[Federal Register: June 21, 2004 (Volume 69, Number 118)]
[Rules and Regulations]
[Page 34472-34500]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21jn04-14]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 200 and 240
[Release No. 34-49831; File No. S7-22-03]
RIN 3235-AI97
Supervised Investment Bank Holding Companies
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting rules to implement Section 17(i) of the Securities Exchange
Act of 1934, which created a new framework for supervising an
investment bank holding company (``IBHC''). An IBHC that meets
specified criteria may elect to become a supervised investment bank
holding company (``SIBHC'') and be subject to supervision on a group-
wide basis by filing a notice of intention with the Commission.
Pursuant to the statute and these new rules, an IBHC is eligible to be
an SIBHC if it is not affiliated with certain types of banks and has a
subsidiary broker-dealer with a substantial presence in the securities
markets. These rules provide an IBHC with a process to become
supervised by the Commission as an SIBHC, and establish regulatory
requirements for an SIBHC, including requirements regarding its group-
wide internal risk management control system, recordkeeping, and
periodic reporting (including reporting of consolidated computations of
allowable capital and risk allowances consistent with the standards
published by the Basel Committee on Banking Supervision). The
Commission also is adopting an exemption to the Commission's risk
assessment rules to exempt a broker-dealer that is affiliated with an
SIBHC from those rules because these new SIBHC rules will require that
an SIBHC maintain substantially the same records and make substantially
the same reports to the Commission that a broker-dealer must maintain
and make pursuant to the risk assessment rules. Finally, the Commission
is amending the audit requirements for over-the-counter (``OTC'')
derivatives dealers to permit OTC derivatives dealers to file, as part
of their annual audits, a supplemental report regarding the firm's
internal risk management control systems based on agreed-upon
procedures rather than auditing standards.
EFFECTIVE DATE: August 20, 2004.
FOR FURTHER INFORMATION CONTACT: With respect to calculations of
allowable capital and risk allowances, internal risk management control
systems, and books and records and reporting requirements, contact
Michael A. Macchiaroli, Associate Director, at (202) 942-0132, Thomas
K. McGowan, Assistant Director, at (202) 942-4886, Rose Russo Wells,
Attorney, at (202) 942-0143, Bonnie L. Gauch, Attorney, at (202) 942-
0765, or David Lynch, Financial Economist, at (202) 942-0059, Division
of Market Regulation, Securities and Exchange Commission, 450 Fifth
Street, NW., Washington, DC 20549-1001.
With respect to general questions, contact Linda Stamp Sundberg,
Attorney Fellow, at (202) 942-0073, Division of Market Regulation,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549-1001.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction.
II. The Proposed Rules.
III. Overview of Comments Received.
IV. Final Rules and Rule Amendments.
A. Rule 17i-1: Definitions.
[[Page 34473]]
B. Rule 17i-2: Notice of Intention To Be Supervised by the
Commission as an SIBHC.
1. Election criteria.
2. Notice of Intention to become an SIBHC.
3. Process for review of Notices of Intention.
4. Requirement that an IBHC be affiliated with a broker-dealer
that has a substantial presence in the securities business.
5. Continuing obligation to amend a Notice of Intention.
C. Rule 17i-3: Withdrawal from Supervision as an SIBHC.
D. Rule 17i-4: Internal Risk Management Control System
Requirements for SIBHCs.
E. Rule 17i-5: Record Creation, Maintenance, and Access
Requirements for SIBHCs.
1. Record creation.
2. Record maintenance.
3. Access to records.
F. Rule 17i-6: Reporting Requirements for SIBHCs.
1. Monthly reports.
2. Quarterly reports.
3. Organizational chart.
4. Additional reports.
5. Annual audit report.
6. Accountant's report on management controls--paragraph
(d)(1)(ii) of Rule 17i-6 and amendment to paragraph (l) of existing
Rule 17a-12.
G. Exemption From Risk Assessment Rules for Broker-Dealer
Affiliates of SIBHCs.
H. Rule 17i-7: Calculations of Allowable Capital and Risk
Allowances or Alternative Capital Assessment.
1. Calculation of consolidated allowable capital.
2. Calculation of consolidated allowance for market risk.
3. Calculation of consolidated allowance for credit risk.
i. Credit equivalent amount.
ii. Current exposure.
iii. Maximum potential exposure.
iv. Credit risk weights.
4. Calculation of consolidated allowance for operational risk.
5. General discussion of Basel pillars.
I. Rule 17i-8: Notification Requirements for SIBHCs.
V. Amendment to Rule 30-3.
VI. Paperwork Reduction Act.
A. Collection of Information Under Amendments to Rules 17h-1T
and 17h-2T and New Rules 17i-2 Through 17i-8.
B. Proposed Use of Information.
C. Respondents.
D. Reporting and Recordkeeping Burdens.
1. Amendments to Rules 17h-1T and 17h-2T.
2. Rule 17i-2.
3. Rule 17i-3.
4. Rule 17i-4.
5. Rule 17i-5.
6. Rule 17i-6.
7. Rule 17i-8.
E. Collection of Information is Mandatory.
F. Confidentiality.
G. Record Retention Period.
VII. Costs and Benefits of the Rules and Rule Amendments.
A. Benefits.
B. Costs.
1. Ongoing costs.
2. One-time costs.
VIII. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition and Capital Formation.
IX. Summary of Regulatory Flexibility Act Certification.
X. Statutory Authority.
I. Introduction
The rules the Commission is adopting today implement the framework
for Commission supervision of SIBHCs set forth in section 17(i) of the
Securities Exchange Act of 1934 (the ``Exchange Act'' or the
``Act'').\1\ These rules also enhance the Commission's supervision of
an SIBHC's affiliated broker-dealers through collection of additional
information and examinations of affiliates of those broker-dealers.
This framework includes qualification criteria for IBHCs that file
notices of intention to be supervised by the Commission, as well as
recordkeeping and reporting requirements for SIBHCs. Taken as a whole,
this framework permits the Commission to monitor the financial
condition, risk management, and activities of an SIBHC and its
affiliates (including broker-dealer affiliates) on a group-wide basis.
Neither the Exchange Act nor these new rules require that an IBHC
become an SIBHC; supervision as an SIBHC is voluntary.
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\1\ 15 U.S.C. 78q(i).
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This regulatory framework for SIBHCs also is intended to provide a
basis for non-U.S. financial regulators to treat the Commission as the
principal U.S. consolidated, home-country supervisor \2\ for SIBHCs and
their affiliates (including broker-dealers). To the extent that non-
U.S. financial regulators treat the Commission as the principal U.S.
consolidated, home-country supervisor for SIBHCs and their affiliates,
any duplicative regulatory burdens on SIBHCs that are active outside
the U.S. would be minimized.
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\2\ See H.R. Conf. Rep. No. 106-434, 165-166 (1999). Without a
demonstration of ``equivalent'' supervision, U.S. securities firms
have expressed concerns that an affiliated institution located in
the EU either may be subject to additional capital charges or be
required to form a sub-holding company in the EU. See ``Directive
2002/87/EC of the European Parliament and of the Council of 16
December 2002.''
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These new rules are not intended to duplicate regulation of banks,
insurance companies, or futures commission merchants by other
regulatory agencies. Section 17(i) of the Exchange Act directs the
Commission to: (i) Accept, to the fullest extent possible, reports that
an SIBHC or an affiliate thereof may have been required to provide to
another appropriate regulatory agency or self-regulatory
organization;\3\ (ii) use, to the fullest extent possible, reports of
examination made by the appropriate regulatory agency or State
insurance regulator;\4\ and (iii) defer to the appropriate regulatory
agency or State insurance regulator with regard to interpretation and
enforcement of banking or insurance regulations.\5\
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\3\ Exchange Act Sec. 17(i)(3)(B)(i) [15 U.S.C.
78q(i)(3)(B)(i)].
\4\ Exchange Act Sec. 17(i)(3)(C)(iii) [15 U.S.C.
78q(i)(3)(C)(iii)].
\5\ Exchange Act Sec. 17(i)(4) [15 U.S.C. 78q(i)(4)].
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II. The Proposed Rules
The Commission proposed Rules 17i-1 through 17i-8 and amendments to
Rules 17a-12, 17h-1T, and 17h-2T on October 24, 2003 (Exchange Act
Release No. 48694 (October 24, 2003)) \6\ (the ``Proposing Release'')
to implement section 17(i) of the Exchange Act.
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\6\ 68 FR 62910 (November 6, 2003).
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Proposed Rules 17i-1 through 17i-8 were designed to implement the
framework for Commission supervision of SIBHCs set forth in section
17(i) of the Act. The proposed rules would have (i) incorporated
definitions found in the Exchange Act into the SIBHC rules and also
would have defined the terms ``affiliate group'' and ``material
affiliate,'' (ii) provided a method by which an IBHC could elect to
become an SIBHC and the criteria the Commission would use to make a
determination as to whether it would be necessary or appropriate in
furtherance of section 17 of the Act for the IBHC to be supervised by
the Commission as an SIBHC, (iii) permitted an SIBHC to withdraw from
Commission supervision by filing a notice of withdrawal with the
Commission and would have provided a method through which the
Commission could terminate supervision if it found that the SIBHC was
no longer an IBHC or it was necessary or appropriate in furtherance of
section 17 of the Act for the Commission to terminate supervision of
the SIBHC, (iv) required that an SIBHC comply with present Exchange Act
Rule 15c3-4 as though it were a broker-dealer \7\ and establish,
document and maintain an internal risk management control system and
periodically review
[[Page 34474]]
this internal risk management control system, (v) required that an
SIBHC make and keep current certain records relating to its business,
and preserve those and other records for certain prescribed time
periods, (vi) required an SIBHC to file with the Commission certain
monthly and quarterly reports and an annual audit report, (vii)
required that an SIBHC calculate, using a Basel-like Standard,\8\ the
affiliate group's allowable capital and allowances for market risk,
credit risk, and operational risk, and (viii) required that an SIBHC
notify the Commission upon the occurrence of certain, specified events
that could indicate a decline in the financial and operational well-
being of the SIBHC.
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\7\ In a separate release, we also proposed rules and rule
amendments that would, among other things, establish optional
alternative net capital requirements for certain broker-dealers. See
Exchange Act Release No. 48690 (October 24, 2003), 68 FR 62872 (Nov.
6, 2003) (the ``CSE Proposing Release''). In the CSE Proposing
Release we proposed amendments to Rule 15c3-4 that would apply to a
broker or dealer that elects to compute its net capital under
proposed Appendix E of Rule 15c3-1.
