,'' the 
Commission extended this expiration date to February 13, 2013. See 
Product Definitions Adopting Release at 48304. On February 7, 2013, 
the Commission extended the expiration date until February 11, 2014. 
See Order Extending Temporary Exemptions under the Securities 
Exchange Act of 1934 in Connection with the Revision of the 
Definition of ``Security'' to Encompass Security-Based Swaps, and 
Request for Comment, Exchange Act Release No. 68864 (Feb. 7, 2013), 
78 FR 10218, 10220 (Feb. 13, 2013). On February 5, 2014, the 
Commission further extended the expiration date until the compliance 
date set forth in any final capital, margin, and segregation rules 
for SBSDs and MSBSPs. See Order Extending Temporary Exemptions under 
the Securities Exchange Act of 1934 in Connection with the Revision 
of the Definition of ``Security'' to Encompass Security-Based Swaps, 
and Request for Comment, Exchange Act Release No. 71485 (Feb. 5, 
2014), 79 FR 7731, 7734 (Feb. 10, 2014).
---------------------------------------------------------------------------

    Second, compliance with Section 3E(f) of the Exchange Act is 
currently subject to temporary exemptive relief.\814\ That relief 
includes an exemption for SBSDs and MSBSPs from the segregation 
requirements for non-cleared security-based swaps in Section 3E(f) of 
the Exchange Act, as well as an exemption (similar but not identical to 
the Section 29(b) Exemption discussed above) providing that no SBS 
contract entered into on or after July 16, 2011 shall be void or 
considered voidable by reason of Section 29(b) of the Exchange Act 
because any person that is a party to the contract violated Section 
3E(f) of the Exchange Act. Both of these exemptions will expire on the 
Registration Compliance Date set forth in section III.B. of this 
release.
---------------------------------------------------------------------------

    \814\ See Order Pursuant to Sections 15F(b)(6) and 36 of the 
Securities Exchange Act of 1934 Extending Certain Temporary 
Exemptions and a Temporary and Limited Exception Related to 
Security-Based Swaps, Exchange Act Release No. 75919 (Sept. 15, 
2015), 80 FR 56519 (Sept. 18, 2015); Temporary Exemptions and Other 
Temporary Relief, Together with Information on Compliance Dates for 
New Provisions of the Securities Exchange Act of 1934 Applicable to 
Security-Based Swaps, Exchange Act Release No. 64678 (June 15, 
2011), 76 FR 36287 (June 22, 2011).
---------------------------------------------------------------------------

    Finally, on December 14, 2012, the Commission issued an order 
granting conditional exemptive relief from compliance with certain 
provisions of the Exchange Act in connection with a program to 
commingle and portfolio margin customer positions in cleared CDS that 
include both swaps and security-based swaps in a segregated account 
established and maintained in accordance with Section 4d(f) of the 
CEA.\815\ This exemptive relief does not contain a sunset date; 
however, the exemptive relief for dually-registered clearing agency/
DCOs is subject to two conditions that will be triggered by the 
adoption of final rules setting forth margin and segregation 
requirements applicable to security-based swaps.\816\ By their terms, 
these two conditions will begin to apply by the later of: (1) Six 
months after adoption of final margin and segregation rules applicable 
to security-based swaps consistent with Section 3E of the Exchange Act; 
or (2) the compliance date of such rules. As discussed above in section 
III.B. of this release, the compliance date for the rules the 
Commission is adopting today will be 18 months after the later of: (1) 
The effective date of final rules establishing recordkeeping and 
reporting requirements for SBSDs and MSBSPs; or (2) the effective date 
of final rules addressing the cross-border application of certain 
security-based swap requirements.\817\ Accordingly, each dually 
registered clearing agency/DCO must comply with these two

[[Page 43957]]

conditions no later than that date. Before the compliance date, the 
Commission intends to continue coordinating with the CFTC to address 
portfolio margining of security-based swaps and swaps by nonbank SBSDs 
and swap dealers.
---------------------------------------------------------------------------

    \815\ Order Granting Conditional Exemptions Under the Securities 
Exchange Act of 1934 in Connection With Portfolio Margining of Swaps 
and Security-Based Swaps, Exchange Act Release No. 68433 (Dec. 14, 
2012), 77 FR 75211 (Dec. 19, 2012) (``CDS Portfolio Margin Order'').
    \816\ See CDS Portfolio Margin Order at 75219 (conditions (a)(1) 
and (2)). Specifically, the first condition requires that the 
clearing agency/DCO, by the later of (i) six months after the 
adoption date of final margin and segregation rules applicable to 
security-based swaps consistent with Section 3E of the Exchange Act 
or (ii) the compliance date of such rules, take all necessary action 
within its control to obtain any relief needed to permit its dually-
registered broker-dealer/FCM clearing members to maintain customer 
money, securities, and property received by the broker-dealer/FCM to 
margin, guarantee, or secure customer positions in cleared CDS, 
which include both swaps and security-based swaps, in a segregated 
account established and maintained in accordance with Section 3E of 
the Exchange Act and any rules thereunder for the purpose of 
clearing (as a clearing member of the clearing agency/DCO) such 
customer positions under a program to commingle and portfolio margin 
CDS. The second condition requires that the clearing agency/DCO, by 
the later of (i) six months after the adoption date of final margin 
and segregation rules applicable to security-based swaps consistent 
with Section 3E of the Exchange Act or (ii) the compliance date of 
such rules, take all necessary action within its control to 
establish rules and operational practices to permit a dually-
registered broker-dealer/FCM (at the broker-dealer/FCM's election) 
to maintain customer money, securities, and property received by the 
broker-dealer/FCM to margin, guarantee, or secure customer positions 
in cleared CDS, which include both swaps and security-based swaps, 
in a segregated account established and maintained in accordance 
with Section 3E of the Exchange Act and any rules thereunder for the 
purpose of clearing (as a clearing member of the clearing agency/
DCO) such customer positions under a program to commingle and 
portfolio margin CDS.
    These two conditions are intended to provide for portfolio 
margining within a securities account as an alternative for 
customers who may desire to conduct portfolio margining under a 
securities account structure as opposed to a swaps account. See CDS 
Portfolio Margining Order at 75215-75218 (discussing conditional 
exemptions for dually-registered Clearing Agencies/DCOs from 
Sections 3E(b), (d) and (e) of the Exchange Act).
    \817\ See Proposed Guidance and Rule Amendments Addressing 
Cross-Border Application of Certain Security-Based Swap 
Requirements, 84 FR 24206.
---------------------------------------------------------------------------

D. Application to Substituted Compliance

    For the amendments to Rule 3a71-6, the Commission is adopting an 
effective date of 60 days following publication in the Federal 
Register. There will be no separate compliance date in connection with 
that rule, as the rule does not impose obligations upon entities. As 
discussed above, SBSDs and MSBSPs will not be required to comply with 
the capital and margin requirements until they are registered, and the 
registration requirement for those entities will not be triggered until 
a number of regulatory benchmarks have been met.
    In practice, the Commission recognizes that if the requirements of 
a foreign regime are comparable to Title VII requirements, and the 
other prerequisites to substituted compliance also have been satisfied, 
then it may be appropriate to permit an SBSD or MSBSP to rely on 
substituted compliance commencing at the time that entity is registered 
with the Commission. Accordingly, the Commission would consider 
substituted compliance requests that are submitted prior to the 
compliance date for its capital and margin requirements. The Commission 
believes this addresses commenters' concerns that the compliance date 
could be before substituted compliance determinations are made.\818\
---------------------------------------------------------------------------

    \818\ See IIB 11/19/2018 Letter; SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

IV. Paperwork Reduction Act

    Certain provisions of the new rules and amendments contain 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\819\ The Commission 
published notice requesting comment on the collection of information 
requirements \820\ and submitted the amendments and the proposed new 
rules to the Office of Management and Budget (``OMB'') for review in 
accordance with the PRA.\821\ The Commission's earlier PRA assessments 
have been revised to reflect the modifications to the final rules and 
amendments from those that were proposed, the adoption of new Rule 18a-
10 as a result of comments received,\822\ and additional information 
and data now available to the Commission.\823\ An agency may not 
conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid OMB 
control number. The titles for the collections of information are:
---------------------------------------------------------------------------

    \819\ See 44 U.S.C. 3501, et seq.
    \820\ See Capital, Margin, and Segregation Proposing Release, 77 
FR 70214; Cross-Border Proposing Release, 81 FR at 31204. See also 
Trade Acknowledgment and Verification of Security-Based Swap 
Transactions, 81 FR at 39831-33 (discussing the paperwork burden for 
Rule 3a71-6).
    \821\ See 44 U.S.C. 3507(d); 5 CFR 1320.11.
    \822\ As discussed in more detail below, the Commission is 
adopting new Rule 18a-10 in response to comments received on the 
proposal not related to the collection of information discussion in 
the proposing release. Therefore, the proposal did not contain a 
collection of information for this new rule. The Commission 
estimates that 3 stand-alone SBSDs will elect to operate under Rule 
18a-10. As discussed in more detail below, however, these 
respondents were included in the proposing release in other 
collections of information (Rule 18a-1 and Rule 18a-3, as proposed), 
and have been moved to the information collection for Rule 18a-10. 
Therefore, the total respondents in the collections of information 
for Rules 18a-1 and 18a-3, as adopted, have been adjusted by three 
respondents. The hour burdens and costs for the collection of 
information for Rule 18a-10, as adopted, are included in the 
collection of information for Rule 18a-3, as adopted.
    \823\ The hourly rates use for internal professionals used 
throughout this section IV of the release are taken from SIFMA's 
Management & Professional Earnings in the Securities Industry 2013, 
modified to account for an 1,800-hour work-year and inflation, and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits, and overhead, in addition to SIFMA's Office Salaries in 
the Securities Industry 2013, modified by Commission staff to 
account for an 1,800-hour work-year and inflation, and multiplied by 
2.93 to account for bonuses, firm size, employee benefits, and 
overhead.
    \824\ The proposed hour burdens for the collection of 
information related to Rule 15c3-3, as amended, in this release were 
included in the collection of information for proposed Rule 18a-4 in 
the proposing release. These hours were moved (and modified as a 
result of comments) to the existing collection of information in 
Rule 15c3-3, as amended, as a result of changes made to the final 
rule to require that broker-dealers that are also registered as 
nonbank SBSDs comply with the segregation requirements of paragraph 
(p) to Rule 15c3-3, as amended, with respect to their security-based 
swap activities. In addition, as a result of comments received, the 
collection of information in the final rule related to Rule 15c3-3, 
as amended, contains additional respondents to account for the 
activities of stand-alone broker-dealers engaged in security-based 
swap activities.

------------------------------------------------------------------------
                                                            OMB control
              Rule                      Rule title              No.
------------------------------------------------------------------------
Rule 18a-1, Rule 18a-1a, Rule    Net capital                   3235-0701
 18a-1b, Rule 18a-1c, and Rule    requirements for SBSDs
 18a-1d.                          for which there is not
                                  a prudential regulator.
Rule 18a-2.....................  Capital requirements          3235-0699
                                  for MSBSPs for which
                                  there is not a
                                  prudential regulator.
Rule 18a-3 and Rule 18a-10.....  Non-cleared security-         3235-0702
                                  based swap margin
                                  requirements for SBSDs
                                  and MSBSPs for which
                                  there is not a
                                  prudential regulator;
                                  Alternative compliance
                                  mechanism for security-
                                  based swap dealers
                                  that are registered as
                                  swap dealers and have
                                  limited security-based
                                  swap activities.
Rule 18a-4 and exhibit.........  Segregation                   3235-0700
                                  requirements for SBSDs
                                  and MSBSPs.
Rule 15c3-1 and appendices.....  Net capital                   3235-0200
                                  requirements for
                                  brokers or dealers.
Rule 15c3-3 and exhibits.......  Customer protection--       \824\ 3235-
                                  reserves and custody              0078
                                  of securities.
Rule 3a71-6....................  Substituted compliance        3235-0715
                                  for SBSDs and MSBSPs.
------------------------------------------------------------------------

A. Summary of Collections of Information Under the Rules and Rule 
Amendments

1. Rule 18a-1 and Amendments to Rule 15c3-1
    Rule 18a-1 establishes minimum capital requirements for stand-alone 
SBSDs and the amendments to Rule 15c3-1 augment capital requirements 
for broker-dealers to accommodate broker-dealer SBSDs and to enhance 
the provisions applicable to ANC broker-dealers. The new rule and 
amendments establish new collections of information requirements.
    First, under paragraphs (a)(2) and (d) of Rule 18a-1, a stand-alone 
SBSD must apply to the Commission to be authorized to use internal 
models to compute net capital. As part of the application process, a 
stand-alone SBSD is required to provide the Commission staff with 
information specified in the rule. In addition, a stand-alone SBSD 
authorized to use internal models will review and update the models it 
uses to compute market and credit risk, as well as backtest the models.

[[Page 43958]]

    Second, under paragraph (f) of Rule 18a-1 and paragraph (a)(10)(ii) 
of Rule 15c3-1, as amended, nonbank SBSDs, including broker-dealer 
SBSDs, are required to implement internal risk management controls in 
compliance with certain requirements of Rule 15c3-4.
    Third, under paragraph (c)(1)(vi)(B)(1)(iii)(A) of Rule 18a-1 and 
paragraph (c)(2)(vi)(P)(1)(iii) of Rule 15c3-1, as amended, broker-
dealers, broker-dealer SBSDs, and stand-alone SBSDs not using models 
are required to use an industry sector classification system, that is 
documented and reasonable in terms of grouping types of companies with 
similar business activities and risk characteristics, for the purposes 
of calculating ``haircuts'' on non-cleared CDS. These firms could use a 
third-party classification system or develop their own classification 
system.
    Fourth, under paragraph (h) of Rule 18a-1, stand-alone SBSDs are 
required to provide the Commission with certain written notices with 
respect to equity withdrawals.
    Fifth, under paragraph (c)(5) of Rule 18a-1d, a stand-alone SBSD is 
required to file with the Commission two copies of any proposed 
subordinated loan agreement at least 30 days prior to the proposed 
execution date of the agreement, as well as a statement setting forth 
the name and address of the lender, the business relationship of the 
lender to the SBSD, and whether the SBSD carried an account for the 
lender effecting transactions in security-based swaps at or about the 
time the proposed agreement was filed.
    Finally, under paragraph (c)(1)(ix)(C)(3) of Rule 18a-1 and 
paragraph (c)(2)(xv)(C)(3) of Rule 15c3-1, as amended, stand-alone 
broker-dealers and nonbank SBSDs may treat collateral held by a third-
party custodian to meet an initial margin requirement of a security-
based swap or swap customer as being held by the stand-alone broker-
dealer or nonbank SBSD for purposes of avoiding the capital deduction 
in lieu of margin or credit risk charge if certain conditions are met.
2. Rule 18a-2
    Rule 18a-2 establishes capital requirements for nonbank MSBSPs. In 
particular, a nonbank MSBSP is required at all times to have and 
maintain positive tangible net worth, and comply with Rule 15c3-4 with 
respect to its security-based swap and swap activities.
3. Rule 18a-3
    Rule 18a-3 prescribes non-cleared security-based swap margin 
requirements for nonbank SBSDs and MSBSPs. Paragraph (e) of Rule 18a-3 
requires a nonbank SBSD to monitor the risk of each account, and 
establish, maintain, and document procedures and guidelines for 
monitoring the risk.
    Finally, under paragraph (d) to Rule 18a-3, a nonbank SBSD applying 
to the Commission for authorization to use and be responsible for a 
model to calculate the initial margin amount under the rule will be 
subject to the application process and ongoing conditions in Rule 15c3-
1e or paragraph (d) of Rule 18a-1, as applicable, governing the use of 
internal models to compute net capital.
4. Rule 18a-4 and Amendments to Rule 15c3-3
    Rule 18a-4 establishes segregation requirements for cleared and 
non-cleared security-based swap transactions for bank and stand-alone 
SBSDs, as well as notification requirements for these entities. 
Amendments to Rule 15c3-3 establish segregation requirements for stand-
alone broker-dealers and broker-dealer SBSDs that are largely parallel 
to the requirements in Rule 18a-4. Specifically, new paragraph (p) to 
Rule 15c3-3 establishes segregation requirements for stand-alone 
broker-dealers and broker-dealer SBSDs with respect to their security-
based swap activity. The provisions of Rule 18a-4, as well as the 
amendments to Rule 15c3-3, are modeled on existing Rule 15c3-3--the 
broker-dealer segregation rule. Rules 18a-4 and 15c3-3 also contain 
provisions that are not modeled specifically on Rule 15c3-3 as it 
exists today. First, paragraph (d) of Rule 18a-4 and paragraph (p)(4) 
of Rule 15c3-3 require SBSDs and MSBSPs to provide the notice required 
by Section 3E(f)(1)(A) of the Exchange Act to a counterparty in writing 
prior to the execution of the first non-cleared security-based swap 
transaction with the counterparty. Second, SBSDs must obtain 
subordination agreements from counterparties that elect individual or 
omnibus segregation.
    Additionally, paragraph (a)(5)(iii) of Rule 18a-4 and paragraph 
(p)(1)(iii) of Rule 15c3-3, as amended, impose documentation 
requirements with respect to a qualified clearing agency account a 
broker-dealer or SBSD maintains at a clearing agency that holds funds 
and other property in order to margin, guarantee, or secure cleared 
security-based swaps of the firm's security-based swap customers.
    Under paragraph (a)(4) of Rule 18a-4 and paragraph (p)(1)(iv) of 
Rule 15c3-3, as amended, a qualified registered security-based swap 
dealer account is defined to mean an account at an SBSD registered with 
the Commission pursuant to Section 15F of the Exchange Act that meets 
conditions that are largely identical to the conditions for a qualified 
clearing agency account.
    Finally, paragraph (c)(1) of Rule 18a-4 and paragraph (p)(3)(i) of 
Rule 15c3-3 require an stand-alone broker-dealer and SBSD, among other 
things, to maintain a special reserve account for the exclusive benefit 
of security-based swap customers separate from any other bank account 
of the broker-dealer or SBSD.
    Paragraph (c)(1) of Rule 18a-4 and paragraph (p)(3)(i) of Rule 
15c3-3, as amended, provide that the stand-alone broker-dealer or SBSD 
must at all times maintain in a customer reserve account, through 
deposits into the account, cash and/or qualified securities in amounts 
computed weekly in accordance with the formula set forth in Exhibit A 
to Rule 18a-4 or Exhibit B to Rule 15c3-3, which is modeled on the 
formula in Exhibit A to Rule 15c3-3.
    Paragraph (e) of Rule 18a-4 specifies when foreign stand-alone and 
bank SBSDs and MSBSPs are not required to comply with the segregation 
requirements in Section 3E of the Exchange Act and Rule 18a-4 
thereunder. In addition, a foreign stand-alone or bank SBSD is required 
to disclose to a U.S. security-based swap customer the potential 
bankruptcy treatment of property segregated by the SBSD.
    Finally, under paragraph (f) of Rule 18a-4, a stand-alone or bank 
SBSD will be exempt from the requirements of Rule 18a-4 if the SBSD 
meets certain conditions, including that the SBSD provides notice to 
the counterparty regarding the right to segregate initial margin at an 
independent third-party custodian, and provides certain disclosures in 
writing regarding the collateral received by the SBSD.
5. Rule 18a-10
    Rule 18a-10 is an alternative compliance mechanism pursuant to 
which a stand-alone SBSD that is registered as a swap dealer and 
predominantly engages in a swaps business may elect to comply with the 
capital, margin, and segregation requirements of the CEA and the CFTC's 
rules in lieu of complying with Rules 18a-1, 18a-3, and 18a-4.

[[Page 43959]]

    Paragraph (b) of Rule 18a-10 sets forth certain requirements for a 
firm that is operating pursuant to the rule. Among other things, 
paragraph (b)(2) of Rule 18a-10 requires the firm to provide a written 
disclosure to its counterparties before the first transaction with the 
counterparty after the firm begins the operating pursuant to the rule 
notifying the counterparty that the firm is complying with the 
applicable capital, margin, and segregation requirements of the CEA and 
the CFTC's rules in lieu of complying with applicable Commission rules. 
Paragraph (b)(3) of Rule 18a-10 requires a stand-alone SBSD operating 
pursuant to the rule to immediately notify the Commission and the CFTC 
in writing if it fails to meet a condition in paragraph (a) of the 
rule.
    Finally, paragraph (d) of Rule 18a-10 addresses how a firm would 
elect to operate pursuant to the rule. Under paragraph (d)(1), a firm 
can make the election as part of the process of applying to register as 
an SBSD. In this case, the firm must provide written notice to the 
Commission and the CFTC during the registration process of its intent 
to operate pursuant to the rule. Under paragraph (d)(2) of Rule 18a-10, 
an SBSD can make an election to operate under the alternative 
compliance mechanism after the firm has been registered as an SBSD by 
providing written notice to the Commission and the CFTC of its intent 
to operate pursuant to the rule.
6. Amendments to Rule 3a71-6
    The Commission is amending Rule 3a71-6 to provide persons with the 
ability to apply for substituted compliance with respect to the capital 
and margin requirements of Section 15F(e) of the Exchange Act and Rules 
18a-1, 18a-2, and 18a-3 thereunder.

B. Use of Information

    The Commission, its staff, and SROs, as applicable, will use the 
information collected under Rules 18a-1, 18a-2, 18a-3, 18a-4, and 18a-
10, as well as the amendments to Rule 15c3-1 and Rule 15c3-3 to 
evaluate whether an SBSD, MSBSP, or stand-alone broker-dealer is in 
compliance with each rule that applies to the entity and to help 
fulfill their oversight responsibilities. The Commission plans to use 
the information collected pursuant to Rule 3a71-6, as amended, to 
evaluate requests for substituted compliance with respect to the 
capital and margin requirements. The collections of information also 
will help to ensure that SBSDs, MSBSPs, and stand-alone broker-dealers 
are meeting their obligations under the new rules and rule amendments 
and have the required policies and procedures in place. In this regard, 
the collections of information will be used by the Commission as part 
of its ongoing efforts to monitor and enforce compliance with the 
federal securities laws through, among other things, examinations and 
inspections.
    Rules 18a-1 and 18a-2, and the amendments to Rule 15c3-1, are 
integral parts of the Commission's financial responsibility program for 
nonbank SBSDs and MSBSPs, and stand-alone broker-dealers. Rules 18a-1 
and 15c3-1 are designed to ensure that nonbank SBSDs and stand-alone 
broker-dealers, respectively, have sufficient liquidity to meet all 
unsubordinated obligations to customers and counterparties and, 
consequently, if the nonbank SBSD or stand-alone broker-dealer fails, 
sufficient resources to wind-down in an orderly manner without the need 
for a formal proceeding. The collections of information in Rule 18a-1, 
Rule 18a-2 and the amendments to Rule 15c3-1 facilitate the monitoring 
of the financial condition of nonbank SBSDs and MSBSPs, and stand-alone 
broker-dealers by the Commission and its staff.
    Rule 18a-3 is intended to help ensure the safety and soundness of 
the nonbank SBSD or MSBSP. Records maintained by these entities 
relating to the collection of collateral required by Rule 18a-3 will 
assist examiners in evaluating whether nonbank SBSDs are in compliance 
with requirements in the rule.
    Rule 18a-4 and the amendments to Rule 15c3-3 are integral to the 
Commission's financial responsibility program as they are designed to 
protect the rights of security-based swap customers and their ability 
to promptly obtain their property from an SBSD or stand-alone broker-
dealer. The collection of information requirements in the rule and 
amendments will facilitate the process by which the Commission and its 
staff monitor how SBSDs and stand-alone broker-dealers are fulfilling 
their custodial responsibilities to security-based swap customers. Rule 
18a-4 and the amendments to Rule 15c3-3 also require that an SBSD to 
provide certain notices to its counterparties to alert them to the 
alternatives available to them with respect to segregation of non-
cleared security-based swaps. The Commission and its staff will use 
this new collection of information to confirm registrants are providing 
the requisite notice to counterparties.
    Rule 18a-10 requires a stand-alone SBSD to: (1) Provide certain 
disclosures to its counterparties to alert them that the firm will be 
complying with the capital, margin, and segregation requirements of the 
CEA and the CFTC's rules in lieu of Rules 18a-1, 18a-3, and 18a-4; (2) 
to notify the Commission and the CFTC the firm is electing to operate 
under the conditions of the rule; and (3) provide a notice to the 
Commission and the CFTC if it fails to meet a condition of the rule. 
The Commission and its staff will use this new collection of 
information to confirm which registrants are operating under the 
conditions of the rule. In addition, the Commission will use the 
information to confirm that registrants are providing the requisite 
disclosures to counterparties, and assist examiners in evaluating 
whether SBSDs are in compliance with requirements in the rule.
    Finally, the requests for substituted compliance determinations 
under Rule 3a71-6 are required when a person seeks a substituted 
compliance determination with respect to the capital and margin 
requirements applicable to foreign SBSDs and MSBSPs. Consistent with 
Exchange Act Rule 0-13(h), the Commission will publish in the Federal 
Register a notice that a complete application has been submitted, and 
provide the public the opportunity to submit to the Commission any 
information that relates to the Commission action requested in the 
application.

C. Respondents

    The Commission estimated the number of respondents in the proposing 
release.\825\ The Commission received no comment on these estimates and 
continues to believe they are appropriate. However, the number of 
respondents has been updated to include stand-alone broker-dealers 
engaged in security-based swap activities as well as the number of 
foreign SBSDs and MSBSPs. In addition, in response to comments 
received, the Commission is adopting new Rule 18a-10, which has 
resulted in the number of respondents being updated in Rules 18a-1, as 
adopted, and Rule 18a-3, as adopted.
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    \825\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70292-93.
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    The following charts summarize the Commission's respondent 
estimates:

------------------------------------------------------------------------
                                                             Number of
                   Type of respondent                       respondents
------------------------------------------------------------------------
SBSDs...................................................              50
Bank SBSDs..............................................              25
Nonbank SBSDs...........................................              25
Broker-Dealer SBSDs.....................................              16
Non-broker-dealer SBSDs.................................              34
Stand-Alone SBSDs.......................................               9

[[Page 43960]]

 
ANC Broker-Dealer SBSDs.................................              10
Broker-Dealer SBSDs (Not Using Models)..................               6
Stand-Alone SBSDs (Using Models)........................               4
Stand-Alone SBSDs (Not Using Models)....................               2
Stand-Alone Broker-Dealers..............................              25
Nonbank MSBSPs..........................................               5
Nonbank SBSDs subject to Rule 18a-3.....................              22
Foreign SBSDs and MSBSPs................................              22
Foreign SBSDs and/or foreign MSBSPs submitting                         3
 substituted compliance applications....................
Bank SBSDs exempt from requirements of Rule 18a-4.......              25
Stand-Alone SBSDs exempt from requirements of Rule 18a-4               6
Stand-Alone SBSDs operating under Rule 18a-10...........               3
------------------------------------------------------------------------

    Consistent with prior releases, based on available data regarding 
the single-name CDS market--which the Commission believes will comprise 
the majority of security-based swaps--the Commission estimates that the 
number of nonbank MSBSPs likely will be five or fewer and, in 
actuality, may be zero.\826\ Therefore, to capture the likely number of 
nonbank MSBSPs that may be subject to the collections of information 
for purposes of the PRA, the Commission estimates that five entities 
will register with the Commission as nonbank MSBSPs.\827\ The 
Commission estimates there will be 1 broker-dealer MSBSP for the 
purposes of calculating paperwork burdens, in recognition that broker-
dealer MSBSPs and stand-alone MSBSPs are subject to different burdens 
under the new and amended rules in certain instances.
---------------------------------------------------------------------------

    \826\ See Registration Process for Security-Based Swap Dealers 
and Major Security-Based Swap Participants, 80 FR at 48990. See also 
Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant'', 77 FR at 30727.
    \827\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4921.
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    Consistent with prior releases, the Commission estimates that 50 or 
fewer entities ultimately may be required to register with the 
Commission as SBSDs, and 16 broker-dealers will likely seek to register 
as SBSDs.\828\
---------------------------------------------------------------------------

    \828\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70292.
---------------------------------------------------------------------------

    Because many of the dealers that currently engage in OTC 
derivatives activities are banks, the Commission estimates that 
approximately 75% of the 34 non-broker-dealer SBSDs will be bank SBSDs 
(i.e., 25 firms), and the remaining 25% will be stand-alone SBSDs 
(i.e., 9 firms).\829\
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    \829\ The Commission does not anticipate that any firms will be 
dually registered as a broker-dealer and a bank.
---------------------------------------------------------------------------

    Of the nine stand-alone SBSDs, the Commission estimates, based on 
its experience with ANC broker-dealers and OTC derivatives dealers, 
that four firms will apply to use internal models to compute net 
capital under Rule 18a-1.\830\ This estimate has been reduced from six 
in the proposing release \831\ to four to account the adoption of Rule 
18a-10, which will enable stand-alone SBSDs to elect an alternative 
compliance mechanism and comply with capital, margin, and segregation 
requirements of the CEA and the CFTC's rules in lieu of Rules 18a-1, 
18a-3, and 18a-4. Finally, in the proposing release, the Commission 
estimated that 3 stand-alone SBSDs would not apply to use models.\832\ 
This estimate has been modified from 3 firms to 2 firms to account for 
the nonbank SBSDs that will elect the alternative compliance mechanism 
under Rule 18a-10.
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    \830\ Internal models, while more risk-sensitive than 
standardized haircuts, tend to substantially reduce the amount of 
the deductions to tentative net capital in comparison to the 
standardized haircuts because the models recognize more offsets 
between related positions than the standardized haircuts. Therefore, 
the Commission expects that stand-alone SBSDs that have the 
capability to use internal models to calculate net capital will 
choose to do so.
    \831\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70293.
    \832\ See 77 FR at 70293.
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    Of the 16 broker-dealer SBSDs, the Commission estimates that 10 
firms will operate as ANC broker-dealer SBSDs authorized to use 
internal models to compute net capital under Rule 15c3-1.\833\
---------------------------------------------------------------------------

    \833\ Currently, 5 broker-dealers are registered as ANC broker-
dealers. The Commission has previously estimated that all current 
and future ANC broker-dealers will also register as SBSDs. See 
Recordkeeping and Reporting Requirements for Security-Based Swap 
Dealers, Major Security-Based Swap Participants, and Broker-Dealers; 
Capital Rule for Certain Security-Based Swap Dealers, 79 FR at 
25261.
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    The Commission estimates that 25 registered broker-dealers will be 
engaged in security-based swap activities but will not be required to 
register as an SBSD or MSBSP (i.e., will be stand-alone broker-
dealers). Other than OTC derivatives dealers, which are subject to 
significant limitations on their activities, broker-dealers 
historically have not participated in a significant way in security-
based swap trading for at least two reasons.\834\ First, because the 
Exchange Act has not previously defined security-based swaps as 
securities, security-based swaps have not been required to be traded 
through registered broker-dealers.\835\ Second, a broker-dealer 
engaging in security-based swap activities is currently subject to 
existing regulatory requirements with respect to those activities, 
including capital, margin, segregation, and recordkeeping requirements. 
The existing financial responsibility requirements make it more costly 
to conduct these activities in a broker-dealer than in an unregulated 
entity. As a result, security-based swap activities are mostly 
concentrated in affiliates of stand-alone broker-dealers.\836\
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    \834\ See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70302.
    \835\ See Section 761 of the Dodd-Frank Act (amending definition 
of security in Section 3 of the Exchange Act).
    \836\ See ISDA Margin Survey 2015 (Aug. 2015). The ISDA survey 
examines the state of collateral use and management among 
derivatives dealers and end-users. The appendix to the survey lists 
firms that responded to the survey, including broker-dealers. The 
ISDA margin surveys cited in this release are available at https://www.isda.org/category/research/surveys/.
---------------------------------------------------------------------------

    For purposes of the exemption from the requirements of Rule 18a-4 
for stand-alone SBSDs and bank SBSDs, the Commission estimates that 25 
bank SBSDs and 6 stand-alone SBSDs will be exempt from the requirements 
of Rule 18a-4 pursuant to paragraph (f) of the rule.\837\ For purposes 
Rule 18a-10, the Commission estimates that 3 stand-alone SBSDS will 
operate pursuant to the rule.\838\
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    \837\ See paragraph (f) of Rule 18a-4, as adopted. The 
Commission estimates that all 25 bank SBSDs will be exempt from the 
requirements of Rule 18a-4. These bank SBSDs will be subject to 
disclosure and notice requirements under paragraph (f) of Rule 18a-
4, as adopted.
    \838\ These respondents (2 stand-alone SBSDS using models and 
one stand-alone SBSD not using models) have been moved from the 
collections of information for proposed Rules 18a-1 and 18a-3. In 
the proposing release, the Commission estimated that 25 nonbank 
SBSDs would be subject to Rule 18a-3, as proposed. See Capital, 
Margin, and Segregation Proposing Release, 77 FR at 70293. As a 
result of the adoption of Rule 18a-10, the Commission estimates that 
22 nonbank SBSDs will be subject to Rule 18a-3 (25 nonbank SBSDs 
minus 3 stand-alone SBSDs electing to operate under Rule 18a-10 = 22 
respondents). As discussed above, the collection of information for 
Rule18a-10 is included with the collection of information for Rule 
18a-3.
---------------------------------------------------------------------------

    For purposes of estimating the number of respondents with respect 
to the amendments to Rule 3a71-6, applications for substituted 
compliance may be filed by foreign financial authorities, or by non-
U.S. SBSDs or MSBSPs. Consistent with prior estimates, the Commission 
staff expects that there may be approximately 22 non-

[[Page 43961]]

U.S. entities that may potentially register as SBSDs.\839\ Potentially, 
all such non-U.S. SBSDs, or some subset thereof, may seek to rely on 
substituted compliance in connection with the requirements being 
adopted today.\840\ For purposes of the PRA, however, consistent with 
prior estimates, the Commission estimates that 3 of these security-
based swap entities will submit such applications in connection with 
the Commission's capital and margin requirements.\841\
---------------------------------------------------------------------------

    \839\ See Trade Acknowledgment and Verification of Security-
Based Swap Transactions, 81 FR at 39832.
    \840\ It is possible that some subset of MSBSPs will be non-U.S. 
MSBSPs that will seek to rely on substituted compliance in 
connection with the final capital and margin rules. See Trade 
Acknowledgment and Verification of Security-Based Swap Transactions, 
81 FR at 39832.
    \841\ See Trade Acknowledgment and Verification of Security-
Based Swap Transactions, 81 FR at 38392.
---------------------------------------------------------------------------

D. Total Initial and Annual Recordkeeping and Reporting Burden

    1. Rule 18a-1 and Amendments to Rule 15c3-1
    The burden estimates for Rule 18a-1 and the amendments to Rule 
15c3-1 are based in part on the Commission's experience with burden 
estimates for similar collections of information requirements, 
including the current collection of information requirements for Rule 
15c3-1.\842\
---------------------------------------------------------------------------

    \842\ The burden hours related to the proposed collection of 
information requirements with respect to the proposed liquidity 
stress test requirements for nonbank SBSDs that were included in the 
proposing release have been deleted from the PRA collections of 
information in this release because these requirements are not being 
adopted today. See Capital, Margin, and Segregation Proposing 
Release, 77 FR at 70294.
---------------------------------------------------------------------------

    First, under paragraph (a)(2) of Rule 18a-1, a stand-alone SBSD is 
required to file an application for authorization to compute net 
capital using internal models.\843\ The requirements for the 
application are set forth in paragraph (d) of Rule 18a-1, which is 
modeled on the application requirements of Appendix E to Rule 15c3-1 
applicable to ANC broker-dealers.\844\
---------------------------------------------------------------------------

    \843\ A broker-dealer SBSD seeking Commission authorization to 
use internal models to compute market and credit risk charges will 
apply under the existing provisions of Appendix E to Rule 15c3-1.
    \844\ Consequently, the Commission is using the current 
collection of information for Appendix E to Rule 15c3-1 as a basis 
for this new collection of information. See Commission, Supporting 
Statement for the Paperwork Reduction Act Information Collection 
Submission for Rule 15c3-1.
---------------------------------------------------------------------------

    Based on its experience with ANC broker-dealers and OTC derivatives 
dealers, the Commission expects that stand-alone SBSDs that apply to 
use internal models to calculate net capital will already have 
developed models and internal risk management control systems. Rule 
18a-1 also contains additional requirements that stand-alone SBSDs may 
not yet have incorporated into their models and control systems. 
Therefore, stand-alone SBSDs will incur one-time hour burdens and 
start-up costs in order to develop their models in accordance with Rule 
18a-1, as well as submit the models along with their application to the 
Commission for approval. While the Commission's burden estimates are 
averages, the burdens may vary depending on the size and complexity of 
each stand-alone SBSD.
    The Commission staff estimates that each of the 4 stand-alone SBSDs 
that apply to use the internal models would spend approximately 1,000 
hours to: (1) Develop and submit their models and the description of 
its their risk management control systems to the Commission; (2) to 
create and compile the various documents to be included with their 
applications; and (3) to work with the Commission staff through the 
application process. The hour burdens include approximately 100 hours 
for an in-house attorney to complete a review of the application. 
Consequently, the Commission staff estimates that the total burden 
associated with the application process for the stand-alone SBSDs will 
result in an industry-wide one-time hour burden of approximately 4,000 
hours.\845\ In addition, the Commission staff allocates 75% (3,000 
hours) of these one-time burden hours \846\ to internal burden and the 
remaining 25% (1,000 hours) to external burden to hire outside 
professionals to assist in preparing and reviewing the stand-alone 
SBSD's application for submission to the Commission.\847\ The 
Commission staff estimates $400 per hour for external costs for 
retaining outside consultants, resulting in a one-time industry-wide 
external cost of $400,000.\848\
---------------------------------------------------------------------------

    \845\ 4 stand-alone SBSDs x 1,000 hours = 4,000 hours.
    \846\ The internal hours likely will be performed by an in-house 
attorney (1,000 hours), a risk management specialist (1,000 hours), 
and a compliance manager (1,000 hours). Therefore, the estimated 
internal cost for this hour burden is calculated as follows: (In-
house attorney for 1,000 hours at $422 per hour) + (risk management 
specialist for 1,000 hours at $202 per hour) + (compliance manager 
for 1,000 hours at $314 per hour) = $938,000.
    \847\ 4,000 hours x .75 = 3,000 hours; 4,000 hours x .25 = 1,000 
hours. Larger firms tend to perform these tasks in-house due to the 
proprietary nature of these models as well as the high fixed-costs 
in hiring an outside consultant. However, smaller firms may need to 
hire an outside consultant to perform certain of these tasks.
    \848\ 1,000 hours x $400 per hour = $400,000. See Financial 
Responsibility Rules for Broker-Dealers, 78 FR 51823 (citing PRA 
analysis in Product Definitions Adopting Release, 77 FR at 48334 
(providing an estimate of $400 per hour to engage an outside 
attorney)). See also Crowdfunding, Exchange Act Release No. 76324 
(Oct. 30, 2015), 80 FR 71387 (Nov. 16, 2015); FAST Act Modernization 
and Simplification of Regulation S-K, Exchange Act Release No. 81851 
(Oct. 11, 2017), 82 FR 50988 (Nov. 2, 2017). The Commission 
recognizes that the costs of retaining outside professionals may 
vary depending on the nature of the professional services, but for 
purposes of this PRA analysis, the Commission estimates that such 
costs would be an average of $400 per hour.
---------------------------------------------------------------------------

    The Commission staff estimates that a stand-alone SBSD authorized 
to use internal models will spend approximately 5,600 hours per year to 
review and update the models and approximately 160 hours each quarter, 
or approximately 640 hours per year, to backtest the models. 
Consequently, the Commission staff estimates that the total burden 
associated with reviewing and back-testing the models for the 4 stand-
alone SBSDs will result in an industry-wide annual hour burden of 
approximately 24,960 hours per year.\849\ In addition, the Commission 
staff allocates 75% (18,720 hours) \850\ of these burden hours to 
internal burden and the remaining 25% (6,240 hours) to external burden 
to hire outside professionals to assist in reviewing, updating and 
backtesting the models.\851\ The Commission staff estimates $400 per 
hour for external costs for retaining outside professionals, resulting 
in an industry-wide external cost of $2.5 million annually.\852\
---------------------------------------------------------------------------

    \849\ 4 stand-alone SBSDs x (5,600 hours + 640 hours) = 24,960 
hours.
    \850\ These functions likely will be performed by a risk 
management specialist (9,360 hours) and a senior compliance examiner 
(9,360 hours). Therefore, the estimated internal cost for this hour 
burden is calculated as follows: (Risk management specialist for 
9,360 hours at $202 per hour) + (senior compliance examiner for 
9,360 hours at $241 per hour) = $4,122,380.
    \851\ 24,960 hours x .75 = 18,720; 24,960 hours x .25 = 6,240. 
Larger firms tend to perform these tasks in-house due to the 
proprietary nature of these models as well as the high fixed-costs 
in hiring an outside consultant. However, smaller firms may need to 
hire an outside consultant to perform these tasks.
    \852\ 6,240 hours x $400 per hour = $2,496,000.
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    Stand-alone SBSDs electing to file an application with the 
Commission to use an internal model will incur start-up costs including 
information technology costs to comply with Rule 18a-1. Based on the 
estimates for the ANC broker-dealers,\853\ it is expected that a stand-
alone SBSD will incur an average of approximately $8.0 million to 
modify its information technology systems to meet the model 
requirements of the Rule 18a-

[[Page 43962]]

1, for a total one-time industry-wide cost of $32 million.\854\
---------------------------------------------------------------------------

    \853\ See Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities, 69 FR 
34428.
    \854\ 4 stand-alone SBSDs x $8 million = $32 million.
---------------------------------------------------------------------------

    Second, a nonbank SBSD is required to comply with most provisions 
of Rule 15c3-4, which requires the establishment of a risk management 
control system as if it were an OTC derivatives dealer.\855\ ANC 
broker-dealers currently are required to comply with Rule 15c3-4.\856\ 
The Commission staff estimates that the requirement to comply with Rule 
15c3-4 will result in one-time and annual hour burdens to nonbank 
SBSDs. The Commission staff estimates that the average amount of time a 
firm will spend implementing its risk management control system will be 
2,000 hours,\857\ resulting in an industry-wide one-time hour burden of 
24,000 hours across the 12 nonbank SBSDs not already subject to Rule 
15c3-4.\858\
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    \855\ See paragraph (f) to Rule 18a-1, as adopted; paragraph 
(a)(10)(ii) of Rule 15c3-1, as amended.
    \856\ See paragraph (a)(7)(iii) of Rule 15c3-1, as amended.
    \857\ This estimate is based on the one-time burden estimated 
for an OTC derivatives dealer to implement its controls under Rule 
15c3-1. See OTC Derivatives Dealers, 62 FR 67940. This also is 
included in the current PRA estimate for Rule 15c3-4. See 
Commission, Supporting Statement for the Paperwork Reduction Act 
Information Collection Submission for Rule 15c3-4.
    \858\ 25 nonbank SBSDs minus 10 ANC broker-dealer SBSDs = 15 
nonbank SBSDs minus 3 nonbank SBSDs electing the alternative 
compliance mechanism under Rule 18a-10, as adopted = 12 nonbank 
SBSDs. 12 nonbank SBSDs x 2,000 hours = 24,000 hours. This number is 
incremental to the current collection of information for Rule 15c3-1 
with regard to complying with the provisions of Rule 15c3-4 and, 
therefore, excludes the 10 respondents included in the collection of 
information for that rule. This work will likely be performed by a 
combination of an in-house attorney (8,000 hours), a risk management 
specialist (8,000 hours), and an operations specialist (8,000 
hours). Therefore, the estimated internal cost for this hour burden 
is calculated as follows: (Attorney for 8,000 hours at $422 per 
hour) + (risk management specialist for 8,000 hours at $202 per 
hour) + (operations specialist for 8,000 hours at $139 per hour) = 
$6,104,000.
---------------------------------------------------------------------------

    In implementing its policies and procedures, a nonbank SBSD is 
required to document and record its system of internal risk management 
controls. The Commission staff estimates that each of these 12 nonbank 
SBSDs will spend approximately 250 hours per year reviewing and 
updating their risk management control systems to comply with Rule 
15c3-4, resulting in an industry-wide annual hour burden of 
approximately 3,000 hours.\859\
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    \859\ 12 nonbank SBSDs x 250 hours = 3,000 hours. These hour-
burden estimates are consistent with similar collections of 
information under Appendix E to Rule 15c3-1. See Supporting 
Statement for the Paperwork Reduction Act Information Collection 
Submission for Rule 15c3-1. These hours likely will be performed by 
a risk management specialist. Therefore, the estimated internal cost 
for this hour burden is calculated as follows: Risk management 
specialist for 3,000 hours at $202 per hour = $606,000.
---------------------------------------------------------------------------

    Nonbank SBSDs may incur start-up costs to comply with the 
provisions of Rules 15c3-1 and 18a-1 that require compliance with Rule 
15c3-4, including information technology costs. Based on the estimates 
for similar collections of information,\860\ it is expected that a 
nonbank SBSD will incur an average of approximately $16,000 for initial 
hardware and software expenses, while the average ongoing cost will be 
approximately $20,500 per nonbank SBSD to meet the requirements of the 
Rule 18a-1 and the amendments to Rule 15c3-1, for a total industry-wide 
initial cost of $192,000 and an ongoing cost of $246,000 per year.\861\
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    \860\ See, e.g., Risk Management Controls for Brokers or Dealers 
with Market Access, Exchange Act Release No. 63421 (Nov. 3, 2010), 
75 FR 69792, 69814 (Nov. 15, 2010).
    \861\ 12 nonbank SBSDs x $16,000 = $192,000; 12 nonbank SBSDs x 
$20,500 = $246,000.
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    Third, under paragraph (c)(2)(vi)(P)(1)(iii) of Rule 15c3-1, as 
amended, and paragraph (c)(1)(vi)(B)(1)(iii)(A) of Rule 18a-1, nonbank 
SBSDs not authorized to use models are required to use an industry 
sector classification system that is documented and reasonable in terms 
of grouping types of companies with similar business activities and 
risk characteristics used for CDS reference obligors for purposes of 
calculating ``haircuts'' on non-cleared security-based swaps under 
applicable net capital rules.
    As discussed above, the Commission staff estimates that 4 broker-
dealer SBSDs and 2 nonbank SBSDs not using models will utilize the CDS 
haircut provisions under the amendments to Rules 15c3-1 and 18a-1, 
respectively. Consequently, these firms will use an industry sector 
classification system that is documented for the credit default swap 
reference obligors. The Commission expects that these firms will 
utilize external classification systems because of reduced costs and 
ease of use as a result of the common usage of several of these 
classification systems in the financial services industry. The 
Commission staff estimates that nonbank SBSDs not using models will 
spend approximately 1 hour per year documenting these industry sector 
classification systems, for a total annual hour burden of 6 hours.\862\
---------------------------------------------------------------------------

    \862\ (2 nonbank SBSDs not using models x 1 hour) + (4 broker-
dealer SBSDs x 1 hour) = 6 hours. This work will likely be performed 
by an internal compliance attorney. Therefore, the estimated 
internal cost for this hour burden is calculated as follows: 
Internal compliance attorney for 6 hours at $371 per hour = $2,226.
---------------------------------------------------------------------------

    Fourth, under paragraph (h) of Rule 18a-1, a nonbank SBSD is 
required to file certain notices with the Commission relating to the 
withdrawal of equity capital. Broker-dealers--which will include 
broker-dealer SBSDs--currently are required to file these notices under 
paragraph (e) of Rule 15c3-1. Based on the number of notices currently 
filed by broker-dealers, the Commission staff estimates that the notice 
requirements will result in annual hour burdens to stand-alone SBSDs. 
The Commission staff estimates that each of the 6 stand-alone SBSDs 
will file approximately 2 notices annually with the Commission. In 
addition, the Commission staff estimates that it will take a stand-
alone SBSD approximately 30 minutes to file these notices, resulting in 
an industry-wide annual hour burden of 6 hours.\863\
---------------------------------------------------------------------------

    \863\ (6 stand-alone SBSDs x 2 notices) x 30 minutes = 6 hours. 
This estimate is based on the 30 minutes it is estimated to take a 
broker-dealer to file a similar notice under Rule 15c3-1. See 
Supporting Statement for the Paperwork Reduction Act Information 
Collection Submission for Rule 15c3-1. The Commission believes 
stand-alone SBSDs will likely perform these functions internally 
using an internal compliance attorney. Therefore, the estimated 
internal cost for this hour burden is calculated as follows: 
Internal compliance attorney for 6 hours at $371 per hour = $2,226.
---------------------------------------------------------------------------

    Fifth, under Rule 18a-1d, a nonbank SBSD is required to file a 
proposed subordinated loan agreement with the Commission (including 
nonconforming subordinated loan agreements). Broker-dealers currently 
are subject to such a requirement. Based on staff experience with Rule 
15c3-1, the Commission staff estimates that each of the 6 stand-alone 
SBSDs will spend approximately 20 hours of internal employee resources 
drafting or updating its subordinated loan agreement template to comply 
with the requirement, resulting in an industry-wide one-time hour 
burden of approximately 120 hours.\864\ In addition, based on staff 
experience with Rule 15c3-1, the Commission staff estimates that each 
stand-alone SBSD will file 1 proposed subordinated loan agreement with 
the Commission per year and that it will take a firm approximately 10 
hours to prepare and file the agreement, resulting in an industry-wide 
annual hour burden of approximately 60 hours.\865\
---------------------------------------------------------------------------

    \864\ 6 stand-alone SBSDs x 20 hours = 120 hours. This work will 
likely be performed by an in-house attorney. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Attorney for 120 hours at $422 per hour = $50,640.
    \865\ 6 stand-alone SBSDs x 1 loan agreement x 10 hours = 60 
hours. This work will likely be performed by an in-house attorney. 
Therefore, the estimated internal cost for this hour burden is 
calculated as follows: Attorney for 60 hours at $422 per hour = 
$25,320.
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    Finally, as a result of comments received, Rules 15c3-1 and 18a-1

[[Page 43963]]

permit a stand-alone broker-dealer and a nonbank SBSD to treat 
collateral held by a third-party custodian to meet an initial margin 
requirement of a security-based swap or swap customer as being held by 
the stand-alone broker-dealer or nonbank SBSD for purposes of the 
capital deduction in lieu of margin provisions of the rule if certain 
conditions are met. The Commission staff estimates that the 16 broker-
dealer SBSDs and 6 stand-alone SBSDs will engage outside counsel to 
draft and review the account control agreement at a cost of $400 per 
hour for an average of 20 hours per respondent, resulting in a one-time 
cost burden of $176,000 for these 22 entities.\866\ Based on staff 
experience with the net capital and customer protection rules, the 
Commission estimates that the 16 broker-dealer SBSDs and 6 stand-alone 
SBSDs will enter into approximately 100 account control agreements per 
year with security-based swap customers and that it will take 
approximately 2 hours to execute each account control agreement, 
resulting in an industry-wide annual hour burden of 4,400 hours.\867\
---------------------------------------------------------------------------

    \866\ (16 broker-dealer SBSDs + 6 stand-alone SBSDs) x $400 per 
hour x 20 hours = $176,000.
    \867\ (16 broker-dealer SBSDs + 6 stand-alone SBSDs) x 100 
account control agreements x 2 hours = 4,400 hours. This work will 
likely be performed by an in-house attorney. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Attorney for 4,400 hours at $422 per hour = $1,856,800.
---------------------------------------------------------------------------

    The Commission staff estimates 16 broker-dealer SBSDs and 6 stand-
alone SBSDs will need to maintain written documentation of their legal 
analysis of the account control agreement. Based on staff experience, 
the Commission estimates that broker-dealers (including broker-dealer 
SBSDs) and stand-alone SBSDs will meet this requirement split evenly 
between obtaining a written opinion of outside legal counsel or through 
the firm's own ``in-house'' analysis. The Commission estimates that the 
approximate cost to a broker-dealer (including a broker-dealer SBSD) or 
a stand-alone SBSD to obtain an opinion of counsel will be $8,000.\868\ 
This figure is based on an estimate of 20 hours per opinion for outside 
counsel at $400 per hour, resulting in an industry-wide one-time cost 
of $88,000.\869\ In addition, the Commission estimates it will take a 
broker-dealer (including a broker-dealer SBSD) or a stand-alone SBSD 
approximately 20 hours to conduct a written ``in house'' analysis, 
resulting in an industry-wide one-time hour-burden of 220 hours.\870\
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    \868\ Consistent with the business conduct release, an opinion 
of counsel is estimated at $400 per hour multiplied by the number of 
hours to produce the opinion. See Business Conduct Standards for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants, 81 FR 29960, 30137 n. 1732 (citing consistency with 
the opinion of counsel paperwork burden in the release adopting a 
registration process for SBSDs and MSBSPs).
    \869\ This estimate is based on the amount of time it is 
estimated for a broker-dealer to obtain an opinion of outside 
counsel as required under Appendix C to Rule 15c3-1 and staff 
experience. (8 broker-dealer SBSDs + 3 stand-alone SBSDs) x $400 per 
hour x 20 hours = $88,000.
    \870\ (8 broker-dealer SBSDs + 3 stand-alone SBSDs) x 20 hours = 
220 hours. This work will likely be performed by an internal 
compliance attorney. Therefore, the estimated internal cost for this 
hour burden is calculated as follows: Compliance attorney for 220 
hours at $371 per hour = $81,620.
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2. Rule 18a-2
    Rule 18a-2 requires nonbank MSBSPs to have and maintain positive 
tangible net worth and implement a system of internal risk management 
controls under Rule 15c3-4. The Commission staff estimates that the 
average amount of time a firm will spend implementing its risk 
management control system will be 2,000 hours,\871\ resulting in an 
industry-wide one-time hour burden of 10,000 hours.\872\
---------------------------------------------------------------------------

    \871\ This estimate is based on the one-time burden estimated 
for an OTC derivatives dealer to implement controls under Rule 15c3-
1. See OTC Derivatives Dealers, 62 FR 67940. This also is included 
in the current PRA estimate for Rule 15c3-4. See Supporting 
Statement for the Paperwork Reduction Act Information Collection 
Submission for Rule 15c3-4.
    \872\ 5 MSBSPs x 2,000 hours = 10,000 hours. This work will 
likely be performed by a combination of an internal compliance 
attorney (3,333.33 hours), a risk management specialist (3,333.33 
hours), and an operations specialist (3,333.33 hours). Therefore, 
the estimated internal cost for this hour burden is calculated as 
follows: (Internal compliance attorney for 3,333.33 hours at $371 
per hour) + (risk management specialist for 3,333.33 hours at $202 
per hour) + (operations specialist for 3,333.33 hours at $139 per 
hour) = $2,373,330.96.
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    In implementing its policies and procedures, a nonbank MSBSP will 
be required to document and record its system of internal risk 
management controls, and prepare and maintain written guidelines 
regarding its internal control system. The Commission staff estimates 
that each of the 5 nonbank MSBSPs will spend approximately 250 hours 
per year reviewing and updating their risk management control systems 
to comply with Rule 15c3-4, resulting in an industry-wide annual hour 
burden of approximately 1,250 hours.\873\
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    \873\ 5 MSBSPs x 250 hours = 1,250 hours. These hour burden 
estimates are consistent with similar collections of information 
under Appendix E to Rule 15c3-1. See Supporting Statement for the 
Paperwork Reduction Act Information Collection Submission for Rule 
15c3-1. This work will likely be performed by a risk management 
specialist. Therefore, the estimated internal cost for this hour 
burden is calculated as follows: Risk management specialist for 
1,250 hours at $202 per hour = $252,500.
---------------------------------------------------------------------------

    Because nonbank MSBSPs may not initially have the systems or 
expertise internally to meet the risk management requirements of Rule 
18a-2, these firms will likely hire an outside risk management 
consultant to assist them in implementing their risk management 
systems. The Commission staff estimates that a nonbank MSBSP may hire 
an outside management consultant for approximately 200 hours to assist 
the firm for a total start-up cost to the nonbank MSBSP of $80,000 per 
MSBSP, or a total of $400,000 for all nonbank MSBSPs.\874\
---------------------------------------------------------------------------

    \874\ 5 nonbank MSBSPs x $80,000 = $400,000.
---------------------------------------------------------------------------

    Nonbank MSBSPs may incur start-up costs to comply with Rule 18a-2, 
including information technology costs. Based on the estimates for 
similar collections of information,\875\ the Commission staff expects 
that a nonbank MSBSP will incur an average of approximately $16,000 for 
initial hardware and software expenses, while the average ongoing cost 
will be approximately $20,500 per nonbank MSBSP to meet the 
requirements of the Rule 18a-2, for a total industry-wide initial cost 
of $80,000 and ongoing cost of $102,500.\876\
---------------------------------------------------------------------------

    \875\ See Risk Management Controls for Brokers or Dealers with 
Market Access, 75 FR at 69814.
    \876\ 5 nonbank MSBSPs x $16,000 = $80,000. 5 nonbank MSBSPs x 
$20,500 = $102,500.
---------------------------------------------------------------------------

3. Rule 18a-3
    Paragraph (e) of Rule 18a-3 requires a nonbank SBSD to establish 
and implement risk monitoring procedures with respect to counterparty 
accounts. Because these firms will be required to comply with Rule 
15c3-4, the Commission staff estimates that each of the 22 nonbank 
SBSDs will spend an average of approximately 210 hours establishing the 
written risk analysis methodology, resulting in an industry-wide one-
time hour burden of approximately 4,620 hours.\877\ In

[[Page 43964]]

addition, based on staff experience, the Commission staff estimates 
that a nonbank SBSD will spend an average of approximately 60 hours per 
year reviewing the written risk analysis methodology and updating it as 
necessary, resulting in an average industry-wide annual hour burden of 
approximately 1,500 hours.\878\
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    \877\ (25 nonbank SBSDs minus 3 stand-alone SBSDs electing the 
alternative compliance mechanism under Rule 18a-10, as adopted = 22 
nonbank SBSDs) x 210 hours = 4,620 hours. See generally Clearing 
Agency Standards for Operation and Governance, 76 FR at 14510 
(estimating 210 one-time burden hours and 60 annual hours to 
implement policies and procedures reasonably designed to use margin 
requirements to limit a clearing agency's credit exposures to 
participants in normal market conditions and to use risk-based 
models and parameters to set and review margin requirements). This 
work will likely be performed internally by an assistant general 
counsel (1,540 hours), an internal compliance attorney (1,540 
hours), and a risk management specialist (1,540 hours). Therefore, 
the estimated internal cost for this hour burden is calculated as 
follows: (Assistant general counsel for 1,540 hours at $473 per 
hour) + (risk management specialist for 1,540 hours at $202 per 
hour) + (compliance attorney for 1,540 hours at $371 per hour) = 
$1,610,840.
    \878\ 22 stand-alone SBSDs x 60 hours = 1,320 hours. This work 
will likely be performed by an internal compliance attorney. 
Therefore, the estimated internal cost for this hour burden is 
calculated as follows: Compliance attorney for 1,320 hours at $371 
per hour = $489,720.
---------------------------------------------------------------------------

    Start-up costs may vary depending on the size and complexity of the 
nonbank SBSD. In addition, the start-up costs may be less for the 16 
broker-dealer SBSDs because these firms may already be subject to 
similar margin requirements.\879\ For the remaining 6 nonbank SBSDs, 
because these written procedures may be novel undertakings for these 
firms, the Commission staff assumes these nonbank SBSDs will have their 
written risk analysis methodology reviewed by outside counsel. As a 
result, the Commission staff estimates that these nonbank SBSDs will 
likely incur $2,000 in legal costs, or $12,000 in the aggregate initial 
burden to review and comment on these materials.\880\
---------------------------------------------------------------------------

    \879\ See, e.g., FINRA Rules 4210 and 4240. See also Business 
Conduct Standards for Security-Based Swap Dealers and Major 
Security-Based Swap Participants, 81 FR at 29967 (noting burden for 
paragraph (g) of Rule 15Fh-3 is based on existing FINRA rules).
    \880\ The Commission staff estimates the review of the written 
risk analysis methodology will require 5 hours of outside counsel 
time at a cost of $400 per hour. See also Business Conduct Standards 
for Security-Based Swap Dealers and Major Security-Based Swap 
Participants, 81 FR at 30093.
---------------------------------------------------------------------------

    Based on comments received, the Commission modified the language in 
the final rule to provide that a nonbank SBSD may use a model to 
calculate the initial margin amount under the rule, if the use of the 
model has been approved by the Commission. Paragraph (d) of Rule 18a-3, 
as adopted, provides that a nonbank SBSD seeking approval to use a 
margin model will be subject to an application process and ongoing 
conditions set forth in Rule 15c3-1e and paragraph (d) of Rule 18a-1 
governing the use of internal models to compute net capital.
    Based on staff experience, the Commission estimates it will take a 
nonbank SBSD approximately 50 hours to prepare and submit an 
application to the Commission to seek authorization to use a model to 
calculate initial margin. Based on observations regarding market 
participants' implementation of final swap margin rules adopted by 
other regulators, the Commission believes it is likely that 22 nonbank 
SBSDs will seek Commission approval to use a model to calculate initial 
margin resulting in a total industry-wide one-time hour burden of 1,100 
hours.\881\ The Commission also estimates that each nonbank SBSD will 
spend approximately 250 hours per year reviewing, updating, and 
backtesting their initial margin model, resulting in a total industry-
wide annual hour burden of 5,500 hours.\882\
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    \881\ 22 nonbank SBSDs x 50 hours = 1,100 hours. This work will 
likely be performed by an in-house attorney. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Attorney for 1,100 hours at $422 per hour = $464,200. A 
nonbank SBSD may use standardized haircuts to compute initial margin 
because of the cost of using an initial margin model. However, the 
Commission is conservatively estimating that 22 nonbank SBSDs will 
choose to use a model to compute initial margin for purposes of this 
collection of information.
    \882\ 22 nonbank SBSDs x 250 hours = 5,500 hours. This work will 
likely be performed internally by a compliance attorney (2,750 
hours) and a risk management specialist (2,750 hours). Therefore, 
the estimated internal cost for this hour burden is calculated as 
follows: (Risk management specialist for 2,750 hours at $202 per 
hour) + (compliance attorney for 2,750 hours at $371 per hour) = 
$1,575,750.
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4. Rule 18a-4 and Amendments to Rule 15c3-3
    As discussed above in section II.C. of this release, the Commission 
is amending Rule 15c3-3 to establish security-based swap segregation 
requirements for stand-alone broker-dealers and broker-dealer SBSDs and 
adopting Rule 18a-4 to establish largely parallel segregation 
requirements applicable to stand-alone and bank SBSDs, as well as 
notification requirements for nonbank SBSDs. The Commission estimates 
that 41 respondents, consisting of 25 stand-alone broker-dealers and 16 
broker-dealer SBSDs, will be subject to the physical possession or 
control and reserve account requirements for security-based swaps in 
paragraph (p) of Rule 15c3-3. \883\ The Commission estimates that 17 
respondents, consisting of 16 broker-dealer SBSDs and 1 broker-dealer 
MSBSP, will be subject to paragraph (p)(4)(i)'s counterparty 
notification requirement with respect to non-cleared security-based 
swap transactions. The Commission estimates that 16 broker-dealer SBSDs 
will be subject to the requirement to obtain a subordination agreement 
from counterparties in paragraph (p)(4)(ii) of Rule 15c3-3.
---------------------------------------------------------------------------

    \883\ The 16 broker-dealer SBSD respondents were included in the 
proposed collection of information for proposed Rule 18a-4. Other 
than the addition of paragraph (p) to Rule 15c3-3, as amended, the 
Commission is not amending the requirements of existing Rule 15c3-3.
---------------------------------------------------------------------------

    Rule 18a-4, as adopted, will apply to SBSDs and MSBSPs that are not 
also registered as broker-dealers with the Commission.\884\ The 
Commission estimates that 3 stand-alone SBSDs and 4 MSBSPs will be 
subject to the collection of information requirements of Rule 18a-4, as 
adopted (because the Commission estimates that the 25 bank SBSD and 6 
stand-alone SBSDs will be exempt from the omnibus segregation 
requirements).\885\
---------------------------------------------------------------------------

    \884\ See Rule 18a-4, as adopted.
    \885\ 50 SBSDs minus 16 broker-dealer SBSDs minus 25 bank SBSDs 
minus 6 stand-alone SBSDs = 3 stand-alone SBSDs. 5 nonbank MSBSPs 
minus 4 nonbank MSBSPs that are not broker-dealers = 1 broker-dealer 
MSBSP.
---------------------------------------------------------------------------

    Under Rule 18a-4 and the amendments to Rule 15c3-3, SBSDs and 
broker-dealers engaged in security-based swap activities are required 
to establish special reserve accounts with banks and obtain written 
acknowledgements from, and enter into written contracts with, the 
banks. Based on staff experience with Rule 15c3-3, the Commission staff 
estimates that each of the 44 respondents \886\ will establish 6 
special reserve accounts at banks (2 for each type of special reserve 
account). Further, based on staff experience with Rule 15c3-3, the 
Commission staff estimates that each respondent will spend 
approximately 30 hours to draft and obtain the written acknowledgement 
and agreement for each account, resulting in an industry-wide one-time 
hour burden of approximately 7,920 hours.\887\ The Commission staff 
estimates that 25%\888\ of the 44 respondents (approximately 11 
respondents) will establish a new special reserve account each year 
because, for example, they change their banking relationship, for each 
type of special reserve account. Therefore, the Commission staff 
estimates an industry-wide annual hour burden of approximately 990 
hours.\889\
---------------------------------------------------------------------------

    \886\ 16 broker-dealer SBSDs + 3 stand-alone SBSDs + 25 stand-
alone broker-dealers = 44 respondents.
    \887\ 44 respondents x 6 special reserve accounts x 30 hours = 
7,920 hours. This work will likely be performed by an internal 
compliance attorney. Therefore, the estimated internal cost for this 
hour burden is calculated as follows: Compliance attorney for 7,920 
hours at $371 per hour = $2,938,320.
    \888\ This number is based on the currently approved PRA 
collection for Rule 15c3-3. See Commission, Supporting Statement for 
the Paperwork Reduction Act Information Collection Submission for 
Rule 15c3-3.
    \889\ 11 SBSDs x 3 types of special reserve accounts x 30 hours 
= 990 hours. This work will likely be performed by an internal 
compliance attorney. Therefore, the estimated internal cost for this 
hour burden is calculated as follows: Internal compliance attorney 
for 990 hours at $371 per hour = $367,290.
---------------------------------------------------------------------------

    Paragraph (c)(1) of Rule 18a-4 and paragraph (p)(3)(i) of Rule 
15c3-3

[[Page 43965]]

provide that the SBSD or broker-dealer engaged in security-based swap 
activities must at all times maintain in a special reserve account, 
through deposits into the account, cash and/or qualified securities in 
amounts computed in accordance with the formula set forth in Exhibit A 
to Rule 18a-4 and Exhibit B to Rule 15c3-3. Paragraph (c)(3) of Rule 
18a-4 and paragraph (p)(3)(iii) of Rule 15c3-3 provide that the 
computations necessary to determine the amount required to be 
maintained in the special bank account must be made on a weekly basis. 
Based on experience with the Rule 15c3-3 reserve computation paperwork 
burden hours and with the OTC derivatives industry, the Commission 
staff estimates that it will take 1-5 hours to compute each reserve 
computation, and that the average time spent across all the respondents 
will be approximately 2.5 hours. Accordingly, the Commission staff 
estimates that the resulting industry-wide annual hour burden is 
approximately 5,720 hours.\890\
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    \890\ 44 respondents x 52 weeks x 2.5 hours/week = 5,720 hours. 
This work will likely be performed by a financial reporting manager. 
Therefore, the estimated internal cost for this hour burden is 
calculated as follows: Financial reporting manager for 5,720 hours 
at $295 per hour = $1,687,400.
---------------------------------------------------------------------------

    Under paragraph (d)(1) of Rule 18a-4, paragraph (f)(2) of Rule 18a-
4, and paragraph (p)(4)(i) of Rule 15c3-3, an SBSD or an MSBSP is 
required to provide a notice to a counterparty prior to their first 
non-cleared security-based swap transaction after the compliance date. 
All 50 SBSDs and 5 MSBSPs are required to provide these notices to 
their counterparties. The Commission staff estimates that these 55 
entities will engage outside counsel to draft and review the notice at 
a cost of $400 per hour for an average of 10 hours per respondent, 
resulting in a one-time cost burden of $220,000 for all of these 55 
entities.\891\
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    \891\ (50 SBSDs + 5 MSBSPs) x $400 per hour x 10 hours = 
$220,000. This work will likely be performed by an outside counsel 
with expertise in financial services law to help ensure that 
counterparties are receiving the proper notice under the statutory 
requirement.
---------------------------------------------------------------------------

    The number of notices sent in the first year the rule is effective 
will depend on the number of counterparties with which each SBSD or 
MSBSP engages in security-based swap transactions. The number of 
counterparties an SBSD or MSBSP has will vary depending on the size and 
complexity of the firm and its operations. The Commission staff 
estimates that each of the 50 SBSDs and 5 MSBSPs will have 
approximately 1,000 counterparties at any given time.\892\ Therefore, 
the Commission staff estimates that approximately 55,000 notices will 
be sent in the first year the rule is effective.\893\ The Commission 
staff estimates that each of the 50 SBSDs and 5 MSBSPs will spend 
approximately 10 minutes sending out the notice, resulting in an 
industry-wide one-time hour burden of approximately 9,167 hours.\894\ 
The Commission staff further estimates that the 50 SBSDs and 5 MSBSPs 
will establish account relationships with 200 new counterparties per 
year. Therefore, the Commission staff estimates that approximately 
11,000 notices will be sent annually,\895\ resulting in an industry-
wide annual hour burden of approximately 1,833 hours.\896\
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    \892\ The Commission previously estimated that there are 
approximately 10,900 market participants in security-based swap 
transactions. See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR at 30089. 
Based on the 10,900 market participants and Commission staff 
experience with the securities and OTC derivatives industry, the 
Commission staff estimates that each SBSD and MSBSP will have 1,000 
counterparties at any given time. The number of counterparties may 
widely vary depending on the size of the SBSD or MSBSP. A large firm 
may have thousands or counterparties at one time, while a smaller 
firm may have substantially less than 1,000. The Commission staff 
also estimates, based on staff experience, that these entities will 
establish account relationships with approximately 200 new 
counterparties per year, or approximately 20% of a firm's existing 
counterparties.
    \893\ (50 SBSDs + 5 MSBSPs) x 1,000 counterparties = 55,000 
notices.
    \894\ 55,000 notices x (10 minutes/60 minutes) = 9,167 hours. A 
compliance clerk will likely send these notices. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Compliance clerk for 9,167 hours at $71 per hour = 
$650,857.
    \895\ (50 SBSDs + 5 MSBSPs) x 200 counterparties = 11,000 
notices.
    \896\ 11,000 notices x (10 minutes/60 minutes) = 1,833 hours. A 
compliance clerk will likely send these notices. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Compliance clerk for 1,833 hours at $71 per hour = 
$130,143.
---------------------------------------------------------------------------

    Under paragraph (d)(2) of Rule 18a-4 and paragraph (p)(4)(ii) of 
Rule 15c3-3, an SBSD is required to obtain subordination agreements 
from certain counterparties. The Commission staff estimates that each 
SBSD will spend, on average, approximately 200 hours to draft and 
prepare standard subordination agreements, resulting in an industry-
wide one-time hour burden of 3,800 hours.\897\ Because the SBSD will 
enter into these agreements with security-based swap customers, after 
the SBSD prepares a standard subordination agreement in-house, the 
Commission staff also estimates that an SBSD will have outside counsel 
review the standard subordination agreements and that the review will 
take approximately 20 hours at a cost of approximately $400 per hour. 
As a result, the Commission staff estimates that each SBSD will incur 
one-time costs of approximately $8,000,\898\ resulting in an industry-
wide one-time cost of approximately $152,000.\899\
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    \897\ 200 hours x 19 SBSDs = 3,800 hours. An in-house attorney 
will likely draft these agreements because the Commission staff 
expects that drafting contracts will be one of the typical job 
functions of an in-house attorney. Therefore, the estimated internal 
cost for this hour burden is calculated as follows: Attorney for 
3,800 hours at $422 per hour = $1,603,600.
    \898\ $400 x 20 hours = $8,000.
    \899\ $8,000 x 19 SBSDs = $152,000.
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    As discussed above, the Commission staff estimates that each of the 
19 SBSDs would have approximately 1,000 counterparties at any given 
time. The Commission staff further estimates that approximately 50% of 
these counterparties will either elect individual segregation or, if 
permitted, to waive segregation altogether.\900\ The Commission staff 
estimates that an SBSD will spend 20 hours per counterparty to enter 
into a written subordination agreement, resulting in an industry-wide 
one-time hour burden of approximately 190,000 hours.\901\ Further, as 
discussed above, the Commission staff estimates that each of the 19 
SBSDs will establish account relationships with 200 new counterparties 
per year. The Commission staff further estimates that 50% or 100 of 
these counterparties will either elect individual segregation or, if 
permitted, to waive segregation altogether. Therefore, the Commission 
staff estimates an industry-wide annual hour burden of approximately 
38,000 hours.\902\
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    \900\ Based on discussions with market participants, the 
Commission staff understands that many large buy-side financial end 
users currently ask for individual segregation and the Commission 
staff assumes that many of these end users will continue to do so. 
However, Commission staff believes that some smaller end users may 
choose to avoid the potential additional cost associated with 
individual segregation. Therefore, the Commission staff estimates 
that approximately 50% of counterparties will either elect 
individual segregation or, if permitted, to waive segregation 
altogether.
    \901\ 19 SBSDs x 500 counterparties x 20 hours = 190,000. This 
work will likely be performed by an internal compliance attorney 
(95,000 hours) and a compliance clerk (95,000 hours). Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: (Internal compliance attorney for 95,000 hours at $371 per 
hour) + (compliance clerk for 95,000 hours at $71 per hour) = 
$41,990,000.
    \902\ 19 SBSDs x 100 counterparties x 20 hours = 38,000 hours. 
This work will likely be performed by an internal compliance 
attorney (19,000 hours) and a compliance clerk (19,000 hours). 
Therefore, the estimated internal cost for this hour burden is 
calculated as follows: (Compliance attorney for 19,000 hours at $371 
per hour) + (compliance clerk for 19,000 hours at $71 per hour) = 
$8,398,000.

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[[Page 43966]]

    Paragraph (e) of Rule 18a-4 establishes exemptions for foreign 
stand-alone or bank SBSDs and MSBSPs from the segregation requirements 
in Section 3E of the Exchange Act, and the rules and regulations 
thereunder, with respect to certain transactions. The Commission 
previously estimated that there will be 22 foreign SBSDs, but does not 
have sufficient information to reasonably estimate the number of 
foreign firms that are dually registered as broker-dealers or are 
foreign banks, how many U.S. counterparties foreign stand-alone or bank 
SBSDs will have, and how many eligible firms will opt out of complying 
with Section 3E of the Exchange Act and the rules and regulations 
thereunder. Moreover, as discussed above, the Commission estimates that 
the 25 bank SBSDs and 6 stand-alone SBSDs will be exempt from the 
omnibus segregation requirements. Therefore, the Commission is making 
the conservative estimate that 22 foreign SBSDs will be subject to 
paragraph (e) of Rule 18a-4.
    Under paragraph (e)(3) of Rule 18a-4, foreign SBSDs are required to 
provide disclosures in writing to their U.S. counterparties. The 
Commission believes that, in most cases, these disclosures will be made 
through amendments to the foreign SBSD's existing trading 
documentation.\903\ Because these disclosures relate to new regulatory 
requirements, the Commission anticipates that all foreign SBSDs will 
need to incorporate new language into their existing trading 
documentation with U.S. counterparties. Disclosure of the potential 
treatment of segregated assets in insolvency proceedings under U.S. 
bankruptcy law and foreign insolvency laws pursuant to paragraph (e)(3) 
of Rule 18a-4 will likely vary depending on the counterparty's 
jurisdiction. Accordingly, the Commission expects that these 
disclosures often may need to be tailored to address the particular 
circumstances of each trading relationship. However, in some cases, 
trade associations or industry working groups may be able to develop 
standard disclosure forms that can be adopted by foreign SBSDs with 
little or no modification. In either case, the paperwork burden 
associated with developing new disclosure language and incorporating 
this language into a registered foreign SBSD's trading documentation 
will vary depending on: (1) The number of non-U.S. counterparties with 
whom the registered foreign SBSD trades; (2) the number of 
jurisdictions represented by the foreign SBSD's counterparties; and (3) 
the availability of standardized disclosure language. To the extent 
standardized disclosures become available, the paperwork burden on 
foreign SBSDs will be limited to amending existing trading 
documentation to incorporate the standardized disclosures. Conversely, 
more time will be necessary where a greater degree of customization is 
required to develop the required disclosures and incorporate this 
language into existing documentation.
---------------------------------------------------------------------------

    \903\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR 29960.
---------------------------------------------------------------------------

    The Commission estimates the maximum total paperwork burden 
associated with developing new disclosure language will require each of 
the 22 foreign SBSDs to spend 5 hours of in-house counsel time on 30 
jurisdictions.\904\ This will create a total one-time industry burden 
of 3,300 hours.\905\ This estimate assumes little or no reliance on 
standardized disclosure language. In addition, the Commission estimates 
the total paperwork burden associated with incorporating new disclosure 
language into each foreign SBSD's trading documentation will be 
approximately 11,000 hours for all 22 foreign SBSDs.\906\
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    \904\ The Commission staff estimates the total paperwork burden 
associated with developing new disclosure language for each foreign 
SBSD would be 5 hours spent on disclosure agreements relating to 30 
potential jurisdictions. See Cross-Border Proposing Release, 78 FR 
at 31107 (providing similar estimates).
    \905\ 22 foreign SBSDs x 5 in-house counsel hours x 30 potential 
jurisdictions = 3,300 hours.
    \906\ The Commission staff estimates that the average foreign 
SBSD will have 50 active non-U.S. counterparties. Accordingly, the 
Commission staff estimates the cost of incorporating new disclosure 
language into the trading documentation of an average foreign SBSD 
would be 500 hours per foreign SBSD (based on 10 hours of in-house 
counsel time x 50 active non-U.S. counterparties).
---------------------------------------------------------------------------

    The Commission expects that the majority of the paperwork burden 
associated with the new disclosure requirements will be experienced 
during the first year as language is developed, whether by individual 
foreign SBSDs or through collaborative efforts, and trading 
documentation is amended. After the new disclosure language is 
developed and incorporated into trading documentation, the Commission 
believes that the ongoing burden associated with paragraph (e) of Rule 
18a-4, as adopted, will be limited to periodically updating the 
disclosures to reflect changes in the applicable law or to incorporate 
new jurisdictions with security-based swap counterparties. The 
Commission estimates that this ongoing paperwork burden will not exceed 
110 hours per year for all 22 foreign SBSDs (approximately 5 hours per 
foreign SBSD per year).
    Paragraph (f) of Rule 18a-4 provides an exemption from the rule's 
requirements if certain conditions are met. These conditions include a 
requirement in paragraph (f)(3) of the rule that the stand-alone or 
bank SBSD must provide notice to a counterparty regarding the right to 
segregate initial margin at an independent third-party custodian, and 
make certain disclosures in writing regarding collateral received by 
the SBSD.\907\
---------------------------------------------------------------------------

    \907\ The PRA estimates for paragraph (f)(2) of Rule 18a-4 are 
discussed above with the notice provisions of paragraph (d)(2) to 
Rule 18a-4.
---------------------------------------------------------------------------

    Paragraph (f)(3) of Rule 18a-4 requires disclosure that margin 
collateral received and held by the firm will not be subject to a 
segregation requirement and of how a claim of a counterparty for the 
collateral would be treated in a bankruptcy or other formal liquidation 
proceeding of the firm. The Commission estimates the maximum total 
paperwork burden associated with developing new disclosure language for 
the purposes of this provision will require each of the 31 SBSDs (25 
bank SBSDs and 6 stand-alone SBSDs) to spend 5 hours of in-house 
counsel time. This will create a total one-time industry burden of 155 
hours.\908\ This estimate assumes little or no reliance on standardized 
disclosure language. In addition, the Commission estimates the total 
paperwork burden associated with incorporating new disclosure language 
into each SBSD's trading documentation will be approximately 310,000 
hours for all 31 SBSDs.\909\ The Commission expects that the majority 
of the paperwork burden associated with the new disclosure requirements 
under paragraph (f)(3) of Rule 18a-4, as adopted will be experienced 
during the first year as language is developed. After the new 
disclosure language is developed and incorporated into trading 
documentation, the Commission believes that the ongoing burden 
associated with paragraph (f)(3) of Rule 18a-4, as adopted, will be 
limited to periodically updating the disclosures. The Commission 
estimates that this ongoing paperwork burden will not exceed 155 hours 
per year for all 31

[[Page 43967]]

SBSDs (approximately 5 hours per SBSD per year).\910\
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    \908\ 31 SBSDs (25 bank SBSDs + 6 stand-alone SBSDs) x 5 in-
house counsel hours = 155 hours.
    \909\ The Commission staff estimates that the average SBSD will 
have approximately 1,000 counterparties at any given time. 
Accordingly, the Commission staff estimates the cost of 
incorporating new disclosure language into the trading documentation 
of an average SBSD would be 10,000 hours per SBSD (based on 10 hours 
of in-house counsel time x 1,000 counterparties).
    \910\ 31 SBSDs (25 bank SBSDs + 6 stand-alone SBSDs) x 5 hours 
per SBSD = 155 hours.
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5. Rule 18a-10
    In response to comments urging the Commission to harmonize 
requirements with the CFTC, as well as specific comments requesting 
that the Commission defer to the CFTC's rules if a nonbank SBSD is 
registered as a swap dealer and conducts only a limited amount of 
security-based swaps business, the Commission is adopting new Rule 18a-
10. Rule 18a-10 contains an alternative compliance mechanism pursuant 
to which a stand-alone SBSD that is registered as a swap dealer and 
predominantly engages in a swaps business may elect to comply with the 
capital, margin, and segregation requirements of the CEA and the CFTC's 
rules in lieu of complying with Rules 18a-1, 18a-3, and 18a-4. As 
discussed above, the Commission estimates that 3 stand-alone SBSDs will 
elect to operate under Rule 18a-10. These respondents were included in 
the proposing release in other collections of information (Rule 18a-1 
and Rule 18a-3, as proposed), and have been moved to the information 
collection for new Rule 18a-10.\911\
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    \911\ As a result, the total respondents for Rules 18a-1 and 
18a-3 have been reduced by three. In addition, these respondents 
will be exempt from Rule 18a-4 under the conditions of paragraph (f) 
of the rule if they meet certain conditions, but will continue to be 
included in the collection of information for the rule because the 
conditions in paragraph (f) contain a collection of information 
under the PRA. Finally, the collections of information for Rule 18a-
10 will be included with the collections of information with Rule 
18a-3 for purposes of submission to OMB.
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    The Commission estimates paperwork burden associated with 
developing new disclosure language under paragraph (b)(2) of Rule 18a-
10 will require each of the 3 stand-alone SBSDs to spend 5 hours of in-
house counsel time. This would create a total one-time industry burden 
of 15 hours.\912\ This estimate assumes little or no reliance on 
standardized disclosure language. In addition, the Commission estimates 
the total paperwork burden associated with incorporating new disclosure 
language into each stand-alone SBSD's trading documentation will be 
approximately 30,000 hours for all 3 stand-alone SBSDs.\913\ The 
Commission expects that the majority of the paperwork burden associated 
with the new disclosure requirements under paragraph (b)(2) of Rule 
18a-10, as adopted, will be experienced during the first year as 
language is developed. After the new disclosure language is developed 
and incorporated into trading documentation, the Commission believes 
that the ongoing burden associated with paragraph (b)(2) of Rule 18a-10 
will be limited to periodically updating the disclosures. The 
Commission estimates that this ongoing paperwork burden will not exceed 
15 hours per year for all 3 stand-alone SBSDs.\914\
---------------------------------------------------------------------------

    \912\ 3 stand-alone SBSDs x 5 in-house counsel hours = 15 hours.
    \913\ The Commission staff estimates that the average SBSD will 
have approximately 1,000 counterparties at any given time. 
Accordingly, the Commission staff estimates the cost of 
incorporating new disclosure language into the trading documentation 
of an average SBSD would be 10,000 hours per stand-alone SBSD (based 
on 10 hours of in-house counsel time x 1,000 counterparties).
    \914\ 3 stand-alone SBSDs x 5 hours per SBSD = 15 hours.
---------------------------------------------------------------------------

    Based on the number of notices currently filed by broker-dealers, 
the Commission staff estimates that the notice requirement of paragraph 
(b)(3) of Rule 18a-10 will result in annual hour burdens to stand-alone 
SBSDs. The Commission staff estimates that 1 stand-alone SBSD will file 
1 notice annually with the Commission. In addition, the Commission 
staff estimates that it will take a stand-alone SBSD approximately 30 
minutes to file this notice, resulting in an industry-wide annual hour 
burden of 30 minutes.\915\
---------------------------------------------------------------------------

    \915\ 1 stand-alone SBSD x 1 notice x 30 minutes = 30 minutes. 
This estimate is based on the 30 minutes it is estimated a stand-
alone broker-dealer spends filing a notice under Rule 15c3-1. See 
Supporting Statement for the Paperwork Reduction Act Information 
Collection Submission for Rule 15c3-1. This work will likely be 
performed by an internal compliance attorney. Therefore, the 
estimated internal cost for this hour burden is calculated as 
follows: Internal compliance attorney for 30 minutes at $371 per 
hour = $185.50.
---------------------------------------------------------------------------

    Finally, under paragraphs (d)(1) and (d)(2) of Rule 18a-10, 
respectively, a stand-alone SBSD can make an election to operate under 
the alternative compliance mechanism, during the registration process 
or after the firm registers as an SBSD, by providing written notice to 
the Commission and the CFTC of its intent to operate pursuant to the 
rule. The Commission believes that in the first 3 years of the 
effective date of the rule that the 3 nonbank SBSDs that elect to 
operate under Rule 18a-10 will file the notice as part of their 
application process. Therefore, the Commission believes that the time 
it would take an entity to file a notice as part of the application 
process would be de minimis and, therefore, would not result in an hour 
burden for this collection of information or any collection of 
information associated with registering with the Commission as an 
SBSD.\916\ Finally, since the Commission believes that the 3 nonbank 
SBSDs will elect to operate under the rule as part of their 
registration process, the Commission believes that there will be no 
respondents, and no paperwork hour or cost burden under the PRA 
associated with paragraph (d)(2) of Rule 18a-10, as adopted.
---------------------------------------------------------------------------

    \916\ See also Registration Process for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, Exchange Act 
Release No. 75611 (Aug. 5, 2015), 80 FR 48964, 48989 (Aug. 14, 
2015).
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6. Rule 3a71-6
    Rule 3a71-6, as amended, will require submission of certain 
information to the Commission to the extent person request a 
substituted compliance determination with respect to the Title VII 
capital and margin requirements. The Commission expects that foreign 
SBSDs and MSBSPs will seek to rely on substituted compliance upon 
registration, and that it is likely that the majority of such requests 
will be made during the first year following the effective date of this 
amendment. Requests would not be necessary with regard to applicable 
rules and regulations of a foreign jurisdiction that have previously 
been the subject of a substituted compliance determination in 
connection with the applicable rules.
    The Commission expects that the majority of substituted compliance 
applications will be submitted by foreign authorities, and that very 
few substituted compliance requests will come from SBSDs or MSBSPs. For 
purposes of this assessment, the Commission estimates that 3 SBSDs or 
MSBSPs will submit such applications in connection with the 
Commission's capital and margin requirements.\917\ After consideration 
of the release adopting Rule 3a71-6, the Commission estimates that the 
total paperwork burden incurred by such entities associated with 
preparing and submitting a request for a substituted compliance 
determination in connection with the capital and margin requirements 
will be approximately 240 hours, plus $240,000 for the services of 
outside professionals for all 3 requests.\918\
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    \917\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR at 30097. 
See also Trade Acknowledgment and Verification of Security-Based 
Swap Transactions, 81 FR at 39382.
    \918\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR at 30097 
(``The Commission estimates that the total one-time paperwork burden 
incurred by such entities associated with preparing and submitting a 
request for a substituted compliance determination in connection 
with the business conduct requirements will be approximately 240 
hours, plus $240,000 for the services of outside professionals for 
all three requests''). The Commission further stated that in 
practice those amounts may overestimate the costs of requests 
pursuant to Rule 3a71-6 as adopted, as such requests would solely 
address the business conduct requirements, rather than the broader 
proposed scope of substituted compliance set forth in the cross-
border proposing release. 81 FR at 30097 n. 1583. To the extent that 
an SBSD submits substituted compliance requests in connection with 
the business conduct requirements, the trade acknowledgment and 
verification requirements, and the capital and margin requirements, 
the Commission believes that the paperwork burden associated with 
the requests would be greater than that associated with a narrower 
request, given the need for more information regarding the 
comparability of the relevant rules and the adequacy of the 
associated supervision and enforcement practices. In the 
Commission's view, however, the burden associated with such a 
combined request would not exceed the prior estimate. See Trade 
Acknowledgment and Verification of Security-Based Swap Transactions, 
81 FR at 39833 n. 258.

