When Dodd-Frank was passed in 2010, the Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission were tasked to create a regulatory framework for “over-the-counter derivatives.” Title VII of Dodd-Frank authorized and directed the SEC to undergo rulemaking for security-based swaps. On October 17, 2012, the SEC voted to propose several requirements for security-based swap dealers and security-based swap participants as required under Dodd-Frank. See Release No. 34-68071; File No. S7-08-12.
In relation to security-based swap dealers, the proposed rules will determine “[h]ow much capital dealers in security-based swaps need to hold,” “[w]hen and how these dealers need to collect collateral, or margin, to protect against losses from counterparties,” and “how these dealers segregate and protect funds and securities held for customers.”
The proposed rules also established regulations for major security-based participants, covering capital and margin requirements. The capital requirements for security-based swap dealers are to be modeled on Rule 15c3-1, which governs capital for broker-dealers. The proposed rules set a minimum net capital requirement, subject to classification as either a dealer that is dually registered as a broker-dealer or a dealer not registered as a broker. The minimum capital requirements would depend on whether a firm is approved by the SEC to use internal models in calculating its regulatory capital. These firms would be subject to “tentative net capital,” which refers to the firm’s net liquid assets before deductions. Firms would be subject to the tentative net capital requirement in addition to the minimum net capital amount.
The proposed rules establish a fixed dollar minimum and a ratio requirement equal to 8 percent of the margin required; this 8 percent margin factor would adjust the capital required based on this factor. In addition, broker-dealer security-based swap dealers would be subject to ratio requirements that presently apply to broker-dealers under Rule 15c3-1. Finally, the fixed minimum capital requirement for all broker-dealers (whether or not they also register as security-based swap dealers) would be increased from $500 million to $1 billion.
The proposed rules would apply standardized percentage deductions for security-based swap dealers that are not approved to use internal models; these are already set forth in Rule 15c3-1. Security-based swap dealers would be required to take a capital charge for any unsecured receivables they have, but some would be allowed to take a less severe charge for uncollateralized exposures to commercial end users.
The proposed rules also establish margin requirements, which would be modeled on those already set for broker-dealers. The dealer would need to cover current exposure and potential future exposure with margin collateral from counterparties to non-cleared security-based swap transactions. Dealers would have to calculate daily using either Current Exposure Calculations or Potential Future Exposure Calculation for each account to determine the amount of current exposure and future exposure. The dealer would then have to cover the negative equity of that calculation on the next business day. However, the margin rule would not be required in certain circumstances or the requirements may be varied. Major security-based participants would not be required to calculate future exposure as they would not be required to cover only current exposure.
Provisions of Dodd-Frank require that collateral be segregated, and only comingled or segregated pursuant to SEC rules. The proposed rule would allow for collateral to be comingled and segregated on “an omnibus basis – that is, held in a single account subject to specific conditions.” The rules would “(1) maintain physical possession or control over customers’ fully paid and excess margin securities…” by essentially allowing dealers to use customer securities to cover only current exposures; and “(2) maintain a reserve of funds or qualified securities in an account at a bank that is equal in value to the net cash owed to customers,” requiring a nonbank to maintain an amount equal to the net cash owed to customers.
A number of comments have already been submitted on the proposal. These include:
- Memorandum from the Division of Trading and Markets regarding an October 22, 2012, meeting with representatives of Markit Group Limited and MarkitSERV, which may be found here; and
- Memorandum from the Office of Commissioner Luis A. Aguilar regarding an October 10, 2012, meeting with representatives of SIFMA, which may be found here.
A more detailed overview of the proposed rules may be found here.