\8\ The central bank governors of the Group of Ten countries
established the Basel Committee in 1974 to provide a forum for
ongoing cooperation among member countries on banking supervisory
matters. Its basic consultative papers are: the Basel Capital Accord
(1988), the Core Principles for Effective Banking Supervision
(1997), and the Core Principles Methodology (1999). The standards
set by the Basel Committee (the ``Basel Standards'') establish a
common measurement system, a framework for supervision, and a
minimum standard for capital adequacy for international banks in the
G-10 countries. The Basel Committee is currently developing a new
international agreement and issued a proposal to modify the Basel
Standards in April 2003, when it released for public comment a
document entitled ``The New Basel Capital Accord'' (the ``New Basel
Capital Accord''). This proposal can presently be found at: http://www.bis.org/bcbs/cp3full.pdf.
The Basel Committee expects to issue a
final version of the New Basel Capital Accord by the middle of 2004,
with an effective date for implementation of December 31, 2006.
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In addition, a proposed amendment to Rule 17a-12(l) would have
required that, similar to the requirements for an SIBHC set forth in
proposed Rule 17i-6(i)(2),\9\ an OTC derivatives dealer submit a
supplemental report, prepared by the accountant using agreed-upon
procedures rather than auditing standards, regarding the accountant's
review of the internal risk management control system established and
documented in accordance with Rule 15c3-4.
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\9\ This requirement is now set forth in paragraph (d)(1)(ii) of
Rule 17i-6, as adopted.
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Finally, the amendments to Rules 17h-1T and 17h-2T \10\ would have
exempted broker-dealers that are affiliated with an SIBHC from those
rules because, pursuant to proposed Rules 17i-5 and 17i-6, the SIBHC
would have been required to make and retain documents and file reports
that are substantially similar to, and contain the same information as,
those its subsidiary broker-dealer is required to make, retain, and
file pursuant to Rules 17h-1T and 17h-2T.
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\10\ 17 CFR 240.17h-1T and 240.17h-2T.
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III. Overview of Comments Received
The Commission received two comment letters regarding the Proposing
Release \11\ from the International Swaps and Derivatives Association
(``ISDA'') and The Bear Stearns Companies, Inc. (``Bear Stearns''). The
comments contained in ISDA's letter generally relate to the proposed
rule requirements regarding the manner in which credit and operational
risk should be calculated by the holding company. Bear Stearns' letter
focused on three areas: The proposed credit risk treatment of margin
loans, the proposed credit risk treatment of over-the-counter
derivatives, and the proposed treatment of market risk. These comments,
and the Commission's response to those comments, are discussed more
specifically below in the descriptions of the final rule amendments.
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\11\ We received a third comment letter that referenced the
Proposing Release; however, it did not address the content of the
Proposing Release.
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IV. Final Rules and Rule Amendments
A. Rule 17i-1: Definitions
New Rule 17i-1 incorporates the definitions of ``investment bank
holding company,''\12\ ``supervised investment bank holding
company,''\13\ ``affiliate,'' \14\ ``bank,'' ``bank holding company,''
``company,'' ``control,'' ``savings association,'' ``insured bank''\15\
``foreign bank,''\16\ ``person associated with an investment bank
holding company'' and ``associated person of an investment bank holding
company''\17\ set forth in section 17(i)(5) of the Exchange Act \18\
into the rules promulgated under section 17(i). Although these
definitions apply regardless of whether they are incorporated into the
rules, incorporating them lets individuals reading the new rules know
that the terms are defined, and directs them to those definitions.
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\12\ Exchange Act Sec. 17(i)(5)(A) [15 U.S.C. 78q(i)(5)(A)].
The term ``investment bank holding company'' means any person, other
than a natural person, that owns or controls one or more broker-
dealers and the associated persons of the investment bank holding
company. An IBHC includes the holding company and all other entities
within the holding company structure that meet the ``control'' test.
\13\ 15 U.S.C. 78q(i)(5)(B). A ``supervised investment bank
holding company'' is any IBHC that is supervised by the Commission
pursuant to Section 17(i) of the Exchange Act.
\14\ Section 17(i)(5)(C) of the Exchange Act states that, for
purposes of Section 17(i) of the Exchange Act, the terms
``affiliate'' [12 U.S.C. 1841(k)], ``bank'' [12 U.S.C. 1841(c)],
``bank holding company'' [12 U.S.C. 1841(a)], ``company'' [12 U.S.C.
1841(b)], ``control'' [12 U.S.C. 1841(a)(2) et seq.], and ``savings
association'' [12 U.S.C. 1841(j)] have the same meaning as given in
Section 2 of the Bank Holding Company Act of 1956 [12 U.S.C. 1841]
(the ``Bank Holding Company Act'').
\15\ Section 17(i)(5)(D) of the Exchange Act states that, for
purposes of Section 17(i) of the Exchange Act, the term ``insured
bank'' has the same meaning as given in Section 3 of the Federal
Deposit Insurance Act [12 U.S.C. 1813(h)].
\16\ Section 17(i)(5)(E) of the Exchange Act states that, for
purposes of Section 17(i) of the Exchange Act, the ``foreign bank''
has the same meaning as given in Section 1(b)(7) of the
International Banking Act [12 U.S.C. 3101(7)].
\17\ Exchange Act Sec. 17(i)(5)(F) [15 U.S.C. 78q(i)(5)(F)].
The terms ``persons associated with an investment bank holding
company'' and ``associated person of an investment bank holding
company'' mean any person directly or indirectly controlling,
controlled by, or under common control, with the IBHC.
\18\ 15 U.S.C. 78q(i)(5).
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New Rule 17i-1 also includes definitions of the terms ``affiliate
group'' and ``material affiliate.'' The term ``affiliate group'' is
defined to include the SIBHC and every affiliate of the SIBHC because
we believe that we would need to obtain information related to all
affiliates to provide effective supervision of an SIBHC. We define the
term ``material affiliate'' to include any member of the affiliate
group that is material to the SIBHC because, based on the Commission's
experience in reviewing holding company documentation, receiving
information specific to affiliates material to a holding company
provides us with a better understanding of the holding company,
including how risk is managed on a consolidated level.
No comments were received regarding these definitions and the
Commission is adopting this rule as proposed.
B. Rule 17i-2: Notice of Intention To Be Supervised by the Commission
as an SIBHC
Exchange Act Sec. 17(i)(1)(B) authorizes the Commission to
prescribe rules regarding the form, information, and documents to be
included in an IBHC's notice of intention to become supervised by the
Commission as an SIBHC (a ``Notice of Intention'') as the Commission
may prescribe as necessary or appropriate in furtherance of the
purposes of Sec. 17 of the Act.\19\ The Commission received no
comments regarding proposed Rule 17i-2. Thus, the Commission is
adopting Rule 17i-2 substantially as it was proposed.\20\
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\19\ 15 U.S.C. 78q(i)(1)(B).
\20\ In addition to minor grammatical changes, the rule, as
adopted, no longer includes proposed paragraph (b)(4)(xiv)(B)
because we believe it is unnecessary.
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New Rule 17i-2 provides that an IBHC that meets the statutory
election criteria may elect to become an SIBHC by filing a written
Notice of Intention with the Commission, and prescribes the form of an
IBHC's Notice of Intention and the information and documents to be
included therewith. New Rule 17i-2 also sets forth the
[[Page 34475]]
process for Commission review of a Notice of Intention and the criteria
the Commission will use to make this determination. The new Rule
specifies that the Commission will supervise the IBHC as an SIBHC
unless the Commission determines that it is not necessary or
appropriate in furtherance of the purposes of Sec. 17 of the Act. The
new Rule further states that the Commission will not consider such
supervision necessary or appropriate unless the IBHC demonstrates that
it owns or controls a broker-dealer that has a substantial presence in
the securities business, which may be demonstrated by a showing that
the broker-dealer maintains tentative net capital of $100 million or
more. Finally, new Rule 17i-2 requires that an IBHC or SIBHC amend its
Notice of Intention in certain, specified circumstances.
If an IBHC becomes an SIBHC, regulation of its affiliated broker-
dealer and related associated persons generally will remain unchanged
(except that, pursuant to amendments described later in this release, a
broker-dealer affiliated with an SIBHC is exempted from the
requirements of Rules 17h-1T and 17h-2T).
1. Election Criteria
Section 17(i)(1)(A) of the Exchange Act sets forth certain
limitations on whether an IBHC is eligible to become an SIBHC,\21\ and
paragraph (a) of new Rule 17i-2 incorporates these statutory
exclusions. Specifically, an IBHC that is not (i) an affiliate of an
insured bank (with certain exceptions) or a savings association; (ii) a
foreign bank, foreign company, or a company that is described in
section 8(a) of the International Banking Act of 1978; or (iii) a
foreign bank that controls, directly or indirectly, a corporation
chartered under section 25A of the Federal Reserve Act is eligible to
file a Notice of Intention.
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\21\ Exchange Act Sec. 17(i)(1)(A) [15 U.S.C. 78q(i)(1)(A)].
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2. Notice of Intention To Become an SIBHC
Paragraph (b) of new Rule 17i-2 requires that an IBHC that elects
to become an SIBHC file a written Notice of Intention with the
Commission that is designed to provide the Commission with a basis for
evaluating the IBHC's activities, financial condition, internal risk
management control systems, and the relationships among its associated
persons in order to determine whether Commission supervision of the
IBHC is necessary and appropriate in furtherance of the purposes of
section 17 of the Exchange Act. Pursuant to the Rule, an IBHC's Notice
of Intention must include (i) a request to become an SIBHC; (ii) a
statement certifying that it is not affiliated with an entity listed in
section 17(i)(1)(A) of the Exchange Act; \22\ (iii) documentation
demonstrating that it owns or controls at least one broker-dealer that
maintains a substantial presence in the securities business as
evidenced either by its holding tentative net capital of $100 million
or more or otherwise; and (iv) other supplemental documents.
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\22\ 15 U.S.C. 78q(i)(1)(A).