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[[Page 43968]]

E. Collection of Information is Mandatory

    The collections of information pursuant to the amendments and new 
rules are mandatory, as applicable, for ANC broker-dealers, broker-
dealers, SBSDs, and MSBSPs. Compliance with the collection of 
information requirements associated with Rule 3a71-6, regarding the 
availability of substituted compliance, is mandatory for all foreign 
financial authorities, foreign SBSDs, or foreign MSBSPs that seek a 
substituted compliance determination. Compliance with the collection of 
information requirements associated with Rule 18a-10 regarding the 
availability of an alternative compliance mechanism is mandatory for 
all stand-alone SBSDs that elect to operate under the conditions of the 
rule.

F. Confidentiality

    The Commission expects to receive confidential information in 
connection with the collections of information. To the extent that the 
Commission receives confidential information pursuant to these 
collections of information, such information will be kept confidential, 
subject to the provisions of applicable law.\919\
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    \919\ See, e.g., 15 U.S.C. 78x (governing the public 
availability of information obtained by the Commission); 5 U.S.C. 
552 et seq. (Freedom of Information Act or ``FOIA''). See also 
paragraph (d)(1) of Rule 18a-1. FOIA provides at least two pertinent 
exemptions under which the Commission has authority to withhold 
certain information. FOIA Exemption 4 provides an exemption for 
matters that are ``trade secrets and commercial or financial 
information obtained from a person and privileged or confidential.'' 
5 U.S.C. 552(b)(4). FOIA Exemption 8 provides an exemption for 
matters that are ``contained in or related to examination, 
operating, or condition reports prepared by, on behalf of, or for 
the use of an agency responsible for the regulation or supervision 
of financial institutions.'' 5 U.S.C. 552(b)(8).
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G. Retention Period for Recordkeeping Requirements

    Under Rule 17a-4, ANC broker-dealers are required to preserve for a 
period of not less than 3 years, the first 2 years in an easily 
accessible place, certain records required under Rule 15c3-4 and 
certain records under Rule 15c3-1e. Rule 17a-4 specifies the required 
retention periods for a broker-dealer. Many of a broker-dealer's 
records must be retained for 3 years; certain other records must be 
retained for longer periods.

V. Other Matters

    Pursuant to the Congressional Review Act,\920\ the Office of 
Information and Regulatory Affairs has designated these rules as a 
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

    \920\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

VI. Economic Analysis

    The Commission is adopting: (1) Rules 18a-1 and 18a-2, and 
amendments to Rule 15c3-1, to establish capital requirements for 
nonbank SBSDs and MSBSPs; (2) Rule 18a-3 to establish margin 
requirements for non-cleared security-based swaps applicable to nonbank 
SBSDs and MSBSPs; and (3) Rule 18a-4, and amendments to Rule 15c3-3, to 
establish segregation requirements for SBSDs and notification 
requirements with respect to segregation for SBSDs and MSBSPs.\921\ 
Some of the amendments to Rules 15c3-1 and 15c3-3 will apply to stand-
alone broker-dealers to the extent that they engage in security-based 
swap or swap activities.\922\ The Commission also is amending Rule 
15c3-1 to increase the minimum net capital requirements for ANC broker-
dealers and amending Rule 3a71-6 to address the potential availability 
of substituted compliance in connection with the Commission's capital 
and margin requirements for foreign SBSDs and MSBSPs. Further, the 
Commission is adopting an alternative compliance mechanism in Rule 18a-
10 pursuant to which a stand-alone SBSD that is registered as a swap 
dealer and predominantly engages in a swaps business may elect to 
comply with the capital, margin, and segregation requirements of the 
CEA and the CFTC's rules in lieu of complying with the capital, margin, 
and segregation requirements being adopted today. Finally, the 
Commission is adopting a rule that specifies when a foreign non-broker-
dealer SBSD or MSBSP need not comply with the segregation requirements 
of Section 3E of the Exchange Act and the rules thereunder.
---------------------------------------------------------------------------

    \921\ See section II of this release.
    \922\ For example, the standardized haircuts for security-based 
swaps and swaps will apply to stand-alone broker-dealers as will the 
segregation requirements for security-based swaps.
---------------------------------------------------------------------------

    The Commission is sensitive to the economic impacts of the rules it 
is adopting. Some of the costs and benefits stem from statutory 
mandates, while others are affected by the discretion exercised in 
implementing the mandates. The following economic analysis seeks to 
identify and consider the economic effects--including the benefits, 
costs, and effects on efficiency, competition, and capital formation--
that will result from the adoption of Rules 18a-1, 18a-2, 18a-3, 18a-4, 
and Rule 18a-10, and from the adoption of the amendments to Rules 15c3-
1, 15c3-3, and 3a71-6. The economic effects considered in adopting 
these new rules and amendments are discussed below and have informed 
the policy choices described throughout this release.
    The discussion below provides a baseline against which the rules 
may be evaluated. For the purposes of this economic analysis, the 
baseline incorporates the state of the security-based swap and swap 
markets as they exist today and does not include any of the regulatory 
provisions that have not yet been adopted. However, to the extent that 
such provisions have been anticipated by and therefore affected the 
behavior of market participants those practices will be considered part 
of the baseline.
    The Commission does not currently have comprehensive data on the 
state of the U.S. security-based swap and swap markets. Consequently, 
the Commission is using the limited data currently available to develop 
the baseline and to inform the following analysis of the anticipated 
costs and benefits resulting from the rules and amendments being 
adopted today.\923\ These rules and amendments have the potential to 
significantly affect efficiency, competition, and capital formation in 
the security-based swap and swap markets, with the impact not being 
limited to the specific entities that fall within the meaning of the 
terms ``security-based swap dealer'' and ``major security-based swap

[[Page 43969]]

participant.'' The following analysis will also consider these effects.
---------------------------------------------------------------------------

    \923\ In the proposing release, the Commission requested data 
and information from commenters to assist it in analyzing the 
economic consequences of the proposed rules. See Capital, Margin, 
and Segregation Proposing Release, 77 FR at 70300. See also Capital, 
Margin, and Segregation Comment Reopening, 83 FR at 53019-20 
(similarly requesting data).
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A. Baseline

    To assess the economic impact of the capital, margin, and 
segregation rules being adopted today, the Commission is using as its 
baseline the state of the security-based swap and swap markets as they 
exist at the time of this release, including applicable rules the 
Commission has already adopted, but excluding rules the Commission has 
proposed but not finalized.\924\ The analysis includes the statutory 
provisions that currently govern the security-based swap market 
pursuant to the Dodd-Frank Act, and rules adopted by the Commission 
regarding: (1) Entity definitions; \925\ (2) cross-border activities; 
\926\ (3) registration of security-based swap data repositories; \927\ 
(4) registration of SBSDs and MSBSPs; \928\ (5) reporting and 
dissemination of security-based swap information; \929\ (6) dealing 
activity of non-U.S. persons with a U.S. connection; \930\ (7) business 
conduct standards; \931\ (8) trade acknowledgments; \932\ and (9) 
applications with respect to statutory disqualifications.\933\ These 
statutes and final rules--even if compliance is not yet required--are 
part of the existing regulatory landscape that market participants 
expect to govern their security-based swap activity. There are 
limitations in the degree to which the Commission can quantitatively 
characterize the current state of the security-based swap market. As 
described in more detail below, because the available data on security-
based swap transactions do not cover the entire market, the Commission 
has developed its understanding of market activity using a sample that 
includes only certain portions of the market.
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    \924\ The Commission also considered, where appropriate, the 
impact of rules and technical standards promulgated by other 
regulators, such as the CFTC, the prudential regulators, and the 
European Securities and Markets Authority, on practices in the 
security-based swap and swap markets.
    \925\ See Entity Definitions Adopting Release, 77 FR 30596.
    \926\ See Application of ``Security-Based Swap Dealer'' and 
``Major Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities, Exchange Act Release No. 
72472 (June 25, 2014, 79 FR 47278 (Aug. 12, 2014).
    \927\ See Security-Based Swap Data Repository Registration, 
Duties, and Core Principles, Exchange Act Release No. 74246 (Feb. 
11, 2015), 80 FR 14438 (Mar. 19, 2015).
    \928\ See Registration Process for Security-Based Swap Dealers 
and Major Security-Based Swap Participants, 80 FR 48964.
    \929\ See Regulation SBSR--Reporting and Dissemination of 
Security-Based Swap Information, Exchange Act Release No. 74244 
(Feb. 11, 2015), 80 FR 14563 (Mar. 19, 2015). See also Regulation 
SBSR--Reporting and Dissemination of Security-Based Swap 
Information, Exchange Act Release No. 78321 (July 14, 2016), 81 FR 
53546 (Aug. 12, 2016).
    \930\ See Security-Based Swap Transactions Connected With a Non-
U.S. Person's Dealing Activity That Are Arranged, Negotiated, or 
Executed by Personnel Located in a U.S. Branch or Office of an 
Agent; Security-Based Swap Dealer De Minimis Exception, Exchange Act 
Release No. 77104 (Feb. 10, 2016), 81 FR 8598 (Feb. 19, 2016).
    \931\ See Business Conduct Standards for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 81 FR 29960; 
Commission Statement on Certain Provisions of Business Conduct 
Standards for Security-Based Swap Dealers and Major Security-Based 
Swap Participants, Exchange Act Release No. 84511 (Oct. 31, 2018), 
83 FR 55486 (Nov. 6, 2018).
    \932\ See Trade Acknowledgment and Verification of Security-
Based Swap Transactions, 81 FR 39808.
    \933\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR 4906.
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    Under the baseline, the security-based swap and swap markets are 
dominated, both globally and domestically, by a small number of firms, 
generally entities that are, or are affiliated with, large commercial 
banks.\934\ The economic impacts of the rules and amendments being 
adopted here are expected to primarily stem from their effect on the 
relatively small number of entities that act as dealers and major 
participants in this market. These firms will become subject to the 
segregation requirements of Rule 15c3-3, as amended, or Rule 18a-4 with 
respect to security-based swap transactions. These firms--if they are a 
stand-alone broker-dealer, nonbank SBSD, or nonbank MSBSP--will also 
become subject to the capital requirements of Rules 15c3-1, 18a-1, and/
or 18a-2, as applicable, and--if they are a nonbank SBSD and MSBSP--
will also become subject to the margin requirements of Rule 18a-3.\935\ 
Many of the directly affected entities--including nonbank entities--are 
currently part of a bank holding company. Therefore, certain Federal 
Reserve regulations applicable to these entities (at the bank-holding 
company level) enter into the baseline and otherwise impact the 
analysis of the costs and benefits. Moreover, participants in the 
security-based swap and swap markets can fall under a number of other 
regulatory regimes, including those of: the prudential regulators, the 
CFTC, or numerous international regulatory authorities.\936\
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    \934\ See, e.g., ISDA Margin Survey 2012 (May 2012).
    \935\ A bank SBSD or MSBSP will be subject to the capital and 
margin requirements of its prudential regulator. See Prudential 
Regulator Margin and Capital Adopting Release, 80 FR 74840.
    \936\ See, e.g., Regulation (EU) No. 648/2012 of the European 
Parliament and of the Council on OTC derivatives, central 
counterparties and trade repositories (July 4, 2012).
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    Prior to the Dodd-Frank Act, many participants in the security-
based swap and swap markets generally were not directly supervised by 
the Commission.\937\ The Commission does not possess regulatory reports 
from many of these entities that can be used to determine the nature 
and extent of their participation in these markets. Consequently, in 
the Commission's analysis, the nature of an entity's participation in 
these markets will generally be inferred from transaction data. Market 
participants meeting the registration thresholds outlined in the 
Commission's intermediary definitions \938\ and cross-border rules are 
expected to register with the Commission.\939\ As discussed elsewhere, 
the Commission expects that up to 50 entities may register as SBSDs, 
and that up to an additional five entities may register as MSBSPs.\940\ 
In addition, the Commission estimates that, of the 50 entities expected 
to register as SBSDs, 16 are registered with the Commission as broker-
dealers.\941\ Of the 50 entities expected to register as SBSDs, 22 are 
expected to be non-U.S. persons.\942\
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    \937\ See section VI.A.1. of this release.
    \938\ See Entity Definitions Adopting Release, 77 FR 30596; 
Application of ``Security-Based Swap Dealer'' and ``Major Security-
Based Swap Participant'' Definitions to Cross-Border Security-Based 
Swap Activities, 79 FR 47278.
    \939\ Though the Commission's SBSD and MSBSP registration rules 
are effective, compliance will not be required until the Commission 
has adopted other rules applicable to these entities. See section 
III of this release discussing effective and compliance dates.
    \940\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR 4906; see also section VI.B.1.b. of this release. 
The Commission's estimate of the number of SBSDs is based on data 
obtained from the Depository Trust & Clearing Corporation 
Derivatives Repository Limited Trade Information Warehouse (``DTCC-
TIW''), which consists of data regarding the activity of market 
participants in the single-name CDS market during 2017.
    \941\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR 4906.
    \942\ See Security-Based Swap Transactions Connected With a Non-
U.S. Person's Dealing Activity That Are Arranged, Negotiated, or 
Executed by Personnel Located in a U.S. Branch or Office of an 
Agent; Security-Based Swap Dealer De Minimis Exception, 81 FR at 
8605.
---------------------------------------------------------------------------

    Certain provisions in the amendments and the rules being adopted 
today affect broker-dealers. Thus, the baseline incorporates the 
current capital and segregation requirements for broker-dealers under 
Rules 15c3-1 and 15c3-3 as well as the current state of the

[[Page 43970]]

broker-dealer industry.\943\ However, because the Exchange Act's 
definition of ``security'' did not include security-based swaps until 
the definition was amended by the Dodd-Frank Act, dealing activity in 
security-based swaps did not require registration with the Commission 
as a broker-dealer. Therefore, these entities were not subject to the 
broker-dealer capital and segregation requirements of the Commission or 
the margin requirements of the Federal Reserve and the SROs. Moreover, 
existing broker-dealer capital and segregation requirements made it 
relatively costly for broker-dealers to trade security-based 
swaps.\944\ As a result, security-based swap transactions have often 
been effected via entities that are affiliated with broker-dealers, but 
not via broker-dealers themselves.
---------------------------------------------------------------------------

    \943\ The current state of the broker-dealer industry is 
affected by, among other things, market practice and relevant SRO 
regulations, as well as margin rules set by the Federal Reserve 
(i.e., Regulation T).
    \944\ For example, because the segregation rules in the United 
States were stricter than those in the United Kingdom, prime-
brokerage services were often provided through London-based broker-
dealer affiliates. See Kenneth R. French et. al., The Squam Lake 
Report: Fixing the Financial System (2010).
---------------------------------------------------------------------------

    The Commission is adopting requirements that apply to MSBSPs. An 
entity is an MSBSP if it is not an SBSD but nonetheless either: (1) 
Maintains a ``substantial position'' in security-based swaps for any of 
the major security-based swap categories; (2) has outstanding security-
based swaps that create substantial counterparty exposure that could 
have serious adverse effects on the financial stability of the U.S. 
banking system or financial markets; or (3) is a ``financial entity'' 
that is ``highly leveraged'' relative to the amount of capital it holds 
(and that is not subject to capital requirements established by an 
appropriate federal banking agency) and maintains a ``substantial 
position'' in outstanding swaps or security-based swaps in any major 
category.\945\ As with SBSDs, such entities have previously operated 
without the Commission's direct supervision (unless separately required 
to register as a broker-dealer). Based on available transaction data, 
the Commission has previously estimated that five or fewer entities 
currently active in the security-based swap market may ultimately 
register as MSBSPs.\946\
---------------------------------------------------------------------------

    \945\ See 17 CFR. 240.3a67-1.
    \946\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4925.
---------------------------------------------------------------------------

    Because many of the entities that may register as SBSDs or MSBSPs 
are subsidiaries of U.S. and international bank holding companies, the 
baseline is affected by the relevant Federal Reserve regulations 
currently applicable at the consolidated bank holding company 
level,\947\ as well as current foreign regulations of security-based 
swaps.
---------------------------------------------------------------------------

    \947\ See 12 CFR 225, Appendix A.
---------------------------------------------------------------------------

    The amendments and rules being adopted today are primarily focused 
on security-based swap activities of stand-alone broker-dealers and 
nonbank SBSDs and MSBSPs. However, certain aspects of the amendments 
and rules being adopted will also affect the treatment of swaps such as 
interest rate swaps or CDS on broad-based security indices. For 
example, entities that are registered with the Commission as nonbank 
SBSDs but who also participate in the swap market will account for the 
swap positions in their capital calculations under the requirements 
being adopted today. Therefore, the Commission's analysis (and the 
baseline thereto) focuses on security-based swaps, but considers the 
broader swap market where appropriate.
    The Commission's analysis of the state of the current security-
based swap market is based on data obtained from the DTCC-TIW, 
particularly data regarding the activity of market participants in the 
single-name CDS market during the period from 2008 to 2017.\948\ 
Although the capital, segregation, and margin rules being adopted today 
apply to all security-based swaps, not just single-name CDS, single-
name CDS represent a significant portion of the security-based swap 
market.\949\
---------------------------------------------------------------------------

    \948\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4924-25 (describing the features of the DTCC-
TIW, including CDS transactions that are not part of the data).
    \949\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4924 n. 245 (providing a breakdown of the 
global security-based swap market and indicating that single-name 
CDSs represent approximately 59% of this market in terms of gross 
notional outstanding at the end of 2017).
---------------------------------------------------------------------------

    Although the Commission believes the DTCC-TIW data to be sufficient 
for characterizing the baseline state of the security-based swap 
market, the complexity of the U.S. regulatory structure presents 
difficulties in drawing inferences from this baseline. The security-
based swap market is dominated by a small number of global financial 
firms.\950\ These firms typically have considerable flexibility in 
structuring their activities. Such firms may choose to house their 
security-based swap dealing activities in one of several affiliated 
entities; the degree to which the rules and amendments being adopted 
today will apply will depend on these choices. If such activities are 
placed in a bank SBSD or MSBSP, such as a federally insured depository 
institution, the capital and margin rules being adopted today will not 
apply.\951\ Conversely, if these activities are instead housed in an 
affiliated (U.S.) nonbank SBSD, the requirements being adopted today 
will apply in full. Thus, the requirements' impact will depend on 
firms' choice of organizational structure, which, in turn, will depend, 
in part, on the requirements' relative attractiveness compared to those 
of other regulators.
---------------------------------------------------------------------------

    \950\ See, e.g., ISDA Margin Survey 2012.
    \951\ The capital and margin requirements adopted today apply to 
nonbank SBSDs and MSBSPs, but the segregation requirements adopted 
today apply to both bank and nonbank SBSDs and MSBSPs. Bank SBSDs 
are subject to the prudential regulators' capital and margin 
requirements. See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR 74840.
---------------------------------------------------------------------------

    Available information about the global OTC derivatives market 
suggests that swap transactions, in contrast to security-based swap 
transactions, dominate trading activities, notional amounts, and market 
values.\952\ The BIS estimates that the total notional amounts 
outstanding and gross market value of global OTC derivatives were $532 
trillion and $11.0 trillion, respectively, as of the end of 2017. Of 
these totals, the BIS estimates that foreign exchange contracts, 
interest rate contracts, and commodity contracts comprised 97% of the 
total notional amount and 92% of the gross market value. CDS, including 
index CDS, comprised 1.8% of the total notional amount and 2.9% of the 
gross market value. Equity-linked contracts, including forwards, swaps 
and options, comprised an additional 1.2% of the total notional amount 
and 5.3% of the gross market value. Because the capital, margin, and 
segregation rules being adopted today for SBSDs and MSBSPs would apply 
to dealers and participants in the security-based swap market, they are 
expected to affect a substantially smaller portion of the U.S. OTC 
derivatives market than the capital, margin, and segregation rules of 
the CFTC and the prudential regulators for swap dealers and major swap 
participants.\953\ Moreover, many of the

[[Page 43971]]

participants in these markets may choose to engage in security-based 
swap transactions through their banking subsidiaries, further reducing 
the impact of the Commission's requirements.\954\
---------------------------------------------------------------------------

    \952\ See BIS, OTC derivatives statistics at end-December 2017 
(May 2018).
    \953\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR 74840; CFTC Margin Adopting Release, 81 FR 636; CFTC 
Capital Proposing Release, 81 FR 91252. The effect of the 
Commission's capital rules on the U.S. OTC derivatives markets 
potentially will be more significant depending on the number of 
CFTC-registered dealers that also register as nonbank SBSDs, given 
the application of the capital requirements to the entire business 
of such dually-registered firms.
    \954\ Section 716 of the Dodd-Frank Act significantly limited 
the security-based swap activities of insured depository 
institutions, effectively requiring that such activities be pushed 
out into affiliated nonbank SBSDs registered with the Commission. 
Section 630 of the Consolidated and Further Continuing 
Appropriations Act of 2015 eliminated most of Section 716's 
limitations; excepting structured financed swaps, insured depository 
institutions may directly engage in security-based swap activity. 
See Public Law 113-235 Sec.  630.
---------------------------------------------------------------------------

1. Market Participants
    Transaction data from the DTCC-TIW indicates that security-based 
swap dealing activity is concentrated among a few dozen entities. In 
addition to these entities, thousands of other participants appear as 
counterparties to security-based swaps in the Commission's sample, and 
include, but are not limited to, investment companies, pension funds, 
private hedge funds, sovereign entities, and industrial companies. A 
detailed discussion of security-based swap market participants can be 
found in the Commission's release regarding applications with respect 
to statutory disqualifications.\955\
---------------------------------------------------------------------------

    \955\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4925-26.
---------------------------------------------------------------------------

a. Dealing Structures
    SBSDs use a variety of business models and legal structures to 
engage in dealing business for a variety of legal, tax, strategic, and 
business reasons.\956\ Dealers may use a variety of structures in part 
to reduce risk and enhance credit protection based on the particular 
characteristics of each entity's business.
---------------------------------------------------------------------------

    \956\ See Application of ``Security-Based Swap Dealer'' and 
``Major Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities; Republication, 79 FR at 
47283.
---------------------------------------------------------------------------

    Bank and nonbank holding companies may use subsidiaries to deal 
with counterparties. Further, dealers may rely on multiple sales forces 
to originate security-based swap transactions. For example, a U.S. bank 
dealer may use a sales force in its U.S. home office to originate 
security-based swap transactions in the United States and use separate 
sales forces spread across foreign branches to originate security-based 
swap transactions with counterparties in foreign markets.
    In some situations, an entity's performance under a security-based 
swap transaction may be supported by a guarantee provided by an 
affiliate. More generally, guarantees may take the form of a blanket 
guarantee of an affiliate's performance on all security-based swap 
contracts, or a guarantee may apply only to a specific transaction or 
counterparty. Guarantees may give counterparties to the dealer direct 
recourse to the holding company or another affiliate for its dealer-
affiliate's obligations under security-based swap transactions for 
which that dealer-affiliate acts as counterparty.

[[Page 43972]]

[GRAPHIC] [TIFF OMITTED] TR22AU19.000

b. Security-Based Swap Market Participant Domiciles
    As depicted in Figure 1, domiciles of new accounts participating in 
the market have shifted over time. It is unclear whether these shifts 
represent changes in the types of participants active in this market, 
changes in reporting, or changes in transaction volumes in particular 
underliers. For example, the percentage of new entrants that are 
foreign accounts increased from 24.4% in the first quarter of 2008 to 
32.3% in the last quarter of 2017, which may reflect an increase in 
participation by foreign account holders in the security-based swap 
market, though the total number of new entrants that are foreign 
accounts decreased from 112 in the first quarter of 2008 to 48 in the 
last quarter of 2017.\958\ Additionally, the percentage of the subset 
of new entrants that are foreign accounts managed by U.S. persons 
increased from 4.6% in the first quarter of 2008 to 16.8% in the last 
quarter of 2017, and the absolute number rose from 21 to 25, which also 
may reflect more specifically the flexibility with which market 
participants can restructure their market participation in response to 
regulatory intervention, competitive pressures, and other stimuli.\959\ 
At the same time, apparent changes in the percentage of new accounts 
with foreign domiciles may also reflect improvements in reporting to 
the DTCC-TIW by market participants, an increase in the percentage of 
transactions between U.S. and non-U.S. counterparties, and/or increased 
transactions in single-name CDS on U.S. reference entities by foreign 
persons.\960\
---------------------------------------------------------------------------

    \957\ Following publication of the Warehouse Trust Guidance on 
CDS data access, the DTCC-TIW surveyed market participants, asking 
for the physical address associated with each of their accounts 
(i.e., where the account is organized as a legal entity). This 
address is designated the registered office location by the DTCC-
TIW. When an account does not report a registered office location, 
the Commission has assumed that the settlement country reported by 
the investment adviser or parent entity to the fund or account is 
the place of domicile. This treatment assumes that the registered 
office location reflects the place of domicile for the fund or 
account.
    \958\ These estimates were calculated by Commission staff using 
DTCC-TIW data.
    \959\ See Charles Levinson, U.S. banks moved billions in trades 
beyond the CFTC's reach, Reuters, Aug. 21, 2015, available at http://www.reuters.com/article/2015/08/21/usa-banks-swaps-idUSL3N10S57R20150821. The estimates of 21 and 25 were calculated by 
Commission staff using DTCC-TIW data.
    \960\ The available data do not include all security-based swap 
transactions but only transactions in single name CDS that involve 
either: (1) At least one account domiciled in the United States 
(regardless of the reference entity); or (2) single-name CDS on a 
U.S. reference entity (regardless of the domicile of the 
counterparties).

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

[[Page 43973]]

[GRAPHIC] [TIFF OMITTED] TR22AU19.001

c. Security-Based Swap Market: Levels of Security-Based Swap Trading 
Activity
    As noted above, firms that act as dealers play a central role in 
the security-based swap market. Based on an analysis of 2017 single-
name CDS data from the DTCC-TIW, accounts of those firms that are 
likely to exceed the security-based swap dealer de minimis thresholds 
and trigger registration requirements intermediated transactions with a 
gross notional amount of approximately $2.9 trillion, approximately 55% 
of which was intermediated by the top five dealer accounts.\961\ A 
commenter stated that security-based swap dealing activity is largely 
concentrated in U.S. and foreign banks, foreign dealers, OTC 
derivatives dealers, and ``stand-alone SBSDs,'' and that stand-alone 
broker-dealers are not significant participants.\962\
---------------------------------------------------------------------------

    \961\ The Commission staff analysis of DTCC-TIW transaction 
records indicates that approximately 99% of single-name CDS price-
forming transactions in 2017 involved an ISDA-recognized dealer.
    \962\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    These dealers transact with hundreds or thousands of 
counterparties. Approximately 21% of accounts of firms expected to 
register as SBSDs and observable in the DTCC-TIW have entered into 
security-based swaps with over 1,000 unique counterparty accounts as of 
year-end 2017.\963\ Another 25% of these accounts transacted with 500 
to 1,000 unique counterparty accounts; 29% transacted with 100 to 500 
unique accounts; and 25% of these accounts intermediated security-based 
swaps with fewer than 100 unique counterparties in 2017. The median 
dealer account transacted with 495 unique accounts (with an average of 
approximately 570 unique accounts). Non-dealer counterparties 
transacted almost exclusively with these dealers. The median non-dealer 
counterparty transacted with two dealer accounts (with an average of 
approximately 3 dealer accounts) in 2017.
---------------------------------------------------------------------------

    \963\ Many dealer entities and financial groups transact through 
numerous accounts. Given that individual accounts may transact with 
hundreds of counterparties, the Commission infers that entities and 
financial groups may transact with at least as many counterparties 
as the largest of their accounts.
---------------------------------------------------------------------------

    Figure 2 describes the percentage of global, notional transaction 
volume in North American corporate single-name CDS reported to the 
DTCC-TIW from January 2008 through December 2017, separated by whether 
transactions are between two ISDA-recognized dealers (interdealer 
transactions) or whether a transaction has at least one non-dealer 
counterparty.
    Figure 2 also shows that the portion of the notional volume of 
North American corporate single-name CDS represented by interdealer 
transactions has remained fairly constant through 2015 before falling 
from approximately 72% in 2015 to approximately 40% in 2017. This fall 
corresponds to the availability of clearing to non-dealers. Interdealer 
transactions continue to represent a significant portion of trading 
activity even as notional volume has declined over the past 10 
years,\964\ from

[[Page 43974]]

more than $6 trillion in 2008 to less than $700 billion in 2017.\965\
---------------------------------------------------------------------------

    \964\ The start of this decline predates the enactment of the 
Dodd-Frank Act and the proposal of security-based swap rules 
thereunder.
    \965\ This estimate is lower than the gross notional amount of 
$7.2 trillion noted above as it includes only the subset of single-
name CDS referencing North American corporate documentation, as 
discussed above.
---------------------------------------------------------------------------

    Against this backdrop of declining North American corporate single-
name CDS activity, about half of the trading activity in North American 
corporate single-name CDS reflected in the analyzed dataset was between 
counterparties domiciled in the United States and counterparties 
domiciled abroad, as shown in Figure 3 below. Using the self-reported 
registered office location of the DTCC-TIW accounts as a proxy for 
domicile, Commission staff estimates that only 12% of the global 
transaction volume by notional volume between 2008 and 2017 was between 
two U.S.-domiciled counterparties, compared to 49% entered into between 
one U.S.-domiciled counterparty and a foreign-domiciled counterparty 
and 39% entered into between two foreign-domiciled counterparties.\966\
---------------------------------------------------------------------------

    \966\ For purposes of this discussion, Commission staff has 
assumed that the registered office location reflects the place of 
domicile for the fund or account, but it is possible that this 
domicile does not necessarily correspond to the location of an 
entity's sales or trading desk. See Application of Certain Title VII 
Requirements to Security-Based Swap Transactions Connected With a 
Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or 
Executed by Personnel Located in a U.S. Branch or Office or in a 
U.S. Branch or Office of an Agent, Exchange Act Release No. 74834 
(Apr. 29, 2015), 80 FR 27452 (May 13, 2015).
---------------------------------------------------------------------------

    If one considers the number of cross-border transactions instead 
from the perspective of the domicile of the corporate group (e.g., by 
classifying a foreign bank branch or foreign subsidiary of a U.S. 
entity as domiciled in the United States), the percentages shift 
significantly. Under this approach, the fraction of transactions 
entered into between two U.S.-domiciled counterparties increases to 
34%, and to 51% for transactions entered into between a U.S.-domiciled 
counterparty and a foreign-domiciled counterparty.
    By contrast, the proportion of activity between two foreign-
domiciled counterparties drops from 39% to 15%. This change in 
respective shares based on different classifications suggests that the 
activity of foreign subsidiaries of U.S. firms and foreign branches of 
U.S. banks accounts for a higher percentage of security-based swap 
activity than the activity of U.S. subsidiaries of foreign firms and 
U.S. branches of foreign banks. It also demonstrates that financial 
groups based in the United States are involved in an overwhelming 
majority (approximately 85%) of all reported transactions in North 
American corporate single-name CDS.
    Financial groups based in the United States are also involved in a 
majority of interdealer transactions in North American corporate 
single-name CDS. Of the 2017 transactions in North American corporate 
single-name CDS between two ISDA-recognized dealers and their branches 
or affiliates, 94% of transaction notional volume involved at least one 
account of an entity with a U.S. parent.
    In addition, a majority of North American corporate single-name CDS 
transactions occur in the interdealer market or between dealers and 
foreign non-dealers, with the remaining portion of the market 
consisting of transactions between dealers and U.S.-person non-dealers. 
Specifically, 60% of North American corporate single-name CDS 
transactions involved either two ISDA-recognized dealers or an ISDA-
recognized dealer and a foreign non-dealer. Approximately 39% of such 
transactions involved an ISDA-recognized dealer and a U.S.-person non-
dealer.

[[Page 43975]]

[GRAPHIC] [TIFF OMITTED] TR22AU19.002

d. Open Positions
    Based on analysis of data from the DTCC-TIW, Table 1 describes the 
gross notional amount of open positions in non-cleared single-name CDS 
between different types of market participants (i.e., ``accounts'') at 
the end of 2017. Gross notional amount of open positions between two 
types of market participants is the sum of the notional amounts in U.S. 
dollars of all outstanding CDS contracts between the two types of 
market participants.
    At the end of 2017, the gross notional amount of open positions 
between ISDA-recognized dealers far exceeded the gross notional amount 
of open positions between all other types of market participants. In 
particular, the gross notional amount of open positions between ISDA-
recognized dealers (``interdealer'') was approximatively $1.25 trillion 
in non-cleared single-name CDS contracts and $557 billion in non-
cleared index CDS contracts. The gross notional amount of open 
positions other than interdealer was approximatively $525 billion in 
non-cleared single-name CDS contracts and just over $1 trillion in non-
cleared index CDS contracts.
    Banks and private funds were among the most active market 
participants that were not ISDA-recognized dealers. The gross notional 
amount of open positions between ISDA-recognized dealers and banks was 
approximatively $184 billion in non-cleared single-name CDS contracts 
and $113 billion in non-cleared index CDS contracts. Similarly, the 
gross notional amount of open positions between ISDA-recognized dealers 
and private funds was approximatively $176 billion in non-cleared 
single-name CDS contracts and $410 billion in non-cleared index CDS 
contracts.

Table 1--Gross Notional Amount of Dealer-Intermediated Open Positions in
                   Non-Cleared CDs at the End of 2017
                       [Billions of U.S. dollars]
------------------------------------------------------------------------
                                            Single-name
                                                CDS          Index CDS
------------------------------------------------------------------------
ISDA-Recognized Dealers.................           1,252             557
Banks...................................             184             113
Insurance Companies.....................              20              30
Private Funds...........................             176             410
Registered Investment Companies.........              24              62
Non-financial Corporations..............              <1              <1
DFA Special Entities....................               4               4
Foreign Sovereign.......................               6              18
Finance Companies.......................               1              <1
Others..................................             100             187

[[Page 43976]]

 
Others/Unclassified.....................              <1          188.57
------------------------------------------------------------------------

    Dealing entities that are likely to register as SBSDs generally 
have significant open positions in the single-name CDS market. For each 
dealing entity that is expected to register as an SBSD and for which 
DTCC-TIW positions data are available as of the end of September 2017, 
the Commission identifies the cleared and non-cleared single-name CDS 
positions that the entity holds against its counterparties. The 
Commission then calculates the aggregate gross notional amount of each 
entity's open single-name CDS positions. For these 23 dealing entities, 
the mean, median, maximum, and minimum aggregate gross notional amount 
are respectively, $219 billion, $115 billion, $902 billion, and $3 
billion. The standard deviation in aggregate gross notional amounts is 
$242 billion.
    These entities also engage in dealing activity in the swap market. 
The aggregate gross notional amounts of their open positions in the 
swap market have a mean of $11,725 billion, a median of $10,244 
billion, a minimum of $72 billion, a maximum of $45,264 billion, and a 
standard deviation of $10,496 billion.\967\ To gauge the relative 
significance of single-name CDS open positions, the Commission 
expresses each entity's single-name CDS aggregate gross notional amount 
as a percentage of its combined swaps and single-name CDS aggregate 
gross notional amount. The mean, median, maximum, and minimum 
percentages are respectively 1.34%, 1.23%, 0.03%, and 5.39%. The 
standard deviation is 1.13%.
---------------------------------------------------------------------------

    \967\ The Commission obtained these entities' open positions in 
interest rate swaps, currency swaps, and index CDS from the CFTC.
---------------------------------------------------------------------------

e. Cross-Market Participation
    The numerous financial markets are integrated, often attracting the 
same market participants that trade across corporate bond, swap, and 
security-based swap markets, among others. In a prior release, the 
Commission discussed the hedging opportunities across the single-name 
CDS and index CDS markets and how such hedging opportunities in turn 
influence the extent to which participants that are active in the 
single-name CDS market are likely to be active in the index CDS 
market.\968\
---------------------------------------------------------------------------

    \968\ See Applications by Security-Based Swap Dealers or Major 
Security-Based Swap Participants for Statutorily Disqualified 
Associated Persons to Effect or Be Involved in Effecting Security-
Based Swaps, 84 FR at 4927.
---------------------------------------------------------------------------

2. Counterparty Credit Risk Mitigation
    In contrast to the securities markets, counterparty credit risk 
represents a major source of risk to participants in the OTC security-
based swap market.\969\ For example, in a CDS transaction, the first 
party, the protection buyer, agrees to pay the second party, the 
protection seller, a periodic premium for a set time period in exchange 
for the protection seller agreeing to pay some amount in the event of 
the occurrence of a given credit event during the same period. The 
ongoing reciprocal obligations of the parties in such transactions 
expose each to ongoing reciprocal counterparty credit risk.
---------------------------------------------------------------------------

    \969\ See Robert R. Bliss and Robert S. Steigerwald, Derivatives 
Clearing and Settlement: A Comparison of Central Counterparties and 
Alternative Structures, Economic Perspectives 30, no. 4.
---------------------------------------------------------------------------

    Currently, security-based swap market participants mitigate 
counterparty credit risk by: (1) Using a central counterparty (``CCP'') 
such as a clearing agency or DCO to clear a trade; (2) using 
standardized netting agreements between counterparties; (3) performing 
portfolio compression to minimize counterparty exposure; and (4) 
requiring margin (i.e., collateral). Below is a brief discussion of the 
extent to which market participants make use of each of these practices 
in the CDS market, which comprises the majority of security-based swap 
transactions.
a. Clearing
    Central clearing through a CCP provides a method for dealing with 
the counterparty credit risk inherent in security-based swap 
transactions. Where a clearing agency provides CCP services, clearance 
and settlement of security-based swap contracts replaces bilateral 
counterparty exposures with exposures against the clearing agency 
providing CCP services.\970\ Using a CCP to centrally manage credit 
risk can reduce the monitoring costs and counterparty credit risk of 
both parties to the original transaction. A centralized clearing 
structure, when widely adopted, also maximizes the opportunities for 
netting offsetting contracts thus reducing collateral requirements in 
centrally-cleared transactions. It can also improve price discovery and 
financial stability
---------------------------------------------------------------------------

    \970\ See Standards for Covered Clearing Agencies, 81 FR 70786.
---------------------------------------------------------------------------

    Although central clearing offers a number of advantages, it is not 
without limitations. For example, ``bespoke'' or otherwise illiquid 
contracts are not amenable to clearing. Widespread adoption of central 
clearing in security-based swap markets would raise the systemic 
importance of CCPs.
    The ratio of the aggregate notional amount of outstanding CDS 
contracts cleared through CCPs to the aggregate notional amount of all 
outstanding CDS contracts has been increasing steadily since 2010.\971\ 
In 2017, this ratio peaked at 27.5%, representing a significant 
increase over 2016 (21.8%), 2015 (17.1%), 2014 (14.6%), 2013 (13.13%), 
2012 (9.75%), 2011 (9.55%), and 2010 (7.36%).\972\ Limiting attention 
to just single-name CDS contracts (i.e., excluding index CDS and multi-
name non-index CDS) provides a less consistent picture. While the 
percentage of single-name CDS contracts that were cleared has increased 
from 36% in 2010 to 40% in 2017, the upward trend has not been uniform, 
with a local peak in 2011 (46%) followed by a decline in

[[Page 43977]]

2012 (45%) and 2013 (37%), an increase in 2014 (43.5%) and 2015 (48%), 
and then another decline in 2016 (47%) and 2017 (40%).\973\
---------------------------------------------------------------------------

    \971\ 2010 is the first year the BIS' OTC derivatives market 
surveys separate out CDS market activity by counterparty, including 
CCPs. See BIS, OTC derivatives market activity in the second half of 
2010 (May 2011).
    \972\ See BIS, OTC derivatives statistics at end-December 2017 
(May 2018), BIS, OTC derivatives statistics at end-December 2016 
(May 2017), BIS, OTC derivatives statistics at end-December 2015 
(May 2016); BIS, OTC derivatives statistics at end-December 2014 
(Apr. 2015); BIS, OTC derivatives statistics at end-December 2013 
(May 2014); BIS, OTC derivatives statistics at end-December 2012 
(May 2013); BIS, OTC derivatives statistics at end-December 2011 
(May 2012); BIS, OTC derivatives market activity in the second half 
of 2010 (May 2011). For each year, the original ratio is obtained 
from Table 4 (replaced by Table D10.1 beginning with 2015) of the 
statistical releases and is calculated by dividing the CCPs' 
outstanding aggregate notional amount by the total outstanding 
aggregate notional amount, with the result divided by two (a 
contract submitted for clearing to a CCP is replaced, post-novation, 
by two contracts (with the same notional value as the original 
contract) between the CCP and each of the original counterparties).
    \973\ These percentages are obtained from Table 4 (replaced by 
Table D10.1 beginning with 2015) of the statistical releases, by 
dividing the CCPs' outstanding aggregate notional amount for single-
name CDS by the CCPs' outstanding aggregate notional amount for all 
CDS contracts.
---------------------------------------------------------------------------

b. Netting Agreements
    Netting agreements between counterparties can mitigate counterparty 
risk by allowing the positive exposure of counterparty A to 
counterparty B in a transaction to offset the positive exposure of 
counterparty B to counterparty A in another transaction. Such offsets 
are made possible through master netting agreements (``MNAs'').\974\
---------------------------------------------------------------------------

    \974\ Under the ISDA Master Agreement, netting can take two 
forms: (1) Settlement (or payment) netting, which is the process of 
combining offsetting cash flow obligations between solvent 
counterparties into a single net payment; and (2) close-out netting, 
which is the process of terminating and netting the marked-to-market 
values of all outstanding transactions when one of the 
counterparties becomes insolvent. The former is optional, while the 
latter is a contractual obligation under the ISDA Master Agreement.
---------------------------------------------------------------------------

    One way to measure the degree of netting in a set of positions is 
with the ``net-to-gross ratio,'' the ratio of the absolute value of the 
sum of the marked-to-market values of the positions after all product-
specific netting agreements (cross-product agreements are excluded) are 
given effect, to the sum of the positions' absolute marked-to-market 
values. The more the gains on some positions offset losses on others, 
the lower the ratio. On an aggregate basis (i.e., across all market 
participants), the net-to-gross ratio for security-based swaps 
positions was 27% in 2015. This is a significant increase compared to 
2014 (23%) and 2013 (21%), and a marginal increase compared to 2012 
(24%) and 2011 (26%).\975\
---------------------------------------------------------------------------

    \975\ See BIS, OTC derivatives statistics at end-December 2015; 
BIS, OTC derivatives statistics at end-December 2014; BIS, OTC 
derivatives statistics at end-December 2013.
---------------------------------------------------------------------------

    On a disaggregated basis, there is substantial variation in the 
degree of netting across different market participants. For instance, 
in 2015, the ratio of net market value to gross market value was as low 
as 18% and 20% for CCPs and dealers, respectively, and as high as 78% 
for insurance companies.\976\ These differences in the net-to-gross 
ratio across different types of market participants reflect differences 
in their participation in the security-based swap market.
---------------------------------------------------------------------------

    \976\ See BIS, OTC derivatives statistics at end-December 2015; 
BIS, OTC derivatives statistics at end-December 2014; BIS, OTC 
derivatives statistics at end-December 2013.
---------------------------------------------------------------------------

c. Portfolio Compression
    Portfolio compression reduces counterparty risk through the 
termination of early redundant derivatives trades without changing the 
net exposure of any of the counterparties. The amount of redundant 
notional amount eliminated through portfolio compression declined 
steadily over the years, from more than $30 trillion in 2008 \977\ and 
more than $15 trillion in 2009, to $9.8 trillion in 2010, $6.4 trillion 
in 2011, and $4.1 trillion in 2012.\978\
---------------------------------------------------------------------------

    \977\ See TriOptima, triReduce Statistics, available at http://www.trioptima.com/resource-center/statistics/triReduce.html. The 
amount of portfolio compression as reported by TriOptima, a provider 
of third-party portfolio compression services.
    \978\ ISDA, OTC Derivatives Market Analysis Year-End 2012 (June 
2013, rev. Aug. 9, 2013). 2012 is the last year when ISDA reported 
aggregate compression statistics.
---------------------------------------------------------------------------

d. Margin
    Participants in the security-based swap market may mitigate 
counterparty risk by collecting collateral through margin assessment 
under an active collateral agreement.\979\ The Commission lacks 
regulatory data on the use of collateral by participants in the 
security-based swap and swap markets.\980\ Thus, the Commission's 
quantitative understanding of margin practices in these markets is 
largely based on the ISDA's annual margin surveys. These surveys 
suggest that: (1) The use of collateral has generally increased over 
the last decade; (2) collateral practices vary by type of market 
participant and counterparty; (3) segregation of collateral is not 
widespread; and (4) use of central clearing is increasing.\981\
---------------------------------------------------------------------------

    \979\ A collateral agreement specifies the terms for the use of 
collateral to support a bilateral derivatives trade. According to 
the ISDA, a collateral agreement is active when: (1) There is an 
open exposure with active trades beneath it, regardless of whether 
collateral has been collected or delivered for any of the trades; 
and (2) collateral has actually been collected or delivered. See 
ISDA Margin Survey 2015. In contrast, inactive collateral agreements 
are those that have been executed and have no current outstanding 
exposure, or those that show no current activity but may be used to 
trade at some point in the future. Cleared OTC derivatives trades 
are generally subject to collateral agreements specified by the CCP.
    \980\ In the proposing release, the Commission requested data 
and information from commenters to assist it in analyzing the 
economic consequences of the proposed rules; no additional data was 
provided. See Capital, Margin, and Segregation Proposing Release, 77 
FR at 70300. See also Capital, Margin, and Segregation Comment 
Reopening, 83 FR at 53019-20.
    \981\ The discussion in this section of the release is based on 
the ISDA Margin Survey 2009 (Apr. 15, 2009), ISDA Margin Survey 2010 
(Aug. 15, 2010), ISDA Margin Survey 2011 (Apr. 14, 2011), ISDA 
Margin Survey 2012, ISDA Margin Survey 2013 (June 21, 2013), ISDA 
Margin Survey 2014 (Apr. 10, 2014), and ISDA Margin Survey 2015. The 
format of these reports has not remained constant over time. 
Consequently, certain statistics are only available in the earlier 
surveys.
---------------------------------------------------------------------------

    The statistics in the margin surveys suggest that the use of 
collateral in security-based swap and swap transactions generally 
increased in the period from the end of 2002 through the end of 
2012.\982\ At the end of 2002, 53% of fixed income derivatives 
transactions and 30% of credit derivatives transactions were subject to 
a credit support agreement (``CSA''); by 2009, the percentages were 63% 
and 71%, respectively.\983\ By 2012, similar statistics indicated that 
79% of fixed income derivative transactions and 83% of credit 
derivative transactions were subject to CSAs.\984\ With respect to non-
cleared transactions, the 2012 percentages of fixed income derivative 
trades and credit derivative trades subject to a CSA were 73% and 79%, 
respectively.
---------------------------------------------------------------------------

    \982\ See ISDA Margin Survey 2009 at Table 4.2; ISDA Margin 
Survey 2010 at Table 3.3; ISDA Margin Survey 2011 at Table 3.2; ISDA 
Margin Survey 2012 at Table 3.2; ISDA, ISDA Margin Survey 2013 at 
Table 3.4.
    \983\ See ISDA Margin Survey 2009 at Table 4.2. This table 
reports the fraction of transactions (cleared and non-cleared) 
subject to a CSA.
    \984\ See ISDA Margin Survey 2013 at Table 3.4. Due to 
methodological changes, the 2002 through 2009 statistics and the 
2012 statistics are not directly comparable. Comparable statistics 
were not reported in more recent surveys.
---------------------------------------------------------------------------

    While the industry margin surveys suggest that the prevalence of 
CSAs in derivative transactions increased over time, they provide less 
recent information about collateralization levels and their cross-
sectional characteristics. The ISDA reports that, in 2010, an estimated 
73% of aggregate OTC derivatives exposures were collateralized.\985\ 
According to the ISDA, collateralization levels in 2010 varied 
considerably depending on the type of counterparty.\986\ 
Collateralization of exposures to sovereigns was very limited (18%). 
Collateralization of exposures to hedge funds was much more extensive 
(160%),\987\ reflecting a greater tendency to collect initial margin 
from those participants. In between these extremes were 
collateralization levels of current

[[Page 43978]]

exposures to mutual funds (100%), banks and broker-dealers (79%), 
pension funds (71%), insurance companies (68%), energy and/or commodity 
firms (37.2%), non-financial firms (37%), and special purpose vehicles 
(19%). The statistics for 2009 reveal a similar pattern.\988\ These 
collateralization level patterns are consistent with the following 
stylized facts: (1) A counterparty's exposure to a special purpose 
vehicle is generally not covered to any significant extent; (2) 
counterparties do not generally require initial margin from dealers, 
banks, pension funds, and insurance companies, but will collect 
variation margin in certain cases or on an ad-hoc basis; (3) 
counterparties require hedge funds to post variation margin and initial 
margin; (4) counterparties require variation margin from mutual funds, 
but generally do not require mutual funds to post initial margin; (5) 
non-financial end-users are generally not required to post margin.\989\
---------------------------------------------------------------------------

    \985\ See ISDA Margin Survey 2011 at Table 3.3. Statistics based 
on derivatives type (e.g., credit derivatives) were not provided. 
More recent ISDA margin surveys do not report these statistics.
    \986\ In this discussion, collateralization level means the 
ratio of collateral to current exposure.
    \987\ The 160% collateralization level for hedge funds indicates 
that on average, current exposures to hedge funds were fully 
collateralized and that some additional margin covering potential 
future exposures (i.e., initial margin) was also collected.
    \988\ See ISDA Margin Survey 2010 at Table 3.3.
    \989\ See generally ISDA Margin Survey 2011; ISDA Margin Survey 
2012. The results of the surveys, however, could be substantially 
different if limited only to U.S. participants, because the data 
contained in the surveys is global. See id. For example, 47% of the 
institutions responding to the ISDA margin survey published in 2012 
were based in Europe, the Middle East, or Africa, and 31% were based 
in the Americas. See ISDA Margin Survey 2012 at Chart 1.1.
---------------------------------------------------------------------------

    An ISDA margin survey provides some evidence about the asset 
composition of collateral. According to this survey, in 2014, of the 
collateral received/(delivered) by survey respondents to cover initial 
margin, 55.4%/(64.7%) was in cash, 24.2%/(11.1%) was in government 
securities, and the rest was in other securities. In addition, of the 
collateral received/(delivered) to cover variation margin, 77.2%/
(75.3%) was in cash, 16.3%/(21.4%) was in government securities, and 
the rest was in other securities. Finally, of the collateral received/
(delivered) to cover commingled initial and variation margin, 71.7%/
(76.4%) was in cash, 12%/(20.9%) was in government securities, and the 
rest was in other securities.\990\
---------------------------------------------------------------------------

    \990\ See ISDA Margin Survey 2015 at Table 7.
---------------------------------------------------------------------------

    The margin surveys also suggest that collateral for non-cleared 
derivatives is generally not segregated. According to an ISDA margin 
survey, where initial margin is collected, ISDA members reported that 
most (72%) was commingled with variation margin and not segregated, and 
only 5% of the amount received was segregated with a third-party 
custodian.\991\
---------------------------------------------------------------------------

    \991\ See ISDA Margin Survey 2012. The survey also notes that 
while the holding of the independent amount (initial margin) and 
variation margin together continued to be the industry standard both 
contractually and operationally, the ability to segregate had been 
made increasingly available to counterparties over the previous 
three years on a voluntary basis, and had led to 26% of the 
independent amounts received and 27.8% of independent amounts 
delivered being segregated in some respects. See id. at 10. See also 
ISDA, Independent Amounts, Release 2.0 (Mar. 1, 2010).
---------------------------------------------------------------------------

    Finally, an ISDA margin survey also reports a significant increase 
in the number of active collateral agreements for client's cleared 
trades. Specifically, 2014 saw a 67.1% increase in collateral 
agreements covering client's cleared trades over the previous 
year.\992\ This significant increase is most likely due to the 
introduction of the clearing mandates in 2013 under the Dodd-Frank Act 
in the US.\993\
---------------------------------------------------------------------------

    \992\ See ISDA Margin Survey 2015. The ISDA also reported that 
the number of active agreements for house cleared trades was 258 for 
2014, which was a decline of 21.3% compared to 2013.
    \993\ The CFTC mandate regarding clearing of certain index CDS 
came into effect on March 11, 2013. See Clearing Requirement 
Determination Under Section 2(h) of the CEA, 77 FR 74284 (Dec. 13, 
2012).
---------------------------------------------------------------------------

    In response to a commenter's suggestion,\994\ the Commission has 
supplemented its analysis of the ISDA margin surveys with an analysis 
of initial margins estimated for dealer CDS positions. For each dealing 
entity that is expected to register as an SBSD, the Commission uses 
DTCC-TIW data as of the end of September 2017 to identify the single-
name and index CDS positions that the entity holds against its 
counterparties. For each dealing entity, the Commission then calculates 
the initial margin amount \995\ from its single-name and index CDS 
positions with each counterparty by using historical CDS price 
movements \996\ from five one-year samples: 2008, 2011, 2012, 2017, and 
2018. The Commission believes the 2008, 2011, and 2012 samples are 
likely to capture stressed market conditions, while the 2017 and 2018 
samples are likely to capture normal market conditions. For each sample 
and each dealing entity, the Commission then calculates the risk margin 
amount (i.e., initial margin amounts) of its cleared and non-cleared 
CDS positions by summing up the initial margins calculated above across 
all counterparties. Table 2 Panel A below reports a number of 
statistics, such as minimum, maximum, mean, standard deviation, and the 
quartiles of the distribution, that summarize the distribution of the 
dealers' risk margin amounts for each sample.
---------------------------------------------------------------------------

    \994\ See SIFMA 11/19/2018 Letter (suggesting that the 
Commission provide data or analysis to support its proposed 8% 
margin factor, which depended, in part, on the total amount of 
initial margin calculated by the nonbank SBSD with respect to 
cleared and non-cleared security-based swaps).
    \995\ The Commission calculates initial margin using the 
methodology described in Darrell Duffie, Martin Scheicher, and 
Guillaume Vuillemey, Central Clearing and Collateral Demand, Journal 
of Financial Economics 116, no. 2, 237-256 (May 2015).
    \996\ These price movements are derived from historical pricing 
data on single-name CDS contracts. The data are purchased from ICE 
Data Services.
---------------------------------------------------------------------------

    The Commission can make a number of observations from Table 2 Panel 
A. The risk margin amounts vary across the five annual samples. Risk 
margin amounts tend to be larger in 2008 and 2017, but smaller in 2011, 
2012, and 2018. For example, the mean risk margin amount in 2008 and 
2017 are $768 million and $507 million, respectively, while the mean 
risk margin amount in 2011, 2012, and 2018 range between $260 and $329 
million. The risk margin amounts also vary across dealing entities, 
suggesting that these entities may hold single-name and index CDS 
positions with different levels of risk. For example, in the 2008 
sample, risk margin amounts range from a minimum of $9.89 million to a 
maximum of $3,302.12 million. The variation in risk margin amounts 
across dealing entities, as measured by the standard deviation, also 
changes across the five annual samples. The standard deviation is 
higher in 2008 and 2017 and lower in 2011, 2012, and 2018.
    The Commission repeats the preceding analysis using only 
interdealer CDS positions (i.e., calculating risk margin amounts for 
single-name and index CDS positions held by a dealing entity against 
another dealing entity). Table 2 Panel B reports statistics summarizing 
the distribution of these interdealer risk margin amounts for each 
sample. A key result from Table 2 Panel B is that interdealer risk 
margin amounts are significantly smaller than risk margin amounts based 
on single-name and index CDS positions held by a dealer against all its 
counterparties. For example, in Table 2 Panel A, the mean risk margin 
amount ranges between $260 million and $768 million, while in Table 2 
Panel B, the mean risk margin amount ranges between $8.4 million and 
$23.1 million. Interdealer risk margin amounts tend to be larger in 
2008 and 2017, but smaller in 2011, 2012, and 2018. Interdealer risk 
margin amounts also vary across different pairs of dealing entities, 
suggesting that these entities may hold single-name and index CDS 
positions with different levels of risk. The variation in interdealer 
risk margin amounts across different pairs of dealing entities, as 
measured by the standard deviation, also changes across the five annual 
samples.

[[Page 43979]]

    Table 2: Risk Margin Amounts. This table reports summary statistics 
of risk margin amounts for the single-name and index CDS positions held 
by dealers against all counterparties (Panel A) and risk margin amounts 
for the single-name and index CDS positions held by dealers against 
other dealers (Panel B) as of the end of September 2017. Risk margin 
amounts are in millions of dollars. The summary statistics are Min 
(minimum), P25 (first quartile/25th percentile), P50 (second quartile/
50th percentile), P75 (third quartile/75th percentile), Max (maximum), 
Mean, and Std (standard deviation).

 Panel A: Risk Margin Amounts for Single-Name and Index CDS Positions Held by Dealers Against All Counterparties
----------------------------------------------------------------------------------------------------------------
                   Year                        Min       P25       P50       P75       Max      Mean       Std
----------------------------------------------------------------------------------------------------------------
2008......................................      9.89    255.73    488.50    673.46   3302.12    767.76    817.96
2011......................................      7.43     95.46    188.56    449.53   1377.82    329.30    381.85
2012......................................      6.67     80.60    154.86    321.10   1137.43    260.05    295.31
2017......................................      1.39    138.58    385.75    600.70   1487.74    507.48    472.19
2018......................................      2.82     95.99    204.94    376.68   1380.57    316.00    350.30
----------------------------------------------------------------------------------------------------------------

   Panel B: Risk Margin Amounts for Single-Name and Index CDS Positions Held by Dealers Against Other Dealers
----------------------------------------------------------------------------------------------------------------
                   Year                        Min       P25       P50       P75       Max      Mean       Std
----------------------------------------------------------------------------------------------------------------
2008......................................      0.01      3.35     10.00     29.98    170.89     21.81     28.39
2011......................................      0.00      1.27      3.28     10.56    100.38     10.32     16.56
2012......................................      0.00      0.92      3.34      8.97     64.82      8.45     12.43
2017......................................      0.00      0.50      3.08     17.23    528.61     23.07     60.24
2018......................................      0.00      0.75      3.83     11.84     67.07      9.46     14.07
----------------------------------------------------------------------------------------------------------------

3. Global Regulatory Efforts
    In 2009, the G20 leaders--whose membership includes the United 
States, 18 other countries, and the European Union--addressed global 
improvements in the OTC derivatives market. They expressed their view 
on a variety of issues relating to OTC derivatives contracts. In 
subsequent summits, the G20 leaders have returned to OTC derivatives 
regulatory reform and encouraged international consultation in 
developing standards for these markets.\997\
---------------------------------------------------------------------------

    \997\ See, e.g., The G20 Toronto Summit Declaration (June 27, 
2010) at paragraph 25; Cannes Summit Final Declaration--Building Our 
Common Future: Renewed Collective Action for the Benefit of All 
(Nov. 4, 2011) at paragraph 24.
---------------------------------------------------------------------------

    Many SBSDs likely will be subject to foreign regulation of their 
security-based swap activities that is similar to regulations that may 
apply to them pursuant to Title VII of the Dodd-Frank Act, even if the 
relevant foreign jurisdictions do not classify certain market 
participants as ``dealers'' for regulatory purposes. Some of these 
regulations may duplicate, and in some cases conflict with, certain 
elements of the Title VII regulatory framework.
    Foreign legislative and regulatory efforts have generally focused 
on five areas: (1) Moving OTC derivatives onto organized trading 
platforms; (2) requiring central clearing of OTC derivatives; (3) 
requiring post-trade reporting of transaction data for regulatory 
purposes and public dissemination of anonymized versions of such data; 
(4) establishing or enhancing capital requirements for non-centrally 
cleared OTC derivatives transactions; and (5) establishing or enhancing 
margin and other risk mitigation requirements for non-centrally cleared 
OTC derivatives transactions. Foreign jurisdictions have been actively 
implementing regulations in connection with each of these categories of 
requirements. A number of major foreign jurisdictions have initiated 
the process of implementing margin and other risk mitigation 
requirements for non-centrally cleared OTC derivatives 
transactions.\998\
---------------------------------------------------------------------------

    \998\ In November 2018, the Financial Stability Board reported 
that 16 member jurisdictions participating in its thirteenth 
progress report on OTC derivatives market reforms had in force 
margin requirements for non-centrally cleared derivatives. A further 
4 jurisdictions made some progress leading to a change in reported 
implementation status during the reporting period. See Financial 
Stability Board, OTC Derivatives Market Reforms Thirteenth Progress 
Report on Implementation (Nov. 19, 2018), available at http://www.fsb.org/wp-content/uploads/P191118-5.pdf.
---------------------------------------------------------------------------

    Notably, the European Parliament and the European Council have 
adopted the European Market Infrastructure Regulation (``EMIR''), which 
includes provisions aimed at increasing the safety and transparency of 
the OTC derivatives market. EMIR mandates the European Supervisory 
Authorities (``ESAs'') to develop regulatory technical standards 
specifying margin requirements for non-centrally cleared OTC derivative 
contracts.\999\ The ESAs have developed, and in October 2016 the 
European Commission adopted, these regulatory technical 
standards.\1000\
---------------------------------------------------------------------------

    \999\ The ESAs are the European Banking Authority, European 
Insurance and Occupational Pensions Authority, and European 
Securities and Markets Authority.
    \1000\ See ESAs, Final Draft Regulatory Technical Standards on 
risk-mitigation techniques for OTC-derivative contracts not cleared 
by a CCP under Article 11(15) of Regulation (EU) No 648/2012 (Mar. 
8, 2016). See also Commission Delegated Regulation (EU) 2016/2251 
supplementing Regulation (EU) No 648/2012 of the European Parliament 
and of the Council on OTC derivatives, central counterparties and 
trade repositories with regard to regulatory technical standards for 
risk-mitigation techniques for OTC derivative contracts not cleared 
by a central counterparty (Oct. 4, 2016).
---------------------------------------------------------------------------

    Several jurisdictions have also taken steps to implement the Basel 
III recommendations governing capital requirements for financial 
entities, which include enhanced capital charges for non-centrally 
cleared OTC derivatives transactions.\1001\ Moreover, as discussed 
above, subsequent to the publication of the proposing release, the BCBS 
and IOSCO issued the BCBS/IOSCO Paper. The BCBS/IOSCO Paper recommended 
(among other things): (1) That all financial entities and systemically 
important non-financial

[[Page 43980]]

entities exchange variation and initial margin appropriate for the 
counterparty risk posed by such transactions; (2) that initial margin 
should be exchanged without provisions for ``netting'' and held in a 
manner that protects both parties in the event of the other's default; 
and (3) that the margin regimes of the various regulators should 
interact so as to be sufficiently consistent and non-duplicative.\1002\
---------------------------------------------------------------------------

    \1001\ In November 2018, the Financial Stability Board reported 
that 23 of the 24 member jurisdictions participating in its 
thirteenth progress report on OTC derivatives market reforms had in 
force interim standards for higher capital requirements for non-
centrally cleared transactions. See Financial Stability Board, OTC 
Derivatives Market Reforms Thirteenth Progress Report on 
Implementation (Nov. 19, 2018).
    \1002\ One commenter noted that since 2015, the prudential 
Regulators, CFTC, and a number of foreign regulators have adopted 
margin requirements that implement the framework in the BCBS/IOSCO 
Paper. See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

4. Capital Regulation
    It is difficult to precisely delineate a baseline for capital 
requirements and capital levels in the security-based swap market. As 
discussed in prior sections, the entities that participate in this 
market may be subject to several overlapping regulatory regimes, 
including Federal Reserve capital standards at the bank holding company 
level,\1003\ bank capital standards of the OCC and FDIC that apply to 
bank security-based swap entities,\1004\ as well as the net capital 
requirements applicable to stand-alone broker-dealers. In addition, 
many entities in this space may be subject to the capital requirements 
applicable to FCMs, as well to the regimes of foreign regulators.\1005\ 
Finally, certain entities may not be subject to any (direct) capital 
requirements under the baseline. In the discussion that follows, the 
relevant aspects of the capital regimes applicable to the various 
entities operating in the security-based swap market are reviewed, and 
their relation to the baseline is noted. The discussion focuses on the 
capital treatment of market risk arising from an entity's proprietary 
positions in security-based swap transactions specifically, and OTC 
derivative transactions generally as well as the capital treatment of 
credit risk arising from exposures to counterparties in OTC derivative 
transactions.
---------------------------------------------------------------------------

    \1003\ These standards are based on the Basel II and Basel III 
framework. See BCBS, Basel II: International Convergence of Capital 
Measurement and Capital Standards: A Revised Framework--
Comprehensive Version (June 2006), available at http://www.bis.org/publ/bcbs128.htm; BCBS, Basel III: A global regulatory framework for 
more resilient banks and banking systems (June 2011), available at 
http://www.bis.org/publ/bcbs189.pdf.
    \1004\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR 74840.
    \1005\ The Commission expects that most entities that will 
register with the Commission and become subject to these final 
capital, margin, and segregation rules have registered with the CFTC 
as swap entities or with the Commission as broker-dealers. The 
Commission has previously estimated that, of the total 55 entities 
expected to register with the Commission as an SBSD or MSBSP, 35 
will be registered with the CFTC as swap dealers or major swap 
participants. See Registration Process for Security-Based Swap 
Dealers and Major Security-Based Swap Participants, 80 FR at 49000.
---------------------------------------------------------------------------

a. Commission-Registered Broker-Dealers
    As described in the prior section, security-based swap dealing 
activity is concentrated in a small number of large financial 
firms.\1006\ Historically, these firms have not undertaken their 
security-based swap activities and OTC derivative transactions through 
Commission-registered broker-dealers. Rather, the dealing activity of 
these financial firms was housed either in its bank affiliates, its 
unregistered nonbank affiliates, or in affiliated foreign entities. 
These arrangements reflected the lack of a legal requirement to house 
such activities in entities regulated by the Commission, the potential 
disadvantage in the capital treatment of these activities under Rule 
15c3-1,\1007\ as well as restrictions on the use of customers' 
collateral under the Commission's customer protection rule.\1008\
---------------------------------------------------------------------------

    \1006\ See section VI.A. of this release.
    \1007\ OTC derivatives dealers and ANC broker-dealers have been 
permitted to use internal models to compute net capital since 1998 
and 2004, respectively. See OTC Derivatives Dealers, 63 FR 59362; 
Alternative Net Capital Requirements for Broker-Dealers That Are 
Part of Consolidated Supervised Entities, 69 FR 34428. However, this 
has not led to increased dealing in security-based swaps by broker-
dealers.
    \1008\ The existing possession or control and customer reserve 
account requirements of Rule 15c3-3 as applied to initial margin 
held for security-based swaps has made it disadvantageous for 
broker-dealers to deal in security-based swaps as compared to 
entities (such as unregulated dealers) that were not subject to 
these requirements. The requirements of Rule 15c3-3 are designed to 
protect customers by preventing broker-dealers from using customer 
assets to finance any part of their business unrelated to servicing 
customer securities activities. Unregulated entities would not be 
subject to these restrictions and could freely use collateral 
received from security-based swap transactions in their business, 
including to finance proprietary activities.
---------------------------------------------------------------------------

    In 1998, the Commission established a program for broker-dealers 
that operate as OTC derivatives dealers. The program, among other 
things, permitted OTC derivatives dealers to use internal models to 
compute capital charges for market and credit risk. In 2004, the 
Commission extended the use of such models to broker-dealers subject to 
consolidated supervision with the adoption of alternative net capital 
requirements for ANC broker-dealers. Today, only a small fraction of 
broker-dealers are ANC broker-dealers; however, these few ANC broker-
dealers are large and account for nearly all of the assets held by 
Commission-supervised broker-dealers. The capital requirements being 
adopted today for nonbank SBSDs, including permitting nonbank SBSDs to 
elect to use models to compute net capital, are modeled on the 
Commission's net capital rule currently applicable to broker-dealers.
    The existing broker-dealer net capital requirements are codified in 
Rule 15c3-1 and seven appendices to Rule 15c3-1. Specifically, Rule 
15c3-1 requires broker-dealers to maintain a minimum level of net 
capital (meaning highly liquid capital) at all times. Paragraph (a) of 
the rule requires that a broker-dealer perform two calculations: (1) A 
computation of the minimum amount of net capital the broker-dealer must 
maintain; and (2) a computation of the amount of net capital the 
broker-dealer is maintaining. The minimum net capital requirement is 
the greater of a fixed-dollar amount specified in the rule and an 
amount determined by applying 1 of 2 financial ratios: The 15-to-1 
ratio or the 2% debit item ratio. Large broker-dealers that dominate 
the industry use the 2% debit item ratio.
    Requirements for computing net capital are set forth in paragraph 
(c)(2) of Rule 15c3-1, which defines the term ``net capital.'' The 
first step in a net capital calculation is to compute the broker-
dealer's net worth under GAAP. Next, the broker-dealer must make 
certain adjustments to its net worth. These adjustments are designed to 
leave the firm in a position in which each dollar of unsubordinated 
liabilities is matched by more than a dollar of highly liquid assets. 
There are fourteen categories of net worth adjustments required by the 
rule, including the application of haircuts.\1009\ Broker-dealers use 
either standardized haircuts or model-based haircuts that are comprised 
of market and credit risk charges.
---------------------------------------------------------------------------

    \1009\ See paragraphs (c)(2)(i) through (xiv) of Rule 15c3-1.
---------------------------------------------------------------------------

Market Risk Charges
    The internal models used by ANC broker-dealers and OTC derivatives 
dealers to compute market risk charges must meet certain qualitative 
and quantitative requirements under Appendix E or F that parallel 
requirements for U.S. banking agencies under Basel II.\1010\ The use of 
internal

[[Page 43981]]

models to compute market risk charges can substantially reduce the 
deductions to the market value of proprietary positions as compared to 
standardized haircuts. Consequently, large broker-dealers that dominate 
the industry rely on internal models rather than the standardized 
haircuts to compute net capital. However, ANC broker-dealers and OTC 
derivative dealers (i.e., dealers using internal models to compute net 
capital) are subject to higher fixed-dollar minimum capital 
requirements than broker-dealers using the standardized haircuts. Under 
existing paragraph (a)(7) of Rule 15c3-1, ANC broker-dealers are 
required to maintain tentative net capital of not less than $1 billion 
and net capital of not less than $500,000,000. In addition, ANC broker-
dealers are required to provide notice to the Commission if their 
tentative net capital falls below $5 billion. For OTC derivative 
dealers, under existing paragraph (a)(5) of Rule 15c3-1, the 
corresponding fixed-dollar minimums are $100 million in tentative net 
capital and $20 million in net capital.
---------------------------------------------------------------------------

    \1010\ See generally OTC Derivatives Dealers, 63 FR 59362; 
Alternative Net Capital Requirements for Broker-Dealers That Are 
Part of Consolidated Supervised Entities, 69 FR 34428. The 
requirements for banks were subsequently enhanced by the prudential 
regulators with the implementation of capital requirements 
consistent with the Basel III framework. See Regulatory Capital 
Rules: Regulatory Capital, Implementation of Basel III, Capital 
Adequacy, Transition Provisions, Prompt Corrective Action, 
Standardized Approach for Risk-weighted Assets, Market Discipline 
and Disclosure Requirements, Advanced Approaches Risk-Based Capital 
Rule, and Market Risk Capital Rule, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------

Credit Risk Charges
    For ANC broker-dealers, the credit risk charge is the sum of 3 
calculated amounts: (1) A counterparty exposure charge; (2) a 
concentration charge if the current exposure to a single counterparty 
exceeds certain thresholds; and (3) a portfolio concentration charge if 
aggregate current exposure to all counterparties exceeds 50% of the 
firm's tentative net capital.\1011\ The OTCDD credit risk model is 
similar to the ANC credit risk model except that the former does not 
include a portfolio concentration charge.\1012\
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    \1011\ See paragraph (c) of Rule 15c3-1e.
    \1012\ See paragraph (d) of Rule 15c3-1f.
---------------------------------------------------------------------------

b. Banking Entities
    As described in previous sections, the security-based swap market 
is dominated by a small number of global financial firms. Of the firms 
expected to register with the Commission as SBSDs, the Commission 
believes that most will, in the near-term, be subsidiaries of a U.S. 
bank holding company and therefore be subject to consolidated 
supervision by the Federal Reserve. Nonbank SBSDs and MSBSPs will be 
subject not only to the Commission's capital requirements but also 
indirectly to the capital standards applicable at their parent bank 
holding companies. For the purposes of satisfying the capital 
requirements at the bank holding company level, the OTC derivatives 
positions booked under any consolidated bank subsidiary are accounted 
for in the capital computation of the holding company. The bank holding 
companies' consolidated bank subsidiaries also are subject to direct 
capital requirements of the prudential regulators and indirect capital 
requirements applicable to their parent bank holding companies. Below 
is a discussion of the relevant aspects of the capital regime for bank 
holding companies as it relates to security-based swap positions (and 
OTC derivative positions in general).
    In July 2013, the Federal Reserve and OCC adopted a final rule that 
implements in the U.S. the Basel III regulatory capital reforms from 
the BCBS and certain changes to the existing capital standards required 
by the Dodd-Frank Act.\1013\ These rules generally strengthened the 
capital regime for bank holding companies and banks (collectively, 
``banks'') by increasing both the quality and the quantity of bank 
regulatory capital.\1014\
---------------------------------------------------------------------------

    \1013\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018.
    \1014\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018. Among other things, the new rules implemented a 
revised definition of regulatory capital, a new common equity tier 1 
minimum capital requirement, a higher minimum tier 1 capital 
requirement, and, for banking organizations subject to the advanced 
approaches risk-based capital rules, a supplementary leverage ratio 
The new rules also amended the methodologies for determining risk-
weighted assets (``RWAs'').
---------------------------------------------------------------------------

    The bank capital regime for OTC derivative transactions prescribes 
the capital treatment of the transactions' market risk and credit risk 
exposures. Banks with significant presence in the security-based swap 
market tend to be large global firms that employ the internal models 
methodology to compute charges for market risk. The quantitative 
requirements for these models resemble in many respects those 
applicable to the market risk models of ANC broker-dealers and OTC 
derivative dealers.\1015\
---------------------------------------------------------------------------

    \1015\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74876.
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    Banks calculate market risk capital charges using a model with a 
one-tailed 99% confidence interval.\1016\ These charges are subject to 
specific risk add-ons and backtesting adjustments.\1017\ Following 
adoption of the Basel III framework by the prudential regulators, these 
capital requirements were strengthened; they now include an additional 
``stressed VaR'' floor to the capital charge, as well as potentially 
binding leverage ratios.\1018\
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    \1016\ This discussion assumes that the bank is subject to 
market risk capital charges. Banking organizations with aggregate 
trading assets and liabilities that exceed $1 billion or 10% of 
total assets are subject to the market risk rule. See Risk-Based 
Capital Standards: Market Risk, 61 FR 47358 (Sept. 6, 1996).
    \1017\ See 12 CFR 3.122(i)(4)(iii); 12 CFR 3.131.
    \1018\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-Weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018.
---------------------------------------------------------------------------

    Capital charges for a bank's credit risk exposure to its OTC 
derivative counterparties are based on the RWA framework. In general, 
under the RWA framework, the capital requirement for a credit exposure 
is 8% times the RWA-equivalent amount of the credit exposure. Under the 
2013 capital rule, large banking organizations (i.e., the type of 
organizations that dominate dealing in the security-based swap market) 
are required to calculate capital requirements using the advanced 
approaches.\1019\ In the advanced approaches, the RWA-equivalent of a 
counterparty exposure is calculated according to the internal rating-
based (``IRB'') capital formula, where the bank's internal credit risk 
model along with the bank's estimates of the probability of default and 
the loss-given default is used to calculate the effective risk weight 
on the exposure amount.
---------------------------------------------------------------------------

    \1019\ See id.
---------------------------------------------------------------------------

    Under the advanced approach, the exposure amount (exposure at 
default (``EAD'')) for an OTC derivative transaction may be calculated 
under either the current exposure method (``CEM'') or using the 
internal models method (``IMM''), with the latter being subject to 
regulatory approval.\1020\ Under the current exposure method, the 
capital charge is the sum of the current exposure and potential future 
exposure. The potential future exposure is calculated as the product of 
the

[[Page 43982]]

derivative's notional amount and a conversion factor that depends on 
the risk and maturity of the transaction. The conversion factors range 
from 0% to 15% and are specified in the regulations.\1021\ For a group 
of transactions within the same asset class that are covered by a 
qualifying master netting agreement, the current exposure for the group 
is calculated on a net basis. Potential future exposure for a group of 
transactions subject to a qualifying master netting agreement is 
calculated as the sum of gross potential future exposures (i.e., no 
netting), multiplied by a factor that is a function of the net-to-gross 
ratio (``NGR'') of current exposures.\1022\ For banks that engage in 
off-setting transactions, the NGR is typically far lower than one, 
permitting some netting benefits.\1023\
---------------------------------------------------------------------------

    \1020\ The OCC, Federal Reserve, and the FDIC have issued a 
notice of proposed rulemaking to provide an updated framework for 
measuring derivative counterparty credit exposure. The proposed rule 
would replace the existing CEM with the Standardized Approach for 
Counterparty Credit Risk (SA-CCR) for banks subject to the advanced 
approaches, while permitting smaller banks to use CEM or SA-CCR. See 
Standardized Approach for Calculating the Exposure Amount of 
Derivative Contracts, 83 FR 64660 (Dec. 17, 2018). See also Proposed 
Changes to Applicability Thresholds for Regulatory Capital and 
Liquidity Requirements, 83 FR 66024 (Dec. 21, 2018).
    \1021\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-Weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018, at Table 19.
    \1022\ The potential future exposure for the group equals ((0.4 
+ 0.6 x NGR) x AGross), where AGross is aggregate gross potential 
future exposure for positions subject to a qualifying master netting 
agreement, and NGR is the ratio of net current exposure to gross 
current credit exposure for the group.
    \1023\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018.
---------------------------------------------------------------------------

    Banks are allowed to recognize a broad set of collateral as credit 
risk mitigants in calculating credit risk charges.\1024\ They may use 
either the simple approach or the collateral haircut approach to reduce 
credit risk capital charges. Under the simple approach, the risk weight 
of a collateralized credit exposure to an OTC derivative counterparty 
is replaced with the risk weight of the collateral posted by that 
counterparty. Under this approach, subject to certain exceptions, the 
risk weight assigned to the collateralized portion of the exposure must 
be at least 20%.\1025\ Under the collateral haircut approach, the risk 
weight of the counterparty exposure does not change, but the exposure 
amount is adjusted by the haircut-adjusted value of the collateral 
received. Banks using the advanced approach to calculate RWA may use 
internal models to compute these haircuts, otherwise regulatory 
haircuts are used.\1026\
---------------------------------------------------------------------------

    \1024\ Generally, the credit risk of the collateral must not be 
positively correlated with the credit risk of the collateralized 
exposure. The set of eligible collateral has been broadened to 
include investment grade corporate debt securities and publicly 
traded equity securities. 78 FR at 62107.
    \1025\ 78 FR 62018. One exception is when the collateral 
consists of ``cash on deposit,'' in which case the risk weight is 
0%. Another exception is when the collateral is a sovereign that 
qualifies for a 0% risk weight under the general risk weight 
provision and it is subject to certain haircuts or account 
maintenance practices, in which case the risk weight can be either 
0% or 10%.
    \1026\ See 78 FR at 62239.
---------------------------------------------------------------------------

    Accounting rules now generally require banks to take into account 
the creditworthiness of an OTC derivative counterparty in determining 
the fair value of an OTC derivative position. During the financial 
crisis, approximately two-thirds of credit losses on OTC derivative 
positions were the result of accounting adjustments rather than 
outright counterparty defaults.\1027\ Subsequently, Basel III 
requirements as implemented by the prudential regulators introduced 
capital charges for potential accounting losses resulting from such 
credit valuation adjustments (``CVA'') due to an increase in credit 
risk of the counterparty. Banks that are subject to the advanced 
approach have to calculate a CVA capital charge using either the 
advanced CVA approach, if the bank is approved to use this method, or 
the simple CVA approach. The former relies on a bank's internal credit 
models while the latter uses a combination of supervisory risk weights, 
external ratings, and the bank's credit-risk calculations.\1028\
---------------------------------------------------------------------------

    \1027\ See BCBS, Basel Committee finalizes capital treatment for 
bilateral counterparty credit risk (June 2011), available at http://www.bis.org/press/p110601.pdf.
    \1028\ Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR at 62134.
---------------------------------------------------------------------------

c. CFTC-Registered Entities
    Starting in October 2012, swap dealers and major swap participants 
were required to provisionally register with the CFTC. However, as of 
now, neither swap dealers nor major swap participants are subject to 
any capital requirements, unless they are also registered as 
FCMs.\1029\
---------------------------------------------------------------------------

    \1029\ The CFTC re-proposed capital requirements for swap 
dealers and major swap participants in 2016. See CFTC Capital 
Proposing Release, 81 FR 91252. The current capital requirements for 
FCMs make it particularly costly for FCMs to engage in OTC CDS. For 
this reason, traditionally, OTC CDS have been conducted outside of 
FCMs, in affiliated entities. See Capital Requirements of Swap 
Dealers and Major Swap Participants, 76 FR 27802.
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    CFTC Rule 1.17 requires FCMs to maintain adjusted net capital in 
excess of a minimum adjusted net capital amount. The rule prescribes a 
net liquid assets test similar to the broker-dealer net capital rule. 
The CFTC defines adjusted net capital as liquid assets net of 
liabilities, after taking into account certain capital deductions for 
market and credit risk. The minimum net adjusted capital depends, among 
other things, on the margin amount of the client-cleared OTC swap 
positions.
    With respect to the treatment of OTC derivatives positions, an FCM 
is required to account for an OTC derivatives position by first 
marking-to-market the position and then deducting (adding) the full 
amount of the loss (collateralized portion of the gain) from (to) its 
adjusted net capital. In addition, an FCM also has to take a capital 
charge for the market risk of its OTC derivatives position. Paragraph 
(c) of CFTC Rule 1.17 allows FCMs registered with the Commission as an 
ANC broker-dealer to compute this capital charge using models approved 
by the Commission.
5. Margin Regulation
    The baseline regulatory regime for margin regulation of security-
based swaps is the phase-in of regulations adopted by U.S. prudential 
regulators, foreign regulators, and the CFTC, as well as the broker-
dealer SRO margin rules.
a. Prudential Regulators, CFTC, and Foreign Regulators
Prudential Regulators
    In October 2015, the U.S. prudential regulators adopted new rules 
to address minimum margin requirements for bank swap dealers, major 
swap participants, SBSDs, and MSBSPs with respect to non-cleared 
security-based swaps and swaps.\1030\ For these entities, the margin 
rules became effective on April 1, 2016, with compliance phased-in over 
4 years beginning in September 2016. The rules impose initial and 
variation margin requirements on bank SBSDs, MSBSPs, swap dealers, and 
major swap participants for non-cleared security-based swaps and swaps.
---------------------------------------------------------------------------

