On June 21, 2019, the Securities and Exchange Commission (the "SEC") adopted final rules (the "Final Rules") that set forth: (1) capital and margin requirements for security‑based swap ("SBS") dealers ("SBSDs") and major SBS participants ("MSBSPs") for which there is not a Prudential Regulator1 ("nonbank SBSDs" and "nonbank MSBSPs"); (2) revised capital requirements for broker‑dealers ("BDs") (including with respect to their SBS and swaps); (3) segregation requirements for SBSDs, MSBSPs, and BDs with respect to collateral for SBS; and (4) the cross-border application of these capital, margin, and segregation requirements.


Capital. The Final Rules' capital requirements for nonbank SBSDs are generally modeled on the net liquid asset requirements that apply to BDs under SEC Rule 15c3-1, but with a minimum net capital requirement that increases in proportion to the volume of a nonbank SBSD's SBS business and certain other modifications designed to work in conjunction with margin rules for non-cleared SBS and swaps. In addition, the Final Rules amend Rule 15c3-1 to establish capital requirements for SBS and swap positions held by BDs (including BDs not registered as SBSDs) and increase the fixed-dollar minimum net capital requirements that apply to BDs that the SEC has approved to use internal models in lieu of standardized haircuts for market and credit risk ("ANC BDs").

Margin. The Final Rules subject nonbank SBSDs to margin requirements for non-cleared SBS that are aligned in several key respects with the global Working Group on Margin Requirements ("WGMR") framework implemented by the Commodity Futures Trading Commission (the "CFTC"), Prudential Regulators, and other G20 regulators.2 However, there are some notable differences between the WGMR framework and the Final Rules, including: (1) no requirement for a nonbank SBSD to post initial margin ("IM"); (2) an exception from IM collection requirements for non-cleared SBS with specified financial market intermediaries (including other SBSDs); (3) a requirement for registered BDs (other than limited-purpose over-the-counter derivatives dealers ("OTCDDs")) that are dually registered as SBSDs ("BD-SBSDs") to use a standardized approach to calculate IM requirements for equity SBS instead of using risk-based models; (4) no exceptions from IM requirements for counterparties with less than $8 billion in average aggregate notional amount ("AANA") of non-cleared derivatives; (5) a two-month compliance window once a $50 million IM threshold is breached by a counterparty; and (6) a requirement to collect variation margin ("VM") from non-U.S. sovereign entities.

Segregation. The Final Rules subject BDs and SBSDs (including SBSDs that are banks) to omnibus segregation requirements for SBS collateral that are modeled on the BD customer protection rule, SEC Rule 15c3-3. However, the Final Rules include an exemption from these requirements for an SBSD that is not dually registered as a BD (a "standalone SBSD") or an SBSD that is an OTCDD (an "OTCDD-SBSD") if the SBSD does not clear SBS for others and provides certain notices to its SBS counterparties.

Alternative Compliance Mechanism. The Final Rules establish an alternative compliance mechanism for CFTC-registered swap dealers ("SDs") that dually register as standalone SBSDs (but not for BD-SBSDs or OTCDD-SBSDs). If such an SD-SBSD satisfies the segregation exemption noted above and the aggregate gross notional amount ("AGNA") of its SBS positions does not exceed the lesser of a maximum fixed-dollar amount and 10% of the combined AGNA of its SBS and swaps positions as of the SBSD's most recent fiscal quarter, the SBSD may elect to comply with the capital, margin, and segregation requirements of the CFTC, rather than those of the SEC.

Cross-Border Application. The SEC will treat its SBSD capital and margin requirements as "entity-level" requirements that apply to foreign SBSDs across all their positions, not just those with U.S. counterparties. But a foreign SBSD can satisfy SEC capital and margin requirements through substituted compliance with home country requirements if the SEC determines that they are comparable to the SEC's requirements. In contrast, the Final Rules treat SBSD segregation requirements as "transaction-level" requirements, which in many instances will only apply to a foreign SBSD's SBS with U.S. counterparties, but a foreign SBSD may not satisfy such requirements through substituted compliance with home country requirements.

Compliance Date. The compliance date for the Final Rules will be the same date as when SBSDs must first register with the SEC, which the SEC set to be 18 months after the later of: (1) the effective date of final rules establishing recordkeeping and reporting requirements for SBSDs and MSBSPs; and (2) the effective date of final rules addressing the cross‑border application of certain SBS requirements.


SEC-CFTC Harmonization. The Final Rules reflect major, and welcome, steps towards further SEC-CFTC harmonization, including: (1) an alternative compliance mechanism that will allow some dual registrants to opt for a single, unified capital, margin, and segregation framework across their SBS and swaps; (2) alignment of key margin requirements such as IM calculation methodologies (in most cases), IM thresholds, eligible collateral, and collateral haircuts; (3) relief from several net capital deductions that, as originally proposed by the SEC, would have run counter to major aspects of the CFTC's margin rules and overall WGMR framework; and (4) provisional SEC approval of risk-based models approved by other regulators. The agencies are also embarking on a further initiative to explore portfolio margining of the products they regulate, including not only SBS and swaps, but also futures and cash equities.3

Potential Competitive Disparities. The Final Rules could create competitive headwinds for BD-SBSDs relative to other SBSDs (e.g., because a BD-SBSD cannot use a model to calculate IM requirements for an equity SBS, and an ANC BD must take a 100% deduction equal to any amount by which its current exposure exceeds 10% of its tentative net capital, including exposure to commercial end users). However, depending on the outcome of the agencies' portfolio margining initiative, a BD-SBSD may be able to offer portfolio margining of SBS with certain types of positions (cash equities, listed securities options) that other SBSDs cannot. Meanwhile, even relative to bank SBSDs, standalone SBSDs and OTCDD-SBSDs could be at an advantage because they will not be required to post IM to their clients, will not be required to collect IM from other financial market intermediaries, and will in most instances not be required to segregate the IM they collect for non-cleared SBS.

Next Steps. Key areas to watch in the next 6-18 months include: (1) the CFTC-SEC portfolio margining initiative noted above; (2) finalization of the SEC's recordkeeping and reporting requirements for SBSDs and MSBSPs; (3) substituted compliance determinations by the SEC; and (4) finalization (but maybe with an intervening re-proposal?) of the CFTC's capital rules for nonbank SDs and nonbank major swap participants ("MSPs").

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[1] The Prudential Regulators include the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Farm Credit Administration, and the Office of the Comptroller of the Currency.

[2] Margin Requirements for Non-Centrally Cleared Derivatives, Basel Committee on Banking Supervision and Board of the International Organization of Securities Commissions (Sept. 2013) (link).

[3] See Joint Statement on CFTC-SEC Portfolio Margining Harmonization Efforts (June 27, 2019) (link).

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