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New Rule 17i-2 specifies that an IBHC must file the following
supplemental documents with its Notice of Intention to assist the
Commission in making its determination:
A narrative describing the business and organization of
the IBHC;
An alphabetical list of each member of the affiliate
group, with an identification of the financial regulator, if any, by
whom the affiliate is regulated, and a designation as to whether the
affiliate is a material affiliate;
An organizational chart identifying the IBHC, each broker-
dealer owned or controlled by the IBHC, and the IBHC's material
affiliates;
Certain consolidated and consolidating financial
statements;
Sample calculations of allowable capital and allowances
for market, and credit risk or alternative capital assessments made in
accordance with Rule 17i-7;
A list of the categories of positions held by the
affiliate group in its proprietary accounts and the methods the IBHC
intends to use for computing allowances for market risk and credit risk
on those positions;
A detailed description of the mathematical models the IBHC
intends to use to price positions and calculate market and credit risk;
A description of any positions for which the IBHC proposes
to use a method other than Value at Risk (``VaR'') to compute an
allowance for market risk;
A description of how the IBHC proposes to calculate
current exposure;
A description of how the IBHC proposes to determine credit
risk weights and internal credit ratings;
A description of the method the IBHC proposes to use to
calculate its allowance for operational risk;
A description of the internal risk management control
system established by the IBHC to manage the risks of the affiliate
group and an explanation of how that system satisfies the requirements
of Rule 17i-4;
Sample risk reports that the holding company provides to
the persons responsible for managing the risks of the affiliate group;
and
An undertaking providing that the SIBHC will cooperate
with the Commission as necessary if the disclosure of any information
with regard to Rules 17i-1 through 17i-8 would be prohibited by law or
otherwise.
The Commission, in its review of each Notice of Intention, will use
the information and documents provided by the IBHC to assess the IBHC's
business, financial condition, and internal risk management control
systems in recognition of the fact that each IBHC manages its business
and its internal risks differently. We have successfully used firm-
specific information and documents in the past to evaluate and monitor
risks to broker-dealers.
Paragraph (b)(xiv) of new Rule 17i-2 requires that an SIBHC provide
the Commission with an undertaking indicating that it agrees to
cooperate with the Commission as needed, including by describing any
secrecy laws or other impediments that could restrict the ability of
the SIBHC to provide information on the operations or activities of the
SIBHC. If any material impediments exist, the SIBHC must describe the
manner in which it proposes to provide the Commission with adequate
assurances of access to information.
In addition to the information and documentation specifically
described in the rules, the IBHC must also furnish such other
information and documents, including documents relating to its
financial position, internal controls, and mathematical models, as the
Commission may request to complete its review of the Notice of
Intention. Paragraph (b)(xv) of new Rule 17i-2 was designed to provide
the Commission with needed flexibility to assure it has the information
and documents necessary to make the required determination.\23\ In
addition, experience the Commission gains over time or changes in
business practice at broker-dealers and IBHCs may cause the Commission
to re-evaluate whether the
[[Page 34476]]
information and documentation it receives is sufficient.
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\23\ For instance, in the course of its review of a Notice of
Intention, the information or documents the Commission receives may
highlight an issue regarding the IBHC's financial position, internal
controls, or a mathematical model. If the Commission is unable to
obtain information or documents not specified in the Rule it may be
unable to make the required determination.
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We find the information and documentation an IBHC is required to
compile and submit as part of its Notice of Intention pursuant to
paragraph (b) of new Rule 17i-2 is necessary and appropriate in
furtherance of the purposes of Sec. 17 of the Act. The information and
documentation will inform the Commission as to the IBHC's activities,
financial condition, policies, and systems for monitoring and
controlling financial and operational risks, transactions and
relationships between any broker or dealer affiliate of the IBHC.
A Notice of Intention or amendment thereto will not be complete
until the IBHC has provided to the Commission all the information and
documentation specified in the Rule and requested by the
Commission.\24\
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\24\ 17 CFR 240.17i-2(d)(1).
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Paragraph (d)(1) of Rule 17i-2 states that all Notices of
Intention, amendments, and other documentation and information filed
pursuant to Rule 17i-2 will be accorded confidential treatment.\25\ We
believe it is important to accord confidential treatment to the
information and documentation an IBHC provides to the Commission as
part of its Notice of Intention because that information and
documentation will generally be highly sensitive, non-public business
information.
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\25\ Section 17(j) of the Exchange Act authorizes the Commission
to keep confidential the information it receives pursuant to rules
adopted under section (i) [15 U.S.C. 78q(j)]. Section 17(j)
provides, ``Notwithstanding any other provision of law, the
Commission shall not be compelled to disclose any information
required to be reported under'' section 17(i).
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3. Process for Review of Notices of Intention
Pursuant to paragraph (d)(2) of new Rule 17i-2, an IBHC will become
an SIBHC subject to Commission supervision 45 calendar days after the
Commission receives a completed Notice of Intention, unless the
Commission issues an order determining either that (i) the Commission
will begin to supervise the IBHC as an SIBHC prior to 45 calendar days
after the Commission received the completed Notice of Intention to
become supervised; or (ii) the Commission will not supervise the IBHC
because supervision of the entity as an SIBHC is not necessary or
appropriate in furtherance of the purposes of section 17 of the
Exchange Act.\26\ The Commission will use the information and documents
provided as part of an IBHC's Notice of Intention to assess the
financial and operational condition of the IBHC and make this
determination.
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\26\ Exchange Act Sec. 17(i)(1)(B) [15 U.S.C. 78q(i)(1)(B)].
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4. Requirement That an IBHC Be Affiliated With a Broker-Dealer That Has
a Substantial Presence in the Securities Business
Pursuant to the Act, the Commission may supervise an IBHC that has
submitted a Notice of Intention as an SIBHC ``[u]nless the Commission
finds that such supervision is not necessary or appropriate in
furtherance of the purposes'' of section 17.\27\ The purposes of
section 17 are quite broad. Section 17 generally permits the Commission
to carry out its regulatory oversight responsibilities regarding
broker-dealers by establishing rules related to recordkeeping,
reporting, and examination. In addition, section 17(h) provides the
Commission authority to require that a broker-dealer obtain information
and make and keep such records and reports regarding the broker-
dealer's affiliates, and the financial and securities activities,
capital and funding of certain of those affiliates,\28\ as the
Commission prescribes to assess the financial and operational risks to
a broker-dealer from those affiliates.
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\27\ 15 U.S.C. 17(i)(1)(B).
\28\ Those affiliates would include, but not be limited to,
affiliates whose business activities are reasonably likely to have a
``material impact'' on the financial or operational condition of the
broker-dealer.
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We find, consistent with the purposes of section 17, the
Commission's supervision of an IBHC as an SIBHC is necessary and
appropriate only when the IBHC is affiliated with a broker-dealer that
has a ``substantial presence'' in the securities business.\29\
Supervision of an SIBHC that owns or controls a broker-dealer with a
substantial presence in the securities business would permit the
Commission to be better informed regarding the financial and
operational conditions of broker-dealers and their holding companies
whose failure could have a materially adverse impact on other
securities market participants, thus reducing systemic risk and
furthering the purposes of section 17. Among other things, evidence
that an IBHC owns or controls a broker-dealer that maintains $100
million in tentative net capital would be sufficient to demonstrate a
substantial presence in the securities business.
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\29\ As set forth in sub-paragraph (d)(2)(i)(B) of Rule 17i-2.
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5. Continuing Obligation To Amend a Notice of Intention
Pursuant to paragraph (c) of new Rule 17i-2, IBHCs and SIBHCs have
a continuing obligation to amend their Notices of Intention. If any of
the information or documentation filed with the Commission as part of
the Notice of Intention is found to be or becomes inaccurate prior to a
Commission determination, an IBHC must notify the Commission and
provide the Commission with a description of the circumstances in which
the information or documentation was found to be or became inaccurate
along with updated, accurate information and documents.
After a Commission determination, if an SIBHC materially changes a
mathematical model or other method used to compute its allowable
capital or allowances for market, credit, or operational risk, or its
internal risk management control systems, prior to making the changes
the SIBHC must file an amended Notice of Intention describing the
changes and obtain Commission approval of the amendment. Commission
approval is necessary to assure that the SIBHC continues to utilize
risk measures that are sufficient to properly manage the financial and
operational risks of the affiliate group.
C. Rule 17i-3: Withdrawal From Supervision as an SIBHC
New Rule 17i-3 permits an SIBHC to withdraw from Commission
supervision by filing a notice of withdrawal with the Commission,
consistent with Exchange Act Sec. 17(i)(2)(A). Pursuant to the Rule, a
notice of withdrawal from supervision will take effect one year after
it is filed with the Commission (or a shorter or longer period that the
Commission determines is necessary or appropriate to help ensure
effective supervision of the material risks to the SIBHC and any
affiliated broker-dealer or to prevent evasion of the purposes of
section 17 of the Exchange Act).\30\ The new Rule also requires an
SIBHC to include in its notice of withdrawal a statement regarding
whether it is in compliance with new Rule 17i-2(c) regarding amendments
to its Notice of Intention to help to assure that the Commission has
current information when considering the SIBHC's withdrawal notice.
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\30\ See section 17(i)(2)(A) of the Exchange Act and paragraph
(b) of Rule 17i-3.
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In addition, paragraph (c) of new Rule 17i-3 provides, consistent
with Exchange Act Sec. 17(i)(2)(B), that the Commission may
discontinue supervising an SIBHC if the Commission finds that the SIBHC
no
[[Page 34477]]
longer exists or is no longer an IBHC, or that continued supervision of
the SIBHC is not necessary or appropriate in furtherance of the
purposes of section 17. Among other things, if an SIBHC makes a
material amendment to a mathematical model or to its internal risk
management control systems as described in its Notice of Intention (and
as modified from time to time), the Commission may review whether the
change would cause continued supervision of the SIBHC to no longer be
necessary or appropriate in furtherance of the purposes of section 17
of the Act.
The Commission will generally review and consider the same types of
information it initially reviewed and considered when making its
original determination to supervise the IBHC as an SIBHC to determine
whether continued supervision of the SIBHC is necessary or appropriate
in furtherance of the purposes of section 17 of the Act.
The Commission received no comments regarding proposed Rule 17i-3,
and the Commission is adopting Rule 17i-3 substantially as it was
proposed.
D. Rule 17i-4: Internal Risk Management Control System Requirements for
SIBHCs
New Rule 17i-4 requires that an SIBHC comply with present Exchange
Act Rule 15c3-4 as if it were an OTC derivatives dealer with respect to
all of its business activities and transactions.\31\ That is, an
SIBHC's compliance with Rule 15c3-4 is not limited to its OTC
derivatives transactions.\32\ Currently, Rule 15c3-4 requires that each
OTC derivatives dealer establish, document and maintain a system of
internal risk management controls to assist it in managing the risks
associated with its business activities, including market risk, credit
risk, operational risk, funding risk, and legal risk.
