SEC Proposes Rules for Security-Based Swaps

Terry Flanagan

The Securities and Exchange Commission has proposed capital, margin and segregation requirements for security-based swap dealers and major security-based swap participants.

Under the Dodd-Frank Act, the SEC must impose margin and capital requirements to help ensure the safety and soundness of security-based swap dealers and major security-based swap participants.

The margin rules are required to be appropriate for the risk associated with security-based swaps that are not cleared by a security-based swap clearing agency.

“Mandatory centralized clearing and bilateral margining of swaps will increase initial margin and collateral costs,” said Ed Elgerzawy, partner at trading technology firm SunGard’s consulting services arm.

As a result, buy-side firms need to improve or implement technologies to focus on swap collateral suitability and substitution rules for initial and variation margin requirements.

“Otherwise, they face increasing cost burdens as well as collateral haircuts that are imposed by their dealer or their prime brokers when the buy-side firm lacks the high investment grade collateral required for central clearing,” said Elgerzawy.

The proposed segregation rules are intended to facilitate the prompt return of customer property to customers before or during a liquidation proceeding if a security-based swap dealer fails.

The Commission proposed rules that will determine how much capital dealers in security-based swaps need to hold, when 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.

“There is a set of new regulations emerging—Dodd-Frank in the U.S., and other similar regulatory packages in Europe, Australia and elsewhere—which will present new challenges around over-the-counter asset classes migrating to exchange traded models,” said Philippe Buhannic, chief executive of TradingScreen, a buy-side focused technology provider.

SEC chairman Mary Schapiro says the SEC has now proposed, and in some cases adopted, substantially all of the rules that create the new regulatory regime for derivatives within its jurisdiction.

The Commodity Futures Trading Commission and other regulators have previously proposed corollary capital and margin rules for swap dealers, security-based swap dealers, swap participants and major security-based swap participants that are subject to their jurisdiction.

The CFTC has also adopted segregation requirements for cleared swaps and proposed segregation requirements for non-cleared swaps.

At the same time, the SEC is proposing to raise current capital requirements for firms that use internal models to compute capital charges and are subject to an alternative net capital regime (ANC broker-dealers), and these firms also would be subject to new specific liquidity standards.

“There is a good deal of complexity in the pricing and margining of these new asset types,” said Buhannic. “In addition, there will be significant challenges around collateral management and co-ordination of payments and receipts.”

From a technology point of view, “these challenges can only be answered by the merger of the functionality of the order management system and execution management system”, Buhannic said.

Under the proposal, the capital requirements for security-based swap dealers would be modeled closely on the rule that governs capital for broker-dealers (Securities Exchange Act Rule 15c3-1), and would be designed to accommodate both security-based swap dealers that are dually registered as broker-dealers (broker-dealer SBSDs) and those that are not dually registered (standalone SBSDs).

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