    \1030\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR 74840.
---------------------------------------------------------------------------

    Bank SBSDs, MSBSPs, swap dealers, and major swap participants are 
required to collect and post variation and initial margin from (to) 
certain counterparties. Initial margin must be collected in the form of 
cash or other eligible collateral. Variation margin must be collected 
on a daily basis and be in the form of cash for a transaction with an 
SBSD, MSBSP, swap dealer, or major swap participant, or cash or other 
eligible collateral for a transaction with a financial end user. These 
bank entities are also required to both collect and post initial margin 
for transactions with

[[Page 43983]]

SBSDs, MSBSPs, swap dealers, major swap participants, and with 
financial end users that have material swaps exposure (i.e., gross 
notional exposure in excess of $8 billion). Initial margin must be 
computed using standardized haircuts or an approved model. The initial 
margin is to be computed on a daily basis but its exchange is not 
required if it falls below a consolidated $50 million threshold. The 
rules further require that the initial margin collected or posted by 
bank SBSDs, MSBSPs, swap dealers, and swap participants be segregated 
with a third-party custodian and prohibit its re-hypothecation. The 
rules provide an exception to the initial margin requirements in 
transactions involving an affiliated entity: In such cases, initial 
margin need not be posted to an affiliated financial end user with 
material swaps exposure.
    In December 2015, the CFTC adopted new rules that address margin 
requirements for nonbank swap dealers and major swap participants with 
respect to non-cleared swaps.\1031\ Similar to the prudential 
regulators' final rules, the rules became effective on April 1, 2016, 
with compliance phased-in over 4 years beginning in September 2016. The 
rules are similar to the final margin rules of the prudential 
regulators. However, with respect to affiliates, swap dealers and major 
swap participants need to collect or post initial margin under certain 
conditions.
---------------------------------------------------------------------------

    \1031\ See CFTC Margin Adopting Release, 81 FR 636.
---------------------------------------------------------------------------

    Foreign entities, including foreign subsidiaries of U.S. entities 
that transact in the security-based swap market fall under a variety of 
foreign regulations, principally those of regulators in certain 
European countries. European regulators have adopted or proposed a 
series of regulations covering mandatory clearing of OTC derivatives as 
well as margin requirements for those derivatives not subject to the 
mandatory clearing requirement.\1032\
---------------------------------------------------------------------------

    \1032\ See Regulation (EU) No 648/2012 of the European 
Parliament and of the Council on OTC derivatives, central 
counterparties and trade repositories (July 4, 2012).
---------------------------------------------------------------------------

    Currently, the European regulations require central clearing of 
certain security-based swap transactions involving parties that are not 
covered by exemptions from the clearing requirement.\1033\ Exemptions 
include certain inter-affiliate transactions, as well as transactions 
involving non-financial counterparties with gross notional values of 
OTC derivative transactions that fall below the regulatory clearing 
thresholds. These clearing requirements are currently being phased in 
and will take full effect by mid-2019.
---------------------------------------------------------------------------

    \1033\ Starting on February 9, 2017, certain iTraxx Europe Index 
CDS became subject to the clearing obligation. See Commission 
Delegated Regulation (EU) 2016/592 supplementing Regulation (EU) No 
648/2012 of the European Parliament and of the Council with regard 
to regulatory technical standards on the clearing obligation (Mar. 
1, 2016).
---------------------------------------------------------------------------

    The European margin rules on non-cleared security-based swap 
transactions will apply to entities with gross notional values for OTC 
derivatives of more than [euro]8 billion. Such entities will generally 
have an obligation to collect and post margin.\1034\
---------------------------------------------------------------------------

    \1034\ See Regulation (EU) No 648/2012 of the European 
Parliament and of the Council on OTC derivatives, central 
counterparties and trade repositories (July 4, 2012).
---------------------------------------------------------------------------

    Entities subject to the European rules will be required to collect 
and post variation margin for non-cleared security-based transactions 
with other covered entities, financial counterparties, as well as non-
financial counterparties that fall above the clearing thresholds. 
Variation margin will have to be exchanged on a daily basis, subject to 
certain de minimis exceptions.
    Entities subject to the European rules (i.e., those with gross 
notional values for OTC derivatives of more than [euro]8 billion) will 
also be required to exchange initial margin. The requirement to collect 
initial margin will not apply if the initial margin amount is less than 
[euro]50 million. Initial margin is limited to cash and other high 
quality assets. The amount of initial margin may be computed using a 
model that satisfies certain technical criteria. The initial margin 
amount must be recomputed under conditions enumerated in the 
regulations; in practice this will generally be on a daily basis. The 
party collecting initial margin must ensure that the collateral 
received is segregated either through a third-party custodian, or 
through other legally binding arrangements. Re-hypothecation of initial 
margin is not permitted. The rules further require that the collecting 
party provide the posting party the option to segregate its initial 
margin from the assets of other posting counterparties.
    While the minimum margin requirements adopted by the prudential 
regulators, CFTC, and foreign regulators will not be completely phased 
in until September 2020, there is already some evidence on how market 
participants are reacting to these requirements. A June 2017 survey on 
dealer financing terms noted that some of the survey respondents 
indicated that their clients' transaction volume or their own 
transaction volume in non-cleared swaps decreased somewhat over the 
period of September 2016 to June 2017.\1035\ However, the respondents 
reported no changes in the prices that they quote to their clients in 
non-cleared swaps over this period. This evidence indicates that some 
dealers responded to margin requirements by reducing the level of 
intermediation services they provided to other market participants on 
an non-cleared basis. One-fifth of the survey respondents also reported 
that they would be less likely to exchange daily variation margin with 
mutual funds, exchange-traded funds, pension plans, endowments, and 
separately managed accounts established with investment advisers due 
primarily to lack of operational readiness (e.g., the need to establish 
or update the necessary credit support annexes to cover daily exchange 
of variation margin) over this period. Two-fifths of the survey 
respondents also reported that the volume of mark and collateral 
disputes on variation margin has increased somewhat over this period. 
Furthermore, the survey noted that there is variation among respondents 
with respect to the number of days it takes to resolve a mark and 
collateral dispute on variation margin, with \1/3\ reporting less than 
two days, while \3/5\ reporting more than two days but less than a 
week, on average.
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    \1035\ See Yesol Huh, Division of Research and Statistics, Board 
of Governors of the Federal Reserve System, The June 2017 Senior 
Credit Officer Opinion Survey on Dealer Financing Terms, available 
at https://www.federalreserve.gov/data/scoos/files/scoos_201706.pdf.
---------------------------------------------------------------------------

    In addition, the ISDA margin survey covering 2017 documents the 
amount and type of collateral collected and posted by the 20 firms with 
the largest non-cleared derivatives exposures (``phase-one'' firms), 
that were subject to the first phase of the new margin regulations for 
non-cleared derivatives in the US, Canada, and Japan from September 
2016, and Europe from February 2017. The survey distinguishes between 
initial margin collected or posted by the phase-one firms to comply 
with the new margin requirements (``regulatory initial margin'') and 
other initial margin collected or posted by these firms 
(``discretionary initial margin''). At the end of 2017, phase-one firms 
collected and posted regulatory initial margin in the amount of $73.7 
billion and $75.2 billion, respectively. Relative to the end of the 
first quarter of 2017, these amounts reflect a 58% and 59% increase, 
respectively. The similarity in these two amounts may reflect the two-
way initial margin requirement applicable to phase-one

[[Page 43984]]

firms. In contrast, at the end of 2017, phase-one firms collected and 
posted $56.9 billion and $6.4 billion, respectively, in discretionary 
initial margin. These amounts reflect a decline in the level of initial 
margin collected and posted by phase-one firms of 6% and 61%, 
respectively, relative to the end of the first quarter of 2017. The 
large discrepancy between these two rates is probably the result of 
phase-one firms continuing to collect initial margin on a discretionary 
basis for transactions that are not yet within the scope of the new 
margin requirements as more counterparties to whom phase-one firms post 
discretionary initial margin become subject to the new margin 
requirements (e.g., phase two of the implementation started in 
September 2017).
    The survey also reports the amount of variation margin collected 
and posted by phase-one firms. At the end of the 2017, phase-one firms 
collected and posted $893.7 billion and $631.7 billion, respectively, 
in variation margin, including both regulatory and discretionary.
    Of the regulatory initial margin posted, 85.3% consisted of 
government securities; while 14.7% consisted of other securities. 
Similarly, of the discretionary initial margin posted, 39.8% was in 
government securities, 37% in cash, and, 23.2% in other securities. In 
contrast, of the variation margin posted, 85.8% was in cash, followed 
by 12.1% in government securities, and, finally, 2.1% in other 
securities.
    The ISDA margin survey covering 2018 applies the methodology of the 
ISDA margin survey covering 2017 but also expands the set of surveyed 
firms to include not just the 20 phase-one firms described above, but 
also firms that were subject to the new margin regulations from 
September 2017 (``phase-two firms'') and September 2018 (``phase-3 
firms''), respectively.\1036\ At the end of 2018, phase-one firms 
collected and posted regulatory initial margin in the amount of $83.8 
billion and $83.2 billion, respectively. Relative to the end of 2017, 
these amounts reflect a 14% and 11% increase, respectively. At the end 
of 2018, phase-one firms collected and posted $74.1 billion and $10.1 
billion, respectively, in discretionary initial margin. These amounts 
have increased by 30% and 57%, respectively, relative to the end of 
2017. The 4 phase-two and 3 phase-3 firms that participated in the 
survey collected $4.8 billion of initial margin at the end of 2018, of 
which $2.2 billion is regulatory initial margin and $2.6 billion is 
discretionary initial margin.
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    \1036\ ISDA received responses from four phase-two firms (out of 
the six in scope) and three phase-three firms (out of the eight 
firms in scope). See ISDA Margin Survey Year-End 2018 (Apr. 2019) at 
p.5.
---------------------------------------------------------------------------

    At the end of 2018, phase-one firms collected and posted $858.6 
billion and $583.9 billion, respectively, in variation margin, 
including both regulatory and discretionary. Relative to the end of 
2017, these amounts represent a 4% and 8% decrease for variation margin 
collected and posted, respectively.
    At the end of 2018, of the regulatory initial margin posted, 88.4% 
consisted of government securities while 11.6% consisted of other 
securities. Of the discretionary initial margin posted, 42% was in 
government securities, 44.4% in cash, and, 13.6% in other securities. 
Of the variation margin posted, 86.5% was in cash, followed by 12% in 
government securities, and, finally, 1.5% in other securities.
b. Broker-Dealer Margin Rules
    Broker-dealers are subject to margin requirements in Regulation T 
promulgated by the Federal Reserve, in rules promulgated by the SROs, 
and, with respect to security futures, in rules jointly promulgated by 
the Commission and the CFTC.\1037\
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    \1037\ See 12 CFR 220.1, et seq.; FINRA Rules 4210 through 4240; 
CBOE Rules 12.1-12.12; 17 CFR 242.400 through 406. See also Capital, 
Margin, and Segregation Proposing Release, 77 FR at 70259 
(discussing broker-dealer margin rules and equity requirements).
---------------------------------------------------------------------------

    Although the Dodd-Frank Act expanded the definition of ``security'' 
to include security-based swaps and in so doing expanded the 
applicability of the aforementioned rules and regulations to security-
based swap transactions, the Commission has issued a series of 
exemptive orders exempting security-based swaps from, among other 
things, the margin requirements of Regulation T.\1038\
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    \1038\ See section III.C. of this release (discussing the 
exemption orders).
---------------------------------------------------------------------------

6. Segregation
    Existing market practice under the baseline is for dealers 
generally not to segregate initial margin related to OTC derivative 
transactions. An ISDA margin survey reports that in 2010, 71% of 
initial margin received was comingled with variation margin.\1039\ Of 
the remaining 29%, 9% was segregated on the books of the dealer,\1040\ 
6% was segregated with a custodian, and 14% was subject to tri-party 
arrangements.\1041\ For large dealers, on average 89% of collateral 
received was eligible for re-hypothecation, while 74% of collateral 
received was actually re-hypothecated.\1042\
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    \1039\ See ISDA Margin Survey 2011 at Table 2.3
    \1040\ See id. The ISDA survey does not define what it means for 
margin to be ``segregated on the books of the dealer.'' Therefore, 
it is not certain that margin segregated in this manner would 
substantially satisfy the omnibus segregation requirements of Rule 
18a-4, as adopted.
    \1041\ See id. The ISDA survey does not define what it means for 
margin to be ``segregated with custodian'' and ``tri-party.'' 
Therefore, it is not certain that margin segregated in this manner 
would substantially satisfy the individual segregation requirements 
of Section 3E(f) of the Exchange Act or the requirements in Rule 
18a-4, as adopted, relating to third-party custodians.
    \1042\ ISDA Margin Survey 2011 at Table 2.4.
---------------------------------------------------------------------------

    The Dodd-Frank Act amended the Exchange Act to establish 
segregation requirements for cleared and non-cleared security-based 
swaps. Section 3E(b) of the Exchange Act provides that, for cleared 
security-based swaps, the money, securities, and property of a 
security-based swap customer shall be separately accounted for and 
shall not be commingled with the funds of the broker, dealer, or SBSD 
or used to margin, secure, or guarantee any trades or contracts of any 
security-based swap customer or person other than the person for whom 
the money, securities, or property are held. However, Section 3E(c)(1) 
of the Exchange Act also provides that, for cleared security-based 
swaps, customers' money, securities, and property may, for convenience, 
be commingled and deposited in the same one or more accounts with any 
bank, trust company, or clearing agency. Section 3E(c)(2) further 
provides that, notwithstanding Section 3E(b), in accordance with such 
terms and conditions as the Commission may prescribe by rule, 
regulation, or order, any money, securities, or property of the 
security-based swaps customer of a broker, dealer, or security-based 
swap dealer described in Section 3E(b) may be commingled and deposited 
as provided in Section 3E with any other money, securities, or property 
received by the broker, dealer, or security-based swap dealer and 
required by the Commission to be separately accounted for and treated 
and dealt with as belonging to the security-based swaps customer of the 
broker, dealer, or security-based swap dealer.
    Section 3E(f) of the Exchange Act establishes a program by which a 
counterparty to non-cleared security-based swaps with an SBSD or MSBSP 
can elect to have initial margin held at an independent third-party 
custodian (individual segregation). Section 3E(f)(4) provides that if 
the counterparty does not choose to require segregation of funds or 
other property, the SBSD or MSBSP shall send a report to the 
counterparty on a quarterly basis stating

[[Page 43985]]

that the firm's back office procedures relating to margin and 
collateral requirements are in compliance with the agreement of the 
counterparties. The Exchange Act also provides that the segregation 
requirements for non-cleared security-based swaps do not apply to 
variation margin payments, so that the right of an SBSD or MSBSP 
counterparty to require individual segregation applies only to initial 
and not variation margin.
    The statutory provisions of Sections 3E(b) and (f) of the Exchange 
Act are self-executing. The baseline incorporates these self-executing 
provisions in the Exchange Act.
7. Historical Pricing Data
    The profits and losses of a security-based swap position depend on 
the fluctuations in risk factors, other than counterparty risks, that 
are relevant to the position. The cumulative exposure of the position 
to these risk factors is commonly referred to as the market risk of the 
position. For entities subject to capital requirements, the market risk 
of their trading books (and corresponding market risk charges the 
trading book positions incur) may affect the amount of capital that 
they have available to establish new trades. Stand-alone broker-dealers 
must maintain capital to cover the market risk of their trading 
portfolios. The use of standardized haircuts is a common method for 
calculating the amount of capital necessary to cover the market risk of 
a position.\1043\
---------------------------------------------------------------------------

    \1043\ See, e.g., Rule 15c3-1; Basel II: International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework--Comprehensive Version (June 2006); Basel III: A global 
regulatory framework for more resilient banks and banking systems 
(June 2011); CFTC Capital Proposing Release, 81 FR 91252.
---------------------------------------------------------------------------

    One commenter suggested that the Commission conduct further 
economic analysis to confirm that the standardized haircuts proposed 
for security-based swaps are appropriately tailored to the risk the 
relevant positions present. The commenter further suggested that the 
analysis should be based on quantitative data regarding the security-
based swap and swap markets since the enactment of the Dodd-Frank 
Act.\1044\ In response to these comments, the Commission is providing 
additional support to the discussion in the proposal \1045\ by 
analyzing historical pricing data for single-name and index CDS 
contracts.\1046\ Specifically, the analysis uses historical pricing 
data to estimate the losses stemming from historical price movements of 
security-based swap and swap positions and compares those estimated 
losses with the Commission's proposed standardized haircuts for CDS 
that are security-based swaps or swaps. The Commission analyzes 
historical prices in several one-year samples: 3 samples that are 
likely to capture stressed market conditions (2008, 2011, and 2012), 
and two samples that are likely to capture normal market conditions 
(2017 and 2018).\1047\
---------------------------------------------------------------------------

    \1044\ See SIFMA 11/19/2018 Letter.
    \1045\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 70311-12.
    \1046\ The pricing data were purchased from ICE Data Services.
    \1047\ With respect to including data from 2008, the Commission 
acknowledges the commenter's suggestion that quantitative data since 
the enactment of the Dodd-Frank Act should be used. However, the 
Commission believes that the inclusion of 2008 data is justified 
because the stressed market conditions in that year would help 
ensure that the analysis does not underestimate the riskiness of 
security-based swap positions. Therefore, the Commission has 
retained 2008 data in the analysis. At the same time, most of the 
data used in the analysis (i.e., 2011, 2012, 2017, and 2018) are 
from the period since the enactment of the Dodd-Frank Act.
---------------------------------------------------------------------------

    For each day of each sample, the Commission assigns each single-
name CDS contract to the appropriate cell in the grid set forth in 
paragraph (c)(2)(vi)(P)(1)(i) of Rule 15c3-1, as amended.\1048\ The 
Commission then calculates the 10-day change in the value of the 
contract based on the historical pricing data for that contract and 
expresses the change as a percentage of the notional value of the 
contract. The Commission repeats this process for each day of the 
sample for all single-name CDS contracts with historical pricing data 
to generate a distribution of 10-day value changes for each cell in the 
grid set forth in paragraph (c)(2)(vi)(P)(1)(i) of Rule 15c3-1. The 
Commission estimates the extreme, but plausible loss for each cell as 
the loss that is only exceeded by 1% of the observations in that 
cell.\1049\ The Commission summarizes the distribution of such extreme 
but plausible losses for all cells in the grid by calculating the 
minimum, maximum, mean, standard deviation, and the quartiles of the 
distribution. The Commission reports the summary statistics for each 
sample in Panel A of Table 3. In Panel B of Table 3, the Commission 
reports the summary statistics of extreme but plausible losses on long 
credit default swap positions.
---------------------------------------------------------------------------

    \1048\ The Commission assigns the single-name CDS contracts 
based on the length of time to maturity and midpoint spread on the 
CDS (i.e., the average of the basis point spread bid and offer on 
the CDS).
    \1049\ In other words, only 1% of the observations experienced 
losses that are larger than the extreme but plausible loss.
---------------------------------------------------------------------------

    To analyze extreme, but plausible losses experienced by CDS 
referencing broad-based securities indices (``index CDS''), the 
Commission repeats the analyses of Panels A and B but uses historical 
pricing data on index CDS contracts and the maturity and spread 
combinations set forth in (b)(2)(i)(A) of Rule 15c3-1b, as amended. The 
Commission reports the summary statistics of extreme, but plausible 
losses on short index CDS and long index CDS in Panels C and D of Table 
3, respectively.
    The summary statistics for CDS provide a number of findings as 
reflected in Table 3, Panels A and B. For both short and long 
positions, the mean and median losses vary across the five annual 
samples. The biggest mean and median losses occurred in 2008, possibly 
a reflection of severe market stresses experienced in that year. Short 
CDS positions tend to experience larger losses than long CDS positions. 
For example, the mean losses on short positions are larger than those 
on long positions for each of the five annual samples. Losses on short 
CDS positions also tend to be more variable than losses on long CDS 
positions. The standard deviation, which captures the extent to which 
losses deviate from the mean, is higher for short positions than for 
long positions in all five annual samples.
    The summary statistics for index CDS provide broadly similar 
findings, although differences exist as reflected in Table 3, Panels C 
and D. For both short and long index CDS positions, the mean and median 
losses vary across the five annual samples. Short index CDS positions 
have the highest mean and median losses in 2008. In contrast, long 
index CDS positions have the highest mean and median losses in 2012. 
Compared to long positions, short positions tend to experience larger 
losses in 2008 and 2011, but smaller losses in 2012, 2017, and 2018. 
For example, in 2008 the mean losses on short and long positions are 
17.1% and 4.7%, respectively; in 2012 the mean losses on short and long 
positions are 2.4% and 5.1%, respectively. For two of the five annual 
samples (2008 and 2018), losses on short index CDS positions tend to be 
more variable than losses on long index CDS positions based on the 
standard deviation. For the other 3 annual samples, long index CDS 
positions tend to have more variable losses than short index CDS 
positions.
    Table 3: Extreme But Plausible Losses Based on Historical CDS 
Pricing Data. This table reports summary statistics of the distribution 
of extreme, but plausible losses stemming from historical price 
movements that could have impacted credit default swap positions. 
Losses are in percentages. The

[[Page 43986]]

summary statistics are Min (minimum), P25 (first quartile/25th 
percentile), P50 (second quartile/50th percentile), P75 (third 
quartile/75th percentile), Max (maximum), Mean, and Std (standard 
deviation).

                                        Single-Name Credit Default Swaps
----------------------------------------------------------------------------------------------------------------
                   Year                        Min       P25       P50       P75       Max      Mean       Std
----------------------------------------------------------------------------------------------------------------
                                            Panel A: Short Positions
----------------------------------------------------------------------------------------------------------------
2008......................................      0.85      6.08     12.10     20.55     71.89     18.49     19.08
2011......................................      0.33      2.94      6.30     11.37     40.89     10.41     11.42
2012......................................      0.00      1.52      3.54      6.26     27.93      6.56      8.11
2017......................................      0.07      1.63      4.44      8.46     71.92     11.24     17.66
2018......................................      0.09      2.33      5.15      9.54     41.35      9.40     11.04
----------------------------------------------------------------------------------------------------------------
                                             Panel B: Long Positions
----------------------------------------------------------------------------------------------------------------
2008......................................      0.15      1.53      4.36      9.52     46.72      7.90      9.72
2011......................................      0.22      1.52      3.49      6.53     19.06      5.34      5.37
2012......................................      0.23      1.38      3.38      6.57     19.18      5.23      5.30
2017......................................      0.08      1.58      3.21      5.75     23.22      5.13      5.31
2018......................................      0.05      1.16      3.32      6.40     20.39      5.18      5.67
----------------------------------------------------------------------------------------------------------------

                                           Index Credit Default Swaps
----------------------------------------------------------------------------------------------------------------
                   Year                        Min       P25       P50       P75       Max      Mean       Std
----------------------------------------------------------------------------------------------------------------
                                            Panel C: Short Positions
----------------------------------------------------------------------------------------------------------------
2008......................................      1.51      2.98      8.02     24.09     87.24     17.06     20.48
2011......................................      0.26      1.61      3.31      5.88     12.46      4.01      3.09
2012......................................      0.19      0.98      1.78      3.15      6.91      2.38      1.92
2017......................................      0.00      0.39      0.76      1.54      3.83      1.12      1.07
2018......................................      0.00      0.34      1.01      2.18      4.50      1.46      1.30
----------------------------------------------------------------------------------------------------------------
                                             Panel D: Long Positions
----------------------------------------------------------------------------------------------------------------
2008......................................      0.00      0.34      1.90      3.59     36.85      4.74      9.24
2011......................................      0.12      1.04      2.08      4.04     30.37      3.83      5.80
2012......................................      0.07      1.33      3.51      4.65     44.16      5.07      8.65
2017......................................      0.10      0.52      1.80      4.74      9.33      2.81      2.60
2018......................................      0.00      0.21      0.66      1.53      3.16      0.91      0.85
----------------------------------------------------------------------------------------------------------------

B. Analysis of the Final Rules and Alternatives

    Prior to the passage of the Dodd-Frank Act, the non-cleared 
security-based swap and swap markets were characterized by opaque and 
complex bilateral exposure networks. As a result, it was not possible 
for market participants to accurately ascertain counterparty exposures 
to other market participants. Moreover, because counterparties did not 
demand margin in support of transactions, nor were such margins 
required by regulation, there was considerable potential for market 
participants to develop large exposures to their counterparties. As a 
result of these large exposures, the failure of a market participant 
could undermine the financial condition of its counterparties, leading 
to sequential counterparty failure. Moreover, the possibility of large 
exposures when combined with uncertainty about where such potential 
exposures lie could cause markets to quickly become illiquid when 
doubts about the viability of even one of the major participants 
surfaced. Specifically, counterparties might be unwilling to extend 
credit or to trade with each other.
    Title VII of the Dodd-Frank Act established a new regulatory 
framework for U.S. markets in security-based swaps and swaps. The Dodd-
Frank Act requires all sufficiently standardized swaps to be cleared 
through a CCP. However, the Dodd-Frank Act does not subject all 
transactions to the mandatory clearing requirement. Section 764 of the 
Dodd-Frank Act requires the Commission to adopt rules imposing margin 
and capital requirements on such ``non-cleared'' security-based swap 
transactions when the transactions are undertaken by entities subject 
to the Commission's oversight \1050\ and for which there is no 
prudential regulator. These requirements are intended to offset the 
greater risk to the entity and the financial system from such 
transactions.
---------------------------------------------------------------------------

    \1050\ These entities include nonbank SBSDs and MSBSPs.
---------------------------------------------------------------------------

    In formulating the new rules and amendments to existing rules being 
adopted today (collectively the ``final rules''), the Commission has 
considered the potential benefits of reducing the risk that the failure 
of one firm will cause financial distress to other firms and disrupt 
financial markets and the U.S. financial system. It has also taken into 
account the potential costs to firms, the financial markets, and the 
U.S. financial system of complying with capital, margin, and 
segregation requirements. The Commission also considered related 
requirements that have been adopted or proposed by other U.S. and 
foreign financial regulators.
    The current broker-dealer capital, margin, and segregation 
requirements serve as the template for the final rules. However, the 
Commission recognized that there may be other appropriate approaches to 
establishing capital, margin, and segregation requirements--including, 
for example, requirements

[[Page 43987]]

based on the proposed or adopted capital, margin, and segregation 
standards of the prudential regulators or the CFTC. In determining the 
appropriate capital, margin, and segregation requirements--whether 
based on current broker-dealer rules or other alternative approaches--
the Commission has assessed and considered a number of different 
approaches, and the Commission recognizes that determinations it has 
made could have a variety of economic consequences for the relevant 
firms, markets, and the financial system as a whole.
    The capital, margin, and segregation requirements being adopted 
today by the Commission are broadly intended to work in tandem to 
improve the resilience of the market for security-based swaps. The 
margin requirements are designed to reduce a dealer's uncollateralized 
counterparty exposures from non-cleared security-based swap positions 
and the potential losses from such exposures in the event of 
counterparty failure. In cases where a nonbank SBSD is not required to 
collect margin (i.e., the counterparty or the security-based swap 
transaction is subject to an exception in Rule 18a-3), capital 
requirements are designed to complement the margin requirements to 
reduce the nonbank SBSD's risk of failure due to potential losses from 
uncollateralized exposures. Specifically, capital requirements are 
designed to enhance the safety and soundness of nonbank SBSDs and 
reduce the likelihood of sequential dealer failure by setting capital 
standards that adjust dynamically with the risk of exposures in 
security-based swaps. In addition, the capital and margin requirements 
work together to reduce the incentives of market participants to engage 
in excessive risk-taking strategies, restrict their implicit leverage 
through non-cleared security-based swap transactions, and reduce the 
potential cost advantage of non-cleared transactions relative to 
cleared transactions, and thereby encourage clearing. Finally, the 
segregation requirements are designed to complement the margin and 
capital requirements by helping ensure that the collateral posted by a 
counterparty is adequately protected and readily available to be 
returned if the nonbank SBSD fails.
    The Commission acknowledges that the new requirements of the final 
rules will impose direct costs on the individual firms. These direct 
costs could lead to potentially significant collective costs for the 
security-based swap market and the financial system. For example, 
restrictive requirements that increase the cost of trading by 
individual firms could reduce their willingness to engage in such 
trading, adversely affecting liquidity in the security-based swap 
market, increasing transaction costs, and harming price discovery. 
These, in turn, can impose costs on those market participants who rely 
on security-based swaps to manage or hedge the risks arising from their 
business activities that may support capital formation.
    Several commenters discussed the absence of an economic analysis in 
the 2018 comment reopening. A commenter stated that the Commission 
``offered no economic analysis of the proposed changes or of the 
original proposals despite the now very different regulatory context.'' 
\1051\ Another commenter noted significant changes to security-based 
swap market since the original 2012 proposal, stating that ``the cost-
benefit analysis conducted by the Commission in 2012 is simply out of 
date.'' \1052\ Other commenters voiced similar concerns.\1053\ In 
addition, a number of commenters had specific concerns about the impact 
of the adopted rules on individual firms, market participants, and 
society in general, and requested that the economic analysis address 
these concerns.\1054\
---------------------------------------------------------------------------

    \1051\ See Better Markets 11/19/2018 Letter.
    \1052\ See SIFMA 11/19/2018 Letter.
    \1053\ See Citadel 11/19/2018 Letter; Harrington 11/19/2018 
Letter; ICI 11/19/2018 Letter; ISDA 11/19/2018 Letter; MFA/AIMA 11/
19/2018 Letter; SIFMA AMG 11/19/2018 Letter; SIFMA 11/19/2018 
Letter.
    \1054\ See American Council of Life Insurers 11/19/2018 Letter; 
Better Markets 11/19/2018 Letter; Citadel 11/29/2018 Letter; FIA 11/
18/2019 Letter; Harrington 11/19/2018 Letter; ICI 11/19/2018 Letter; 
IIB 11/19/2018 Letter; ISDA 11/19/2018 Letter; MFA/AIMA 11/19/2018 
Letter; Morgan Stanley 11/19/2018 Letter; SIFMA AMG 11/19/2018 
Letter; SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission is sensitive to the issues raised by commenters. As 
noted in the 2018 comment reopening, the 2012 proposals contained an 
analysis of the potential economic consequences, and the Commission 
sought further comment on that analysis, including changes to the 
baseline. The economic analysis in this adopting release takes into 
consideration the changes to the baseline since 2012 and, relative to 
the economic analysis in the 2012 proposing release, provides a more 
thorough and complete discussion of the issues involved because it has 
been informed by commenters and addresses the issues they raised. In 
particular, the analysis takes into consideration market trends and 
changes to market practices, the regulatory environment, and regulatory 
data to identify the appropriate baseline. The analysis also evaluates 
the costs and the benefits of the final rules and their impact on the 
efficiency, competition, and capital formation relative to this 
baseline.
    In addition, as discussed in the 2018 comment reopening, the 
Commission proposed the amendments in 2012, extended the comment period 
once, reopened the comment period in connection with the cross-border 
release and proposed an additional security-based swap nonbank capital 
requirement in 2014. In the 2012 proposal, 2013 proposal and 2014 
proposal, the Commission described the potential economic consequences, 
including the baseline against which the proposed rules and amendments 
may be evaluated, the potential costs and benefits, reasonable 
alternatives, and the potential effects on efficiency, competition and 
capital formation. The Commission also has issued other releases 
related to Title VII rulemakings since 2014. The economic analysis from 
2012 was brought forward and made more current by these later releases.
    With respect to the magnitude of the economic impact of the final 
rules, it is generally difficult to quantify certain benefits and costs 
that may result from them. For example, although the adverse spillover 
effects of defaults on liquidity and valuations were evident during the 
financial crisis, it is difficult to quantify the effects of measures 
intended to reduce the default probability of the individual 
intermediary, the ensuing prevention of contagion, and the adverse 
effects on liquidity and valuation. More broadly, it is difficult to 
quantify the costs and benefits that may be associated with steps to 
mitigate or avoid future sequential counterparty failures. Similarly, 
although capital, margin, or segregation requirements may, among other 
things, affect liquidity and transaction costs in the security-based 
swap market, and result in a different allocation of capital than may 
otherwise occur, it is difficult to quantify the extent of these 
effects, or the resulting effect on the financial system more 
generally.
    These difficulties are compounded by the availability of limited 
public and regulatory data related to the security-based swap market, 
in general, and to security-based swap market participants in 
particular, all of which could assist in quantifying certain benefits 
and costs. In light of these challenges, much of the discussion of the 
final rules in this economic analysis will remain qualitative in 
nature, although where possible the economic analysis attempts to 
quantify these benefits and costs. The

[[Page 43988]]

inability to quantify certain benefits and costs, however, does not 
mean that the overall benefits and costs of the final rules are any 
less significant.
    In addition, as noted above, the final rules include a number of 
specific quantitative requirements, such as numerical thresholds, 
limits, deductions, and ratios. These quantitative requirements have 
not been derived directly from econometric or mathematical models, but 
are based on the Commission's prior experience and understanding of the 
markets, and by rules promulgated by the CFTC and SROs. Accordingly, 
the discussion generally describes in a qualitative way the primary 
costs, benefits, and other economic effects that the Commission has 
identified and taken into account in developing these specific 
quantitative requirements. Where possible, the Commission supplements 
the qualitative discussion of these requirements with quantitative 
analysis of historical data.
1. The Capital Rules for Nonbank SBSDs--Rules 15c3-1 and 18a-1
    As noted earlier, dealers and major participants in the non-cleared 
security based swap market are generally not subject to capital 
requirements. Given the central role played by these entities, the lack 
of a capital standard may raise concerns about the continued safety and 
soundness of these firms and the provision of liquidity in this market. 
Such concerns can destabilize the market in the event of a dealer 
failure, especially in times of economic stress. The new capital rules 
are intended to alleviate such concerns by imposing capital standards 
for nonbank SBSDs that are designed to adjust dynamically with the risk 
of their security-based swap exposures. In this section, the Commission 
first describes the mechanics of the new capital requirements, and then 
discusses in detail the benefits and the costs associated with these 
requirements.
a. Overview
    The key features of Rule 18a-1, as adopted and Rule 15c3-1, as 
amended, are regulatory minimum levels of capital, capital charges for 
posting margin, capital charges in lieu of collecting margin, methods 
for computing haircuts for security-based swaps and swaps, and risk 
management procedures. Each of these features is considered in turn.
i. Minimum Net Capital Requirements
    The minimum requirements consist of a fixed-dollar component and a 
variable component. These components differ across different types of 
nonbank SBSDs, and for nonbank SBSDs that are also registered as 
broker-dealers.
    As described in detail in section II.A.2.a. of this release, 
nonbank SBSDs authorized to use models are subject to minimum tentative 
net capital and net capital requirements. Nonbank SBSDs not authorized 
to use models are subject to minimum net capital requirements (but not 
minimum tentative net capital requirements). The minimum tentative net 
capital requirement for an ANC broker-dealer, including an ANC broker-
dealer SBSD, is $5 billion and the minimum net capital requirement is 
the greater of $1 billion or the applicable existing financial ratio 
amount (the 15-to-1 ratio or 2% debit item ratio) plus the 2% margin 
factor. The tentative net capital requirement for a stand-alone SBSD 
authorized to use models (including a firm registered as an OTC 
derivatives dealer) is $100 million and the minimum net capital 
requirements is the greater of $20 million or the 2% margin factor. The 
minimum net capital requirement for a broker-dealer SBSD not authorized 
to use models is the greater of $20 million or the applicable existing 
financial ratio amount (the 15-to-1 ratio or 2% debit item ratio) plus 
the 2% margin factor. The minimum net capital requirement for a stand-
alone SBSD not approved to use internal models is the greater of a $20 
million or the 2% margin factor.
    The 2% margin factor will remain level for 3 years after the 
compliance date of the rule. After 3 years, the multiplier could 
increase to not more than 4% by Commission order, and after 5 years the 
multiplier could increase to not more than 8% by Commission order if 
the Commission had previously issued an order raising the multiplier to 
4% or less. The final rules further provide that the Commission will 
consider the capital and leverage levels of the firms subject to these 
requirements as well as the risks of their security-based swap 
positions and provide notice before issuing an order raising the 
multiplier. This approach will enable the Commission to analyze the 
impact of the new requirement.
ii. Capital Charge for Posting Initial Margin
    As described in detail in section II.A.2.b.i. of this release, if a 
broker-dealer or nonbank SBSD delivers initial margin to another SBSD 
or other counterparty, it must take a capital charge in the amount of 
the posted collateral. The Commission is providing interpretive 
guidance as to how a broker-dealer or nonbank SBSD can avoid taking 
this capital charge. Under the guidance, initial margin provided by the 
broker-dealer or nonbank SBSD to a counterparty need not be deducted 
from net worth when computing net capital if:
     The initial margin requirement is funded by a fully 
executed written loan agreement with an affiliate of the broker-dealer 
or nonbank SBSD;
     The loan agreement provides that the lender waives re-
payment of the loan until the initial margin is returned to the broker-
dealer or nonbank SBSD; and
     The liability of the broker-dealer or the nonbank SBSD to 
the lender can be fully satisfied by delivering the collateral serving 
as initial margin to the lender.
    Nonbank SBSDs and broker-dealers may apply this guidance to 
security-based swap and swap transactions.
iii. Capital Deductions in Lieu of Margin
    As described in detail in section II.A.2.b.ii. of this release, 
broker-dealers and nonbank SBSDs will be required to take a deduction 
for under-margined accounts because of a failure to collect margin 
required under Commission, CFTC, clearing agency, DCO, or DEA) rules 
(i.e., a failure to collect margin when there is no exception from 
collecting margin). These firms also will be required to take 
deductions when they elect not to collect margin pursuant to exceptions 
in the margin rules of the Commission and the CFTC for non-cleared 
security-based swaps and swaps, respectively. For firms that are not 
approved to use models, these deductions for electing not to collect 
margin must equal 100% of the amount of margin that would have been 
required to be collected from the security-based swap or swap 
counterparty in the absence of an exception. These deductions can be 
reduced by the value of collateral held in the account.
    Regarding the capital charges for initial margin collected but 
segregated with a third-party custodian, the final rule contains a 
provision that allows a nonbank SBSD to avoid taking a capital 
deduction or the alternative credit risk charge for the initial margin 
collected but held with a third-party custodian as long as certain 
conditions are satisfied.
iv. Standardized Haircuts for Security-Based Swaps
    As described in detail in section II.A.2.b.iii. of this release, a 
nonbank SBSD will be required to apply standardized haircuts to its 
proprietary positions (including security-based swap and swap 
positions), unless the Commission has approved its use of

[[Page 43989]]

model-based haircuts. The standardized haircuts for positions--other 
than security-based swaps and swaps--generally are the pre-existing 
standardized haircuts required by Rule 15c3-1. With respect to 
security-based swaps and swaps, the Commission is prescribing 
standardized haircuts tailored to those instruments. In the case of a 
cleared security-based swap and swap, the standardized haircut is the 
applicable clearing agency or DCO margin requirement. For a non-cleared 
CDS, the standardized haircut is set forth in two grids (one for 
security-based swaps and one for swaps) in which the amount of the 
deduction is based on two variables: The length of time to maturity of 
the CDS contract and the amount of the current offered basis point 
spread on the CDS. For other types of non-cleared security-based swaps 
and swaps, the standardized haircut generally is the percentage 
deduction of the standardized haircut that applies to the underlying or 
referenced position multiplied by the notional amount of the security-
based swap or swap.
v. Credit Risk Charges
    As described in detail in section II.A.2.b.v. of this release, ANC 
broker-dealers and stand-alone SBSDs authorized to use models may take 
credit risk charges instead of the deductions in lieu of margin 
discussed in section II.A.2.b.ii. of this release. More specifically, 
an ANC broker-dealer (including a firm registered as an SBSD) and a 
stand-alone SBSD approved to use models for capital purposes can apply 
a credit risk charge with respect to uncollateralized exposures arising 
from derivatives instruments, including exposures arising from not 
collecting variation and/or initial margin pursuant to exceptions in 
the non-cleared security-based swap and swap margin rules of the 
Commission and CFTC, respectively. In applying the credit risk charges, 
ANC broker-dealers (including firms registered as SBSDs) are subject to 
a portfolio concentration charge that has a threshold equal to 10% of 
the firm's tentative net capital. Under the portfolio concentration 
charge, the application of the credit risk charges to uncollateralized 
current exposure across all counterparties arising from derivatives 
transactions is limited to an amount of the current exposure equal to 
no more than 10% of the firm's tentative net capital. The firm must 
take a charge equal to 100% of the amount of the firm's aggregate 
current exposure in excess of 10% of its tentative net capital. Stand-
alone SBSDs, including SBSDs operating as OTC derivatives dealers, are 
not subject to a portfolio concentration charge with respect to 
uncollateralized current exposure.
vi. Risk Management Procedures
    As described in detail in section II.A.2.c. of this release, 
nonbank SBSDs will be required to comply with the risk management 
provisions of Rule 15c3-4 as if they were OTC derivatives dealers. The 
risks of trading security-based swaps--including market, credit, 
operational, and legal risks--are similar to the risks faced by OTC 
derivatives dealers in trading other types of OTC derivatives.\1055\
---------------------------------------------------------------------------

    \1055\ For example, individually negotiated OTC derivatives, 
including security-based swaps, generally are not very liquid. 
Market participants face risks associated with the financial and 
legal ability of counterparties to perform under the terms of 
specific transactions.
---------------------------------------------------------------------------

b. Benefits and Costs of the Capital Rules for Nonbank SBSDs
    The OTC market for security-based swaps as it exists today is 
characterized by complex networks of bilateral exposures. At the center 
of these networks are the dealers, who are the main liquidity providers 
to this market. The networks are fairly opaque; market participants 
have little or no knowledge about a dealer's uncollateralized exposure 
to any given counterparty or the dealer's ability to withstand 
potential losses from such exposure. In times of market stress, 
uncertainty about the safety and soundness of the dealers may hinder 
the efficient allocation of capital between market participants. For 
instance, in the event of a dealer or a major participant failure, 
uncertainty about the uncollateralized exposures of the surviving 
dealers to the failed entity and their ability to withstand potential 
losses from such exposures may discourage some market participants from 
seeking new transactions with the surviving dealers. This ``run'' by 
the market participants on the surviving dealers may cause some of 
these dealers to fail. Sequential dealer failure would have a 
significant negative impact on the provision of liquidity in this 
market, and may ultimately cause the security-based swap market to 
break down.
    The safety and soundness of the dealer, including its ability to 
withstand losses from its trading activity depends ultimately on the 
dealer's capital. As noted earlier, there are no market-imposed capital 
standards in the market for non-cleared security-based swaps.
    Some of the dealers in this market are affiliated with broker-
dealers, but are not subject to the capital requirements applicable to 
broker-dealers. In addition, a majority of the dealers are organized as 
subsidiaries of bank holding companies and, while they may not be 
subject to direct capital requirements, they are indirectly subject to 
capital requirements imposed on their bank holding company parent. Some 
dealers are not affiliated with a broker-dealer or have a parent bank 
holding company and, consequently, are not subject to direct or 
indirect capital requirements.
    Given that most of the dealers in this market are affiliated with 
institutions that are subject to capital regulation, it is likely that 
these dealers are organized as dealing structures designed to 
efficiently deploy capital. Such capital-efficient dealing structures 
may not voluntarily maintain capital buffers that adjust with the risk 
of their exposures, such as to minimize the risk of their own failure 
and the cost of externalities caused by such failure. Dealers currently 
not subject to direct capital regulation may choose capital levels and 
capital assets that, while privately optimal, are too low and too 
illiquid from a market stability perspective.
    The final capital rules in this adopting release impose a capital 
standard on nonbank SBSDs. This capital standard requires that, among 
other things, a nonbank SBSD maintain a minimum level of net capital 
that adjusts dynamically with the risk of its exposure in security-
based swap market and that promotes the liquidity of the firm. This 
capital standard is intended to enhance the safety and soundness of 
nonbank SBSDs by reducing their incentives to engage in excessive risk-
taking, by increasing their ability to withstand losses from their 
trading activity, and by reducing the risk of sequential counterparty 
failure. The Commission acknowledges, however, that the new capital 
requirements may impose direct costs on nonbank SBSDs, and indirect 
costs on the rest of the market participants.
    Due to the opacity of the market for non-cleared security-based 
swaps, dealers currently may have an incentive to engage in excessive 
risk-taking behavior. As a result, aside from reputational concerns, 
the market, as it exists today, lacks mechanisms that would force 
dealers to internalize the cost of the negative externalities created 
by their excessive risk-taking behavior.
    The final capital rules require nonbank SBSDs to allocate 
additional liquid capital for any new security-based swap position, 
cleared or non-cleared. Specifically, nonbank SBSDs will need to 
maintain net capital (and, for firms authorized to use models, 
tentative net capital) levels that are no less than their minimum 
fixed-dollar

[[Page 43990]]

requirements. Further, once their ratio-based minimum net capital 
requirements equal or exceed their fixed-dollar minimum net capital 
requirements, nonbank SBSDs will have to increase their minimum net 
capital to enter a new cleared or non-cleared security-based swap 
position (i.e., because the amount required under the 2% margin factor 
will increase). In addition, the nonbank SBSD will have to take a 
capital charge against the market risk of the position (e.g., risk of 
that a change in value or default of the reference entity will cause a 
mark-to-market loss for the security-based swap position). Furthermore, 
to the extent that the credit exposure is uncollateralized (e.g., the 
counterparty is subject to a margin collection exception), the nonbank 
SBSD will also have to take a capital deduction to act as a buffer 
against potential losses from replacing or closing out the position in 
the event of the counterparty's failure. These capital charges increase 
with the risk of the position. In particular, these capital charges may 
discourage risk-taking. A reduction in risk-taking by nonbank SBSDs 
would arise because the firms will have to allocate capital to account 
for the market and credit exposures created by their trading positions. 
In some instances, reduced risk-taking may represent an intended 
economic consequence of the final rules, for example, if it manifests 
as a lower propensity to establish large directional positions in 
security-based swaps that may impose negative externalities on other 
market participants (e.g., such positions may not take into account the 
cost of the SBSD's potential failure on its counterparties). In other 
cases, however, reduced risk taking could impede market functioning by, 
for example, increasing the compensation that nonbank SBSDs demand to 
intermediate transactions between other market participants, 
potentially impairing efficient risk sharing.
    The requirements of the final margin rule may further discourage 
risk-taking behavior among nonbank SBSDs. For instance, the final 
margin rule requires that nonbank SBSDs post variation margin to all 
their counterparties that are not subject to a variation margin 
exception. In particular, a nonbank SBSD will have to post more 
variation margin to a counterparty as the counterparty's current 
exposure to the dealer increases. Here too, reductions in nonbank SBSD 
risk-taking may reflect margin requirements that cause nonbank SBSDs to 
appropriately internalize more of the costs their activities impose on 
other market participants, even as these margin requirements 
potentially curtail efficient reallocation of risk by market 
participants.
    In general, by requiring nonbank SBSDs to allocate capital in an 
amount that scales up with the size of the security-based swap 
positions, and by requiring nonbank SBSDs to post variation margin 
whenever they create an exposure, the capital and margin requirements 
of the final capital and margin rules and amendments are intended to 
reduce a nonbank SBSD's incentive to engage in excessive risk-taking 
behavior in the market for non-cleared security-based swaps.
    Similarly, due to the opacity of the market for security-based 
swaps, currently, it is not always clear whether a dealer is 
financially sound. In particular, it is not clear whether dealers are 
adequately capitalized to withstand losses from their trading activity. 
The final capital rules impose a capital standard on nonbank SBSDs. As 
discussed above, this capital standard requires a nonbank SBSD to 
allocate capital against the market and credit exposures created by a 
security-based swap position, which would permit the nonbank SBSD to 
cover potential losses stemming from these exposures. These capital 
charges are designed to help a nonbank SBSD manage losses from its 
trading activities in cases where the nonbank SBSD cannot rely entirely 
on collateral.
    Moreover, by imposing a capital standard on nonbank SBSDs that 
complements the requirements of the final margin rule, the capital and 
margin requirements of the final capital and margin rules and 
amendments are intended to increase a nonbank SBSD's viability, 
including its ability to withstand potential losses from its trading 
activity. In general, when a counterparty to a non-cleared security-
based swap transaction fails, the dealer may want to replace the 
position. To this end, under the final capital and margin rules, a 
nonbank SBSD will be able to rely on the collateral posted by the 
counterparty prior to its default (e.g., variation and initial margin) 
and the capital that the nonbank SBSD allocated at the outset and 
throughout the life of the position (e.g., the capital charges against 
the market and credit exposure created by the position). If in the 
aftermath of the counterparty's failure the market exposure of the 
position continues to deteriorate, the collateral that the dealer 
collected from the counterparty prior to its default may not be enough 
to offset the replacement cost of the position. In this case the 
nonbank SBSD may incur losses on the position. However, the nonbank 
SBSD's losses would be limited by the capital that the nonbank SBSD was 
required to allocate by way of a capital charge to support the position 
prior to the counterparty's default as well as the increase in the 
minimum net capital amount that reflects the exposure of the position 
and that the nonbank SBSD is required to maintain at all times (e.g., 
the incremental adjustment to the 2% margin factor resulting from the 
position).
    Finally, due to the opacity of the market for security-based swaps, 
dealers do not know other dealers' exposures outside the positions that 
they have in common. In particular, losses from trading activity may 
cause a dealer to fail, which in turn, may cause losses for surviving 
counterparty dealers and precipitate their failure. In other words, the 
market for security-based swaps as it exists today is subject to the 
risk of sequential dealer failure.
    Because the final margin rule would require nonbank SBSDs to 
collect variation margin but not initial margin from other nonbank 
SBSDs and financial market intermediaries, nonbank SBSDs would have 
credit exposures to each other that may not be fully collateralized 
(i.e., no inter-dealer exchange of initial margin). However, the final 
capital rules and amendments work in tandem with the final margin rules 
to impose a capital standard on nonbank SBSDs that requires them to 
allocate capital against the market and credit exposures created by the 
inter-dealer positions, and further increase their minimum net capital 
by an amount that is proportional to the exposure created by the 
positions. This capital buffer is designed to help a nonbank SBSD 
withstand potential losses from replacing inter-dealer positions that 
expose the dealer to uncollateralized credit exposure, because of the 
absence of inter-dealer collection of initial margin. In addition, 
while nonbank SBSDs are not required to collect initial margin from 
each other, they are not prohibited from doing so.
    Thus, by requiring nonbank SBSDs to allocate capital that scales up 
with the risk of the inter-dealer credit exposures (whether or not 
collateralized), the capital and margin requirements of the final 
capital and margin rules and amendments are expected to reduce the 
likelihood that the losses at one nonbank SBSD impact the other nonbank 
SBSD. In turn, the final capital and margin rules, taken together, 
should reduce the risk of sequential dealer failure.

[[Page 43991]]

    The final capital rules and amendments will impose direct 
compliance costs on nonbank SBSDs. To be adequately capitalized, SBSDs 
will have to ensure that their net capital is larger than the required 
minimum net capital. An SBSD will have to calculate its net capital by 
taking capital charges against their tentative net capital for the 
uncollateralized exposures created by their trading activity. As noted 
earlier, the minimum net capital, through the 2% margin factor, as well 
as the capital charges (i.e., standardized or model-based haircuts) 
scale up with a nonbank SBSD's trading activity in the security-based 
swap market. Thus, the new capital requirements directly constrain a 
nonbank SBSD's trading activity, and the profits that the nonbank SBSD 
expects to generate from such activity. In turn, these capital 
constraints may limit the provision of liquidity in the market for non-
cleared security-based swaps, and the resulting reduction in price 
discovery may, in turn, impose a cost on market participants.
    The Commission has made two significant modifications to the final 
capital rules for nonbank SBSDs. First, as discussed above in section 
II.A.2.b.v. of this release, the Commission has modified Rule 18a-1 so 
that it no longer contains a portfolio concentration charge that is 
triggered when the aggregate current exposure of the stand-alone SBSD 
to its derivatives counterparties exceeds 50% of the firm's tentative 
net capital.\1056\ This means that stand-alone SBSDs that have been 
authorized to use models will not be subject to this limit on applying 
the credit risk charges to uncollateralized current exposures related 
to derivatives transactions. The second significant modification is an 
alternative compliance mechanism.
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    \1056\ See paragraph (e)(2) of Rule 18a-1, as adopted. See also 
Capital, Margin, and Segregation Proposing Release, 77 FR at 70244 
(proposing a portfolio concentration charge in Rule 18a-1 for stand-
alone SBSDs).
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    The Commission acknowledges that under these two modifications a 
stand-alone SBSD will be subject to: (1) A capital standard that is 
less rigid than Rule 15c3-1 in terms of imposing a net liquid assets 
test (in the case of firms that will comply with Rule 18a-1); or (2) a 
capital standard that potentially does not impose a net liquid assets 
test (in the case of firms that will operate under the alternative 
compliance mechanism and, therefore, comply with the CFTC's capital 
rules). Accordingly, this will mean that the final rules may not 
enhance these firms' liquidity position to the same degree as they will 
for broker-dealer SBSDs. As a result, the risk that a stand-alone SBSD 
may not be able to self-liquidate in an orderly manner will be higher 
relative to broker-dealer SBSDs. However, stand-alone SBSDs will likely 
engage in a more limited business than broker-dealers, including 
broker-dealer SBSDs. Thus, they will likely be less significant 
participants in the overall securities markets. For example, they will 
not be dealers in the cash securities markets or the markets for listed 
options and they will not maintain custody of cash or securities for 
retail investors in those markets. Given their limited role, the 
Commission believes that it is appropriate to more closely align the 
requirements for stand-alone SBSDs with the requirements of the CFTC 
and the prudential regulators.
    As a result of these modifications, stand-alone SBSDs will likely 
be able to comply with the final rules at a lower cost than broker-
dealer SBSDs. First, a stand-alone SBSD will not be subject to a 
portfolio concentration charge if its aggregate current exposures to 
derivatives counterparties exceed 10% of its tentative net capital, 
reducing its overall capital requirement, and attendant costs, under 
the final rules. Second, stand-alone SBSDs would be permitted to comply 
solely with CFTC capital rules if they meet the conditions of the 
alternative compliance mechanism. While this may preserve stand-alone 
SBSDs' ability to intermediate transactions in the security-based swap 
market, it may also shift competition among nonbank SBSDs in favor of 
stand-alone SBSDs.
    One commenter argued that the Commission failed to provide an 
analysis showing the economic impact of the proposed rules on 
investors, systemic stability, and crisis prevention.\1057\ Another 
commenter argued that the Commission should analyze the operational 
risks and concerns associated with not maintaining adequate levels of 
capital.\1058\ Finally, a commenter recommended that the Commission 
provide an economic analysis in a final rulemaking to justify changes 
to Rule 15c3-1.\1059\
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    \1057\ See Better Markets 11/19/2018 Letter.
    \1058\ See Harrington 11/19/2018 Letter.
    \1059\ See Morgan Stanley 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to these commenters, the analysis provided in the 
adopting release addresses the effects of the final capital rules and 
amendments on the safety and soundness of nonbank SBSDs, including the 
risk of sequential dealer failure. As noted in the discussion above, 
the analysis starts with a discussion of the problems that may arise in 
OTC markets when dealers are not subject to explicit capital or margin 
requirements. In particular, it notes that lack of adequate 
capitalization or collateralization may encourage excessive risk 
taking, may cause a dealer to fail, and may result in sequential dealer 
failure. The discussion also describes how the final capital rules and 
amendments work together with the final margin rules to address these 
issues. The analysis that follows discusses in more detail the costs 
and benefits associated with specific capital requirements in the final 
capital rules for both stand-alone and broker-dealer SBSDs as well as 
other market participants and attempts to provide quantitative 
estimates whenever possible.
i. Minimum Net Capital Requirements
    As noted above, the minimum capital requirements contain both a 
minimum fixed-dollar component and a variable component (the 2% margin 
factor).\1060\ The fixed-dollar component sets a lower bound on the 
amount of tentative and net capital that a nonbank SBSD must hold, as 
applicable. The variable component sets a lower bound on the amount of 
capital for a nonbank SBSD that scales up with the security-based swap 
activity of the dealer. These two components are likely to affect a 
nonbank SBSD differently based on the volume of its security-based swap 
activity. For instance, a nonbank SBSD that engages in limited amount 
of security-based swap activity will likely care more about the fixed-
dollar component than the variable component. On the other hand, a 
nonbank SBSD that engages in substantial amount of security-based swap 
activity will likely care more about the variable component than the 
fixed-dollar component. More generally, the design of these two 
components of minimum capital requirements will likely affect the entry 
costs in the nonbank SBSD industry, and the distribution of firms, by 
activity, within this industry. The analysis below focuses on these two 
aspects when identifying the main costs and the benefits associated 
with the design of the minimum capital requirements.
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    \1060\ As discussed above, the 2% margin factor for all nonbank 
SBSDs will remain level for 3 years from the compliance date of the 
rule, and the rule prescribes a process by which the Commission, by 
order, could increase the 2% multiplier thereafter.
---------------------------------------------------------------------------

    The $20 million fixed-dollar minimum net capital requirement for 
nonbank SBSDs (other than firms that are ANC broker-dealers) is 
consistent with the $20 million fixed-dollar minimum requirement 
applicable to

[[Page 43992]]

OTC derivatives dealers under paragraph (a)(5) of Rule 15c3-1, and is 
therefore already familiar to certain market participants. OTC 
derivatives dealers are limited purpose broker-dealers that are 
authorized to trade in certain derivatives, including security-based 
swaps, and use internal models to calculate net capital. They also are 
required to maintain minimum tentative net capital of $100 million. 
These current fixed-dollar minimums have been the capital standards for 
OTC derivative dealers for 20 years. A commenter supported the 
Commission's thresholds for the fixed-dollar component of the minimum 
capital requirements stating that they are generally consistent with 
the capital requirements for OTC derivatives dealers.\1061\
---------------------------------------------------------------------------

    \1061\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    Stand-alone SBSDs not authorized to use models will be required to 
maintain minimum net capital of the greater of $20 million or the 2% 
margin factor.\1062\ The $20 million fixed-dollar minimum net capital 
requirement for these SBSDs is substantially higher than the fixed-
dollar minimums in Rule 15c3-1 currently applicable to broker-dealers 
that are not authorized to use models.\1063\ In cases where the 2% 
margin factor results in a net capital requirement greater than $20 
million, the total net capital requirement for these nonbank SBSDs will 
be greater than $20 million minimum requirement for OTC derivatives 
dealers as well. The more stringent minimum net capital requirement of 
the greater of $20 million or the 2% margin factor for stand-alone 
SBSDs not approved to use models reflects that these firms to a greater 
extent than broker-dealers that are not SBSDs, will be able to deal in 
security-based swaps, which, in general, pose risks that are different 
from, and in some respects greater than, those arising from dealing in 
other types of securities. Moreover, stand-alone SBSDs, unlike OTC 
derivative dealers, have direct customer relationships and have custody 
of customer funds. Therefore, the failure of a stand-alone SBSD would 
have a broader adverse impact on a larger number of market 
participants, including customers and counterparties. Relatively higher 
capital requirements for stand-alone SBSDs as compared to broker-
dealers and OTC derivatives dealers (which will not be subject to the 
2% margin factor, unless they are also registered as a nonbank SBSD or 
ANC broker-dealer) are intended to mitigate these relatively more 
substantial risks.
---------------------------------------------------------------------------

    \1062\ This is consistent with the CFTC's proposed capital 
requirements for nonbank swap dealers, which impose $20 million 
fixed-dollar minimum requirements regardless of whether the firm is 
approved to use internal models to compute regulatory capital. See 
CFTC Capital Proposing Release, 81 FR 91252.
    \1063\ For example, a broker-dealer that carries customer 
accounts has a fixed-dollar minimum net capital requirement of 
$250,000; a broker-dealer that does not carry customer accounts but 
engages in proprietary securities trading (defined as more than 10 
trades per year) has a fixed-dollar minimum net capital requirement 
of $100,000; and a broker-dealer that does not carry accounts for 
customers or otherwise receive or hold securities or cash for 
customers, and does not engage in proprietary trading activities, 
has a fixed-dollar minimum net capital requirement of $5,000. See 
paragraph (a)(2) of Rule 15c3-1.
---------------------------------------------------------------------------

    Consequently, a benefit of these heightened minimum capital 
requirements is that they should enhance the safety and soundness of 
the nonbank SBSDs not authorized to use models, and, indirectly, should 
reduce the cost of counterparty failure that market participants 
internalize when transferring credit risk in the security-based swap 
market.
    Stand-alone SBSDs authorized to use models will be required to 
maintain minimum net capital of the greater of $20 million or the 2% 
margin factor, as well as a minimum tentative net capital of $100 
million (a requirement that also applies to OTC derivatives dealers). 
Models to calculate deductions from tentative net capital for 
proprietary positions generally lead to market and credit risk charges 
that are substantially lower than the standardized haircuts and 100% 
capital deductions, respectively.\1064\ As a consequence, the minimum 
tentative net capital requirement for firms using models is intended to 
provide an additional assurance of adequate capital to reflect this 
concern and to account for risks that may not be fully captured by the 
models.
---------------------------------------------------------------------------

    \1064\ See, e.g., Alternative Net Capital Requirements for 
Broker-Dealers That Are Part of Consolidated Supervised Entities, 69 
FR at 34455 (stating that the ``major benefit for the broker-
dealer'' of using an internal model ``will be lower deductions from 
net capital for market and credit risk''). See also OTC Derivatives 
Dealer Release, 63 FR 59362. Given the significant benefits of using 
models in reducing the capital required for security-based swap 
positions, it is likely that for new entrants to capture substantial 
volume in security-based swaps they will need to use models.
---------------------------------------------------------------------------

    Under the amendments to paragraph (a)(7) of Rule 15c3-1, ANC 
broker-dealers, including ANC broker-dealer SBSDs, will be required to 
maintain: (1) Tentative net capital of not less than $5 billion; and 
(2) net capital of not less than the greater of $1 billion or the 
financial ratio amount required pursuant to paragraph (a)(1) of Rule 
15c3-1 plus the 2% margin factor. These requirements are higher than 
current requirements for ANC broker-dealers in a number of ways. First, 
the inclusion of a 2% margin factor represents an additional capital 
requirement that reflects, and scales with, an ANC broker-dealers' 
security-based swap activities. Second, the final rules increase the 
existing tentative net capital requirement of $1 billion and net 
capital requirement of $500 million.
    These higher minimum capital requirements for ANC broker-dealers 
(as compared with the requirements for other types of broker-dealers) 
reflect the substantial and diverse range of business activities 
engaged in by these entities and their importance as intermediaries in 
the securities markets. Further, the heightened capital requirements 
reflect the fact that, as noted above, models are more risk sensitive 
but also generally permit substantially reduced deductions to tentative 
net capital as compared to the standardized haircuts as well as the 
fact that models may not capture all risks.\1065\
---------------------------------------------------------------------------

    \1065\ See Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities, 69 FR 
34428.
---------------------------------------------------------------------------

    One commenter argues that allowing certain nonbank SBSDs to use 
models for the purpose of calculating net capital could give these 
dealers a competitive advantage over the rest of nonbank SBSDs not 
authorized to use models.\1066\ This commenter further argues that 
models routinely fail in a crisis and, importantly, they may encourage 
dealers to engage in additional risk-taking by permitting dealers to 
use models to lower their minimum required regulatory capital. As noted 
above, nonbank SBSDs that are approved to use internal models are 
subject to more stringent capital requirements than nonbank SBSDs that 
do not use internal models. In particular, ANC broker-dealer SBSDs are 
subject to a much higher minimum net capital requirement than broker-
dealer SBSDs that do not use internal models, with a fixed-dollar 
component of $1 billion versus a fixed-dollar component of $20 million. 
Furthermore, both stand-alone SBSDs using internal models and ANC 
broker-dealers are subject to a tentative net capital requirement that 
does not apply to broker-dealer SBSDs that do not use internal models. 
These heightened capital requirements are designed to accommodate 
potential losses associated with higher trading activity, including 
losses induced by model failure. In other words, to the extent that a 
nonbank SBSD's model underestimates exposures, on occasion, and to the 
extent that some of these exposures result in losses for the

[[Page 43993]]

nonbank SBSD using the model, the heightened capital requirements for 
the nonbank SBSD should help absorb these losses.
---------------------------------------------------------------------------

    \1066\ See Systemic Risk Council 1/24/2013 Letter.
---------------------------------------------------------------------------

    The use of internal models for the purpose of calculating net 
capital should permit nonbank SBSDs to significantly reduce the amount 
of capital that they have to allocate to support their trading activity 
(e.g., the capital charges for the market and credit risk of a 
position). This capital savings may increase the trading capacity of 
nonbank SBSDs that are authorized to use internal models, which, in 
turn, may increase liquidity provision in the security-based swap 
market. This benefit together with the heightened capital requirements 
for this type of nonbank SBSD potentially offsets some of the potential 
costs associated with the impact on competition of permitting certain 
nonbank SBSDs to use internal models for the purpose of calculating net 
capital. In addition, the final capital rules include a provision that 
grants a nonbank SBSD temporary use of a provisional model that has 
been approved by certain other regulators, while the nonbank SBSD has 
an application pending for its internal model. Under certain 
conditions, this provision could facilitate dealing structures that 
currently rely on internal models approved by other regulators to 
continue to use their models after they register as nonbank SBSDs, 
while their application for approval to use an internal model for the 
purposes of the final capital rules is pending.\1067\
---------------------------------------------------------------------------

    \1067\ See paragraph (a)(7)(ii) of Rule 15c3-1e, as amended; 
paragraph (d)(5)(ii) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

    Finally, as discussed above, the final margin and capital rules 
would cause nonbank SBSDs to internalize a significant portion of the 
negative externalities associated with a nonbank SBSD's potential risk-
taking behavior that could arise under the baseline.\1068\ Nonbank 
SBSDs may pass on some of these costs to their customers and 
counterparties.
---------------------------------------------------------------------------

    \1068\ While it is likely that a counterparty may demand 
compensation (e.g., better pricing terms) for the credit risk 
associated with a security-based swap position with a nonbank SBSD, 
the counterparty's other counterparties may not have sufficient 
information about indirect exposures to the nonbank SBSD to also 
demand compensation for these indirect risks.
---------------------------------------------------------------------------

    Based on financial information reported by the ANC broker-dealers 
in their FOCUS Reports filed with the Commission, the five current ANC 
broker-dealers maintain capital levels in excess of these increased 
minimum requirements. Further, under paragraph (a)(7)(ii) of Rule 15c3-
1, ANC broker-dealers are currently required to notify the Commission 
if their tentative net capital falls below $5 billion. The Commission 
uses this notification provision to trigger increased supervision of 
the firm's operations and to take any necessary corrective action and 
is similar to corollary early warning requirements for OTC derivatives 
dealers under Rule 17a-11. Consequently, this $5 billion early warning 
level currently acts as the de facto minimum tentative net capital 
requirement since the ANC broker-dealers seek to avoid providing this 
regulatory notice that their tentative net capital has fallen below the 
early warning level.
    The increases to the minimum tentative and minimum net capital 
requirements in the final capital rules may not present a material cost 
to the current ANC broker-dealers because, currently, they already hold 
more tentative and net capital than the new minimum requirements. The 
more relevant number is the increase in the early warning notification 
threshold from $5 billion to $6 billion. The new ``early warning'' 
threshold for ANC broker-dealers of $6 billion in tentative net capital 
is modeled on a similar requirement for OTC derivatives dealers. The 
existing early warning requirement for OTC derivatives dealers under 
paragraph (c)(3) of Rule 17a-11 triggers a notice when the firm's 
tentative net capital falls below an amount that is 120% of the firm's 
required minimum tentative net capital amount of $100 million (i.e., 
the early warning threshold for tentative net capital is $120 million).
    Based on the Commission staff's supervision of the ANC broker-
dealers, the current ANC broker-dealers report tentative net capital 
levels that are generally well in excess of $6 billion threshold. As a 
result, the costs to the ANC broker-dealers to comply with the new 
minimum tentative net capital requirement are not expected to be 
material. However, these costs may be prohibitive to prospective 
registrants that are not already ANC broker-dealers and that wish to 
register as broker-dealer SBSDs using internal models (i.e., ANC 
broker-dealers). As discussed below in this section, such barriers to 
entry may prevent or reduce competition among SBSDs, which in turn can 
lead to higher transaction costs and less liquidity than would 
otherwise exist.
    In addition to the fixed-dollar-amount components, the minimum net 
capital requirements also include the 2% margin factor.\1069\ This 
variable component is intended to establish a minimum capital 
requirement that scales with the level of the nonbank SBSD's security-
based swap activity.
---------------------------------------------------------------------------

    \1069\ The 2% margin factor will be additive to the existing 
Rule 15c3-1 ratio-based minimum net capital requirement for an ANC 
broker-dealer. Therefore, the cost impact to an ANC broker-dealer 
will depend on whether and how much the 2% margin factor increases 
that ANC broker-dealer's minimum net capital requirement relative to 
the existing ratio-based minimum net capital requirements in Rule 
15c3-1 in the baseline as well as the amount of excess net capital 
the firm maintains.
---------------------------------------------------------------------------

    The 2% margin factor is similar to an existing requirement in the 
CFTC's net capital rule for FCMs, and the CFTC's proposed capital 
requirements for swap dealers and major swap participants registered as 
FCMs.\1070\ Under the process set forth in the final rules, the 2% 
multiplier will remain level for 3 years after the compliance date of 
the rule. After 3 years, the multiplier could increase to not more than 
4% by Commission order, and after 5 years the multiplier could increase 
to not more than 8% by Commission order if the Commission had 
previously issued an order raising the multiplier to 4% or less. The 
process sets an upper limit for the multiplier of 8% (the day-1 
multiplier under the proposed rules) and requires the issuance of two 
successive orders to raise the multiplier to as much as 8% (or an 
amount between 4% and 8%).
---------------------------------------------------------------------------

    \1070\ See CFTC Capital Proposing Release, 81 FR at 91306. The 
8% calculation under the CFTC's proposal relates to cleared and non-
cleared swaps or futures transactions, as well as cleared and non-
cleared security-based swaps, whereas the 2% margin factor in Rule 
15c3-1, as amended, and Rule 18a-1, as adopted, is based on cleared 
and non-cleared security-based swaps.
---------------------------------------------------------------------------

    The 2% margin factor will provide a nonbank SBSD with a buffer of 
liquid capital that should complement the SBSD's capital charges 
against the market and credit risk associated with its exposures from 
transacting in security-based swaps. This capital buffer would be 
useful in situations where unanticipated losses on a security-based 
swap position exceed the value of the collateral that the SBSD collects 
or the capital charges that the SBSD takes against the exposures 
created by the position. Such situations may arise when the 
standardized or model-based haircuts that apply to the exposures 
created by a security-based swap position or the collateral collected 
to cover that exposure are not large enough to cover the actual losses 
from the position.\1071\ In the case of cleared security-based swap 
positions, the 2% margin factor will also create a capital

[[Page 43994]]

buffer that a nonbank SBSD with credit exposure to a CCP could access 
in the scenario that a CCP fails. This capital buffer should improve 
the financial stability of a nonbank SBSD, because the final capital 
rule and amendments do not require that a nonbank SBSD collect initial 
margin from a CCP or take a capital deduction for margin posted to a 
CCP.
---------------------------------------------------------------------------

    \1071\ Situations where actual losses exceed model-based 
haircuts are instances of model risk.
---------------------------------------------------------------------------

    The 2% margin factor will also provide a nonbank SBSD with a buffer 
of liquid capital that may be needed in situations where the SBSD 
cannot access in a timely manner the initial margin collected from a 
failing counterparty, but that is not under the SBSD's control (e.g., 
the collateral is either re-hypothecated or segregated at a third-party 
custodian, in the case of non-cleared security-based swaps, or posted 
with a CCP, as part of the SBSD's client clearing business in the case 
of a cleared security-based swap). The nonbank SBSD could rely on the 
liquid capital provided by the 2% margin factor to offset some of the 
replacement or liquidation costs of the positions with the failed 
counterparty, before it takes possession of, and potentially 
liquidates, the failing counterparty's collateral. Furthermore, the 
nonbank SBSD will be able to recover in whole or in part the portion of 
the 2% margin factor that it used as a temporary source of liquidity, 
after it liquidates the recovered collateral.
    As noted above, absent the capital buffer created by the 2% margin 
factor, a nonbank SBSD may be short on liquid capital precisely at the 
time when the value of this capital is high (e.g., when markets are 
stressed and SBSDs face unanticipated losses on their positions that 
exceed the capital charges associated with the positions). To raise the 
needed liquid capital, on demand, nonbank SBSDs may face significant 
costs (e.g., the SBSD may have to engage in a ``fire sale'' of assets 
that it would not sell otherwise), which could destabilize the SBSD. 
The 2% margin factor is intended to ensure that nonbank SBSDs have a 
buffer of liquid capital at all times, and reduce the need to source 
liquid capital at times when such capital is needed. As a result, the 
2% margin factor should improve the financial stability of nonbank 
SBSDs, and therefore benefit market participants that rely on liquidity 
provided by nonbank SBSDs.
    In summary, the 2% margin factor is intended to ensure that nonbank 
SBSDs have needed liquid capital in situations where collateral 
collected or capital charges may not fully cover the actual losses from 
a security-based swap positions. As a consequence, the 2% margin factor 
should improve the safety and soundness of nonbank SBSDs, which 
ultimately, should benefit market participants that rely on liquidity 
provided by nonbank SBSDs.
    However, the 2% margin factor likely also will impose direct costs 
on nonbank SBSDs, as the dealer may have to either access the capital 
markets or restructure illiquid assets and liabilities on its balance 
sheet to ensure that it stays above the minimum net capital threshold 
established by this requirement. Furthermore, the 2% margin factor 
scales up with a nonbank SBSD's security-based swap activity, and 
increases with each new security-based swap position, regardless of the 
direction of the position, whether the SBSD hedges the position, or 
whether the SBSD collects initial margin on the position. For instance, 
if the nonbank SBSD enters into two similar positions but in opposite 
directions (i.e., zero net market risk) and with different 
counterparties, the SBSD will have to allocate capital towards the 2% 
margin factor for each of the two positions. Similarly, if the nonbank 
SBSD collects initial margin on the position, it still has to allocate 
capital towards the 2% margin factor for that position.
    The 2% margin factor may have an initial impact on nonbank SBSDs 
with legacy security-based swap positions. As noted above, nonbank SBSD 
may have margin requirements that are sufficiently large that the 2% 
margin factor plus the Rule 15c3-1 financial ratio, if applicable, 
yields a net capital requirement that exceeds the fixed-dollar minimums 
specified in Rules 15c3-1 and 18a-1, as applicable. Under the final 
rules, these nonbank SBSDs will have to allocate additional capital 
towards the 2% margin factor for each new security-based swap position, 
as well as for all its legacy security-based swap positions. Firms that 
anticipate a large initial impact of the 2% margin factor due to their 
legacy positions may change their behavior prior to the implementation 
date of the final capital rules to avoid registration as a nonbank SBSD 
or to mitigate costs associated with being subject to the nonbank SBSD 
capital rules once it is required to register. Specifically, these 
firms may have an incentive to reduce their security-based swap 
activity in the run-up to the implementation date. However, lower 
security-based swap activity may result in reduced liquidity provision 
in the security-based swap market, which may manifest in higher prices 
for market participants. From this perspective, the application of the 
2% margin factor to legacy positions may impose indirect costs on 
market participants.
    Nevertheless, as noted above, the final rule and amendments permit 
a phase-in over time of the margin factor. As a result, the impact of 
the margin factor on nonbank SBSDs would be smaller at the outset of 
the implementation, and then become progressively larger if the 
Commission chooses to increase the requirement's percent multiplier. 
The rate of increase of the impact of the margin factor is limited by 
the final rules, because the Commission can use the process set forth 
in the rules to, at most, double the margin factor after 3 years and, 
at most, double the margin factor again after 5 years. Moreover, under 
the process in the final rules, the percent multiplier for the margin 
factor can be raised to no more than 8%, limiting the overall impact of 
the margin factor on nonbank SBSDs. The initial multiplier in the final 
rules is similar to an existing minimum net capital requirement for 
broker-dealers, namely the 2% debit item ratio.
    In addition, for a given position with a given counterparty, a firm 
that is authorized to use a margin model would generally allocate less 
capital for that position towards the 2% margin factor than a firm that 
is not authorized to use a margin model. Firms that are not authorized 
to use a margin model would have to calculate the 2% margin factor 
using standardized haircuts for the initial margin calculation with 
respect to the non-cleared security-based swap. In contrast, firms that 
are approved to use a margin model would be permitted to calculate the 
2% margin factor using the margin model. The Commission expects that 
most firms would seek approval to use models for the purpose of 
calculating net capital and initial margin requirements for non-cleared 
security-based swap transactions with counterparties.
    The 2% margin factor of the final capital rules may also impose 
additional costs on nonbank SBSDs due to regulatory uncertainty. 
Because the Commission, after 3 years, could use the process in the 
final rules to increase the multiplier to not more than 4% by order, 
and, the Commission, after 5 years, could increase the multiplier to 
not more than 8% by order (if the Commission had previously issued an 
order raising the multiplier to 4% or less), firms face uncertainty 
about when or if the new increase in the margin factor would take 
place, and whether they would have the additional capital needed to 
meet the requirement. However, the Commission also could modify any of 
the new requirements

[[Page 43995]]

being adopted today (including the 2% margin factor) by rule amendment.
    Relative to the proposed capital rules, the final capital rules 
also reduce the costs to nonbank SBSDs due to overlapping regulatory 
requirements. As discussed above, one of the components of the 2% 
margin factor addresses cleared security-based swaps. Nonbank SBSDs 
that are also registered as FCMs with the CFTC will also have to comply 
with the CFTC's capital requirements for FCMs with respect to cleared 
swaps and security-based swaps. These requirements are based on the 
initial margin calculated by the clearing agency or DCO. In contrast, 
the 2012 proposal required that nonbank SBSDs allocate capital towards 
the proposed 8% margin factor for a cleared security-based swap in an 
amount equal to 8% times the maximum of the initial margin calculated 
by the clearing agency and the capital deductions that the SBSD would 
have to take were this position proprietary. However, the final capital 
rules require that nonbank SBSDs allocate capital towards the 2% margin 
factor for a cleared security-based swap in an amount equal to the 
initial margin calculated by the clearing agency times the 2% margin 
factor requirement. Thus, the 2% margin factor requirement for cleared 
security-based swaps aligns more closely with the CFTC's existing and 
proposed capital requirements (i.e., because risk margin amount for a 
cleared security-based swap is based solely on the initial margin 
calculated by the clearing agency).
    In general, firms may pass on some of the capital costs arising 
from complying with the 2% margin factor requirement to their 
counterparties in the form of higher prices. As a result, the 2% margin 
factor may impose indirect costs on market participants.
    A number of commenters raised concerns about the proposed 8% margin 
factor requirement. A commenter suggested that the Commission replace 
the proposed requirement with an alternative requirement modeled on the 
2% debit items ratio in Rule 15c3-1.\1072\ Another commenter stated 
that a minimum capital requirement that is scalable to the volume, 
size, and risk of a nonbank SBSD's activities would be consistent with 
the safety and soundness standards mandated by the Dodd-Frank Act and 
the Basel Accords and would be comparable to the requirements 
established by the CFTC and the prudential regulators.\1073\ The 
commenter, however, expressed concern that the proposed 8% margin 
factor was not appropriately risk-based.\1074\ The commenter also 
suggested that, if the proposed 8% margin factor is retained, the 
Commission should exclude security-based swaps that are portfolio 
margined with swaps or futures in a CFTC-supervised account.\1075\ 
Another commenter believed that a broker-dealer dually registered as an 
FCM should be subject to a single risk margin amount calculated 
pursuant to the CFTC's rules, since the CFTC calculation incorporates 
both security-based swaps and swaps.\1076\ A commenter suggested 
modifying the proposed definition of the risk margin amount to reflect 
the lower risk associated with central clearing by ensuring that 
capital requirements for cleared security-based swaps are lower than 
the requirements for equivalent non-cleared security-based swaps.\1077\ 
Other commenters argued that the proposed 8% margin factor may 
undermine existing regulatory standards for security-based swaps and 
swaps.\1078\ Another commenter argued that the Commission should 
identify the areas of divergence and assess the impact of conflicting 
rules on entities that are registered with the Commission and the 
CFTC.\1079\ Finally, a commenter questioned the usefulness of the 
proposed 8% margin factor arguing that it does not serve a purpose 
outside the capital charges that a firm would have to take against the 
market and credit exposures from its trading activity.\1080\
---------------------------------------------------------------------------

    \1072\ See SIFMA 11/19/2018 Letter.
    \1073\ See SIFMA 2/22/2013 Letter.
    \1074\ See SIFMA 2/22/2013 Letter. SIFMA suggested two 
approaches: One for nonbank SBSDs authorized to use models and one 
for nonbank SBSDs not authorized to use models. Under the first 
approach, the risk margin amount would be a percent of the firm's 
aggregate model-based haircuts. The second approach was a credit 
quality adjusted version of the proposed 8% margin factor.
    \1075\ See SIFMA 11/19/18 Letter.
    \1076\ See Morgan Stanley 11/19/2018 Letter.
    \1077\ See MFA 2/22/2013 Letter. See also OneChicago 11/19/18 
Letter.
    \1078\ See FIA 11/19/2018 Letter; MFA/AIMA 11/19/2018 Letter; 
Morgan Stanley 11/19/2018 Letter; SIFMA 2/22/2013 Letter.
    \1079\ See Citadel 11/19/2018 Letter.
    \1080\ See SIFMA 2/22/2013 Letter.
---------------------------------------------------------------------------

    Commenters also addressed the modifications to the proposed rule 
text in the 2018 comment reopening pursuant to which the input for 
cleared security-based swaps in the risk margin amount would be 
determined solely by reference to the amount of initial margin required 
by clearing agencies (i.e., not be the greater of those amounts or the 
amount of the haircuts that would apply to the cleared security-based 
swap positions). Some commenters supported the potential rule language 
modifications.\1081\ Other commenters opposed them.\1082\ A commenter 
opposing the modifications stated that the ``greater of'' provision 
creates a backstop to protect against the possibility that varying 
margin requirements across clearing agencies and over time could be 
insufficient to reflect the true risk to an SBSD arising from its 
customers' positions.\1083\ Another commenter believed that eliminating 
the haircut requirement may incentivize clearing agencies to compete on 
the basis of margin requirements.\1084\
---------------------------------------------------------------------------

    \1081\ See ICI 11/19/18 Letter; MFA/AIMA 11/19/2019 Letter; 
SIFMA 11/19/2018 Letter.
    \1082\ See Americans for Financial Reform Education Fund Letter; 
Better Markets 11/19/2018 Letter; Rutkowski 11/20/2018 Letter.
    \1083\ See Better Markets 11/19/2018 Letter.
    \1084\ See Americans for Financial Reform Education Fund Letter.
---------------------------------------------------------------------------

    The Commission acknowledges the commenters' concerns about the 
potential impact of the 2% margin factor requirement. In response to 
concerns about the proposed requirement being inconsistent with the 2% 
debit item ratio requirement for broker-dealers, the final capital 
rules could phase in the margin factor over time, as discussed above in 
section II.A.2.a. of this release, and set the initial multiplier for 
the margin factor at 2%. The phase-in of the margin factor over time 
will result in an initial impact on the capital costs of the nonbank 
SBSDs that is lower than the impact that would have resulted if the 
multiplier had initially been 8%, as proposed. However, the final rules 
will result in lower initial levels of minimum net capital, relative to 
the 2012 proposal. As discussed above, lower levels of minimum net 
capital may negatively impact a nonbank SBSD's safety and soundness.
    In response to concerns about the proposed 8% margin factor not 
being appropriately risk-based, as discussed above, the final 2% margin 
factor is designed to complement the capital charges that nonbank SBSDs 
would be required to take against the uncollateralized exposures 
created by their security-based swap positions. The 2% margin factor 
will cause capital charges and net capital requirements (beyond the 
fixed dollar minimum capital requirements) to increase as the nonbank 
SBSD's exposures increase and thus should be sensitive to the risk of 
the firm's exposures.
    In response to concerns about potential costs of the proposed 8% 
margin factor requirement due to regulatory overlap, the Commission 
modified the proposed 8% margin factor in the final capital rules such 
that the risk margin amount for cleared security-

[[Page 43996]]

based swaps equals the initial margin calculated by the clearing 
agency. This modification aligns more closely the final capital rules 
with the CFTC's existing and proposed capital requirements, and 
therefore should reduce the potential costs arising from regulatory 
overlap on cleared security-based swaps. The proposed requirement to 
calculate the margin amount for cleared security-based swaps based on 
the haircuts that would apply to the position would have reduced the 
SBSD's exposure to CCP margin requirements, due, for example, to 
requirements established in response to competition among CCPs. 
However, as noted further below, because nonbank SBSDs would have 
likely passed on the additional capital costs of the proposed 
requirement to their counterparties, the proposed requirement could 
have reduced market participants' incentives to clear security-based 
swaps.
    With respect to the portfolio margining concern, the Commission 
plans to coordinate further with CFTC on the issue.
    In general, it is difficult to quantify the costs of the minimum 
capital requirements on nonbank SBSDs. However, for ANC broker-dealers, 
who will experience an increase in both in the early warning level and 
in the minimum tentative net capital and net capital requirements, one 
can provide preliminary estimates of this cost by comparing the fixed 
components of the minimum capital requirements against the firm's 
current levels of net capital. This exercise will provide an indication 
of the costs of complying with the minimum capital requirements of the 
final capital rule and amendments for ANC broker-dealers and for 
broker-dealer SBSDs.
    Based on FOCUS Report information as of year-end 2017, 
approximatively 16 broker-dealers, including the current ANC broker-
dealers, maintain tentative net capital in excess of $5 billion, 
approximately 48 broker-dealers maintain tentative net capital in 
excess of $1 billion, approximately 191 broker-dealers maintain 
tentative net capital in excess of $100 million, and approximately 446 
broker-dealers maintain net capital in excess of $20 million.
    Although the increase in minimum capital and early warning 
requirements for ANC broker-dealers will not affect firms that already 
have this classification (i.e., the 5 ANC broker-dealers), it does 
reduce the number of additional firms (from 44 to 11, according to 
FOCUS Report data) that currently qualify for this designation (i.e., 
broker-dealers with tentative net capital in excess of $1 billion that 
are not ANC broker-dealers). Each of the 11 broker-dealers that have 
tentative net capital in excess of $5 billion but less than $6 billion 
and are not ANC broker-dealers will have to raise at most $1 billion in 
additional capital to be able to clear the early warning threshold and 
to be eligible to register as ANC broker-dealer or as an ANC broker-
dealer SBSD. This amount increases to a maximum of $5 billion for each 
of the 44 broker-dealers that have tentative net capital in excess of 
$1 billion but less than $6 billion and that wants to register as ANC 
broker-dealer or as an ANC broker-dealer SBSD. Thus, the potential cost 
of registering as an ANC broker-dealer or as an ANC broker-dealer SBSD 
could be large, especially for broker-dealers that currently maintain 
tentative net capital levels below $5 billion and/or net capital levels 
below $1 billion. A broker-dealer may avoid these costs by choosing to 
register as a nonbank SBSD that is not authorized to use models or by 
limiting its security-based swap trading activity to the point where it 
does not need to register as an SBSD. A firm that is not a broker-
dealer could avoid these costs by registering as a stand-alone SBSD.
    In general, absent the minimum net capital requirements, there 
might be greater opportunities for more competition among entities that 
are engaging in dealing activities in the security-based swap market, 
which in turn might lower transaction costs and increase liquidity in 
this market.
    However, higher minimum capital requirements for ANC broker-
dealers, including ANC broker-dealer SBSDs, are intended to mitigate 
the risk of disruptions to financial markets by supporting the scale 
and scope of activities that these entities engage in. An ANC broker-
dealer SBSD will be able to engage in the entire spectrum of activities 
that are traditionally associated with large ANC broker-dealers, 
including prime brokerage services, securities lending, financing 
assets for clients (e.g., financing securities on margin). The ability 
to use internal models for the purpose of calculating net capital 
further allows ANC broker-dealers, including ANC broker-dealer SBSDs, 
to engage in these activities at a scale that is far larger than that 
of non-ANC broker-dealers. The same applies to the security-based swap 
market, where ANC broker-dealers, including ANC broker-dealer SBSDs, 
can enter into new transactions at a lower cost compared to broker-
dealers and nonbank SBSDs that do not use internal models. Two reasons 
underpin this conclusion. First, the model-based haircuts for market 
risk exposure on a security-based swap position are typically much 
smaller than the standardized haircuts for the same position. Second, 
an ANC broker-dealer that holds both cash securities positions and 
security-based swap positions (or otherwise offsetting positions) can 
further reduce these model-based haircuts by taking advantage of the 
natural hedge between these two types of instruments within a 
portfolio.
    Relative to broker-dealers and nonbank SBSDs that do not use 
internal models, ANC broker-dealers, including those registered as 
SBSDs, can enter security-based swap transactions at lower cost and 
therefore may trade in larger volumes. However, more volume could 
expose an ANC broker-dealer, including an ANC broker-dealer SBSD, to 
either a higher incidence of losses or an increase in the size of the 
losses. The former could happen when more volume is achieved by 
expanding the portfolio of security-based swaps, while the latter could 
happen when more volume is achieved by increasing the size of the 
positions. Generally speaking, a broker-dealer or an SBSD that 
neutralizes both the market risk of all its security-based swap 
positions (i.e., it hedges or book-matches all its security-based swap 
positions) and the counterparty risk (e.g., by collecting variation and 
initial margin) should have minimal remaining exposure to losses on its 
portfolio of security-based swap positions. In contrast, when neither 
market risk nor counterparty risk is neutralized, the broker-dealer or 
the SBSD may be exposed to losses from its security-based swap 
positions. As discussed in more detail below, an ANC broker-dealer, 
including an ANC broker-dealer SBSD, may not fully neutralize 
counterparty risk for its positions with counterparties that are 
subject to a margin collection exception, because ANC broker-dealers, 
including ANC broker-dealers SBSDs, are allowed to take the alternative 
credit risk charge, as applicable, instead of the 100% capital 
deduction for transactions in derivatives instruments with 
counterparties, including uncollected margin from these counterparties. 
The alternative credit risk charge is typically much smaller than the 
100% capital deduction, and therefore an ANC broker-dealer, including 
an ANC broker-dealer SBSD, may incur losses from exposure to 
counterparty risk. These losses could scale up with the ANC broker-
dealer's trading activity on security-based swap market. In addition, 
as discussed above, an ANC broker-dealer may also incur losses from

[[Page 43997]]

exposure to market risk from security-based swap positions that are 
subject to a margin collection exception or that are not book-matched, 
and these losses could also scale up with the ANC broker-dealer's 
trading activity.
    The potential losses from security-based swap trading activity are 
on top of the losses that an ANC broker-dealer may incur from its 
activities that are not related to trading in security-based swap 
market (e.g., swap market). The 2% margin factor requirement will 
create a capital buffer to cover potential losses from security-based 
swap trading activity that is sensitive to the risks arising from 
security-based swap exposures. It does not increase with respect to 
swaps activity. However, swaps will be subject to the model-based 
haircuts applied by ANC broker-dealers and uncollateralized exposures 
arising from swap transactions will be subject to the credit risk 
charges. Moreover, to the extent an ANC broker-dealer engages in more 
than a de minimis amount of swap activity, it will need to register as 
a swap dealer and be subject to the CFTC's minimum capital requirements 
when they are adopted and with the CFTC's margin rules for non-cleared 
swaps.
    Two commenters argue that the fixed component of the final capital 
rules will act as a barrier to entry for prospective dealers that want 
to register as ANC broker-dealers, and could force incumbent dealers 
that cannot maintain these minimum capital requirements to exit the 
industry.\1085\ As discussed above and at the beginning of the section, 
less conservative capital requirements for ANC broker-dealers could 
compromise the safety and soundness of this type of broker-dealer. The 
use of models allows ANC broker-dealers to economize on the regulatory 
capital required to open and maintain positions in the security-based 
swap market, which, in turn, allows them to trade in larger volumes 
compared to other broker-dealers. However, more volume could expose ANC 
broker-dealers to more overall losses, and therefore ANC broker-dealers 
should maintain higher levels of capital compared to other types of 
broker-dealers. In addition, since losses from trading activity in the 
security-based swap market add to the losses that ANC broker-dealers 
may incur from other activities unrelated to security-based swap 
market, the capital requirements for ANC broker-dealer SBSDs should be 
at least as conservative as the capital requirements for ANC broker-
dealers under Rule 15c3-1.
---------------------------------------------------------------------------

    \1085\ See Better Markets 1/23/2013 Letter; MFA 2/23/2013 
Letter.
---------------------------------------------------------------------------

    The higher minimum net capital thresholds for ANC broker-dealers in 
the final capital rule and amendments could be regarded as a barrier to 
entry for broker-dealers that want to register as ANC broker-dealer, 
regardless of whether they engage in security-based swap dealing 
activity. As noted above, the minimum net capital requirements for ANC 
broker-dealers can impose substantial costs on non-ANC broker-dealers 
that want to register as ANC broker-dealers, relative to the baseline. 
For example, any non-ANC broker-dealers with tentative net capital 
below $5 billion and that want to register as an ANC broker-dealer 
would need to raise enough capital to meet the $6 billion early warning 
threshold in the final capital rules.
    The higher minimum capital requirements for ANC broker-dealers may 
be a barrier to entry for prospective nonbank SBSDs that want to 
register as ANC broker-dealers. However, to the extent that potential 
new entrants are able to operate effectively in these markets as stand-
alone SBSDs (i.e., SBSDs that are not registered as broker-dealers), 
they will be eligible for lower minimum capital requirements and able 
to compete for security-based swap dealing business without the 
heightened requirements for ANC broker-dealers. For instance, a stand-
alone SBSD could seek the Commission's approval to use an internal 
model for the purpose of calculating its net capital. The Commission 
believes that most nonbank SBSDs will seek approval to use an internal 
model for this purpose.
    As discussed above in section VI.A. of this release, most trading 
in security-based swaps and other derivatives is currently conducted by 
large banks and their affiliates. Among these entities are the current 
ANC broker-dealers. Other broker-dealers affiliated with firms 
presently conducting business in security-based swaps may be among the 
446 broker-dealers that maintain net capital in excess of $20 million. 
Consequently, broker-dealers presently trading in security-based swaps 
may not need to raise significant new amounts of capital in order to 
register as nonbank SBSDs.\1086\ At the same time, the minimum capital 
requirements could discourage entry by entities other than the 
approximately 446 broker-dealers that already have capital in excess of 
the required minimums.
---------------------------------------------------------------------------

    \1086\ According to the most recent version (i.e., 2017) of the 
Focus Report statistics that the Commission publishes on a periodic 
basis, carrying broker-dealers are financed with 5.4% equity capital 
and 94.6% liabilities, on average. Of these liabilities, 34.7% 
consist of repurchase agreements, 10.9% consist of other non-
subordinated debt, and 3% consist of subordinated debt. The other 
non-subordinated debt includes publicly issued commercial paper and 
corporate bonds. The average overnight Treasury GC repo rate from a 
daily survey of the primary dealers for 2017 was 90 basis points. 
These estimates are derived from the data on the overnight Treasury 
GC repo primary dealers survey rate collected by the Federal Reserve 
Bank of New York on a daily basis, available at https://www.newyorkfed.org/medialibrary/media/markets/HistoricalOvernightTreasGCRepoPriDealerSurvRate.xlsx. In contrast, 
the average 3-month AA-rated financial commercial paper rate for 
2017 was 106 basis points. These rates provide an incomplete but 
informative picture of the costs that broker-dealers face in raising 
new capital.
---------------------------------------------------------------------------

    One commenter suggested that the Commission provide a detailed 
quantitative analysis of the costs associated with capital requirements 
for nonbank SBSDs.\1087\ Other commenters suggested that the Commission 
provide an analysis that supports the quantitative requirements of the 
proposed 8% margin factor.\1088\ However, in order to provide a 
reliable quantitative analysis of these costs, the Commission would 
have to make significant assumptions about individual firms' ultimate 
organizational structure. In particular, the Commission would have to 
make assumptions about how much of U.S. security-based swap dealing 
activity would eventually be housed in nonbank SBSDs rather than in 
bank SBSDs not subject to the Commission's capital rules. In addition, 
the Commission would have to make further assumptions about the number 
of nonbank SBSDs that register as stand-alone SBSDs, as opposed to 
broker-dealer SBSDs. Such assumptions are highly speculative in nature. 
Moreover, the minimum capital requirements may not bind for all nonbank 
SBSDs; any estimate of capital costs would depend on assumptions about 
the amount of capital that those entities assumed to register as 
nonbank SBSDs currently carry.\1089\
---------------------------------------------------------------------------

    \1087\ See Sutherland Letter.
    \1088\ See FIA 11/19/2018 Letter; Morgan Stanley 11/19/2018 
Letter; SIFMA 11/19/2018 Letter.
    \1089\ In addition, under the final rules, minimum capital 
requirements vary across entities that are authorized to use models 
and entities that use standardized haircuts; any estimates of the 
costs associated with capital requirements for nonbanks SBSDs 
require the Commission to make assumptions about the number of 
entities the Commission approves to use models in the future. In 
section IV.C. of this release, the Commission estimates that out of 
25 estimated nonbank SBSDs, 14 will use models to calculate model-
based haircuts (10 ANC broker-dealer SBSDs and 4 stand-alone SBSDs). 
The Commission expects that 8 nonbank SBSDs (6 broker-dealer SBSDs 
and 2 stand-alone SBSDs) will use standardized haircuts. The 
Commission expects the remaining 3 stand-alone SBSDs to elect the 
alternative compliance mechanism under Rule 18a-10. Even with these 
estimates, the Commission would need to make assumptions about the 
distribution of dealing activity across bank and nonbank SBSDs, as 
well as the amount of capital these nonbank SBSDs currently carry. 
Given this uncertainty, the Commission does not believe that its 
estimates of the numbers of registered SBSDs would assist in 
producing reliable estimates of capital costs.