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\31\ Paragraphs (c)(5)(xiii), (c)(5)(xiv), (d)(8), and (d)(9)
would not apply to an IBHC that elects SIBHC supervision because
those paragraphs relate solely to limitations on the types of
transactions an OTC derivatives dealer may undertake.
\32\ See 17 CFR 240.15c3-4(c)(5)(x), (c)(5)(xi), (d)(1), (d)(5),
and (d)(10).
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An SIBHC that has adopted and follows appropriate risk management
controls reduces its risk of significant loss, which also reduces the
risk to other market participants or throughout the financial markets
as a whole. Due to the level of risk exposures created by the types of
business activities of SIBHCs, it is important for SIBHCs to implement
robust internal risk management control systems. Based on the
Commission's experience with OTC derivatives dealers, we believe new
Rule 17i-4 will cause SIBHCs to develop strong internal controls that
will reduce risk at the SIBHC and require that each SIBHC adequately
document those internal controls. It is important that the internal
controls be adequately documented to assure that examiners and
accountants can review and audit them. We also believe that, similar to
Rule 15c3-4, new Rule 17i-4 provides flexibility for an SIBHC to design
and implement internal risk management control systems specific to its
business model and circumstances.
Paragraph (b) of new Rule 17i-4 contains one requirement that is
not presently included in Rule 15c3-4 `` it requires that an SIBHC
establish, document, and maintain procedures for the detection and
prevention of money laundering and terrorist financing as part of its
internal risk management control system. This requirement is designed
to allow the Commission to examine the SIBHC and members of the
affiliate group as provided for in the Act.\33\ An SIBHC's procedures
should include appropriate safeguards at the holding company level to
prevent money laundering through affiliates.\34\
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\33\ See generally, Exchange Act Sec. 17(i)(3)(C)(i)(II) [15
U.S.C. 78q(i)(3)(C)(i)(II)], which provides the Commission with the
authority to make examinations of any SIBHC and any affiliate of
such company in order to monitor compliance with the provisions of
subsection 17(i) of the Act, provisions governing transactions and
relationships between any broker-dealer affiliated with the SIBHC
and any of the company's other affiliates and applicable provisions
of subchapter II of chapter 53, title 31, United States Code
(commonly known as the ``Bank Secrecy Act'') and the regulations
thereunder.
\34\ This parallels requirements in the New Basel Capital Accord
(See supra, note 8). See also Financial Action Task Force on Money
Laundering (``FATF''), The Forty Recommendations (2003),
Recommendation 22, and see generally the FATF's Special
Recommendations on Terrorist Financing. (The FATF's documents can
presently be found at: http://www.FATF-GAFI.org).
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The Commission received no comments regarding proposed Rule 17i-4.
The Commission is adopting Rule 17i-4 substantially as it was proposed.
E. Rule 17i-5: Record Creation, Maintenance, and Access Requirements
for SIBHCs
Section 17(i)(3)(A) of the Exchange Act authorizes the Commission
to require that an SIBHC must make and keep records, furnish copies
thereof, and make such reports as the Commission may require.\35\ New
Rule 17i-5 specifies the records that an SIBHC must make and keep
current, the length of time those records must be preserved, and the
format SIBHCs may use to preserve those records. This rule is designed
to require an SIBHC to create and maintain sufficient records to keep
the Commission informed as to: (i) The SIBHC's activities, financial
condition, policies, systems for monitoring and controlling financial
and operational risks, and transactions among members of the affiliate
group; and (ii) the extent to which the SIBHC has complied with the
provisions of the Exchange Act and rules to which it is subject.
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\35\ 15 U.S.C. 78q(i)(3)(A).
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In addition, new Rule 17i-5(d) \36\ specifies that all information
obtained by the Commission from the SIBHC pursuant to this Rule will be
accorded confidential treatment to the extent permitted by law.\37\ We
believe it is important to accord confidential treatment to these
documents because the information an SIBHC is required create,
maintain, and grant the Commission access to pursuant to new Rule 17i-5
generally is highly sensitive, non-public business information.
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\36\ 17 CFR 240.17i-5(d).
\37\ See supra, note 25.
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The Commission received no comments regarding proposed Rule 17i-5,
and, except as described below, the Commission is adopting Rule 17i-5
substantially as it was proposed. The Commission has added a
requirement to Rule 17a-5 that an SIBHC make a record of the
calculations of allowable capital and allowances for market, credit,
and operational risk computed at least monthly.
1. Record Creation
Paragraph (a) of new Rule 17i-5 requires that an SIBHC make and
keep current (i) a record reflecting the results of quarterly stress
testing of the affiliate group's funding and liquidity with respect to
certain specified events; (ii) a record of the SIBHC's contingency
plans to respond to certain specified events affecting the affiliate
group's funding and liquidity; and (iii) a record of the basis for
credit risk weights and internal credit ratings, if applicable, for
each counterparty.
The specified events for which an SIBHC will need to conduct stress
tests and create a contingency plan would include: (i) A credit rating
downgrade of the SIBHC; (ii) an inability of the SIBHC to access
capital markets for unsecured, short-term funding; (iii) an inability
of the SIBHC to move liquid assets across international borders when an
event described in (i) or (ii) occurs; or (iv) an inability of the
SIBHC to access credit or assets held at a particular institution when
an event described in (i) or (ii) occurs. The Commission believes these
events would present liquidity and funding stress scenarios that would
[[Page 34478]]
likely create significant financial distress for the SIBHC. The records
an SIBHC is required to create pursuant to Rule 17i-5 are intended to
provide the Commission with sufficient information to adequately assess
the SIBHC's financial condition and financial and operational risks.
These records will be available to the Commission during examinations
or as otherwise requested.
The Commission requested comment on whether there are any other
records that an SIBHC should be required to create. The Commission has
given additional consideration to the questions raised in its request
for comment and has determined to add a requirement that an SIBHC make
a record, on a consolidated basis, of the calculations of allowable
capital and allowances for market, credit, and operational risk
computed on at least a monthly basis. This parallels the manner in
which net capital is recorded at the broker-dealer level. As proposed,
an SIBHC would have been required to maintain copies of all reports
required to be filed with the Commission, and those reports would have
included calculations of allowable capital, and allowances for market,
credit, and operational risk (as opposed to statements of allowable
capital and allowances for market, credit, and operational risk which
the rule, as adopted, requires). Because we do not believe it is
necessary for an SIBHC to provide the Commission with the detailed
calculations, we eliminated the requirement that an SIBHC report this
information to the Commission \38\ and instead is requiring an SIBHC to
simply maintain a record of these calculations.
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\38\ See proposed Rule 17i-6(a)(1)(i).
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2. Record Maintenance
Pursuant to paragraph (b) of new Rule 17i-5, the SIBHC must
preserve (i) the records required to be created pursuant to 17i-5(a)
(as described above); (ii) all Notices of Intention, amendments
thereto, and other documentation and information filed with the
Commission in accordance with Rule 17i-2, and any responses thereto;
(iii) reports and notices filed with the Commission in accordance with
Rules 17i-6 and 17i-8; and (iv) records documenting the internal risk
management control system established in accordance with Rule 17i-4 to
manage the risks of the affiliate group. This requirement is designed
to require that an SIBHC maintain the specified records, which would
provide the Commission with sufficient information to adequately assess
the SIBHC's financial condition and financial and operational risks.
New Rule 17i-5 requires that an SIBHC maintain the specified
records for a period of three years in an easily accessible place. This
requirement is designed to assure that the specified records will be
available to the Commission during examinations or as otherwise
requested. Exchange Act Rule 17a-4 presently requires that broker-
dealers maintain certain records for three years, and we believe this
time period is appropriate with relation to the records required
pursuant to new Rule 17i-5. The new Rule would allow an SIBHC to
maintain these records in any manner permitted pursuant to Rule 17a-
4(f).\39\
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\39\ 17 CFR 240.17a-4(f). Rule 17a-4 allows a broker-dealer to
maintain its records either in hard-copy (paper), microfiche,
microfilm, or electronic format, subject to the conditions set forth
in paragraph (f).
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New Rule 17i-5 does not require an SIBHC to maintain its required
records in a prescribed standard form. To reduce the recordkeeping
burden on SIBHCs, new Rule 17i-5 instead allows an SIBHC to meet its
recordkeeping requirements using records it created for its own use so
long as those records include the information required in the rules.
Paragraph (c) of new Rule 17i-5 allows an SIBHC to maintain the
records required under the rule either at the SIBHC, at an affiliate,
or at a records storage facility, provided that the records are located
within the United States. If these records are maintained by an entity
other than the SIBHC, the SIBHC must file with the Commission a written
undertaking from the entity which states that the records will be
treated as if the SIBHC were maintaining the records and that the
entity undertakes to permit examination of these records by
representatives of the Commission and to promptly furnish copies of
such records to the Commission. This provision is intended to provide
an SIBHC with flexibility with relation to record maintenance, without
impairing the Commission's ability to obtain the SIBHC's records as
necessary.
3. Access to Records
The Commission has authority to examine an SIBHC and its affiliates
pursuant to Section 17(i)(3)(C) of the Exchange Act.\40\ However, the
Act limits the focus and scope of such examinations. The statutory
provisions also require that the Commission use, to the fullest extent
possible, examination reports regarding an examination made by an
appropriate regulator of the SIBHC or certain regulated affiliates.\41\
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\40\ 15 U.S.C. 78q(i)(3)(C). The primary purpose of our
examination of supervised investment bank holding companies is to
verify their financial and operational positions and to verify
whether the internal risk management controls and the methodologies
for calculating allowable capital and allowances for market, credit,
and operational risk are consistent with those controls and
methodologies approved by the Commission.
\41\ See supra, note 41.
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F. Rule 17i-6: Reporting Requirements for SIBHCs
New Rule 17i-6 requires that an SIBHC file certain monthly and
quarterly reports with the Commission, as well as an annual audit
report. These reporting requirements are designed to keep the
Commission informed as to the SIBHC's activities, financial condition,
policies, systems for monitoring and controlling financial and
operational risks, and transactions and relationships between any
broker or dealer affiliate of the SIBHC, and the extent to which the
SIBHC has complied with the provisions of the Act and the regulations
prescribed and orders issued thereunder.
The Commission received no comments regarding proposed Rule 17i-6,
and except as noted below, is adopting Rule 17i-6 as proposed. We have
amended the timing of the reports, extending the deadline for the
filing of monthly reports to 30 calendar days after month-end (instead
of 17 business days after month-end) and the deadline for filing the
annual audit report to 65 calendar days after year-end (instead of 60
calendar days after year-end). In addition, certain financial
information need not be filed with the monthly and quarterly reports if
that financial information has not yet been made public in the SIBHC's
annual report on Form 10-K. We believe that an extension of these time
periods is appropriate because an SIBHC must include detailed
information, potentially from a number of affiliates, in these reports.
