The SEC has adopted rule amendments and new rules under Title VII of the Dodd-Frank Act (Wall Street Transparency and Accountability), which established a new regulatory framework for the U.S. over-the-counter (OTC) derivatives markets. These final rules:
The SEC first proposed these rules in October 2012 and reopened the comment period in 2018. The final rules will become effective 60 days after publication in the Federal Register. Compliance is required 18 months after the later of i) the effective date of final rules establishing recordkeeping and reporting requirements for SBSDs and MSBSPs (these rules have not yet been finalized), or ii) the effective date of the final rules addressing the cross-border application of certain security-based swap requirements.
Similarly, the final rules also set the Registration Compliance Date for SBSDs and MSBSPs as 18 months after the later of i) the effective date of final rules establishing recordkeeping and reporting requirements for SBSDs and MSBSPs, or ii) the effective date of the final rules addressing the cross-border application of certain security-based swap requirements. (see page 298, final rule)
Capital requirements – SBSDs
SEC Rule 15c3-1 (as amended) and new Rule 18a-1 prescribe minimum net capital requirements for SBSDs that are the greater of a fixed dollar amount and an amount derived by applying a financial ratio. The SEC summarizes the minimum net capital requirements in the following table.
Type of Registrant
Tentative Net Capital
(net capital before haircuts)
|Fixed dollar||Financial Ratio|
|Stand-alone SBSD (not using internal models)||
|$20 million||2% margin factor|
|Stand-alone SBSD (using internal models)*||
|$20 million||2% margin factor|
Broker-dealer SBSD(not using internal models)
|$20 million||2% margin factor + Rule 15c3-1 ratio|
Broker-dealer SBSD (using internal models)
|$1 billion||2% margin factor + Rule 15c3-1 ratio|
Risk Management. SBSDs must also comply with Rule 15c3-4, which requires them to establish, document, and maintain a system of internal risk management controls to include market, credit, leverage, liquidity, legal, and operational risks.
Capital requirements – MSBSPs
SEC Rule 18a-2 prescribes capital requirements for stand-alone MSBSPs, and requires them to have, and maintain at all times, a positive tangible net worth (defined to mean net worth excluding goodwill and other intangible assets).
Risk Management. All MSBSPs must also comply with Rule 15c3-4 with respect to their security-based swap and swap activities.
Margin requirements – SBSDs
Calculation. SEC Rule 18a-3 prescribes margin requirements for nonbank SBSDs with respect to non-cleared security-based swaps. The Rule requires a SBSD to calculate with respect to each account of a counterparty as of the close of business each day: i) the amount of current exposure in the account (i.e., variation margin) and ii) the initial margin amount for the account. Variation margin is calculated by marking the position to market. Initial margin must be calculated by applying standardized haircuts in Rule 15c3-1 or 18a-1, as applicable.
Collecting Collateral. Under SEC Rule 18a-3, nonbank SBSDs must collect collateral from a counterparty to cover variation and/or initial margin requirement as well as to deliver collateral to the counterparty to cover a variation requirement, as appropriate. SBSDs are not required to post initial margin to counterparties. Margin collateral must meet or exceed the margin requirement after applying the standardized haircuts and must meet certain conditions, including i) have a ready market, ii) be readily transferable, and iii) not consist of securities issued by the SBSD or the counterparty.
Exceptions. A nonbank SBSD need not collect variation or initial margin or deliver variation margin to certain counterparties under certain circumstances. The SEC summarizes these exceptions in the following table.
Status of Exceptions to
Status of Exceptions to 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||$1 billion|
|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|
Margin requirements – MSBSPs
SEC Rule 18a-3 prescribes margin requirements for MSBSPs with respect to non-cleared security-based swaps. It requires them to calculate variation margin for the account of each counterparty daily and to collect collateral from, or deliver collateral to, a counterparty to cover the variation margin requirement. Exceptions, as outlined in the Rule, apply to the collection of variation margin to certain counterparties (similar to those for SBSDs), though there is no exception to delivering variation margin to those same types of counterparties. No requirements to collect or deliver initial margin.
Segregation requirements - SBSDs and broker dealers
Segregation requirements for broker-dealer SBSDs (other than firms registered as OTC derivatives dealers) and stand-alone broker-dealers are codified in SEC Rule 15c3-3. The segregation requirements for all other stand-alone SBSDs (including firms that have no other registration, are registered as OTC derivatives dealers, or are bank SBSDs) are codified in SEC Rule 18a-4. Further:
Exemptions. A stand-alone SBSD or a bank SBSD will be exempt from the requirements of Rule 18a-4 if the firm meets certain conditions, including that it i) does not clear security-based swap transactions for other persons, ii) provides notice to the counterparty regarding the right to segregate initial margin, iii) discloses in writing that any collateral received will not be subject to a segregation requirement, and iv) discloses how a claim for the collateral would be treated in bankruptcy or other formal liquidation proceeding.
SEC Rule 18a-10 provides an alternative compliance mechanism for a stand-alone SBSD registered as a swap dealer and predominantly engaged in a swaps business. These firms may elect to comply with the capital, margin, and segregation requirements of the Commodity Exchange Act and the CFTC’s rules in lieu of SEC Rules 18a-1, 18a-3, and 18a-4. To qualify, the stand alone SBSD may not be registered as a broker-dealer or an OTC derivatives dealer and must meet certain conditions.
Foreign SBSDs and MSBSPs have the potential to avail themselves of substituted compliance to satisfy the capital and margin requirements. Substituted compliance is not available for segregation requirements, though SEC Rule 18a-4 provides an exception for foreign stand alone or bank SBSDs or MSBSPs from 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.
The issuance of these rules brings the SBSDs one step closer to meeting the registration requirements required under the Dodd Frank Act. It establishes nonbank financial responsibility requirements for both stand-alone and broker-dealer SBSDs as well as non SBSD broker-dealers dealing in security-based swaps and swap transactions. The issuance of these rules will enable the CFTC to finalize their regulatory responsibility rules, as the CFTC rules cross reference certain SEC Capital Rules.
The finalization of the SBSD registration requirements and the CFTC financial responsibility rules address the significant issues that caused the financial crisis of 2007 - 2009. The capital markets are both stronger and more transparent today than pre-crisis.
We anticipate firms with multiple swap dealers and potential SBSDs will now determine the most beneficial capital structure for its entities. Once determined, firms will need to take the necessary steps to consolidate the entities, which will possibly require repapering of various customer agreements.
Firms that wish to use models should take steps as soon as possible to start the approval process with the SEC so that once registration is required, their use of models will have been approved