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[[Page 43998]]

    In response to these comments, with respect to the proposed 8% 
margin factor, section VI.A.2. of this release contains an analysis of 
the risk margin amount of current dealers based on their current level 
of trading activity. The Commission has used this analysis to provide a 
range of estimates for the potential costs of complying with the final 
2% margin factor requirement, under certain assumptions.
    The first of these assumptions is that, at the time when the final 
rules are implemented, a dealer that would register as nonbank SBSD has 
a level of trading activity (i.e., legacy transactions) that falls 
within the range of trading activity currently observed among current 
dealers. Because it is uncertain which of the current dealers will 
register as nonbank SBSDs, and because risk margin amounts vary widely 
across dealing entities, this assumption allows the Commission to focus 
on the costs of the requirement on the average nonbank SBSD from its 
legacy security-based swap positions at the time of the implementation 
produced by the range of trading activity currently observed among 
current dealers.
    The second and third assumptions are related to net capital 
requirements. The second assumption is that current dealers will be 
required to hold more capital as a result of the 2% margin factor (and 
the Rule 15c3-1 financial ratio, if applicable,) than the fixed-dollar 
amounts of $20 million (for all stand-alone SBSDs, and for broker-
dealer SBSDs not authorized to use models) and $1 billion (for broker-
dealer SBSDs authorized to use models) because their security-based 
swap positions are sufficiently large or risky. In other words, likely 
nonbank SBSDs have sufficient levels of security-based swap positions 
that the 2% margin factor is relevant for calculation of required net 
capital. The third assumption is that dealers that are likely to 
register as nonbank SBSDs currently maintain only enough capital to 
cover the market and credit risk exposures of their positions, so that 
current levels of net capital represent the minimum level of net 
capital required under the baseline. Because the final capital rules 
also require that a nonbank SBSD take capital charges with respect to 
the market and credit risk exposures from its legacy transactions, this 
assumption allows the Commission to focus on the impact of legacy 
transactions on the minimum net capital, generally, and the final 2% 
margin factor, specifically.
    Under these assumptions, the Commission estimates the initial 
capital impact of the 2% margin factor (i.e., percent multiplier set to 
2%) on a nonbank SBSD to range from $0.03 million to $66.04 million, 
depending on the year and on where the SBSD's level of trading activity 
from legacy transactions falls within the range of trading activity 
currently observed among current dealers. Within this range, the 
average initial capital impact of the 2% margin factor can be estimated 
in each sample year and the average impact is between $5.2 million and 
$15.35 million. However, the precision of the estimate of the average 
initial capital impact of the 2% margin factor varies significantly 
over the sample years. For example, the $5.2 million estimate has the 
highest precision with the shortest 95% confidence interval, namely 
$2.74 million to $7.67 million. In contrast, the $15.35 million 
estimate has the lowest precision with the longest 95% confidence 
interval, namely $8.52 million to $22.19 million.\1090\
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    \1090\ The Commission calculates the range for the initial 
capital impact of the 2% margin factor by multiplying the minimum 
and maximum risk margin amounts across sample years in Table 2, 
Panel A, of Section VI.A.2. of this release by 2%. For example, 
$66.04 million equals 2% multiplied by the maximum risk margin 
amount over the sample years (i.e., $3,303.12 million). The 
Commission calculates the range for the average initial capital 
impact of the 2% margin factor by multiplying the average risk 
margin amount in each sample year by 2%. For example, the average 
initial capital impact of the 2% margin factor based on the 2008 
sample is $15.35 million and equals 2% multiplied by the average 
risk margin amount for that sample year (i.e., $767.76 million). 
Assuming that the risk margin amounts are approximately normally 
distributed, the Commission calculates the 95% confidence interval 
around an estimate by subtracting (for the lower end of the 
interval) or adding (for the upper end of the interval) 1.96 
multiplied by the standard error of the mean, which is defined as 
the standard deviation for the sample divided by the square root of 
the sample size. Each of the annual samples has the same size, 
namely 22. For example, the lower end of the 95% confidence interval 
for $15.35 million estimate is $8.52 million and equals $15.35 
million--1.96 * (2% * $817.96 million)/[radic]22. Similarly, the 
upper end of that interval is $22.19 million and equals $15.35 
million + 1.96 * (2% * $817.96 million)/[radic]22.
---------------------------------------------------------------------------

    A nonbank SBSD will have to compare the initial capital impact of 
the 2% margin factor against the fixed component of the minimum net 
capital requirement to determine the amount of capital it needs to 
comply with the minimum capital requirement. For example, for a stand-
alone SBSD, the capital needed to comply with the minimum net capital 
requirement will be the greater of $20 million or the 2% margin factor.
    Similarly, if the percent multiplier of the margin factor 
requirement increases by f% from the initial percent multiplier, 2%, or 
other interim percent multiplier, the additional capital impact of the 
requirement on nonbank SBSDs due to this increase would be the initial 
capital impact of the requirement estimated above multiplied by f/2. 
For example, if the percentage multiplier increases from 2% to 3% 
(i.e., f = 1), the additional capital impact on SBSDs due to this 
change equals the initial capital impact estimated above multiplied by 
0.5.
    In addition, and to further respond to comments, a more limited 
analysis that focuses exclusively on registered broker-dealers that 
would potentially register as broker-dealer SBSDs (e.g., because the 
security-based swap dealing affiliate of a broker-dealer is folded into 
the broker-dealer, which then registers as a broker-dealer SBSD) can 
provide an indication of the costs. As discussed above, if the 5 ANC 
broker-dealers were to consolidate their SBSD subsidiaries and register 
as an ANC broker-dealer SBSD, they would incur no additional capital 
requirements because their current capital levels already exceed the 
early warning tentative net capital threshold of $6 billion. An 
additional 11 broker-dealers that have between $5 billion and $6 
billion in tentative net capital but are not ANC broker-dealers could 
register as nonbank ANC broker-dealer SBSDs. Assuming that all these 11 
broker-dealers do so, their total additional tentative net capital 
shortfall is capped at $11 billion. Of the remaining broker-dealers 
whose tentative net capital range between $1 billion and $5 billion, it 
is not clear if any of them would consider registering as a nonbank ANC 
broker-dealer SBSD. To the extent that one such broker-dealer does 
register, its potential tentative net capital shortfall would range 
between $1 billion and $5 billion.
    One commenter believed that the proposed rule would impose costs 
that are disproportionate to the risks of security-based swap dealing 
activity.\1091\ More specifically, this commenter believed that the 
proposed 8% margin factor would require the maintenance of resources 
far in excess of the risks posed by an SBSD's exposures, and that the 
100% deduction for collateral held by third-party custodians and legacy 
account positions were excessive, and inconsistent with other 
regulators. This commenter stated that, at the time of the letter, the 
ANC broker-dealers have

[[Page 43999]]

preliminarily projected that, in light of the severity of these 
requirements, the amount of capital that would be required for the 
single business line of security-based swap dealing under the proposal 
would exceed $87 billion, the amount of capital currently devoted to 
all of those firms' securities businesses combined, including 
investment banking, prime brokerage, market making, and retail 
brokerage.\1092\
---------------------------------------------------------------------------

    \1091\ See SIFMA 2/22/2013 Letter.
    \1092\ The commenter stated that the six SIFMA member firms who 
operate as ANC broker-dealers estimated the amount capital currently 
devoted to their securities businesses by determining the amount of 
capital, after deductions for non-allowable assets and capital 
charges, necessary for them to have net capital in excess of the 
early warning level specified in Rule 17a-11. However, the majority 
of the estimated costs flowed from the proposed 100% capital 
deduction for initial margin collected but held at third-party 
custodians, the proposed 100% capital deduction for initial margin 
posted away, and the proposed 100% capital deduction for 
uncollateralized legacy security-based swaps. As discussed above in 
section II.A. of this release and further below, the final rules 
include significant modifications to these requirements, as 
proposed.
---------------------------------------------------------------------------

    In response to this commenter, as noted above, the 2% margin factor 
would be relevant for nonbank SBSDs that engage in an amount of 
security-based swap activity that requires more supporting capital than 
the fixed-dollar minimum capital thresholds. As discussed at the 
beginning of this section, these types of nonbank SBSDs are 
instrumental for the overall liquidity provision in the security-based 
swap market, and, given their centrality in this market, they have to 
be adequately capitalized. To this end, the 2% margin factor is 
intended to ensure that the minimum capital requirements of these 
central SBSDs scale proportionally with their trading activity. As 
further noted above, the 2% margin factor also will help address the 
issue of funding the replacement cost or close-out costs of a nonbank 
SBSD's positions with a failed counterparty, when the margin collected 
from the counterparty is temporarily unavailable or was not collected 
because of an exception in the margin rules.
    With regard to the commenter's estimated $87 billion in capital 
needed for the ANC broker-dealers to become compliant with the final 
capital rules, most of these costs were the result of the proposed 100% 
capital deduction for initial margin collected but held at third-party 
custodians, the proposed 100% capital deduction for initial margin 
posted away, and the proposed 100% capital deduction for 
uncollateralized legacy security-based swaps. Modifications to the 
final rules should help reduce the costs to the ANC broker-dealers of 
becoming compliant with the new requirements. The final capital rules 
contain a provision that allows nonbank SBSDs to avoid any capital 
deduction for initial margin held at a third-party custodian under 
certain conditions. Similarly, this release contains guidance with 
respect to Rules 15c3-1 and 18a-1 for a method by which the nonbank 
SBSD could fund the initial margin posted to a counterparty through an 
affiliate and avoid taking a 100% deduction for initial margin posted 
away. Finally, under the final rules, an ANC broker-dealer (including 
an ANC broker-dealer SBSD) and a stand-alone SBSD approved to use 
models for capital purposes can apply a credit risk charge with respect 
to uncollateralized exposures arising from transactions in derivatives 
instruments, including exposures arising from not collecting variation 
and/or initial margin pursuant to exceptions in the non-cleared 
security-based swap and swap margin rules of the Commission and CFTC, 
respectively. In particular, the final rule, unlike the proposed rule, 
allows ANC broker-dealer SBSDs to avoid taking a 100% capital deduction 
in lieu of margin for legacy security-based swaps and instead take an 
alternative credit risk charge.\1093\ This credit risk charge is 
usually much smaller than the 100% capital charge, which should further 
reduce the costs to the ANC broker-dealers of becoming compliant with 
the capital requirements of nonbank SBSDs.
---------------------------------------------------------------------------

    \1093\ As discussed above, for non-cleared security-based swaps 
and swaps, a capital deduction in lieu of margin must be taken when 
the SBSD elects not to collect margin under an exception in the 
Commission's rule for non-cleared swaps (including the exception for 
legacy security-based swaps) or an exception for initial margin for 
swap transactions under the CFTC's margin rules. These capital 
deductions in lieu of margin are for 100% of the amount of margin 
that would have been collected. However, a nonbank SBSD authorized 
to use models can apply a credit risk charge rather than take this 
deduction (which may result in significantly less than a 100% 
deduction). An ANC broker-dealer, including an ANC broker-dealer 
SBSD, must take a portfolio concentration charge for 
uncollateralized current exposures to the extent the amounts to 
which the credit risk charges are applied, in the aggregate, exceed 
10% of the firm's tentative net capital. A 100% capital charge will 
apply to the amount that exceeds 10% of the firm's tentative net 
capital.
---------------------------------------------------------------------------

ii. Capital Charge for Posting Initial Margin
    As discussed above, if a nonbank SBSD delivers initial margin to 
another SBSD or other counterparty, it must take a capital deduction in 
the amount of the posted collateral.\1094\ This capital deduction will 
increase the nonbank SBSD's transaction costs because the nonbank SBSD 
will incur a cost to obtain the capital to account for the deduction, a 
cost that it need not incur in the absence of such a deduction. To the 
extent that nonbank SBSDs pass on the increased transaction costs to 
their customers in the form of higher prices for liquidity provision, 
those customers could incur higher costs when transacting with nonbank 
SBSDs in the security-based swap market. The degree to which the 
increased transaction costs could be passed on to customers depends in 
part on the intensity of competition for liquidity provision in the 
security-based swap market. If competition for liquidity provision is 
strong, nonbank SBSDs may pass on a smaller portion of the increased 
costs to customers in order to stay competitive. Conversely, if 
competition for liquidity provision is more limited, nonbank SBSDs may 
pass on a larger portion of the increased costs to customers. The 
effects discussed above could be mitigated if nonbank SBSDs avoid the 
capital deduction by following the Commission's interpretive guidance 
as discussed above in section II.A.2.b.i. of this release. In addition 
to the preceding, the capital deduction could affect the competition 
between nonbank SBSDs and bank SBSDs, as discussed below in section 
VI.D.2. of this release.
---------------------------------------------------------------------------

    \1094\ Furthermore, under the final capital rules, stand-alone 
broker-dealers and nonbank SBSDs may treat margin collateral posted 
to a clearing agency for cleared security-based swaps or to a DCO 
for cleared swaps as a ``clearing deposit'' and, therefore, not 
deduct the value of the collateral from net worth when computing net 
capital. See paragraph (c)(2)(iv)(E)(3) of Rule 15c3-1, as amended; 
paragraph (c)(1)(iii) of Rule 18a-1, as adopted.
---------------------------------------------------------------------------

iii. Capital Deductions in Lieu of Margin
    The final capital rules and amendments require that nonbank SBSDs 
take capital deductions in lieu of margin with respect to non-cleared 
security-based swap transactions when the SBSD has failed to collect 
required margin or has elected to not collect margin pursuant to an 
exception in the margin rules of the Commission or the CFTC. Deductions 
in lieu of margin are designed to address the risks associated with 
exposures to counterparties and may incentivize the nonbank SBSD to 
collect margin even when it is not required to do so under the rules. 
In general, the capital deductions in lieu of margin for 
uncollateralized exposures from security-based swap or swap positions 
will be 100% of the amount of the uncollected margin (i.e., dollar for 
dollar). However, nonbank SBSDs approved to use internal models for the 
purpose of calculating net capital will be allowed to take a model-
based credit risk charge as an alternative to the 100% capital 
deduction. As discussed below

[[Page 44000]]

in section VI.B.1.b.v. of this release, these credit charges could be 
substantially smaller than the comparable 100% capital deductions.
    The final capital rules do not require that nonbank SBSDs take a 
capital deduction for the difference between clearing agency or DCO 
margin requirements for customers' cleared security-based swaps and the 
haircuts that would apply to those positions if they were proprietary 
positions, as was proposed.\1095\
---------------------------------------------------------------------------

    \1095\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 70245-46. See also Capital, Margin, and Segregation Comment 
Reopening, 83 FR at 53009-10.
---------------------------------------------------------------------------

    As discussed above in section II.A.2.b.ii. of this release, broker-
dealers and nonbank SBSDs will be required to take a deduction for 
under-margined accounts because of a failure to collect margin required 
under Commission, CFTC, clearing agency, DCO, or designated examining 
authority rules (i.e., a failure to collect margin when there is no 
exception from collecting margin). Nonbank SBSDs are also required to 
take capital deductions in lieu of margin when an exception to the 
final margin rule applies, such as where the initial margin falls below 
the $50 million threshold or the counterparty is a financial market 
intermediary. In addition, the Commission modified the final capital 
rules from the proposal such that nonbank SBSDs will be required to 
take capital deductions in lieu of margin with respect to uncollected 
margin on swap positions that are subject to a variation or initial 
margin exception in the rules of the CFTC. The Commission has also 
added an exception in the final rule that allows a nonbank SBSD to 
treat initial margin with respect to a non-cleared security-based swap 
or swap held at a third-party custodian as if the collateral were 
delivered to the nonbank SBSD and, thereby, avoid taking the capital 
deduction for failing to hold the collateral directly.
    As discussed above, the final capital rules are designed to enhance 
the safety and soundness of nonbank SBSDs by requiring them to take 
capital deductions in situations where collateral is not available to 
cover counterparty exposures. The capital buffer created by capital 
deduction or charge is designed to complement the capital buffer 
created by other capital requirements (e.g., minimum net capital) to 
permit a nonbank SBSD to cover losses from uncollateralized exposures. 
The capital deduction and charges are also designed to incentivize a 
nonbank SBSD to collect margin.
    The capital deduction in lieu of margin or credit risk charge is 
intended to perform a particularly important function in an SBSD's non-
cleared security based transactions with financial market 
intermediaries, including with other nonbank SBSDs. A capital deduction 
in lieu of margin or credit risk charge is required for 
uncollateralized exposures to other financial market intermediaries 
from non-cleared security-based swap positions that are subject to an 
exception of the final margin rule. For transactions with financial 
market intermediaries, the final margin rule requires that nonbank 
SBSDs collect and post variation margin but not collect initial margin 
from these types of counterparties. This means that nonbank SBSDs will 
have credit exposure (i.e., potential future exposure) to financial 
market intermediaries, including other nonbank SBSDs, from non-cleared 
security-based swap transactions. In the event that a financial market 
intermediary counterparty fails, the nonbank SBSD would have to bear 
the potential costs of replacing or closing out the positions with the 
failed counterparty, and, therefore, incur potential losses. Because 
these positions could be large (e.g., as noted in section VI.A.1.d. of 
this release, interdealer positions are generally large), the losses 
that a nonbank SBSD may face as a result of a failed financial market 
intermediary counterparty could be large, and could eventually 
precipitate the demise of the nonbank SBSD. Imposing capital deductions 
in lieu of margin is intended to increase the likelihood that the 
nonbank SBSD has a buffer of capital to absorb potential losses from 
uncollateralized exposures to the failed financial market intermediary 
counterparty. These capital deductions are designed to increase with 
the size of the positions with the failed counterparty and provide the 
nonbank SBSD with a capital buffer against potential losses from 
replacing or closing out these positions. Furthermore, for every new 
non-cleared and uncollateralized security-based swap position with a 
financial market intermediary, a nonbank SBSD will be required to 
increase its net capital (or have sufficient excess net capital) to 
accommodate the capital deductions resulting from the uncollateralized 
exposures created by the new position. In other words, a nonbank SBSD 
cannot enter a new non-cleared security-based swap position with a 
financial market intermediary that creates uncollateralized exposures 
without increasing its net capital or having sufficient excess net 
capital.
    The capital deductions for uncollateralized security-based swap 
exposures to financial market intermediaries create a capital buffer 
against potential losses from such exposures, and, therefore, reduce 
the risk of a nonbank SBSD's failure and the potential for sequential 
SBSD failure. As a result, these deductions and charges should enhance 
the safety and soundness of the nonbank SBSDs and, therefore, provide 
an important benefit for market participants that rely on liquidity 
provision and other services provided by nonbank SBSDs. However, the 
requirement to take capital deductions in lieu of margin against 
uncollateralized exposures from security-based swap transactions with 
financial market intermediaries may impose costs on nonbank SBSDs to 
the extent that reallocating capital from other activities or raising 
additional capital to support the SBSD's security-based swap trading 
activity is costly. These costs could increase a nonbank SBSD's costs 
of hedging non-cleared security-based swap positions, relative to the 
baseline. Nonbank SBSDs generally rely on financial market 
intermediaries to hedge their market risk exposures from non-cleared 
security-based swaps with other market participants. If transacting 
with financial market intermediaries becomes more costly, nonbank SBSDs 
would face higher hedging costs, relative to the baseline. Nonbank 
SBSDs may pass on these hedging costs to the market participants that 
access the market for security-based swaps through nonbank SBSDs. 
Because market participants can access this market through market 
intermediaries that are not nonbank SBSDs, competitive pressure may 
limit the extent to which nonbank SBSDs could pass on their potentially 
higher hedging costs to the market participants.
    Nonbank SBSDs will also have to take capital deductions in lieu of 
margin for uncollateralized exposures from swaps that are subject to an 
exception in the margin rules of the CFTC. Absent these capital 
deductions or charges, potential losses from uncollateralized swap 
exposure to counterparties that are subject to an exception in the 
margin rules of CFTC may destabilize a nonbank SBSD even if the SBSD is 
adequately capitalized with respect to its dealing activity in the 
security-based swap market. Thus, capital deductions for 
uncollateralized swap exposures create a capital buffer against 
potential losses from uncollateralized swap positions that should 
enhance the safety and soundness of a nonbank SBSD that

[[Page 44001]]

engages in swap activity. This potential enhancement should benefit the 
market participants that rely on liquidity provision and other services 
provided by nonbank SBSDs.
    However, the requirement to take capital deductions for 
uncollateralized swap exposures will also impose costs on nonbank 
SBSDs, because reallocating capital from other activities to support 
the SBSD's swap trading activity or raising additional capital is 
generally costly. These costs may put a nonbank SBSD at a competitive 
disadvantage compared to a swap dealer that is not a nonbank SBSD and 
that is not required to take similar capital deduction by the rules of 
the CFTC. However, under certain conditions, a stand-alone SBSD that 
engages in limited security-based swap activity may be permitted to use 
the alternative compliance mechanism to the capital, margin, and 
segregation requirements of the CEA and the CFTC's rules in lieu of 
complying with Rules 18a-1, 18a-3, and 18a-4. These rules may not have 
provisions for such capital charges.
    The final capital rules will also require that nonbank SBSDs take a 
capital deduction in lieu of margin or credit risk charge for legacy 
security-based swap and swap positions. This requirement is designed to 
ensure that the nonbank SBSD's credit risk exposures from legacy 
security-based swap and swap positions are either collateralized (i.e., 
required variation and initial margin has been collected) or 
uncollateralized but supported with adequate capital (i.e., the capital 
deduction in lieu of margin or credit risk charge). Absent this 
requirement, nonbank SBSDs would be exposed to uncollateralized credit 
risk from these legacy positions without any compensating capital 
buffer, which, in turn, would compromise the effectiveness of the final 
capital rules post implementation.
    The requirement could impose costs on some nonbank SBSDs with 
legacy security-based swap and swap positions because reallocating 
capital from other activities or raising new capital to support these 
legacy positions is generally costly. These potential costs generally 
scale up with the size of the legacy positions.\1096\ As discussed 
above in section VI.A.1.e. of this release, certain dealers that may 
register as nonbank SBSDs carry large legacy swap positions. The 
capital deductions on the swap legacy positions and the new swap 
positions that these firms would face if they were to register as 
nonbank SBSDs may impact these firms' decision whether to register as 
nonbank SBSDs, particularly if they plan to maintain a level of swap 
trading activity similar to the current one. In particular, some firms 
may choose to register as nonbank SBSDs but keep the swap trading 
activity outside the SBSD structure. This potential separation of 
trading activity between security-based swaps and swaps may reduce the 
benefits that firms currently enjoy from managing risk exposures from 
these activities on a centralized basis. However, as discussed below, 
the inter-affiliate exception to the final margin rule for initial 
margin may offset the change in the benefits from centralized risk 
management. Alternatively, some firms may choose to maintain a level of 
security-based swap activity that is sufficiently low to meet the 
conditions necessary to operate under the alternative compliance 
mechanism.\1097\ As discussed below, nonbank SBSDs that make use of the 
alternative compliance mechanism will be subject to a different 
capital, margin, and segregation regime that may offer different 
protections to the market participants that access the security-based 
swap market through nonbank SBSDs that us the mechanism relative to 
nonbank SBSDs that do not. If this difference is not reflected in 
prices, some market participants may be overpaying for transacting in 
the security-based swap market (e.g., SBSDs that are subject to 
different regimes that offer different levels of protection charging 
their counterparties similar prices).
---------------------------------------------------------------------------

    \1096\ If the nonbank SBSD is reallocating capital from other 
activities to support its legacy positions, the cost to the firm is 
the opportunity cost associated with those other activities. This 
cost scales up with the amount of capital being reallocated. If the 
nonbank SBSD is raising new capital to support its legacy positions, 
the cost to the firm is the cost of capital that investors demand in 
return for their capital and the costs associated with underwriting 
the financial instruments that facilitate the transfer of capital 
from investors to the firm. Some of these costs (e.g., the cost of 
capital) scale up with the amount of capital being transferred.
    \1097\ See section II.D. of this release (discussing these 
conditions and their economic impact).
---------------------------------------------------------------------------

    Nonbank SBSDs that expect to face large costs due to their legacy 
security-based swap and swap positions may reduce these costs by 
reassigning a portion of their legacy positions to SBSDs that are 
subject to a regulatory regime that does not impose these type of 
capital deductions (e.g., bank SBSDs), prior to the final capital rules 
and amendments taking effect, as long as such transactions are feasible 
(i.e., the cost associated with reassigning the legacy positions does 
not dominate the legacy capital deduction or charge for the position).
    The legacy capital deduction for a nonbank SBSD could cause a 
nonbank SBSD to renegotiate its legacy security-based swaps and swaps 
with its counterparties immediately after the final capital rules take 
effect. The incentives of the two parties to renegotiate a legacy 
security-based swap or swap would depend on the costs of replacing the 
legacy transaction with the new transaction and how the new transaction 
would be treated under the final capital and margin rules as compared 
with the legacy transaction. In particular, if the net effect of these 
two factors leaves both parties better off, the parties would have an 
incentive to renegotiate.
    The requirement that nonbank SBSDs take a capital deduction in lieu 
of margin or credit risk charge for their legacy security-based swap 
and swap positions also reduces the aggregate demand for collateral 
that nonbank SBSDs would otherwise need to meet the requirements of the 
final margin rule. Absent such a requirement, counterparties to nonbank 
SBSDs' security-based swap positions would have to post variation and 
initial margin at the same time--namely, at the time when the final 
rules and amendments take effect. This systemic call for margin could 
be potentially destabilizing for those counterparties that have large 
legacy security-based swap positions.
    Two commenters argued that capital deductions, including those for 
legacy accounts, impose costs on nonbank SBSDs, which may be passed on, 
directly or indirectly, to the nonbank SBSD's counterparties.\1098\ 
Other commenters argued that the legacy account deduction is 
inconsistent with the capital regimes of the prudential regulators and 
the proposed capital regime of the CFTC, and would result in 
unwarranted variations in regulated entities' capital requirements, 
which could lead to market fragmentation.\1099\
---------------------------------------------------------------------------

    \1098\ See PIMCO Letter; SIFMA 2/22/2013 Letter.
    \1099\ See Morgan Stanley 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to these commenters' concerns, to the extent that 
nonbank SBSDs expect to face large costs due to their legacy security-
based swap and swap positions, these SBSDs may reduce these costs by 
reassigning a portion of their legacy positions to SBSDs that are 
subject to a regulatory regime that does not impose these type of 
capital deductions (e.g., bank SBSDs). Furthermore, under certain 
conditions, a nonbank SBSD may be able to make use of the alternative 
compliance mechanism and therefore potentially

[[Page 44002]]

avoid taking capital deductions for legacy positions. This means of 
avoiding the deductions or charges will depend on whether the CFTC's 
final capital rules for swap dealers do not include such deductions.
    The Commission estimates that most nonbank SBSDs will be authorized 
to use internal models and therefore will take the credit risk charges 
instead of the capital deductions in lieu of margin. Under the 
assumption that dealers that are likely to register as nonbank SBSDs 
currently maintain only enough capital to cover the market risk 
exposures of their positions and that they maintain a level of trading 
activity (i.e., legacy transactions) that falls within the range of 
trading activity currently observed among current dealers, the 
Commission estimates that the initial impact of the credit risk charges 
on a nonbank SBSD to range between 0 and $253.73 million. Within this 
range, the average initial capital impact of capital charges for credit 
risk exposures can be estimated in each sample year and the average 
impact is between $0.41 million and $11.07 million. However, the 
precision of the estimate of the average initial capital impact of 
capital charges for credit risk exposures varies significantly over the 
sample years. For example, among the estimates in the range above, the 
$0.41 million estimate has a shorter 95% confidence interval, and 
therefore higher precision, namely $0.32 million to $0.49 million, 
while the $11.07 million estimate has a longer 95% confidence interval, 
and therefore lower precision, namely $6.73 million to $15.42 
million.\1100\
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    \1100\ The Commission calculates the range for the initial 
capital impact of the capital charges for credit risk exposures by 
multiplying the minimum and the maximum risk margin amounts across 
sample years in Table 2, Panel B, of section VI.A.2. of this release 
with the lower bound and upper bound of the range of estimates for 
the size of the credit risk charge as a fraction of the 100% capital 
deduction calculated in section II.B.1.b.v. of this release (i.e., 
4.8% and 48%). For example, $253.73 million equals 48% multiplied by 
the maximum risk margin amount over the sample years (i.e., $528.61 
million). The Commission calculates the range for the average 
initial capital impact of the capital charges for credit risk 
exposures by multiplying the average risk margin amount in each 
sample year with the upper and lower bounds of the range of 
estimates for the size of the credit risk charge as a fraction of 
the 100% capital deduction. For example, the average initial capital 
impact of the capital charges for credit risk exposures based on the 
2017 sample is $11.07 million and equals the average risk margin 
amount for that sample year (i.e., $23.07 million) multiplied by the 
upper bound of the range above (i.e., 48%). Assuming that the risk 
margin amounts are approximately normally distributed, the 
Commission calculates the 95% confidence interval around an estimate 
by subtracting (for the lower end of the interval) or adding (for 
the upper end of the interval) 1.96 multiplied by the standard error 
of the mean, which is defined as the standard deviation for the 
sample divided by the square root of the sample size. Each of the 
annual samples has approximatively the same size, namely 170. For 
example, the lower end of the 95% confidence interval for the $11.07 
million estimate is $6.73 million and equals $11.07 million-1.96 * 
(48% * $60.24 million)/[radic]170. Similarly, the upper end of that 
interval is $15.42 million and equals $11.07 million + 1.96 * (48% * 
$60.24 million)/[radic]170.
---------------------------------------------------------------------------

    Nonbank SBSDs will also be required to take a capital deduction in 
lieu of margin or credit risk charge for initial margin collateral that 
a counterparty chooses to segregate with an independent third-party 
custodian if the conditions for qualifying for the exception from 
taking the charge are not met. These conditions may impose costs on a 
firm. For example, one condition requires that that the nonbank SBSD 
must maintain written documentation of its analysis that the tri-party 
custodial agreement is 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. However, these conditions are designed so that 
existing agreements with counterparties entered into for the purposes 
of the third-party custodian and documentation rules of the CFTC and 
the prudential regulators will suffice for purposes of the final rule.
    Those nonbank SBSDs that do not qualify for the exception will have 
to take a capital deduction for the initial margin collateral held at a 
third-party custodian, which they will likely pass on to the 
counterparties that elect to segregate initial margin in this manner. 
This cost, if large, may undermine the benefits associated with 
safeguarding the collateral from a potential default by the nonbank 
SBSD, and may reduce the appeal of the individual segregation option 
relative to other options (e.g., omnibus segregation). However, market 
participants may avoid this cost by choosing to trade with a nonbank 
SBSD that qualifies for the exception, with a nonbank SBSD that elects 
to use the alternative compliance mechanism, or with a bank SBSD.
    Several commenters suggested that the Commission should eliminate 
the capital deduction in lieu of margin for margin collateral held at a 
third-party custodian noting that customers will ultimately incur the 
additional cost, and the proposed capital charge would make electing 
individual segregation prohibitively expensive.\1101\ Another commenter 
believed that applying the deduction would also make such collateral 
arrangements prohibitively expensive, frustrating Congress's clear 
intention that such arrangements should be available to 
counterparties.\1102\ Several commenters noted that the SBSDs would 
simply pass on the capital charge to the counterparties, which would 
undermine the benefits of third-party segregation.\1103\ Some 
commenters suggested that, at a minimum, the capital charge should be 
waived where custodian arrangements meet robust legal and operational 
criteria to ensure the nonbank SBSD's access to collateral in the event 
of counterparty default.\1104\ One commenter stated that the third-
party custodian deduction would make nonbank SBSDs uncompetitive and 
would result in huge disparities in capital requirements for bank and 
nonbank SBSDs engaged in identical market activities.\1105\ Two 
commenters expressed concerns with the implementation costs of the 
provision, generally, and the inclusion of a legal opinion, 
specifically.\1106\
---------------------------------------------------------------------------

    \1101\ See AIMA 2/22/2013 Letter; American Benefits Council, et 
al. 5/19/2014 Letter; Financial Services Roundtable Letter; ICI 12/
5/2013 Letter; MFA 2/22/2013 Letter; MFA 2/24/2014 Letter; Morgan 
Stanley 2/22/2013 Letter; SIFMA AMG 2/22/2013 Letter; SIFMA 2/22/
2013 Letter.
    \1102\ See ICI 12/5/2013 Letter; MFA 2/24/2014 Letter; Morgan 
Stanley 2/22/2013 Letter.
    \1103\ See American Council of Life Insurers 11/19/2018 Letter; 
ICI 11/19/2018 Letter; SIFMA 11/19/2018 Letter.
    \1104\ See ICI 12/5/2013 Letter; MFA 2/24/2014 Letter; Morgan 
Stanley 10/29/2014 Letter; SIFMA 2/22/2013 Letter.
    \1105\ See SIFMA 2/22/2013 Letter.
    \1106\ See ICI 11/24/2014 Letter; SIFMA AMG 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to commenters' concerns regarding the impact of the 
capital deduction for margin collateral held at a third-party 
custodian, as discussed above, the final capital rules contain a 
provision that will allow nonbank SBSDs to avoid taking this capital 
deduction all together, if they meet certain conditions. In particular, 
this provision will make third-party segregation a viable option for 
market participants that prefer to access the security-based swap 
market using a nonbank SBSD that qualifies for the exception.
    Furthermore, in response to commenters' concerns regarding the 
potential conditions for the exception that were asked about in the 
2018 comment reopening, in the final rule, the Commission has balanced 
the potential difficulties in obtaining a legal opinion of outside 
counsel with the need for the broker-dealer or nonbank SBSD to enter 
into a custodial agreement that will operate as intended under the 
relevant laws. Therefore, the final rules do not require the broker-
dealer or nonbank SBSD to obtain a legal opinion of outside counsel. 
Instead, the final rules require the

[[Page 44003]]

broker-dealer or nonbank SBSD to maintain 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. This documentation requirement will benefit the 
parties involved by reducing legal uncertainty about whether and when 
such an agreement is binding, and mitigating the risk of litigation 
(and its associated costs) among parties to the agreement. Absent such 
requirement, the costs associated with such litigation could be passed 
on to the party to the agreement that requested individual segregation 
(e.g., the counterparty to a nonbank SBSD), potentially increasing the 
cost of electing this form of segregation.
    The final capital rules will also require nonbank SBSDs to take a 
capital deduction in lieu of margin or credit risk charge for 
uncollected initial margin amounts from commercial end users, sovereign 
entities, the BIS, the European Stability Mechanism, and certain 
multilateral development banks. In addition, the final rule and 
amendments also require that nonbank SBSDs take a capital deduction in 
lieu of margin or credit risk charge with respect to unsecured 
receivables arising from electing not to collect variation margin from 
commercial end users, the BIS, the European Stability Mechanism, and 
certain multilateral development banks.
    Finally, the final capital rules will also require nonbank SBSDs to 
take a capital deduction in lieu of margin or credit risk charge for 
electing not to collect initial margin under other exceptions in the 
margin rules for non-cleared security-based swaps and swaps, such as 
the $50 million initial margin threshold exception of Rule 18a-3.
    A nonbank SBSD will also be required to take a capital deduction in 
lieu of margin or credit risk charge for uncollateralized credit risk 
exposure created by non-cleared security-based swaps with an affiliate 
(i.e., pursuant to an initial margin exception for affiliates). Parent 
companies of nonbank SBSDs may rely on inter-affiliate transactions to 
manage risk exposures within the organization. For example, a nonbank 
SBSD and a bank affiliate that share the same parent may have exposure 
to the same entity as a result of dealing in security-based swaps and 
as a result of extending credit (e.g., loans), respectively. The parent 
may decide to minimize its overall exposure to the entity by having the 
nonbank SBSD and the bank affiliate enter into a security based swap 
with each other (i.e., an inter-affiliate transaction). This 
centralized management of risk exposures may benefit the parent and its 
affiliates. The requirement that nonbank SBSDs take a capital deduction 
in lieu of margin or credit risk charge for inter-affiliate security-
based swap transactions may impose costs on nonbank SBSD--such as costs 
associated with reallocating capital from other activities or from 
raising new capital--that may reduce the benefits associated with 
managing risk exposures on a centralized basis.
    Nonbank SBSDs will likely pass on the potential costs associated 
with these capital deductions or charges to these counterparties. Some 
counterparties may prefer to incur this cost and enter an 
uncollateralized transaction rather than incurring the opportunity cost 
of reallocating capital from other activities (e.g., productive 
capital) to finance margin collateral and enter a collateralized 
transaction. Market participants, however, may be able to avoid these 
indirect costs of transacting with a nonbank SBSD entirely by accessing 
the security-based swap market through SBSDs that are not subject to 
similar capital deductions, such as a bank SBSD or a nonbank SBSD that 
is subject to the alternative compliance mechanism. Thus, competitive 
pressure from these SBSDs may limit the extent to which a nonbank SBSD 
is able to pass on the costs associated with these capital deductions 
to their counterparties.
    At the same time, uncollateralized exposures from inter-affiliate 
security-based swaps may expose a nonbank SBSD to the failure of its 
affiliates. While some of the affiliates may themselves be subject to 
regulatory capital and margin requirements, others may not (e.g., a 
hedge fund affiliate). In particular, some affiliates may operate with 
minimal levels of capital that, while privately optimal, may not be 
adequate for the level of risk associated with their positions. The 
failure of such an affiliate may destabilize a nonbank SBSD that has an 
uncollateralized exposure to this affiliate. The requirement to take a 
capital deduction for uncollateralized inter-affiliate exposures should 
reduce the likelihood that the failure of a counterparty that is an 
affiliate of the nonbank SBSD may cause the SBSD to fail. From this 
perspective, the requirement may enhance the safety and soundness of a 
nonbank SBSD that engages in inter-affiliate transactions, which, in 
turn, may benefit the market participants that rely on liquidity 
provision and other services provided by nonbank SBSDs.
iv. Standardized Haircuts for Security-Based Swaps
    Standardized haircuts are applied to a firm's proprietary 
positions, and deducted from tentative net capital to calculate the 
firm's net capital. Nonbank SBSDs may apply model-based haircuts to 
positions for which they have been authorized by the Commission to use 
models. For all other types of positions, a nonbank SBSDs must use the 
standardized haircuts.
    The standardized CDS haircut grids in the final rules are unchanged 
relative to the 2012 proposal; however, in the final rule, they are 
only applied to non-cleared CDS. The number of maturity and spread 
categories in the grids for single-name and index CDS are based on 
staff's experience with the maturity grids for other securities in Rule 
15c3-1 and, in part, on FINRA Rule 4240. The standardized haircuts for 
cleared security-based swaps and swaps will be the applicable clearing 
agency margin or DCO margin requirements.
    The offsets recognized under the standardized haircut approach for 
calculating net capital may permit a nonbank SBSD that relies on this 
approach to deploy the capital savings that are the result of these 
offsets in other areas of operations more efficiently, as well as 
enhance operational efficiencies.
    The benefit of the standardized haircut approach of measuring 
market risk, besides its inherent simplicity, is that, compared to the 
model-based approach, it may reduce the likelihood of default or 
failure by nonbank SBSDs that have not demonstrated that they have the 
risk management capabilities, of which internal models are an integral 
part, or capital levels to support the use of internal models. 
Therefore, the standardized haircut approach, in turn, may improve 
customer protections and reduce the likelihood of a nonbank SBSD's 
failure compared to the model-based approach. In addition, a 
standardized haircut approach may reduce costs for the nonbank SBSD 
compared to the model-based approach related to the risk of failing to 
observe or correct a problem with the use of internal models that could 
adversely impact the firm's financial condition, because the use of 
internal models will require the allocation by the nonbank SBSD of 
additional firm resources and personnel.

[[Page 44004]]

    Conversely, if the standardized haircuts are too conservative, 
security-based swap business may face increased transaction costs and 
be unable to engage security-based swap transactions. This would reduce 
liquidity, and reduce the availability of security-based swaps, 
including for risk mitigation by financial market intermediaries and 
end users.
    The standardized haircut approach for calculating net capital in 
the final rules, like other types of standardized haircuts, will likely 
require a higher amount of capital to support open security-based swap 
positions in contrast to the model-based approach. While the 
standardized haircuts, including the non-cleared CDS grids, recognize 
certain offsets, standardized haircuts generally result in higher 
capital charges because the standardized approaches do not recognize 
all ways in which a nonbank SBSD might offset its exposures, and impose 
a relatively conservative charge for the remaining (net) exposure. The 
higher capital charges resulting from using the standardized haircuts 
may be acceptable for nonbank SBSDs that occasionally trade in 
security-based swaps, but not in a substantial enough volume to justify 
the initial and ongoing systems and personnel costs to develop, 
implement, and monitor the performance of internal models. On the other 
hand, firms that conduct a substantial business in security-based swaps 
in general will likely choose to use the more cost-efficient models to 
measure and manage the risks of their positions over time. Moreover, 
while the standardized approach may result in higher haircuts, ANC 
broker-dealers and stand-alone SBSDs that will use the model-based 
approach will be subject to higher minimum capital requirements and 
ongoing monitoring with respect to their use of and governance over the 
models.
    One commenter expressed concerns with the magnitude of the 
standardized haircuts relative to the model-based haircuts and 
suggested that the Commission perform a more thorough review of the 
standardized haircuts required by the proposed CDS grids based on 
empirical data on historical volatility and loss given default.\1107\ 
The commenter also suggested that the Commission conduct further 
economic analysis to confirm that the standardized haircuts are 
appropriately tailored to the risk of the relevant positions and 
suggested that the analysis should be based on quantitative data 
regarding the security-based swap and swap markets since the enactment 
of the Dodd-Frank Act.\1108\ In response to the commenters, the 
standardized haircut grids in the final rules are based on existing 
Rule 15c3-1 and, in part, on FINRA Rule 4240, and will apply to non-
cleared CDS. Furthermore, as discussed above in section VI.A.7 of this 
release, the Commission has provided an analysis of the extreme but 
plausible losses on CDS positions observed from historical data.\1109\ 
The Commission uses this analysis to measure the extent to which the 
extreme but plausible loss in a cell is covered by the associated 
standardized haircut. To this end, the Commission calculates the loss 
divided by the standardized haircut, which is referred to as the ``loss 
coverage ratio.'' If this ratio is smaller than or equal to 1, then the 
standardized haircut covers the loss. If this ratio is larger than 1, 
then the haircut does not fully cover the loss. The Commission 
summarizes the distribution of loss coverage ratios for all cells in 
the grid by calculating a number of statistics, including the mean, 
standard deviation, and the range. The Commission reports the summary 
statistics for each year sample in Table 4. Panels A and B of Table 4 
focus on short and long CDS positions that reference single-name 
obligors, while panels C and D of Table 4 focus on short and long CDS 
positions that reference broad-based securities indexes. For each panel 
the Commission uses the standardized haircut grids, as specified by the 
final rules.
---------------------------------------------------------------------------

    \1107\ See SIFMA 2/22/2013 Letter.
    \1108\ See SIFMA 11/19/2018 Letter.
    \1109\ See section VI.A.7. of this release.
---------------------------------------------------------------------------

    With respect to short CDS referencing single-name obligors (Table 
4, Panel A), the mean of the loss coverage ratio is below one in all 
annual samples except the 2008 sample. In response to the commenter, 
based on this analysis, the standardized haircuts would not, on their 
own, cover losses similar to the losses of short single-name CDS 
positions in the 2008 sample. However, with the exception of 2008, the 
standardized haircuts are sufficiently large to cover the losses of 
these positions, on average. The average loss coverage ratio in the 
2011-2018 samples ranges from 38% to 59%. For 2008, the average loss 
coverage ratio is 1.07 meaning that the average loss in 2008 exceeds 
the appropriate haircut by about 7%. For long CDS referencing single-
name obligors (Table 4, Panel B), the average loss coverage ratio 
ranges from 55% to 82%. This result suggests that the proposed haircuts 
for long CDS referencing single-name obligors are sufficiently large to 
cover the losses of these positions, on average. Moreover, the 
requirements in the final capital rules to mark-to-market the value of 
positions in computing net capital and to maintain the required minimum 
amount of net capital at all times are designed to ensure that a firm 
maintains sufficient regulatory capital during periods of volatility.
    With respect to CDS referencing a broad-based securities index, the 
results are qualitatively similar, but the magnitudes are slightly 
different. For instance, while the average loss coverage ratio is 
usually not as high as for single-name CDS in the 2011-2018 samples 
(i.e., the standardized haircuts are more likely to cover losses), the 
average loss coverage ratio exceeded that for single-name CDS in the 
2008 sample (e.g., on the short positions). Further, in contrast to the 
single-name CDS, the maximum loss coverage ratio can be less than one 
for CDS referencing a broad-based securities index.
    Table 4: Analysis of the Proposed Haircut Grids. This table reports 
summary statistics of the distribution of loss coverage ratio, which is 
the extreme but plausible loss divided by the standardized haircut. The 
summary statistics are Min (minimum), P25 (first quartile/25th 
percentile), P50 (second quartile/50th percentile), P75 (third 
quartile/75th percentile), Max (maximum), Mean, and Std (standard 
deviation).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                            Single-Name Credit Default Swaps
---------------------------------------------------------------------------------------------------------------------------------------------------------
                  Year                          Min             P25             P50             P75             Max            Mean             Std
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                Panel A: Short Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008....................................            0.43            0.76            0.84            1.13            4.04            1.07            0.64
2011....................................            0.22            0.39            0.45            0.49            2.01            0.56            0.38
2012....................................            0.00            0.21            0.25            0.31            1.86            0.38            0.37
2017....................................            0.07            0.20            0.31            0.44            4.11            0.59            0.86

[[Page 44005]]

 
2018....................................            0.09            0.25            0.36            0.49            2.46            0.52            0.50
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Panel B: Long Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008....................................            0.22            0.41            0.59            0.78            6.23            0.82            0.89
2011....................................            0.20            0.43            0.50            0.58            2.39            0.59            0.38
2012....................................            0.18            0.43            0.52            0.58            2.21            0.59            0.36
2017....................................            0.16            0.39            0.47            0.55            1.85            0.56            0.34
2018....................................            0.10            0.33            0.42            0.56            1.99            0.55            0.41
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               Index Credit Default Swaps
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                Panel C: Short Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008....................................            0.19            0.31            0.37            2.52           17.61            2.98            4.79
2011....................................            0.07            0.21            0.33            0.43            1.56            0.37            0.27
2012....................................            0.05            0.18            0.21            0.25            0.42            0.21            0.09
2017....................................            0.00            0.05            0.09            0.15            0.27            0.11            0.07
2018....................................            0.00            0.06            0.16            0.21            0.29            0.15            0.09
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Panel D: Long Positions
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008....................................            0.00            0.13            0.37            0.54            2.63            0.54            0.71
2011....................................            0.20            0.30            0.45            0.53            1.82            0.49            0.32
2012....................................            0.02            0.45            0.53            0.71            2.65            0.65            0.48
2017....................................            0.01            0.22            0.49            0.73            1.02            0.48            0.29
2018....................................            0.00            0.09            0.20            0.32            0.46            0.20            0.14
--------------------------------------------------------------------------------------------------------------------------------------------------------

    This analysis shows that the maximum loss coverage ratio exceeds 1 
in all sample years for CDS positions referencing single-name obligors. 
However, this is not always the case for CDS positions referencing an 
index. These results suggest that the standardized haircuts in the 
final rules are generally not set at the most conservative level, as 
losses on some positions exceed the corresponding standardized 
haircuts. The standardized haircuts are intended to strike a balance 
between being sufficiently conservative to cover losses in most cases, 
including stressed market conditions, and being sufficiently nimble to 
allow dealers to operate efficiently in all market conditions. In 
response to the commenter, based on the results of the analysis, as 
described above, the Commission believes that the standardized haircuts 
in the final rules take into account this tradeoff. The standardized 
haircut grids are designed to produce margin amounts that generally 
scale with risk of the underlying positions, and are designed to 
capture the relative risk of the underlying positions across maturity 
and credit spread. Finally, the standardized haircut grids for non-
cleared CDS are based on well-established haircuts prescribed in Rule 
15c3-1and FINRA Rule 4240, haircuts that have been used by broker-
dealers for many years.
    In the final rules, the standardized haircuts for cleared security-
based swaps and swaps are based on clearing agency margin requirements. 
This will impose direct costs on nonbank SBSDs that clear proprietary 
security-based swaps and swaps. For example, these costs will impact 
nonbank SBSDs that make a market in security-based swaps and/or swaps, 
and hedge some of their market risk exposure to their counterparties by 
entering into cleared security-based swap or swap positions. A nonbank 
SBSD that makes a market in non-cleared CDS and that has some residual 
market risk exposure (e.g., the nonbank SBSD is not running a flat 
trading book) could hedge some of that exposure by entering into a 
cleared index CDS (i.e., a swap) on its own account. Applying 
standardized haircuts to cleared positions will make this type of 
hedging activity more costly relative to the baseline. To offset the 
costs imposed by this requirement, SBSDs may charge counterparties more 
for providing liquidity in the security-based swap market. In 
particular, the costs to market participants of trading in these 
markets may be higher, relative to the baseline.
    However, the costs associated with the standardized haircuts for 
cleared security-based swaps would be in part mitigated by the use of 
model-based haircuts as an alternative to the standardized haircuts. 
Specifically, ANC broker-dealers and stand-alone SBSDs approved to use 
internal models would be allowed to use the model-based haircuts. As 
noted above, model-based haircuts can be substantially smaller than 
standardized haircuts. Furthermore, as noted above, the Commission 
believes that most nonbank SBSDs will seek approval to use internal 
models for capital purposes, including for the calculation of model-
based haircuts of cleared and non-cleared security-based swap and swap 
positions.
v. Credit Risk Charges
    Section VI.B.1.b.iii. of this release analyzes the benefits and 
costs associated with the capital deductions in lieu of margin. These 
benefits and costs associated with the capital deductions in lieu of 
margin depend on whether the ANC broker-dealer or stand-alone SBSD will 
be allowed to take the alternative model-based credit risk charge. 
Since the credit risk charge is substantially smaller than the 100% 
capital deduction, an ANC broker-dealer or stand-alone SBSD that is 
authorized to use internal models and that takes the alternative credit 
risk charge instead of the capital deduction in lieu of margin will 
face substantially lower costs compared to a broker-dealer or nonbank 
SBSD that is not using internal models and that has to take the 100% 
capital deduction.\1110\
---------------------------------------------------------------------------

    \1110\ See section II.A.2.b.v. of this release (discussing the 
calculation of the model-based credit risk charge); section 
II.B.2.a.i. of this release (discussing the calculation of the 
model-based initial margin requirement). The alternative credit risk 
charge can range from approximatively 4.8% to 48% of the 100% 
capital deduction in lieu of margin, depending on the multiplication 
factor used to calculate the maximum potential exposure, which 
ranges between 3 and 4, and the credit risk weight of the 
counterparty. The lower end of the range (i.e., 4.8%) is calculated 
as the product between the lowest multiplication factor (i.e., 3), 
and a credit risk weight of 20%, and 8%. The upper end of the range 
(i.e., 48%) is calculated as the product between the highest 
multiplication factor (i.e., 4) and a credit risk weight of 150%, 
and 8%.

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

[[Page 44006]]

    While the alternative credit risk charge may allow ANC broker-
dealers and nonbank SBSDs to economize on the direct costs associated 
with capital charges in lieu of margin, it also provides less of a 
buffer against potential losses compared to the 100% capital deduction. 
The 100% capital deduction for the uncollateralized credit risk 
exposure created by a security-based swap or swap position provides a 
capital buffer that is similar in size with the margin requirement of 
the position that the ANC broker-dealer or stand-alone SBSD will 
calculate for the counterparty. In contrast, the alternative credit 
risk charge for the uncollateralized exposure of the same position 
provides a capital buffer that could be substantially smaller than the 
margin requirement of the position. Thus, in general, the capital 
buffer created by the 100% capital deduction could be substantially 
more effective against potential losses from an uncollateralized 
exposure compared to the capital buffer created by the alternative 
credit risk charge. Everything else equal, the likelihood of the 
failure of an ANC broker-dealer or stand-alone SBSD because of losses 
from uncollateralized exposures is smaller if the firm takes the 100% 
capital deduction against this exposure compared to the alternative 
credit risk charge.
    In addition, and as a corollary, compared to a nonbank SBSD that is 
not using internal models, an ANC broker-dealer or stand-alone SBSD 
that is approved to use internal models, and that takes the alternative 
credit risk charge, will allocate less capital ex-ante (when the 
counterparty is solvent) but may potentially require more capital ex-
post (when the counterparty is insolvent). From this perspective, the 
net capital of an ANC broker-dealer or stand-alone SBSD that is 
approved to use internal models is more sensitive to the risk of 
counterparty failure. However, as discussed above, ANC broker-dealers 
and stand-alone SBSDs that are approved to use internal models are 
subject to higher minimum capital requirements.
    Finally, as discussed above, in applying the credit risk charges, 
ANC broker-dealers (including ANC broker-dealer SBSDs) are subject to a 
portfolio concentration charge that has a threshold equal to 10% of the 
firm's tentative net capital. Under the portfolio concentration charge, 
the application of the credit risk charges to uncollateralized current 
exposure across all counterparties arising from derivatives 
transactions is limited to an amount of the current exposure equal to 
no more than 10% of the firm's tentative net capital. The firm must 
take a charge equal to 100% of the amount of the firm's aggregate 
current exposure in excess of 10% of its tentative net capital. Stand-
alone SBSDs, including SBSDs operating as OTC derivatives dealers, are 
not subject to a portfolio concentration charge with respect to 
uncollateralized current exposure. However, all these entities (i.e., 
ANC Broker-dealers, ANC broker-dealer SBSDs, stand-alone SBSDs, and 
stand-alone SBSDs that also are registered as OTC derivatives dealers) 
are subject to a concentration charge for large exposures to single a 
counterparty that is calculated using the existing methodology in Rule 
15c3-1e.\1111\
---------------------------------------------------------------------------

    \1111\ Stand-alone SBSDs (including firms that also are 
registered as OTC derivatives dealers) are subject to Rule 18a-1, 
which includes a counterparty concentration charge that parallels 
the existing in charge in Rule 15c3-1e.
---------------------------------------------------------------------------

    Currently, dealing entities affiliated with ANC broker-dealers are 
among the largest in terms of level of trading activity in the 
security-based swap and swap markets.\1112\ If these dealing entities 
are currently registered with the CFTC as swap dealers, major swap 
participants or FCMs, their market and credit risk exposures from 
certain legacy security-based swap and swap positions will have to be 
collateralized per CFTC's margin rules. However, these margin rules 
have exceptions such that not all exposures from legacy positions have 
to be collateralized (e.g., security-based swaps and swaps with 
counterparties that are not a ``covered swap entity'' or ``financial 
end user,'' as defined by the CFTC's margin rules).\1113\ To the extent 
that these dealing entities will register as ANC broker-dealers or ANC 
broker-dealer SBSDs, the requirement to cap the use of the alternative 
credit risk charge for capital charges in lieu of margin to 10% of an 
ANC broker-dealer's tentative net capital as a portfolio concentration 
charge could impose costs on these broker-dealers. More generally, the 
10% cap requirement may impose additional costs on a dealer that has 
uncollateralized market risk exposure from legacy and new security-
based swap and swap positions in excess of the 10% cap and that chooses 
to register as ANC broker-dealer or both ANC broker-dealer and SBSD 
rather than other forms of nonbank SBSD, including stand-alone SBSDs 
approved to use models. ANC broker-dealers may pass on a portion of 
these additional costs to their counterparties, and therefore, the 
requirement may increase the costs of transacting in security-based 
swaps and swaps for market participants that access these markets 
through ANC broker-dealers. However, competitive pressure may limit the 
extent to which ANC broker-dealers may be able to pass on these 
additional costs to their counterparties. For instance, stand-alone 
SBSDs that are not subject to this requirement may be able to offer 
better prices compared to ANC broker-dealers that are subject to this 
requirement. As a corollary, if a dealing entity expects the additional 
costs to be large, the requirement may reduce the entity's incentives 
to engage in security-based swap dealing activity that would trigger a 
requirement to register as an ANC broker-dealer SBSD.
---------------------------------------------------------------------------

    \1112\ See section VI.A.1. of this release.
    \1113\ See CFTC Margin Adopting Release, 81 FR 636. In certain 
cases, FCMs may have to take capital charges against 
uncollateralized security-based swap and swap positions. See section 
VI.A.4.c. of this release (discussing the capital requirements for 
FCMs).
---------------------------------------------------------------------------

    As discussed above, the 10% cap requirement will limit the extent 
to which an ANC broker-dealer, including an ANC broker-dealer SBSD, can 
make use of the alternative credit risk charge in lieu of the 100% 
capital deduction. As a result, the capital buffer that an ANC broker-
dealer will have to hold as a result of the 10% cap requirement is 
larger than the capital buffer that the ANC broker-dealer would hold, 
absent this requirement. Because a larger capital buffer allows ANC 
broker-dealers to better withstand potential losses from 
uncollateralized market risk exposures, the requirement is intended to 
enhance the safety and soundness of ANC broker-dealers and therefore 
benefit market participants.
vi. Risk Management Procedures
    Nonbank SBSDs will be required to comply with Rule 15c3-4, which 
currently applies to OTC derivatives dealers and ANC broker-dealers. 
Rule 15c3-4 requires firms to, among other things, establish, document, 
and maintain a system of internal risk management controls to assist in 
managing the risks associated with its business activities, including 
market, credit, leverage, liquidity, legal, and operational risks. 
These requirements may help nonbank SBSDs better monitor the risk of 
their operations, and it may help reduce the risk of significant

[[Page 44007]]

losses from unmonitored positions.\1114\ Nonbank SBSDs may incur costs 
in documenting their risk management procedures and updating their 
information technology systems to meet these requirements. These costs 
could vary significantly among nonbank SBSDs depending on their size, 
the degree to which their risk management systems are already 
documented, and the types of business they engage in.\1115\
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    \1114\ See Barnard Letter.
    \1115\ See section VI.C. of this release.
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c. Alternatives Considered
    The 2012 proposal discussed the benefits and the costs of the 
proposed net liquid assets test capital standard for nonbank SBSDs. A 
number of commenters suggested several other alternatives to this 
standard. In this section, the Commission discusses alternative capital 
standards that were either proposed or suggested by commenters.
i. Bank Standard
    One commenter argued that the bank capital standard should be used 
for nonbank SBSDs, and was concerned that the proposed capital 
requirements for nonbank SBSDs were not comparable to those proposed by 
other U.S. regulators and that modeling the capital standards on the 
broker-dealer capital standard was not appropriate.\1116\ As discussed 
above in section II.A.1. of this release, the Commission has made two 
significant modifications to the final capital rules for nonbank SBSDs 
that reduce some of the differences between the final capital rules for 
nonbank SBSDs and the capital rules of the prudential regulators (and 
the CFTC). First, as discussed above in section II.A.2.b.v. of this 
release, the Commission has modified Rule 18a-1 so that it no longer 
contains a portfolio concentration charge that is triggered when the 
aggregate current exposure of a stand-alone SBSD to its derivatives 
counterparties exceeds 50% of the firm's tentative net capital.\1117\ 
This means that stand-alone SBSDs that have been authorized to use 
models will not be subject to this limit on applying the credit risk 
charges to uncollateralized current exposures related to derivatives 
transactions. This includes uncollateralized current exposures arising 
from electing not to collect variation margin for non-cleared security-
based swap and swap transactions under exceptions in the margin rules 
of the Commission and the CFTC (which is generally consistent with the 
margin rules of the prudential regulators). The credit risk charges are 
based on the creditworthiness of the counterparty and can result in 
charges that are substantially lower than deducting 100% of the amount 
of the uncollateralized current exposure.\1118\ This approach to 
addressing credit risk arising from uncollateralized current exposures 
related to derivatives transactions is generally consistent with the 
treatment of such exposures under the capital rules for banking 
institutions.\1119\
---------------------------------------------------------------------------

    \1116\ See Morgan Stanley 2/22/2013 Letter.
    \1117\ See paragraph (e)(2) of Rule 18a-1, as adopted. See also 
Capital, Margin, and Segregation Proposing Release, 77 FR at 70244 
(proposing a portfolio concentration charge in Rule 18a-1 for stand-
alone SBSDs).
    \1118\ See paragraph (e)(2) of Rule 18a-1, as adopted.
    \1119\ See OTC Derivatives Dealers, 63 FR at 59384-87.
---------------------------------------------------------------------------

    The second significant modification is the alternative compliance 
mechanism. As discussed above in section II.D. of this release, the 
alternative compliance mechanism will permit a stand-alone SBSD that is 
registered as a swap dealer and that predominantly engages in a swaps 
business to comply with the capital, margin, and segregation 
requirements of the CEA and the CFTC's rules in lieu of complying with 
the Commission's capital, margin, and segregation requirements.\1120\ 
The CFTC's proposed capital rules for swap dealers that are FCMs would 
retain the existing capital framework for FCMs, which imposes a net 
liquid assets test similar to the existing capital requirements for 
broker-dealers.\1121\ However, under the CFTC's proposed capital rules, 
swap dealers that are not FCMs would have the option of complying with: 
(1) A capital standard based on the capital rules for banks; (2) a 
capital standard based on the Commission's capital requirements in Rule 
18a-1; or (3) if the swap dealer is predominantly engaged in non-
financial activities, a capital standard based on a tangible net worth 
requirement.
---------------------------------------------------------------------------

    \1120\ See Rule 18a-10, as adopted.
    \1121\ See CFTC Capital Proposing Release, 81 FR 91252.
---------------------------------------------------------------------------

    Notwithstanding the modification to Rule 18a-1 described above, the 
rule continues to be modeled in large part on the broker-dealer capital 
rule. For example, as is the case with Rule 15c3-1, most unsecured 
receivables (aside from uncollateralized current exposure relating to 
derivatives transactions) will not count as allowable capital. 
Moreover, fixed assets and other illiquid assets will not count as 
allowable capital. Consequently, stand-alone SBSDs subject to Rule 18a-
1 (i.e., firms that do not operate under the alternative compliance 
mechanism) will remain subject to certain requirements designed to 
promote their liquidity. Additionally, broker-dealer SBSDs will be 
subject to Rule 15c3-1 and the stricter (as compared to Rule 18a-1) net 
liquid assets test it imposes.
    Several factors have influenced the Commission's decision not to 
use a bank capital standard for nonbank SBSDs. First, a nonbank SBSD's 
role of dealing in security-based swaps and performing market-making 
activity is fundamentally different from a bank's central role of 
making loans and taking deposits. Second, banks have access to sources 
of liquidity and support that nonbank SBSDs do not have access to, such 
as retail deposits and central bank support. Finally, like the bank 
standard, the net liquid test capital standard is also risk-based, as 
nonbank SBSDs will be required to take capital charges that are 
proportionate to the risk exposures from their trading activity, and 
the 2% margin factor for calculating the minimum net capital 
requirement is tied directly to the credit risk of the nonbank SBSD's 
exposures from trading activity.
    The adopted capital standard has a number of similarities and 
differences compared to the bank capital standard. Under the current 
bank capital standard, bank SBSDs would also have to allocate capital 
for their exposures with other covered entities, including other 
dealers. The capital that supports a bank SBSD's dealing activities in 
the OTC markets is determined in accordance with the prudential 
regulators' rules on banks' capital adequacy. These rules require that 
bank SBSDs calculate a risk weight amount for each of their exposures, 
including exposures to non-cleared security-based swaps. Furthermore, 
the rules require that bank SBSDs calculate an additional risk weight 
amount for the exposure created through the posting of initial margin 
to collateralize a non-cleared security-based swap. However, both of 
these risk weight amounts are likely to be small. The dealer's exposure 
to a covered-entity counterparty is collateralized by the initial 
margin that the counterparty has to post with a third-party custodian 
(for the benefit of the dealer), and the risk weight of this exposure 
reflects almost entirely the risk weight of the collateral--usually 
minimal. Similarly, by posting initial margin, the dealer creates an 
exposure to the third-party custodian holding the collateral. Exposures 
to custodian banks usually have low risk weight.
    The capital that bank SBSDs have to allocate for their non-cleared 
security-based swaps equals the sum of the two risk weight amounts 
calculated above multiplied by a factor--usually 8%.