The extension, moreover, does not delay significantly the time at which
the Commission will receive the reports and, therefore, should provide
the Commission with accurate information about risks that the SIBHC and
its affiliates may pose to any affiliated broker-dealer.
The Commission also made other changes to the rule as proposed. We
have added a section to require that an SIBHC provide the Commission
with an organizational chart on a yearly basis. In addition, the rule,
as adopted, no longer includes a requirement that an SIBHC file a
supplemental report on inventory pricing and modeling with its annual
audited statements, nor does it include many of the technical audit
report
[[Page 34479]]
requirements. These changes are discussed more fully below.
1. Monthly Reports
Paragraph (a) of new Rule 17i-6 requires an SIBHC to file a monthly
risk report with the Commission, within 30 calendar days after the end
of each month that does not end a calendar quarter. This report must
include a consolidated balance sheet and income statement for the
affiliate group, computations of consolidated allowable capital and
allowances for market, credit, and operational risk, a graph reflecting
daily intra-month VaR for each business line, consolidated credit risk
information, a summary report of the SIBHC's exposures on a
consolidated basis for each of the top ten countries to which it is
exposed, and certain regular risk reports the SIBHC generally provides
to the persons responsible for managing risk for the affiliate group.
These monthly reports are intended to allow the Commission to review
and monitor the risk profile for the affiliate group, and alert the
Commission to any deterioration in the affiliate group's financial
position, operational position, or risk profile.
We changed the language of the rule to provide that an SIBHC is not
required to file a separate monthly report when the monthly report
would coincide with a quarter-end. The quarterly report requirement was
expanded to include the information contained in the monthly report, a
consolidating balance sheet and income statement for the affiliate
group, the results of backtesting of all models used to compute
allowable capital and allowances for market and credit risk, a
description of all material pending legal or arbitration proceedings
involving the SIBHC or any member of the affiliate group, and the
aggregate amount of short-term, unsecured borrowings and lines of
credit as to each material affiliate
In addition, the rule, as amended, no longer includes a requirement
that an SIBHC provide consolidated credit risk information regarding
the 5 largest exposures to regulated financial institutions.\42\ These
exposures will be reflected as part of an SIBHC's response to
paragraphs (a)(1)(iii)(A) and (B),\43\ that require that an SIBHC
provide the Commission with information regarding its 15 largest
exposures to all persons. Thus, it would be duplicative to require that
an SIBHC report its 5 largest exposures to financial institutions
separately.
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\42\ Paragraphs (a)(1)(iii)(A)(2) and (a)(1)(iii)(C)(2) in
proposed Rule 17i-6.
\43\ The requirements contained in paragraphs (a)(1)(iii)(A)(1)
and (a)(1)(iii)(C)(1) of proposed Rule 17i-6 can now be found in
paragraphs (a)(1)(iii)(A) and (a)(1)(iii)(B) in new Rule 17i-6.
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2. Quarterly Reports
Paragraph (a)(2) of new Rule 17i-6 requires that an SIBHC file a
quarterly risk report with the Commission within 35 calendar days after
the end of each quarter. In addition to all the information required to
be filed on a monthly basis, the quarterly report must include: (i)
Consolidating financial statements (that break out data regarding each
material affiliate into separate columns); (ii) the results of
backtesting of each of the models used to compute allowable capital and
allowances for market and credit risk; (iii) a description of all
material pending legal or arbitration proceedings involving any member
of the affiliate group that are required to be disclosed under
generally accepted accounting principles; and (iv) the aggregate amount
of debt scheduled to mature within twelve months from the most recent
quarter by each affiliate that is a broker-dealer and any other
material affiliate, together with the allowance for losses for such
transactions. The information an SIBHC must file on a quarterly basis
will provide the Commission with valuable insight as to the financial
and operational condition of the SIBHC.
As proposed, these reports are required to be filed within 35
calendar days after the end of each quarter, which is similar to the
time frames for quarterly reports due from public companies that are
``accelerated filers'' \44\ and are required to file information,
documents, and reports pursuant to Sec. Sec. 13(a) or 15(d) of the
Exchange Act.\45\
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\44\ As defined in 17 CFR Sec. 240.12b-2.
\45\ See Release No. 33-8128 (Sept. 5, 2002), 67 FR 58480 (Sept.
16, 2002).
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New paragraph (a)(3) of Rule 17i-6 states that the SIBHC need not
include consolidated and consolidating balance sheets and income
statements with its quarterly report on the quarter-end that coincides
with the SIBHC's fiscal year-end. This provision was revised so that an
SIBHC that is a publicly traded company would not be required to file
its financial statements, under this rule, prior to the date it would
otherwise be required to file its financial statements with the
Commission pursuant to rules applicable to public companies.
3. Organizational Chart
We have added a new paragraph (b) to Rule 17i-6, which would
require that an SIBHC file an organizational chart with the Commission
at least once each year as of its fiscal year-end. In addition, this
paragraph would require that an SIBHC provide the Commission with
quarterly updates if a material change in its organization has
occurred. The Commission finds these organizational charts to be useful
tools in reviewing holding company risk.\46\
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\46\ Pursuant to Sec. 240.17h-2T(a)(1)(i) and Form 17H, a
broker-dealer subject to Rule 17h-2T must file an organizational
report with its annual filing and with any quarterly filing if there
has been a material change in the information provided to the
Commission. We proposed to exempt from Rules 17h-1T and 17h-2T a
broker-dealer that is affiliated with an SIBHC because the
information an SIBHC would have been required to provide to the
Commission pursuant to proposed Rule 17i-6 was substantially similar
to that which broker-dealers must provide pursuant to Rules 17h-1T
and 17h-2T. However, Rule 17i-6, as proposed, did not include this
organizational chart requirement.
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4. Additional Reports
Paragraph (c) of new Rule 17i-6 \47\ provides that an SIBHC may be
required, upon receiving written notice from the Commission, to provide
the Commission with additional financial or operational information.
This rule provides the Commission with the flexibility to request
additional reports, during periods of market stress or otherwise, to
monitor the SIBHC's activities, financial condition, policies, systems
for monitoring and controlling financial and operational risks,
transactions and relationships among members of the affiliate group,
and the extent to which the SIBHC has complied with the provisions of
the Exchange Act and regulations prescribed and orders issued
thereunder. In addition, if a broker-dealer affiliated with the SIBHC
or the SIBHC were to file a notice, pursuant to Rule 17a-11 or Rule
17i-8, respectively, the Commission may request additional reports from
the SIBHC to fully assess the situation giving rise to the filing of
the notice.
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\47\ Paragraph (b) of proposed Rule 17i-6 was redesignated as
paragraph (c) f new Rule 17i-6.
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5. Annual Audit Report
Pursuant to paragraph (d)(1) of new Rule 17i-6,\48\ an SIBHC must
file an annual audit report containing consolidated financial
statements and a supporting schedule containing statements of allowable
capital, and allowances for market, credit, and operational risk. The
audit must be conducted by a registered public accounting firm (as that
term is defined at 15 U.S.C. 7201(a)(12)) in accordance the rules
promulgated by the Public Company Accounting Oversight Board. Paragraph
(d)(2) of new Rule 17i-6 requires that the annual audit report be
[[Page 34480]]
``as of'' the same date as the annual audit of the SIBHC's affiliated
broker-dealer, and filed with the Commission not later than 65 calendar
days after the end of the fiscal year.
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\48\ Paragraph (c)(1) of proposed Rule 17i-6 was redesignated as
paragraph (d)(1) of new Rule 17i-6.
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Paragraph (f) of new Rule 17i-6 \49\ allows the Commission to grant
extensions or exemptions from the annual audit requirement at the
request of the SIBHC, or on its own motion. This provision will provide
the Commission with flexibility to address firm-specific issues as they
arise.
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\49\ Paragraph (k) of proposed Rule 17i-6 was redesignated as
paragraph (f) of new Rule 17i-6.
---------------------------------------------------------------------------
We did not adopt the proposed requirement that an SIBHC file
supplemental reports on reportable conditions and inventory pricing and
modeling with its annual audited statements \50\ because the report on
reportable conditions would generally be reported through Form 8-K for
public companies, and the staff has found the supplemental report on
inventory pricing and modeling filed by OTC derivatives dealers to be
less useful than other information required to be filed.
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\50\ As set forth in paragraph (i)(3) of proposed Rule 17i-6.
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Rule 17i-6 no longer includes certain additional, technical
paragraphs regarding the annual audit because, upon further
consideration, they were found to be duplicative with the rules of the
Public Company Accounting Oversight Board (``PCAOB''),\51\ including
their independence standards.
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\51\ New Rule 17i-6(d)(1)(i) requires that an SIBHC's financial
statements must be audited by a registered public accounting firm.
The term ``registered public accounting firm'' is defined in Section
2(a)(12) of the Sarbanes-Oxley Act of 2002 [Pub. L. 107-204]
[codified at 15 U.S.C. 7201(a)(12)] as ``a public accounting firm
registered with the [Public Company Accounting Oversight] Board in
accordance with this Act.''
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Paragraph (h) of new Rule 17i-6 \52\ specifies that all information
obtained by the Commission pursuant to these rules will be accorded
confidential treatment to the extent permitted by law.\53\ We believe
it is important to accord confidential treatment to the reports and
statements filed pursuant to new Rule 17i-6 because these reports will
contain information that generally would be non-public and highly
sensitive.
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\52\ Paragraph (m) of proposed Rule 17i-6 was redesignated as
paragraph (h) of new Rule 17i-6.
\53\ See supra, note 25.
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6. Accountant's Report on Management Controls--Paragraph (d)(1)(ii) of
Rule 17i-6 and Amendment to Paragraph (l) of Existing Rule 17a-12
Paragraph (d)(1)(ii) of new Rule 17i-6 \54\ requires that an SIBHC
submit a supplemental report, prepared by its accountant, regarding the
accountant's review of the internal risk management control system
established and documented in accordance with Rule 17i-4. This review
must be accomplished using procedures agreed-upon by the accountant and
the SIBHC. The Rule also specifies that the agreed-upon procedures must
be performed and the report must be prepared in accordance with the
rules promulgated by the PCAOB. Pursuant to paragraph (d)(1)(ii) of new
Rule 17i-6, the SIBHC must submit the agreed-upon procedures to the
Commission prior to the accountant's initial review.
