In December 2016, the Commodity Futures Trading Commission (“CFTC”) released its re-proposed capital rules for swap dealers (“SDs”) and major swap participants (“MSPs”).1 Additionally, the Securities and Exchange Commission (“SEC”) proposed its capital rules in 20122 for security-based SDs and MSPs. The CFTC’s re-proposal attempts to accomplish several things, including harmonization with the proposed SEC capital rules. It further provides optionality for financial and non-financial SDs regarding computing capital under a standardized versus models-based approaches.3 It is important for each financial SD to assess the implications of the proposed rulemaking to its swap dealing operating model. Questions to consider include: (1) Why should SDs consider a models-based capital approach versus non-model? (2) How does entity type (e.g., bank, broker-dealer) impact capital methodology?
The CFTC and SEC proposed capital rules provide financial SDs some optionality for computing net capital (see Appendix 1). Specifically, there are two approaches available for computing capital—standardized and models-based—as outlined below:
Financial institutions may apply with the SEC and the National Futures Association (“NFA”) for models-based capital treatment, where capital is computed using market and credit risk models.
The re-proposal emphasizes inter-agency harmonization of the rules and the use of quantitative models to compute risk charges. It also requires financial institutions to consider the following:
In addition to the above, a deeper dive into the proposed capital rules raises some considerations on computing capital, including:
Models-based capital application
The proposed rules would likely push financial institutions toward a models-based capital approach given the onerous nature of the standardized approach. Although the SEC’s capital rules for security-based SDs have not yet been finalized, the broker-dealer lite rules5 are final and the SEC has an application and approval process for models-based capital in place. The broker-dealer lite registration and application approval structure can be used as an alternative and later converted to a security-based SD upon finalization of the security-based SD capital rules. Broker-dealer lite registration allows for exempt borrower status under the FRB’s margin rule (Regulation T). For jointly registered SDs, models approved by the SEC will be coordinated with the CFTC for joint recognition. Appendix 2 provides a high-level overview of the models-based capital application process.
How Deloitte can help
Deloitte has been at the forefront of assisting clients with their pro-forma capital calculations and legal entity analyses. While the rules and standards summarized above continue to be refined by the regulators, there are many things firms can do to prepare. This includes being proactive in determining how to effectively manage and implement finalized ruling, as well as future rulings. Deloitte welcomes the opportunity to discuss how our Regulatory & Operational Risk professionals can assist in your efforts to meet these regulatory needs or challenges.
Appendix 1 – Capital requirements summary table
Appendix 2 – Internal model application summary
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