[[Page 44008]]

Thus, the capital that a bank SBSD has to allocate to support a non-
cleared security-based swap is relatively small, and likely of the same 
order of magnitude as the capital that a nonbank SBSD would have to 
allocate for a similar exposure. However, unlike the nonbank SBSD, the 
bank SBSD still has to post away the initial margin. The posting of 
collateral will ``consume'' the bank SBSD's capital, and gives nonbank 
SBSD a comparative advantage in terms of capital efficiency, to the 
extent their counterparty is not an entity that is required to collect 
initial margin from them.
    While collateral posting makes dealing under a bank SBSD structure 
costly, the cost of funding such collateral is likely smaller for these 
dealers compared to nonbank SBSDs. Unlike nonbank SBSDs, bank SBSDs may 
have access to less costly sources of collateral funding, including 
deposits and central bank mechanisms.
ii. Harmonization with the CFTC
    As discussed above in section II.A.1. of this release, several 
commenters argued that the Commission should harmonize its rules with 
the CFTC and other regulatory bodies that have finalized their capital 
and/or margin rules.\1122\ One commenter suggested that the Commission 
coordinate with the CFTC and, as appropriate, the prudential regulators 
to assure that each agency's respective capital rules are harmonized 
and do not have the unintended effect of impairing the ability of 
broker-dealers that are dually registered as FCMs to provide clearing 
services for security-based swaps and swaps.\1123\ Differences between 
these final capital rules and any final rules adopted by the CFTC could 
mean that nonbank SBSDs that are also registered with the CFTC as swap 
dealers would need to perform two different calculations to determine 
whether they satisfy their respective capital standards. The 
difficulties and inefficiencies associated with satisfying both 
standards could cause some firms to separate nonbank SBSDs from nonbank 
swap dealers. Thus, relative to the adopted rule, an approach that 
prioritized greater regulatory harmonization might have mitigated the 
costs borne by nonbank SBSDs.
---------------------------------------------------------------------------

    \1122\ See Citadel 11/19/18 Letter; Financial Services 
Roundtable Letter; FIA 11/19/2018 Letter; Morgan Stanley 11/19/2018 
Letter.
    \1123\ See FIA 11/19/2018 Letter.
---------------------------------------------------------------------------

    Although the Commission has declined to fully harmonize its rules 
with the CFTC's proposed approach to capital for the reasons described 
above, the final rules eliminate or modify many of the provisions in 
the proposed rules that commenters identified as posing particular 
challenges to firms registered as both SBSDs and swap dealers. 
Moreover, the alternative compliance mechanism should achieve the same 
benefits as full harmonization for a subset of firms that will register 
as SBSDs by permitting those stand-alone SBSDs that are likely to be 
most affected by differences between the Commission's rules and the 
CFTC's rules to comply with the capital, margin, and segregation 
requirements of the CEA and the CFTC's rules (if they meet certain 
conditions).
iii. Tangible Net Worth Test
    Several commenters were concerned about the differences between the 
risk-based capital standards used for banks, and the transaction volume 
based broker-dealer capital standard.\1124\ One commenter suggested 
that the Commission apply a tangible net worth test to nonbank SBSDs, 
claiming that it is ``particularly appropriate for entities that have 
not been prudentially regulated before and effectively protects against 
any losses in the event of a potential liquidation.'' \1125\
---------------------------------------------------------------------------

    \1124\ See section II.A.1. of this release.
    \1125\ See Sutherland Letter.
---------------------------------------------------------------------------

    As mentioned in section II.A.1., the Commission believes that a 
tangible net worth test would give incentives to nonbank SBSDs to hold 
illiquid, higher yielding assets to meet the requirement, which would 
undermine the Commission's goal of promoting liquidity for SBSDs. In 
addition, a nonbank SBSD will not also have the support of retail 
deposits or central bank support. Thus, the Commission is adopting the 
broker-dealer capital standard for nonbank SBSDs.
iv. Standardized Haircuts for Cleared Security-Based Swap and Swap 
Positions
    The Commission proposed that the standardized haircuts for cleared 
and non-cleared security-based swaps be calculated the same way. The 
proposed standardized haircut for a CDS was determined using one of two 
maturity grids: one for a CDS that is a security-based swap and the 
other for a CDS that is a swap.\1126\ For a security-based swap that is 
not a CDS, the proposed standardized haircuts required multiplying the 
notional amount of the security-based swap by the amount of the 
standardized haircut that applied to the underlying position pursuant 
to the pre-existing provisions of Rule 15c3-1.\1127\ In addition, under 
the proposal, firms authorized to use internal models were allowed to 
use model-based haircuts instead of the standardized haircuts.
---------------------------------------------------------------------------

    \1126\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 70232-34, 70248-49.
    \1127\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 70234-36.
---------------------------------------------------------------------------

    The final capital rules differ from the proposed rules in terms of 
how broker-dealers and nonbank SBSDs must calculate standardized 
haircuts for cleared security-based swaps and swaps. Namely, the 
Commission is modifying the proposed standardized haircut requirements 
for cleared security-based swaps and swaps to require that the amount 
of the deduction will be the amount of margin required by the CCP where 
the position is cleared.\1128\ However, an ANC broker-dealer and stand-
alone SBSD authorized to use a model can calculate model-based haircuts 
instead of standardized haircuts for positions for which the firm has 
been approved to use the model.
---------------------------------------------------------------------------

    \1128\ See paragraph (c)(2)(vi)(O) of Rule 15c3-1, as amended; 
paragraph (b)(1) of Rule 15c3-1b, as amended; paragraph 
(c)(1)(vi)(A) of Rule 18a-1, as adopted; paragraph (b)(1) of Rule 
18a-1b, as adopted.
---------------------------------------------------------------------------

    As an alternative to the final capital rules, the Commission could 
have taken the proposed approach with respect to standardized haircuts 
for cleared security-based swaps and swaps. The Commission analyzes 
below the economic impact of this alternative. Requiring SBSDs to take 
the proposed standardized haircuts for cleared proprietary security-
based swap and swap positions could create a larger capital buffer 
against the market risk of a cleared position if the proposed 
standardized haircuts were more conservative than the margin 
requirements of the CCPs. As a result, the proposed approach could 
increase the safety and soundness of SBSDs, which would benefit the 
market participants in the security-based swap and swap markets, all 
things being equal. At the same time, however, to the extent the 
proposed standardized haircuts were more conservative, generally, than 
the margin requirements of the CCPs, the proposed approach would have 
resulted in relatively higher capital requirements for cleared 
security-based swap and swap positions. This could have discouraged 
broker-dealers and nonbank SBSDs from engaging in cleared security-
based swap and swap transactions if the firms believed their capital 
could be deployed more profitably. Alternatively, nonbank SBSDs would 
likely have passed the costs associated higher capital requirements 
under this alternative to

[[Page 44009]]

their customers, increasing the relative costs of cleared transactions.
    Adopting standardized haircuts based on clearing agency and DCO 
margin requirements is consistent with the treatment of futures 
products and potentially consistent with the standardized haircuts the 
CFTC ultimately will adopt. Differences in the capital treatment of 
these positions under the Commission's and the CFTC's rules could have 
caused broker-dealers and nonbank SBSDs to be subject to overlapping 
regulatory regimes if they were registered as FCMs or swap dealers in 
terms of calculating standardized haircuts for cleared security-based 
swaps and swaps. This could have imposed costs on broker-dealers and 
SBSDs if the proposed standardized haircuts were larger than the margin 
amount required by the CCP where the position is cleared. These costs 
could have further reduced the incentives of broker-dealers and nonbank 
SBSDs to clear security-based swap and swap positions.
    Finally, cleared security-based swaps and swaps differ from non-
cleared security-based swaps and swaps in ways that could have made the 
capital charges using the proposed standardized haircuts for cleared 
security-based swaps and swaps inappropriately high. In particular, as 
counterparties to cleared OTC derivatives contracts, CCPs must meet 
risk management standards that support the orderly liquidation of 
portfolios in the event of clearing member default and mitigate the 
risk of CCP default. In addition, regulatory standards as well as 
private incentives encourage CCPs to offer to clear products that are 
sufficiently liquid to enable CCPs to replace positions they hold 
against defaulting members without substantial price impact.
v. 1% Minimum Standardized Haircut for Interest Rate Swaps
    Under the final rules being adopted today, the standardized 
haircuts for non-cleared interest rate swaps are determined using the 
maturity grid for U.S. government securities in paragraph (c)(2)(vi)(A) 
of Rule 15c3-1.\1129\ Moreover, the standardized haircuts for non-
cleared security-based swaps and swaps (other than CDS) being adopted 
today permit a broker-dealer and nonbank SBSD to reduce the deduction 
by an amount equal to any reduction recognized for a comparable long or 
short position in the reference security under the standardized 
haircuts in Rule 15c3-1.\1130\ The standardized haircuts in paragraph 
(c)(2)(vi)(A) of Rule 15c3-1 permit a broker-dealer to take a capital 
charge on the net long or short position in U.S. government securities 
that are in the same maturity categories in the rule. This treatment 
will apply to interest rate swaps. The standardized haircut for non-
cleared interest rate swaps can be no less than \1/8\ of 1% of a long 
position that is netted against a short position in the case of a non-
cleared swap with a maturity of 3 months or more.\1131\ The 
standardized haircuts in paragraph (c)(2)(vi)(A) of Rule 15c3-1 require 
a 0% haircut for the unhedged amount of U.S. government securities that 
have a maturity of less than 3 months. Therefore, the standardized 
haircuts for interest rate swaps will treat hedged and unhedged 
positions with maturities of less than 3 months identically in that 
there will be no haircut applied to the positions. The minimum 
standardized haircut for hedged interest rate swaps with a maturity of 
3 months or more will be \1/8\ of 1%.
---------------------------------------------------------------------------

    \1129\ See paragraph (b)(2)(ii)(A)(3) of Rule 15c3-1b, as 
amended; paragraph (b)(2)(ii)(A)(3) of Rule 18a-1b, as adopted.
    \1130\ See paragraph (c)(2)(vi)(P)(2) of Rule 15c3-1, as 
amended; paragraph (b)(2)(ii)(B) of Rule 15c3-1b, as amended; 
paragraph (c)(1)(vi)(B)(2) of Rule 18a-1, as adopted; paragraph 
(b)(2)(ii)(B) of Rule 18a-1b, as adopted.
    \1131\ See paragraph (b)(2)(ii)(A)(3) of Rule 15c3-1b, as 
amended; paragraph (b)(2)(ii)(A)(3) of Rule 18a-1b, as adopted.
---------------------------------------------------------------------------

    The proposed haircut for interest rate swaps had a floor of 1% 
(whereas U.S. government securities with a maturity of less than 9 
months are subject to haircuts of \3/4\ of 1%, \1/2\ of 1%, or 0% 
depending on the time to maturity). The proposed 1% floor is an 
alternative to the minimum standardized haircut for non-cleared 
interest rate swaps in the final rules. A commenter opposed the 
proposed 1% minimum standardized haircut for interest rate swaps as 
being too severe.\1132\ Based on an analysis of sample positions, this 
commenter believed that the proposed 1% minimum standardized haircut 
would result in market risk charges that are nearly 35 times higher 
than charges without the 1% minimum.\1133\
---------------------------------------------------------------------------

    \1132\ See SIFMA 2/22/2013 Letter.
    \1133\ See SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that the 1% minimum haircut was too 
conservative, particularly when applied to tightly hedged positions 
such as those in the commenter's examples. A minimum standardized 
haircut for non-cleared interest rate swaps that was too conservative 
could have unduly increased the transaction costs of broker-dealers and 
nonbank SBSDs that engage in these types of swaps. To the extent that 
these entities passed on these increased costs to their customers in 
the form of higher prices to liquidity provision, the ability of their 
customers to use interest rate swaps for risk mitigation could have 
been impaired. In addition, by raising their prices for liquidity 
provision, broker-dealers and nonbank SBSDs could have become less 
competitive than other liquidity providers that are not subject to the 
Commission's capital rules.
    However, the Commission continues to believe that a minimum haircut 
should be applied to non-cleared interest rate swaps. A minimum haircut 
for non-cleared interest rate swaps will help enhance the safety and 
soundness of broker-dealers and nonbank SBSDs by reducing their 
incentives to engage in excessive risk-taking, by increasing their 
ability to withstand losses from their trading activity, and by 
reducing the risk of sequential counterparty failure. It also will 
account for potential differences between the movement of interest 
rates on U.S. government securities and interest rates upon which the 
non-cleared interest rate swap payments are based. The Commission 
believes the final rules for standardized haircuts for non-cleared 
security-based swaps strike an appropriate balance in terms of 
addressing commenters' concerns that the proposed minimum was too 
conservative and the objective of enhancing the safety and soundness of 
nonbank SBSDs. Thus, the Commission believes that the adopted approach 
is preferable to the alternative.
vi. Same Control and Opinion of Counsel Conditions for Avoiding Capital 
Charge When Collateral is Held by an Independent Third-Party Custodian 
as Initial Margin
    The Commission asked in the 2018 comment reopening whether there 
should be an exception to taking the deduction for initial margin 
collateral held by an independent third-party custodian pursuant to 
Section 3E(f) of the Act or Section 4s(l) of the CEA under conditions 
that promote the SBSD's ability to promptly access the collateral if 
needed.\1134\ Specifically, the Commission sought comment on whether 
there should be such an exception under the following conditions: (1) 
The custodian is a bank; (2) the nonbank SBSD enters into an agreement 
with the custodian and the counterparty that provides the nonbank SBSD 
with the same control over the collateral as would be the case if the 
nonbank SBSD controlled the collateral

[[Page 44010]]

directly; and (3) an opinion of counsel deems the agreement 
enforceable.
---------------------------------------------------------------------------

    \1134\ See Capital, Margin, and Segregation Comment Reopening, 
83 FR at 53011-12.
---------------------------------------------------------------------------

    As discussed above in section II.A.2.b.ii. of this release, the 
Commission agrees with commenters that the ``same control'' language 
could create practical obstacles that would make it difficult to 
execute an account control agreement that would be sufficient to avoid 
the capital charge when initial margin is held by a third-party 
custodian. Moreover, even if such an agreement could be executed, 
existing agreements that are in place in accordance with the third-
party custodian and documentation requirements of the CFTC and the 
prudential regulators likely would need to be re-drafted to meet the 
requirements of the potential condition. Doing so would be a costly and 
burdensome process. Some commenters opposed the condition requiring a 
legal opinion of outside counsel on the basis of cost and 
impracticability, arguing it is inconsistent with market practice and 
operationally burdensome to implement. The Commission acknowledges that 
requiring an opinion of counsel could have been a costly burden. To the 
extent that the counterparties of nonbank SBSDs bore at least part of 
the costs associated with the re-drafting of account control agreements 
and the acquisition of an opinion of counsel, they would have incurred 
higher costs in transacting in the security-based swap market, which 
could have reduced their participation in this market. These effects 
could have been strengthened if the nonbank SBSDs bore part of the 
costs associated with the re-drafting of account control agreements and 
the acquisition of an opinion of counsel, and passed on those costs to 
their counterparties in the form of higher prices for liquidity 
provision. In light of these concerns, the Commission believes that the 
adopted approach is preferable to this alternative.
vii. Requiring a Nonbank SBSD To Take a Capital Deduction for the 
Margin Difference
    The Commission proposed a deduction that applied if a nonbank SBSD 
collects margin from a counterparty in an amount that is less than the 
deduction that would apply to the security-based swap if it was a 
proprietary position of the nonbank SBSD (i.e., the collected margin 
was less than the amount of the standardized or model-based haircuts, 
as applicable).\1135\ This proposed requirement was designed to account 
for the risk of the counterparty defaulting by requiring the nonbank 
SBSD to maintain capital in the place of collateral in an amount that 
is no less than required for a proprietary position. It also was 
designed to ensure that there is a standard minimum coverage for 
exposure to cleared security-based swap counterparties apart from the 
individual clearing agency margin requirements, which could vary among 
clearing agencies and over time. In the 2018 comment reopening, the 
Commission asked whether this proposed rule change should be modified 
to include a risk-based threshold under which the deduction need not be 
taken, and provided modified rule text to apply the deduction to 
cleared swap transactions.\1136\
---------------------------------------------------------------------------

    \1135\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 7045-47.
    \1136\ See Capital, Margin, and Segregation Comment Reopening, 
83 FR at 53009. More specifically, the Commission requested comment 
on whether the rule should provide that the deduction need not be 
taken if the difference between the clearing agency margin amount 
and the haircut is less than 1% (or some other amount) of the SBSD's 
tentative net capital, and less than 10% (or some other amount) of 
the counterparty's net worth, and the aggregate difference across 
all counterparties is less than 25% (or some other amount) of the 
counterparty's tentative net capital.
---------------------------------------------------------------------------

    In light of comments received and for reasons discussed further 
below, the final rules will not require a nonbank SBSD to deduct the 
margin difference for each account it carries that holds cleared 
security-based swaps or swaps. Consequently, this approach is analyzed 
below as an alternative.
    As discussed above in section II.A.2.b.ii. of this release, 
commenters raised a number of concerns with the proposed capital 
deduction for the difference between the haircuts and CCP margin 
requirements for cleared security-based swaps and swaps and with 
potential threshold discussed in the 2018 comment reopening. In light 
of these concerns, the Commission has supplemented the analysis of the 
capital deduction in the proposing release \1137\ by analyzing the 
potential direct costs associated with the capital charge for the 
margin difference for each account carried by the nonbank SBSD that 
holds cleared security-based swaps or swaps. To estimate the capital 
charge under this alternative, Commission staff examined initial margin 
requirements \1138\ for customer accounts carried by 11 registered 
broker-dealers \1139\ that hold cleared security-based swap and swap 
positions. The Commission staff also reviewed initial margin 
requirements for a range of hypothetical single-name and index CDS that 
were calculated using clearing agency initial margin methodology \1140\ 
and ISDA's SIMMTM model. Assuming that the SIMMTM 
model initial margin calculations reasonably approximate the initial 
margin requirements that would apply if the hypothetical security-based 
swap and swap positions were proprietary, the resulting margin 
difference--expressed as a ratio of the SIMMTM initial 
margin requirements to the clearing agency initial margin 
requirements--ranges from a minimum of 0.57 to a maximum of 2, 
depending on the direction of the hypothetical security-based swap and 
swap positions.\1141\ Commission staff applied these ratios to the 
initial margin requirements for customer accounts to estimate an upper 
bound for the capital charge. At the maximum ratio of 2, the aggregate 
capital charge would be $4,644.55 million \1142\ or 422.23 million 
\1143\ per broker-dealer.
---------------------------------------------------------------------------

    \1137\ See Capital, Margin, and Segregation Proposing Release, 
77 FR at 70312-13.
    \1138\ These initial margin requirements were calculated as of 
October 2, 2017, based on clearing agency data.
    \1139\ These 11 registered broker-dealers are clearing members 
of a CCP. These broker-dealers are entities that will likely 
register as SBSDs or are affiliated with entities that will likely 
register as SBSDs.
    \1140\ This is the initial margin methodology of the clearing 
agency that provided the initial margin requirements examined by 
Commission staff.
    \1141\ A ratio of 0.57 for a position means that the associated 
SIMMTM initial margin requirement is 57% of the 
associated clearing agency initial margin requirement. Conversely, a 
ratio of 2 means that the SIMMTM initial margin 
requirement is 200% of the clearing agency initial margin 
requirement. When the ratio is greater than 1, there would be a 
capital charge under this alternative.
    \1142\ The aggregate capital charge is calculated as $4,644.55 
million (total initial margin requirements for customer accounts) x 
(2-1) = $4,644.55 million.
    \1143\ The capital charge per registered broker-dealer is 
calculated as $4,644.55 million / 11 registered broker-dealers = 
$422.23 million.
---------------------------------------------------------------------------

    Under this alternative, nonbank SBSDs would likely have passed on 
the costs associated with this capital charge to their clients, either 
in the form of higher prices or by demanding that clients post 
collateral in excess of the amounts set by the CCPs. As a result, the 
proposed capital charge may have increased the cost of clearing 
security-based swaps or swaps for market participants who wish to clear 
such transactions through nonbank SBSDs. Instead of passing on costs 
associated with the capital charge to clients, nonbank SBSDs may have 
chosen to limit their client clearing services to those security-based 
swap and swap products that are less likely to attract the capital 
charge. These responses from nonbank SBSDs may have reduced the 
incentive of market participants to engage in centrally cleared 
security-

[[Page 44011]]

based swap or swap transactions.\1144\ Further, CCPs are generally 
required to meet minimum margin standards under the rules of most 
jurisdictions. These minimum standards--to the extent they prohibit a 
``race to the bottom'' by a CCP in terms of the margin it requires from 
clearing members--would limit the likelihood of a margin difference and 
the associated capital deduction.
---------------------------------------------------------------------------

    \1144\ This reduction in the incentives to clear a security-
based swap or a swap transaction may have been limited by a number 
of factors, including but not limited to: (1) Any mandatory clearing 
determinations for security-based swaps by the Commission under 
Section 763(a) of the Dodd-Frank Act; (2) any mandatory clearing 
determinations for swaps by the CFTC under Section 723(a) of the 
Dodd-Frank Act; (3) the margin requirements for non-cleared 
security-based swaps and swaps; (4) the segregation regime of 
initial margin posted by the customer to collateralize a non-cleared 
security-based swap or swap; and (5) the presence of financial 
market intermediaries that are clearing members and that are not 
directly subject to the requirements of the proposed capital rule 
and amendments (e.g., banks).
---------------------------------------------------------------------------

    While the proposed capital deduction would have imposed a cost on 
nonbank SBSDs and ultimately, their clients, the Commission 
acknowledges it could have enhanced the safety and soundness of nonbank 
SBSDs, and in turn promoted financial stability. Indeed, absent this 
proposed requirement, a nonbank SBSD may collect margin from the client 
that is just enough to satisfy the CCP's margin requirements. This CCP-
bound margin may not always adequately capture the risk of the 
position, relative to the margining standards of nonbank SBSDs. For 
example, if CCPs weaken their margin standards as a way to compete 
among themselves, and, if this competition turns into a ``race to the 
bottom,'' the initial margin that a CCP would assess at the outset of a 
trade would have to reflect, in part, this competitive pressure and, as 
a result, may not adequately capture the risk of the cleared 
position.\1145\ Because the nonbank SBSD would have to fulfil any CCP-
bound margin calls that the insolvent client was not able to fulfill, 
resulting in an unexpected draw on the nonbank SBSD's capital, the 
proposed requirement was intended to provide a capital buffer (in the 
form of a capital deduction for the margin difference) against such 
potential losses, potentially allowing the nonbank SBSD to better 
withstand a client default. The main beneficiaries of the enhanced 
safety and soundness of the nonbank SBSD as a result of the requirement 
would have been market participants, in particular those market 
participants that employ the services of the nonbank SBSD.
---------------------------------------------------------------------------

    \1145\ Market participants have often raised concerns about the 
adverse effects of a race to the bottom in initial margin standards 
among CCPs. See, e.g., Futures & Options World (FOW), OTC 
Derivatives Clearing Roundtable. There is also some preliminary 
evidence of the adverse effects of competition on margin standards 
among CCPs in the futures markets. See Nicole Abbruzzo and Yang-Ho 
Park, An Empirical Analysis of Futures Margin Changes: Determinants 
and Policy Implications, Finance and Economics Discussion Series, 
Divisions of Research & Statistics and Monetary Affairs, Federal 
Reserve Board (2014-86), available at https://www.federalreserve.gov/econresdata/feds/2014/files/201486pap.pdf.
---------------------------------------------------------------------------

2. The Capital Rule for Nonbank MSBSPs--Rule 18a-2
    As discussed above in section II.A.3. of this release, Rule 18a-2 
will prescribe capital requirements for nonbank MSBSPs that are not 
also registered as broker-dealers and will require them to hold at all 
times positive tangible net worth. Nonbank MSBSPs are also required to 
comply with Rule 15c3-4 with respect to their security-based swap and 
swap activities.
a. Benefits and Costs of the Capital Rule for Nonbank MSBSPs
    The entities that are expected to register as nonbank MSBSPs 
typically engage in both security-based swap activities and other 
business activities. These other business activities could be 
commercial in nature (e.g., manufacturing, energy, transportation), and 
require that firms pre-commit capital in advance (i.e., capital that is 
generally not liquid). In contrast, security-based swap activities 
(like other securities activities) are more opportunistic in nature and 
require liquid capital.
    The requirement that nonbank MSBSPs maintain positive tangible net 
worth will allows these entities to offset losses in their security-
based swap positions with capital that is tied to other business 
activities. In particular, a nonbank MSBSP does not need to hold liquid 
capital beyond what is necessary to support its security-based swap 
activities. Since capital tied to other business activities counts 
toward regulatory capital, the requirement should result in more 
efficient use of capital, which would be a clear benefit for nonbank 
MSBSPs.
    While the requirement may allow a nonbank MSBSP to engage in 
security-based swap activities without having to reallocate its capital 
inefficiently, it may also lead to situations where the nonbank MSBSP 
may fail to be compliant with the final margin rule and, thereby, 
create risk for counterparties that rule is designed to protect. Under 
Rule 18a-3, as adopted, a nonbank MSBSP is required to post collateral 
to cover current exposure of counterparties to the nonbank SBSD if the 
transaction is not subject to an exception in the rule. Consider a 
situation where a nonbank MSBSP has losses on its non-cleared security-
based swap positions (i.e., gains for the counterparty) that are in 
excess of its liquid capital. If its productive capital cannot be 
liquidated right away, then the nonbank MSBSP may not have collateral 
available to post to the counterparty to cover the counterparty's 
current exposure to the nonbank SBSD. In this case, the nonbank SBSD 
would be in violation of Rule 18a-3, as adopted, and, as a consequence, 
the counterparty with the gains would be at risk.
    However, as discussed above, Rule 18a-2, as adopted, has a 
provision that requires nonbank MSBSPs to comply with Rule 15c3-4. To 
the extent that a nonbank MSBSP has effective risk management controls 
in place, it should be able limit the number of situations where 
potential losses on its positions exceed its buffer of liquid capital.
b. Alternatives Considered
    An alternative to the positive tangible net worth standard is the 
net liquid assets test standard. The main difference between these two 
approaches is that under the former nonbank MSBSPs are allowed to count 
capital tied to other business activities towards regulatory capital, 
while under the latter they are not to the extent the capital is 
illiquid. Thus, the net liquid assets test standard is substantially 
more conservative as nonbank MSBSPs would now need to set aside more 
liquid capital to support their non-cleared security-based swap trading 
activities. To the extent that nonbank MSBSPs obtain their liquid 
capital by scaling down their business activities, the alternative 
leads to less efficient allocation of capital and imposes significant 
costs on nonbank MSBSPs.
3. The Margin Rule--Rule 18a-3
a. Overview
    As discussed above in section II.B.1. of this release, Rule 18a-3, 
as adopted, will establish margin requirements for nonbank SBSDs and 
nonbank MSBSPs with respect to transactions with counterparties in non-
cleared security-based swaps.
i. Nonbank SBSDs
    Rule 18a-3 prescribes margin requirements for nonbank SBSDs with 
respect to non-cleared security-based swaps. The rule requires a 
nonbank SBSD to perform two calculations with respect to each account 
of a counterparty as of the close of business each day: (1) The amount 
of current exposure in the account of the

[[Page 44012]]

counterparty (also known as variation margin); and (2) the initial 
margin amount for the account of the counterparty (also known as 
potential future exposure or initial margin). Variation margin is 
calculated by marking the position to market. Initial margin must be 
calculated by applying the standardized haircuts prescribed in Rule 
15c3-1 or Rule 18a-1 (as applicable). However, a nonbank SBSD may apply 
to the Commission for authorization to use a model (including an 
industry standard model) to calculate initial margin. Broker-dealer 
SBSDs must use the standardized haircuts (which include the option to 
use the more risk sensitive methodology in Appendix A to Rule 15c3-1) 
to compute initial margin for non-cleared equity security-based swaps 
(even if the firm is approved to use a model to calculate initial 
margin). Stand-alone SBSDs may use a model to calculate initial margin 
for non-cleared equity security-based swaps (and potentially equity 
swaps if portfolio margining is implemented by the Commission and 
CFTC), provided the account of the counterparty does not hold equity 
security positions other than equity security-based swaps (and 
potentially equity swaps).
    Rule 18a-3 requires a nonbank SBSD to collect collateral from a 
counterparty to cover a variation and/or initial margin requirement. 
The rule also requires the nonbank SBSD to deliver collateral to the 
counterparty to cover a variation margin requirement. The collateral 
must be collected or delivered by the close of business on the next 
business day following the day of the calculation, except that the 
collateral can be collected or delivered by the close of business on 
the second business day following the day of the calculation if the 
counterparty is located in another country and more than four time 
zones away. Further, collateral to meet a margin requirement must 
consist of cash, securities, money market instruments, a major foreign 
currency, the settlement currency of the non-cleared security-based 
swap, or gold. The fair market value of collateral used to meet a 
margin requirement must be reduced by the standardized haircuts in Rule 
15c3-1 or 18a-1 (as applicable), or the nonbank SBSD can elect to apply 
the standardized haircuts prescribed in the CFTC's margin rules. The 
value of the collateral must meet or exceed the margin requirement 
after applying the standardized haircuts. In addition, collateral being 
used to meet a margin requirement must meet conditions specified in the 
rule, including, for example, that it must have a ready market, be 
readily transferable, and not consist of securities issued by the 
nonbank SBSD or the counterparty.
    There are exceptions in Rule 18a-3 to the requirements to collect 
initial and/or variation margin and to deliver variation margin. A 
nonbank SBSD need not collect variation or initial margin from (or 
deliver variation margin to) a counterparty that is a commercial end 
user, the BIS, the European Stability Mechanism, or a multilateral 
development bank identified in the rule. Similarly, a nonbank SBSD need 
not collect variation or initial margin (or deliver variation margin) 
with respect to a legacy account (i.e., an account holding security-
based swaps entered into prior to the compliance date of the rule). 
Further, a nonbank SBSD need not collect initial margin from a 
counterparty that is a financial market intermediary (i.e., an SBSD, a 
swap dealer, a broker-dealer, an FCM, a bank, a foreign broker-dealer, 
or a foreign bank) or an affiliate. A nonbank SBSD also need not hold 
initial margin directly if the counterparty delivers the initial margin 
to an independent third-party custodian. Further, a nonbank SBSD need 
not collect initial margin from a counterparty that is a sovereign 
entity if the nonbank SBSD has determined that the counterparty has 
only a minimal amount of credit risk.
    The rule also has a threshold exception to the initial margin 
requirement. Under this exception, a nonbank SBSD need not collect 
initial margin to the extent that the initial margin amount when 
aggregated with other security-based swap and swap exposures of the 
nonbank SBSD and its affiliates to the counterparty and its affiliates 
does not exceed $50 million. The rule also would permit an SBSD to 
defer collecting initial margin from a counterparty for two months 
after the month in which the counterparty does not qualify for the $50 
million threshold exception for the first time. Finally, the rule has a 
minimum transfer amount exception of $500,000. Under this exception, if 
the combined amount of margin required to be collected from or 
delivered to a counterparty is equal to or less than $500,000, the 
nonbank SBSD need not collect or deliver the margin. If the initial and 
variation margin requirements collectively or individually exceed 
$500,000, collateral equal to the full amount of the margin requirement 
must be collected or delivered.
ii. Nonbank MSBSPs
    Rule 18a-3 also prescribes margin requirements for nonbank MSBSPs 
with respect to non-cleared security-based swaps. The rule requires a 
nonbank MSBSP to calculate variation margin for the account of each 
counterparty as of the close of each business day. The rule requires 
the nonbank MSBSP to collect collateral from (or deliver collateral to) 
a counterparty to cover a variation margin requirement. The collateral 
must be collected or delivered by the close of business on the next 
business day following the day of the calculation, except that the 
collateral can be collected or delivered by the close of business on 
the second business day following the day of the calculation if the 
counterparty is located in another country and more than four time 
zones away. Further, the variation margin must consist of cash, 
securities, money market instruments, a major foreign currency, the 
security of settlement of the non-cleared security-based swap, or gold. 
The rule has an exception pursuant to which the nonbank MSBSP need not 
collect variation margin if the counterparty is a commercial end user, 
the BIS, the European Stability Mechanism, or one of the multilateral 
development banks identified in the rule (there is no exception from 
delivering variation margin to these types of counterparties). The rule 
also has an exception pursuant to which the nonbank MSBSP need not 
collect or deliver variation margin with respect to a legacy account. 
There also is a $500,000 minimum transfer amount exception to the 
collection and delivery requirements for nonbank MSBSPs.
b. Benefits and Costs of the Margin Rule
    As noted earlier, the market for non-cleared security-based swaps 
as it exists today is fairly opaque. Market participants have little or 
no knowledge about a dealer's uncollateralized exposure to a failed 
counterparty and the dealer's ability to withstand potential losses 
from such exposure. When a dealer fails, uncertainty about the 
uncollateralized exposures of the surviving dealers to the failed 
dealer and their safety and soundness may discourage some market 
participants from entering transactions with the surviving dealers. In 
turn, this uncertainty may hinder the efficient allocation of capital 
in this market.
    In the market for non-cleared security-based swaps and in the 
market for OTC derivatives generally, collateral is the means for 
mitigating counterparty credit risk.\1146\ Counterparties can 
collateralize a transaction by exchanging variation and initial margin. 
The regular exchange of variation margin between counterparties limits 
the potential for

[[Page 44013]]

one party in an OTC derivative transaction to build up a large 
``current exposure'' to the other. The current exposure of counterparty 
A to counterparty B is the amount that counterparty B would be 
obligated to pay counterparty A if all the OTC derivatives contracts 
between the two parties were terminated (i.e., it is the net amount of 
the current receivable from counterparty B). A positive current 
exposure of counterparty A to counterparty B implies a zero current 
exposure of counterparty B to counterparty A. The exchange of variation 
margin between two parties represents the settlement of profits and 
losses resulting from some subset of derivative transactions between 
those parties.
---------------------------------------------------------------------------

    \1146\ See section VI.A.5. of this release.
---------------------------------------------------------------------------

    In the absence of significant market frictions and under suitable 
conditions, requiring the exchange of variation margin at a suitably 
high frequency can limit the probability that a counterparty exposure 
grows beyond a set level.\1147\ However, in many instances, this may 
not be the case. In particular, market frictions in the CDS market, 
especially in times of stress, can result in liquidity shortages that 
prevent timely replacement of defaulted CDS positions. Delays in the 
replacement of such defaulted positions or closing out the positions 
can lead to losses for the non-defaulting party. Moreover, the 
occurrence of unexpected credit-related events at the reference entity 
can precipitate a counterparty default. For example, a seller of credit 
protection may itself enter financial distress as a result of a 
downgrade of the reference entity. Under such conditions, the exchange 
of variation margin may--by itself--be inadequate at limiting 
counterparty credit risk as unexpected credit events at the reference 
entity can contribute to both the development of current exposures to a 
counterparty and its default.
---------------------------------------------------------------------------

    \1147\ This follows under the assumption of, among other things, 
frictionless markets in which a defaulted position can be 
immediately replaced. In other words, if frequent exchange of 
variation margin guarantees that a market participant has collected 
enough margin to replace an outstanding position, markets for 
collateral assets are sufficiently liquid to permit sales with no 
price impact, and derivatives markets are sufficiently liquid to 
permit replacement of an outstanding position with no price impact, 
the market participant would be indifferent to whether her 
counterparty defaults or not, because she would be able to replace 
her outstanding position with the counterparty instantly without 
taking on any market risk.
---------------------------------------------------------------------------

    Such concerns provide the economic rationale for requiring initial 
margin. The exchange of initial margin is intended to limit ``potential 
future exposures'' (i.e., losses resulting from the costs of replacing 
transactions with a failed counterparty). The potential future exposure 
of counterparty A to counterparty B is an estimate of the amount that 
the current exposure of counterparty A to counterparty B could increase 
before the position can be liquidated in the event of B's default. 
Generally, both parties in an OTC derivatives transaction will have 
positive potential future exposures to each other. By collecting 
initial margin amounts to cover these potential future exposures, 
market participants can reduce the costs associated with re-
establishing their positions with a failed counterparty.
    However, initial margin may be less effective in circumstances 
where the prevalent market practice is to not exchange initial margin 
and where there is no regulatory requirement that market participants 
do so. If only a limited number of inter-dealer exposures are 
collateralized with initial margins, and absent a capital regime for 
dealers that is sufficiently conservative to cover losses from 
positions that are not collateralized with initial margin, the failure 
of one dealer may still trigger the sequential failure of other 
dealers. Uncertainty about the uncollateralized exposures of the 
surviving dealers to the failed dealer and their ability to withstand 
losses from such exposures may erode the confidence of market 
participants in the safety and soundness of the surviving dealers. In 
times of stress, this uncertainty may cause the market to break down; 
market participants may suddenly ``run'' on the surviving firms due to 
uncertainty about their uncollateralized exposure to the failed dealer.
    Thus, if the exchange of initial margin is not an adopted market 
practice or is not mandated by regulation, or if capital requirements 
for dealers are not sufficiently conservative to cover losses from 
positions that are not collateralized with initial margin, market 
participants may face additional uncertainty about the safety and 
soundness of the surviving dealers, which, in times of stress, may lead 
to a market shutdown.
    A number of commenters argue that an approach based on the exchange 
of initial margin may prevent an inappropriate build-up of systemic 
risk within the financial system, which they argue would be more 
consistent with the intent of the Dodd-Frank Act.\1148\ A commenter 
argued that it would be inappropriate to allow a nonbank SBSD to have 
non-cleared security-based swap exposure to another SBSD without any 
requirement to collect initial margin or to take a capital charge to 
recognize the risk in the non-cleared security-based swap and in the 
counterparty.\1149\ Other commenters noted that the prudential 
regulators have explicitly required bank SBSDs to collect initial 
margin from other SBSDs and argued that the Commission should do so as 
well, and that the Commission should maximize harmonization with rules 
already implemented by the CFTC and the prudential regulators.\1150\ 
Finally, one commenter criticized the Commission for making these 
proposals despite the fact that insufficient margin and capital were 
two of the triggers of the financial crisis.\1151\
---------------------------------------------------------------------------

    \1148\ See Americans for Financial Reform Education Letter; 
Barnard Letter; Citadel 11/19/2018 Letter; Council for Institutional 
Investors Letter.
    \1149\ See OneChicago 2/19/2013 Letter.
    \1150\ See Americans for Financial Reform Education Fund Letter; 
Citadel 11/19/2018 Letter; Rutkowski 11/20/2018 Letter.
    \1151\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    The Commission agrees with the commenters that allowing dealers to 
enter non-cleared security-based swap exposures without having to 
collect initial margin or take a capital deduction for the credit risk 
of exposure may increase risk in the financial system, which may 
increase the risk of sequential dealer failure. This is why the final 
capital rules impose a capital deduction or credit risk charge when a 
nonbank SBSD elects not to collect initial margin under an exception in 
the Commission's final margin rule or the margin rules of the CFTC. In 
addition, there is a trade-off in terms of the benefits of requiring a 
nonbank SBSD to collect initial margin from another financial market 
intermediary: Namely, the liquidity of the delivering firm is reduced 
by the amount of initial margin posted to the nonbank SBSD. Thus, while 
the initial margin collected by the nonbank SBSD enhances the firm's 
safety and soundness, the delivery of liquid capital by the other 
financial market intermediary diminishes that firm's safety and 
soundness because it cannot use the delivered liquid capital to protect 
itself from losses or to meet liquidity demands.
    Moreover, the final margin rule is intended to enhance the safety 
and soundness of nonbank SBSDs in the market for non-cleared security-
based swaps by reducing the uncertainty about uncollateralized 
exposures to a failed counterparty. The requirement to exchange 
variation margin is intended to reduce a nonbank SBSD's potential 
losses stemming from uncollateralized market risk exposures, and the 
risk of nonbank SBSD failure as a result of

[[Page 44014]]

these potential losses. Further, the requirement that nonbank SBSDs 
collect initial margin from their counterparties that are not subject 
to an exception to the margin rule is intended to reduce a nonbank 
SBSD's potential losses stemming from uncollateralized credit risk 
exposures, and therefore reduce the risk of nonbank SBSD failure as a 
result of these potential losses.
    However, the final margin rule includes a number of exceptions to 
the requirement that nonbank SBSDs collect variation and/or initial 
margin from counterparties, such as the exception from the requirement 
to collect variation or initial margin in transactions with commercial 
end users and the exception from the requirement to collect initial 
margin in transactions with other financial market intermediaries. The 
Commission acknowledges, however, as noted by a number of commenters, 
that financing additional collateral can also impose certain costs on 
parties in non-cleared security-based swap transactions, as well as 
potentially reduce liquidity in that market. In cases where an 
exception to the final margin rule applies and nonbank SBSDs have 
uncollateralized exposures from security-based swap transactions, the 
final capital rules and amendments require nonbank SBSDs to take 
capital deductions or credit risk charges against such uncollateralized 
exposures. While this approach may leave nonbank SBSDs with residual 
uncollateralized exposures, because capital deductions and credit risk 
charges against uncollateralized credit exposures can be much lower 
than the initial margin appropriate for such exposures, this approach 
may benefit nonbank SBSDs and market participants more generally, by 
supporting nonbank SBSD liquidity provision and promoting the liquidity 
and therefore the safety and soundness of nonbank SBSDs to the extent 
it relieves them from having to post initial margin to other nonbank 
SBSDs.
    As described in the baseline, reliable information about 
counterparty exposures in the non-cleared security-based swap market is 
not currently publicly observable. Because market participants 
generally lack reliable information about their counterparty's exposure 
to a failed dealer or major participant, the failure of a dealer or 
major participant in these markets can lead to questions about the 
continued viability of other firms. It is generally not possible for 
market participants to reliably estimate the size of other 
participants' exposures to a failing firm. Uncertainty can cause market 
participants to cease trading with participants suspected of having had 
large exposures to the failed entity. This can precipitate the demise 
of suspect firms. By constraining uncollateralized counterparty 
exposures, margin requirements reduce the likelihood of sequential 
dealer failure.
    To reduce these exposures, the final rule requires nonbank SBSDs to 
collect variation margin on a daily basis from other financial market 
intermediaries, including other SBSDs. Under the baseline, non-cleared 
security-based swap transactions are typically covered by agreements 
outlining the rights of the parties to make margin calls; however, such 
agreements may not require the contracting parties to exchange 
variation margin on a daily basis.\1152\ Therefore, dealers may defer 
making margin calls during relatively benign market conditions, and 
make margin demands only when conditions deteriorate or when doubts 
about specific counterparties surface. This can destabilize markets and 
lead to contagion. By requiring daily collection or delivery of 
variation margin in inter-dealer trades, the final rule will limit the 
buildup of uncollateralized inter-dealer exposures. This will help 
ensure that, at all times, the immediate losses of a nonbank SBSD 
resulting from its non-cleared security-based swap exposures to a 
failing financial market intermediary are limited to a one-day change 
in the value of its positions with the failing firm.\1153\
---------------------------------------------------------------------------

    \1152\ See, e.g., ISDA, User's Guide to the ISDA 1994 Credit 
Support Annex, 1994.
    \1153\ Although the immediate losses are limited to a one-day 
net change in the value of the positions, eventual losses may be 
more significant due to the surviving dealer's inability to replace 
defaulted positions in a timely manner.
---------------------------------------------------------------------------

    While the inter-dealer exchange of variation margin may reduce the 
immediate losses from exposure to a failed dealer, this form of 
collateralization is usually not enough to isolate a dealer against 
potential losses from re-establishing or closing out the positions with 
a failed dealer. As noted earlier, such losses are usually covered by 
initial margin. The final margin rule does not require nonbank SBSDs to 
collect initial margin from other financial market intermediaries, 
including other SBSDs. While the rule does not preclude nonbank SBSDs 
from collecting initial margin from other financial market 
intermediaries, in general, the Commission does not expect most inter-
dealer transactions to be collateralized with initial margin. However, 
as discussed above in section II.A.2.b.ii. of this release, the final 
capital rules will require nonbank SBSDs to take a capital deduction or 
credit risk charge for these inter-dealer uncollateralized exposures. 
In addition, the final capital rules require dealers to increase their 
minimum net capital by a factor proportional to the initial margin that 
would cover such exposures (when the margin factor amount equals or 
exceeds its fixed-dollar requirement). The additional capital that a 
surviving nonbank SBSD will have to allocate to support inter-dealer 
transactions that are not collateralized with initial margin will act 
as a buffer against potential losses from replacing or closing out the 
positions with a failed firm, and reduce the surviving nonbank SBSD's 
risk of default. To this end, while surviving nonbank SBSDs may still 
incur losses from replacing or closing out positions with defaulting 
counterparties that were not collateralized with initial margin, the 
final capital rules are designed to reduce the likelihood that such 
losses will lead to their failure. Thus, the final capital rules 
complement the margin requirements to limit the risk of sequential 
dealer failure in this market. By reducing the uncertainty about 
uncollateralized exposures to a failed dealer, and by reducing the risk 
of sequential dealer failure, the margin requirements together with the 
capital requirements should enhance the safety and soundness of the 
dealers in times of stress. Further, as discussed above, the exception 
from collecting initial margin from other financial market 
intermediaries involves a trade-off between the benefits that initial 
margin provides the collecting firm and the costs (including the loss 
of liquid capital) that such a requirement imposes on the delivering 
firm.
    While the scale of the above benefits is difficult to quantify, it 
can be broadly characterized as a function of the size of the affected 
transactions and the degree to which a dealer's private incentives in 
those transactions may create uncollateralized exposures that reduce 
the stability of the market for security-based swaps. In the non-
cleared security-based swap market, inter-dealer transactions represent 
a significant portion of transactions.\1154\ Industry surveys indicate 
that on average, these transactions are partly collateralized (i.e., 
margin for current or potential future exposure is not always 
collected).\1155\ This collateralization practice, while limited, is 
consistent with major dealer defaults being rare and resulting from 
certain aggregate shocks. Dealer failures resulting from aggregate 
shocks could impose significant negative externalities on the financial 
system. If dealers were to fully

[[Page 44015]]

margin their inter-dealer transactions, including collecting initial 
margin from other dealers, the negative externalities associated with a 
dealer failure would be significantly reduced, resulting in 
improvements to financial stability. However, fully-margining inter-
dealer transactions would impose costs on dealers because delivering 
margin collateral may reduce a dealer's available liquid capital and, 
therefore, the extent to which the dealer can provide liquidity to the 
market. Improvements to financial stability, on one hand, and higher 
costs associated with liquidity provision on the other hand could have 
offsetting effects on the overall economy. While dealers may pass on 
some of these costs to other security-based swap market participants 
through increased spreads or reduced liquidity provision, these costs 
generally may reduce a dealer's incentives to fully-margin its 
transactions with other dealers. Thus, private incentives alone may be 
insufficient to result in margin arrangements that improve the 
stability of the market for security-based swaps and the benefit of 
regulations can be significant.
---------------------------------------------------------------------------

    \1154\ See section VI.A.1.d of this release.
    \1155\ See section VI.A.2.d of this release.
---------------------------------------------------------------------------

    The requirement to collect variation and initial margin from non-
excepted counterparties is likely to generate qualitatively similar but 
quantitatively smaller benefits. The requirement should significantly 
limit the extent to which a nonbank SBSD can build a large 
uncollateralized exposure to a non-excepted counterparty, and 
therefore, significantly reduce the likelihood of the SBSD's failure 
due to potential losses from such exposure. However, although defaults 
among certain non-excepted counterparties may be more common, their 
defaults tend to be idiosyncratic and the negative externalities of 
these failures are less significant compared to those that result from 
a financial market intermediary's failure.
    Margin requirements--initial margin requirements in particular--can 
also constrain risk-taking. As noted above, currently, nonbank dealers 
may collateralize some portion of the exposures created by their 
positions.\1156\ In general, depending on the margin arrangements with 
the counterparties, a dealer may maintain a buffer of pledgeable assets 
to satisfy expected margin calls from the counterparties over a given 
period. In the absence of regulatory margin requirements, privately-
negotiated margin requirements may be limited, resulting in small 
expected margin calls from the counterparties.\1157\ This may likely 
result in a buffer of pledgeable assets that is small relative to the 
size of the exposures created by the dealer's derivatives book. 
Conversely, regulatory margin requirements, by imposing more extensive 
margin requirements, increase expected margin calls; the increased 
expected margin calls necessitate a larger buffer of pledgeable assets 
to support the same derivatives book. As pledgeable collateral must be 
funded, margin requirements link the expansion of a firm's derivatives 
book, and therefore the amount of risk it takes, more closely to its 
ability to obtain funding. In particular, regulatory margin 
requirements may reduce a dealer's ability to create uncollateralized 
exposures, and, therefore, limit its ability to take on risk.
---------------------------------------------------------------------------

    \1156\ See section VI.A.2.d. of this release.
    \1157\ Although private incentives may be sufficient to require 
margin under certain circumstances, private incentives alone need 
not result in margin exchange policies that are optimal from a 
social perspective. In general, privately negotiated margin policies 
do not take account of the systemic risk externalities of 
uncollateralized counterparty exposures and are therefore expected 
to result in margin policies that require too little margin. See, 
e.g., Viral V. Acharya, Aaditya M. Iyer, and Rangarajan K. Sundaram, 
Risk-Sharing and the Creation of Systemic Risk (New York University 
Stern School of Business, Working Paper (2015), available at http://
pages.stern.nyu.edu/~sternfin/vacharya/public_html/pdfs/2015-01-
23_SystemicRiskCreation.pdf.
---------------------------------------------------------------------------

    The margin rule should further contribute to financial stability by 
limiting effective leverage in the non-cleared security-based swap 
market. By requiring nonbank SBSDs to exchange variation margin and to 
collect initial margin from non-commercial counterparties when the 
amount exceeds the initial margin threshold, the rule increases the 
collateral required to support non-cleared security-based swap 
transactions, limiting the effective leverage of such transactions. One 
commenter noted that the economic analysis should consider the impact 
of the final rules on market participants' ability to build up leverage 
through non-cleared security-based swaps.\1158\ Absent the need to post 
margin, financial entities such as dealers, hedge funds, insurance 
companies, and banks are relatively unconstrained in the size of their 
security-based swap exposures.\1159\ Failure of a large financial 
entity or of a group of smaller financial entities with significant 
derivatives exposures could lead to large dealer losses, dealer 
failures, or significant market dislocations. The rule limits the 
potential impact of financial entities' defaults by: (1) Reducing the 
probability of their occurrence; (2) reducing their scale; and (3) 
reducing losses to nonbank SBSDs from transaction with the defaulted 
counterparties. The first two effects follow from reductions in such 
firms' leverage. The third effect follows from a nonbank SBSD's ability 
to collateralize its exposures from the positons with a financial 
entity counterparty, prior to the default of the counterparty.
---------------------------------------------------------------------------

    \1158\ See Better Markets 11/19/2018 Letter.
    \1159\ For example, hedge funds are not generally subject to 
regulatory capital requirements. Therefore, in the absence of a 
requirement to post initial margin, the scale of their derivatives 
exposures is not directly constrained by available capital.
---------------------------------------------------------------------------

    As noted above, under the final rule, a nonbank SBSD can defer 
collecting initial margin for up to two months following the month in 
which a counterparty no longer qualifies for the fixed-dollar $50 
million threshold exception for the first time. This one-time deferral 
is designed to provide the counterparty with sufficient time to take 
the steps necessary to begin posting initial margin pursuant to the 
final rule. Thus, the deferral should support the benefits of the 
initial margin requirement discussed above by ensuring that 
counterparties have enough time to execute agreements, establish 
processes for exchanging initial margin, and take other steps to comply 
with the initial margin requirement. A nonbank SBSD that chooses to use 
the one-time deferral will continue to take a capital deduction in lieu 
of margin or credit risk charge. As noted above, the requirement to 
take this capital deduction or charge may impose costs on SBSDs and may 
create benefits for market participants.\1160\ These costs could be 
limited to the extent that the nonbank SBSD and its counterparty have 
an existing agreement and processes that can be readily modified to 
incorporate the $50 million threshold and thus help shorten the 
deferral period.
---------------------------------------------------------------------------

    \1160\ See section VI.B.1.b.iii. of this release.
---------------------------------------------------------------------------

    Regulatory margin requirements on non-cleared transactions make 
them relatively less attractive vis-[agrave]-vis similar cleared 
transactions, and thereby encourage the use of cleared transactions. 
Cleared contracts significantly reduce the contagion risk inherent in 
bilateral contracts. When an OTC derivatives contract between two 
counterparties is submitted for clearing, it is replaced by two new 
contracts: Separate contracts between the CCP and each of the two 
original counterparties. At that point, the original counterparties no 
longer have credit risk exposures to each other. Instead, both are left 
with a

[[Page 44016]]

credit risk exposure to the CCP.\1161\ Structured and operated 
appropriately, CCPs can improve the management of counterparty risk, 
reduce uncertainty, and provide additional benefits such as 
multilateral netting of trades.\1162\ However, prudent risk management 
at CCPs will generally take the form of requirements on participants to 
frequently post initial and variation margin and requirements to 
contribute to a general guarantee fund.\1163\ These measures impose 
costs on counterparties to cleared transactions. These costs can be 
avoided through non-cleared transactions if regulatory margin 
requirements are absent or the costs of regulatory margin requirements 
are lower.
---------------------------------------------------------------------------

    \1161\ See Stephen Cecchetti, Jacob Gyntelberg, and Mark 
Hollanders, Central Counterparties for Over-the-counter Derivatives, 
BIS Quarterly Review (Sept. 2009).
    \1162\ See Daniel Heller and Nicholas Vause, Expansion of 
Central Clearing, BIS Quarterly Review (June 2011) (arguing 
expansion of central clearing within or across segments of the 
derivatives market could economize both on margin and non-margin 
resources). See also Process for Submissions of Security-Based 
Swaps, 77 FR at 41602.
    \1163\ See Standards for Covered Clearing Agencies, 81 FR 70786.
---------------------------------------------------------------------------

    By imposing regulatory margin requirements on nonbank SBSDs for 
non-cleared security-based swap transactions that, in large part, 
mirror certain margin requirements imposed by a clearinghouse on its 
participants, namely to collect variation and initial margin, the rule 
decreases the cost advantage of non-cleared security-based swap 
transactions relative to central clearing. For parties that derive 
sufficiently large private benefits from their collateral and who 
generally prefer to transact with more limited use of margin, the 
rule's requirements may, at the margin, increase the costs of non-
cleared security-based swap transactions relative to cleared security-
based swap transactions, encouraging these parties to clear their 
security-based swap transactions. Insofar as the final margin rule 
causes previously non-cleared transactions to be cleared, an important 
net benefit of the rule is promoting central clearing.
    The final margin rule should also improve the information set for 
regulatory oversight of nonbank SBSDs and MSBSPs. The rule requires 
nonbank SBSDs and MSBSPs to perform margin calculations as of the close 
of each business day with respect to each account carried by the firm 
for a counterparty to a non-cleared security-based swap transaction. 
Even if the counterparty is not required to deliver collateral, the 
calculations will provide examiners with enhanced information about 
non-cleared security-based swaps, allowing the Commission and other 
appropriate regulators to gain ``snapshot'' information at a point in 
time for examination purposes.\1164\
---------------------------------------------------------------------------

    \1164\ See Recordkeeping and Reporting Requirements for 
Security-Based Swap Dealers, Major Security-Based Swap Participants, 
and Broker-Dealers; Capital Rule for Certain Security-Based Swap 
Dealers, 79 FR at 25206.
---------------------------------------------------------------------------

    The principal costs resulting from the final margin rule arise from 
the requirement on a nonbank SBSD to collect initial margin from non-
excepted counterparties to which the SBSD has a significant exposure 
(i.e., an exposure that is above the $50 million initial margin 
threshold under the rule). As noted above, currently, nonbank dealers 
do not always collect initial margin from their counterparties on non-
cleared security-based swap transactions.\1165\ Thus, by requiring the 
collection of initial margin, absent an exception, the rule has the 
effect of increasing the demand for a market participant's unpledged 
collateral, and thereby raises the cost of engaging in non-cleared 
security-based swap transactions. This can reduce the efficiency of 
risk sharing through the non-cleared security-based swap market. The 
increased cost is also likely to lead to a reduction in the quantity of 
transactions. Reductions in the quantity of transactions can have 
negative implications for market liquidity, price discovery and on 
dealer profitability.\1166\ Similarly, the additional margin required 
under the rule can reduce the availability of collateral for other 
transactions and limit the effective leverage of participants in the 
non-cleared security-based swap market. Finally, by reducing effective 
leverage, the requirements may reduce the profitability (e.g., the 
expected returns) of investment strategies that currently take 
advantage of the leverage created by uncollateralized exposures in this 
market.
---------------------------------------------------------------------------

    \1165\ See section VI.A.2.d. of this release.
    \1166\ Concerns with these costs were highlighted by several 
commenters. One commenter believed the proposed initial margin 
requirement would severely impact liquidity in the non-cleared 
security-based swap market and make non-cleared security-based swaps 
significantly more expensive because of the costs of initial margin. 
This commenter stated that these costs include not only the costs of 
the actual initial margin but also the operational burdens of 
complex daily posting and reconciliation of initial margin. This 
commenter stated that the OTC derivatives market is critical to the 
functioning of the overall economy and provided examples of non-
clearable security-based swaps that the commenter believed are 
critical to key sectors of the global economy that would be harmed 
by the imposition of initial margin requirements. See ISDA 1/23/13 
Letter.
---------------------------------------------------------------------------

    Several commenters argued that initial margin is unnecessary, and 
potentially counterproductive.\1167\ One commenter believed that in 
lieu of initial margin, systemic risk could be effectively mitigated by 
daily variation margining with zero thresholds, implementation of 
appropriate capital requirements, and mandatory clearing of liquid 
standardized security-based swaps.\1168\ The Commission believes that 
while all of the aforementioned mechanisms can play an important role 
in maintaining financial stability, they do not fully address it. In 
particular, as noted earlier, due to various market frictions, 
variation margin alone does not offer adequate protection against 
unexpected counterparty defaults in times of stress when such defaults 
are precipitated by the counterparty's losses in the same positions, 
and liquidity is scarce.\1169\
---------------------------------------------------------------------------

    \1167\ A commenter asserted that ``VM, with daily collection 
(subject to limited exceptions for illiquid collateral) and zero 
thresholds, effectively protects against accumulated and unrealized 
losses in over-the-counter (``OTC'') derivatives positions.'' See 
ISDA 1/23/2013 Letter. Another commenter stated that ``[r]igorous 
variation margin requirements have the potential to significantly 
reduce systemic risk by eliminating the accumulation of 
uncollateralized current exposures while avoiding the potentially 
destabilizing and pro-cyclical effects of initial margin . . .'' See 
SIFMA 2/23/2013 Letter.
    \1168\ See ISDA 1/23/13 Letter.
    \1169\ As discussed earlier in this section, liquidity shortages 
during times of market stress can prevent timely replacement of 
defaulted CDS positions, and delays in replacement can lead to 
losses for the non-defaulting counterparty. Moreover, the occurrence 
of unexpected credit-related events at the reference entity can 
precipitate a counterparty default. Under such conditions, the 
exchange of variation margin may--by itself--be inadequate at 
limiting counterparty credit risk as unexpected credit events at the 
reference entity can contribute to both the development of current 
exposures to a counterparty and its default.
---------------------------------------------------------------------------

    Another commenter argued that the Commission should not accept 
claims that the full margining of security-based swap transactions will 
make it difficult to use them for hedging purposes, or will shrink the 
size of the global security based swap market.\1170\ This commenter 
also argued that the use of uncollateralized or under-collateralized 
security-based swaps does not reduce risk, it increases it, even if 
users claim the security-based swaps are ``hedges.'' This commenter 
also believed that to the degree the unregulated security-based swap 
market in place prior to the Dodd-Frank Act was overleveraged, it was 
also too large because full social costs of the market were not 
incorporated into user decisions.
---------------------------------------------------------------------------

    \1170\ See Americans for Financial Reform Letter.
---------------------------------------------------------------------------

    Several comments raised concerns about certain technical aspects of 
the proposed initial margin calculation. Some commenters asked the

[[Page 44017]]

Commission to revise the standardized haircuts (which would be used to 
calculate initial margin if the firm was not authorized to use a model) 
to better reflect the historical market volatility and losses given 
default associated with CDS positions. A few commenters argued that 
methods (e.g., using a model) other than the Appendix A methodology 
should be permitted to calculate initial margin for equity security-
based swaps.\1171\ One commenter stated that the Appendix A methodology 
is inadequate and inefficient for a proper initial margin calculation 
and does not sufficiently recognize portfolio margining.\1172\ This 
commenter also stated that the Appendix A methodology does not 
incorporate critical factors such as volatility, and, as a result, 
initial margin on equity security-based swaps would likely be 
insufficient in times of stressed markets (in contrast to a model-based 
approach). Another commenter raised concerns that applying the Appendix 
A methodology would result in initial margin requirements that are 
substantially less sensitive to the economic risks of a security-based 
swap portfolio than a model-based approach, and suggested the 
Commission permit a nonbank SBSD to use either the Appendix A 
methodology or an internal model to compute the initial margin amount 
for equity security-based swaps.\1173\ Another commenter requested that 
the Commission permit the use of models for both debt and equity 
security-based swaps.\1174\
---------------------------------------------------------------------------

    \1171\ See ISDA 1/23/2013 Letter; SIFMA 2/22/2013 Letter.
    \1172\ See ISDA 1/23/2013 Letter.
    \1173\ See SIFMA 2/22/2013 Letter.
    \1174\ See SIFMA AMG 2/22/2013 Letter.
---------------------------------------------------------------------------

    In response to commenters' concerns regarding the use of the 
Appendix A methodology to compute initial margin for equity security-
based swaps, the Commission modified the final margin rule to permit a 
stand-alone SBSD to use a model to calculate initial margin for non-
cleared equity-based security-based swaps, provided the account does 
not hold equity security positions other than equity security-based 
swaps and equity swaps.\1175\ Permitting the model-based approach under 
these limited circumstances strikes an appropriate balance in terms of 
addressing commenters' concerns and maintaining regulatory parity 
between the cash equity and the equity security-based swap markets.
---------------------------------------------------------------------------

    \1175\ See paragraph (d)(2)(ii) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

    Broker-dealer SBSDs will not be permitted to use a model to compute 
initial margin for equity security-based swaps. The Commission has also 
considered the objections of commenters to requiring the use of the 
Appendix A methodology to calculate the initial margin amount for non-
cleared equity security-based swaps (rather than permitting a 
model).\1176\ While the Commission agrees that the Appendix A 
methodology has certain limitations, particularly with respect to 
recognizing offsets arising from correlated positions, it notes that 
the use of models in this context is unlikely to address these 
limitations, and moreover, can introduce additional problems. Due to 
the volatility of equity returns, correlations in these returns are 
difficult to estimate without significant modeling assumptions. To the 
extent that parties in security-based swap transactions wish to 
minimize the total amount of initial margin devoted to such 
transactions, incentives to adopt optimistic assumptions can lead to 
models that overestimate negative correlations, underestimate positive 
correlations, and lead to inadequate margin levels. These are some of 
the reasons why the final capital and margin rules impose qualitative 
and quantitative requirements on the use of models and why the final 
capital rules impose higher capital requirements for (and increased 
monitoring of) nonbank SBSDs that use models.
---------------------------------------------------------------------------

    \1176\ Nonbank SBSDs may also use the non-portfolio based 
standardized approach to calculate the haircut/margin for equity 
security-based swaps. In most cases, the deduction is the notional 
amount of the equity security-based swap multiplied by the deduction 
(haircut) that would apply to the underlying instrument referenced 
by the equity security-based swap.
---------------------------------------------------------------------------

    In addition, the Commission recognizes the concerns commenters 
raised about the historical accuracy of the standardized haircuts. As 
discussed sections VI.A.7. and VI.B.1.iv. of this release, the 
Commission has provided an analysis that compares the standardized 
haircuts to the actual losses on credit default swap positions observed 
from historical data. In response to the commenters, the Commission 
notes that the standardized haircut grids for non-cleared CDS in the 
final rules are based on existing Rule 15c3-1 and, in part, on FINRA 
Rule 4240. The Commission further notes that in the analysis for CDS 
positions referencing single-name obligors, the maximum loss on a 
position scaled by its corresponding haircut--the so-called loss 
coverage ratio--exceeds 1 in all sample years. However, this is not 
always the case in the analysis for CDS positions referencing an index. 
These results suggest that the standardized haircuts in the final rules 
are generally not set at the most conservative level, as losses on some 
positions exceed the corresponding standardized haircuts. In general, 
haircuts are intended to strike a balance between being sufficiently 
conservative to cover losses in most cases, including in stressed 
market conditions, and being sufficiently nimble to allow dealers to 
operate efficiently in all market conditions. Based on the results of 
the analysis, as described above, the Commission believes that the 
standardized haircuts in the final rules take into account this 
tradeoff.\1177\
---------------------------------------------------------------------------

    \1177\ As discussed above in section VI.B.1. of this release, a 
standardized haircut grid calibrated to historical volatilities and 
recoveries will generally not be accurate going forward, due to 
variation in volatilities and recoveries over time.
---------------------------------------------------------------------------

    Several commenters argued against the adoption of initial margin 
requirements for certain types of counterparties. One commenter 
believed that substantial initial margin requirements could impose 
significantly greater costs on life insurers and suggested that dealers 
and major participants in the security-based swap market have the 
flexibility to determine whether and to what extent life insurers 
should be required to pledge initial margin to financial firms.\1178\ 
One commenter argued that, as proposed, the initial margin requirements 
will ``severely challenge the resiliency of the financial system and 
will severely curtail the use of non-cleared swaps for hedging.'' 
\1179\ Another commenter believed that the initial margin requirement 
is a new and costly requirement for most financial end users, while the 
variation margin requirement may undermine the ability of an end-user 
to negotiate the best terms for a security-based swap.\1180\ This 
commenter stated that a survey found that a 3% initial margin 
requirement on the S&P 500 companies could be expected to reduce 
capital spending by $5.1 billion to $6.7 billion, and that United 
States would lose 100,000 to 130,000 jobs from both direct and indirect 
effects. One commenter urged the Commission to except counterparties 
with material swaps exposure of less than $8 billion from the margin 
requirements to be consistent with the margin rules adopted by the 
prudential regulators, the CFTC, and non-U.S. regulators.\1181\ Other 
commenters opposed margin requirements for certain types of

[[Page 44018]]

transactions. One commenter opposed margin requirements for inter-
affiliate transactions and stated that this requirement would cause 
artificial and inefficient capital allocation for end-users, increase 
consumer costs, and undermine efficiencies that end-users currently 
realize through centralized treasury units.\1182\ Another commenter 
argued that nonprofit sovereign institutions should be granted an 
exception to the posting of margin requirement because these 
institutions do not trade for profit-seeking reasons and they benefit 
from explicit or implicit guarantees from their sovereign 
governments.\1183\ In addition, the commenter argued that the 
Commission's requirement to collect margin from this type of 
institution is not consistent with the margin requirements adopted by 
the CFTC and the prudential regulators.\1184\
---------------------------------------------------------------------------

    \1178\ See American Council of Life Insurers 2/22/2013 Letter.
    \1179\ See ISDA 1/23/13 Letter.
    \1180\ See Coalition for Derivatives End-Users 2/22/2013 Letter.
    \1181\ See ICI 11/19/2018 Letter.
    \1182\ See Coalition for Derivatives End-Users 2/22/2013 Letter.
    \1183\ See KFW Bankengruppe Letter.
    \1184\ See CFTC Margin Final Release, 81 FR at 696 (providing 
that the term ``financial end user'' (meaning an entity from whom 
margin must be collected) does not generally include any 
counterparty that is: A sovereign entity, a multilateral development 
bank, the BIS, a captive finance company that qualifies for the 
exemption from clearing under Section 2(h)(7)(C)(iii) of the 
Commodity Exchange Act and implementing regulations, or a person 
that qualifies for the affiliate exemption from clearing pursuant to 
Section 2(h)(7)(D) of the Commodity Exchange Act or Section 3C(g)(4) 
of the Securities Exchange Act and implementing regulations). See 
also Prudential Regulator Margin and Capital Final Release, 80 FR at 
74855.
---------------------------------------------------------------------------

    Several commenters provided estimates of the additional collateral 
that would be required to satisfy the proposed rules.\1185\ One 
commenter estimated that the potential impact of initial margin 
requirements assuming the use of models and a zero threshold, would be 
$1.7 trillion for universal two-way margin and $1.2 trillion for dealer 
only collection, as proposed by the Commission.\1186\ This commenter 
also estimated that under proposed Alternative A (nonbank SBSDs 
exchange only variation margin) the total initial margin requirements 
would drop to $500 billion, assuming full use of models.
---------------------------------------------------------------------------

    \1185\ See ISDA 1/23/2013 Letter; SIFMA 3/12/2014 Letter; SIFMA 
2/22/2013 Letter.
    \1186\ See ISDA 1/23/13 Letter.
---------------------------------------------------------------------------

    This commenter stated that its member firms have estimated that the 
liquidity demands associated with mandatory initial margin requirements 
are likely to range between approximately $1.1 trillion (if dealers are 
not required to collect initial margin from each other) to $3 trillion 
(if dealers must collect initial margin from each other) to $4.1 
trillion (if dealers must post initial margin to non-dealers).\1187\ 
Moreover, in stressed conditions, the commenter estimated that initial 
margin amounts collected by firms that use internal models could 
increase by more than 400%. A final commenter requested that 
multilateral development banks be exempt from the Commission's 
regulatory margin requirements, noting specifically that the 
International Bank for Reconstruction ``could face a potential posting 
requirement over the medium term of $20-30 billion under plausible 
scenarios,'' with a ``possible cost of carry in the range of $40-90 
million per year,'' which could be problematic, given that none of the 
multilateral development banks have access to a liquidity facility of 
last resort.\1188\
---------------------------------------------------------------------------

    \1187\ See SIFMA 2/22/2013 Letter.
    \1188\ See World Bank Letter. In response to these comments, in 
the final rule, the Commission is adopting additional exceptions 
from the margin rule for the BIS, European Stability Mechanism, 
multilateral development banks, sovereign entities that have minimal 
credit risk, and affiliates. See Rule 18a-3, as adopted. These 
modifications to the final rule should alleviate commenters' 
concerns to some extent regarding the overall impact of the rule.
---------------------------------------------------------------------------

    Estimates of the aggregate impact of the Commission's margin rule 
are subject to two major uncertainties. First, as discussed below in 
section VI.D.2. of this release, the aggregate impact of the 
Commission's margin rule will largely depend on the SBSD organizational 
structure chosen by the large banking groups that dominate security-
based swap trading activity. To the extent that security-based swap 
trades continue to be conducted primarily through entities subject to 
the prudential regulators' supervision (i.e., bank SBSDs), relatively 
few transactions will be subject to the Commission's margin rules. To 
the same extent, the additional collateral required, and the costs 
associated with this additional collateral will, in the aggregate, be 
minimal. If however, security-based swap trading migrates to nonbank 
affiliates (i.e., nonbank SBSDs), the aggregate impact of the rule 
could be considerably larger to the extent it imposes requirements that 
differ from the requirements of the prudential regulators' margin 
rules. Second, as discussed below in section VI.B.4. of this release, 
the aggregate amount of collateral required to satisfy the final margin 
rule will also depend on counterparties' choices with respect to 
segregation. The Exchange Act provides counterparties of nonbank SBSDs 
a choice of several alternatives to the segregation of their initial 
margin, including the option to waive segregation (though only 
affiliated counterparties can waive segregation in the case of a stand-
alone broker-dealer or broker-dealer SBSD). As discussed below in 
section VI.B.4. of this release, when segregation is waived, the 
private costs associated with the requirement to collect initial margin 
can be significantly reduced as the SBSD collecting said initial margin 
would obtain the benefit of using the collected collateral in its 
operations.
    One commenter \1189\ suggested that the Commission estimate the 
additional collateral required to satisfy the margin requirements. 
However, as noted above, the collateral required to satisfy the 
Commission's rule will depend in large part on the business decisions 
of entities currently operating in the security-based swap market. To 
estimate the eventual collateral demand resulting from the Commission's 
new margin rule, the Commission would have to make significant 
assumptions about individual firms' ultimate organizational structure. 
In particular, the Commission would have to make assumptions about how 
much of U.S. security-based swap dealing activity would eventually be 
housed in nonbank SBSDs, rather than in bank SBSDs not subject to the 
Commission's margin rule; such assumptions would be highly speculative. 
Further, estimates of collateral demand resulting from the Commission's 
margin rule would also be significantly affected by market 
participant's contracting arrangements with respect to segregation of 
collateral. Because the Commission's new rules do not prevent re-
hypothecation of collateral and permit the waiving of segregation, 
counterparties' choices in these areas will ultimately play a major 
role in determining the additional collateral demand; the Commission 
does not have information on the private contracting arrangements of 
counterparties or the preferences for particular segregation regimes 
that would allow for meaningful estimates of the use of segregation and 
re-hypothecation.
---------------------------------------------------------------------------

    \1189\ See ISDA 1/23/13 Letter.
---------------------------------------------------------------------------

    Finally, to obtain estimates for the entire security-based swap 
market, the Commission would have to make significant assumptions about 
unobserved security-based swap activity (i.e., those transactions that 
are not single-name CDS). Although the Commission has provided 
estimates of the scale of such activity, such broad estimates are 
generally inadequate for quantifying the collateral required to support 
this activity under the final margin rule: To do so with some degree of 
accuracy would require detail on the non-CDS positions at the 
counterparty

[[Page 44019]]

level of entities that will register as nonbank SBSDs.\1190\ Because 
the Commission would have to make several layers of assumptions that 
cannot be rigorously justified with available data, the Commission does 
not believe that attempts to quantify the cost of the final margin rule 
would provide reliable estimates of the true collateral demand 
resulting from it.
---------------------------------------------------------------------------

    \1190\ In this and other Title VII releases, the Commission has 
stated its belief that single-name CDS data are sufficiently 
representative of the security-based swap market to directly inform 
the analysis of the current state of the market. Moreover, in prior 
releases, the Commission has used its estimate that single-name CDS 
represent 82% of the total security-based swap market to make 
inferences about unobserved security-based swap activity. See Trade 
Acknowledgment and Verification of Security-Based Swap Transactions, 
81 FR 39808. In those cases, a specific regulatory requirement--as 
well as the cost of the requirement--did not depend on the nature of 
the particular security-based swap. For example, security-based swap 
entities must provide trade acknowledgments to their counterparties 
for all security-based swaps. The requirement does not vary with the 
type of security-based swap. In contrast, margin requirements vary 
across security-based swaps. For example, initial margin 
requirements for non-cleared CDS that reference a narrow-based 
security index vary with the maturity and credit spread of the 
contract, as well as whether the dealer is approved to use models. 
As another example, broker-dealer SBSDs are not permitted to use 
models to calculate initial margin requirements for equity security-
based swaps. Thus, in contrast to previous releases, any estimate of 
collateral costs will depend greatly on the composition of 
unobserved activity.
---------------------------------------------------------------------------

    The final rule's requirements for the collection and posting of 
variation margin by nonbank SBSDs and MSBSPs may also lead to 
additional collateral funding costs for participants in the non-cleared 
security-based swap market. These costs, however, are likely to be of a 
smaller magnitude. Unlike segregated initial margin, variation margin 
does not ``consume'' collateral: Variation margin posted by one party 
can be used to satisfy margin requirements of the party collecting it. 
Moreover, the amount of required variation margin reflects the 
receiving party's mark-to-market gain (receivable) and delivering 
party's mark-to-market loss (payable) on the transaction. The exchange 
of variation margin settles the daily mark-to-market change in the 
value of the position (i.e., it settles the receivable and payable). 
However, to the extent that collateral other than U.S. dollars or 
short-term U.S. government securities is used to meet a variation 
margin requirement, the final margin rule requires haircuts to be 
applied to the collateral. These haircuts could impose an incremental 
need to hold additional collateral to meet variation margin 
requirements. The Commission expects that cash and U.S. government 
securities (which require no or minimal haircuts) will predominantly be 
used to meet variation margin requirements and, therefore, the 
aggregate additional collateral required as a result of the haircuts 
should not be substantial.\1191\ Thus, imposing variation margin 
requirements on security-based swap transactions where variation margin 
has not previously been collected may not significantly increase the 
overall amount of collateral required to support those transactions. 
However, the knowledge that variation margin must be posted on a daily 
basis can be expected to result in affected parties maintaining larger 
buffer stocks of unpledged collateral to ensure that margin calls can 
be satisfied.\1192\ While this can indirectly increase the amount of 
collateral that is required to support such transactions and in so 
doing increase their cost, this effect is likely to be limited as the 
regular exchange of variation margin is a relatively common market 
practice under the baseline.
---------------------------------------------------------------------------

    \1191\ See ISDA Margin Survey 2012 at 8, Table 2.1.
    \1192\ See Central Clearing and Collateral Demand, Journal of 
Financial Economics 116, no. 2, 237-256.
---------------------------------------------------------------------------

    The impact of the Commission's margin rules on the non-cleared 
security-based swaps is expected to be qualitatively similar to the 
impact of the prudential regulators' margin rules for non-cleared 
security-based swaps and swaps and the CFTC's margin rules on non-
cleared swaps. Quantitatively however, the scale of the impact will be 
much less significant. As of the end of 2017, non-cleared security-
based swap positions represented less than 2% of the outstanding non-
cleared swap positions.\1193\ Nevertheless, if the Commission's final 
margin rule makes trading in the security-based swap market 
prohibitively expensive, the cost of this lost investment opportunity 
to market participants that currently are very active in the security-
based swap market would be very significant.
---------------------------------------------------------------------------

    \1193\ This figure is based on global notional amounts of swaps 
outstanding. See BIS, OTC derivatives outstanding, Tables D5.1 and 
D5.2.
---------------------------------------------------------------------------

    The additional collateral funding costs resulting from the 
Commission's final margin rule are mitigated by the broad range of 
eligible collateral permitted by the rule, which may consist of cash, 
securities, money market instruments, a major foreign currency, the 
settlement currency of the non-cleared security-based swap, or gold. 
Because of the relation between security-based swaps and other 
securities positions, permitting various types of securities to count 
as collateral may be more practical for margin arrangements involving 
security-based swaps than for other types of derivatives. This 
flexibility to accept a broad range of securities, along with 
consistency with existing margin requirements,\1194\ takes advantage of 
efficiencies that result from correlations between securities and 
security-based swaps.\1195\ One commenter supported the use of a broad 
range of collateral noting that it is important that the Commission 
recognize that the proposed rules could impose significantly greater 
costs on life insurers due to the potential narrowing of the securities 
categories eligible to be used as margin.\1196\ Another commenter 
supported the Commission's broad approach to permissible collateral, 
arguing that a narrower approach could increase costs and liquidity 
pressures on market participants by increasing demand for and placing 
undue pressure on the supply of such collateral.\1197\ However, another 
commenter believed that the collateral requirements under the proposal 
would nonetheless significantly increase the cost of using non-cleared 
security-based swaps, penalizing end users, including the pension 
plans, mutual funds and other vehicles for which commenter serves as a 
fiduciary.\1198\
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    \1194\ See 12 CFR 220.1 et seq. (Regulation T); FINRA Rule 4210 
(SRO margin rule); CBOE Rule 12.3 (SRO margin rule).
    \1195\ An ISDA margin survey states, with regard to the types of 
assets used as collateral, that the use of cash and government 
securities as collateral remained predominant, constituting 90.4% of 
collateral received and 96.8% of collateral delivered. See ISDA 
Margin Survey 2012 at 8, Table 2.1.
    \1196\ See American Council of Life Insurers 2/22/2013 Letter 
(arguing that ``[n]arrow limits on the types of permitted collateral 
could greatly impair liquidity in the derivatives marketplace and 
thwart constructive risk management'').
    \1197\ See SIFMA 2/22/2014 Letter.
    \1198\ See PIMCO Letter (suggesting two modifications to the 
proposed margin rule to mitigate costs: (1) Model-based margin 
calculations should be based on a shorter liquidation period; and 
(2) the required haircuts on collateral should be adjusted to expand 
the range of collateral that can effectively be used).
---------------------------------------------------------------------------

    The final margin rule is generally modeled on broker-dealer margin 
rules in terms of establishing an ``account equity'' requirement; 
requiring nonbank SBSDs to collect collateral to meet the requirement; 
and allowing a range of securities for which there is a ready market to 
be used as collateral. This approach promotes consistency with existing 
rules, which will generally reduce the implementation costs for 
entities with affiliates already subject to the Commission's broker-
dealer financial responsibility rules, and the broker-dealer margin 
rules. It also facilitates the ability to provide portfolio margining 
of security-based swaps with other types of securities, and in 
particular single-name CDS with bonds

[[Page 44020]]

referenced by the CDS. This consistent approach can also reduce the 
potential for regulatory arbitrage and lead to simpler interpretation 
and enforcement of applicable regulatory requirements across U.S. 
securities markets.
    Finally, the Commission has modified the final margin rule in 
response to commenters' concerns about the rule excluding collateral 
types that are permitted by the CFTC and the prudential regulators. As 
noted above, the final rule permits cash, securities, money market 
instruments, a major foreign currency, the settlement currency of the 
non-cleared security-based swap, or gold to serve as eligible 
collateral.\1199\ This will avoid the operational burdens of having 
different sets of collateral that may be used with respect to a 
counterparty depending on whether the nonbank SBSD is entering into a 
security-based swap (subject to the Commission's rule) or a swap 
(subject to the CFTC's rule) with the counterparty. It also will avoid 
potential unintended competitive effects of having different sets of 
collateral for non-cleared security-based swaps under the margin rules 
for nonbank SBSDs and bank SBSDs. Finally, by giving the option of 
aligning with the requirements of the CFTC and the prudential 
regulators, the final rule should avoid the necessity of amending 
existing collateral agreements that may specifically reference the 
forms of margin permitted by those requirements.
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    \1199\ See paragraph (c)(4)(i)(C) of Rule 18a-3, as adopted. The 
additional collateral requirements in the final rule are discussed 
below.
---------------------------------------------------------------------------

c. Alternatives Considered
i. Alternative B: Inter-Dealer margin
    As discussed above in section II.B.2.b.i. of this release, the 
Commission proposed two alternatives (Alternatives A and B) with 
respect to inter-dealer margin requirements. Under Alternative A, a 
nonbank SBSD would need to collect variation margin but not initial 
margin from the other SBSD. Under alternative B, a nonbank SBSD would 
be required to collect variation and initial margin from the other SBSD 
and the initial margin needed to be held at a third-party custodian.
    Alternative B was generally consistent with the recommendations in 
the BCBS/IOSCO Paper and the margin rules of the CFTC, prudential 
regulators, and European authorities in that it would have required 
nonbank SBSDs to exchange initial (in addition to variation margin). 
Further, it was consistent with the margin rules of the CFTC and the 
prudential regulators in that it would have required that initial 
margin be held at an unaffiliated third-party custodian.\1200\ The 
BCBS/IOSCO Paper recommends that ``[i]nitial margin collected should be 
held in such a way as to ensure that (i) the margin collected is 
immediately available to the collecting party in the event of the 
counterparty's default, and (ii) the collected margin must be subject 
to arrangements that protect the posting party to the extent possible 
under applicable law in the event that the collecting party enters 
bankruptcy.'' \1201\ The EU's margin rule requires the collecting 
counterparty to provide the posting counterparty with the option to 
segregate its collateral from the assets of the other posting 
counterparties.\1202\
---------------------------------------------------------------------------

    \1200\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74863; CFTC Margin Adopting Release, 81 FR 636.
    \1201\ See BCBS/IOSCO Paper at 20 (``There are many different 
ways to protect provided margin, but each carries its own risk. For 
example, the use of third-party custodians is generally considered 
to offer the most robust protection, but there have been cases where 
access to assets held by third-party custodians has been limited or 
practically difficult. The level of protection would also be 
affected by the local bankruptcy regime, and would vary across 
jurisdictions.'').
    \1202\ The margin rules of the European Union require that 
initial margin be segregated on the books and records of a third-
party holder or custodian; or via other legally binding arrangements 
so that the initial margin is protected from the default or 
insolvency of the collecting counterparty. Where cash is collected 
as initial margin, it must be deposited with an unaffiliated third-
party holder or custodian or with a central bank. Initial margin 
cannot be re-hypothecated.
---------------------------------------------------------------------------

    Alternatives A and B would have required nonbank SBSDs to collect 
variation and initial margin from non-excepted counterparties. 
Therefore, both alternatives would protect nonbank SBSDs from the 
consequences of one of these counterparties defaulting. However, 
because Alternative B would have required a nonbank SBSD also to 
collect variation and initial margin from an SBSD counterparty and 
segregate it with an independent third-party custodian, this 
alternative would have provided greater protection to nonbank SBSDs 
from the consequences of one of these counterparties defaulting than 
Alternative A. By providing greater protection against the consequences 
of non-excepted counterparties and SBSDs defaulting, Alternative B 
would have further reduced the likelihood of sequential dealer failure 
as a result of defaulting counterparties relative to Alternative A. 
This would have enhanced the safety and soundness of nonbank SBSDs in 
terms of this risk. As noted earlier in this release, most of the 
benefits of this enhancement would accrue to market participants that 
rely on nonbank SBSDs for liquidity provision in security-based swap 
market and other services.
    However, Alternative B would likely impose more costs than 
Alternative A. As discussed above, there is a trade-off in terms of the 
benefits of requiring a nonbank SBSD to collect initial margin from 
another financial market intermediary: Namely, the liquidity of the 
delivering firm is reduced by the amount of initial margin posted to 
the nonbank SBSD. Thus, while the initial margin collected by the 
nonbank SBSD enhances the firm's safety and soundness, the delivery of 
liquid capital by the other financial market intermediary diminishes 
that firm's safety and soundness because it cannot use the delivered 
liquid capital to protect itself from losses or to meet liquidity 
demands. Thus, Alternative B would have reduced the safety and 
soundness of nonbank SBSDs in terms of this risk. In addition, the 
requirement that the initial margin be segregated at a third-party 
custodian could have contributed to the instability of the nonbank SBSD 
for whom the initial margin was posted if the initial margin was not 
immediately available to the nonbank SBSD upon the default of the SBSD 
counterparty.\1203\ During periods of general market unrest, even a 
brief delay in access to liquid collateral, could increase 
instability.\1204\ Further, Alternative B's negative impact on nonbank 
SBSDs' liquidity could have reduced their ability to trade in non-
cleared security-based swaps. Nonbank SBSDs likely would have passed on 
these costs to other market participants who, in turn, may have had 
less of an incentive to trade in the security-based swap market.
---------------------------------------------------------------------------

    \1203\ For example, the defaulting SBSD counterparty could claim 
that the secured nonbank SBSD is not entitled to access the initial 
margin held by the third-party custodian and bring a court action to 
bar such access. The resolution of this claim in court could 
substantially delay the secured nonbank SBSD's access to the 
collateral.
    \1204\ Importantly, as discussed below in section VI.B.4. of 
this release, the ultimate market effects will also depend on the 
approach adopted by market participants with regard to the 
segregation of initial margin.
---------------------------------------------------------------------------

    In summary, although Alternative B would provide greater protection 
against a defaulting SBSD counterparty, it would also impose more costs 
on dealers and other market participants, relative to Alternative A.
ii. Third-Party Segregation Requirements
    The final margin rules of the CFTC and the prudential regulators 
generally require that initial margin to be held at a third-party 
custodian. The purpose of using a third-party custodian is to have

[[Page 44021]]

the initial margin held in a manner that is bankruptcy-remote from the 
secured party. The Commission's final margin rule does not require that 
initial margin posted by a counterparty to the nonbank SBSD be held at 
a third-party custodian. However, Section 3E(f) of the Exchange Act 
provides counterparties the right to elect to have the initial margin 
they post to a nonbank SBSD to be held at an independent third-party 
custodian. Given the limited use of third-party segregation under 
existing market practice in security-based swap transactions, the 
circumstances in which third-party segregation is elected may be 
limited.
    As an alternative, the Commission's margin rule could have required 
that initial margin posted to nonbank SBSDs be held at a third-party 
custodian. This would have provided more counterparties (i.e., ones 
that would not have otherwise elected to have their initial margin held 
at a third-party custodian) with the benefit of having their initial 
margin protected from the consequences of the nonbank SBSD's 
bankruptcy. The main benefit of such an approach would be that the 
return of the initial margin to the counterparty would not be subject 
to the delay caused by having to make a claim in a bankruptcy 
proceeding and the subsequent processing of that claim.
    However, mandating (rather than permitting) initial margin to be 
held at a third-party custodian would entail costs. For example, under 
existing market practice, initial margin is not typically employed in 
inter-dealer transactions; rather, it is largely limited to dealer 
transactions with non-dealer counterparties, where the non-dealers are 
the parties posting initial margin.\1205\ Non-dealer counterparties 
typically have not required that initial margin they post to dealers be 
held at a third-party custodian. This may reflect a preference for 
granting dealers more flexibility with respect to the use of their 
collateral over its safety, given the added costs associated with 
establishing and maintaining tri-party custodial arrangements and 
potentially imposed by dealers when they cannot directly hold the 
initial margin. Mandating that initial margin be held at a third-party 
custodian could increase these costs.
---------------------------------------------------------------------------

    \1205\ See section VI.A.2.d. of this release.
---------------------------------------------------------------------------

iii. Eligible Collateral
    The margin rules of the CFTC and the prudential regulators permit 
the following types of assets to serve as collateral: (1) Cash; (2) 
U.S. Treasury securities; (3) certain securities guaranteed by the 
U.S.; (4) certain securities issued or guaranteed by the European 
Central Bank, a sovereign entity, or the BIS; (5) certain corporate 
debt securities; (6) certain equity securities contained in major 
indices; (7) certain redeemable government bond funds; (7) a major 
foreign currency; (8) the settlement currency of the non-cleared 
security-based swap or swap; or (9) gold.\1206\ The Commission's final 
margin rule permits cash, securities, money market instruments, a major 
foreign currency, the settlement currency of the non-cleared security-
based swap, or gold. Consequently, unlike the margin rules of the CFTC 
and the prudential regulators, the Commission's final margin rule does 
not list the specific types of securities that can serve as eligible 
collateral. However, the Commission's final margin rule requires, among 
other things, that the collateral have a ready market.
---------------------------------------------------------------------------

    \1206\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR at 74870; CFTC Margin Adopting Release, 81 FR at 701-
2.
---------------------------------------------------------------------------

    In addition, the margin rules of the CFTC and the prudential 
regulators generally require that cash be used to meet a variation 
margin requirement in a transaction between dealers. The Commission's 
final margin rule does not place this limit on the collateral that must 
be used to meet a variation margin requirement.
    As an alternative, the Commission could have specifically 
identified the types of securities that can serve as collateral and 
could have required that cash be used to meet a variation margin 
requirement of a financial market intermediary.
    A benefit of this alternative is that with respect to the cash 
collateral requirement for variation margin in inter-dealer 
transactions it would limit the potential for losses resulting from 
liquidating non-cash collateral in times of stress, reduce the 
likelihood of fire-sale dynamics, and reduce uncertainty and disputes 
with respect to collateral valuation.\1207\ A second benefit is that it 
would more closely align the Commission's margin rule with the margin 
rules of the CFTC and the prudential regulators. Commenters supported 
such consistency. One commenter urged consistency so that different 
rules would not apply to economically related transactions, or to 
transactions involving different types of counterparties, which could, 
in turn, lead to increased costs for end users.\1208\ Another commenter 
requested that the Commission develop a list of permissible collateral 
that is consistent across jurisdictions to ``improve the efficiency of 
the derivatives market.'' \1209\ These comments were aimed at the 
Commission's proposed margin rule. The Commission's final margin rule 
has been modified to permit the types of collateral that are eligible 
under the margin rules of the CFTC and the prudential regulators as 
discussed above in section II.B.2.b.i. of this release.
---------------------------------------------------------------------------

    \1207\ See Gary Gorton and Guillermo Ordo[ntilde]ez, Collateral 
Crises, Yale University Working Paper (Mar. 2012) (arguing that 
during normal times collateral values are less precise, but during 
volatile times are reassessed). This reassessment can possibly lead 
to large negative shocks in their values, which by deduction can 
lead to market disruptions if collateral needs to be liquidated.
    \1208\ See SIFMA AMG 2/22/2013 Letter.
    \1209\ See ISDA 2/5/2014 Letter.
---------------------------------------------------------------------------

    On the other hand, the alternative approach could increase demand 
for the types of securities enumerated in the margin rules of the CFTC 
and the prudential regulators and potentially cause shortages in their 
supply.\1210\ Moreover, such forms of collateral may not be readily 
available to counterparties wishing to engage in non-cleared security-
based swap transactions, significantly restricting their ability to 
engage in such transactions, and limiting the ability of these markets 
to facilitate risk transfer in the economy.
---------------------------------------------------------------------------

    \1210\ See IMF, Global Financial Stability Report: The Quest for 
Lasting Stability, 96 and 120 (Apr. 2012), available at http://www.imf.org/External/Pubs/FT/GFSR/2012/01/pdf/text.pdf.
---------------------------------------------------------------------------

    A commenter identified 3 adverse consequences of limiting 
collateral in the manner of the CFTC and the prudential 
regulators.\1211\ First, the commenter argued that investors may be 
forced to hold unnecessarily low-yielding securities. Second, the 
commenter argued that the securities that investors will be forced to 
deliver as initial margin may be different from the transactions or 
portfolios hedged by the security-based swap, thereby creating 
undesirable basis risk and running counter to clients' desire to match 
benchmark composition. Third, the commenter argued that investors 
seeking to avoid this unnecessary cost or basis risk may look to 
``collateral transformation'' approaches to convert holdings to assets 
that satisfy the posting requirements. The commenter argued that these 
collateral transformations will typically include haircuts on 
securities that will create additional costs for the funding component 
of the transformation.
---------------------------------------------------------------------------

    \1211\ See PIMCO Letter.
---------------------------------------------------------------------------

    The Commission broadly agrees with this commenter and believes that 
the alternative could unduly restrict the ability of entities to 
participate in the security-based swap market. It also could impede the 
ability to portfolio