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\54\ Proposed paragraph 17i-6(i)(1) was redesignated as
paragraph 17i-6(d)(1)(ii) in the rules as adopted.
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As explained in the Proposing Release, proposed paragraph
(d)(1)(ii) of Rule 17i-6 differs from present Rule 17a-12(l), which
requires that an accountant provide an opinion regarding an OTC
derivatives dealer's compliance with its internal risk management
control system. Auditors of OTC derivatives dealers have stated that
the lack of standards for evaluating compliance with internal risk
management control systems prevents them from issuing an opinion. For
this reason, the Commission is also amending present Rule 17a-12(l) so
that, similar to the requirements of paragraph (d)(1)(ii) of new Rule
17i-6, an OTC derivatives dealer would be required to submit a
supplemental report, prepared by the accountant using agreed-upon
procedures, regarding the accountant's review of the internal risk
management control system established and documented in accordance with
Rule 15c3-4.
Paragraph (d)(1)(ii) of new Rule 17i-6 and this amendment to Rule
17a-12(l) will require an accountant to review an SIBHC's or OTC
derivatives dealer's internal risk management control systems and
provide a report regarding whether the internal risk management control
systems comply with the requirements of Rule 17i-4 or Rule 15c3-4,
respectively, and whether the SIBHC or OTC derivatives dealer is
following its internal risk management control systems.
The Commission received no comments regarding its proposed
amendments to Rule 17a-12(l), and is thus adopting this amendment to
Rule 17a-12(l) as it was proposed.
G. Exemption From Risk Assessment Rules for Broker-Dealer Affiliates of
SIBHCs
The Commission presently receives financial and risk information
about certain holding companies and other broker-dealer affiliates,
including certain off-balance sheet items pursuant to the risk
assessment rules \55\ and through meetings with industry
representatives. These supervisory tools generally have performed well
by assisting the Commission in identifying, at an early stage, firms
that are experiencing financial problems.
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\55\ Pursuant to the ``risk-assessment rules,'' adopted under
Exchange Act Section 17(h), broker-dealers also submit consolidated
and consolidating financial statements, organizational charts of the
holding company, descriptions of material legal exposures, and risk
management policies and procedures to the Commission. [17 CFR
240.17h-1T and 17 CFR 240.17h-2T].
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As part of this rulemaking, the Commission is amending Rules 17h-1T
and 17h-2T \56\ to exempt broker-dealers that are affiliated with an
SIBHC from those rules. Rule 17h-1T requires that a broker-dealer
maintain and preserve records and other information concerning the
broker-dealer's holding companies, affiliates, or subsidiaries that are
likely to have a material impact on the financial or operational
condition of the broker-dealer. Rule 17h-2T requires that broker-
dealers file quarterly reports with the Commission concerning the
information required to be maintained and preserved under Rule 17h-1T.
We believe it is appropriate to exempt a broker-dealer that is
affiliated with an SIBHC because, pursuant to new Rule 17i-5, the SIBHC
must make and retain documents substantially similar to those the
broker-dealer is required to make and retain pursuant to Rule 17h-1T.
Further, pursuant to new Rule 17i-6, the SIBHC would be required to
make reports that are substantially similar to those the broker-dealer
is required to make pursuant to 17h-2T.
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\56\ Id.
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The Commission received no comments regarding these proposed
amendments to Rules 17h-1T and 17h-2T. Consequently, the Commission is
adopting these amendments to Rules 17h-1T and 17h-2T as proposed.
H. Rule 17i-7: Calculations of Allowable Capital and Risk Allowances or
Alternative Capital Assessment
New Rule 17i-7 requires that an SIBHC compute allowable capital and
allowances for market, credit, and
[[Page 34481]]
operational risk on a consolidated basis for the affiliate group. These
calculations are designed to be consistent with the Basel Standards,
which will provide the Commission with a useful measure of the SIBHC's
financial position and allow for greater comparability of an SIBHC's
financial condition to that of other international securities firms and
banking institutions.
New Rule 17i-7 does not set minimum group-wide capital levels for
SIBHCs; rather, it requires the SIBHC to perform certain calculations
that the Commission will review, when they are reported pursuant to the
requirements of new Rule 17i-6, to gain an understanding of the
financial and operational position of the affiliate group and identify
any risks the SIBHC may pose its affiliated broker-dealer or other
market participants.
As discussed below, we believe the new rules provide prudent
parameters for measuring allowable capital and allowances for risk for
the SIBHC.
1. Calculation of Consolidated Allowable Capital
Consistent with the Basel Standards,\57\ new Rule 17i-7 requires
that an SIBHC calculate ``allowable capital'' for the affiliate group
that includes common shareholders' equity (less goodwill, certain
deferred tax assets,\58\ other intangible assets, and certain other
deductions), certain cumulative and non-cumulative preferred stock,\59\
certain properly subordinated debt, and hybrid capital instruments. As
set forth in further detail in the rule, to be included in allowable
capital the cumulative and non-cumulative preferred stock and the
subordinated debt are subject to additional limitations based on
comparisons of the individual components of allowable capital.\60\
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\57\ New Rule 17i-7 is generally consistent with the Basel
Standards. However, one difference is our method for computing
maximum potential exposure based on the VaR of those positions (as
opposed to approximating maximum potential exposure through the use
of notional add-ons) when calculating credit risk for OTC
derivatives instruments. This difference is described more
specifically in the section relating to the calculations of
allowance for credit risk.
\58\ Pursuant to the paragraph (a)(1)(ii) of new Rule 17i-7,
deferred tax assets, except those permitted for inclusion in Tier 1
capital by the Board of Governors of the Federal Reserve (12 CFR
225, Appendix A) must be deducted from shareholders' equity when
computing allowable capital.
\59\ The cumulative and non-cumulative preferred stock may not
(i) have a maturity date, (ii) be redeemed at the option of the
holder, or (iii) contain any other provisions that would require
future redemption of the issue. In addition, the issuer must be able
to defer or eliminate dividends.
\60\ See paragraphs (a)(2) and (a)(3)(i) of Rule 17i-7.
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The Commission received no comments regarding the requirement to
calculate allowable capital set forth in paragraph (a) of proposed Rule
17i-7.
As proposed, Rule 17i-7 would have required that all deferred tax
assets be subtracted from common shareholders' equity when computing
allowable capital. In order to remain consistent with the CSE
Release,\61\ certain deferred-tax assets are now includable in an
SIBHC's allowable capital, subject to the limitations set forth in
paragraph (a)(1)(ii). Generally, an SIBHC may include the amount of
deferred-tax assets dependent upon future taxable income, so long as
they do not exceed the lesser of the amount of deferred-tax assets the
company expects to realize within one year of the calendar quarter-end
date (based upon its projected taxable income for the year), or 10
percent of allowable capital.\62\ Any deferred tax assets in excess of
this amount must be subtracted from common shareholder's equity. There
generally is no limit in allowable capital on the amount of deferred-
tax assets that can be realized from taxes paid in prior carry-back
years or from future reversals of existing taxable temporary
differences.
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\61\ In a separate, companion release, we amended rules to,
among other things, establish optional alternative net capital
requirements for certain broker-dealers. See Exchange Act Release
No. 49830 (June 8, 2004) (the ``CSE Release''). That release also
outlined a capital calculation to be performed by the holding
company of a broker-dealer that uses that alternative net capital
requirement. The rules set forth in the CSE Release were proposed on
October 24, 2003 (see supra, note 7).
\62\ For purposes of calculating the 10% limitation, allowable
capital is defined as the sum of the elements set forth in Rule 17i-
7, paragraph (a)(1).
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Paragraph (a)(3)(ii) of proposed Rule 17i-7 would have allowed an
SIBHC to include subordinated debt as part of its allowable capital,
subject to certain criteria intended to help assure that the
subordinated debt provides a long-term source of working capital to the
SIBHC and that it has many of the characteristics of capital. We did
not receive any comments relating to this provision, so we are adopting
paragraph (a)(3)(ii) of new Rule 17i-7 as it was proposed.
As proposed, Rule 17i-7 would not have allowed an SIBHC to include
hybrid capital instruments in its calculation of allowable capital. The
proposing CSE Release also would have disallowed holding companies from
using hybrid capital instruments as part of allowable capital.\63\ In
response to views expressed by firms that a holding company should be
allowed to include hybrid capital instruments in the calculation of
allowable capital to be more consistent with both the Basel Standards
and the Federal Reserve's definition of Tier 1 and Tier 2 capital, Rule
17i-7, as adopted, allows an SIBHC to include hybrid capital
instruments in its calculation of allowable capital, subject to the
requirements set forth in paragraph (a)(4). This change is consistent
with the final CSE Release.
---------------------------------------------------------------------------
\63\ The paragraph headings (A)-(D) in paragraph (a)(3)(ii) were
deleted; the language, however, is the same as the Proposing
Release.
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Hybrid capital instruments generally have characteristics of both
equity and debt. Generally, to be includable in allowable capital,
hybrid capital instruments must be unsecured, fully paid, subordinated
to general creditors, not redeemable before maturity at the option of
the holder, available to participate in losses while the issuer is
operating as a going concern, and must permit the issuer the option to
defer interest payments if the issuer does not report a profit in the
preceding annual period. Hybrid capital instruments may constitute no
more than 15% of allowable capital, before deductions.
In the Proposing Release, the Commission solicited comment on
whether long-term debt, subject to appropriate limitations, should be
included in allowable capital. These same questions were asked in the
CSE Release. Some firms expressed interest in favor of inclusion. Other
firms expressed an interest that long-term debt be included as
allowable capital during a phase-out period, suggesting that a swift
phase-out of long-term debt would be difficult because of the amount of
debt involved and could impact capital markets negatively, increasing
funding costs.
To maintain consistency with the Basel Standards, holding companies
may not include long-term debt in allowable capital. We understand,
however, that an SIBHC might not be able to convert significant amounts
of long-term debt to subordinated debt quickly without potentially
incurring significant costs and causing market disruptions.
Accordingly, as part of its Notice of Intention, the SIBHC may request
to phase-out the inclusion of long-term debt as allowable capital over
a period of up to three years \64\ that
[[Page 34482]]
begins upon adoption of these final rules. At the end of three years,
an SIBHC no longer may include long-term debt in allowable capital.
