In June of 2019, the U.S. Securities and Exchange Commission (SEC) adopted a new suite of rules and rule amendments under the Dodd-Frank Act, Title VII (Wall Street Transparency and Accountability). These changes increase regulatory oversight for security-based swap dealers (SBSDs). Consideration should be paid to minimum capital requirements, margin requirements, segregation requirements and substituted compliance. More information may be found by referring to 84 FR 44071.
THE FINAL RULE:
- Establishes capital and margin requirements for nonbank security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs), for which there is not a prudential regulator (hereinafter, all SBSD and MSBSP references are to nonbank entities), including:
- Broker-dealers registered as SBSDs (broker-dealer SBSDs);
- Broker-dealers registered as major security-based swap participants (broker-dealer MSBSPs);
- Nonbank SBSDs not registered as broker-dealers (stand-alone SBSDs);
- Nonbank MSBSPs not registered as broker-dealers (stand-alone MSBSPS).
- Increases net capital requirements for broker-dealers authorized to use internal models to compute net capital (ANC broker-dealers)
- Adds segregation requirements for SBSDs and related notification requirements
- Changes existing cross-border rules to provide a mechanism for foreign nonbank SBSDs and MSBSPs to seek substituted compliance with respect to capital and margin requirements.
This document focuses on SEC Rule 18a-3, which prescribes non-cleared security-based swap margin requirements for nonbank SBDs and MSBSPs. Paragraph (e) of Rule 18a-3 requires a nonbank SBSD to monitor the risk of each account and to establish, maintain and document procedures and guidelines for monitoring the risk, which aligns to rule 15c3-4 requiring OTC derivatives dealers to establish, document and maintain a system of internal risk management controls to assist it in managing the risks associated with its business activities.
Under paragraph (d) to Rule 18a-3, a nonbank SBSD applying to the SEC 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.
TABLE 1
| Exception | Exception to Collecting Margin | Status of Exceptions to Collecting VM |
| IM | VM |
| Legacy Account | Need not collect | Need not collect | Need not deliver |
| IM below $50 Million Threshold | Need not collect | Must Collect | Must deliver |
| Minimum Transfer Amount | Need not collect | Need not collect | Need not deliver |
| Affiliate | Need not collect | Must collect | Must deliver |
| Commercial End User | Need not collect | Need not collect | Need not deliver |
| BIS or 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 | Need not collect | Must collect | Must deliver |
| Sovereign with Minimal Credit Risk | Need not collect | Must collect | Must deliver |
COLLATERAL COLLECTION REQUIREMENTS
SEC Rule 18a-3 requires that margin must meet or exceed the margin requirement after applying standardized haircuts in accordance with SEC Rule 15c3-1 and must meet certain conditions such as: i) have a ready market, ii) be readily transferrable and iii) not consist of securities issued by the SBSD or the counterparty.
MARGIN REQUIREMENTS FOR MSBSPS
SEC Rule 18a-3 prescribes margin requirements for MSBSPs with respect to non-cleared security-based swaps.
Specifics include:
- MSBSPs are not required to collect or deliver initial margin;
- MSBSPs are required collect and deliver variation margin;
- Exceptions, as outlined in the Rule, apply to the collection of variation margin from certain counterparties (like those for SBSDs), though there is no exception existing for delivering variation margin to those same types of counterparties.
1 ANC means Alternative Net Capital. A broker dealer may apply to the SEC for authorization to use the alternative method for computing net capital or the ANC computation contained in Appendix E to Rule 15c3-1. Under Appendix E, firms with strong internal risk management practices may apply to use the mathematical modeling methods they used to manage their own business risk, including Value at Risk (VaR) models and scenario analysis, to compute deductions from net capital for market and credit risk arising from OTC derivatives.
As a condition of approval, applicants must maintain an “early warning” level of at least $5 billion tentative net capital, minimum levels at least $1 billion in tentative net capital and at least $500 million in net capital. If a decrease in tentative net capital breaches the $1 billion level, the SEC must be notified.