[[Page 44022]]

margin security-based positions with related securities positions. 
Further, by granting participants in security-based swap transactions 
the flexibility to post a wider range of securities, the Commission's 
final margin rule may reduce the collateral costs for participants in 
the security-based swap market. Finally, the ready market requirement 
and collateral haircuts are designed to ensure that the collateral 
adequately covers the credit exposures that variation and initial 
margin are designed to address.
iv. Excluding Certain Assets From List of Eligible Collateral
    The Commission's proposed margin rule permitted cash, securities, 
and money market instruments to serve as collateral to meet variation 
and initial margin requirements. Therefore, unlike the margin rules of 
the CFTC and the prudential regulators, it did not permit a major 
foreign currency, the settlement currency of the non-cleared security-
based swap, or gold from serving as collateral. The margin rules of the 
CFTC and the prudential regulators permit major foreign currencies, the 
currency of settlement for the security-based swap, and gold to serve 
as eligible collateral. The Commission's final margin rule has been 
modified to permit the types of collateral that are eligible under the 
margin rules of the CFTC and the prudential regulators as discussed 
above in section II.B.2.b.i. of this release.
    As an alternative, the Commission's margin rule could have 
continued to exclude a major foreign currency, the settlement currency 
of the non-cleared security-based swap, or gold from serving as 
collateral. However, differences between the sets of permitted 
collateral under the margin rules of the Commission and the CFTC and 
the prudential regulators could have imposed operational burdens on a 
nonbank SBSD. For example, a nonbank SBSD that is registered as a swap 
dealer would have been required to adhere to a different set of 
permitted collateral depending on whether it was entering into a 
security-based swap (subject to the Commission's rule) or a swap 
(subject to the CFTC's rule) with the counterparty. In addition, the 
nonbank SBSD and its counterparties would likely have had to incur 
costs to amend existing collateral agreements that may specifically 
reference the forms of margin permitted by CFTC and prudential 
requirements.
    Further, prudential regulators permitting major foreign currencies, 
the currency of settlement for the security-based swap, and gold to 
serve as collateral (while the Commission did not) would have meant 
that a bank SBSD and its counterparties had more options when sourcing 
for permitted collateral compared to a nonbank SBSD. This greater range 
of options, in turn, could have allowed the bank SBSD to obtain 
eligible collateral at lower cost than a nonbank SBSD, even if both 
entities were entering into economically equivalent non-cleared 
security-based swap transactions. This could have allowed bank SBSDs to 
gain a competitive advantage over nonbank SBSDs.
    In light of the operational burden, costs, and competitive 
disparity associated with the alternative, the Commission believes that 
final margin rule, which permits a major foreign currency, the 
settlement currency of the non-cleared security-based swap, and gold to 
serve as eligible collateral, is preferable to the alternative.
v. Not Permitting the Option To Use Collateral Haircuts Adopted by CFTC 
and Prudential Regulators
    As discussed above in section II.B.2.b.i. of this release, the 
Commission's proposed margin rule provided that the fair market value 
of securities and money market instruments held in the account of a 
counterparty needed to be reduced by the amount of the standardized 
haircuts the nonbank SBSD would apply to the positions pursuant to the 
proposed capital rules for the purpose of determining whether the level 
of equity in the account met the minimum margin requirements. The 
proposed haircuts and the haircuts in the margin rules of the CFTC and 
the prudential regulators (which are based on the recommended 
standardized haircuts in the BCBS/IOSCO Paper) are largely comparable. 
However, there were differences. In order to promote greater 
harmonization with the margin rules of the CFTC and the prudential 
regulators, the Commission's final margin rule provides nonbank SBSDs 
with the option of choosing to use the standardized haircuts in the 
capital rules or the standardized haircuts in the CFTC's margin rule.
    As an alternative, the Commission could have adopted the proposed 
requirement that did not provide the option to use the standardized 
haircuts in the CFTC's margin rule. However, this could have imposed 
operational burdens on nonbank SBSDs. For example, a nonbank SBSD that 
was also registered as a swap dealer would have been required to adhere 
to a different set of collateral haircuts depending on whether it was 
entering into a security-based swap (subject to the Commission's rule) 
or a swap (subject to the CFTC's rule) with the counterparty. In 
addition, the nonbank SBSD and its counterparties would likely have had 
to incur costs to amend existing collateral agreements that may 
specifically reference the haircuts in the margin rules of the CFTC and 
the prudential regulators.
    This alternative also could have resulted in competitive 
disparities between bank SBSDs and nonbank SBSDs. To the extent that 
the prudential regulators' collateral haircuts result in more favorable 
treatment of a counterparty's collateral, the counterparty might have 
preferred to trade with a bank SBSD rather than with a nonbank SBSD, 
even if both SBSDs are equally attractive liquidity providers in all 
other respects. Thus, the alternative could have allowed bank SBSDs to 
gain a competitive advantage over nonbank SBSDs.
    The Commission believes that final margin rule, which provides 
nonbank SBSDs with the option of using the CFTC's collateral haircuts, 
is preferable to the alternative as it will avoid the operational 
burdens, costs, and competitive disparities discussed above.
vii. Risk-Based Threshold
    In the 2018 comment reopening, the Commission requested comment on 
whether it would be appropriate to establish a risk-based threshold 
where a nonbank SBSD would not be required to collect initial margin 
from a counterparty to the extent the amount does not exceed the lesser 
of: (1) 1% of the SBSD's tentative net capital; or (2) 10% of the net 
worth of the counterparty.\1212\ As an alternative, the Commission 
could have adopted this risk-based initial margin threshold instead of 
the fixed-dollar $50 million initial margin threshold.
---------------------------------------------------------------------------

    \1212\ Capital, Margin, and Segregation Comment Reopening, 83 FR 
at 53013.
---------------------------------------------------------------------------

    One commenter was concerned that, were the Commission to adopt an 
initial margin threshold tied to counterparty net worth, nonbank SBSDs 
would effectively be required to collect initial margin from all in-
scope counterparties because they would be unable to confirm that the 
calculated initial margin amounts had not crossed the 10% net worth 
threshold. The commenter believed that such a requirement would put 
nonbank SBSDs at a significant competitive disadvantage relative to 
bank SBSDs and foreign SBSDs.\1213\ The commenter also noted that the 
1% tentative net capital threshold would effectively

[[Page 44023]]

increase the prices offered by smaller nonbank SBSDs to counterparties 
relative to their competitors. Additionally, the commenter pointed out 
that the costs of overhauling systems and re-documenting initial margin 
agreements to incorporate the proposed thresholds would have a 
disproportionate impact on smaller firms, since such costs do not 
generally scale to a firm's size. These substantial disadvantages would 
likely reduce the ability of smaller nonbank SBSDs to attract 
counterparties, which would cause greater market concentration and less 
efficient pricing. A commenter argued that the Commission did not 
explain its views on why a counterparty-specific unsecured threshold 
(e.g., $50 million) should be rejected in favor of a measure that would 
relate to a percentage of the nonbank SBSD's tentative net capital, 
which captures counterparty exposures only indirectly, or the 
counterparty's overall net worth unrelated to a specific counterparty 
relationship.\1214\
---------------------------------------------------------------------------

    \1213\ See SIFMA 11/19/2018 Letter.
    \1214\ See Better Markets 11/19/2018 Letter.
---------------------------------------------------------------------------

    In response to the comments above, the Commission is adopting a 
fixed $50 million initial margin threshold below which initial margin 
need not be collected.\1215\ This fixed threshold is consistent with 
the threshold adopted by the prudential regulators. Having a more 
consistent threshold will minimize potential competitive disparities 
and address operational concerns raised by commenters. The Commission 
recognizes that a fixed-dollar threshold (as opposed to a scalable 
threshold) does not necessarily bear a relation to the financial 
condition of the nonbank SBSD and its counterparty. To address this 
consequence, as discussed above, and as suggested by a commenter, a 
nonbank SBSD will be required to take a capital deduction in lieu of 
margin or credit risk charge if it does not collect initial margin 
pursuant to the fixed-dollar $50 million threshold exception. 
Furthermore, the nonbank SBSD will be required to establish, maintain, 
and document procedures and guidelines for monitoring counterparty 
risk. Consequently, the Commission does not believe the fixed-dollar 
$50 million threshold exception will unduly increase systemic risk as 
suggested by a commenter.
---------------------------------------------------------------------------

    \1215\ See paragraph (c)(1)(iii)(G) of Rule 18a-3, as adopted.
---------------------------------------------------------------------------

4. The Segregation Rules--Rules 15c3-3 and 18a-4
a. Overview
    As discussed above in section II.C. of this release, Section 3E(b) 
of the Exchange Act provides that, for cleared security-based swaps, 
the money, securities, and property of a security-based swap customer 
shall be separately accounted for and shall not be commingled with the 
funds of the broker, dealer, or SBSD or used to margin, secure, or 
guarantee any trades or contracts of any security-based swap customer 
or person other than the person for whom the money, securities, or 
property are held. However, Section 3E(c)(1) of the Exchange Act also 
provides that, for cleared security-based swaps, customers' money, 
securities, and property may, for convenience, be commingled and 
deposited in the same one or more accounts with any bank, trust 
company, or clearing agency. Section 3E(c)(2) further provides that, 
notwithstanding Section 3E(b), in accordance with such terms and 
conditions as the Commission may prescribe by rule, regulation, or 
order, any money, securities, or property of the security-based swaps 
customer of a broker, dealer, or security-based swap dealer described 
in Section 3E(b) may be commingled and deposited as provided in Section 
3E with any other money, securities, or property received by the 
broker, dealer, or security-based swap dealer and required by the 
Commission to be separately accounted for and treated and dealt with as 
belonging to the security-based swaps customer of the broker, dealer, 
or security-based swap dealer.
    Section 3E(f) of the Exchange Act establishes a program by which a 
counterparty to non-cleared security-based swaps with an SBSD or MSBSP 
can elect to have initial margin held at an independent third-party 
custodian (individual segregation). Section 3E(f)(4) provides that if 
the counterparty does not choose to require segregation of funds or 
other property, the SBSD or MSBSP shall send a report to the 
counterparty on a quarterly basis stating that the firm's back office 
procedures relating to margin and collateral requirements are in 
compliance with the agreement of the counterparties. The statutory 
provisions of Sections 3E(b) and (f) are self-executing.
    The Commission is adopting omnibus segregation rules pursuant to 
which money, securities, and property of a security-based swap customer 
relating to cleared and non-cleared security-based swaps must be 
segregated but can be commingled with money, securities, or property of 
other customers. The omnibus segregation requirements for stand-alone 
broker-dealers and broker-dealer SBSDs are codified in amendments to 
Rule 15c3-3. The omnibus segregation requirements for stand-alone SBSDs 
(including those also registered as OTC derivatives dealers) and bank 
SBSDs are codified in Rule 18a-4.
    The omnibus segregation requirements are mandatory with respect to 
money, securities, or other property that is held by a stand-alone 
broker-dealer or SBSD and that relate to cleared security-based swap 
transaction (i.e., customers cannot waive segregation). With respect to 
non-cleared security-based swap transactions, the omnibus segregation 
requirements are an alternative to the statutory provisions discussed 
above pursuant to which a counterparty can elect to have initial margin 
individually segregated or waive segregation. With respect to non-
cleared security-based swap transactions, the omnibus segregation 
requirements are an alternative to the statutory provisions discussed 
above pursuant to which a counterparty can elect to have initial margin 
individually segregated or waive segregation. However, under the final 
omnibus segregation rules for stand-alone broker-dealers and broker-
dealer SBSDs codified in Rule 15c3-3, counterparties that are not an 
affiliate of the firm cannot waive segregation. Affiliated 
counterparties of a stand-alone broker-dealer or broker-dealer SBSD can 
waive segregation. Under Section 3E(f) of the Exchange Act and Rule 
18a-4, all counterparties (affiliated and non-affiliated) to a non-
cleared security-based swap transaction with a stand-alone or bank SBSD 
also can waive segregation The omnibus segregation requirements are the 
``default'' requirement if the counterparty does not elect individual 
segregation or to waive segregation (in the cases where a counterparty 
is permitted to waive segregation).
    Under the final segregation rules, an SBSD or stand-alone broker-
dealer must maintain a security-based swap customer reserve account to 
segregate cash and/or qualified securities in an amount equal to the 
net cash owed to security-based swap customers. The SBSD or stand-alone 
broker-dealer must at all times maintain, through deposits into the 
account, cash and/or qualified securities in amounts computed weekly in 
accordance with the formula set forth in the rules. In the case of a 
broker-dealer, this account must be separate from the reserve accounts 
it maintains

[[Page 44024]]

for traditional securities customers and broker-dealers.
    The formula in the final segregation rules requires the SBSD or 
stand-alone broker-dealer to add up various credit items (amounts owed 
to security-based swap customers) and debit items (amounts owed by 
security-based swap customers). If, under the formula, credit items 
exceed debit items, the SBSD or stand-alone broker-dealer must maintain 
cash and/or qualified securities in that net amount in the security-
based swap customer reserve account. For purposes of the security-based 
swap reserve account requirement, qualified securities are: Obligations 
of the United States; obligations fully guaranteed as to principal and 
interest by the United States; and, subject to certain conditions and 
limitations, general obligations of any state or a political 
subdivision of a state that are not traded flat and are not in default, 
are part of an initial offering of $500 million or greater, and are 
issued by an issuer that has published audited financial statements 
within 120 days of its most recent fiscal year end.
    With respect to non-cleared security-based swaps, Section 
3E(f)(1)(A) of the Exchange Act provides that an SBSD and an MSBSP 
shall be required to notify a counterparty of the SBSD or MSBSP at the 
beginning of a non-cleared security-based swap transaction that the 
counterparty has the right to require the segregation of the funds or 
other property supplied to margin, guarantee, or secure the obligations 
of the counterparty. SBSDs and MSBSPs must provide this notice in 
writing to a duly authorized individual prior to the execution of the 
first non-cleared security-based swap transaction with the counterparty 
occurring after the compliance date of the rule. SBSDs also must obtain 
subordination agreements from a counterparty that affirmatively elects 
to have initial margin held at a third-party custodian or that waives 
segregation.
    The final segregation rules modify the proposed definition of 
``excess securities collateral'' to exclude securities collateral held 
in a ``third-party custodial account'' as that term is defined in the 
rules.\1216\ The final segregation rules also incorporate the 
definition of ``third-party custodial account'' that was included in 
the 2018 comment reopening but with modifications suggested by the 
commenters to broaden the definition to include domestic registered 
clearing organizations and depositories and foreign supervised banks, 
clearing organizations, and depositories.\1217\ The final segregation 
rules also modify the proposed definition of ``qualified registered 
security-based swap dealer account'' to remove the limitation that the 
account be held at an unaffiliated SBSD.
---------------------------------------------------------------------------

    \1216\ See paragraph (p)(1)(ii)(B) of Rule 15c3-3, as amended; 
paragraph (a)(2)(ii) of Rule 18a-4, as adopted.
    \1217\ See paragraph (p)(1)(viii) of Rule 15c3-3, as amended; 
paragraph (a)(10) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

    MSBSPs collect initial margin from security-based swap 
counterparties under a house margin requirement are subject to Section 
3E(f) of the Exchange Act under the baseline, which--as discussed 
above--establishes a program by which a counterparty to non-cleared 
security-based swaps with an MSBSP can elect to have initial margin 
held at an independent third-party custodian.
b. Benefits and Costs of the Segregation Rules
    Under the baseline, the Section 3E(b) of the Exchange Act provides 
that, for cleared security-based swaps, the money, securities, and 
property of a security-based swap customer shall be separately 
accounted for and shall not be commingled with the funds of the broker, 
dealer, or SBSD or used to margin, secure, or guarantee any trades or 
contracts of any security-based swap customer or person other than the 
person for whom the money, securities, or property are held. Therefore, 
under the baseline, stand-alone broker-dealers and SBSDs must segregate 
collateral for cleared security-based swaps and, therefore, the 
benefits of segregation (i.e., protecting initial margin) will accrue 
to market participants to the extent they clear security-based swaps 
through stand-alone broker-dealers and SBSDs. However, the Section 
3E(c)(1) of the Exchange Act also provides that, for cleared security-
based swaps, customers' money, securities, and property may, for 
convenience, be commingled and deposited in the same one or more 
accounts with any bank, trust company, or clearing agency. The 
Commission's final omnibus segregation rules will permit stand-alone 
broker-dealers and SBSDs to commingle customers' initial margin for 
cleared security-based swaps. Therefore, these entities will benefit 
from the efficiencies and lower costs of treating initial margin for 
cleared security-based swaps in this manner as compared to individually 
segregating each customer's initial margin. The benefits of these 
efficiencies and lower costs will accrue to market participants in the 
form of quicker executions of cleared security-based swap transactions 
and lower transaction fees.
    Stand-alone broker-dealers and SBSDs will incur costs to develop 
systems, controls, and procedures to comply with the omnibus 
segregation requirements and to operate those systems, controls, and 
procedures. These costs may be passed on to market participants to the 
extent they clear security-based swaps through stand-alone broker-
dealers and SBSDs. However, these costs will be lower than the costs 
that would have been incurred under the baseline segregation 
requirement for cleared security-based swaps because it would not have 
permitted commingling of customers' initial margin. Thus, under the 
baseline, the stand-alone broker-dealers and SBSDs would have needed to 
develop and operate systems, controls, and procedures to individually 
segregate each customer's initial margin in separate accounts. This 
would have been a much more complex undertaking than it will be to 
develop and operate systems to comply with the omnibus segregation 
requirements where commingling customers' initial margin in a single 
account is permitted.
    With respect to non-cleared security-based swaps, the final omnibus 
segregation rules are not mandatory. Counterparties that are affiliates 
of the stand-alone broker-dealer or broker-dealer SBSD with whom they 
are transacting the non-cleared security-based swap can potentially 
elect individual segregation, omnibus segregation, or to waive 
segregation. Counterparties (regardless of whether they are affiliates) 
potentially can elect any of these alternatives if they are a 
counterparty to a non-cleared security-based transaction with a stand-
alone or bank SBSD. Counterparties that are not affiliates of the 
stand-alone broker-dealer or broker-dealer SBSD with whom they are 
transacting the non-cleared security-based swap can potentially elect 
either individual segregation or omnibus segregation (they cannot waive 
segregation).
    Therefore, the direct benefits and costs of the Commission's final 
omnibus segregation rules as applied to non-cleared security-based swap 
transactions will depend, in large part, on the entities with whom 
counterparties choose to transact: Stand-alone broker-dealers and 
broker-dealer SBSDs (where the option to waive segregation is not 
available to non-affiliates) or stand-alone and bank SBSDs (where the 
option to waive segregation is potentially available to all 
counterparties and where the option for the stand-alone or bank SBSD to 
operate

[[Page 44025]]

under the exemption from the omnibus segregation rules is available).
    Because segregation (individual or omnibus) is mandatory when a 
non-affiliated counterparty enters into a non-cleared security-based 
swap with a stand-alone broker-dealer or broker-dealer SBSD, and 
because omnibus segregation is the default requirement for a stand-
alone SBSD or bank SBSD, the final rules could incrementally increase 
the amount of collateral that is segregated for non-cleared security-
based swaps. The amount of this increase will depend on whether 
counterparties elect individual segregation or, if permitted, to waive 
segregation. It also will depend on whether counterparties elect to 
transact with stand-alone or bank SBSDs operating under the exemption 
to the omnibus segregation requirements or with stand-alone SBSDs 
operating pursuant to the alternative compliance mechanism. If 
counterparties elect these alternatives to omnibus segregation, the 
final rules (themselves) will have a limited impact on the amount of 
collateral that is segregated. However, if they do increase the amount 
of collateral that is segregated, SBSDs may pass these costs to market 
participants.
    However, these costs may be limited. In general, the Commission 
expects most non-cleared security-based swap dealing will be conducted 
by stand-alone and bank SBSDs (where waiver by non-affiliated 
counterparties will be permitted). This is because the Commission 
expects that dealers in non-cleared security-based swaps will organize 
themselves as stand-alone SBSDs to take advantage of the more favorable 
capital requirements applicable to stand-alone SBSDs under the final 
rules (i.e., the absence of a portfolio concentration charge and the 
ability to use the alternative compliance mechanism).
    Furthermore, the Commission expects that dealers in non-cleared 
security-based swaps will generally seek exemption from the omnibus 
segregation requirements in Rule 18a-4, which is available to stand-
alone and bank SBSDs. While qualifying for the exemption means they 
will not be able to clear security-based swap transactions for others, 
the Commission does not believe that will discourage dealers in non-
cleared security-based swaps from organizing as stand-alone or bank 
SBSDs to take advantage of the exemption.\1218\ Moreover, the 
Commission does not believe that an entity will register solely as an 
SBSD to clear security-based swap transactions for others, given the 
relative size of the cleared security-based swap market as compared to 
the cleared swap market. Therefore, entities that want to clear 
security-based swaps will also want to clear swaps and, therefore, need 
to register as FCMs. This creates a strong incentive to effect brokered 
cleared transactions through entities that are dually registered as 
broker-dealers and FCMs, and to deal in non-cleared transactions in 
stand-alone SBSDs and swap dealers.
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    \1218\ In particular, to clear swaps for others, a swap dealer 
must be registered as an FCM under the CFTC's rules. The FCM capital 
rule prescribes a net liquid asset test similar to the broker-dealer 
net capital rule (Rule 15c3-1). Bank swap dealers in particular 
appear to avoid clearing swaps for customers (and limit their swap 
dealing activities to non-cleared swaps), as engaging in such 
business would subject them to the capital requirements for FCMs in 
addition to the capital requirements that would apply to them under 
the bank capital rules.
---------------------------------------------------------------------------

    Finally, based on FOCUS information, the Commission believes that 
the broker-dealers most active in dealing in non-cleared security-based 
swaps will trade mostly with affiliates that will be permitted to waive 
segregation under the final omnibus segregation rule for stand-alone 
broker-dealers and broker-dealer SBSDs. For these reasons, the 
Commission does not expect the limitation in Rule 15c3-3 that prohibits 
a non-affiliated counterparty from waiving segregation will 
significantly increase the amount of collateral segregated for non-
cleared security-based swap transactions.
    In the context of transactions where the waiver limitation does not 
apply, the benefits and costs of the final segregation rule will depend 
on whether counterparties elect individual segregation or to waive 
segregation under Section 3E(f) of the Exchange Act, or, alternatively, 
elect to have their initial margin held directly by the stand-alone 
broker-dealer or SBSD subject to the omnibus segregation requirements. 
Thus, in evaluating the costs and benefits of the final segregation 
rules, the Commission considers the implications of optionality on the 
segregation choices of market participants, and the impact of those 
choices on the costs and benefits of the rules. In this regard, 
available information suggests that customer assets related to 
security-based swap transactions are currently not consistently 
segregated from dealer proprietary assets. With respect to non-cleared 
security-based swaps, available information suggests that there is no 
uniform segregation practice but that collateral for most accounts is 
not segregated.\1219\ According to an ISDA margin survey, where 
independent amounts (initial margin) are collected, ISDA members 
reported that most (72%) was commingled with variation margin and not 
segregated, and less than 5% of the amount received was segregated with 
a third party-custodian.\1220\
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    \1219\ See generally ISDA Margin Survey 2012. More recent ISDA 
margin surveys do not include the relevant statistics.
    \1220\ See ISDA Margin Survey 2012. The survey also notes that 
while the holding of the independent amounts and variation margin 
together continues to be the industry standard both contractually 
and operationally, the ability to segregate has been made 
increasingly available to counterparties over the past three years 
on a voluntary basis, and has led to adoption of 26% of independent 
amounts received and 27.8% of independent amounts delivered being 
segregated in some respects. See also ISDA, Independent Amounts, 
Release 2.0.
---------------------------------------------------------------------------

    As a general matter, more restrictive segregation regimes (i.e., 
individual segregation, omnibus segregation, or similar privately 
negotiated arrangements) provide more protection to the posting party. 
However, they ``lock up'' collateral to varying degrees, restricting 
its use by the collecting party, and raise the overall cost of the 
transaction. Avoiding segregation can lower the costs of the 
transaction by permitting the recipient of collateral to obtain 
benefits from its use. However, collateral that is not segregated may 
be difficult to recover when the holder of the collateral is in 
distress. Thus, the absence of segregation can potentially contribute 
to instability in times of stress.
    In response to the 2018 comment reopening, one commenter 
recommended that the Commission not impose the omnibus segregation 
requirements on bank SBSDs, foreign SBSDs, stand-alone SBSDs, and OTC 
derivatives dealers that do not clear for customers.\1221\ This 
commenter argued that the proposed omnibus segregation requirements 
could conflict with bank liquidation or resolution, may cause 
jurisdictional disputes, and are not consistent with the Exchange Act. 
In addition, this commenter stated that omnibus segregation 
requirements would impair hedging and funding activities for stand-
alone SBSDs and OTC derivatives dealers because the exclusions related 
to the use of excess securities collateral admit only a narrow range of 
hedging activities. In particular, the commenter was concerned that a 
failure to recognize hedging strategies using instruments other than 
security-based swaps would create undue regulatory incentives to 
transact using one type of instrument versus another.
---------------------------------------------------------------------------

    \1221\ See SIFMA 11/19/2018 Letter.

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

[[Page 44026]]

    As discussed above, the final segregation rule for stand-alone and 
bank SBSDs will exempt these entities from the requirements of the rule 
if the SBSD meets certain conditions, including that the SBSD does not 
clear security-based swap transactions for other persons, provides 
statutory notice to the counterparty regarding the right to segregate 
initial margin at an independent third-party custodian, and discloses 
in writing that any collateral received by the SBSD will not be subject 
to a segregation requirement and how a counterparty's claim on 
collateral would be treated in a bankruptcy or other formal liquidation 
proceeding of the SBSD. This modification from the proposed rule will 
lessen the costs imposed on stand-alone and bank SBSDs that do not 
clear security-based swaps for other persons by avoiding conflict with 
other regulations and minimizing the impact on hedging activity. As 
discussed above, the Commission expects these firms will not choose to 
clear security-based swaps for others because, from an economic 
perspective, it is more attractive to clear security-based swaps and 
swaps for others. Clearing swaps for others requires registration as an 
FCM and, therefore, compliance with the CFTC's capital requirements for 
FCMs.
    However, the exemption to the final segregation rule may also 
impose costs on market-participants. A stand-alone or bank SBSD that is 
making use of this exemption would be able to comingle the collateral 
collected from counterparties with its own assets. In particular, the 
firm would be able to use a counterparty's collateral to collateralize 
a transaction with another counterparty (i.e., collateral re-
hypothecation). In the event of the stand-alone or bank SBSD's failure, 
counterparties may have difficulty recovering their collateral in a 
timely manner, or at all.
    The omnibus segregation requirements are the default requirement 
for non-cleared security-based swaps if the counterparty does not 
affirmatively elect individual segregation or to waive segregation (and 
if the SBSD is not operating pursuant to the exemption for bank and 
stand-alone SBSDs). A large body of behavioral economics literature has 
documented the power of defaults in driving individual behavior.\1222\ 
In addition, the final segregation rules require a foreign SBSD to 
disclose to a U.S. security-based swap customer the potential treatment 
of the assets segregated by the SBSD pursuant to Section 3E of the 
Exchange Act, and the rules and regulations thereunder, in insolvency 
proceedings under U.S. bankruptcy law and applicable foreign insolvency 
laws. This requirement may cause SBSDs' customers to devote more 
attention to the choice of segregation regime and may potentially 
trigger greater reluctance to transact without segregation.\1223\ Thus, 
the rule's requirement that omnibus segregation be the default approach 
for non-cleared security-based swaps could have the effect of 
increasing the use of some form of segregation in non-cleared security-
based swap transactions. However, the Commission cannot determine the 
extent to which having omnibus segregation be the default requirement 
will increase the use of segregation. In particular, the Commission 
lacks information on the extent to which market participants prefer 
various segregation options, as well as data on the extent to which 
defaults determine the behavior of market participants active in the 
security-based swap market.\1224\
---------------------------------------------------------------------------

    \1222\ See William Samuelson and Richard Zeckhauser, Status Quo 
Bias in Decision Making, Journal of Risk and Uncertainty 7-59 
(1988).
    \1223\ See Victor Stango and Jonathan Zinman, Limited and 
varying consumer attention evidence from shocks to the salience of 
bank overdraft fees, Review of Financial Studies (2014).
    \1224\ Broadly, the evidence for behavioral biases tends to be 
more limited in ``professional'' contexts. See, e.g., John A. List, 
Does Market Experience Eliminate Market Anomalies? Quarterly Journal 
of Economics (Feb. 2003); Zur Shapira and Itzhak Venezia. Patterns 
of behavior of professionally managed and independent investors, 
Journal of Banking & Finance 25.8 (2001): 1573-1587.
---------------------------------------------------------------------------

    The Commission cannot predict the ultimate magnitude of the use of 
segregation by counterparties to non-cleared security-based swap 
transactions under the final rules. Counterparties to non-cleared 
security-based swap transactions may find it privately beneficial to 
waive segregation. For example, a hedge fund customer of a dealer may 
consider the risk of dealer insolvency to be too remote to warrant 
requiring the segregation of its initial margin if waiving segregation 
results in the dealer offering better terms, or providing other non-
pecuniary benefits.\1225\ Alternatively, two dealers with bilateral 
security-based swap exposures that require similar amounts of initial 
margin can reduce the total collateral required to support those 
exposures by waiving segregation. Waiving segregation allows collateral 
posted by the first dealer to be used by the second dealer to satisfy 
its margin obligation to the first: the end result is similar to when 
initial margin is not required. In addition, other factors may 
contribute to a lower use of segregation. For example, a dealer's 
counterparties may not be fully aware of the implications of the lack 
of segregation,\1226\ or have insufficient bargaining power to extract 
the desired segregation arrangements.\1227\
---------------------------------------------------------------------------

    \1225\ Similar concerns were raised by a commenter who argued 
that by not mandating individual segregation, ``cost considerations 
will lead [SBSDs] to pressure counterparties not to elect 
segregation.'' See PIMCO Letter. Another commenter stated that the 
costs for imposing omnibus segregation on foreign SBSDs would be 
significant. See IIB 11/19/2018 Letter.
    \1226\ See Alarna Carlsson-Sweeny, Trends in Prime Brokerage, 
Practical Law: The Journal (Apr. 2010) (``Few US hedge funds fully 
comprehended the repercussions of allowing their assets to be 
transferred offshore'' to avoid the Commission's segregation 
requirements.).
    \1227\ See id. (``Before Lehman's collapse, the relationship 
between hedge funds and prime brokers was one-sided, with prime 
brokers holding most of the bargaining power.'').
---------------------------------------------------------------------------

    Importantly, parties that decide that it is privately optimal to 
waive segregation for non-cleared security-based swaps may not take 
into account the potential externalities of their decisions. If 
customers generally do not avail themselves of the option to segregate 
collateral for non-cleared security-based swaps, this will reduce the 
potential positive contribution of the final segregation rules to 
financial stability. For example, the emergence of doubts about a 
dealer can lead to sudden demands for segregation, which during times 
of market stress may be difficult for dealers to satisfy, precipitating 
distress or failure. Moreover, if a dealer fails, the likelihood that 
its counterparties can recover their collateral in a timely manner is 
decreased, raising questions about the financial condition of those 
counterparties. In addition, to the extent that actual insolvency 
contributes to the dealer's failure, counterparties' collateral may 
never be fully recovered. Delays in recovery of collateral, realized 
losses, and the potential of such losses, could potentially lead to 
contagion, and destabilizing runs.
    Conversely, to the extent that the final segregation rules 
ultimately increase the use of segregation for non-cleared security-
based swaps, they could impose costs on SBSDs (and their 
counterparties). These costs would primarily result from limitations on 
SBSDs' use of initial margin. As discussed above in section VI.A.5.a. 
of this release, margin requirements have been adopted by the CFTC, 
prudential regulators, and foreign regulators, but they are being 
phased-in over time. Further, current market practice (in the absence 
of regulatory requirements)

[[Page 44027]]

does not generally involve posting initial margin. Therefore, the 
impact of any restrictions on the use of such collateral strictly 
relative to the baseline should be quite limited. More specifically, 
under the baseline scenario where the exchange of initial margin for 
non-cleared security-based swaps is largely voluntary, segregation 
requirements that impose restrictions on how SBSDs can use collateral 
posted by their counterparties should have minimal economic effect, as 
the final segregation rules would be unlikely to bind. However, the 
margin requirements of the CFTC, prudential regulators, and the 
Commission (as they come into full effect) are expected to increase the 
prevalence of initial margin in non-cleared security-based swap 
transactions, and the Commission believes it is meaningful to also 
analyze the interaction of the new margin and segregation requirements. 
In this context, the impact of the Commission's final segregation rules 
is likely to be more significant.\1228\ If, as a result of the final 
margin and segregation rules, security-based swap counterparties 
increase demand for segregation of initial margin for non-cleared 
security-based swaps, dealers' costs of engaging in security-based swap 
transactions will increase. Having unhindered access to customers' 
collateral represents a significant benefit to a dealer. Such 
collateral can be used by the dealer in its hedging and proprietary 
trading activities. In its absence, the dealer will bear the cost of 
financing the collateral to support these activities. Depending on the 
level of segregation required by the dealer's counterparties, the 
collateral required to support current levels of security-based swap 
activity could be significantly greater than in a regime without 
segregation and no restrictions on re-hypothecation. To the extent that 
the provisions of the final segregation rules increase demand for 
segregation in non-cleared security-based swap transactions, a dealer's 
costs of hedging these transactions may be higher than under existing 
market practice. Similarly, increased use of segregation for non-
cleared security-based swaps would reduce dealers' ability to otherwise 
benefit from the use of customers' collateral. Both of these factors 
could potentially lead to higher apparent transaction costs in the 
security-based swap market.\1229\
---------------------------------------------------------------------------

    \1228\ See section VI.B.3. of this release for estimates of the 
use of margin under the Commission's final margin rules.
    \1229\ In the absence of segregation, part of the consideration 
offered by the SBSD's counterparty to the SBSD in an OTC derivatives 
transaction is non-pecuniary: the right to make use of the 
counterparty's collateral. In the absence of this benefit, the SBSD 
can be expected to require additional (likely pecuniary) 
consideration from the counterparty. This would appear as higher 
transaction costs. It is important to note that there would be a 
corresponding benefit realized by security-based swap 
counterparties: increased collateral safety.
---------------------------------------------------------------------------

    Additional operational and up-front costs resulting from the final 
rules as applied to cleared and non-cleared security-based swaps 
include costs of establishing qualifying bank accounts, costs of third-
party custody services and associated legal fees, as well as costs of 
building systems to maintain custody of customer securities and to 
perform the required calculations.\1230\ The final rules require that 
stand-alone broker-dealers and SBSDs compute the amount required to be 
maintained in the special reserve account for the exclusive benefit of 
security-based swap customers at least weekly. This requirement 
supports the benefits of segregation described above, by ensuring that 
the assets subject to segregation more accurately reflect the risks to 
the posting party in the event that the holder of collateral fails. The 
final rules permit more frequent computations. Such flexibility will be 
valuable to those broker-dealers and standalone SBSDs that have the 
operational capability and resources to perform daily computations. 
These entities may choose to perform daily computations if the benefits 
of doing so--for example, being able to more rapidly take advantage of 
investment opportunities using cash withdrawn from the reserve 
account--outweigh the costs associated with daily computations.
---------------------------------------------------------------------------

    \1230\ See Rule 15c3-3, as amended; Rule 18a-4, as adopted. See 
section VI.C. of this release (discussing implementation costs).
---------------------------------------------------------------------------

    In cases of a broker-dealer SBSD, the costs of adapting existing 
systems to account for cleared and non-cleared security-based swap 
transactions may not be material in light of the similarities between 
the systems and procedures currently required by Rule 15c3-3 and those 
that will be required by final segregation rules. For bank and stand-
alone SBSDs without such systems, the operational up-front costs could 
be higher. However, even in these cases it is likely that the entities 
in question will have access to similar systems and expertise from 
their broker-dealer affiliates.\1231\
---------------------------------------------------------------------------

    \1231\ As discussed above in section VI.A. of this release, 
dealing activity in the security-based swap and swap market is 
concentrated in affiliates of large diversified bank holding 
companies. Such firms can be expected to have access to expertise 
and systems of their broker-dealer affiliates.
---------------------------------------------------------------------------

    As discussed above, the extent to which segregation will be used by 
market participants for non-cleared security-based swaps is unknown. In 
particular, the Commission lacks data on the preferences of current 
market participants for various segregation options, as well as the 
private benefits and costs described qualitatively above that may 
inform a market participant's choice of whether to use individual 
segregation or omnibus segregation, or to waive segregation. In the 
absence of a material increase in the use of segregation for non-
cleared security-based swaps, the direct costs of the final segregation 
rules borne by counterparties to security-based swaps should be 
minimal. Moreover, for market participants electing omnibus segregation 
for non-cleared security-based swaps, the direct costs should be lower 
than counterparties that elect individual segregation where the stand-
alone broker-dealer or SBSD will not hold the collateral directly and 
will not be able to use it for the limited purpose permitted in the 
final rules (i.e., hedging the customer's transaction). Thus, firms 
running matched books that collect initial margin from end-users should 
not have to fund additional collateral to support hedging transactions 
with other SBSDs. For these reasons, the costs of omnibus segregation 
should be lower as compared with individual segregation.\1232\
---------------------------------------------------------------------------

    \1232\ In addition, and as noted by one commenter, individually 
segregated accounts impose increased administrative burdens and 
related costs. See MFA 2/22/2013 Letter.
---------------------------------------------------------------------------

c. Alternatives Considered
i. Mandatory Individual Segregation
    A potential alternative to the final rules would be to mandate 
individual segregation for non-cleared security-based swaps in a manner 
that is consistent with the margin rules of the CFTC and the prudential 
regulators.\1233\ This alternative would not give an SBSD's 
counterparty to a non-cleared security-based swap the option to elect 
omnibus segregation or to waive segregation altogether (if such a 
waiver is permitted). Thus, the alternative is considerably more 
restrictive. As discussed above, the magnitude of the costs and 
benefits of segregation depends on the extent to which it is adopted by 
market participants. Under this alternative, individual segregation 
would be mandatory and thus universally practiced. As a result, it 
would be more costly to market participants primarily due to 
significant additional collateral funding costs,

[[Page 44028]]

while also providing financial stability benefits.
---------------------------------------------------------------------------

    \1233\ See CFTC Margin Adopting Release, 81 FR 636; Prudential 
Regulator Margin and Capital Adopting Release, 80 FR 74840.
---------------------------------------------------------------------------

    Mandatory individual segregation would likely reduce the risk of 
contagion. Third-party segregation with no re-hypothecation minimizes 
the risk of delays and losses in the recovery of collateral for 
transactions involving an entity that enters into financial 
distress.\1234\ Under such arrangements, the counterparties of the 
troubled entity can be confident in their ability to recover their 
collateral in the event of its default. This reduces the incentives for 
counterparties to ``run'' on the troubled entity. In addition, it 
increases market participants' confidence in the financial condition of 
the troubled entity's counterparties in the event of its default: in 
such an event counterparties can be expected to recover their 
collateral and the collateral posted by the defaulting party. Access to 
the latter compensates the surviving counterparties for losses incurred 
in replacing the defaulted transaction. Together, these effects can 
stabilize the market in times of stress. Relatedly, this alternative 
would restrict the implicit leverage in non-cleared security-based swap 
transactions. By preventing re-hypothecation, the alternative would tie 
growth in the gross notional amounts of non-cleared security-based swap 
activity to the amount of collateral devoted to this activity. Similar 
to other forms of leverage limits, this can contribute to financial 
stability. Finally, by increasing the collateral costs of non-cleared 
security-based swap transactions, this alternative would create 
incentives for central clearing. Together, the aforementioned benefits 
could further reduce the likelihood of sequential counterparty failure 
in the security-based swap market beyond the rules the Commission is 
adopting.
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    \1234\ These risks are not entirely eliminated. Delays may still 
occur due to legal disputes that prevent the third-party custodian 
from releasing the collateral. Similarly, losses may still occur if 
the third-party custodian suffers from financial distress. However, 
under individual segregation with no re-hypothecation, the potential 
for such delays and losses is expected to be relatively limited.
---------------------------------------------------------------------------

    However, these benefits of mandatory individual segregation with no 
re-hypothecation come with a cost. The alternative would deprive the 
SBSD of the use of collected collateral for re-hypothecation in related 
transactions, or in support of its trading operations. As discussed in 
the prior section, the locking up of collateral would raise the SBSD's 
costs of facilitating security-based swap transactions.
    Aside from the additional collateral funding costs, this 
alternative may further increase costs by reducing the SBSD's access to 
defaulting counterparties' collateral in typical default scenarios. A 
typical defaulting counterparty is not expected to be another SBSD, but 
rather an end-user who does not collect collateral from the SBSD. In 
such scenarios, third-party segregation can complicate the SBSD's 
attempts to make use of the defaulting counterparty's collateral: 
Rather than having immediate access to collateral in its possession or 
control, the SBSD would need to obtain the collateral from a third 
party. This could create delays that harm the SBSD's ability to 
liquidate and reestablish the positions of the insolvent counterparty, 
and may cause the SBSD to incur losses.
    The Commission has considered the costs and benefits of requiring 
segregation at a third-party custodian and prohibiting re-
hypothecation. Based on its judgment and prior experience, the 
Commission determines that the potential benefits to financial 
stability do not justify the potentially considerable additional costs 
that would need to be borne by market participants under this 
alternative approach.
ii. Daily Computations To Determine Reserve Account Requirement
    The proposed rule provided that the computations necessary to 
determine the amount required to be maintained in the SBS Customer 
Reserve Account must be made daily as of the close of the previous 
business day and any deposit required to be made into the account must 
be made on the next business day following the computation no later 
than one hour after the opening of the bank that maintains the account. 
A commenter requested that the Commission require a weekly computation 
rather than a daily computation.\1235\ The commenter stated that 
calculating the reserve account formula is an onerous process that is 
operationally intensive and requires a significant commitment of 
resources. The commenter further stated that the Commission can achieve 
its objective of decreasing liquidity pressures on SBSDs while limiting 
operational burdens by requiring weekly computations and permitting 
daily computations. The Commission acknowledges that a daily reserve 
calculation will increase operational burdens as compared to a weekly 
computation. Therefore, in response to comments, the Commission is 
modifying the final rules to require a weekly SBS Customer Reserve 
Account computation.\1236\
---------------------------------------------------------------------------

    \1235\ See SIFMA 2/22/2013 Letter.
    \1236\ See paragraphs (p)(3)(A) and (B) of Rule 15c3-3, as 
amended; paragraphs (c)(3)(i) and (ii) of Rule 18a-4, as adopted.
---------------------------------------------------------------------------

iii. Including Securities Collateral Held in a Third-Party Custodial 
Account in the Definition of ``Excess Securities Collateral''
    The proposed definition of ``excess securities collateral'' did not 
include securities collateral held in a third-party custodial account. 
As discussed above in section II.C.3.a.i. of this release, the proposed 
definition would have prevented a stand-alone broker-dealer or SBSD 
from posting a customer's securities collateral to a third-party 
custodian in accordance with the requirements of the prudential 
regulators. This consequence could have increased the cost incurred by 
the stand-alone broker-dealer or nonbank SBSD to enter into a non-
cleared security-based swap with another SBSD to hedge a non-cleared 
security-based swap with a customer under the conditions in the final 
segregation rules. Under the proposed definition of ``excess securities 
collateral,'' a broker-dealer or SBSD would have had to use proprietary 
securities or cash to enter into a hedging transaction with a bank 
SBSD. To the extent that the firm incurs a cost to obtain the 
proprietary securities or cash, that cost would add to the cost of 
entering into the hedging transaction with the bank SBSD and thus raise 
the overall cost of hedging the transaction with the customer. 
Alternatively, the broker-dealer or SBSD would have had to limit its 
hedging transactions to nonbank SBSDs and avoid trading with bank 
SBSDs. This approach would have avoided the need to use proprietary 
securities or cash to enter into a hedging transaction, as discussed 
above. However, by limiting itself to a smaller set of potential 
counterparties (i.e., other SBSDs), the firm would have reduced the 
competition among potential counterparties to provide hedging services 
to the firm. If the reduced competition resulted in higher prices for 
liquidity provision, for example, wider bid-ask spreads, the broker-
dealer or SBSD may have incurred a higher cost to enter into a hedging 
transaction. To the extent that the firm passed on the increased 
hedging cost to the customer by charging a higher price for providing 
liquidity to the customer, transaction costs in the security-based swap 
market could have risen, which may have discouraged participation in 
the security-based swap market and

[[Page 44029]]

impeded the use of this market for hedging economic exposures. In light 
of this concern, the Commission believes that the definition of 
``excess securities collateral'' in the final rules is preferable to 
this alternative.
iv. Including ``Unaffiliated'' in the Definition of ``Qualified 
Registered Security-Based Swap Dealer Account''
    The proposed definition of ``qualified registered security-based 
swap dealer account'' included the term ``unaffiliated,'' which meant 
that an affiliated SBSD would not fall within the scope of the proposed 
definition. As the Commission has discussed elsewhere, entities that 
engage in security-based swap dealing activities may lay off the risk 
associated with a security-based swap transaction to another affiliate 
via a back-to-back transaction or an assignment of the security-based 
swap.\1237\ To the extent that a broker-dealer or SBSD enters into a 
non-cleared security-based swap with an affiliated SBSD to hedge a non-
cleared security-based swap with a customer as part of its risk 
management, the proposed definition could impede the firm's risk 
management because it could not use the counterparty's initial to meet 
the margin requirement of the affiliated SBSD under the conditions of 
the final rules. As a consequence, the broker-dealer or SBSD could have 
incurred a higher cost to enter into a non-cleared security-based swap 
with an affiliated SBSD for hedging purposes as permitted under the 
conditions in the final rules. If the broker-dealer or SBSD chose to 
enter into a hedging transaction with an affiliated SBSD, it would had 
to use proprietary securities or cash to meet the affiliate SBSD's 
margin requirement. To the extent that the nonbank SBSD incurred a cost 
to obtain the proprietary securities or cash, that cost would add to 
the cost of entering into the hedging transaction with the affiliated 
SBSD and thus raise the overall cost of hedging the firm's transaction 
with the counterparty. Alternatively, the nonbank SBSD could enter into 
a hedging transaction with an unaffiliated SBSD that satisfies the 
proposed definition of ``qualified registered security-based swap 
dealer account'' so that it could use the counterparty's initial margin 
to meet the margin requirement of the unaffiliated SBSD. However, the 
nonbank SBSD may have still incurred a higher cost to enter into the 
hedging transaction, if the unaffiliated SBSD charges a higher price 
for providing liquidity than the affiliated SBSD. More generally, to 
the extent that cost efficiencies are realized through the use of the 
affiliated SBSD for risk management purposes, those efficiencies would 
be lost if the broker-dealer or SBSD enters into a hedging transaction 
with an unaffiliated SBSD, which would raise the overall cost of the 
hedging transaction. To the extent that the broker-dealer or SBSD 
passed on the increased hedging cost to the counterparty by charging a 
higher price for providing liquidity to the counterparty, transaction 
costs in the security-based swap market could have risen, which could 
have discouraged participation in the security-based swap market and 
impede the use of this market for hedging economic exposures. In light 
of this concern, the Commission believes that the definition of 
``qualified registered security-based swap dealer account'' in the 
final rules is preferable to this alternative.
---------------------------------------------------------------------------

    \1237\ See Proposed Guidance and Rule Amendments Addressing 
Cross-Border Application of Certain Security-Based Swap 
Requirements, 84 FR 24206.
---------------------------------------------------------------------------

5. Cross-Border Application
a. Overview
    As the Commission has previously indicated, security-based swap 
market is global, and market data presented in the economic baseline 
demonstrates extensive cross-border participation in the market.\1238\ 
For example, approximately half of price-forming North American 
corporate single-name CDS transactions from January 2008 to December 
2015 were cross-border transactions between a U.S.-domiciled 
counterparty and a foreign-domiciled counterparty. Counterparties in 
the security-based swap market are highly interconnected; dealers 
transact with hundreds of counterparties, and most non-dealers transact 
with multiple dealers. The global scale of the security-based swap 
market allows counterparties to access liquidity across jurisdictional 
boundaries, providing market participants with opportunities to share 
these risks with counterparties around the world. Because dealers 
facilitate the great majority of security-based swap transactions, with 
bilateral relationships that extend to potentially thousands of 
counterparties spanning multiple jurisdictions, the safety and 
soundness of non-U.S. dealers can have significant implications for 
U.S. financial stability.
---------------------------------------------------------------------------

    \1238\ See, e.g., Application of ``Security-Based Swap Dealer'' 
and ``Major Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities; Republication, 79 FR at 
47280; Application of Certain Title VII Requirements to Security-
Based Swap Transactions Connected With a Non-U.S. Person's Dealing 
Activity That Are Arranged, Negotiated, or Executed by Personnel 
Located in a U.S. Branch or Office or in a U.S. Branch or Office of 
an Agent, 80 FR at 27454; Business Conduct Standards for Security-
Based Swap Dealers and Major Security-Based Swap Participants, 81 FR 
29960.
---------------------------------------------------------------------------

    As discussed above in section II.E.1. of this release, the 
Commission is treating the capital and margin requirements of the 
Exchange Act the final rules as entity-level requirements. The 
Commission also is amending Rule 3a71-6 to make a substituted 
compliance available with respect to the capital and margin 
requirements of Section 15F(e) of the Exchange Act and Rules 18a-1, 
18a-2, and/or 18a-3.
    The Commission is treating the segregation requirement as a 
transaction-level requirement. Further, substituted compliance is not 
available with respect to the final segregation requirements. However, 
the final segregation rule for stand-alone and bank SBSDs and MSBSPs 
has exceptions under which a foreign firm need not comply with the 
segregation requirements of Section 3E of the Exchange Act and Rule 
18a-4 for certain transactions. The final rule also requires a foreign 
stand-alone or bank SBSD to make certain disclosures to a U.S. 
security-based swap customer relating to segregation and U.S. 
bankruptcy and foreign insolvency laws. There are no exceptions from 
the segregation rule for cross-border transactions of a broker-dealer 
SBSD or MSBSP.
b. Benefits and Costs
    In considering the economic effects of this cross-border approach, 
the Commission recognizes that the economic baseline reflects markets 
as they exist today, in which no population of registered SBSDs and 
MSBSPs exists and compliance with capital, margin, and segregation 
requirements for security-based swaps is not required. Therefore, these 
final rules will apply with respect to security-based swap transactions 
intermediated by entities where they currently do not.
    Imposing the new capital and margin requirements on non-U.S. SBSDs 
and MSBSPs has the potential to significantly impact the willingness of 
foreign entities to transact with U.S. counterparties in the security-
based swap market, especially firms for which the U.S. market 
represents a relatively small fraction of total security-based swap 
business. For such firms, the additional costs resulting from having to 
comply with the capital and margin requirements of the Exchange Act the 
Commission's final rules in addition to corresponding regulations 
applicable in their own jurisdiction may not justify the benefits of 
conducting security-based swap transactions with U.S.

[[Page 44030]]

entities. The exit of foreign firms from the U.S. security-based swap 
market could potentially harm liquidity in these markets, and more 
importantly, would likely reduce valuable risk-sharing opportunities 
for U.S. counterparties.
    However, as noted earlier, the global and inter-connected nature of 
the security-based swap market implies that the safety and soundness of 
non-U.S. firms operating in this market can have a significant impact 
on U.S. financial stability. Moreover, failing to apply capital and 
margin regulations to such foreign entities would potentially create 
incentives for regulatory arbitrage as participants in U.S. markets 
would seek to locate in jurisdictions with the most favorable capital 
and margin treatment.
    With respect to capital requirements, the Commission believes that 
imposing the same entity-level requirements that are applicable to U.S. 
firms on non-U.S. entities with the opportunity for substituted 
compliance in cases where the foreign jurisdiction imposes comparable 
requirements reflects appropriate consideration of potential compliance 
costs and benefits to U.S. markets. By allowing non-U.S. entities to 
satisfy comparable requirements in foreign jurisdictions, the rule 
mitigates the compliance burden on these non-U.S. entities. At the same 
time, by requiring compliance with capital requirements at the entity 
level, the rule should reduce the likelihood that entities operating in 
the U.S. market will impose negative financial stability externalities 
on the U.S. market by locating in a foreign jurisdiction. The 
Commission did not receive comments addressing the proposed treatment 
of capital as an entity-level requirement.
    Similar considerations apply to the Commission's approach in 
treating the final margin requirements as entity-level requirements. A 
number of commenters suggested that the Commission should apply margin 
requirements on a transaction-level basis instead of on an entity-level 
basis, with several arguing that this was necessary for consistency 
with other domestic and foreign regulators.\1239\ Some of these 
commenters also pointed to the costs and operational complications that 
could result from subjecting a foreign registrant to both Commission 
and home country margin requirements.\1240\
---------------------------------------------------------------------------

    \1239\ See Better Markets 8/21/2013 Letter (arguing that 
treating margin as a transaction-level requirement ``is more 
consistent with the CFTC's cross-border guidance''); IIB 8/21/2013 
Letter (stating that the Commission's divergence from the CFTC's 
rules and those envisioned by the EMIR would be ``impracticable'' 
and ``could also lead to significant competitive distortions''); 
ISDA 1/23/2013 Letter (generally requesting that the Commission 
recognize local margin requirements for SBSDs outside the United 
States, and coordinate with the CFTC and other domestic and foreign 
regulators to achieve consistency in the treatment of swaps and 
security-based swaps involving multiple jurisdictions); Japan SDA 
Letter (urging the Commission and the CFTC to align their rules to 
avoid ``hamper[ing] efficient management of derivatives 
transactions'').
    \1240\ See IIB 8/21/2013 Letter (stating that it would be 
``cost-intensive'' to ``negotiate and execute separate credit 
support documentation, make separate margin calculations and have 
separate operational procedures across its swap and [security-based 
swap] transactions''); Japan SDA Letter (inconsistent rules would 
``hamper efficient management of derivatives transactions'').
---------------------------------------------------------------------------

    While there are potential consistency issues and operational 
complications to applying the Commission's margin requirements at the 
entity-level rather than at the transaction-level, these considerations 
have to be considered in the context of the economic function of margin 
requirements. The primary economic function of the Commission's final 
margin requirements is to enhance financial stability to help ensure 
the safety and soundness of nonbank SBSDs and nonbank MSBSPs. 
Permitting substantially different margin requirements based on the 
location of the counterparty would not be consistent with this 
objective and could undermine the stability of U.S. markets. Moreover, 
as above discussed in section VI.B.3. of this release, the Commission 
expects market participants to employ industry standard models in the 
calculation of initial margin amounts. It is reasonable to expect that 
such models will be designed in a manner to comply with the margin 
requirements of the key jurisdictions implementing margin regulations, 
thereby reducing the potential for significant discrepancies. Finally, 
minor differences in margin requirements across jurisdictions can be 
addressed through applications for substituted compliance.
    While Commission's final capital and margin requirements primarily 
serve to ensure the safety and soundness of regulated entities and 
thereby enhance financial stability, a primary economic function of the 
Commission's final segregation requirements is to protect the assets of 
U.S. customers and counterparties in the event of an SBSD's insolvency 
and to align the final segregation requirements with U.S. insolvency 
laws. As such, the Commission proposed transaction-level requirements 
tailored to address the risks faced by U.S. customers of non-U.S. 
entities. The Commission did not receive comments addressing the 
transaction-level treatment of the segregation requirements. However, 
one commenter stated that it ``support[s] the Commission's overall 
proposal to distinguish between entity-level and transaction-level 
requirements'' and that it ``generally support[s] the Commission's 
proposed cross-border application of segregation requirements to 
foreign SBSDs.'' \1241\ The main considerations in the design of the 
Commission's segregation requirements with respect to non-U.S. SBSDs 
and MSBSPs are of a legal rather than economic nature. They are 
discussed in section II.D.1. of this release.
---------------------------------------------------------------------------

    \1241\ See IIB 8/21/2013 Letter.
---------------------------------------------------------------------------

6. Rule 18a-10
a. Overview
    As discussed above in section II.D. of this release, the final 
capital, margin, and segregation rules include an alternative 
compliance mechanism (codified in Rule 18a-10) pursuant to which a 
stand-alone SBSD that is registered as a swap dealer and predominantly 
engages in a swaps business may elect to comply with the capital, 
margin, and segregation requirements of the CEA and the CFTC's rules 
applicable to swap dealers instead of complying with Rules 18a-1, 18a-
3, and 18a-4.\1242\ In order to qualify for the alternative compliance 
mechanism, the firm must: (1) Be registered as an SBSD pursuant to 
Section 15F(b) of the Exchange Act and the rules thereunder; (2) be 
registered as a swap dealer pursuant to Section 4s of the Commodity 
Exchange Act and the rules thereunder; (3) not be registered as a 
broker-dealer pursuant to Section 15 of the Exchange Act or the rules 
thereunder; (4) meet the conditions to be exempt from Rule 18a-4 
specified in paragraph (f) of that section; and (5) as of the most 
recently ended quarter of the fiscal year, have an aggregate gross 
notional amount of the security-based swap positions of the that do not 
exceed the lesser of the maximum fixed-dollar amount specified in 
paragraph (f) of the rule or 10 percent of the combined aggregate gross 
notional amount of the security-based swap and swap positions of the 
SBSD. The maximum fixed-dollar amount is set at a transitional level of 
$250 billion for the first 3 years after the compliance date of the 
rule and then drops to $50 billion thereafter unless the Commission 
issues an order: (1) Maintaining the $250 billion maximum fixed-dollar 
amount for an additional period of time or indefinitely; or (2) 
lowering the maximum fixed-dollar

[[Page 44031]]

amount to an amount between $250 billion and $50 billion.
---------------------------------------------------------------------------

    \1242\ See Rule 18a-10. As discussed above in section II.D. of 
this release, while a bank SBSD could theoretically use the 
alternative compliance mechanism, the Commission does not expect 
such an entity will do so.
---------------------------------------------------------------------------

    The rule further requires a stand-alone SBSD operating pursuant the 
alternative compliance mechanism to provide a written disclosure to its 
counterparties before the first transaction with the counterparty after 
the firm begins operating pursuant to the mechanism notifying the 
counterparty that the firm is complying with the applicable capital, 
margin, segregation, recordkeeping, and reporting requirements of the 
CEA and the CFTC's rules in lieu of complying with Rules 18a-1, 18a-3, 
and 18a-4. The rule further requires, among other things, that the firm 
comply with the capital, margin, and segregation requirements of the 
CEA and the CFTC's rules applicable to swap dealers and treat security-
based swaps and related collateral pursuant to those requirements to 
the extent the requirements do not specifically address security-based 
swaps and related collateral.
b. Benefits and Costs of Rule 18a-10
    The final rule provides stand-alone SBSDs that are also registered 
as swap dealers and that engage predominantly in swap activity with 
flexibility to comply with a single set of requirements under the CEA 
and the CFTC's rules. The primary benefit of the alternative compliance 
mechanism is that it will avoid the costs of complying with two sets of 
capital, margin, and segregation requirements for a firm that is dually 
registered as a stand-alone SBSD and a swap dealer. This benefit is 
perhaps best illustrated through how it will permit a stand-alone SBSD 
to comply with the capital requirements of the CEA and the CFTC's rules 
exclusively rather than comply both with those requirements and with 
the capital requirements of the Commission's rules. For example, a 
stand-alone SBSD operating pursuant to the alternative compliance will 
not need to perform two capital computations and monitor its capital 
position and financial condition to ensure it is complying with the 
Commission's capital requirements (in addition to the capital 
requirements of the CEA and the CFTC's rules).
    Moreover, as discussed above, the Commission's final capital rules 
impose certain requirements with respect to swap positions that are not 
imposed by the CFTC's proposed capital rules and that could have 
important economic implications for firms that engage in swap trading 
activity. These requirements include a requirement that a stand-alone 
SBSD will need to take a capital deduction if the firm posts initial 
margin to a counterparty in a swap transaction pursuant to the margin 
rules of the CFTC. The Commission is providing guidance in this release 
to as to how a firm could avoid this capital deduction. While some 
firms may be able to take advantage of this guidance, others may not. 
Thus, generally, the requirement may impose costs on those firms that 
cannot use the guidance.
    In addition, stand-alone SBSDs also will be required to take a 
capital deduction in lieu of margin or credit risk charge for 
uncollateralized exposures from swap positions that are subject to an 
exception in the margin rules of the CFTC. For example, one such 
exception in the CFTC's margin rules is that swap dealers are not 
required to collect initial margin on swaps from counterparties that 
are not ``covered swap entities'' or ``financial end users,'' as those 
terms are defined in the rules. Because reallocating capital from other 
activities to support the swap trading activity or raising capital is 
generally costly, the requirement may impose a cost on those firms that 
carry uncollateralized exposures from swap transactions.
    Another requirement is that stand-alone SBSDs will be required to 
take a capital deduction or credit risk charge for margin collateral 
required of a counterparty pursuant to the CFTC's margin rule that is 
held at a third-party custodian. The final capital rules contain an 
exception from having to take this capital charge. The conditions for 
the exception are designed to recognize existing agreements entered 
into pursuant the margin rules of the CFTC. However, to the extent 
firms cannot meet all the conditions for the exception, they may not be 
able to avoid taking the capital charges associated with this 
requirement, and therefore may incur potential costs.
    The proposed capital rules of the CFTC do not include some 
requirements being adopted by the Commission, and therefore swap 
dealers that are not dually registered as SBSDs may not face the 
potential costs associated with these requirements. From this 
perspective, stand-alone SBSDs that can meet the conditions of the 
alternative compliance mechanism will have an incentive to take 
advantage of it. The larger the potential costs associated with the 
differences between the final capital rules of the CFTC (when adopted) 
and the Commission, the larger the potential impact of the overlapping 
regulatory regimes on the swap trading activity. The alternative 
compliance mechanism will reduce the potential impact of these costs on 
the swap trading activity of stand-alone SBSDs, which, in turn, could 
benefit the swap market participants to the extent that stand-alone 
SBSDs that use the alternative compliance mechanism pass on the 
associated cost savings to their counterparties in the form of lower 
prices for liquidity provision.
    Firms that face potential costs associated with differences between 
the capital, margin, and segregation requirements of the Commission's 
rules and the CFTC's rules may be at a competitive disadvantage 
relative to firms that are subject to the CFTC's rules only, and, as a 
result, the latter category of firms may be able to offer better prices 
to swap market participants. Therefore, the primary benefit of the 
alternative compliance mechanism is that it will avoid these costs and 
the corresponding competitive impact of them.
    However, using the alternative compliance mechanism will also 
impose costs on stand-alone SBSDs. In particular, the requirement to 
provide written disclosure to all counterparties prior to the first 
transaction that would be subject to the alternative compliance 
mechanism will impose costs. These implementation costs are discussed 
in more detail in section VI.C. below.
    The maximum fixed-dollar amount is set at a transitional level of 
$250 billion for the first 3 years after the compliance date of the 
rule and then drops to $50 billion thereafter unless the Commission 
issues an order: (1) Maintaining the $250 billion maximum fixed-dollar 
amount for an additional period of time or indefinitely; or (2) 
lowering the maximum fixed-dollar amount to an amount between $250 
billion and $50 billion.
    Analysis by Commission staff indicates that the 10% threshold 
likely will be the greater of the two thresholds for stand-alone SBSDs 
that are also registered as swap dealers. Thus, the following 
discussion focuses on the maximum fixed-dollar threshold. Commission 
staff estimates that up to seven stand-alone SBSDs that are also 
registered as swap dealers have aggregate gross notional amount of 
single-name CDS positions that fall under the $250 billion threshold. 
Out these 7 stand-alone SBSDs that are also swap dealers, Commission 
staff estimates that between 1 and 4 \1243\ may engage in levels of 
security-based swap activity such that the aggregate gross notional 
amount of their single-name CDS positions may fall under the $50 
billion threshold.
---------------------------------------------------------------------------

    \1243\ The upper bound estimate of 4 accounts for data 
limitations and measurement errors.

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

[[Page 44032]]

    To the extent that the aggregate gross notional amount of these 
stand-alone SBSDs' single-name CDS positions remains unchanged, the 
lowering of the maximum fixed-dollar amount from $250 billion to $50 
billion could impose costs on certain stand-alone SBSDs that may seek 
to use the alternative compliance mechanism. In particular, stand-alone 
SBSDs with aggregate gross notional amount of less than $250 billion 
but above $50 billion will be able to use alternative compliance 
mechanism in the first 3 years and benefit from the associated cost 
savings discussed above. If the maximum fixed-dollar amount is lowered 
to $50 billion after 3 years, these stand-alone SBSDs would not be able 
to use alternative compliance mechanism and would begin to incur the 
costs described above. To the extent that these stand-alone SBSDs have 
to incur higher costs in order to operate their dealing businesses, 
they may be at a competitive disadvantage relative to dealers that are 
subject to CFTC requirements. In addition, to the extent that 
differences between Commission and CFTC capital, margin, and 
segregation requirements result in different implementation 
requirements (e.g., different information technology infrastructures) 
these stand-alone SBSDs may have to incur costs to modify their 
existing systems and operations to support compliance with the 
Commission's capital, margin, and segregation requirements. However, 
the Commission believes these costs would be mitigated by the fact the 
final rules adopted today are harmonized with those of the CFTC to the 
maximum extent practicable. Moreover, if the Commission lowers the 
maximum fixed-dollar amount to a level that is between $250 billion and 
$50 billion, some of the firms with aggregate gross notional amount of 
single-name CDS positions may be able to continue to use the 
alternative compliance mechanism.

C. Implementation Costs

    As discussed above, Rules 18a-1 through 18a-4, and 18a-10, as well 
as the amendments to Rules 15c3-1 and 15c3-3, will impose certain 
implementation costs on SBSDs and MSBSPs. The Commission expects that 
the highest economic cost impact as a result of the final rules will 
likely result from the additional capital that nonbank SBSDs and MSBSPs 
may need to hold as a result of the capital rules, and the additional 
margin that nonbank SBSDs and MSBSPs, and other market participants may 
need to post and/or collect as a result of the Commission's margin 
requirements.
    Other costs may include start-up costs, including personnel and 
other costs, such as technology costs, to comply with the final rules. 
As discussed above in section IV.D. of this release, the Commission has 
estimated the burdens and related costs of these implementation 
requirements for SBSDs and MSBSPs.\1244\ These costs are summarized 
below.
---------------------------------------------------------------------------

    \1244\ See section IV.D. of this release (discussing the total 
initial and annual recordkeeping and reporting burdens of the new 
rules and rule amendments).
---------------------------------------------------------------------------

    A stand-alone SBSD that applies to use internal models will be 
required under Rule 18a-1 to create and compile various documents to be 
included with the application, including documents related to the 
development of its models, and to provide additional documentation to, 
and respond to questions from, Commission staff throughout the 
application process.\1245\ These firms also will be required to review 
and backtest these models annually. The requirements are estimated to 
impose one-time and annual costs in the aggregate of approximately 
$1.34 million \1246\ and $6.6 million,\1247\ respectively. It is also 
estimated that these firms will incur initial technology costs of $32 
million \1248\ in the aggregate.
---------------------------------------------------------------------------

    \1245\ See section IV.A.1. of this release.
    \1246\ This consists of external costs of $400,000, plus 
internal costs of $938,000. See section IV.D.1. of this release.
    \1247\ This consists of external costs of $2.496 million, plus 
internal costs of $4.12 million. See section IV.D.1. of this 
release.
    \1248\ See section IV.D.1. of this release.
---------------------------------------------------------------------------

    Rule 18a-1 also will require stand-alone SBSDs to establish, 
document, and maintain a system of internal risk management controls 
required under Rule 15c3-4, as well as to review and update these 
controls.\1249\ This requirement will impose one-time and annual costs 
in the aggregate of $6.1 million \1250\ and $606,000,\1251\ 
respectively. These firms also may incur aggregate initial and ongoing 
information technology costs of $192,000 and $246,000, 
respectively.\1252\
---------------------------------------------------------------------------

    \1249\ See section IV.A.1. of this release.
    \1250\ See section IV.D.1. of this release.
    \1251\ See id.
    \1252\ See id.
---------------------------------------------------------------------------

    As discussed above, the Commission staff estimates that 4 broker-
dealer SBSDs and 2 standalone SBSDs not authorized to use models will 
utilize the CDS haircut provisions under the amendments to Rules 15c3-1 
and 18a-1, respectively. Consequently, these firms will use an industry 
sector classification system that is documented for the credit default 
swap reference obligors. The Commission staff estimates that nonbank 
SBSDs not using models will incur an aggregate annual cost of $2,226 
\1253\ to document these industry sectors.
---------------------------------------------------------------------------

    \1253\ See id.
---------------------------------------------------------------------------

    Under paragraph (h) of Rule 18a-1, a nonbank SBSD is required to 
file certain notices with the Commission relating to the withdrawal of 
equity capital. The Commission staff estimates that stand-alone SBSDs 
will incur an aggregate annual cost of $2,226 \1254\ to file such 
notices.
---------------------------------------------------------------------------

    \1254\ See id.
---------------------------------------------------------------------------

    Under Rule 18a-1d, a nonbank SBSD is required to file a proposed 
subordinated loan agreement with the Commission (including 
nonconforming subordinated loan agreements). In connection with this 
provision, the Commission staff estimates that stand-alone SBSDs will 
incur aggregate one-time and annual costs of $50,640 and $25,320, 
respectively.\1255\
---------------------------------------------------------------------------

    \1255\ See id.
---------------------------------------------------------------------------

    Rule 18a-1, as adopted, and Rule 15c3-1, as amended, will also 
require the execution of an account control agreement by nonbank SBSDs. 
This will require firms to execute each account control agreement 
internally, and they may engage outside counsel to review the account 
control agreement and potentially to draft and review an opinion that 
an account control agreement is (or a set of account control agreements 
are) legally valid, binding, and enforceable in all material respects. 
These requirements are estimated to impose one-time and annual costs in 
the aggregate of approximately $345,620 \1256\ and $1.86 million,\1257\ 
respectively.
---------------------------------------------------------------------------

    \1256\ Calculated as $176,000 (outside counsel to draft and 
review account control agreement) + $88,000 (opinion of counsel) + 
$81,620 (written `in-house' analysis) = $345,620. See section 
IV.D.1. of this release.
    \1257\ This is the estimated industry-wide annual burden of 
$1,856,800. See section IV.D.1. of this release.
---------------------------------------------------------------------------

    Rule 18a-2 also will require nonbank MSBSPs to establish, document, 
and maintain a system of internal risk management controls required 
under Rule 15c3-4, as well as to review and update these 
controls.\1258\ This requirement is estimated to impose one-time and 
annual costs in the aggregate of $2.77 million \1259\ and $252,500 
\1260\ for nonbank MSBSPs, respectively. These nonbank MSBSPs also may 
incur initial and ongoing information

[[Page 44033]]

technology costs of $80,000 and $102,500, respectively.\1261\
---------------------------------------------------------------------------

    \1258\ See section IV.A.2. of this release.
    \1259\ This consists of external costs of $400,000, plus 
internal costs of $2.37 million. See section IV.D.2. of this 
release.
    \1260\ See section IV.D.2. of this release.
    \1261\ See id.
---------------------------------------------------------------------------

    Rule 18a-3 will require nonbank SBSDs to establish a written risk 
analysis methodology, which will need to be reviewed and updated.\1262\ 
This requirement is estimated to impose one-time and annual costs in 
the aggregate of $1.62 million \1263\ and $489,720,\1264\ respectively.
---------------------------------------------------------------------------

    \1262\ See section IV.A.3. of this release.
    \1263\ See section IV.D.3. of this release. This consists of 
external costs of $12,000, plus internal costs of $1.61 million.
    \1264\ See id.
---------------------------------------------------------------------------

    Rule 18a-3, as adopted will require nonbank SBSDs to seek 
Commission approval to use an internal model to calculate initial 
margin.\1265\ This requirement is estimated to impose one-time and 
annual costs in the aggregate of $464,200 and $1,575,750, 
respectively.\1266\
---------------------------------------------------------------------------

    \1265\ See section IV.A.3. of this release.
    \1266\ See section IV.D.3. of this release.
---------------------------------------------------------------------------

    SBSDs and MSBSPs will incur various one-time and ongoing costs in 
the aggregate in order to comply with the segregation and notification 
requirements of Rule 18a-4 and the amendments to Rule 15c3-3.\1267\ 
Each SBSD will incur one-time and annual costs in establishing special 
bank accounts required by the rule. This requirement is estimated to 
impose one-time and annual costs of $2.9 million \1268\ and $367,290 
\1269\ in the aggregate on SBSDs, respectively. In addition, SBSDs will 
be required to perform a reserve computation required by Exhibit A to 
Rule 18a-4 or Exhibit B to Rule 15c3-3, which is estimated to impose on 
these firms annual costs in the aggregate of approximately $1.69 
million.\1270\
---------------------------------------------------------------------------

    \1267\ See section IV.A.4. of this release.
    \1268\ See section IV.D.4. of this release.
    \1269\ See id.
    \1270\ See id.
---------------------------------------------------------------------------

    In addition, both SBSDs and MSBSPs will be required to prepare and 
send to their counterparties segregation-related notices pursuant to 
Section 3E(f) of the Exchange Act.\1271\ This requirement is estimated 
to impose one-time and annual costs in the aggregate to SBSDs and 
MSBSPs of $870,857 \1272\ and $130,143,\1273\ respectively.
---------------------------------------------------------------------------

    \1271\ See section IV.A.4. of this release.
    \1272\ See section IV.D.4. of this release. This consists of 
external costs of $220,000, plus internal costs of $650,857.
    \1273\ See section IV.D.4. of this release.
---------------------------------------------------------------------------

    Rule 15c3-3, as amended, and Rule 18a-4, as adopted, will require 
each SBSD to draft, prepare, and enter into subordination agreements 
with certain counterparties.\1274\ This requirement is estimated to 
impose on these firms one-time and annual costs in the aggregate of 
$43.7 million \1275\ and $8.4 million,\1276\ respectively.
---------------------------------------------------------------------------

    \1274\ See section IV.A.4. of this release.
    \1275\ See section IV.D.4. of this release. Calculated as 
$1,603,600 (drafting and preparation of subordination agreements) + 
$152,000 (review by outside counsel) + $41,990,000 (entering into 
subordination agreements with counterparties) = $43,745,600.
    \1276\ See section IV.D.4 of this release (estimating that 19 
SBSDs will incur an industry-wide annual burden of $8,398,000 in 
connection with establishing account relationships with new 
counterparties per year).
---------------------------------------------------------------------------

    Rule 15c3-3, as amended, and Rule 18a-4, as adopted, will require 
registered foreign SBSDs to provide disclosures to their U.S. 
counterparties. This requirement is estimated to impose on these firms 
one-time and annual costs in the aggregate of $6,034,600 \1277\ and 
$46,420,\1278\ respectively.
---------------------------------------------------------------------------

    \1277\ This consists of 3,300 hours of in-house attorney time in 
addition to 11,000 of in-house counsel hours required to create and 
incorporate disclosure language in trading documentation, at a rate 
of $422 per hour. See section IV.D.4. of this release.
    \1278\ This consists of 110 hours of in-house attorney time 
multiplied by $422 per hour. See section IV.D.4. of this release.
---------------------------------------------------------------------------

    The Commission estimates that 31 SBSDs (25 bank SBSDs and 6 stand-
alone SBSDs) will incur costs in connection with the disclosure 
condition under paragraph (f)(3) of Rule 18a-4. These SBSDs are 
estimated to incur one-time and annual costs in the aggregate of 
$130,885,410,\1279\ and $65,410,\1280\ respectively.
---------------------------------------------------------------------------

    \1279\ Calculated as cost of developing new disclosure language 
(155 in-house counsel hours x $422 per hour = $65,410) + cost of 
incorporating new disclosure language into trading documentation 
(310,000 in-house counsel hours x $422 per hour = $130,820,222) = 
$130,885,410. See section IV.D.4. of this release.
    \1280\ Calculated as 155 in-house counsel hours x $422 per hour 
= $65,410. See section IV.D.4. of this release.
---------------------------------------------------------------------------

    Rule 18a-10 prescribes an alternative compliance mechanism pursuant 
to which a stand-alone that is registered as a swap dealer and 
predominantly engages in a swaps business may elect to comply with the 
capital, margin, and segregation requirements of the CEA and the CFTC's 
rules in lieu of complying with Rules 18a-1, 18a-3, and 18a-4 (as 
applicable). As discussed above, the Commission estimates that 3 stand-
alone SBSDs will elect to operate under Rule 18a-10. In connection with 
the disclosure requirements under paragraph (b)(2) of Rule 18a-10, 
these stand-alone SBSDs are estimated to incur one-time and annual 
costs in the aggregate of $12,666,330,\1281\ and $6,300,\1282\ 
respectively. The Commission estimates that the notice requirement of 
paragraph (b)(3) of Rule 18a-10 will impose an aggregate annual cost of 
$185.50.\1283\
---------------------------------------------------------------------------

    \1281\ Calculated as cost of developing new disclosure language 
(15 in-house counsel hours x $422 per hour = $6,330) + cost of 
incorporating new disclosure language into trading documentation 
(30,000 in-house counsel hours x $422 per hour = $12,660,000) = 
$12,666,300. See section IV.D.5. of this release.
    \1282\ Calculated as 15 in-house counsel hours x $422 per hour = 
$6,330. See section IV.D.5. of this release.
    \1283\ See section IV.D.5. of this release estimating that an 
internal compliance attorney of one stand-alone SBSD will take 30 
minutes to file one notice annually with the Commission. Therefore, 
the estimated cost = 30 minutes at $371 per hour = $185.50.
---------------------------------------------------------------------------

    Rule 3a71-6 gives firms the option of applying for substituted 
compliance with regard to the final capital and margin rules. This 
requirement is estimated to impose on these firms a one-time cost in 
the aggregate of $341,280.\1284\
---------------------------------------------------------------------------

    \1284\ This consists of 240 initial burden hours times $422 an 
hour for in-house attorney ($101,280), in addition to the $240,000 
estimated costs for outside counsel. See section IV.D.6. of this 
release.
---------------------------------------------------------------------------

D. Effects on Efficiency, Competition, and Capital Formation

    The OTC swaps and security-based swap market is characterized by 
complex bilateral exposure networks. Currently, such networks are 
opaque. Consequently, it is not possible for market participants to 
accurately ascertain counterparty exposures to other market 
participants. During times of market stress, market participants' 
uncertainty about the financial condition of their OTC derivative 
counterparties can lead markets to become illiquid. Distress at dealers 
or at other major participants is a particular source of concern. The 
lack of information about individual market participants' exposures to 
such troubled firms can lead to widespread ``contagion'' which may lead 
markets to break down. Disruptions to the OTC derivative markets can 
shut down critical risk-transfer mechanisms and further exacerbate 
concerns about the exposures of important financial intermediaries. 
This, in turn, can lead to disruptions in credit provision to the real 
economy. Moreover, the opacity of these markets can foster excessive 
risk taking, which can both instigate and exacerbate the breakdown of 
these markets.
    The final capital, margin, and segregation rules work together to 
help improve the stability of the security-based swap market, and in so 
doing mitigate the inefficiencies in these markets arising from the 
existence of default risk of derivative counterparties. The final 
capital and margin rules will reduce a nonbank SBSD's

[[Page 44034]]

uncollateralized derivative exposures and require firms to hold 
additional capital to address uncollateralized exposures. This will 
reduce potential losses from these exposures in the event of a 
counterparty default. In cases where nonbank SBSDs are not required to 
collect margin or where the collected margin is not under the SBSD's 
control, the final capital rules require nonbank SBSDs to allocate 
capital to reduce the potential losses from uncollateralized 
counterparty exposure. In this way, the capital rules complement the 
margin rule to reduce a nonbank SBSD's probability of default, reduce 
incentives for excessive risk-taking, and reduce the probability of 
sequential counterparty failure. Finally, the capital requirements for 
nonbank MSBSPs should reduce the likelihood of a MSBSP's failure and 
the potential losses to nonbank SBSD counterparties in the event of 
MSBSP's failure. In this way, the capital and margin rules are designed 
to reduce the risk that the failure of one entity propagates to its 
counterparties.
    Furthermore, the margin rule will reduce a nonbank SBSD's incentive 
for excessive risk taking and will restrict the amount of implicit 
leverage that market participants can achieve through non-cleared 
security-based swaps. In addition, the margin rule will also reduce the 
potential cost advantages of non-cleared transactions relative to 
cleared transactions, and thereby encourage the clearing of such 
transactions. While the final margin rule provides protection for the 
margin collector against the default of the margin poster, it 
simultaneously exposes the poster of initial margin to additional risk. 
The Commission's final segregation rules, however, are designed to 
complement the margin rule by ensuring that posted margin is adequately 
protected.
    Through the aforementioned channels, the Commission's capital, 
margin, and segregation rules are expected to have a generally positive 
effect on economic efficiency, and capital formation. However, because 
of the complex, overlapping regulatory environment of the security-
based swap market, the final rules' effects on competition are more 
uncertain. In this section, the Commission considers each of these 
effects in turn.
1. Efficiency and Capital Formation
    In principle, the security-based swap market improves efficiency by 
facilitating risk transfer in the economy. In addition, by mitigating 
market imperfections in underlying securities markets (such as limited 
liquidity), it can help improve price discovery with attendant positive 
effects on firms' borrowing costs. However, the extent to which the 
security-based swap market improves efficiency is limited due to 
counterparty credit risk. Specifically, the imperfection in the 
security-based swap market resulting from counterparty default can 
facilitate excessive and opaque risk-taking and have negative effects 
on the stability of this market.\1285\ The final capital, margin, and 
segregation rules help address these market imperfections.
---------------------------------------------------------------------------

    \1285\ See BCBS/IOSCO Paper.
---------------------------------------------------------------------------

    Excessive risk-taking by dealers and other major participants in 
the security-based swap market can arise from misaligned incentives of 
the firms' manager-owners and those of other investors due to limited 
liability.\1286\ More generally, contracting frictions can cause 
similar incentive misalignments between managers and shareholders, 
other investors, counterparties, and customers. Because the costs of 
monitoring large financial intermediaries are significant, the 
creditors and customers of such firms are generally not in a position 
to monitor their management. This lack of monitoring can lead financial 
firms to pursue inefficient risk management policies.
---------------------------------------------------------------------------

    \1286\ See Michael C. Jensen and William H. Meckling, Theory of 
the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 
Journal of Financial Economics (Oct. 1976).
---------------------------------------------------------------------------

    Even absent these incentive conflicts and monitoring limitations, 
firms may choose to engage in trading activity that, while privately 
optimal, reduces overall financial stability. Unexpected losses on 
derivatives positions at one firm can threaten the financial viability 
of its counterparties, with the potential to precipitate sequential 
counterparty failures. Moreover, due to the opacity of financial firms, 
market fears of such contagion can lead to anticipatory ``runs'' on 
financial institutions, further undermining financial stability. 
Importantly, the costs associated with the reductions in financial 
stability that result from a given firm's policies and strategies are 
not fully internalized by the firm.\1287\ The final capital, margin, 
and segregation rules help to mitigate the inefficiencies resulting 
from this negative externality.
---------------------------------------------------------------------------

    \1287\ One commenter noted that the dollar cost of the financial 
collapse will exceed $12.8 trillion, and argued that Congress's 
resolve to prevent another massively costly financial crisis 
overrides any industry-claimed cost concerns under the Dodd-Frank 
Act. See Better Markets 2/22/2013 Letter.
---------------------------------------------------------------------------

    The final capital, margin, and segregation rules for participants 
in the security-based swap market being adopted by the Commission can 
improve efficiency by addressing the aforementioned market failures. By 
imposing a set of minimum risk management standards on affected 
entities, these requirements reduce the scope for incentive conflicts 
that may arise among these entities, their investors, counterparties, 
and customers, which can lead to more efficient investment policies. In 
addition, these new requirements can reduce the degree to which an 
individual firm's risk-taking imposes negative externalities on the 
market as a whole by: (1) Reducing uncertainty about exposures to non-
cleared security-based swaps and the resulting potential for contagion; 
(2) reducing the ability of entities to engage in excessive risk 
taking; (3) promoting central clearing of sufficiently standardized 
products; and (4) promoting a uniform set of standards across 
regulatory agencies that limit opportunities for regulatory arbitrage. 
By improving financial stability in these ways, the final capital, 
margin, and segregation rules may also facilitate capital formation. In 
particular, because financial crises are typically associated with 
large reductions in the supply of aggregate capital, financial 
instability and financial crises resulting from such instability can 
have large negative economic consequences, including significant harm 
to capital formation. By reducing the likelihood of such crises, the 
Commission expects the capital, margin, and segregation rules will 
enhance capital formation.
    The Commission acknowledges that nonbank SBSDs might pass on a 
portion of the costs incurred as a result of the capital, margin, and 
segregation rules to end users. To the extent that end users bear these 
costs, they might reduce investments. This potential impact on 
investment depends in part on the degree of competition among SBSDs. In 
particular, robust competition among SBSDs would limit their ability to 
pass on costs to end users and in turn mitigate any adverse impact on 
investment.
    As acknowledged in section VI.C. of this release, the degree to 
which the aforementioned benefits improve efficiency depends on the 
costs imposed by these measures. These costs include the costs of 
funding additional collateral to meet margin requirements, the costs of 
additional capital, and the costs of implementation and compliance. In 
isolation, these additional costs would be expected to increase 
transaction costs of security-based swap trading, suppressing trading, 
and liquidity. Insofar as the benefits of the regulations do not 
counteract these effects, price discovery may be harmed and 
opportunities for risk sharing may be

[[Page 44035]]

reduced. This, in turn, can potentially reduce the supply of credit to 
the real economy.
    Although data limitations discussed above prevent the Commission 
from quantifying efficiency gains or losses from the rules being 
adopted, based on its judgment and experience, the Commission believes 
that the final rules will have a positive contribution to the overall 
efficiency of the market. The final rules work together to help improve 
the financial stability of participants in security-based swap market, 
and in so doing help address the market failures resulting from the 
possibility of counterparty defaults. By imposing margin requirements 
on nonbank SBSDs, the final margin rules reduce counterparty exposures 
and the expected costs borne by non-defaulting counterparties in the 
event of a counterparty default. While these new margin requirements 
provide protection for the margin collector against the default of the 
margin poster, they could simultaneously expose the poster of initial 
margin to additional credit risk. To address this risk, the 
Commission's segregation rules help ensure that posted initial margin 
is adequately protected. Finally, by imposing capital requirements on 
nonbank SBSDs and MSBSPs, the capital rules help reduce the probability 
of their default and moreover, increase the likelihood of recoveries in 
the event of default.
    As mentioned earlier, several commenters urged the Commission to 
harmonize with other regulatory regimes when developing these rules. 
One commenter cited impacts on efficiency, competition, and capital 
formation, while another was concerned about the loss of netting and 
risk management efficiencies caused by fragmentation of trading 
activities.\1288\ In developing its rules on capital, margin, and 
segregation for SBSDs and MSBSPs, the Commission has sought to minimize 
costs to the affected entities and other participants in the security-
based swap market while still achieving the broader economic objective 
of enhancing financial stability. One key feature of the Commission's 
approach has been maintaining consistency with existing regulations 
applicable to broker-dealers. This consistency reduces compliance costs 
for entities with affiliates already subject to the Commission's 
broker-dealer financial responsibility rules. This consistent approach 
to regulation across firms subject to the Commission's rules can also 
reduce the potential for regulatory arbitrage and lead to simpler 
interpretation and enforcement of applicable regulatory requirements 
across U.S. securities markets. Moreover, the final rules reflect the 
Commission's consideration of rules promulgated by the CFTC and the 
prudential regulators. For example, Rule 18a-3, while modeled on the 
broker-dealer margin rule, includes significant modifications that 
further harmonize it with the final margin rules of the CFTC and the 
prudential regulators.\1289\
---------------------------------------------------------------------------

    \1288\ See MFA/AIMA 11/19/2018 Letter; Mizuho/ING Letter.
    \1289\ See section II.B. of this release.
---------------------------------------------------------------------------

    For entities that choose to consolidate security-based swap dealing 
under a broker-dealer, the Commission's approach helps to simplify and 
streamline risk management, allows for the more efficient use of 
capital, and creates operational efficiencies such as avoiding the need 
for multiple netting and other agreements. It also facilitates the 
ability to provide portfolio margining of security-based swaps with 
other types of securities, and in particular single-name CDS along with 
bonds that serve as reference obligations for the CDS. This can yield 
additional efficiencies for clients conducting business in securities 
and security-based swaps, including netting benefits,\1290\ a reduction 
in the number of account relationships required with affiliated 
entities, and a reduction in the number of governing agreements.
---------------------------------------------------------------------------

    \1290\ See, e.g., paragraph (c)(5) of Rule 18a-3, as adopted. 
See MFA 2/22/2013 Letter.
---------------------------------------------------------------------------

    The final rules also offer various flexibilities that aim to 
minimize compliance burdens without subverting the objectives of the 
rules, such as allowing counterparties the flexibility to post a 
variety of collateral types to meet margin requirements, providing a 
$50 million initial margin threshold, and permitting the use of third-
party models in margin calculations. Similarly, the omnibus segregation 
requirements of Rule 15c3-3, as amended, and Rule 18a-4, as adopted, 
provide a less expensive segregation alternative to individual 
segregation.\1291\
---------------------------------------------------------------------------

    \1291\ See 15 U.S.C. 78c(f)(1)(B).
---------------------------------------------------------------------------

2. Competition
    The final capital, margin, and segregation rules significantly 
alter the regulatory environment for registered nonbank SBSDs and 
MSBSPs, and in the case of the segregation requirements, all SBSDs and 
MSBSPs participating in the U.S. security-based swap market. Thus, 
these new regulations are likely to have direct implications for 
competition among SBSDs and MSBSPs subject to the Commission's 
jurisdiction. As discussed in this section and elsewhere in this 
release, and notwithstanding uncertainties about potential effects on 
competition, the Commission believes that the final rules and 
amendments are appropriate because they achieve the purposes of the 
Exchange Act, including by improving financial stability. Because the 
Commission does not have sole rulemaking authority for all SBSDs and 
MSBSPs in the U.S. security-based swap market, and because the 
security-based swap market is global with competition across 
jurisdictional boundaries, consideration of the effects of the 
Commission's rules on competition is not limited to entities directly 
affected by the Commission's rules. In particular, U.S. banks operating 
in these markets are subject to capital and margin regulations already 
adopted by the prudential regulators.\1292\ These entities may compete 
in the security-based swap market with entities regulated by the 
Commission. Similarly, foreign banking entities subject to foreign 
capital, margin, and segregation requirements may actively compete with 
these same entities. In the following subsection the Commission 
considers the impact of its rules on competition in these various 
contexts.
---------------------------------------------------------------------------

    \1292\ See Prudential Regulator Margin and Capital Adopting 
Release, 80 FR 74840.
---------------------------------------------------------------------------

a. Nonbank SBSDs
    The rules and amendments being adopted by the Commission are 
expected to have a significant impact on the regulatory environment of 
nonbank SBSDs; namely, stand-alone SBSDs and broker-dealer SBSDs. Under 
the baseline, stand-alone SBSDs are largely unregulated and hence not 
subject to capital or margin requirements on security-based swap 
transactions. Generally speaking, broker-dealers have historically not 
engaged in security-based swap transactions due to--among other 
factors--the relatively high capital costs of such transactions and the 
segregation requirements under existing broker-dealer capital and 
segregation rules. Thus, security-based swap dealing activity has been 
concentrated in stand-alone SBSDs and banks, which were not subject to 
the Commission's rules.\1293\ The new rules and amendments create a 
harmonized regulatory environment

[[Page 44036]]

for all nonbank SBSDs. By improving the financial stability of nonbank 
SBSDs, the final capital, margin, and segregation rules are likely to 
promote trade between nonbank SBSDs and a wide range of non-dealer 
counterparties, with potential benefits to competition. However, as 
discussed in more detail below, a harmonized set of rules for both 
stand-alone and broker-dealer SBSDs may also provide broker-dealers 
certain economies of scale and scope. These economies of scale and 
scope may provide incentives for market participants to migrate their 
security-based swap transaction activity away from stand-alone SBSDs. 
The Commission acknowledges that such migration could lead to further 
concentration in dealing activity.
---------------------------------------------------------------------------

    \1293\ The references to the historical activities of ``nonbank 
SBSDs'' in this discussion is somewhat imprecise as it refers to 
entities that operated prior to the Commission's adoption of 
security-based swap entity definitions and registration 
requirements. Such references should be interpreted to refer to 
entities that would have been required to register as SBSDs had the 
Commission's security-based swap entity registration requirements 
been in effect at the time. See Registration Process for Security-
Based Swap Dealers and Major Security-Based Swap Participants, 80 FR 
48964.
---------------------------------------------------------------------------

    Under the baseline, security-based swap dealing activity is 
dominated by a few large financial firms, reflecting in part the 
counterparty credit risk concerns of counterparties. The Commission's 
capital, margin, and segregation rules are expected to enhance the 
financial stability of entities subject to its rules, namely stand-
alone and broker-dealer SBSDs. This may, in turn, favorably increase 
the views of market participants about the creditworthiness of nonbank 
SBSDs, increasing the amount of trade with these dealers and attracting 
new entrants to the industry. However, prospective new entrants will 
have to evaluate the costs of establishing and maintaining compliance 
with the Commission's new rules against the value of dealing in 
security-based swaps. As discussed above in sections VI.B.1. and 
VI.B.3. of this release, nonbank SBSDs will be subject to capital and 
margin requirements that vary depending on whether the nonbank SBSD 
obtains approval to use internal models. Although the costs of 
obtaining approval to use such models would likely not be large for the 
five ANC broker-dealers currently using models to compute net capital, 
for prospective dealers that are not ANC broker-dealers these costs 
could be large and place the nonbank SBSD at a competitive disadvantage 
relative to those nonbank SBSDs already are authorized to use internal 
models. In particular, a nonbank SBSD authorized to use internal models 
can make more efficient use of its capital and pass on some of the 
benefits to customers in the form of competitive pricing. Therefore, 
the success of a new entrant to attract order flow in the security-
based swap business would also depend on the extent to which the 
entrant would be able to obtain the Commission's approval to use 
internal models.\1294\ As several commenters observed, nonbank SBSDs 
lacking such approvals will generally find it difficult to compete with 
SBSDs that have obtained approvals.\1295\ However, as discussed above, 
the use of models for capital purposes is standard in financial market 
regulation. Indeed, the prudential regulators' rules for bank SBSDs and 
bank swap dealers, as well as the Commission's own rules for ANC 
broker-dealers, permit the use of internal models for capital purposes. 
Furthermore, the CFTC has proposed permitting nonbank swap dealers to 
use models for capital purposes. While the Commission acknowledges the 
potential competitive advantage identified by commenters, the 
Commission believes it is appropriate to promote consistency with these 
other regulatory approaches.
---------------------------------------------------------------------------

    \1294\ See, e.g., Alternative Net Capital Requirements for 
Broker-Dealers That Are Part of Consolidated Supervised Entities, 69 
FR at 34455 (stating that the ``major benefit for the broker-
dealer'' of using an internal model ``will be lower deductions from 
net capital for market and credit risk''). See also OTC Derivatives 
Dealer Release, 63 FR 59362. Given the significant benefits of using 
models in reducing the capital required for security-based swap 
positions, it is likely that for new entrants to capture substantial 
volume in security-based swaps they will need to use models.
    \1295\ See CFA Institute Letter; Systemic Risk Council Letter; 
SIFMA 11/19/2018 Letter.
---------------------------------------------------------------------------

    As noted above, while the Commission's rules may encourage 
competition in the security-based swap market by increasing the safety 
and soundness of nonbank SBSDs (and thereby favorably increasing market 
participants' views about the creditworthiness of these dealers), they 
may also incentivize migration of dealing activities to broker-dealer 
SBSDs. Aggregating security-based swaps business with other securities 
businesses in a single entity, such as a broker-dealer SBSD, can help 
simplify and streamline risk management, allow more efficient use of 
capital, and avoid the need for multiple netting and other agreements. 
This increase in operating flexibility may yield efficiencies for 
clients conducting business in securities and security-based swaps, 
including netting benefits, portfolio margining, a reduction in the 
number of account relationships required with affiliated entities, and 
a reduction in the number of governing agreements. In particular, 
broker-dealer SBSDs could gain a competitive edge over stand-alone 
SBSDs by passing on some of the benefits from the added operating 
flexibility to their customers. Similar considerations may make it 
relatively costly for customers to transact through multiple dealers. 
To the extent that customers consolidate their positions with a single 
dealer, opportunities for smaller, more specialized dealers may be 
diminished. Moreover, customers consolidating their positions at a 
single and more efficient broker-dealer SBSD may find it more 
operationally difficult to change SBSDs in the future.
    On the other hand, the less restrictive capital requirements 
applicable to stand-alone SBSDs could result in lower costs to these 
firms and, in turn, lower fees for their security-based swap customers. 
This could draw business away from broker-dealer SBSDs in the favor of 
stand-alone SBSDs.
    The Commission acknowledges the various aforementioned competitive 
impacts, including the potential advantages held by broker-dealer and 
stand-alone SBSDs approved to use models over entities that must use 
standardized haircuts. However, overall, the Commission does not expect 
these competitive impacts to have a major net effect on competition 
among entities currently operating as nonbank SBSDs or those likely to 
do so in the immediate future. As noted in the baseline discussion 
above, security-based swap dealing activity is highly concentrated in a 
few entities affiliated with large national and international banking 
groups. This concentrated market structure reflects the importance of 
counterparty credit quality, scale, and financial sophistication to 
operating in the security-based swap market. The importance of these 
factors is not expected to be materially affected by the Commission's 
rules, nor are the rules expected to have significant disproportionate 
impacts on particular subsets of entities that currently operate as 
dealers in the security-based swap market.
b. Nonbank SBSDs and Bank SBSDs
    The final margin, capital, and segregation rules have the potential 
to affect domestic competition in the security-based swap market 
significantly due to differences in the regulation of bank and nonbank 
SBSDs. As discussed above in sections I and II of this release, the 
rules adopted by the prudential regulators were considered in 
developing the Commission's capital, margin, and segregation 
requirements for SBSDs and MSBSPs. Nevertheless, the Commission's final 
rules differ in certain respects from the rules adopted by the 
prudential regulators. While some differences are based on differences 
in the activities of securities firms and banks, other differences 
reflect an alternative approach to balancing relevant policy choices 
and considerations.