However, an SIBHC that wishes to extend the long-term debt phase-out
beyond the initial three-year period may amend its notice of intention,
pursuant to new Rule 17i-2(c)(2), to include long-term debt in its
allowable capital calculation for an additional two years. The
Commission will determine if the amount of the SIBHC's long-term debt
and market conditions warrant an extension.\65\
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\64\ We believe, based on the staff's experience, that three
years should be a sufficient time period for a firm to convert its
funding sources from long-term debt to other types of positions that
could be included in allowable capital pursuant to this rule. Long-
term debt must meet the criteria specified in paragraph (a)(3)(iii)
of Rule 17i-7, as adopted, to be included.
\65\ See Rule 17i-7(a)(3)(iii).
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2. Calculation of Consolidated Allowance for Market Risk
Paragraph (b) of new Rule 17i-7 requires that an SIBHC compute a
consolidated allowance for market risk for its proprietary positions
using either a VaR model or, if there is not adequate historical data
to support a VaR model, an alternative method.\66\ An SIBHC must
provide the Commission with information regarding any alternative
method for computing allowance for market risk for particular positions
during the Commission's review of its Notice of Intention so that the
Commission can evaluate the method to determine whether it adequately
measures the risks of those positions. The VaR of the positions must be
multiplied by an appropriate multiplication factor \67\ to provide
adequate capital during periods of market stress. The computation of
the allowance for market risk is consistent with the calculation of
market risk charges under the Basel Standards.
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\66\ Generally, the allowance for market risk constitutes three
times the largest amount the SIBHC could lose over a ten-day period
with a 99% confidence level (as determined using the VaR model or
alternative method). See supra, note 61. see Sec. 17 CFR 240.15c3-
1e(d)(2)(i).
\67\ Paragraph (b)(1) of Rule 17i-7 establishes the initial
multiplication factor (three); however, the multiplication factor
would subsequently be set based on the number of backtesting errors
generated through use of the model. The initial multiplication
factor was derived from the minimum requirement set forth in Sec.
17 CFR 240.15c3-1f(e)(1)(iv)(C) (the rule used by OTC derivatives
dealers to calculate market risk capital charges). This initial
multiplication factor would be used until sufficient backtesting
results has been collected to use the Table set forth in Sec. 17
CFR 240.15c3-1e(d)(1)(iii)(C).
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Paragraph (b)(1) of new Rule 17i-7 requires that each VaR model
used to calculate allowance for market risk meet the qualitative and
quantitative requirements set forth in rules the Commission is also
adopting today in a separate release, Rule 15c3-1e(d).\68\ The
qualitative and quantitative standards set forth in Rule 15c3-1e(d) are
similar to the requirements for models used by OTC derivatives dealers
and are consistent with the Basel Standards. The qualitative
requirements address four aspects of an SIBHC's risk management system:
(i) The model must be integrated into, and thus relied upon, in the
SIBHC's daily risk management process; (ii) the model must undergo
periodic reviews by the SIBHC's internal audit staff and annual reviews
by an accountant; (iii) the SIBHC must conduct backtesting of the
model, the results of which must be used by the SIBHC to determine the
multiplication factor to be used when calculating market and credit
risk, and (iv) for purposes of incorporating specific risk into a VaR
model, a firm must demonstrate that it has methodologies in place to
capture liquidity, event, and default risk adequately for each
position.\69\ The quantitative requirements set forth basic standards
for each model including, (i) for purposes of determining market risk,
the model must use a 99 percent, one-tailed confidence level, with
price changes equivalent to a ten business-day movement in rates and
prices, (ii) the model must use an effective historical observation
period of at least one year, and the firm must consider the effects of
market stress when constructing the model, and historical data sets
must be updated at least monthly and re-assessed whenever market prices
or volatilities change significantly, and (iii) the model must take
into account and incorporate all significant identifiable market risk
factors applicable to the affiliate group's positions.
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\68\ See supra, note 61. Where Rule 17i-7 cross-references or
incorporates requirements set forth in Sec. 240.15c3-1e, the SIBHC
must comply with those provisions as though it were a broker-dealer.
\69\ See supra, note 61. Specifically, see Sec. 17 CFR
240.15c3-1e(d)(1).
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The Commission received no comments regarding the requirement that
an SIBHC calculate an allowance for market risk as set forth in
paragraph (b) of proposed Rule 17i-7.
As proposed, Rule 17i-7 would have required that an SIBHC compute
an allowance for market risk daily. Firms argued that an SIBHC should
not be required to calculate allowance for market risk daily because of
the burden this would impose on firms and because the information only
must be reported to the Commission monthly. The rule, as adopted, no
longer requires that an SIBHC compute an allowance for market risk
daily. Further, as adopted, under Rule 17i-5, an SIBHC must make and
keep current a record of monthly computations of allowable capital and
allowances for market, credit, and operational risk. We also note that,
under Rule 17i-6, an SIBHC must report a consolidated allowance for
market risk to the Commission monthly. As part of the qualitative and
quantitative requirements for the use of models, an SIBHC must compute
VaR on its positions on a daily basis as part of its daily risk
management process. These changes are consistent with the CSE Release.
3. Calculation of Consolidated Allowance for Credit Risk
Paragraph (c) of new Rule 17i-7 requires that an SIBHC compute a
consolidated allowance for credit risk using either the methodology set
forth in paragraph (c)(1) of Rule 17i-7, which is similar to the
proposed New Basel Capital Accord, or, pursuant to paragraph (c)(2) of
Rule 17i-7 (if the Commission approves the SIBHC's request), a
calculation consistent with the present Basel Standards. This choice
provides SIBHCs with flexibility while the Basel Standards are under
review.
As proposed, Rule 17i-7 would have required that an SIBHC compute
an allowance for credit risk daily. In response to comments made by
firms, the rule no longer requires that an SIBHC compute an allowance
for credit risk daily. Pursuant to Rule 17i-5, as adopted, an SIBHC
must make and keep current a record of monthly computations of its
allowance for credit risk. In addition, an SIBHC must calculate its
current exposures on a daily basis as part of its internal risk
management control system.
The methodology an SIBHC must use to compute its allowance for
credit risk, as set forth in paragraph (c)(1) of new Rule 17i-7,
requires that an SIBHC multiply the credit equivalent amount of certain
asset and off-balance sheet items by the appropriate credit risk weight
of the asset or off-balance sheet item, and then multiply the result by
8%.\70\ In general, the asset and off-balance sheet items subject to
this allowance are loans and loan commitments receivable, receivables
arising from derivatives contracts, repurchase and reverse repurchase
agreements, stock loans, stock borrows, structured financial products,
credit substitutes, and other extensions of credit.
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\70\ This is consistent with the calculation of credit risk used
by OTC derivatives dealers (See 17 CFR 240.15c3-1f(d)(2)). In
addition, the 8% basic multiplier to calculate credit risk capital
charges is consistent with the Basel Standards.
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[[Page 34483]]
The credit equivalent amount of receivables relating to derivatives
contracts, repurchase and reverse repurchase agreements, stock loans,
stock borrows, and other similar collateralized instruments is the sum
of the SIBHC's maximum potential exposure to a counterparty, multiplied
by the appropriate multiplication factor, plus the SIBHC's current
exposure to that counterparty. The Commission believes that calculating
an allowance for credit risk using a maximum potential exposure
computed using a VaR model is a more precise method than using a
``notional add-on'' to approximate maximum potential exposure.\71\ In
addition, Commission reviews of risk management systems of large U.S.
broker-dealers indicate that these firms generally use maximum
potential exposure to measure and manage the credit risk of their
portfolios. Consequently, many of these firms already have systems in
place to calculate maximum potential exposure using VaR models.
---------------------------------------------------------------------------
\71\ See supra, note 61.
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ISDA, in its comment letter, indicated that it strongly supported
the Commission's proposal to allow firms to calculate current exposure
and maximum potential exposure at the counterparty (as opposed to the
transactional) level, recognizing the effect of netting arrangements,
taking account of collateral posted by the counterparty, and
recognizing the protection value of credit derivatives. ISDA also
indicated that it believes that OTC derivatives and securities
financing transactions (such as repurchase agreements) often exhibit
similar counterparty risk characteristics and should receive uniform
treatment, and that Proposed Rule 17i-7 does provide for uniform
treatment of these types of instruments.
i. Credit Equivalent Amount
Consistent with the proposed New Basel Capital Accord, Paragraph
(c)(1)(i) of new Rule 17i-7 establishes the manner in which the
``credit equivalent amount'' of a balance sheet item should be
calculated. The credit equivalent amounts for receivables relating to:
(i) Loans and loan commitments receivable; (ii) derivatives contracts,
repurchase agreements, reverse repurchase agreements, stock loans,
stock borrows, and other similar collateralized transactions; and (iii)
other assets would be calculated differently, and are set forth in
paragraphs (c)(1)(i)(A), (B), and (C) of new Rule 17i-7, respectively.
As proposed, paragraph (c)(1)(i)(B)(2) of Rule 17i-7 would have
included a 5% credit conversion factor for margin loans. Bear Stearns,
in its comment letter, argued that its experience with margin loans
suggested that such a level is unjustifiably high. Bear Stearns stated
that the requirements of Regulation T and New York Stock Exchange Rule
431, combined with strict operational controls, substantially minimize
risk of loss. Thus, Bear Stearns recommended that firms be allowed to
adopt a portfolio-specific risk-based methodology, consistent with the
proposed New Basel Capital Accord, for determining the appropriate
amount of capital related to margin lending regardless of whether the
loan is held at a broker-dealer or a non-broker-dealer affiliate.
After considering these comments, we have determined that it is
appropriate to delete proposed paragraph (c)(1)(i)(B)(2). Consistent
with the Basel Standards, an SIBHC may apply to use the VaR-based
exposure treatment under paragraph (c)(1)(i)(B) for its margin loans as
a ``similar collateralized transaction.'' For unrated counterparties,
the Commission could determine, after a review of the description of
the margin loans in the SIBHC's Notice of Intention, that the margin
loans could be treated as a pool with a very low loss history. In this
case, the SIBHC could use internal estimates of exposure at default
that take into account the loss history for the pool.
ii. Current Exposure
We have revised the definition of current exposure as set forth in
paragraph (c)(1)(i)(D) of new Rule 17i-7. The rule, as adopted, defines
the term ``current exposure'' to be the current replacement value of
the counterparty's positions, including the effect of netting
agreements with that counterparty,\72\ and taking into account the
value of collateral from that counterparty.\73\ As adopted, Rule 17i-7
no longer requires that the SIBHC subtract the fair market value of any
credit derivatives that specifically change the exposure to the
counterparty.\74\ Instead, pursuant to paragraph (c)(1)(iii), an SIBHC
may include in its Notice of Intention (or in an amendment thereto) a
proposal for use of credit derivatives in its calculation of allowance
for credit risk.\75\ Requiring subtraction of the fair market value of
credit derivatives could reduce the allowance for credit risk without
consideration of the SIBHC's credit risk exposure to the credit
derivative counterparty. The Commission will be able to consider that
exposure in its review of an SIBHC's Notice of Intention (or an
amendment thereto).