[[Page 44037]]

    Large national and international banking groups that dominate 
dealing activity in the security-based swap market enjoy considerable 
flexibility in organizing their operations. Such entities can be 
expected to minimize the private compliance costs of participating in 
the security-based swap market by organizing their activities to take 
advantage of differences in regulators' policy choices. Prior to the 
passage of the Dodd-Frank Act and subsequent rulemaking, these entities 
have been able to conduct security-based swap dealing from either their 
prudentially regulated bank affiliates or affiliated nonbank entities. 
In either case, they were not subject to margin requirements. Following 
the passage of Dodd-Frank, these entities will have to reconsider the 
costs and benefits of these alternative organizational structures 
taking into consideration differences in capital, margin, and 
segregation requirements applicable to the different types of entities.
    An SBSD's choice between these competing regulatory regimes will 
likely be driven by the relative costs arising from differences in the 
two regimes. The most significant of these differences are: (1) Initial 
margin requirements for inter-dealer transactions; (2) segregation 
requirements; (3) capital treatment of security-based swaps; and (4) 
availability of collateral financing.
    The Commission's margin requirements on inter-dealer transactions 
are not consistent with the prudential regulators' rules. Under the 
Commission's final margin rule, nonbank SBSDs are not required to 
collect initial margin from financial market intermediaries, including 
other SBSDs. In contrast, under the prudential regulators' rules, 
covered entities, including SBSDs, are required to exchange initial 
margin on inter-dealer transactions. Furthermore, covered entities are 
required to segregate the initial margin at an independent third-party 
custodian.
    The prudential regulators' approach to collateralizing inter-dealer 
transactions puts significant strain on dealers' capital. Under this 
approach, dealers ``consume'' their own capital every time they enter a 
transaction with other dealers. As a result, market-making activities, 
such as book-matching transactions with end users, become very capital 
intensive. While bank SBSDs may have access to alternative ways of 
funding collateral relative to nonbank SBSDs, the sheer amount of 
collateral needed to intermediate non-cleared security based swaps 
under the prudential regulators' margin rule will make it expensive for 
bank SBSDs to conduct business in this market.
    The Commission's approach does not require that nonbank SBSDs 
collect initial margin from financial market intermediaries, but it 
does require them to take capital deductions in lieu of margin or 
credit risk charges with respect to uncollateralized potential futures 
exposures. They also will need to increase their net capital by a 
factor proportional to the initial margin that would cover this 
exposure when the amount of the 2% margin factor reaches or exceeds 
their minimum fixed-dollar net capital requirement. However, this 
additional capital is not likely to exceed the initial margin for the 
exposure, which means that for a given inter-dealer exposure, a nonbank 
SBSD will likely allocate less capital than a bank SBSD. Furthermore, 
unlike the prudential regulators' margin rules, the additional capital 
that nonbank SBSDs have to allocate to inter-dealer exposures is always 
under the firm's control. In addition, while bank SBSDs are not subject 
to a requirement to deduct 100% of the value of initial margin posted 
to a counterparty, nonbank SBSDs may avoid this deduction using the 
guidance in section II.A.2.b.i. of this release.
    These considerations suggest that nonbank SBSDs may have a 
competitive advantage over bank SBSDs in the market for non-cleared 
security-based swaps. In particular, a bank holding company may 
determine to structure its dealing activities into a nonbank SBSD. 
However, this competitive advantage may be muted given the advantages 
bank SBSDs have over nonbank SBSDs in terms of access to low cost 
sources of funding (i.e., deposits) and central bank support 
mechanisms.
    A counterparty posting initial margin to an SBSD for a non-cleared 
security-based swap transaction may elect individual segregation or to 
waive segregation (if permitted to waive segregation) under section 
3E(f) of the Exchange Act, or elect that the initial margin be held 
directly by the SBSD subject to the omnibus segregation requirements of 
the Commission's final segregation rule. Under the margin rule of the 
prudential regulators, initial margin must be segregated in an 
individual account at an independent third-party custodian.
    Individual segregation of collateral is expensive because it 
prevents the re-hypothecation of collateral along intermediation 
chains. With individual segregation, the amount of initial margin 
required to support the transfer of risk from party A to party B 
depends on the length of the intermediation chain linking party A to 
party B (i.e., the number of SBSDs with matched books standing between 
the initial transaction by party A and the final transaction with party 
B): Each SBSD in the chain may require initial margin to be ``locked 
up'' at the custodian. In contrast, when individual segregation is not 
used, the amount of collateral required to support the transfer of risk 
from party A to party B does not depend on the length of the 
intermediation chain linking party A to party B; at each non-terminal 
link in the chain initial margin that is collected by an SBSD can be 
delivered to the SBSD that is the next link in the chain (i.e., the 
initial margin can be re-hypothecated).
    Thus, operating as a nonbank SBSD could provide a potential cost 
advantage. Specifically, if the parties along an intermediation chain 
are willing to rely on the default omnibus segregation regime, or agree 
to waive segregation entirely (when this is permitted), then the amount 
of collateral necessary to support the transaction can be considerably 
smaller than under third-party segregation. For example, a CDS 
transaction involving 3 dealers where dealer A purchases protection 
from dealer B who in turn purchases this protection from dealer C 
requires approximately two units of initial margin under third-party 
segregation: Dealer C provides one unit collateral to the third-party 
custodian for the benefit of dealer B, while dealer B provides another 
unit of collateral to the third-party custodian for the benefit of 
dealer A. Conversely, under omnibus segregation or waived segregation, 
only one unit of collateral is required: The collateral posted by 
dealer C is received by dealer B, who may then use the collateral 
received to satisfy his posting obligation to dealer A.
    As noted earlier, nonbank SBSDs will be required to allocate 
capital for their dealing activities in the market for non-cleared 
security-based swaps. Importantly, uncollateralized exposures from 
inter-dealer transactions require that these entities scale up their 
minimum net capital by a factor proportional to the initial margin of 
the exposure if the amount of the 2% margin factor equals or exceeds 
the firm's fixed-dollar minimum net capital requirement. Furthermore, 
dealers are required to take a capital deduction in lieu of margin or 
credit risk charge for the uncollateralized inter-dealer potential 
future exposures.
    Similarly, bank SBSDs will also have to allocate capital for their 
exposures with other covered entities, including other dealers. The 
capital that supports a bank SBSD's dealing activities in the

[[Page 44038]]

OTC markets is determined in accordance with the prudential regulators' 
capital rules. These rules require that bank SBSDs calculate a risk 
weight amount for each of their exposures, including exposure to non-
cleared security-based swaps. Furthermore, the rules require that bank 
SBSDs calculate an additional risk weight amount for the exposure 
created through the posting of initial margin to collateralize a non-
cleared security-based swap. However, both of these risk weight amounts 
are likely to be small. The dealer's exposure to a covered-entity 
counterparty is collateralized by the initial margin that the 
counterparty has to post with a third-party custodian (for the benefit 
of the dealer), and the risk weight of this exposure reflects almost 
entirely the risk weight of the collateral--usually minimal. Similarly, 
by posting initial margin, the dealer creates an exposure to the third-
party custodian holding the collateral. Custodian banks usually have 
low risk weights.
    The capital that bank SBSDs have to allocate for their non-cleared 
security-based swaps equals the sum of the two risk weight amounts 
calculated above multiplied by a factor--usually 8%. Thus, the capital 
that a bank SBSD has to allocate to support a non-cleared security-
based swap is relatively small, and likely of the same order of 
magnitude as the capital that a nonbank SBSD would have to allocate for 
a similar exposure. However, the bank SBSD must deliver initial margin 
to certain counterparties. The posting of collateral will ``consume'' 
the bank SBSD's capital, and gives nonbank SBSD a comparative advantage 
in terms of capital efficiency. However, this advantage will not exist 
if a nonbank SBSD transacts with a bank SBSD because in this scenario 
the bank SBSD will be required to collect initial margin from the 
nonbank SBSD. It also will not exist if a counterparty demands initial 
margin from the nonbank SBSD under the terms of an agreement between 
the two parties. While collateral posting makes dealing under a bank 
SBSD structure costly, the cost of funding such collateral is likely 
smaller for these dealers compared to nonbank SBSDs. Unlike nonbank 
SBSDs, bank SBSD may have access to low cost sources of collateral 
funding, including deposits or a discount window with a central bank.
    Several commenters addressed the impact of the final rules on 
competition between bank and nonbank SBSDs. One commenter stated that 
the Commission's proposal would make nonbank SBSDs uncompetitive, and 
that consistency with the CFTC's margin and capital rules is also 
necessary for nonbank SBSDs to be competitive with bank SBSDs.\1296\ 
This commenter noted that bank SBSDs will be subject to a single set of 
capital and margin rules for security-based swaps and swaps, but that 
nonbank SBSDs that are also registered with the CFTC as swap dealers 
would be subject to two sets of requirements with respect to these 
instruments. This commenter believed that the proposal's 
inconsistencies with other regulators' regimes would increase costs. 
Another commenter stated that the proposed capital requirements would 
result in a very different approach to capital for bank holding company 
subsidiaries that are swap dealers (based on the CFTC's proposal to 
apply the bank capital standard to these entities) and for such 
subsidiaries that are SBSDs, again potentially preventing the 
establishment of dually registered entities.\1297\ Similarly, other 
commenters noted that the Commission's capital and margin rules would 
increase costs and reduce efficiency due to their potential 
inconsistency with the BCBS/IOSCO Paper, foreign requirements, and 
other domestic regulators' rules.\1298\ One commenter argued that 
several components of the proposed margin rules differ from the 
recommended framework in the BCBS/IOSCO Paper and would generally make 
nonbank SBSDs uncompetitive with bank SBSDs and foreign SBSDs.\1299\ 
The commenter argued that the Commission could best address these 
differences by permitting OTC derivatives dealers and stand-alone SBSDs 
to collect and maintain margin in a manner consistent with the 
recommendations of the BCBS/IOSCO Paper.
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    \1296\ See SIFMA 2/22/2013 Letter.
    \1297\ See Financial Services Roundtable Letter.
    \1298\ See CFA Institute Letter; ISDA 1/23/2013 Letter; KfW 
Bankengruppe Letter; Morgan 10/29/2014 Stanley Letter; SIFMA 2/22/
2013 Letter.
    \1299\ See SIFMA 11/19/2018 Letter.
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    As discussed above in section II.A. of this release, the Commission 
has made two significant modifications to the final capital rules for 
nonbank SBSDs that should mitigate some of these concerns raised by 
commenters. First, as discussed above in section II.A.2.b.v. of this 
release, the Commission has modified Rule 18a-1 so that it no longer 
contains a portfolio concentration charge that is triggered when the 
aggregate current exposure of the stand-alone SBSD to its derivatives 
counterparties exceeds 50% of the firm's tentative net capital.\1300\ 
This means that stand-alone SBSDs that have been authorized to use 
models will not be subject to this limit on applying the credit risk 
charges to uncollateralized current exposures related to derivatives 
transactions. This includes uncollateralized current exposures arising 
from electing not to collect variation margin for non-cleared security-
based swap and swap transactions under exceptions in the margin rules 
of the Commission and the CFTC. The credit risk charges are based on 
the creditworthiness of the counterparty and can result in charges that 
are substantially lower than deducting 100% of the amount of the 
uncollateralized current exposure.\1301\ This approach to addressing 
credit risk arising from uncollateralized current exposures related to 
derivatives transactions is generally consistent with the treatment of 
such exposures under the capital rules for banking institutions.\1302\
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    \1300\ See paragraph (e)(2) of Rule 18a-1, as adopted. See also 
Capital, Margin, and Segregation Proposing Release, 77 FR at 70244 
(proposing a portfolio concentration charge in Rule 18a-1 for stand-
alone SBSDs).
    \1301\ See paragraph (e)(2) of Rule 18a-1, as adopted.
    \1302\ See OTC Derivatives Dealers, 63 FR at 59384-87 (``[T]he 
Board of Governors of the Federal Reserve System, the Office of the 
Comptroller of the Currency, and the Federal Deposit Insurance 
Corporation (collectively, the ``U.S. Banking Agencies'') have 
adopted rules implementing the Capital Accord for U.S. banks and 
bank holding companies. Appendix F is generally consistent with the 
U.S. Banking Agencies' rules, and incorporates the qualitative and 
quantitative conditions imposed on-banking institutions.''). The use 
of models to compute market risk charges in lieu of the standardized 
haircuts (as nonbank SBSDs will be permitted to do under Rules 15c3-
1 and 18a-1) also is generally consistent with the capital rules for 
banking institutions. Id.
---------------------------------------------------------------------------

    The second significant modification is an alternative compliance 
mechanism. As discussed above in section II.D. of this release, the 
alternative compliance mechanism will permit a stand-alone SBSD that is 
registered as a swap dealer and that predominantly engages in a swaps 
business to comply with the capital, margin, and segregation 
requirements of the CEA and the CFTC's rules in lieu of complying with 
the Commission's capital, margin, and segregation requirements.\1303\ 
The CFTC's proposed capital rules for swap dealers that are FCMs would 
retain the existing capital framework for FCMs, which imposes a net 
liquid assets test similar to the existing capital requirements for 
broker-dealers.\1304\ However, under the CFTC's proposed capital rules, 
swap dealers that are not FCMs would have the option of complying with: 
(1) A capital standard based on the capital rules for banks; (2)

[[Page 44039]]

a capital standard based on the Commission's capital requirements in 
Rule 18a-1; or (3) if the swap dealer is predominantly engaged in non-
financial activities, a capital standard based on a tangible net worth 
requirement.
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    \1303\ See Rule 18a-10, as adopted.
    \1304\ See CFTC Capital Proposing Release, 81 FR 91252.
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    In addition, as discussed above in section II.B. of this release, 
the Commission has made a number of modifications to the final margin 
rule to more closely align the rule with the margin rules of the CFTC 
and the prudential regulators.
    Nevertheless, to the extent that regulatory requirements differ 
across regimes, the Commission acknowledges the potential for 
registrants subject to more than one regulatory regime to face an 
increased compliance burden, even if capital and margin requirements 
are no more binding for dually-registered SBSDs than bank SBSDs. In 
particular, the Commission acknowledges that dual registrants may need 
to devote more resources towards compliance and regulatory monitoring. 
Because of the similarity between single-name and index CDS, the 
Commission expects that participants active in one market are likely to 
be active in the other, and dual registrants may need to devote more 
resources to ensure that the appropriate rules are applied to security-
based swap and swap transactions than a bank SBSD.
    However, as described above, the Commission expects that nonbank 
SBSDs will engage in a securities business with respect to security-
based swaps that is more similar to the dealer activities of broker-
dealers than to the lending and deposit-taking activities of commercial 
banks. Therefore, the Commission has modeled its capital, margin, and 
segregation regime on the existing rules for broker-dealers, rather 
than the rules of the CFTC and the prudential regulators. However, as 
discussed throughout this release, the Commission has modified its 
final rules in an effort to harmonize them, where appropriate, with the 
rules of the CFTC and the prudential regulators.
c. Domestic and Foreign SBSDs
    The market for security-based swaps is a global market that 
transcends traditional jurisdiction boundaries. As discussed above in 
section VI.A.1. of this release, it is quite common for counterparties 
to a security-based swap transaction to not be based in the same 
jurisdiction. The specific regulatory requirements applicable in a 
dealer's jurisdictions can create competitive advantages and 
disadvantages for that dealer vis-[agrave]-vis dealers operating in 
other jurisdictions. There exists the possibility that differences in 
the capital, margin, and segregation rules eventually adopted by 
foreign regulators and those of the Commission may create advantages or 
disadvantage for U.S. registrants participating in this global market.
    The potential disadvantages to U.S. registrants were pointed out by 
commenters. One commenter argued that because U.S. registrants must 
structure their activities so as to margin non-cleared security-based 
swaps and swaps separately from other non-centrally cleared 
derivatives, U.S. registrants would be at a significant competitive 
disadvantage to foreign competitors.\1305\ The commenter argued that 
several components of the proposed margin rules differ from the 
recommended framework in the BCBS/IOSCO Paper and would generally make 
nonbank SBSDs uncompetitive with bank SBSDs and foreign SBSDs.\1306\ 
The commenter argued that the Commission could best address these 
differences by permitting OTC derivatives dealers and stand-alone SBSDs 
to collect and maintain margin in a manner consistent with the 
recommendations of the BCBS/IOSCO Paper. Another commenter stated that 
requiring the use of the Appendix A methodology (rather than internal 
models) for initial margin calculations on non-cleared equity security-
based swaps would place U.S.-based nonbank SBSDs at a competitive 
disadvantage in the market.\1307\ For example, the technical standards 
published by the European regulators do not include similar provisions 
precluding the use of internal models in the calculation of initial 
margin for equity swaps. As discussed above in section VI.B.3. of this 
release, while the Commission acknowledges that the Appendix A 
methodology has certain limitations, the Commission believes that 
permitting the use of internal models for equity swaps could lead to 
inadequate margin levels in comparison to the broker-dealer margin 
rules. However, the Commission has modified the final rule to permit 
nonbank SBSDs that are not broker-dealers to apply to the Commission to 
use internal models to compute initial margin for equity-based 
security-based swaps.
---------------------------------------------------------------------------

    \1305\ See SIFMA 3/12/2014 Letter.
    \1306\ See SIFMA 11/19/2018 Letter.
    \1307\ See ISDA 1/23/2013 Letter.
---------------------------------------------------------------------------

    Based on a review of proposals by European regulators, the 
Commission does not believe that its capital, margin, and segregation 
rules will place U.S. firms at a significant competitive disadvantage 
in the security-based swap market. Although certain aspects of the 
Commission's rules--such as the required use of Appendix A methodology 
for calculating initial margin for equity security-based swaps for 
broker-dealer SBSDs--are more restrictive than the corresponding 
aspects of the European rules, other aspects are less restrictive. In 
addition, foreign entities transacting with U.S. counterparties will, 
absent Commission approval for substituted compliance (with respect to 
capital and margin requirements) or transaction-based exceptions (with 
respect to segregation requirements), be subject to the Commission's 
rules. Thus, differences in foreign regulatory regimes are expected to 
have only limited impact in terms of competition for the business of 
domestic end users.
d. Nonbank MSBSPs
    Some of the considerations outlined above for SBSDs apply to the 
analysis of the competitive effects on nonbank MSBSPs, although here 
the impact on competition is likely to be even more limited. The key 
characteristic distinguishing nonbank MSBSPs from nonbank SBSDs is that 
the former do not engage in dealing activity. Thus, the population of 
MSBSPs will likely consist of large financial non-dealing entities that 
maintain significant non-cleared security-based swap exposures. Under 
the final capital, margin, and segregation rules, such entities are 
subject to less extensive requirements than nonbank SBSDs, and 
consequently, the costs of compliance with these requirements is--other 
things being equal--expected to be less significant.
    That said, the Commission acknowledges that some (non-dealing) 
market participants' internal systems and processes may not be designed 
to handle the new requirements. For example, under the new rules, 
nonbank MSBSPs will in most cases be required to post and collect 
variation margin on a daily basis. This requires back-office systems 
and procedures capable of handling the daily exchange of collateral. 
For certain participants in the non-cleared security-based swap market, 
such a capability may be absent or inadequate. Similarly, under the new 
capital provisions, nonbank MSBSPs will be required to ensure that 
tangible net worth is positive at all times; again, certain non-cleared 
security-based swap market participants may not currently possess 
systems or procedures for tracking tangible net worth on a real-time 
basis.\1308\
---------------------------------------------------------------------------

    \1308\ In determining net worth, all long and short positions in 
security-based swaps, swaps, and related positions must be marked to 
their market value. See Rule 18a-2, as adopted.

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[[Page 44040]]

    Disparities in the ease with which potential nonbank MSBSPs could 
comply with the Commission's new rules could rearrange the relative 
competitive positions of these entities. However, the Commission 
believes the registration thresholds for nonbank MSBSPs that the 
Commission has previously adopted are sufficiently high to minimize 
such disruptions. As discussed above in section VI.A. of this release, 
the Commission expects that between zero and five entities will 
initially register as MSBSPs, and that these entities will be operating 
at a scale where prudent risk management practices already include much 
of the infrastructure necessary to implement systems and procedures 
that can satisfy the Commission's new requirements.

VII. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \1309\ requires Federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small entities. Pursuant to Section 605(b) of the RFA,\1310\ the 
Commission certified in the proposing release and the cross-border 
proposing release that proposed new Rules 3a71-6 and 18a-1 through 18a-
4, and the proposed amendments to Rules 15c3-1 and 15c3-3 would not 
have a significant economic impact on any ``small entity'' \1311\ for 
purposes of the RFA.\1312\ The Commission is also adopting Rule 18a-10 
today.
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    \1309\ See 5 U.S.C. 601 et seq.
    \1310\ See 5 U.S.C. 605(b).
    \1311\ Although Section 601(b) of the RFA defines the term 
``small entity,'' the statute permits agencies to formulate their 
own definitions. The Commission has adopted definitions for the term 
``small entity'' for the purposes of Commission rulemaking in 
accordance with the RFA. Those definitions, as relevant to this 
rulemaking, are set forth in 17 CFR 240.0-10 (``Rule 0-10''). See 
Statement of Management on Internal Accounting Control, Exchange Act 
Release No. 18451, (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982).
    \1312\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers; Proposed 
Rule, 77 FR at 70328-70329; Cross-Border Proposing Release, 78 FR at 
31204-31205.
---------------------------------------------------------------------------

    For purposes of Commission rulemaking in connection with the RFA, a 
small entity includes: (1) When used with reference to an ``issuer'' or 
a ``person,'' other than an investment company, an ``issuer'' or 
``person'' that, on the last day of its most recent fiscal year, had 
total assets of $5 million or less,\1313\ or (2) a broker-dealer with 
total capital (net worth plus subordinated liabilities) of less than 
$500,000 on the date in the prior fiscal year as of which its audited 
financial statements were prepared pursuant to paragraph (d) of Rule 
17a-5,\1314\ or, if not required to file such statements, a broker-
dealer with total capital (net worth plus subordinated liabilities) of 
less than $500,000 on the last day of the preceding fiscal year (or in 
the time that it has been in business, if shorter); and is not 
affiliated with any person (other than a natural person) that is not a 
small business or small organization.\1315\ Under the standards adopted 
by the Small Business Administration, small entities in the finance and 
insurance industry include the following: (1) For entities in credit 
intermediation and related activities,\1316\ firms with $175 million or 
less in assets; (2) for non-depository credit intermediation and 
certain other activities,\1317\ firms with $7 million or less in annual 
receipts; (3) for entities in financial investments and related 
activities,\1318\ firms with $7 million or less in annual receipts; (4) 
for insurance carriers and entities in related activities,\1319\ firms 
with $7 million or less in annual receipts; and (5) for funds, trusts, 
and other financial vehicles,\1320\ firms with $7 million or less in 
annual receipts.\1321\
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    \1313\ See 17 CFR 240.0-10(a).
    \1314\ See 17 CFR 240.17a-5(d).
    \1315\ See 17 CFR 240.0-10(c).
    \1316\ Including commercial banks, savings institutions, credit 
unions, firms involved in other depository credit intermediation, 
credit card issuing, sales financing, consumer lending, real estate 
credit, and international trade financing.
    \1317\ Including firms involved in secondary market financing, 
all other non-depository credit intermediation, mortgage and 
nonmortgage loan brokers, financial transactions processing, reserve 
and clearing house activities, and other activities related to 
credit intermediation.
    \1318\ Including firms involved in investment banking and 
securities dealing, securities brokerage, commodity contracts 
dealing, commodity contracts brokerage, securities and commodity 
exchanges, miscellaneous intermediation, portfolio management, 
providing investment advice, trust, fiduciary and custody 
activities, and miscellaneous financial investment activities.
    \1319\ Including direct life insurance carriers, direct health 
and medical insurance carriers, direct property and casualty 
insurance carriers, direct title insurance carriers, other direct 
insurance (except life, health and medical) carriers, reinsurance 
carriers, insurance agencies and brokerages, claims adjusting, third 
party administration of insurance and pension funds, and all other 
insurance related activities.
    \1320\ Including pension funds, health and welfare funds, other 
insurance funds, open-end investment funds, trusts, estates, and 
agency accounts, real estate investment trusts, and other financial 
vehicles.
    \1321\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    With respect to nonbank SBSDs and MSBSPs, based on feedback from 
market participants and the Commission's information about the 
security-based swap market, the Commission continues to believe that: 
(1) The types of entities that would engage in more than a de minimis 
level of dealing activity involving security-based swaps--which 
generally would be large financial institutions--would not be ``small 
entities'' for purposes of the RFA; and (2) the types of entities that 
may have security-based swap positions above the level required to 
register as ``major security-based swap participants'' would not be 
``small entities'' for purposes of the RFA. Thus, it is unlikely that 
Rules 18a-1 through 18a-4, Rule 18a-10, and the amendments to Rules 
15c3-1, 15c3-3, and 3a71-6 will have a significant economic impact on 
any small entity.
    The Commission estimates that as of December 31, 2018, there were 
approximately 996 broker-dealers that were ``small'' for the purposes 
Rule 0-10. While certain amendments to Rules 15c3-1 and 15c3-3 will 
apply to stand-alone broker-dealers, these amendments will not have any 
impact on ``small'' broker-dealers, since few, if any, of these firms 
engage in security-based swaps activities.\1322\
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    \1322\ The amendments are discussed in detail in sections I, II, 
and III of this release. The Commission discusses the economic 
impact, including the compliance costs and burdens, of the 
amendments in section IV (PRA) and section VI (Economic Analysis) of 
this release.
---------------------------------------------------------------------------

    For the foregoing reasons, the Commission certifies that new Rules 
18a-1 through 18a-4, new Rule 18a-10, and the amendments to Rules 3a71-
6, 15c3-1, and 15c3-3 will not have a significant economic impact on a 
substantial number of small entities for purposes of the RFA.

VIII. Statutory Basis

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and 
particularly, Sections 3(b), 3E, 15, 15F, and 23(a) (15 U.S.C. 78c(b), 
78c-5, 78o, 78o-10, and 78w(a)), thereof, the Commission is amending 
Sec. Sec.  200.30-3, 240.3a71-6, 240.15c3-1, 240.15c3-1a, 240.15c3-1b, 
240.15c3-1d, 240.15c3-1e, and 240.15c3-3, and adopting Sec. Sec.  
240.15c3-3b, 240.18a-1, 240.18a-1a, 240.18a-1b, 240.18a-1c, 240.18a-1d, 
240.18a-2, 240.18a-3, 240.18a-4, 240.18a-4a, and 240.18a-10 under the 
Exchange Act.\1323\
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    \1323\ If any of the provisions of these rules, or the 
application thereof to any person or circumstance, is held to be 
invalid, such invalidity shall not affect other provisions or 
application of such provisions to other persons or circumstances 
that can be given effect without the invalid provision or 
application.
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations 
(Government agencies), Civil rights, Classified information, Conflicts 
of interest, Environmental impact statements, Equal employment

[[Page 44041]]

opportunity, Federal buildings and facilities, Freedom of information, 
Government securities, Organization and functions (Government 
agencies), Privacy, Reporting and recordkeeping requirements, Sunshine 
Act.

17 CFR Part 240

    Brokers, Confidential business information, Fraud, Reporting and 
recordkeeping requirements, Securities.

Text of Rules and Rule Amendments

    In accordance with the foregoing, title 17, chapter II of the Code 
of Federal Regulations is amended as follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND 
REQUESTS

Subpart A--Organization and Program Management

0
1. The authority citation for part 200, subpart A, continues to read in 
part as follows:

    Authority:  15 U.S.C. 77c, 77o, 77s, 77z-3, 77sss, 78d, 78d-1, 
78d-2, 78o-4, 78w, 78ll(d), 78mm, 80a-37, 80b-11, 7202, and 7211 et 
seq., unless otherwise noted.
* * * * *
    Section 200.30-3 is also issued under 15 U.S.C. 78b, 78d, 78f, 
78k-1, 78q, 78s, and 78eee.
* * * * *

0
2. Section 200.30-3 is amended by revising paragraphs (a)(7) 
introductory text, (a)(7)(i) and (iv), (a)(7)(vi)(A) and (C) through 
(F), (a)(7)(vii) and (a)(10)(i) to read as follows:

Sec.  200.30-3   Delegation of authority to Director of Division of 
Trading and Markets.

* * * * *
    (a) * * *
    (7) Pursuant to Rule 15c3-1 (Sec.  240.15c3-1 of this chapter) and 
Rule 18a-1 (Sec.  240.18a-1 of this chapter):
    (i) To approve lesser equity requirements in specialist or market 
maker accounts pursuant to Rule 15c3-1(a)(6)(iii)(B) (Sec.  240.15c3-
1(a)(6)(iii)(B) of this chapter);
* * * * *
    (iv) To approve a change in election of the alternative capital 
requirement pursuant to Rule 15c3-1(a)(1)(ii) (Sec.  240.15c3-
1(a)(1)(ii) of this chapter);
* * * * *
    (vi)(A) To review amendments to applications of brokers or dealers 
and security-based swap dealers filed pursuant to Sec. Sec.  240.15c3-
1e, 240.15c3-1g, and 240.18a-1(d) of this chapter and to approve such 
amendments, unconditionally or subject to specified terms and 
conditions;
* * * * *
    (C) To impose additional conditions, pursuant to Sec. Sec.  
240.15c3-1e(e) and 240.18a-1(d)(9)(iii) of this chapter, on a broker or 
dealer that computes certain of its net capital deductions pursuant to 
Sec.  240.15c3-1e of this chapter, or on an ultimate holding company of 
the broker or dealer that is not an ultimate holding company that has a 
principal regulator, as defined in Sec.  240.15c3-1(c)(13)(ii) of this 
chapter, or on a security-based swap dealer that computes certain of 
its net capital deductions pursuant to Sec.  240.18a-1(d) of this 
chapter;
    (D) To require that a broker or dealer, or the ultimate holding 
company of the broker or dealer, or a security-based swap dealer 
provide information to the Commission pursuant to Sec. Sec.  240.15c3-
1e(a)(1)(viii)(G), 240.15c3-1e(a)(1)(ix)(C) and (a)(4), 240.18a-
1(d)(2), and 240.15c3-1g(b)(1)(i)(H), and (b)(2)(i)(C) of this chapter;
    (E) To determine, pursuant to Sec. Sec.  240.15c3-1e(a)(10)(ii) and 
240.18a-1(d)(7)(ii), that the notice that a broker or dealer and 
security-based swap dealer must provide to the Commission pursuant to 
Sec. Sec.  240.15c3-1e(a)(10)(i) and 240.18a-1(d)(7)(i) of this chapter 
will become effective for a shorter or longer period of time; and
    (F) To approve, pursuant to Sec. Sec.  240.15c3-1e(a)(7)(ii) and 
240.18a-1(d)(5)(ii) of this chapter, the temporary use of a provisional 
model, in whole or in part, unconditionally or subject to any 
conditions or limitations;
    (vii)(A) To approve the prepayments of a subordinated loan 
agreement of a security-based swap dealer pursuant to Sec.  240.18a-
1d(b)(6) of this chapter;
    (B) To approve a prepayment of a revolving subordinated loan 
agreement of a security-based swap dealer pursuant to Sec.  240.18a-
1d(c)(4) of this chapter; and
    (C) To examine a proposed subordinated loan agreement filed by a 
security-based swap dealer and to find it acceptable pursuant to Sec.  
240.18a-1d(c)(5) of this chapter.
* * * * *
    (10)(i) Pursuant to Rule 15c3-3 (Sec.  240.15c3-3 of this chapter) 
and Rule 18a-4 (Sec.  240.18a-4 of this chapter) to find and designate 
as control locations for purposes of Rule 15c3-3(c)(7) (Sec.  240.15c3-
3(c)(7) of this chapter), Rule 15c3-3(p)(2)(ii)(E) (Sec.  240.15c3-
3(p)(2)(ii)(E) of this chapter), and Rule 18a-4(b)(2)(v) (Sec.  
240.18a-4(b)(2)(v) of this chapter), certain broker-dealer and 
security-based swap accounts which are adequate for the protection of 
customer securities.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
3. The general authority citation for part 240 is revised, the 
sectional authorities for Sec. Sec.  240.15c3-1 and 240.15c3-3 are 
revised, adding sectional authorities for Sec. Sec.  240.15c3-1a, 
240.15c3-1e, 240.15c3-3, 240.18a-1, 240.18a-1a, 240.18a-1b, 240.18a-1c, 
240.18a-1d, 240-18a-2, 240.18a-3 and 240.18a-4 in numerical order to 
read as follows.

     Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm, 
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et 
seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 
1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-
106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
    Section 240.15c3-1 is also issued under 15 U.S.C. 78o(c)(3), 
78o-10(d), and 78o-10(e).
    Section 240.15c3-3 is also issued under 15 U.S.C. 78c-5, 
78o(c)(2), 78(c)(3), 78q(a), 78w(a); sec. 6(c), 84 Stat. 1652; 15 
U.S.C. 78fff.
* * * * *
    Sections 240.18a-1, 240.18a-1a, 240.18a-1b, 240.18a-1c, 240.18a-
1d, 240.18a-2, 240.18a-3, and 240.18a-10 are also issued under 15 
U.S.C. 78o-10(d) and 78o-10(e).
    Section 240.18a-4 is also issued under 15 U.S.C. 78c-5(f).
* * * * *

0
4. Section 240.3a71-6 is amended by adding paragraphs (d)(4) and (5) to 
read as follows:

Sec.  240.3a71-6  Substituted compliance for security-based swap 
dealers and major security-based swap participants.

* * * * *
    (d) * * *
    (4) Capital--(i) Security-based swap dealers. The capital 
requirements of section 15F(e) of the Act (15 U.S.C. 78o-10(e)) and 
Sec.  240.18a-1; provided, however, that prior to making such 
substituted compliance determination, the Commission intends to 
consider (in addition to any conditions imposed) whether the capital 
requirements of the foreign financial regulatory system are designed to 
help ensure the safety and soundness of registrants in a manner that is 
comparable to the applicable provisions arising under the Act and its 
rules and regulations.
    (ii) Major security-based swap participants. The capital 
requirements of section 15F(e) of the Act (15 U.S.C. 78o-10(e)) and 
Sec.  240.18a-2; provided,

[[Page 44042]]

however, that prior to making such substituted compliance 
determination, the Commission intends to consider (in addition to any 
conditions imposed) whether the capital requirements of the foreign 
financial regulatory system are comparable to the applicable provisions 
arising under the Act and its rules and regulations.
    (5) Margin--(i) Security-based swap dealers. The margin 
requirements of section 15F(e) of the Act (15 U.S.C. 78o-10(e)) and 
Sec.  240.18a-3; provided, however, that prior to making such 
substituted compliance determination, the Commission intends to 
consider (in addition to any conditions imposed) whether the foreign 
financial regulatory system requires registrants to adequately cover 
their current and potential future exposure to over-the-counter 
derivatives counterparties, and ensures registrants' safety and 
soundness, in a manner comparable to the applicable provisions arising 
under the Act and its rules and regulations.
    (ii) Major security-based swap participants. The margin 
requirements of section 15F(e) of the Act (15 U.S.C. 78o-10(e)) and 
Sec.  240.18a-3; provided, however, that prior to making such 
substituted compliance determination, the Commission intends to 
consider (in addition to any conditions imposed) whether the foreign 
financial regulatory system requires registrants to adequately cover 
their current exposure to over-the-counter derivatives counterparties, 
and ensures registrants' safety and soundness, in a manner comparable 
to the applicable provisions arising under the Act and its rules and 
regulations.

0
5. Section 240.15c3-1 is amended by:
0
 a. Redesignating paragraph (a)(5) as paragraph (a)(5)(i) and adding 
paragraph (a)(5)(ii);
0
 b. Revising paragraph (a)(7)(i) and (ii) and the undesignated center 
heading above paragraph (a)(7);
0
c. Adding paragraph (a)(10) with an undesignated center heading above 
it;
0
d. Revising paragraph (c)(2)(iv)(E);
0
 e. Adding paragraphs (c)(2)(vi)(O) and (P);
0
 f. Redesignating paragraph (c)(2)(xii) as paragraph (c)(2)(xii)(A) and 
adding paragraph (c)(2)(xii)(B);
0
 g. Adding paragraph (c)(2)(xv); and
0
 h. Adding paragraph (c)(17).
    The revisions and additions read as follows:

Sec.  240.15c3-1  Net capital requirements for brokers or dealers.

* * * * *
    (a) * * *
    (5) * * *
    (ii) An OTC derivatives dealer that is also registered as a 
security-based swap dealer under section 15F of the Act (15 U.S.C. 78o-
10) is subject to the capital requirements in Sec. Sec.  240.18a-1, 
240.18a-1a, 240.18a-1b, 240.18a-1c and 240.18a-1d instead of the 
capital requirements of this section and its appendices.
* * * * *
    Alternative Net Capital Computation for Broker-Dealers Authorized 
to Use Models
    (7) In accordance with Sec.  240.15c3-1e, the Commission may 
approve, in whole or in part, an application or an amendment to an 
application by a broker or dealer to calculate net capital using the 
market risk standards of Sec.  240.15c3-1e to compute a deduction for 
market risk on some or all of its positions, instead of the provisions 
of paragraphs (c)(2)(vi) and (vii) of this section, and Sec.  240.15c3-
1b, and using the credit risk standards of Sec.  240.15c3-1e to compute 
a deduction for credit risk on certain credit exposures arising from 
transactions in derivatives instruments, instead of the provisions of 
paragraphs (c)(2)(iv) and (c)(2)(xv)(A) and (B) of this section, 
subject to any conditions or limitations on the broker or dealer the 
Commission may require as necessary or appropriate in the public 
interest or for the protection of investors. A broker or dealer that 
has been approved to calculate its net capital under Sec.  240.15c3-1e 
must:
    (i)(A) At all times maintain tentative net capital of not less than 
$5 billion and net capital of not less than the greater of $1 billion 
or the sum of the ratio requirement under paragraph (a)(1) of this 
section and:
    (1) Two percent of the risk margin amount; or
    (2) 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
    (3) 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)(7)(i)(B) of this section;
    (B) If, after considering the capital and leverage levels of 
brokers or dealers subject to paragraph (a)(7) of this section, 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)(7)(i)(A)(2) or (3) of this section, the Commission 
will publish a notice of the potential change and subsequently will 
issue an order regarding any such change.
    (ii) Provide notice that same day in accordance with Sec.  240.17a-
11(g) if the broker's or dealer's tentative net capital is less than $6 
billion. The Commission may, upon written application, lower the 
threshold at which notification is necessary under this paragraph 
(a)(7)(ii), either unconditionally or on specified terms and 
conditions, if a broker or dealer satisfies the Commission that 
notification at the $6 billion threshold is unnecessary because of, 
among other factors, the special nature of its business, its financial 
position, its internal risk management system, or its compliance 
history; and
* * * * *

Broker-Dealers Registered as Security-Based Swap Dealers

    (10) A broker or dealer registered with the Commission as a 
security-based swap dealer, other than a broker or dealer subject to 
the provisions of paragraph (a)(7) of this section, must:
    (i)(A) At all times maintain net capital of not less than the 
greater of $20 million or the sum of the ratio requirement under 
paragraph (a)(1) of this section and:
    (1) Two percent of the risk margin amount; or
    (2) 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
    (3) 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)(10)(i)(B) of this section;
    (B) If, after considering the capital and leverage levels of 
brokers or dealers subject to paragraph (a)(10) of this section, 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)(10)(i)(A)(2) or (3) of this 
section, the Commission will publish a notice of the potential change 
and subsequently will issue an order regarding any such change; and
    (ii) Comply with Sec.  240.15c3-4 as though it were an OTC 
derivatives dealer with respect to all of its business activities, 
except that paragraphs (c)(5)(xiii) and (xiv), and (d)(8) and (9) of 
Sec.  240.15c3-4 shall not apply.
* * * * *

[[Page 44043]]

    (c) * * *
    (2) * * *
    (iv) * * *
    (E) Other deductions. All other unsecured receivables; all assets 
doubtful of collection less any reserves established therefor; 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 the following need not be deducted:
    (1) Any amounts deposited in a Customer Reserve Bank Account or PAB 
Reserve Bank Account pursuant to Sec.  240.15c3-3(e) or in the 
``special reserve account for the exclusive benefit of security-based 
swap customers'' established pursuant to Sec.  240.15c3-3(p)(3),
    (2) Cash and securities held in a securities account at a carrying 
broker or dealer (except where the account has been subordinated to the 
claims of creditors of the carrying broker or dealer), and
    (3) Clearing deposits.
* * * * *
    (vi) * * *
    (O) Cleared security-based swaps. In the case of a cleared 
security-based swap held in a proprietary account of the broker or 
dealer, deducting the amount of the applicable margin requirement of 
the clearing agency or, if the security-based swap references an equity 
security, the broker or dealer may take a deduction using the method 
specified in Sec.  240.15c3-1a.
    (P) 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 Sec.  240.15c3-
1(c)(2)(vi)(P)(1)(i):

                                                    Table 1 to Sec.   240.15c3-1(c)(2)(vi)(P)(1)(i )
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Basis point spread
    Length of time to maturity of credit default swap    -----------------------------------------------------------------------------------------------
                        contract                          100 or less  %    101-300  %      301-400  %      401-500  %      501-699  %    700 or more  %
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months.....................................            1.00            2.00            5.00            7.50           10.00           15.00
12 months but less than 24 months.......................            1.50            3.50            7.50           10.00           12.50           17.50
24 months but less than 36 months.......................            2.00            5.00           10.00           12.50           15.00           20.00
36 months but less than 48 months.......................            3.00            6.00           12.50           15.00           17.50           22.50
48 months but less than 60 months.......................            4.00            7.00           15.00           17.50           20.00           25.00
60 months but less than 72 months.......................            5.50            8.50           17.50           20.00           22.50           27.50
72 months but less than 84 months.......................            7.00           10.00           20.00           22.50           25.00           30.00
84 months but less than 120 months......................            8.50           15.00           22.50           25.00           27.50           40.00
120 months and longer...................................           10.00           20.00           25.00           27.50           30.00           50.00
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (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)(2)(vi)(P)(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)(2)(vi)(P)(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)(2)(vi)(P)(1)(i) of this 
section, deducting 50 percent of the amount required by paragraph 
(c)(2)(vi)(P)(1)(i) of this section on the short position plus the 
deduction required by paragraph (c)(2)(vi)(P)(1)(ii) of this section on 
the excess long position, if any. For the purposes of this section, the 
broker or 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 broker or 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 broker or dealer is long the same 
debt security, deducting 50 percent of the amount specified in 
paragraph (c)(2)(vi) or (vii) of this section for the debt security, 
provided that the broker or dealer can deliver the debt security to 
satisfy the obligation of the broker or 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 broker or 
dealer is short the debt security or a debt security issued by the 
corporate entity, deducting the amount specified in paragraph 
(c)(2)(vi) or (vii) of this section 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 broker or dealer is 
short the asset-backed security, deducting the amount specified in 
paragraph (c)(2)(vi) or (vii)

[[Page 44044]]

of this section for the asset-backed security.
    (2) Non-cleared security-based swaps that are not credit default 
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 paragraph (c)(2)(vi) of this section applicable to the reference 
security. A broker or dealer may reduce the deduction under this 
paragraph (c)(2)(vi)(P)(2) by an amount equal to any reduction 
recognized for a comparable long or short position in the reference 
security under paragraph (c)(2)(vi) of this section and, in the case of 
a security-based swap referencing an equity security, the method 
specified in Sec.  240.15c3-1a.
* * * * *
    (xii) * * *
    (B) 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, Examining Authority, 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.
* * * * *
    (xv) 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 
Sec.  240.18a-3(c)(1)(i)(B) for the account of a counterparty at the 
broker or dealer that is subject to a margin exception set forth in 
Sec.  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 broker or 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)(2)(xv)(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 broker or 
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 broker or 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 broker or dealer with the right to access the collateral to satisfy 
the counterparty's obligations to the broker or dealer arising from 
transactions in the account of the counterparty; and
    (3) The broker or 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.
* * * * *
    (17) The term risk margin amount means the sum of:
    (i) The total initial margin required to be maintained by the 
broker or 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 broker or 
dealer with respect to non-cleared security-based swaps pursuant to 
Sec.  240.18a-3(c)(1)(i)(B).
* * * * *

0
6. Section 240.15c3-1a is amended by revising paragraphs (a)(3) and (4) 
and (b)(1)(v)(C)(3) and (4) and adding paragraph (b)(1)(v)(C)(5) to 
read as follows:

Sec.  240.15c3-1a  Options (Appendix A to 17 CFR 240.15c3-1)

    (a) * * *
    (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 
section, 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.
* * * * *
    (b) * * *
    (1) * * *
    (v) * * *
    (C) * * *
    (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.
* * * * *

0
7. Section 240.15c3-1b is amended:
0
a. In paragraph (a)(3)(iii)(C) by adding the phrase ``cleared swap 
transactions or,'' before the phrase ``commodity futures or options 
transactions''; and
0
b. By adding paragraph (b).

[[Page 44045]]

    The addition reads as follows:

Sec.  240.15c3-1b  Adjustments to net worth and aggregate indebtedness 
for certain commodities transactions (Appendix B to 17 CFR 240.15c3-1).

* * * * *
    (b) Every broker or dealer in computing net capital pursuant to 
Sec.  240.15c3-1 must comply with the following:
    (1) Cleared swaps. In the case of a cleared swap held in a 
proprietary account of the broker or dealer, deducting the amount of 
the applicable margin requirement of the derivatives clearing 
organization or, if the swap references an equity security index, the 
broker or dealer may take a deduction using the method specified in 
Sec.  240.15c3-1a.
    (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 Sec.  240.15c3-1e 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 table 1 to 
Sec.  240.15c3-1a(b)(2)(i)(A):

                                                        Table 1 to Sec.   240.15c3-1a(b)(2)(i)(A)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Basis point spread
    Length of time to maturity of credit default swap    -----------------------------------------------------------------------------------------------
                        contract                            100 or less                                                                     700 or more
                                                                (%)         101-300 (%)     301-400 (%)     401-500 (%)     501-699 (%)         (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months.....................................            0.67            1.33            3.33            5.00            6.67           10.00
12 months but less than 24 months.......................            1.00            2.33            5.00            6.67            8.33           11.67
24 months but less than 36 months.......................            1.33            3.33            6.67            8.33           10.00           13.33
36 months but less than 48 months.......................            2.00            4.00            8.33           10.00           11.67           15.00
48 months but less than 60 months.......................            2.67            4.67           10.00           11.67           13.33           16.67
60 months but less than 72 months.......................            3.67            5.67           11.67           13.33           15.00           18.33
72 months but less than 84 months.......................            4.67            6.67           13.33           15.00           16.67           20.00
84 months but less than 120 months......................            5.67           10.00           15.00           16.67           18.33           26.67
120 months and longer...................................            6.67           13.33           16.67           18.33           20.00           33.33
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (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 broker or 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 
Sec.  240.15c3-1(c)(2)(vi) for the component securities, provided the 
broker or dealer can deliver the component securities to satisfy the 
obligation of the broker or 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 broker or dealer is 
short a basket of debt securities comprising all of the components of 
the security index, deducting the amount specified in Sec.  240.15c3-
1(c)(2)(vi) for the component securities.
    (ii) All other swaps. (A) In the case of a non-cleared swap that is 
not a credit default swap for which the deductions in Sec.  240.15c3-1e 
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 Sec.  
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 Sec.  
240.15c3-1 does not specify a percentage deduction for the type of 
asset; or
    (3) In the case of non-cleared interest rate swap, Sec.  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 broker or dealer may reduce the deduction under paragraph 
(b)(2)(ii)(A) by an amount equal to any reduction recognized for a 
comparable long or short position in the reference asset or interest 
rate under Sec.  240.15c3-1 or 17 CFR 1.17.
* * * * *

0
8. Section 240.15c3-1d is amended by revising paragraphs (b)(7) and 
(8), (b)(10)(ii)(B), (c)(2), and (c)(5)(i)(B) to read as follows:

Sec.  240.15c3-1d  Satisfactory subordination agreements (Appendix D to 
17 CFR 240.15c3-1).

* * * * *
    (b) * * *
    (7) A broker or dealer at its option but not at the option of the 
lender may, if the subordination agreement so provides, make a Payment 
of all or any portion of the Payment Obligation thereunder prior to the 
scheduled maturity date of such Payment Obligation (hereinafter 
referred to as a ``Prepayment''), but in no event may any Prepayment be 
made before the expiration of one year from the date such subordination 
agreement became effective. This restriction shall not apply to 
temporary subordination agreements that comply with the provisions of 
paragraph (c)(5) of this section. No Prepayment shall be made, if, 
after

[[Page 44046]]

giving effect thereto (and to all Payments of Payment Obligations under 
any other subordinated agreements then outstanding the maturity or 
accelerated maturities of which are scheduled to fall due within six 
months after the date such Prepayment is to occur pursuant to this 
provision or on or prior to the date on which the Payment Obligation in 
respect of such Prepayment is scheduled to mature disregarding this 
provision, whichever date is earlier) without reference to any 
projected profit or loss of the broker or dealer, either aggregate 
indebtedness of the broker or dealer would exceed 1000 percent of its 
net capital or its net capital would be less than 120 percent of the 
minimum dollar amount required by Sec.  240.15c3-1 or, in the case of a 
broker or dealer operating pursuant to Sec.  240.15c3-1(a)(1)(ii), its 
net capital would be less than 5 percent of its aggregate debit items 
computed in accordance with Sec.  240.15c3-3a, or if registered as a 
futures commission merchant, 7 percent of the funds required to be 
segregated pursuant to the Commodity Exchange Act and the regulations 
thereunder (less the market value of commodity options purchased by 
option customers subject to the rules of a contract market, each such 
deduction not to exceed the amount of funds in the option customer's 
account), if greater, or its net capital would be less than 120 percent 
of the minimum dollar amount required by Sec.  240.15c3-1(a)(1)(ii), or 
if, in the case of a broker or dealer operating pursuant to Sec.  
240.15c3-1(a)(10), its net capital would be less than 120 percent of 
its minimum requirement.
    (8)(i) The Payment Obligation of the broker or dealer in respect of 
any subordination agreement shall be suspended and shall not mature if, 
after giving effect to Payment of such Payment Obligation (and to all 
Payments of Payment Obligations of such broker or dealer under any 
other subordination agreement(s) then outstanding that are scheduled to 
mature on or before such Payment Obligation) either:
    (A) The aggregate indebtedness of the broker or dealer would exceed 
1200 percent of its net capital, or in the case of a broker or dealer 
operating pursuant to Sec.  240.15c3-1(a)(1)(ii), its net capital would 
be less than 5 percent of aggregate debit items computed in accordance 
with Sec.  240.15c3-3a or, if registered as a futures commission 
merchant, 6 percent of the funds required to be segregated pursuant to 
the Commodity Exchange Act and the regulations thereunder (less the 
market value of commodity options purchased by option customers on or 
subject to the rules of a contract market, each such deduction not to 
exceed the amount of funds in the option customer's account), if 
greater, or, in the case of a broker or dealer operating pursuant to 
Sec.  240.15c3-1(a)(10), its net capital would be less than 120 percent 
of its minimum requirement; or
    (B) Its net capital would be less than 120 percent of the minimum 
dollar amount required by Sec.  240.15c3-1 including paragraph 
(a)(1)(ii), if applicable. The subordination agreement may provide that 
if the Payment Obligation of the broker or dealer thereunder does not 
mature and is suspended as a result of the requirement of this 
paragraph (b)(8) for a period of not less than six months, the broker 
or dealer shall thereupon commence the rapid and orderly liquidation of 
its business, but the right of the lender to receive Payment, together 
with accrued interest or compensation, shall remain subordinate as 
required by the provisions of Sec. Sec.  240.15c3-1 and 240.15c3-1d.
    (ii) [Reserved]
* * * * *
    (10) * * *
    (ii) * * *
    (B) The aggregate indebtedness of the broker or dealer exceeding 
1500 percent of its net capital or, in the case of a broker or dealer 
that has elected to operate under Sec.  240.15c3-1(a)(1)(ii), its net 
capital computed in accordance therewith is less than two percent of 
its aggregate debit items computed in accordance with Sec.  240.15c3-3a 
or, if registered as a futures commission merchant, four percent of the 
funds required to be segregated pursuant to the Commodity Exchange Act 
and the regulations thereunder (less the market value of commodity 
options purchased by option customers on or subject to the rules of a 
contract market, each such deduction not to exceed the amount of funds 
in the option customer's account), if greater, or, in the case of a 
broker or dealer operating pursuant to Sec.  240.15c3-1(a)(10), its net 
capital is less than its minimum requirement, throughout a period of 15 
consecutive business days, commencing on the day the broker or dealer 
first determines and notifies the Examining Authority for the broker or 
dealer, or the Examining Authority or the Commission first determines 
and notifies the broker or dealer of such fact;
* * * * *
    (c) * * *
    (2) Every broker or dealer shall immediately notify the Examining 
Authority for such broker or dealer if, after giving effect to all 
Payments of Payment Obligations under subordination agreements then 
outstanding that are then due or mature within the following six months 
without reference to any projected profit or loss of the broker or 
dealer either the aggregate indebtedness of the broker or dealer would 
exceed 1200 percent of its net capital or its net capital would be less 
than 120 percent of the minimum dollar amount required by Sec.  
240.15c3-1, or, in the case of a broker or dealer operating pursuant to 
Sec.  240.15c3-1(a)(1)(ii), its net capital would be less than 5 
percent of aggregate debit items computed in accordance with Sec.  
240.15c3-3a, or, if registered as a futures commission merchant, 6 
percent of the funds required to be segregated pursuant to the 
Commodity Exchange Act and the regulations thereunder (less the market 
value of commodity options purchased by option customers on or subject 
to the rules of a contract market, each such deduction not to exceed 
the amount of funds in the option customer's account), if greater, or 
less than 120 percent of the minimum dollar amount required by Sec.  
240.15c3-1(a)(1)(ii), or, in the case of a broker or dealer operating 
pursuant to Sec.  240.15c3-1(a)(10), its net capital would be less than 
120 percent of its minimum requirement.
* * * * *
    (5)(i) * * *
    (B) In the case of a broker or dealer operating pursuant to Sec.  
240.15c3-1(a)(1)(ii), its net capital is less than 5 percent of 
aggregate debits computed in accordance with Sec.  240.15c3-1, or, if 
registered as a futures commission merchant, less than 7 percent of the 
funds required to be segregated pursuant to the Commodity Exchange Act 
and the regulations thereunder (less the market value of commodity 
options purchased by option customers on or subject to the rules of a 
contract market, each such deduction not to exceed the amount of funds 
in the option customer's account), if greater, or less than 120 percent 
of the minimum dollar amount required by paragraph (a)(1)(ii) of this 
section, or, in the case of a broker or dealer operating pursuant to 
Sec.  240.15c3-1(a)(10), its net capital would be less than 120 percent 
of its minimum requirement, or
* * * * *

0
9. Section 240.15c3-1e is amended by:
0
a. Redesignating the Preliminary Note as introductory text and revising 
it;
0
b. Revising paragraph (a) introductory text;
0
c. Redesignating paragraph (a)(7) as paragraph (a)(7)(i) and adding 
paragraph (a)(7)(ii);

[[Page 44047]]

0
d. Revising paragraph (c)(3);
0
e. Adding paragraphs (c)(4)(v)(B)(1) and (2);
0
f. Removing paragraph (c)(4)(v)(D) and redesignating paragraphs 
(c)(4)(v)(E) through (H) as paragraphs (c)(4)(v)(D) through (G);
0
g. In paragraph (e) introductory text by removing the phrase ``Sec.  
240.15c3-1(c)(2)(vi), (c)(2)(vii), and (c)(2)(iv), as appropriate'' and 
adding in its place ``Sec.  240.15c3-1(c)(2)(iv), (vi), and (vii), 
(c)(2)(xv)(A) and (B), as appropriate, and Sec.  240.15c-1b, as 
appropriate''; and
0
h. Revising paragraph (e)(1).
    The revisions read as follows:

Sec.  240.15c3-1e  Deductions for market and credit risk for certain 
brokers or dealers (Appendix E to 17 CFR 240.15c3-1).

    Sections 240.15c3-1e and 240.15c3-1g set forth a program that 
allows a broker or dealer to use an alternative approach to computing 
net capital deductions, subject to the conditions described in 
Sec. Sec.  240.15c3-1e and 240.15c3-1g, including supervision of the 
broker's or dealer's ultimate holding company under the program. The 
program is designed to reduce the likelihood that financial and 
operational weakness in the holding company will destabilize the broker 
or dealer, or the broader financial system. The focus of this 
supervision of the ultimate holding company is its financial and 
operational condition and its risk management controls and 
methodologies.
    (a) A broker or dealer may apply to the Commission for 
authorization to compute deductions for market risk pursuant to this 
section in lieu of computing deductions pursuant to Sec. Sec.  
240.15c3-1(c)(2)(vi) and (vii) and 240.15c3-1b, and to compute 
deductions for credit risk pursuant to this section on credit exposures 
arising from transactions in derivatives instruments (if this section 
is used to calculate deductions for market risk on these instruments) 
in lieu of computing deductions pursuant to Sec.  240.15c3-1(c)(2)(iv) 
and (c)(2)(xv)(A) and (B):
* * * * *
    (7) * * *
    (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 broker or 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 
Sec.  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 
Sec.  240.3a71-6 if the provisional model is used for the purposes of 
calculating initial margin pursuant to Sec.  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.
* * * * *
    (c) * * *
    (3) A portfolio concentration charge of 100 percent of the amount 
of the broker's or dealer's aggregate current exposure for all 
counterparties in excess of 10 percent of the tentative net capital of 
the broker or dealer;
    (4) * * *
    (v) * * *
    (B) * * *
    (1) The collateral is subject to the broker's or dealer's physical 
possession or control and may be liquidated promptly by the firm 
without intervention by any other party; or
    (2) 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;
* * * * *
    (e) * * *
    (1) The broker or dealer is required by Sec.  240.15c3-1(a)(7)(ii) 
to provide notice to the Commission that the broker's or dealer's 
tentative net capital is less than $6 billion;
* * * * *

0
10. Section 240.15c3-3 is amended by adding introductory text and 
paragraph (p) to read as follows:

Sec.  240.15c3-3  Customer protection--reserves and custody of 
securities.

    Except where otherwise noted, Sec.  240.15c3-3 applies to a broker 
or dealer registered under section 15(b) of the Act (15 U.S.C. 78o(b)), 
including a broker or dealer also registered as a security-based swap 
dealer or major security-based swap participant under section 15F(b) of 
the Act (15 U.S.C. 78o-10(b)). A security-based swap dealer or major 
security-based swap participant registered under section 15F(b) of the 
Act that is not also registered as a broker or dealer under section 
15(b) of the Act is subject to the requirements under Sec.  240.18a-4.
* * * * *
    (p) Segregation requirements for security-based swaps. The 
following requirements apply to the security-based swap activities of a 
broker or dealer.
    (1) Definitions. For the purposes of this paragraph:
    (i) The term cleared security-based swap means a security-based 
swap that is, directly or indirectly, submitted to and cleared by a 
clearing agency registered with the Commission pursuant to section 17A 
of the Act (15 U.S.C. 78q-1);
    (ii) The term excess securities collateral means securities and 
money market instruments carried for the account of a security-based 
swap customer that have a market value in excess of the current 
exposure of the broker or dealer (after reducing the current exposure 
by the amount of cash in the account) to the security-based swap 
customer, excluding:
    (A) Securities and money market instruments held in a qualified 
clearing agency account but only to the extent the securities and money 
market instruments are being used to meet a margin requirement of the 
clearing agency resulting from a security-based swap transaction of the 
security-based swap customer; and
    (B) Securities and money market instruments held in a qualified 
registered security-based swap dealer account or in a third-party 
custodial account but only to the extent the securities and money 
market instruments are being used to meet a regulatory margin 
requirement of a security-based swap dealer resulting from the broker 
or dealer entering into a non-cleared security-based swap transaction 
with the security-based swap dealer to offset the risk of a non-cleared 
security-based swap transaction between the broker or dealer and the 
security-based swap customer;
    (iii) The term qualified clearing agency account means an account 
of a broker or dealer at a clearing agency registered with the 
Commission pursuant to section 17A of the Act (15

[[Page 44048]]

U.S.C. 78q-1) that holds funds and other property in order to margin, 
guarantee, or secure cleared security-based swap transactions for the 
security-based swap customers of the broker or dealer that meets the 
following conditions:
    (A) The account is designated ``Special Clearing Account for the 
Exclusive Benefit of the Cleared Security-Based Swap Customers of [name 
of broker or dealer]'';
    (B) The clearing agency has acknowledged in a written notice 
provided to and retained by the broker or dealer that the funds and 
other property in the account are being held by the clearing agency for 
the exclusive benefit of the security-based swap customers of the 
broker or dealer in accordance with the regulations of the Commission 
and are being kept separate from any other accounts maintained by the 
broker or dealer with the clearing agency; and
    (C) The account is subject to a written contract between the broker 
or dealer and the clearing agency which provides that the funds and 
other property in the account shall be subject to no right, charge, 
security interest, lien, or claim of any kind in favor of the clearing 
agency or any person claiming through the clearing agency, except a 
right, charge, security interest, lien, or claim resulting from a 
cleared security-based swap transaction effected in the account.
    (iv) The term qualified registered security-based swap dealer 
account means an account at a security-based swap dealer that is 
registered with the Commission pursuant to section 15F of the Act that 
meets the following conditions:
    (A) The account is designated ``Special Reserve Account for the 
Exclusive Benefit of the Security-Based Swap Customers of [name of 
broker or dealer]'';
    (B) The security-based swap dealer has acknowledged in a written 
notice provided to and retained by the broker or dealer that the funds 
and other property held in the account are being held by the security-
based swap dealer for the exclusive benefit of the security-based swap 
customers of the broker or dealer in accordance with the regulations of 
the Commission and are being kept separate from any other accounts 
maintained by the broker or dealer with the security-based swap dealer;
    (C) The account is subject to a written contract between the broker 
or dealer and the security-based swap dealer which provides that the 
funds and other property in the account shall be subject to no right, 
charge, security interest, lien, or claim of any kind in favor of the 
security-based swap dealer or any person claiming through the security-
based swap dealer, except a right, charge, security interest, lien, or 
claim resulting from a non-cleared security-based swap transaction 
effected in the account; and
    (D) The account and the assets in the account are not subject to 
any type of subordination agreement between the broker or dealer and 
the security-based swap dealer.
    (v) The term qualified security means:
    (A) Obligations of the United States;
    (B) Obligations fully guaranteed as to principal and interest by 
the United States; and
    (C) General obligations of any State or a political subdivision of 
a State that:
    (1) Are not traded flat and are not in default;
    (2) Were part of an initial offering of $500 million or greater; 
and
    (3) Were issued by an issuer that has published audited financial 
statements within 120 days of its most recent fiscal year end.
    (vi) The term security-based swap customer means any person from 
whom or on whose behalf the broker or dealer has received or acquired 
or holds funds or other property for the account of the person with 
respect to a cleared or non-cleared security-based swap transaction. 
The term does not include a person to the extent that person has a 
claim for funds or other property which by contract, agreement or 
understanding, or by operation of law, is part of the capital of the 
broker or dealer or, in the case of an affiliate of the broker or 
dealer, is subordinated to all claims of customers (including PAB 
customers) and security-based swap customers of the broker or dealer.
    (vii) The term special reserve account for the exclusive benefit of 
security-based swap customers means an account at a bank that meets the 
following conditions:
    (A) The account is designated ``Special Reserve Account for the 
Exclusive Benefit of the Security-Based Swap Customers of [name of 
broker or dealer]'';
    (B) The account is subject to a written acknowledgement by the bank 
provided to and retained by the broker or dealer that the funds and 
other property held in the account are being held by the bank for the 
exclusive benefit of the security-based swap customers of the broker or 
dealer in accordance with the regulations of the Commission and are 
being kept separate from any other accounts maintained by the broker or 
dealer with the bank; and
    (C) The account is subject to a written contract between the broker 
or dealer and the bank which provides that the funds and other property 
in the account shall at no time be used directly or indirectly as 
security for a loan or other extension of credit to the broker or 
dealer by the bank and, shall be subject to no right, charge, security 
interest, lien, or claim of any kind in favor of the bank or any person 
claiming through the bank.
    (viii) The term third-party custodial account means an account 
carried by an independent third-party custodian that meets the 
following conditions:
    (A) The account is established for the purposes of meeting 
regulatory margin requirements of another security-based swap dealer;
    (B) The account is carried by a bank as defined in section 3(a)(6) 
of the Act or a registered U.S. clearing organization or depository or, 
if the collateral to be held in the account consists of foreign 
securities or currencies, a supervised foreign bank, clearing 
organization, or depository that customarily maintains custody of such 
foreign securities or currencies;
    (C) The account is designated for and on behalf of the broker or 
dealer for the benefit of its security-based swap customers and the 
account is subject to a written acknowledgement by the bank, clearing 
organization, or depository provided to and retained by the broker or 
dealer that the funds and other property held in the account are being 
held by the bank, clearing organization, or depository for the 
exclusive benefit of the security-based swap customers of the broker or 
dealer and are being kept separate from any other accounts maintained 
by the broker or dealer with the bank, clearing organization, or 
depository; and
    (D) The account is subject to a written contract between the broker 
or dealer and the bank, clearing organization, or depository which 
provides that the funds and other property in the account shall at no 
time be used directly or indirectly as security for a loan or other 
extension of credit to the security-based swap dealer by the bank, 
clearing organization, or depository and, shall be subject to no right, 
charge, security interest, lien, or claim of any kind in favor of the 
bank, clearing organization, or depository or any person claiming 
through the bank, clearing organization, or depository.
    (2) Physical possession or control of excess securities collateral. 
(i) A broker or dealer must promptly obtain and thereafter maintain 
physical possession or control of all excess securities collateral 
carried for the security-based

[[Page 44049]]

swap accounts of security-based swap customers.
    (ii) A broker or dealer has control of excess securities collateral 
only if the securities and money market instruments:
    (A) Are represented by one or more certificates in the custody or 
control of a clearing corporation or other subsidiary organization of 
either national securities exchanges, or of a custodian bank in 
accordance with a system for the central handling of securities 
complying with the provisions of Sec. Sec.  240.8c-1(g) and 240.15c2-
1(g) the delivery of which certificates to the broker or dealer does 
not require the payment of money or value, and if the books or records 
of the broker or dealer identify the security-based swap customers 
entitled to receive specified quantities or units of the securities so 
held for such security-based swap customers collectively;
    (B) Are the subject of bona fide items of transfer; provided that 
securities and money market instruments shall be deemed not to be the 
subject of bona fide items of transfer if, within 40 calendar days 
after they have been transmitted for transfer by the broker or dealer 
to the issuer or its transfer agent, new certificates conforming to the 
instructions of the broker or dealer have not been received by the 
broker or dealer, the broker or dealer has not received a written 
statement by the issuer or its transfer agent acknowledging the 
transfer instructions and the possession of the securities or money 
market instruments, or the broker or dealer has not obtained a 
revalidation of a window ticket from a transfer agent with respect to 
the certificate delivered for transfer;
    (C) Are in the custody or control of a bank as defined in section 
3(a)(6) of the Act, the delivery of which securities or money market 
instruments to the broker or dealer does not require the payment of 
money or value and the bank having acknowledged in writing that the 
securities and money market instruments in its custody or control are 
not subject to any right, charge, security interest, lien or claim of 
any kind in favor of a bank or any person claiming through the bank;
    (D)(1) Are held in or are in transit between offices of the broker 
or dealer; or
    (2) Are held by a corporate subsidiary if the broker or dealer owns 
and exercises a majority of the voting rights of all of the voting 
securities of such subsidiary, assumes or guarantees all of the 
subsidiary's obligations and liabilities, operates the subsidiary as a 
branch office of the broker or dealer, and assumes full responsibility 
for compliance by the subsidiary and all of its associated persons with 
the provisions of the Federal securities laws as well as for all of the 
other acts of the subsidiary and such associated persons; or
    (E) Are held in such other locations as the Commission shall upon 
application from a broker or dealer find and designate to be adequate 
for the protection of security-based swap customer securities.
    (iii) Each business day the broker or dealer must determine from 
its books and records the quantity of excess securities collateral in 
its possession or control as of the close of the previous business day 
and the quantity of excess securities collateral not in its possession 
or control as of the previous business day. If the broker or dealer did 
not obtain possession or control of all excess securities collateral on 
the previous business day as required by this section and there are 
securities or money market instruments of the same issue and class in 
any of the following non-control locations:
    (A) Securities or money market instruments subject to a lien 
securing an obligation of the broker or dealer, then the broker or 
dealer, not later than the next business day on which the determination 
is made, must issue instructions for the release of the securities or 
money market instruments from the lien and must obtain physical 
possession or control of the securities or money market instruments 
within two business days following the date of the instructions;
    (B) Securities or money market instruments held in a qualified 
clearing agency account, then the broker or dealer, not later than the 
next business day on which the determination is made, must issue 
instructions for the release of the securities or money market 
instruments by the clearing agency and must obtain physical possession 
or control of the securities or money market instruments within two 
business days following the date of the instructions;
    (C) Securities or money market instruments held in a qualified 
registered security-based swap dealer account maintained by another 
security-based swap dealer or in a third-party custodial account, then 
the broker or dealer, not later than the next business day on which the 
determination is made, must issue instructions for the release of the 
securities or money market instruments by the security-based swap 
dealer or the third-party custodian and must obtain physical possession 
or control of the securities or money market instruments within two 
business days following the date of the instructions;
    (D) Securities or money market instruments loaned by the broker or 
dealer, then the broker or dealer, not later than the next business day 
on which the determination is made, must issue instructions for the 
return of the loaned securities or money market instruments and must 
obtain physical possession or control of the securities or money market 
instruments within five business days following the date of the 
instructions;
    (E) Securities or money market instruments failed to receive more 
than 30 calendar days, then the broker or dealer, not later than the 
next business day on which the determination is made, must take prompt 
steps to obtain physical possession or control of the securities or 
money market instruments through a buy-in procedure or otherwise;
    (F) Securities or money market instruments receivable by the broker 
or dealer as a security dividend, stock split or similar distribution 
for more than 45 calendar days, then the broker or dealer, not later 
than the next business day on which the determination is made, must 
take prompt steps to obtain physical possession or control of the 
securities or money market instruments through a buy-in procedure or 
otherwise; or
    (G) Securities or money market instruments included on the broker's 
or dealer's books or records that allocate to a short position of the 
broker or dealer or a short position for another person, for more than 
30 calendar days, then the broker or dealer must, not later than the 
business day following the day on which the determination is made, take 
prompt steps to obtain physical possession or control of such 
securities or money market instruments.
    (3) Deposit requirement for special reserve account for the 
exclusive benefit of security-based swap customers. (i) A broker or 
dealer must maintain a special reserve account for the exclusive 
benefit of security-based swap customers that is separate from any 
other bank account of the broker or dealer. The broker or dealer must 
at all times maintain in the special reserve account for the exclusive 
benefit of security-based swap customers, through deposits into the 
account, cash and/or qualified securities in amounts computed in 
accordance with the formula set forth in Sec.  240.15c3-3b. In 
determining the amount maintained in a special reserve account for the 
exclusive benefit of security-based swap customers, the broker or 
dealer must deduct:

[[Page 44050]]

    (A) The percentage of the value of a general obligation of a State 
or a political subdivision of a State specified in Sec.  240.15c3-
1(c)(2)(vi);
    (B) The aggregate value of general obligations of a State or a 
political subdivision of a State to the extent the amount of the 
obligations of a single issuer (after applying the deduction in 
paragraph (p)(3)(i)(A) of this section) exceeds two percent of the 
amount required to be maintained in the special reserve account for the 
exclusive benefit of security-based swap customers;
    (C) The aggregate value of all general obligations of States or 
political subdivisions of States to the extent the amount of the 
obligations (after applying the deduction in paragraph (p)(3)(i)(A) of 
this section) exceeds 10 percent of the amount required to be 
maintained in the special reserve account for the exclusive benefit of 
security-based swap customers;
    (D) The amount of cash deposited with a single non-affiliated bank 
to the extent the amount exceeds 15 percent of the equity capital of 
the bank as reported by the bank in its most recent Call Report or any 
successor form the bank is required to file by its appropriate federal 
banking agency (as defined by section 3 of the Federal Deposit 
Insurance Act (12 U.S.C. 1813)); and
    (E) The total amount of cash deposited with an affiliated bank.
    (ii) A broker or dealer must not accept or use credits identified 
in the items of the formula set forth in Sec.  240.15c3-3b except for 
the specified purposes indicated under items comprising Total Debits 
under the formula, and, to the extent Total Credits exceed Total 
Debits, at least the net amount thereof must be maintained in the 
Special Reserve Account pursuant to paragraph (p)(3)(i) of this 
section.
    (iii)(A) The computations necessary to determine the amount 
required to be maintained in the special reserve account for the 
exclusive benefit of security-based swap customers must be made weekly 
as of the close of the last business day of the week and any deposit 
required to be made into the account must be made no later than one 
hour after the opening of banking business on the second following 
business day. The broker or dealer may make a withdrawal from the 
special reserve account for the exclusive benefit of security-based 
swap customers only if the amount remaining in the account after the 
withdrawal is equal to or exceeds the amount required to be maintained 
in the account pursuant to paragraph (p)(3) of this section.
    (ii) (B) Computations in addition to the computations required 
pursuant to paragraph (p)(3)(iii)(A) of this section may be made as of 
the close of any business day, and deposits so computed must be made no 
later than one hour after the open of banking business on the second 
following business day.
    (iv) A broker or dealer must promptly deposit into a special 
reserve account for the exclusive benefit of security-based swap 
customers cash and/or qualified securities of the broker or dealer if 
the amount of cash and/or qualified securities in one or more special 
reserve accounts for the exclusive benefit of security-based swap 
customers falls below the amount required to be maintained pursuant to 
this section.
    (4) Requirements for non-cleared security-based swaps--(i) Notice. 
A broker or dealer registered under section 15F(b) of the Act (15 
U.S.C. 78o-10(b)) as a security-based swap dealer or major security-
based swap participant must provide the notice required pursuant to 
section 3E(f)(1)(A) of the Act (15 U.S.C. 78c-5(f)) in writing to a 
duly authorized individual prior to the execution of the first non-
cleared security-based swap transaction with the counterparty occurring 
after the compliance date of this section.
    (ii) Subordination--(A) Counterparty that elects to have individual 
segregation at an independent third-party custodian. A broker or dealer 
must obtain an agreement from a counterparty whose funds or other 
property to meet a margin requirement of the broker or dealer are held 
at a third-party custodian in which the counterparty agrees to 
subordinate its claims against the broker or dealer for the funds or 
other property held at the third-party custodian to the claims of 
customers (including PAB customers) and security-based swap customers 
of the broker or dealer but only to the extent that funds or other 
property provided by the counterparty to the independent third-party 
custodian are not treated as customer property as that term is defined 
in 11 U.S.C. 741 or customer property as defined in 15 U.S.C. 78lll(4) 
in a liquidation of the broker or dealer.
    (B) Counterparty that elects to have no segregation. A broker or 
dealer registered under section 15F(b) of the Act as a security-based 
swap dealer must obtain an agreement from a counterparty that is an 
affiliate of the broker or dealer that affirmatively chooses not to 
require segregation of funds or other property pursuant to section 
3E(f) of the Act (15 U.S.C. 78c-5(f)) in which the counterparty agrees 
to subordinate all of its claims against the broker or dealer to the 
claims of customers (including PAB customers) and security-based swap 
customers of the broker or dealer.

0
 11. Section 240.15c3-3b is added to read as follows:

Sec.  240.15c3-3b  Exhibit B--Formula for determination of security-
based swap customer reserve requirements of brokers and dealers under 
Sec.  240.15c3-3.

------------------------------------------------------------------------
                                              Credits         Debits
------------------------------------------------------------------------
1. Free credit balances and other credit            $___  ..............
 balances in the accounts carried for
 security-based swap customers (See Note
 A).....................................
2. Monies borrowed collateralized by                $___  ..............
 securities in accounts carried for
 security-based swap customers (See Note
 B).....................................
3. Monies payable against security-based            $___  ..............
 swap customers' securities loaned (See
 Note C)................................
4. Security-based swap customers'                   $___  ..............
 securities failed to receive (See Note
 D).....................................
5. Credit balances in firm accounts                 $___  ..............
 which are attributable to principal
 sales to security-based swap customers.
6. Market value of stock dividends,                 $___  ..............
 stock splits and similar distributions
 receivable outstanding over 30 calendar
 days...................................
7. Market value of short security count             $___  ..............
 differences over 30 calendar days old..
8. Market value of short securities and             $___  ..............
 credits (not to be offset by longs or
 by debits) in all suspense accounts
 over 30 calendar days..................
9. Market value of securities which are             $___  ..............
 in transfer in excess of 40 calendar
 days and have not been confirmed to be
 in transfer by the transfer agent or
 the issuer during the 40 days..........
10. Debit balances in accounts carried    ..............            $___
 for security-based swap customers,
 excluding unsecured accounts and
 accounts doubtful of collection (See
 Note E)................................
11. Securities borrowed to effectuate     ..............            $___
 short sales by security-based swap
 customers and securities borrowed to
 make delivery on security-based swap
 customers' securities failed to deliver

[[Page 44051]]

 
12. Failed to deliver of security-based   ..............            $___
 swap customers' securities not older
 than 30 calendar days..................
13. Margin required and on deposit with   ..............            $___
 the Options Clearing Corporation for
 all option contracts written or
 purchased in accounts carried for
 security-based swap customers (See Note
 F).....................................
14. Margin related to security futures    ..............            $___
 products written, purchased or sold in
 accounts carried for security-based
 swap customers required and on deposit
 in a qualified clearing agency account
 at a clearing agency registered with
 the Commission under section 17A of the
 Act (15 U.S.C. 78q-1) or a derivatives
 clearing organization registered with
 the Commodity Futures Trading
 Commission under section 5b of the
 Commodity Exchange Act (7 U.S.C. 7a-1)
 (See Note G)...........................
15. Margin related to cleared security-   ..............            $___
 based swap transactions in accounts
 carried for security-based swap
 customers required and on deposit in a
 qualified clearing agency account at a
 clearing agency registered with the
 Commission pursuant to section 17A of
 the Act (15 U.S.C. 78q-1)..............
16. Margin related to non-cleared         ..............            $___
 security-based swap transactions in
 accounts carried for security-based
 swap customers required and held in a
 qualified registered security-based
 swap dealer account at a security-based
 swap dealer or at a third-party
 custodial account......................
                                         -------------------------------
    Total Credits.......................            $___  ..............
    1Total Debits.......................  ..............            $___
    Excess of Credits over Debits.......            $___  ..............
------------------------------------------------------------------------
Note A. Item 1 must include all outstanding drafts payable to security-
  based swap customers which have been applied against free credit
  balances or other credit balances and must also include checks drawn
  in excess of bank balances per the records of the broker or dealer.
Note B. Item 2 must include the amount of options-related or security
  futures product-related Letters of Credit obtained by a member of a
  registered clearing agency or a derivatives clearing organization
  which are collateralized by security-based swap customers' securities,
  to the extent of the member's margin requirement at the registered
  clearing agency or derivatives clearing organization.
Note C. Item 3 must include in addition to monies payable against
  security-based swap customers' securities loaned the amount by which
  the market value of securities loaned exceeds the collateral value
  received from the lending of such securities.
Note D. Item 4 must include in addition to security-based swap
  customers' securities failed to receive the amount by which the market
  value of securities failed to receive and outstanding more than thirty
  (30) calendar days exceeds their contract value.
Note E. (1) Debit balances in accounts carried for security-based swap
  customers must be reduced by the amount by which a specific security
  (other than an exempted security) which is collateral for margin
  requirements exceeds in aggregate value 15 percent of the aggregate
  value of all securities which collateralize all accounts receivable;
  provided, however, the required reduction must not be in excess of the
  amount of the debit balance required to be excluded because of this
  concentration rule. A specified security is deemed to be collateral
  for an account only to the extent it is not an excess margin security.
(2) Debit balances in special omnibus accounts, maintained in compliance
  with the requirements of section 4(b) of Regulation T under the Act
  (12 CFR 220.4(b)) or similar accounts carried on behalf of a security-
  based swap dealer, must be reduced by any deficits in such accounts
  (or if a credit, such credit must be increased) less any calls for
  margin, marks to the market, or other required deposits which are
  outstanding 5 business days or less.
(3) Debit balances in security-based swap customers' accounts included
  in the formula under item 10 must be reduced by an amount equal to 1
  percent of their aggregate value.
(4) Debit balances in accounts of household members and other persons
  related to principals of a broker or dealer and debit balances in
  accounts of affiliated persons of a broker or dealer must be excluded
  from the reserve formula, unless the broker or dealer can demonstrate
  that such debit balances are directly related to credit items in the
  formula.
(5) Debit balances in accounts (other than omnibus accounts) must be
  reduced by the amount by which any single security-based swap
  customer's debit balance exceeds 25 percent (to the extent such amount
  is greater than $50,000) of the broker's or dealer's tentative net
  capital (i.e., net capital prior to securities haircuts) unless the
  broker or dealer can demonstrate that the debit balance is directly
  related to credit items in the Reserve Formula. Related accounts
  (e.g., the separate accounts of an individual, accounts under common
  control or subject to cross guarantees) will be deemed to be a single
  security-based swap customer's account for purposes of this provision.
If the registered national securities exchange or the registered
  national securities association having responsibility for examining
  the broker or dealer (``designated examining authority'') is
  satisfied, after taking into account the circumstances of the
  concentrated account including the quality, diversity, and
  marketability of the collateral securing the debit balances in
  accounts subject to this provision, that the concentration of debit
  balances is appropriate, then such designated examining authority may,
  by order, grant a partial or plenary exception from this provision.
  The debit balance may be included in the reserve formula computation
  for five business days from the day the request is made.
(6) Debit balances of joint accounts, custodian accounts, participations
  in hedge funds or limited partnerships or similar type accounts or
  arrangements that include both assets of a person who would be
  excluded from the definition of security-based swap customer (``non-
  security-based swap customer'') and assets of a person or persons
  includible in the definition of security-based swap customer must be
  included in the Reserve Formula in the following manner: if the
  percentage ownership of the non-security-based swap customer is less
  than 5 percent then the entire debit balance shall be included in the
  formula; if such percentage ownership is between 5 percent and 50
  percent then the portion of the debit balance attributable to the non-
  security-based swap customer must be excluded from the formula unless
  the broker or dealer can demonstrate that the debit balance is
  directly related to credit items in the formula; if such percentage
  ownership is greater than 50 percent, then the entire debit balance
  must be excluded from the formula unless the broker or dealer can
  demonstrate that the debit balance is directly related to credit items
  in the formula.
Note F. Item 13 must include the amount of margin required and on
  deposit with Options Clearing Corporation to the extent such margin is
  represented by cash, proprietary qualified securities, and letters of
  credit collateralized by security-based swap customers' securities.
Note G. (a) Item 14 must include the amount of margin required and on
  deposit with a clearing agency registered with the Commission under
  section 17A of the Act (15 U.S.C. 78q-1) or a derivatives clearing
  organization registered with the Commodity Futures Trading Commission
  under section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1) for
  security-based swap customer accounts to the extent that the margin is
  represented by cash, proprietary qualified securities, and letters of
  credit collateralized by security-based swap customers' securities.
(b) Item 14 will apply only if the broker or dealer has the margin
  related to security futures products on deposit with:
(1) A registered clearing agency or derivatives clearing organization
  that:
(i) Maintains security deposits from clearing members in connection with
  regulated options or futures transactions and assessment power over
  member firms that equal a combined total of at least $2 billion, at
  least $500 million of which must be in the form of security deposits.
  For purposes of this Note G, the term ``security deposits'' refers to
  a general fund, other than margin deposits or their equivalent, that
  consists of cash or securities held by a registered clearing agency or
  derivative clearing organization;
(ii) Maintains at least $3 billion in margin deposits; or
(iii) Does not meet the requirements of paragraphs (b)(1)(i) through
  (b)(1)(ii) of this Note G, if the Commission has determined, upon a
  written request for exemption by or for the benefit of the broker or
  dealer, that the broker or dealer may utilize such a registered
  clearing agency or derivatives clearing organization. The Commission
  may, in its sole discretion, grant such an exemption subject to such
  conditions as are appropriate under the circumstances, if the
  Commission determines that such conditional or unconditional exemption
  is necessary or appropriate in the public interest, and is consistent
  with the protection of investors; and

[[Page 44052]]

 
(2) A registered clearing agency or derivatives clearing organization
  that, if it holds funds or securities deposited as margin for security
  futures products in a bank, as defined in section 3(a)(6) of the Act
  (15 U.S.C. 78c(a)(6)), obtains and preserves written notification from
  the bank at which it holds such funds and securities or at which such
  funds and securities are held on its behalf. The written notification
  will state that all funds and/or securities deposited with the bank as
  margin (including security-based swap customer security futures
  products margin), or held by the bank and pledged to such registered
  clearing agency or derivatives clearing agency as margin, are being
  held by the bank for the exclusive benefit of clearing members of the
  registered clearing agency or derivatives clearing organization
  (subject to the interest of such registered clearing agency or
  derivatives clearing organization therein), and are being kept
  separate from any other accounts maintained by the registered clearing
  agency or derivatives clearing organization with the bank. The written
  notification also will provide that such funds and/or securities will
  at no time be used directly or indirectly as security for a loan to
  the registered clearing agency or derivatives clearing organization by
  the bank, and will be subject to no right, charge, security interest,
  lien, or claim of any kind in favor of the bank or any person claiming
  through the bank. This provision, however, will not prohibit a
  registered clearing agency or derivatives clearing organization from
  pledging security-based swap customer funds or securities as
  collateral to a bank for any purpose that the rules of the Commission
  or the registered clearing agency or derivatives clearing organization
  otherwise permit; and
(3) A registered clearing agency or derivatives clearing organization
  that establishes, documents, and maintains:
(i) Safeguards in the handling, transfer, and delivery of cash and
  securities;
(ii) Fidelity bond coverage for its employees and agents who handle
  security-based swap customer funds or securities. In the case of
  agents of a registered clearing agency or derivatives clearing
  organization, the agent may provide the fidelity bond coverage; and
(iii) Provisions for periodic examination by independent public
  accountants; and
(4) A derivatives clearing organization that, if it is not otherwise
  registered with the Commission, has provided the Commission with a
  written undertaking, in a form acceptable to the Commission, executed
  by a duly authorized person at the derivatives clearing organization,
  to the effect that, with respect to the clearance and settlement of
  the security-based swap customer security futures products of the
  broker or dealer, the derivatives clearing organization will permit
  the Commission to examine the books and records of the derivatives
  clearing organization for compliance with the requirements set forth
  in Sec.   240.15c3-3a, Note G. (b)(1) through (3).
(c) Item 14 will apply only if a broker or dealer determines, at least
  annually, that the registered clearing agency or derivatives clearing
  organization with which the broker or dealer has on deposit margin
  related to security futures products meets the conditions of this Note
  G.

0
12. An undesignated center heading and Sec.  240.18a-1 are added to 
read as follows:

Capital, Margin and Segregation Requirements for Security-Based Swap 
Dealers and Major Security-Based Swap Participants

Sec.  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. 78o-10), including a security-based 
swap dealer that is an OTC derivatives dealer as that term is defined 
in Sec.  240.3b-12. A security-based swap dealer registered under 
section 15F of the Act (15 U.S.C. 78o-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 Sec.  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 Sec.  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 Sec.  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

[[Page 44053]]

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, Sec. Sec.  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 Sec.  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 Sec.  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

[[Page 44054]]

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 Sec.  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 Sec.  240.18a-
1(c)(1)(vi)(B)(1)(i):

                                                     Table 1 to Sec.   240.18a-1(c)(1)(vi)(B)(1)(i)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Basis point spread
    Length of time to maturity of credit default swap    -----------------------------------------------------------------------------------------------
                        contract                            100 or less                                                                     700 or more
                                                                (%)         101-300 (%)     301-400 (%)     401-500 (%)     501-699 (%)         (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months.....................................            1.00            2.00            5.00            7.50           10.00           15.00
12 months but less than 24 months.......................            1.50            3.50            7.50           10.00           12.50           17.50
24 months but less than 36 months.......................            2.00            5.00           10.00           12.50           15.00           20.00
36 months but less than 48 months.......................            3.00            6.00           12.50           15.00           17.50           22.50
48 months but less than 60 months.......................            4.00            7.00           15.00           17.50           20.00           25.00
60 months but less than 72 months.......................            5.50            8.50           17.50           20.00           22.50           27.50

[[Page 44055]]

 
72 months but less than 84 months.......................            7.00           10.00           20.00           22.50           25.00           30.00
84 months but less than 120 months......................            8.50           15.00           22.50           25.00           27.50           40.00
120 months and longer...................................           10.00           20.00           25.00           27.50           30.00           50.00
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (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 
Sec.  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 Sec.  
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 
Sec.  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 Sec.  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 Sec.  240.15c3-1(c)(2)(vi) 
and, in the case of a security-based swap referencing an equity 
security, the method specified in Sec.  240.18a-1a.
    (vii) All other securities, money market instruments or options. 
Deducting the percentages specified in Sec.  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 
Sec.  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 Sec.  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

[[Page 44056]]

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 Sec.  240.18a-1(c)(1)(x)(A):

                 Table 2 to Sec.   240.18a-1(c)(1)(x)(A)
------------------------------------------------------------------------
                                                             Number of
                                                           business days
                     Differences \1\                           after
                                                             discovery
------------------------------------------------------------------------
25 percent..............................................               7
50 percent..............................................              14
75 percent..............................................              21
100 percent.............................................              28
------------------------------------------------------------------------
\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 Sec.  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 Sec.  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 Sec.  
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 Sec.  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

[[Page 44057]]

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 
Sec.  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 
Sec.  240.3a71-6 if the provisional model is used for the purposes of 
calculating initial margin pursuant to Sec.  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;

[[Page 44058]]

    (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 Sec.  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 Sec.   240.18a-1(d)(9)(i)(C)(3)--Multiplication Factor Based
        on the Number of Backtesting Exceptions of the VaR model
------------------------------------------------------------------------
                                                          Multiplication
                  Number of exceptions                        factor
------------------------------------------------------------------------
4 or fewer..............................................            3.00
5.......................................................            3.40
6.......................................................            3.50
7.......................................................            3.65
8.......................................................            3.75
9.......................................................            3.85
10 or more..............................................            4.00
------------------------------------------------------------------------

    (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

[[Page 44059]]

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 Sec.  
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)-(B)_[Reserved];
    (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 Sec.  
240.15c3-1(c)(2)(vi), Sec.  240.15c3-1(c)(2)(vii), and applicable 
appendices to Sec.  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

[[Page 44060]]

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 Sec.  240.15c3-4 as if it were an OTC 
derivatives dealer with respect to all of its business activities, 
except that Sec.  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 Sec.  
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 Sec.  
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 Sec.  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:

[[Page 44061]]

    (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 Sec.  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 Sec.  
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 Sec.  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 Sec.  
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.

0
13. Section 240.18a-1a is added to read as follows:

Sec.  240.18a-1a  Options.

    (a)(1) Definitions. The term unlisted option means any option not 
included in the definition of listed option provided in Sec.  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

[[Page 44062]]

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 
Sec.  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

[[Page 44063]]

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.

0
 14. Section 240.18a-1b is added to read as follows:

Sec.  240.18a-1b  Adjustments to net worth for certain commodities 
transactions.

    (a) Every registered security-based swap dealer in computing net 
capital pursuant to Sec.  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 Sec.  240.18a-1, the 
inclusion or exclusion of all or part of such asset or liability for 
net capital shall be in accordance with Sec.  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 Sec.  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 Sec.  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.

[[Page 44064]]

    (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 Sec.  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 Sec.  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).

[[Page 44065]]

    (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 Sec.  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 Sec.  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 Sec.  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 Sec.  240.18a-1b(b)(2)(i)(A):

                                                        Table 1 to Sec.   240.18a-1b(b)(2)(i)(A)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Basis point spread
   Length of time to maturity of credit  default swap    -----------------------------------------------------------------------------------------------
                        contract                            100 or less                                                                     700 or more
                                                                (%)        101-300  (%)    301-400  (%)    401-500  (%)    501-699  (%)         (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months.....................................            0.67            1.33            3.33            5.00            6.67           10.00
12 months but less than 24 months.......................            1.00            2.33            5.00            6.67            8.33           11.67
24 months but less than 36 months.......................            1.33            3.33            6.67            8.33           10.00           13.33
36 months but less than 48 months.......................            2.00            4.00            8.33           10.00           11.67           15.00
48 months but less than 60 months.......................            2.67            4.67           10.00           11.67           13.33           16.67
60 months but less than 72 months.......................            3.67            5.67           11.67           13.33           15.00           18.33
72 months but less than 84 months.......................            4.67            6.67           13.33           15.00           16.67           20.00
84 months but less than 120 months......................            5.67           10.00           15.00           16.67           18.33           26.67
120 months and longer...................................            6.67           13.33           16.67           18.33           20.00           33.33
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (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 Sec.  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 
Sec.  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 Sec.  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 Sec.  
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 Sec.  
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, Sec.  
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 Sec.  240.15c3-1.

0
15. Section 240.18a-1c is added to read as follows:

Sec.  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 Sec.  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.

0
16. Section 240.18a-1d is added to read as follows:

Sec.  240.18a-1d  Satisfactory Subordinated Loan Agreements.

    (a) Introduction--(1) Minimum requirements. This section sets forth 
minimum and non-exclusive requirements for satisfactory subordinated 
loan agreements. The Commission may require or the

[[Page 44066]]

security-based swap dealer may include such other provisions as deemed 
necessary or appropriate to the extent such provisions do not cause the 
subordinated loan agreement to fail to meet the minimum requirements of 
this section.
    (2) Certain definitions. For purposes of Sec.  240.18a-1 and this 
section:
    (i) The term ``subordinated loan agreement'' shall mean the 
agreement or agreements evidencing or governing a subordinated 
borrowing of cash.
    (ii) The term ``Payment Obligation'' shall mean the obligation of a 
security-based swap dealer to repay cash loaned to the security-based 
swap dealer pursuant to a subordinated loan agreement and ``Payment'' 
shall mean the performance by a security-based swap dealer of a Payment 
Obligation.
    (iii) The term ``lender'' shall mean the person who lends cash to a 
security-based swap dealer pursuant to a subordinated loan agreement.
    (b) Minimum requirements for subordinated loan agreements--(1) 
Subordinated loan agreement. Subject to paragraph (a) of this section, 
a subordinated loan agreement shall mean a written agreement between 
the security-based swap dealer and the lender, which has a minimum term 
of one year, and is a valid and binding obligation enforceable in 
accordance with its terms (subject as to enforcement to applicable 
bankruptcy, insolvency, reorganization, moratorium and other similar 
laws) against the security-based swap dealer and the lender and their 
respective heirs, executors, administrators, successors and assigns.
    (2) Specific amount. All subordinated loan agreements shall be for 
a specific dollar amount which shall not be reduced for the duration of 
the agreement except by installments as specifically provided for 
therein and except as otherwise provided in this section.
    (3) Effective subordination. The subordinated loan agreement shall 
effectively subordinate any right of the lender to receive any Payment 
with respect thereto, together with accrued interest or compensation, 
to the prior payment or provision for payment in full of all claims of 
all present and future creditors of the security-based swap dealer 
arising out of any matter occurring prior to the date on which the 
related Payment Obligation matures consistent with the provisions of 
Sec. Sec.  240.18a-1 and 240.18a-1d, except for claims which are the 
subject of subordinated loan agreements that rank on the same priority 
as or junior to the claim of the lender under such subordinated loan 
agreements.
    (4) Proceeds of subordinated loan agreements. The subordinated loan 
agreement shall provide that the cash proceeds thereof shall be used 
and dealt with by the security-based swap dealer as part of its capital 
and shall be subject to the risks of the business.
    (5) Certain rights of the security-based swap dealer. The 
subordinated loan agreement shall provide that the security-based swap 
dealer shall have the right to deposit any cash proceeds of a 
subordinated loan agreement in an account or accounts in its own name 
in any bank or trust company.
    (6) Permissive prepayments. A security-based swap dealer at its 
option but not at the option of the lender may, if the subordinated 
loan agreement so provides, make a Payment of all or any portion of the 
Payment Obligation thereunder prior to the scheduled maturity date of 
such Payment Obligation (hereinafter referred to as a ``Prepayment''), 
but in no event may any Prepayment be made before the expiration of one 
year from the date such subordinated loan agreement became effective. 
No Prepayment shall be made, if, after giving effect thereto (and to 
all Payments of Payment Obligations under any other subordinated loan 
agreements then outstanding the maturity or accelerated maturities of 
which are scheduled to fall due within six months after the date such 
Prepayment is to occur pursuant to this provision or on or prior to the 
date on which the Payment Obligation in respect of such Prepayment is 
scheduled to mature disregarding this provision, whichever date is 
earlier) without reference to any projected profit or loss of the 
security-based swap dealer, either its net capital would fall below 120 
percent of its minimum requirement under Sec.  240.18a-1, or, if the 
security-based swap dealer is approved to calculate net capital under 
Sec.  240.18a-1(d), its tentative net capital would fall to an amount 
below 120 percent of the minimum requirement. Notwithstanding the 
above, no Prepayment shall occur without the prior written approval of 
the Commission.
    (7) Suspended repayment. The Payment Obligation of the security-
based swap dealer in respect of any subordinated loan agreement shall 
be suspended and shall not mature if, after giving effect to Payment of 
such Payment Obligation (and to all Payments of Payment Obligations of 
such security-based swap dealer under any other subordinated loan 
agreement(s) then outstanding that are scheduled to mature on or before 
such Payment Obligation) either its net capital would fall below 120 
percent of its minimum requirement under Sec.  240.18a-1, or, if the 
security-based swap dealer is approved to calculate net capital under 
Sec.  240.18a-1(d), its tentative net capital would fall to an amount 
below 120 percent of the minimum requirement. The subordinated loan 
agreement may provide that if the Payment Obligation of the security-
based swap dealer thereunder does not mature and is suspended as a 
result of the requirement of this paragraph (b)(7) for a period of not 
less than six months, the security-based swap dealer shall thereupon 
commence the rapid and orderly liquidation of its business, but the 
right of the lender to receive Payment, together with accrued interest 
or compensation, shall remain subordinate as required by the provisions 
of Sec. Sec.  240.18a-1 and 240.18a-1d.
    (8) Accelerated maturity--obligation to repay to remain 
subordinate. (i) Subject to the provisions of paragraph (b)(7) of this 
section, a subordinated loan agreement may provide that the lender may, 
upon prior written notice to the security-based swap dealer and the 
Commission given not earlier than six months after the effective date 
of such subordinated loan agreement, accelerate the date on which the 
Payment Obligation of the security-based swap dealer, together with 
accrued interest or compensation, is scheduled to mature to a date not 
earlier than six months after the giving of such notice, but the right 
of the lender to receive Payment, together with accrued interest or 
compensation, shall remain subordinate as required by the provisions of 
Sec. Sec.  240.18a-1 and 240.18a-1d.
    (ii) Notwithstanding the provisions of paragraph (b)(7) of this 
section, the Payment Obligation of the security-based swap dealer with 
respect to a subordinated loan agreement, together with accrued 
interest and compensation, shall mature in the event of any 
receivership, insolvency, liquidation, bankruptcy, assignment for the 
benefit of creditors, reorganization whether or not pursuant to the 
bankruptcy laws, or any other marshalling of the assets and liabilities 
of the security-based swap dealer but the right of the lender to 
receive Payment, together with accrued interest or compensation, shall 
remain subordinate as required by the provisions of Sec. Sec.  240.18a-
1 and 240.18a-1d.
    (9) Accelerated maturity of subordinated loan agreements on event 
of default and event of acceleration--obligation to repay to remain 
subordinate. (i) A subordinated loan

[[Page 44067]]

agreement may provide that the lender may, upon prior written notice to 
the security-based swap dealer and the Commission of the occurrence of 
any Event of Acceleration (as hereinafter defined) given no sooner than 
six months after the effective date of such subordinated loan 
agreement, accelerate the date on which the Payment Obligation of the 
security-based swap dealer, together with accrued interest or 
compensation, is scheduled to mature, to the last business day of a 
calendar month which is not less than six months after notice of 
acceleration is received by the security-based swap dealer and the 
Commission. Any subordinated loan agreement containing such Events of 
Acceleration may also provide, that if upon such accelerated maturity 
date the Payment Obligation of the security-based swap dealer is 
suspended as required by paragraph (b)(7) of this section and 
liquidation of the security-based swap dealer has not commenced on or 
prior to such accelerated maturity date, then notwithstanding paragraph 
(b)(7) the Payment Obligation of the security-based swap dealer with 
respect to such subordinated loan agreement shall mature on the day 
immediately following such accelerated maturity date and in any such 
event the Payment Obligations of the security-based swap dealer with 
respect to all other subordinated loan agreements then outstanding 
shall also mature at the same time but the rights of the respective 
lenders to receive Payment, together with accrued interest or 
compensation, shall remain subordinate as required by the provisions of 
this section. Events of Acceleration which may be included in a 
subordinated loan agreement complying with this paragraph (b)(9) shall 
be limited to:
    (A) Failure to pay interest or any installment of principal on a 
subordinated loan agreement as scheduled;
    (B) Failure to pay when due other money obligations of a specified 
material amount;
    (C) Discovery that any material, specified representation or 
warranty of the security-based swap dealer which is included in the 
subordinated loan agreement and on which the subordinated loan 
agreement was based or continued was inaccurate in a material respect 
at the time made;
    (D) Any specified and clearly measurable event which is included in 
the subordinated loan agreement and which the lender and the security-
based swap dealer agree:
    (1) Is a significant indication that the financial position of the 
security-based swap dealer has changed materially and adversely from 
agreed upon specified norms; or
    (2) Could materially and adversely affect the ability of the 
security-based swap dealer to conduct its business as conducted on the 
date the subordinated loan agreement was made; or
    (3) Is a significant change in the senior management of the 
security-based swap dealer or in the general business conducted by the 
security-based swap dealer from that which obtained on the date the 
subordinated loan agreement became effective;
    (E) Any continued failure to perform agreed covenants included in 
the subordinated loan agreement relating to the conduct of the business 
of the security-based swap dealer or relating to the maintenance and 
reporting of its financial position; and
    (ii) Notwithstanding the provisions of paragraph (b)(7) of this 
section, a subordinated loan agreement may provide that, if liquidation 
of the business of the security-based swap dealer has not already 
commenced, the Payment Obligation of the security-based swap dealer 
shall mature, together with accrued interest or compensation, upon the 
occurrence of an Event of Default (as hereinafter defined). Such 
agreement may also provide that, if liquidation of the business of the 
security-based swap dealer has not already commenced, the rapid and 
orderly liquidation of the business of the security-based swap dealer 
shall then commence upon the happening of an Event of Default. Any 
subordinated loan agreement which so provides for maturity of the 
Payment Obligation upon the occurrence of an Event of Default shall 
also provide that the date on which such Event of Default occurs shall, 
if liquidation of the security-based swap dealer has not already 
commenced, be the date on which the Payment Obligations of the 
security-based swap dealer with respect to all other subordinated loan 
agreements then outstanding shall mature but the rights of the 
respective lenders to receive Payment, together with accrued interest 
or compensation, shall remain subordinate as required by the provisions 
of this section. Events of Default which may be included in a 
subordinated loan agreement shall be limited to:
    (A) The net capital of the security-based swap dealer falling to an 
amount below its minimum requirement under Sec.  240.18a-1, or, if the 
security-based swap dealer is approved to calculate net capital under 
Sec.  240.18a-1(d), its tentative net capital falling below the minimum 
requirement, throughout a period of 15 consecutive business days, 
commencing on the day the security-based swap dealer first determines 
and notifies the Commission, or the Commission first determines and 
notifies the security-based swap dealer of such fact;
    (B) The Commission revoking the registration of the security-based 
swap dealer;
    (C) The Commission suspending (and not reinstating within 10 days) 
the registration of the security-based swap dealer;
    (D) Any receivership, insolvency, liquidation, bankruptcy, 
assignment for the benefit of creditors, reorganization whether or not 
pursuant to bankruptcy laws, or any other marshalling of the assets and 
liabilities of the security-based swap dealer. A subordinated loan 
agreement that contains any of the provisions permitted by this 
paragraph (b)(9) shall not contain the provision otherwise permitted by 
paragraph (b)(8)(i) of this section.
    (c) Miscellaneous provisions--(1) Prohibited cancellation. The 
subordinated loan agreement shall not be subject to cancellation by 
either party; no Payment shall be made with respect thereto and the 
agreement shall not be terminated, rescinded or modified by mutual 
consent or otherwise if the effect thereof would be inconsistent with 
the requirements of Sec. Sec.  240.18a-1 and 240.18a-1d.
    (2) Notification. Every security-based swap dealer shall 
immediately notify the Commission if, after giving effect to all 
Payments of Payment Obligations under subordinated loan agreements then 
outstanding that are then due or mature within the following six months 
without reference to any projected profit or loss of the security-based 
swap dealer, either its net capital would fall below 120 percent of its 
minimum requirement under Sec.  240.18a-1, or, if the security-based 
swap dealer is approved to calculate net capital under Sec.  240.18a-
1(d), its tentative net capital would fall to an amount below 120 
percent of the minimum requirement.
    (3) Certain legends. If all the provisions of a satisfactory 
subordinated loan agreement do not appear in a single instrument, then 
the debenture or other evidence of indebtedness shall bear on its face 
an appropriate legend stating that it is issued subject to the 
provisions of a satisfactory subordinated loan agreement which shall be 
adequately referred to and incorporated by reference.
    (4) Revolving subordinated loan agreements. A security-based swap 
dealer shall be permitted to enter into a revolving subordinated loan 
agreement that provides for prepayment within

[[Page 44068]]

less than one year of all or any portion of the Payment Obligation 
thereunder at the option of the security-based swap dealer upon the 
prior written approval of the Commission. The Commission, however, 
shall not approve any prepayment if:
    (i) After giving effect thereto (and to all Payments of Payment 
Obligations under any other subordinated loan agreements then 
outstanding, the maturity or accelerated maturities of which are 
scheduled to fall due within six months after the date such prepayment 
is to occur pursuant to this provision or on or prior to the date on 
which the Payment Obligation in respect of such prepayment is scheduled 
to mature disregarding this provision, whichever date is earlier) 
without reference to any projected profit or loss of the security-based 
swap dealer, either its net capital would fall below 120 percent of its 
minimum requirement under Sec.  240.18a-1, or, if the security-based 
swap dealer is approved to calculate net capital under Sec.  240.18a-
1(d), its tentative net capital would fall to an amount below 120 
percent of the minimum requirement; or
    (ii) Pre-tax losses during the latest three-month period equaled 
more than 15 percent of current excess net capital. Any subordinated 
loan agreement entered into pursuant to this paragraph (c)(4) shall be 
subject to all the other provisions of this section. Any such 
subordinated loan agreement shall not be considered equity for purposes 
of Sec.  240.18a-1(g), despite the length of the initial term of the 
loan.
    (5) Filing. Two copies of any proposed subordinated loan agreement 
(including nonconforming subordinated loan agreements) shall be filed 
at least 30 days prior to the proposed execution date of the agreement 
with the Commission. The security-based swap dealer shall also file 
with the Commission a statement setting forth the name and address of 
the lender, the business relationship of the lender to the security-
based swap dealer, and whether the security-based swap dealer carried 
an account for the lender for effecting transactions in security-based 
swaps at or about the time the proposed agreement was so filed. All 
agreements shall be examined by the Commission prior to their becoming 
effective. No proposed agreement shall be a satisfactory subordinated 
loan agreement for the purposes of this section unless and until the 
Commission has found the agreement acceptable and such agreement has 
become effective in the form found acceptable.

0
 17. Section 240.18a-2 is added to read as follows:

Sec.  240.18a-2  Capital requirements for major security-based swap 
participants for which there is not a prudential regulator.

    (a) Every major security-based swap participant for which there is 
not a prudential regulator and is not registered as a broker or dealer 
pursuant to section 15(b) of the Act (15 U.S.C. 78o(b)) must at all 
times have and maintain positive tangible net worth.
    (b) The term tangible net worth means the net worth of the major 
security-based swap participant as determined in accordance with 
generally accepted accounting principles in the United States, 
excluding goodwill and other intangible assets. In determining net 
worth, all long and short positions in security-based swaps, swaps, and 
related positions must be marked to their market value. A major 
security-based swap participant must include in its computation of 
tangible net worth all liabilities or obligations of a subsidiary or 
affiliate that the participant guarantees, endorses, or assumes either 
directly or indirectly.
    (c) Every major security-based swap participant must comply with 
Sec.  240.15c3-4 as though it were an OTC derivatives dealer with 
respect to its security-based swap and swap activities, except that 
Sec.  240.15c3-4(c)(5)(xiii) and (xiv) and (d)(8) and (9) shall not 
apply.

0
18. Section 240.18a-3 is added to read as follows:

Sec.  240.18a-3  Non-cleared security-based swap margin requirements 
for security-based swap dealers and major security-based swap 
participants for which there is not a prudential regulator.

    (a) Every security-based swap dealer and major security-based swap 
participant for which there is not a prudential regulator must comply 
with this section.
    (b) Definitions. For the purposes of this section:
    (1) The term account means an account carried by a security-based 
swap dealer or major security-based swap participant that holds one or 
more non-cleared security-based swaps for a counterparty.
    (2) The term commercial end user means a counterparty that 
qualifies for an exception from clearing under section 3C(g)(1) of the 
Act (15 U.S.C. 78o-3(g)(1)) and implementing regulations or satisfies 
the criteria in section 3C(g)(4) of the Act (15 U.S.C. 78o-3(g)(4)) and 
implementing regulations.
    (3) The term counterparty means a person with whom the security-
based swap dealer or major security-based swap participant has entered 
into a non-cleared security-based swap transaction.
    (4) The term initial margin amount means the amount calculated 
pursuant to paragraph (d) of this section.
    (5) The term non-cleared security-based swap means a security-based 
swap that is not, directly or indirectly, submitted to and cleared by a 
clearing agency registered pursuant to section 17A of the Act (15 
U.S.C. 78q-1) or by a clearing agency that the Commission has exempted 
from registration by rule or order pursuant to section 17A of the Act 
(15 U.S.C. 78q-1).
    (6) The term security-based swap legacy account means an account 
that holds no security-based swaps entered into after the compliance 
date of this section and that only is used to hold one or more 
security-based swaps entered into prior to the compliance date of this 
section and collateral for those security-based swaps.
    (c) Margin requirements--(1) Security-based swap dealers--(i) 
Calculation required. A security-based swap dealer must calculate with 
respect to each account of a counterparty as of the close of each 
business day:
    (A) The amount of the current exposure in the account of the 
counterparty; and
    (B) The initial margin amount for the account of the counterparty.
    (ii) Account equity requirements. Except as provided in paragraph 
(c)(1)(iii) of this section, a security-based swap dealer must take an 
action required in paragraph (c)(1)(ii)(A) or (B) of this section by no 
later than the close of business of the first business day following 
the day of the calculation required under paragraph (c)(1)(i) of this 
section or, if the counterparty is located in another country and more 
than four time zones away, the second business day following the day of 
the calculation required under paragraph (c)(1)(i) of this section:
    (A)(1) Collect from the counterparty collateral in an amount equal 
to the current exposure that the security-based swap dealer has to the 
counterparty; or
    (2) Deliver to the counterparty collateral in an amount equal to 
the current exposure that the counterparty has to the security-based 
swap dealer, provided that such amount does not include the initial 
margin amount collected from the counterparty under paragraph 
(c)(1)(ii)(B) of this section; and
    (B) Collect from the counterparty collateral in an amount equal to 
the initial margin amount.
    (iii) Exceptions--(A) Commercial end users. The requirements of 
paragraph

[[Page 44069]]

(c)(1)(ii) of this section do not apply to an account of a counterparty 
that is a commercial end user.
    (B) Counterparties that are financial market intermediaries. The 
requirements of paragraph (c)(1)(ii)(B) of this section do not apply to 
an account of a counterparty that is a security-based swap dealer, swap 
dealer, broker or dealer, futures commission merchant, bank, foreign 
bank, or foreign broker or dealer.
    (C) Counterparties that use third-party custodians. The 
requirements of paragraph (c)(1)(ii)(B) of this section do not apply to 
an account of a counterparty that delivers the collateral to meet the 
initial margin amount to an independent third-party custodian.
    (D) Security-based swap legacy accounts. The requirements of 
paragraph (c)(1)(ii) of this section do not apply to a security-based 
swap legacy account.
    (E) Bank for International Settlements, European Stability 
Mechanism, and Multilateral development banks. The requirements of 
paragraph (c)(1)(ii) of this section do not apply to an account of a 
counterparty that is the Bank for International Settlements or the 
European Stability Mechanism, or is the International Bank for 
Reconstruction and Development, the Multilateral Investment Guarantee 
Agency, the International Finance Corporation, the Inter-American 
Development Bank, the Asian Development Bank, the African Development 
Bank, the European Bank for Reconstruction and Development, the 
European Investment Bank, the European Investment Fund, the Nordic 
Investment Bank, the Caribbean Development Bank, the Islamic 
Development Bank, the Council of Europe Development Bank, or any other 
multilateral development bank that provides financing for national or 
regional development in which the U.S. government is a shareholder or 
contributing member.
    (F) Sovereign entities. The requirements of paragraph (c)(1)(ii)(B) 
of this section do not apply to an account of a counterparty that is a 
central government (including the U.S. government) or an agency, 
department, ministry, or central bank of a central government if the 
security-based swap dealer has determined that the counterparty has 
only a minimal amount of credit risk pursuant to policies and 
procedures or credit risk models established pursuant to Sec.  
240.15c3-1 or Sec.  240.18a-1 (as applicable).
    (G) Affiliates. The requirements of paragraph (c)(1)(ii)(B) of this 
section do not apply to an account of a counterparty that is an 
affiliate of the security-based swap dealer.
    (H) Threshold amount. (1) A security-based swap dealer may elect 
not to collect the initial margin amount required under paragraph 
(c)(1)(ii)(B) of this section to the extent that the sum of that amount 
plus all other credit exposures resulting from non-cleared swaps and 
non-cleared security-based swaps of the security-based swap dealer and 
its affiliates with the counterparty and its affiliates does not exceed 
$50 million. For purposes of this calculation, a security-based swap 
dealer need not include any exposures arising from non-cleared security 
based swap transactions with a counterparty that is a commercial end 
user, and non-cleared swap transactions with a counterparty that 
qualifies for an exception from margin requirements pursuant to section 
4s(e)(4) of the Commodity Exchange Act (7 U.S.C. 6s(e)(4)).
    (2) One-time deferral. Notwithstanding paragraph (c)(1)(iii)(H)(1) 
of this section, a security-based swap dealer may defer collecting the 
initial margin amount required under paragraph (c)(1)(ii)(B) of this 
section for up to two months following the month in which a 
counterparty no longer qualifies for this threshold exception for the 
first time.
    (I) Minimum transfer amount. Notwithstanding any other provision of 
this rule, a security-based swap dealer is not required to collect or 
deliver collateral pursuant to this section with respect to a 
particular counterparty unless and until the total amount of collateral 
that is required to be collected or delivered, and has not yet been 
collected or delivered, with respect to the counterparty is greater 
than $500,000.
    (2) Major security-based swap participants--(i) Calculation 
required. A major security-based swap participant must with respect to 
each account of a counterparty calculate as of the close of each 
business day the amount of the current exposure in the account of the 
counterparty.
    (ii) Account equity requirements. Except as provided in paragraph 
(c)(2)(iii) of this section, a major security-based swap participant 
must take an action required in paragraph (c)(2)(ii)(A) or (B) of this 
section by no later than the close of business of the first business 
day following the day of the calculation required under paragraph 
(c)(2)(i) or, if the counterparty is located in another country and 
more than four time zones away, the second business day following the 
day of the calculation required under paragraph (c)(2)(i) of this 
section:
    (A) Collect from the counterparty collateral in an amount equal to 
the current exposure that the major security-based swap participant has 
to the counterparty; or
    (B) Deliver to the counterparty collateral in an amount equal to 
the current exposure that the counterparty has to the major security-
based swap participant.
    (iii) Exceptions--(A) Commercial end users. The requirements of 
paragraph (c)(2)(ii)(A) of this section do not apply to an account of a 
counterparty that is a commercial end user.
    (B) Security-based swap legacy accounts. The requirements of 
paragraph (c)(2)(ii) of this section do not apply to a security-based 
swap legacy account.
    (C) Bank for International Settlements, European Stability 
Mechanism, and Multilateral development banks. The requirements of 
paragraph (c)(2)(ii)(A) of this section do not apply to an account of a 
counterparty that is the Bank for International Settlements or the 
European Stability Mechanism, or is the International Bank for 
Reconstruction and Development, the Multilateral Investment Guarantee 
Agency, the International Finance Corporation, the Inter-American 
Development Bank, the Asian Development Bank, the African Development 
Bank, the European Bank for Reconstruction and Development, the 
European Investment Bank, the European Investment Fund, the Nordic 
Investment Bank, the Caribbean Development Bank, the Islamic 
Development Bank, the Council of Europe Development Bank, or any other 
multilateral development bank that provides financing for national or 
regional development in which the U.S. government is a shareholder or 
contributing member.
    (D) Minimum transfer amount. Notwithstanding any other provision of 
this rule, a major security-based swap participant is not required to 
collect or deliver collateral pursuant to this section with respect to 
a particular counterparty unless and until the total amount of 
collateral that is required to be collected or delivered, and has not 
yet been collected or delivered, with respect to the counterparty is 
greater than $500,000.
    (3) Deductions for collateral. (i) The fair market value of 
collateral delivered by a counterparty or the security-based swap 
dealer must be reduced by the amount of the standardized deductions the 
security-based swap dealer would apply to the collateral pursuant to

[[Page 44070]]

Sec.  240.15c3-1 or Sec.  240.18a-1, as applicable, for the purpose of 
paragraph (c)(1)(ii) of this section.
    (ii) Notwithstanding paragraph (c)(3)(i) of this section, the fair 
market value of assets delivered as collateral by a counterparty or the 
security-based swap dealer may be reduced by the amount of the 
standardized deductions prescribed in 17 CFR 23.156 if the security-
based swap dealer applies these standardized deductions consistently 
with respect to the particular counterparty.
    (4) Collateral requirements. A security-based swap dealer or a 
major security-based swap participant when calculating the amounts 
under paragraphs (c)(1) and (2) of this section may take into account 
the fair market value of collateral delivered by a counterparty 
provided:
    (i) The collateral:
    (A) Has a ready market;
    (B) Is readily transferable;
    (C) Consists of cash, securities, money market instruments, a major 
foreign currency, the settlement currency of the non-cleared security-
based swap, or gold;
    (D) Does not consist of securities and/or money market instruments 
issued by the counterparty or a party related to the security-based 
swap dealer, the major security-based swap participant, or the 
counterparty; and
    (E) Is subject to an agreement between the security-based swap 
dealer or the major security-based swap participant and the 
counterparty that is legally enforceable by the security-based swap 
dealer or the major security-based swap participant against the 
counterparty and any other parties to the agreement; and
    (ii) The collateral is either:
    (A) Subject to the physical possession or control of the security-
based swap dealer or the major security-based swap participant and may 
be liquidated promptly by the security-based swap dealer or the major 
security-based swap participant without intervention by any other 
party; or
    (B) The collateral is carried 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.
    (5) Qualified netting agreements. A security-based swap dealer or 
major security-based swap participant may include the effect of a 
netting agreement that allows the security-based swap dealer or major 
security-based swap participant to net gross receivables from and gross 
payables to a counterparty upon the default of the counterparty, for 
the purposes of the calculations required pursuant to paragraphs 
(c)(1)(i) and (c)(2)(i) of this section, if:
    (i) The netting agreement is legally enforceable in each relevant 
jurisdiction, including in insolvency proceedings;
    (ii) The gross receivables and gross payables that are subject to 
the netting agreement with a counterparty can be determined at any 
time; and
    (iii) For internal risk management purposes, the security-based 
swap dealer or major security-based swap participant monitors and 
controls its exposure to the counterparty on a net basis.
    (6) Frequency of calculations increased. The calculations required 
pursuant to paragraphs (c)(1)(i) and (c)(2)(i) of this section must be 
made more frequently than the close of each business day during periods 
of extreme volatility and for accounts with concentrated positions.
    (7) Liquidation. A security-based swap dealer or major security-
based swap participant must take prompt steps to liquidate positions in 
an account that does not meet the margin requirements of this section 
to the extent necessary to eliminate the margin deficiency.
    (d) Calculating initial margin amount. A security-based swap dealer 
must calculate the initial margin amount required by paragraph 
(c)(1)(i)(B) of this section for non-cleared security-based swaps as 
follows:
    (1) Standardized approach--(i) Credit default swaps. For credit 
default swaps, the security-based swap dealer must use the method 
specified in Sec.  240.18a-1(c)(1)(vi)(B)(1) or, if the security-based 
swap dealer is registered with the Commission as a broker or dealer, 
the method specified in Sec.  240.15c3-1(c)(2)(vi)(P)(1).
    (ii) All other security-based swaps. For security-based swaps other 
than credit default swaps, the security-based swap dealer must use the 
method specified in Sec.  240.18a-1(c)(1)(vi)(B)(2) or, if the 
security-based swap dealer is registered with the Commission as a 
broker or dealer, the method specified in Sec.  240.15c3-
1(c)(2)(vi)(P)(2).
    (2) Model approach. (i) For security-based swaps other than equity 
security-based swaps, a security-based swap dealer may apply to the 
Commission for authorization to use and be responsible for a model to 
calculate the initial margin amount required by paragraph (c)(1)(i)(B) 
of this section subject to the application process in Sec.  240.15c3-1e 
or Sec.  240.18a-1(d), as applicable. The model must use a 99 percent, 
one-tailed confidence level with price changes equivalent to a ten 
business-day movement in rates and prices, and must use risk factors 
sufficient to cover all the material price risks inherent in the 
positions for which the initial margin amount is being calculated, 
including foreign exchange or interest rate risk, credit risk, equity 
risk, and commodity risk, as appropriate. Empirical correlations may be 
recognized by the model within each broad risk category, but not across 
broad risk categories.
    (ii) Notwithstanding paragraph (d)(2)(i) of this section, a 
security-based swap dealer that is not registered as a broker or dealer 
pursuant to Section 15(b) of the Act (15 U.S.C. 78o(b)), other than as 
an OTC derivatives dealer, may apply to the Commission for 
authorization to use a model to calculate the initial margin amount 
required by paragraph (c)(1)(i)(B) of this section for equity security-
based swaps, subject to the application process and model requirements 
of paragraph (d)(2)(i) of this section; provided, however, the account 
of the counterparty subject to the requirements of this paragraph may 
not hold equity security positions other than equity security-based 
swaps and equity swaps.
    (e) Risk monitoring and procedures. A security-based swap dealer 
must monitor the risk of each account and establish, maintain, and 
document procedures and guidelines for monitoring the risk of accounts 
as part of the risk management control system required by Sec.  
240.15c3-4. The security-based swap dealer must review, in accordance 
with written procedures, at reasonable periodic intervals, its non-
cleared security-based swap activities for consistency with the risk 
monitoring procedures and guidelines required by this section. The 
security-based swap dealer also must determine whether information and 
data necessary to apply the risk monitoring procedures and guidelines 
required by this section are accessible on a timely basis and whether 
information systems are available to adequately capture, monitor, 
analyze, and report relevant data and information. The risk monitoring 
procedures and guidelines must include, at a minimum, procedures and 
guidelines for:
    (1) Obtaining and reviewing account documentation and financial 
information necessary for assessing the amount of current and potential 
future exposure to a given counterparty

[[Page 44071]]

permitted by the security-based swap dealer;
    (2) Determining, approving, and periodically reviewing credit 
limits for each counterparty, and across all counterparties;
    (3) Monitoring credit risk exposure to the security-based swap 
dealer from non-cleared security-based swaps, including the type, 
scope, and frequency of reporting to senior management;
    (4) Using stress tests to monitor potential future exposure to a 
single counterparty and across all counterparties over a specified 
range of possible market movements over a specified time period;
    (5) Managing the impact of credit exposure related to non-cleared 
security-based swaps on the security-based swap dealer's overall risk 
exposure;
    (6) Determining the need to collect collateral from a particular 
counterparty, including whether that determination was based upon the 
creditworthiness of the counterparty and/or the risk of the specific 
non-cleared security-based swap contracts with the counterparty;
    (7) Monitoring the credit exposure resulting from concentrated 
positions with a single counterparty and across all counterparties, and 
during periods of extreme volatility; and
    (8) Maintaining sufficient equity in the account of each 
counterparty to protect against the largest individual potential future 
exposure of a non-cleared security-based swap carried in the account of 
the counterparty as measured by computing the largest maximum possible 
loss that could result from the exposure.

0
19. Section 240.18a-4 is added to read as follows:

Sec.  240.18a-4  Segregation requirements for security-based swap 
dealers and major security-based swap participants.

    Section 240.18a-4 applies to a security-based swap dealer or major 
security-based swap participant registered under section 15F(b) of the 
Act (15 U.S.C. 78o-10(b)), including a security-based swap dealer that 
is an OTC derivatives dealer as that term is defined in Sec.  240.3b-
12. A security-based swap dealer registered under section 15F of the 
Act (15 U.S.C. 78o-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 customer protection requirements under Sec.  
240.15c3-3, including paragraph (p) of that rule with respect to its 
security-based swap activity.
    (a) Definitions. For the purposes of this section:
    (1) The term cleared security-based swap means a security-based 
swap that is, directly or indirectly, submitted to and cleared by a 
clearing agency registered with the Commission pursuant to section 17A 
of the Act (15 U.S.C. 78q-1);
    (2) The term excess securities collateral means securities and 
money market instruments carried for the account of a security-based 
swap customer that have a market value in excess of the current 
exposure of the security-based swap dealer (after reducing the current 
exposure by the amount of cash in the account) to the security-based 
swap customer, excluding:
    (i) Securities and money market instruments held in a qualified 
clearing agency account but only to the extent the securities and money 
market instruments are being used to meet a margin requirement of the 
clearing agency resulting from a security-based swap transaction of the 
security-based swap customer; and
    (ii) Securities and money market instruments held in a qualified 
registered security-based swap dealer account or in a third-party 
custodial account but only to the extent the securities and money 
market instruments are being used to meet a regulatory margin 
requirement of another security-based swap dealer resulting from the 
security-based swap dealer entering into a non-cleared security-based 
swap transaction with the other security-based swap dealer to offset 
the risk of a non-cleared security-based swap transaction between the 
security-based swap dealer and the security-based swap customer.
    (3) The term foreign major security-based swap participant has the 
meaning set forth in Sec.  240.3a67-10(a)(6).
    (4) The term foreign security-based swap dealer has the meaning set 
forth in Sec.  240.3a71-3(a)(7).
    (5) The term qualified clearing agency account means an account of 
a security-based swap dealer at a clearing agency registered with the 
Commission pursuant to section 17A of the Act (15 U.S.C. 78q-1) that 
holds funds and other property in order to margin, guarantee, or secure 
cleared security-based swap transactions for the security-based swap 
customers of the security-based swap dealer that meets the following 
conditions:
    (i) The account is designated ``Special Clearing Account for the 
Exclusive Benefit of the Cleared Security-Based Swap Customers of [name 
of security-based swap dealer]'';
    (ii) The clearing agency has acknowledged in a written notice 
provided to and retained by the security-based swap dealer that the 
funds and other property in the account are being held by the clearing 
agency for the exclusive benefit of the security-based swap customers 
of the security-based swap dealer in accordance with the regulations of 
the Commission and are being kept separate from any other accounts 
maintained by the security-based swap dealer with the clearing agency; 
and
    (iii) The account is subject to a written contract between the 
security-based swap dealer and the clearing agency which provides that 
the funds and other property in the account shall be subject to no 
right, charge, security interest, lien, or claim of any kind in favor 
of the clearing agency or any person claiming through the clearing 
agency, except a right, charge, security interest, lien, or claim 
resulting from a cleared security-based swap transaction effected in 
the account.
    (6) The term qualified registered security-based swap dealer 
account means an account at another security-based swap dealer 
registered with the Commission pursuant to section 15F of the Act that 
meets the following conditions:
    (i) The account is designated ``Special Reserve Account for the 
Exclusive Benefit of the Security-Based Swap Customers of [name of 
security-based swap dealer]'';
    (ii) The other security-based swap dealer has acknowledged in a 
written notice provided to and retained by the security-based swap 
dealer that the funds and other property held in the account are being 
held by the other security-based swap dealer for the exclusive benefit 
of the security-based swap customers of the security-based swap dealer 
in accordance with the regulations of the Commission and are being kept 
separate from any other accounts maintained by the security-based swap 
dealer with the other security-based swap dealer;
    (iii) The account is subject to a written contract between the 
security-based swap dealer and the other security-based swap dealer 
which provides that the funds and other property in the account shall 
be subject to no right, charge, security interest, lien, or claim of 
any kind in favor of the other security-based swap dealer or any person 
claiming through the other security-based swap dealer, except a right, 
charge, security interest, lien, or claim resulting from a non-cleared 
security-based swap transaction effected in the account; and

[[Page 44072]]

    (iv) The account and the assets in the account are not subject to 
any type of subordination agreement between the security-based swap 
dealer and the other security-based swap dealer.
    (7) The term qualified security means:
    (i) Obligations of the United States;
    (ii) Obligations fully guaranteed as to principal and interest by 
the United States; and
    (iii) General obligations of any State or a political subdivision 
of a State that:
    (A) Are not traded flat and are not in default;
    (B) Were part of an initial offering of $500 million or greater; 
and
    (C) Were issued by an issuer that has published audited financial 
statements within 120 days of its most recent fiscal year end.
    (8) The term security-based swap customer means any person from 
whom or on whose behalf the security-based swap dealer has received or 
acquired or holds funds or other property for the account of the person 
with respect to a cleared or non-cleared security-based swap 
transaction. The term does not include a person to the extent that 
person has a claim for funds or other property which by contract, 
agreement or understanding, or by operation of law, is part of the 
capital of the security-based swap dealer or is subordinated to all 
claims of security-based swap customers of the security-based swap 
dealer.
    (9) The term special reserve account for the exclusive benefit of 
security-based swap customers means an account at a bank that meets the 
following conditions:
    (i) The account is designated ``Special Reserve Account for the 
Exclusive Benefit of the Security-Based Swap Customers of [name of 
security-based swap dealer]'';
    (ii) The account is subject to a written acknowledgement by the 
bank provided to and retained by the security-based swap dealer that 
the funds and other property held in the account are being held by the 
bank for the exclusive benefit of the security-based swap customers of 
the security-based swap dealer in accordance with the regulations of 
the Commission and are being kept separate from any other accounts 
maintained by the security-based swap dealer with the bank; and
    (iii) The account is subject to a written contract between the 
security-based swap dealer and the bank which provides that the funds 
and other property in the account shall at no time be used directly or 
indirectly as security for a loan or other extension of credit to the 
security-based swap dealer by the bank and, shall be subject to no 
right, charge, security interest, lien, or claim of any kind in favor 
of the bank or any person claiming through the bank.
    (10) The term third-party custodial account means an account 
carried by an independent third-party custodian that meets the 
following conditions:
    (i) The account is established for the purposes of meeting 
regulatory margin requirements of another security-based swap dealer;
    (ii) The account is carried by a bank as defined in section 3(a)(6) 
of the Act or a registered U.S. clearing organization or depository or, 
if the collateral to be held in the account consists of foreign 
securities or currencies, a supervised foreign bank, clearing 
organization, or depository that customarily maintains custody of such 
foreign securities or currencies;
    (iii) The account is designated for and on behalf of the security-
based swap dealer for the benefit of its security-based swap customers 
and the account is subject to a written acknowledgement by the bank, 
clearing organization, or depository provided to and retained by the 
security-based swap dealer that the funds and other property held in 
the account are being held by the bank, clearing organization, or 
depository for the exclusive benefit of the security-based swap 
customers of the security-based swap dealer and are being kept separate 
from any other accounts maintained by the security-based swap dealer 
with the bank, clearing organization, or depository; and
    (iv) The account is subject to a written contract between the 
security-based swap dealer and the bank, clearing organization, or 
depository which provides that the funds and other property in the 
account shall at no time be used directly or indirectly as security for 
a loan or other extension of credit to the security-based swap dealer 
by the bank, clearing organization, or depository and, shall be subject 
to no right, charge, security interest, lien, or claim of any kind in 
favor of the bank, clearing organization, or depository or any person 
claiming through the bank, clearing organization, or depository.
    (11) The term U.S. person has the meaning set forth in Sec.  
240.3a71-3(a)(4).
    (b) Physical possession or control of excess securities collateral. 
(1) A security-based swap dealer must promptly obtain and thereafter 
maintain physical possession or control of all excess securities 
collateral carried for the security-based swap accounts of security-
based swap customers.
    (2) A security-based swap dealer has control of excess securities 
collateral only if the securities and money market instruments:
    (i) Are represented by one or more certificates in the custody or 
control of a clearing corporation or other subsidiary organization of 
either national securities exchanges, or of a custodian bank in 
accordance with a system for the central handling of securities 
complying with the provisions of Sec. Sec.  240.8c-1(g) and 240.15c2-
1(g) the delivery of which certificates to the security-based swap 
dealer does not require the payment of money or value, and if the books 
or records of the security-based swap dealer identify the security-
based swap customers entitled to receive specified quantities or units 
of the securities so held for such security-based swap customers 
collectively;
    (ii) Are the subject of bona fide items of transfer; provided that 
securities and money market instruments shall be deemed not to be the 
subject of bona fide items of transfer if, within 40 calendar days 
after they have been transmitted for transfer by the security-based 
swap dealer to the issuer or its transfer agent, new certificates 
conforming to the instructions of the security-based swap dealer have 
not been received by the security-based swap dealer, the security-based 
swap dealer has not received a written statement by the issuer or its 
transfer agent acknowledging the transfer instructions and the 
possession of the securities or money market instruments, or the 
security-based swap dealer has not obtained a revalidation of a window 
ticket from a transfer agent with respect to the certificate delivered 
for transfer;
    (iii) Are in the custody or control of a bank as defined in section 
3(a)(6) of the Act, the delivery of which securities or money market 
instruments to the security-based swap dealer does not require the 
payment of money or value and the bank having acknowledged in writing 
that the securities and money market instruments in its custody or 
control are not subject to any right, charge, security interest, lien 
or claim of any kind in favor of a bank or any person claiming through 
the bank;
    (iv)(A) Are held in or are in transit between offices of the 
security-based swap dealer; or (B) Are held by a corporate subsidiary 
if the security-based swap dealer owns and exercises a majority of the 
voting rights of all of the voting securities of such subsidiary, 
assumes or guarantees all of the subsidiary's obligations and 
liabilities, operates the subsidiary as a branch office of the 
security-based swap dealer, and assumes full responsibility for 
compliance by the subsidiary and all of its associated persons with the 
provisions of the Federal securities laws

[[Page 44073]]

as well as for all of the other acts of the subsidiary and such 
associated persons; or
    (v) Are held in such other locations as the Commission shall upon 
application from a security-based swap dealer find and designate to be 
adequate for the protection of security-based swap customer securities.
    (3) Each business day the security-based swap dealer must determine 
from its books and records the quantity of excess securities collateral 
in its possession or control as of the close of the previous business 
day and the quantity of excess securities collateral not in its 
possession or control as of the previous business day. If the security-
based swap dealer did not obtain possession or control of all excess 
securities collateral on the previous business day as required by this 
section and there are securities or money market instruments of the 
same issue and class in any of the following non-control locations:
    (i) Securities or money market instruments subject to a lien 
securing an obligation of the security-based swap dealer, then the 
security-based swap dealer, not later than the next business day on 
which the determination is made, must issue instructions for the 
release of the securities or money market instruments from the lien and 
must obtain physical possession or control of the securities or money 
market instruments within two business days following the date of the 
instructions;
    (ii) Securities or money market instruments held in a qualified 
clearing agency account, then the security-based swap dealer, not later 
than the next business day on which the determination is made, must 
issue instructions for the release of the securities or money market 
instruments by the clearing agency and must obtain physical possession 
or control of the securities or money market instruments within two 
business days following the date of the instructions;
    (iii) Securities or money market instruments held in a qualified 
registered security-based swap dealer account maintained by another 
security-based swap dealer or in a third-party custodial account, then 
the security-based swap dealer, not later than the next business day on 
which the determination is made, must issue instructions for the 
release of the securities or money market instruments by the other 
security-based swap dealer or by the third-party custodian and must 
obtain physical possession or control of the securities or money market 
instruments within two business days following the date of the 
instructions;
    (iv) Securities or money market instruments loaned by the security-
based swap dealer, then the security-based swap dealer, not later than 
the next business day on which the determination is made, must issue 
instructions for the return of the loaned securities or money market 
instruments and must obtain physical possession or control of the 
securities or money market instruments within five business days 
following the date of the instructions;
    (v) Securities or money market instruments failed to receive for 
more than 30 calendar days, then the security-based swap dealer, not 
later than the next business day on which the determination is made, 
must take prompt steps to obtain physical possession or control of the 
securities or money market instruments through a buy-in procedure or 
otherwise;
    (vi) Securities or money market instruments receivable by the 
security-based swap dealer as a security dividend, stock split or 
similar distribution for more than 45 calendar days, then the security-
based swap dealer, not later than the next business day on which the 
determination is made, must take prompt steps to obtain physical 
possession or control of the securities or money market instruments 
through a buy-in procedure or otherwise; or
    (vii) Securities or money market instruments included on the 
security-based swap dealer's books or records that allocate to a short 
position of the security-based swap dealer or a short position for 
another person, for more than 30 calendar days, then the security-based 
swap dealer must, not later than the business day following the day on 
which the determination is made, take prompt steps to obtain physical 
possession or control of such securities or money market instruments.
    (c) Deposit requirement for special reserve account for the 
exclusive benefit of security-based swap customers. (1) A security-
based swap dealer must maintain a special reserve account for the 
exclusive benefit of security-based swap customers that is separate 
from any other bank account of the security-based swap dealer. The 
security-based swap dealer must at all times maintain in the special 
reserve account for the exclusive benefit of security-based swap 
customers, through deposits into the account, cash and/or qualified 
securities in amounts computed in accordance with the formula set forth 
in Sec.  240.18a-4a.
    (i) In determining the amount maintained in a special reserve 
account for the exclusive benefit of security-based swap customers, the 
security-based swap dealer must deduct:
    (A) The percentage of the value of a general obligation of a State 
or a political subdivision of a State specified in Sec.  240.15c3-
1(c)(2)(vi);
    (B) The aggregate value of general obligations of a State or a 
political subdivision of a State to the extent the amount of the 
obligations of a single issuer (after applying the deduction in 
paragraph (c)(1)(i)(A) of this section) exceeds two percent of the 
amount required to be maintained in the special reserve account for the 
exclusive benefit of security-based swap customers;
    (C) The aggregate value of all general obligations of States or 
political subdivisions of States to the extent the amount of the 
obligations (after applying the deduction in paragraph (c)(1)(i)(A) of 
this section) exceeds 10 percent of the amount required to be 
maintained in the special reserve account for the exclusive benefit of 
security-based swap customers;
    (D) The amount of cash deposited with a single non-affiliated bank 
to the extent the amount exceeds 15 percent of the equity capital of 
the bank as reported by the bank in its most recent Call Report or any 
successor form the bank is required to file by its appropriate federal 
banking agency (as defined by section 3 of the Federal Deposit 
Insurance Act (12 U.S.C. 1813)); and
    (E) The total amount of cash deposited with an affiliated bank.
    (ii) Exception. A security-based swap dealer for which there is a 
prudential regulator need not take the deduction specified in paragraph 
(c)(1)(i)(D) of this section if it maintains the special reserve 
account for the exclusive benefit of security-based swap customers 
itself rather than at an affiliated or non-affiliated bank.
    (2) A security-based swap dealer must not accept or use credits 
identified in the items of the formula set forth in Sec.  240.18a-4a 
except for the specified purposes indicated under items comprising 
Total Debits under the formula, and, to the extent Total Credits exceed 
Total Debits, at least the net amount thereof must be maintained in the 
Special Reserve Account pursuant to paragraph (c)(1) of this section.
    (3)(i) The computations necessary to determine the amount required 
to be maintained in the special reserve account for the exclusive 
benefit of security-based swap customers must be made weekly as of the 
close of the last business day of the week and any

[[Page 44074]]

deposit required to be made into the account must be made no later than 
one hour after the opening of banking business on the second following 
business day. The security-based swap dealer may make a withdrawal from 
the special reserve account for the exclusive benefit of security-based 
swap customers only if the amount remaining in the account after the 
withdrawal is equal to or exceeds the amount required to be maintained 
in the account pursuant to paragraph (c)(1) of this section.
    (ii) Computations in addition to the computations required pursuant 
to paragraph (c)(3)(i) of this section may be made as of the close of 
any business day, and deposits so computed must be made no later than 
one hour after the open of banking business on the second following 
business day.
    (4) A security-based swap dealer must promptly deposit into a 
special reserve account for the exclusive benefit of security-based 
swap customers cash and/or qualified securities of the security-based 
swap dealer if the amount of cash and/or qualified securities in one or 
more special reserve accounts for the exclusive benefit of security-
based swap customers falls below the amount required to be maintained 
pursuant to this section.
    (d) Requirements for non-cleared security-based swaps--(1) Notice. 
A security-based swap dealer and a major security-based swap 
participant must provide the notice required pursuant to section 
3E(f)(1)(A) of the Act (15 U.S.C. 78c-5(f)) in writing to a duly 
authorized individual prior to the execution of the first non-cleared 
security-based swap transaction with the counterparty occurring after 
the compliance date of this section.
    (2) Subordination--(i) Counterparty that elects to have individual 
segregation at an independent third-party custodian. A security-based 
swap dealer must obtain an agreement from a counterparty whose funds or 
other property to meet a margin requirement of the security-based swap 
dealer are held at a third-party custodian in which the counterparty 
agrees to subordinate its claims against the security-based swap dealer 
for the funds or other property held at the third-party custodian to 
the claims of security-based swap customers of the security-based swap 
dealer but only to the extent that funds or other property provided by 
the counterparty to the third-party custodian are not treated as 
customer property as that term is defined in 11 U.S.C. 741 in a 
liquidation of the security-based swap dealer.
    (ii) Counterparty that elects to have no segregation. A security-
based swap dealer must obtain an agreement from a counterparty that 
affirmatively chooses not to require segregation of funds or other 
property pursuant to section 3E(f) of the Act (15 U.S.C. 78c-5(f)) in 
which the counterparty agrees to subordinate all of its claims against 
the security-based swap dealer to the claims of security-based swap 
customers of the security-based swap dealer.
    (e) Segregation and disclosure requirements for foreign security-
based swap dealers and foreign major security-based swap participants--
(1) Segregation requirements for foreign security-based swap dealers--
(i) Foreign bank. Section 3E of the Act (15 U.S.C. 78c-5) and this 
section thereunder apply to a foreign security-based swap dealer 
registered under section 15F of the Act (15 U.S.C. 78o-10) that is a 
foreign bank, foreign savings bank, foreign cooperative bank, foreign 
savings and loan association, foreign building and loan association, or 
foreign credit union:
    (A) With respect to a security-based swap customer that is a U.S. 
person, and
    (B) With respect to a security-based swap customer that is not a 
U.S. person if the foreign security-based swap dealer holds funds or 
other property arising out of a transaction had by such person with a 
branch or agency (as defined in section 1(b) of the International 
Banking Act of 1978) in the United States of such foreign security-
based swap dealer.
    (ii) Not a foreign bank. Section 3E of the Act (15 U.S.C. 78c-5) 
and this section thereunder apply to a foreign security-based swap 
dealer registered under section 15F of the Act (15 U.S.C. 78o-10) that 
is not a foreign bank, foreign savings bank, foreign cooperative bank, 
foreign savings and loan association, foreign building and loan 
association, or foreign credit union:
    (A) Cleared security-based swaps. With respect to all cleared 
security-based swap transactions, if such foreign security-based swap 
dealer has received or acquired or holds funds or other property for at 
least one security-based swap customer that is a U.S. person with 
respect to a cleared security-based swap transaction with such U.S. 
person, and
    (B) Non-cleared security-based swaps. With respect to funds or 
other property such foreign security-based swap dealer has received or 
acquired or holds for a security-based swap customer that is a U.S. 
person with respect to a non-cleared security-based swap transaction 
with such U.S. person.
    (2) Segregation requirements for foreign major security-based swap 
participants. Section 3E of the Act (15 U.S.C. 78c-5) and this section 
thereunder apply to a foreign major security-based swap participant 
registered under section 15F of the Act (15 U.S.C. 78o-10), with 
respect to a counterparty that is a U.S. person.
    (3) Disclosure requirements for foreign security-based swap 
dealers. A foreign security-based swap dealer registered under section 
15F of the Act (15 U.S.C. 78o-10) must disclose in writing to a 
security-based swap customer that is a U.S. person, prior to receiving, 
acquiring, or holding funds or other property for such security-based 
swap customer with respect to a security-based swap transaction, the 
potential treatment of the funds or other property segregated by such 
foreign security-based swap dealer pursuant to section 3E of the Act 
(15 U.S.C. 78c-5), and the rules and regulations thereunder, in 
insolvency proceedings under U.S. bankruptcy law and any applicable 
foreign insolvency laws. Such disclosure must include whether the 
foreign security-based swap dealer is subject to the segregation 
requirement set forth in section 3E of the Act (15 U.S.C. 78c-5), and 
the rules and regulations thereunder, with respect to the funds or 
other property received, acquired, or held for the security-based swap 
customer that will receive the disclosure, whether the foreign 
security-based swap dealer could be subject to the stockbroker 
liquidation provisions in the U.S. Bankruptcy Code, whether the 
segregated funds or other property could be afforded customer property 
treatment under U.S. bankruptcy law, and any other relevant 
considerations that may affect the treatment of the funds or other 
property segregated under section 3E of the Act (15 U.S.C. 78c-5), and 
the rules and regulations thereunder, in insolvency proceedings of the 
foreign security-based swap dealer.
    (f) Exemption. The requirements of this section do not apply if the 
following conditions are met:
    (1) The security-based swap dealer does not:
    (i) Effect transactions in cleared security-based swaps for or on 
behalf of another person;
    (ii) Have any open transactions in cleared security-based swaps 
executed for or on behalf of another person; and
    (iii) Hold or control any money, securities, or other property to 
margin, guarantee, or secure a cleared security-based swap transaction 
executed for or on behalf of another person (including money, 
securities, or other property accruing to another person as a result of

[[Page 44075]]

a cleared security-based swap transaction);
    (2) The security-based swap dealer provides the notice required 
pursuant to section 3E(f)(1)(A) of the Act (15 U.S.C. 78c-5(f)(1)(A)) 
in writing to a duly authorized individual prior to the execution of 
the first non-cleared security-based swap transaction with the 
counterparty occurring after the compliance date of this section; and
    (3) The security-based swap dealer discloses in writing to a 
counterparty before engaging in the first non-cleared security-based 
swap transaction with the counterparty that any margin collateral 
received and held by the security-based swap dealer will not be subject 
to a segregation requirement and how a claim of a counterparty for the 
collateral would be treated in a bankruptcy or other formal liquidation 
proceeding of the security-based swap dealer.

0
20. Section 240.18a-4a is added to read as follows:

Sec.  240.18a-4a  Exhibit A--Formula for determination of security-
based swap customer reserve requirements under Sec.  240.18a-4.

------------------------------------------------------------------------
                                              Credits         Debits
------------------------------------------------------------------------
1. Free credit balances and other credit            $___  ..............
 balances in the accounts carried for
 security-based swap customers (See Note
 A).....................................
2. Monies borrowed collateralized by                $___  ..............
 securities in accounts carried for
 security-based swap customers (See Note
 B).....................................
3. Security-based swap customers'                   $___  ..............
 securities failed to receive (See Note
 C).....................................
4. Credit balances in firm accounts                 $___  ..............
 which are attributable to principal
 sales to security-based swap customers.
5. Market value of stock dividends,                 $___  ..............
 stock splits and similar distributions
 receivable outstanding over 30 calendar
 days...................................
6. Market value of short security count             $___  ..............
 differences over 30 calendar days old..
7. Market value of short securities and             $___  ..............
 credits (not to be offset by longs or
 by debits) in all suspense accounts
 over 30 calendar days..................
8. Market value of securities which are   ..............            $___
 in transfer in excess of 40 calendar
 days and have not been confirmed to be
 in transfer by the transfer agent or
 the issuer during the 40 days..........
9. Securities borrowed to effectuate      ..............            $___
 short sales by security-based swap
 customers and securities borrowed to
 make delivery on security-based swap
 customers' securities failed to deliver
10. Failed to deliver of security-based   ..............            $___
 swap customers' securities not older
 than 30 calendar days..................
11. Margin required and on deposit with   ..............            $___
 the Options Clearing Corporation for
 all option contracts written or
 purchased in accounts carried for
 security-based swap customers (See Note
 D).....................................
12. Margin related to security futures    ..............            $___
 products written, purchased or sold in
 accounts carried for security-based
 swap customers required and on deposit
 in a qualified clearing agency account
 at a clearing agency registered with
 the Commission under section 17A of the
 Act (15 U.S.C. 78q-1) or a derivatives
 clearing organization registered with
 the Commodity Futures Trading
 Commission under section 5b of the
 Commodity Exchange Act (7 U.S.C. 7a-1)
 (See Note E)...........................
13. Margin related to cleared security-   ..............            $___
 based swap transactions in accounts
 carried for security-based swap
 customers required and on deposit in a
 qualified clearing agency account at a
 clearing agency registered with the
 Commission pursuant to section 17A of
 the Act (15 U.S.C. 78q-1)..............
14. Margin related to non-cleared         ..............            $___
 security-based swap transactions in
 accounts carried for security-based
 swap customers required and held in a
 qualified registered security-based
 swap dealer account at another security-
 based swap dealer or at a third-party
 custodial account......................
                                         -------------------------------
    Total Credits.......................            $___  ..............
                                         -------------------------------
    Total Debits........................  ..............            $___
                                         -------------------------------
    Excess of Credits over Debits.......            $___  ..............
------------------------------------------------------------------------
Note A. Item 1 must include all outstanding drafts payable to security-
  based swap customers which have been applied against free credit
  balances or other credit balances and must also include checks drawn
  in excess of bank balances per the records of the security-based swap
  dealer.
Note B. Item 2 shall include the amount of options-related or security
  futures product-related Letters of Credit obtained by a member of a
  registered clearing agency or a derivatives clearing organization
  which are collateralized by security-based swap customers' securities,
  to the extent of the member's margin requirement at the registered
  clearing agency or derivatives clearing organization.
Note C. Item 3 must include in addition to security-based swap
  customers' securities failed to receive the amount by which the market
  value of securities failed to receive and outstanding more than thirty
  (30) calendar days exceeds their contract value.
Note D. Item 11 must include the amount of margin required and on
  deposit with Options Clearing Corporation to the extent such margin is
  represented by cash, proprietary qualified securities, and letters of
  credit collateralized by security-based swap customers' securities.
Note E. (a) Item 12 must include the amount of margin required and on
  deposit with a clearing agency registered with the Commission under
  section 17A of the Act (15 U.S.C. 78q-1) or a derivatives clearing
  organization registered with the Commodity Futures Trading Commission
  under section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1) for
  security-based swap customer accounts to the extent that the margin is
  represented by cash, proprietary qualified securities, and letters of
  credit collateralized by security-based swap customers' securities.
(b) Item 12 will apply only if the security-based swap dealer has the
  margin related to security futures products on deposit with:
(1) A registered clearing agency or derivatives clearing organization
  that:
(i) Maintains security deposits from clearing members in connection with
  regulated options or futures transactions and assessment power over
  member firms that equal a combined total of at least $2 billion, at
  least $500 million of which must be in the form of security deposits.
  For purposes of this Note E the term ``security deposits'' refers to a
  general fund, other than margin deposits or their equivalent, that
  consists of cash or securities held by a registered clearing agency or
  derivative clearing organization;
(ii) Maintains at least $3 billion in margin deposits; or
(iii) Does not meet the requirements of paragraphs (b)(1)(i) through
  (b)(1)(ii) of this Note E, if the Commission has determined, upon a
  written request for exemption by or for the benefit of the security-
  based swap dealer, that the security-based swap dealer may utilize
  such a registered clearing agency or derivatives clearing
  organization. The Commission may, in its sole discretion, grant such
  an exemption subject to such conditions as are appropriate under the
  circumstances, if the Commission determines that such conditional or
  unconditional exemption is necessary or appropriate in the public
  interest, and is consistent with the protection of investors; and

[[Page 44076]]

 
(2) A registered clearing agency or derivatives clearing organization
  that, if it holds funds or securities deposited as margin for security
  futures products in a bank, as defined in section 3(a)(6) of the Act
  (15 U.S.C. 78c(a)(6)), obtains and preserves written notification from
  the bank at which it holds such funds and securities or at which such
  funds and securities are held on its behalf. The written notification
  will state that all funds and/or securities deposited with the bank as
  margin (including security-based swap customer security futures
  products margin), or held by the bank and pledged to such registered
  clearing agency or derivatives clearing agency as margin, are being
  held by the bank for the exclusive benefit of clearing members of the
  registered clearing agency or derivatives clearing organization
  (subject to the interest of such registered clearing agency or
  derivatives clearing organization therein), and are being kept
  separate from any other accounts maintained by the registered clearing
  agency or derivatives clearing organization with the bank. The written
  notification also will provide that such funds and/or securities will
  at no time be used directly or indirectly as security for a loan to
  the registered clearing agency or derivatives clearing organization by
  the bank, and will be subject to no right, charge, security interest,
  lien, or claim of any kind in favor of the bank or any person claiming
  through the bank. This provision, however, will not prohibit a
  registered clearing agency or derivatives clearing organization from
  pledging security-based swap customer funds or securities as
  collateral to a bank for any purpose that the rules of the Commission
  or the registered clearing agency or derivatives clearing organization
  otherwise permit; and
(3) A registered clearing agency or derivatives clearing organization
  that establishes, documents, and maintains:
(i) Safeguards in the handling, transfer, and delivery of cash and
  securities;
(ii) Fidelity bond coverage for its employees and agents who handle
  security-based swap customer funds or securities. In the case of
  agents of a registered clearing agency or derivatives clearing
  organization, the agent may provide the fidelity bond coverage; and
(iii) Provisions for periodic examination by independent public
  accountants; and
(4) A derivatives clearing organization that, if it is not otherwise
  registered with the Commission, has provided the Commission with a
  written undertaking, in a form acceptable to the Commission, executed
  by a duly authorized person at the derivatives clearing organization,
  to the effect that, with respect to the clearance and settlement of
  the security-based swap customer security futures products of the
  security-based swap dealer, the derivatives clearing organization will
  permit the Commission to examine the books and records of the
  derivatives clearing organization for compliance with the requirements
  set forth in Sec.   240.15c3-3a, Note E. (b)(1) through (3).
(c) Item 12 will apply only if a security-based swap dealer determines,
  at least annually, that the registered clearing agency or derivatives
  clearing organization with which the security-based swap dealer has on
  deposit margin related to security futures products meets the
  conditions of this Note E.

0
21. Section 240.18a-10 is added to read as follows:

Sec.  240.18a-10  Alternative compliance mechanism for security-based 
swap dealers that are registered as swap dealers and have limited 
security-based swap activities.

    (a) A security-based swap dealer may comply with capital, margin, 
and segregation requirements of the Commodity Exchange Act and chapter 
I of title 17 of the Code of Federal Regulations applicable to swap 
dealers in lieu of complying with Sec. Sec.  240.18a-1, 240.18a-3, and 
240.18a-4 if:
    (1) The security-based swap dealer is registered as such pursuant 
to section 15F(b) of the Act and the rules thereunder;
    (2) The security-based swap dealer is registered as a swap dealer 
pursuant to section 4s of the Commodity Exchange Act and the rules 
thereunder;
    (3) The security-based swap dealer is not registered as a broker or 
dealer pursuant to section 15 of the Act or the rules thereunder;
    (4) The security-based swap dealer meets the conditions to be 
exempt from Sec.  240.18a-4 specified in paragraph (f) of that section; 
and
    (5) As of the most recently ended quarter of the fiscal year of the 
security-based swap dealer, the aggregate gross notional amount of the 
outstanding security-based swap positions of the security-based swap 
dealer did not exceed the lesser of the maximum fixed-dollar amount 
specified in paragraph (f) of this section or 10 percent of the 
combined aggregate gross notional amount of the security-based swap and 
swap positions of the security-based swap dealer.
    (b) A security-based swap dealer operating under this section must:
    (1) Comply with the capital, margin, and segregation requirements 
of the Commodity Exchange Act and chapter I of title 17 of the Code of 
Federal Regulations applicable to swap dealers and treat security-based 
swaps and related collateral pursuant to those requirements to the 
extent the requirements do not specifically address security-based 
swaps and related collateral;
    (2) Disclose in writing to each counterparty to a security-based 
swap before entering into the first transaction with the counterparty 
after the date the security-based swap dealer begins operating under 
this section that the security-based swap dealer is operating under 
this section and is therefore complying with the applicable capital, 
margin, and segregation requirements of the Commodity Exchange Act and 
the rules promulgated by the Commodity Futures Trading Commission 
thereunder in lieu of complying with the capital, margin, and 
segregation requirements promulgated by the Commission in Sec. Sec.  
240.18a-1, 240.18a-3, and 240.18a-4; and
    (3) Immediately notify the Commission and the Commodity Futures 
Trading Commission in writing if the security-based swap dealer fails 
to meet a condition specified in paragraph (a) of this section.
    (c) A security-based swap dealer that fails to meet one or more of 
the conditions specified in paragraph (a) of this section must begin 
complying with Sec. Sec.  240.18a-1, 240.18a-3, and 240.18a-4 no later 
than:
    (1) Two months after the end of the month in which the security-
based swap dealer fails to meet a condition in paragraph (a) of this 
section; or
    (2) A longer period of time as granted by the Commission by order 
subject to any conditions imposed by the Commission.
    (d)(1) A person applying to register as a security-based swap 
dealer that intends to operate under this section beginning on the date 
of its registration must provide prior written notice to the Commission 
and the Commodity Futures Trading Commission of its intent to operate 
under the conditions of this section.
    (2) A security-based swap dealer that elects to operate under this 
section beginning on a date after the date of its registration as a 
security-based swap dealer must:
    (i) Provide prior written notice to the Commission and the 
Commodity Futures Trading Commission of its intent to operate under the 
conditions of this section; and
    (ii) Continue to comply with Sec. Sec.  240.18a-1, 240.18a-3, and 
240.18a-4 for at least:
    (A) Two months after the end of the month in which the security-
based swap dealer provides the notice; or
    (B) A shorter period of time as granted by the Commission by order 
subject to any conditions imposed by the Commission.
    (e) The notices required by this section must be sent by facsimile 
transmission to the principal office of the Commission and the regional 
office of the Commission for the region in which the security-based 
swap dealer has its principal place of business or to an email address 
to be specified separately, and to the principal office of the 
Commodity Futures Trading Commission in a manner consistent with the 
notification requirements of the Commodity Futures Trading

[[Page 44077]]

Commission. The notice must include a brief summary of the reason for 
the notice and the contact information of an individual who can provide 
further information about the matter that is the subject of the notice.
    (f)(1) The maximum fixed-dollar amount is $250 billion until the 
three-year anniversary of the compliance date of this section at which 
time the maximum fixed-dollar amount is $50 billion unless the 
Commission issues an order to:
    (i) Maintain the maximum fixed-dollar amount at $250 billion for an 
additional period of time or indefinitely; or
    (ii) Lower the maximum fixed-dollar amount to an amount that is 
less than $250 billion but greater than $50 billion.
    (2) If, after considering the levels of security-based swap 
activity of security-based swap dealers operating under this section, 
the Commission determines that it may be appropriate to change the 
maximum fixed-dollar amount pursuant paragraph (f)(1)(i) or (ii) of 
this section, the Commission will publish a notice of the potential 
change and subsequently will issue an order regarding any such change.

    By the Commission.

    Dated: June 21, 2019.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-13609 Filed 8-21-19; 8:45 am]
 BILLING CODE 8011-01-P