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\72\ Only netting agreements that meet the requirements set
forth in paragraph (c)(4)(iv) of Rule 15c3-1e could be used to
reduce current or maximum potential exposures. See supra, note 61.
Generally, the SIBHC could use a netting agreement that allows the
SIBHC to net gross receivables and gross payables with a
counterparty upon default of the counterparty if (i) the netting
agreement is legally enforceable in each relevant jurisdiction,
including in insolvency proceedings; (ii) the gross receivables and
gross payables subject to the netting agreement with a counterparty
can be determined at any time; and (iii) for internal risk
management purposes, the SIBHC monitors and controls its exposure to
the counterparty on a net basis.
\73\ Only collateral that meets the requirements set forth in
paragraph (c)(4)(v) of Rule 15c3-1e could be used to reduce current
or maximum potential exposures. See supra, note 61. Generally, the
SIBHC can take into account the fair market value of collateral
pledged and held, provided (i) the collateral is marked to market
each day and is subject to a daily margin maintenance requirement;
(ii) the collateral is subject to the firm's physical possession or
control; (iii) the collateral is liquid and transferable; (iv) the
collateral may be liquidated promptly by the firm without
intervention by another party; (v) the collateral agreement is
legally enforceable by the SIBHC against the counterparty and any
other parties to the agreement; (vi) the collateral does not consist
of securities issued by the counterparty or a party related to the
SIBHC or to the counterparty; (vii) the Commission has approved the
SIBHC's use of a VaR model to calculate its allowance for market
risk for the type of collateral during its review of the SIBHC's
Notice of Intention, and (viii) the collateral is not used in
determining the credit rating of the counterparty.
\74\ These changes are consistent with the CSE release.
\75\ The credit derivative must be one that (i) provides credit
protection equivalent to a guarantee, (ii) is used for bona fide
hedging purposes to reduce the credit risk weight of a counterparty,
and (iii) is not held for market timing purposes.
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iii. Maximum Potential Exposure
We have revised the definition of maximum potential exposure as set
forth in paragraph (c)(1)(i)(E) of new Rule 17i-7. The rule, as
adopted, defines the term ``maximum potential exposure'' to be the VaR
of the counterparty's positions, after applying the effect of netting
agreements with that counterparty,\76\ and taking into account the
value of collateral from that counterparty and the current replacement
value of the counterparty's positions.\77\ Paragraph (c)(1)(i)(E) of
new Rule 17i-7 also states that maximum potential exposure must be
calculated using a VaR model that meets the same qualitative and
quantitative standards as required for models used to compute the
allowance for market risk.\78\ Similar to
[[Page 34484]]
the changes made to the definition of current exposure, paragraph
(c)(1)(i)(E) no longer requires that an SIBHC subtract the fair market
value of any credit derivatives that specifically change the exposure
to the counterparty because requiring subtraction of the fair market
value of credit derivatives could reduce the allowance for credit risk
without consideration of the SIBHC's credit risk exposure to the credit
derivative counterparty. As was stated above, pursuant to paragraph
(c)(1)(iii), an SIBHC may propose to use credit derivatives in its
calculation of allowance for credit risk in its Notice of Intention (or
in an amendment thereto).
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\76\ See supra, note 72.
\77\ See supra, note 73.
\78\ However, the quantitative requirements for a VaR model
intended to calculate maximum potential exposure would be required
to use a 99 percent, one-tailed confidence level, with price changes
equivalent to a movement in rates and prices of not less than five-
days for repurchase agreements, reverse repurchase agreements, stock
lending and borrowing, and similar collateralized transactions (See
paragraph (c)(1)(i)(E) of Rule 17i-7) and to a movement in rates and
prices of one-year for other positions (See Sec. 17 CFR 240.15c3-
1e(d)(2)(ii)) (as opposed to a ten business-day movement for VaR
models used to calculate the allowance for market risk (See Sec. 17
CFR 240.15c3-1e(d)(2)(i)). The proposal would have required that the
maximum potential exposure for repurchase agreements, reverse
repurchase agreements, stock lending and borrowing, and similar
collateralized transactions be calculated using a time horizon of
``five days,'' as opposed to ``not less than five days.'' This
revision clarifies that the time horizon is a minimum period, not an
absolute period.
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Bear Stearns, in its comment letter, suggested that the time
horizon for VaR models used for purposes of determining maximum
potential exposure should be ten business days if the position is
marked to market daily and a written agreement enforceable against the
counterparty provides that the broker-dealer or its affiliate may call
for additional collateral daily. Paragraph (e)(2)(ii) of proposed Sec.
240.15c3-1e, proposed for comment in the CSE Proposing Release,\79\
would have required the VaR model to use a time horizon of one year. In
response to comments received, including Bear Stearns' comment,
paragraph (d)(2)(ii) of Sec. 240.15c3-1e \80\ as adopted allows a firm
to use a shorter time horizon to calculate MPE under specified
conditions. More specifically, the Commission may approve a shorter
time horizon, if there is a valid collateral agreement, based on a
demonstration by the firm that it has sufficient systems and controls,
including those necessary to mark positions to market daily and
promptly call for and track collateral posted, and promptly liquidate
positions as may be necessary to avoid loss by the firm. This
modification of the time horizon requirement should help a firm to
maintain a liquid capital basis while promoting operational efficiency.
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\79\ Paragraph (e)(2)(ii) of proposed Sec. 240.15c3-1e has been
re-designated as paragraph (d)(2)(ii) of that section, as adopted.
See supra, note 61.
\80\ Id.
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iv. Credit Risk Weights
Paragraph (c)(1)(ii) of new Rule 17i-7 provides that credit risk
weights must generally be determined according to the standards
published by the Basel Committee, as modified from time to time.\81\ In
its Notice of Intention or an amendment to its Notice of Intention, an
SIBHC may propose to use internal credit ratings or internal
calculations when computing its allowance for credit risk.\82\ In
addition, paragraph (c)(1)(ii)(B) of new Rule 17i-7 allows SIBHCs to
adjust credit risk weights of receivables covered by certain forms of
credit protection.\83\ As adopted, Rule 17i-7 would allow an SIBHC to
adjust credit risk weights of receivables covered by certain
derivatives (such as credit default swaps and similar instruments used
to manage credit risk) if the SIBHC has requested, in its Notice of
Intention of an amendment thereto, to use these derivatives to adjust
credit risk weights. Allowing an SIBHC to adjust credit risk weights of
receivables covered by certain credit derivatives could have reduced
credit risk weights without consideration of the SIBHC's credit
exposure to the credit derivative counterparty. Thus, we decided only
to permit this adjustment of credit risk weights where we have had a
chance to consider that exposure.
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\81\ See paragraph (c)(1)(ii)(A) of new Rule 17i-7.
\82\ See generally paragraph (b)(4)(x) of new Rule 17i-2.
\83\ The guarantee must be an unconditional and irrevocable
guarantee of the due and punctual payment and performance of the
obligation and the SIBHC or member of the affiliate group can demand
immediate payment after any payment is missed without having to make
collection efforts. Further, the guarantee must be evidenced by a
written obligation of the guarantor that allows the SIBHC or member
of the affiliate group to substitute the guarantor for the
counterparty upon default or nonpayment by the counterparty. These
requirements are designed to allow an SIBHC to reduce its allowance
for credit risk only if the guarantee contains features that make it
more reliable.
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4. Calculation of Consolidated Allowance for Operational Risk
Pursuant to new Rule 17i-7(d), an SIBHC must calculate an allowance
for operational risk in accordance with the standards published by the
Basel Committee. The Basel Committee has proposed three methods for the
calculation of an allowance for operational risk (i) The basic
approach; (ii) the standardized approach; and (iii) the advanced
measurement approach. For a complete discussion of the proposed
operational risk calculation, please refer to the proposed New Basel
Capital Accord.\84\ The basic and standardized approach calculations
are based on fixed percentages. Generally, under the basic approach,
the allowance is 15% of consolidated annual revenues net of interest
expense averaged over the past three years. The standardized approach
maps these revenues to eight business lines. The allowance for
operational risk is then a percentage of revenues net of interest
expense, ranging from 12% to 18%, attributed to each business line. The
advanced measurement approach requires a system for tracking and
controlling operational risk and provides that the allowance for
operational risk is the largest operational loss that might be expected
over a one-year period with 99.9% confidence.
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\84\ See supra, note 8.
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One commenter stated that, as currently structured, there is a
perverse incentive built into the standardized approach for computing
operational risk in that firms built around business lines with a beta
factor of 18% (e.g., corporate finance, trading and sales, and payments
and settlements) end up with a higher capital charge than if they were
to remain on the basic indicator approach. Thus, the commenter argued
that this structural defect should be removed.
We are adopting paragraph (d) of Rule 17i-7 as it was proposed. The
rules are intended to provide SIBHCs with flexibility by permitting the
computation of operational risk in accordance with the Basel Standards.
We recognize, however, that the proposed New Basel Capital Accord has
not been adopted in its final form and that we may need to further
tailor our operational risk requirements. If, in finalizing the New
Basel Capital Accord, the Basel Committee changes the operational risk
computations or charges, we will review and consider amending this
Rule.
5. General Discussion of Basel Pillars
These amendments apply a capital reporting requirement consistent
with the Basel Standards to an SIBHC. The Basel Committee is currently
developing the proposed New Basel Capital Accord that specifies three
``pillars'' for the group-wide supervision of internationally active
banks and financial enterprises. The first pillar, ``minimum regulatory
capital'' requirements, requires calculations for credit and
operational risk and, for firms with significant trading activity,
market risk. The second pillar, ``supervisory review,'' requires that
capital be
[[Page 34485]]
assessed relative to overall risks and that supervisors review and take
action in response to those assessments.
The third pillar of the proposed New Basel Capital Accord requires
certain disclosures that are intended to allow market participants to
assess key pieces of information about, for example, the capital, risk
exposures, and risk assessment processes of the institution. The
purpose of the third pillar is to complement the minimum capital
requirements and the supervisory review process by encouraging market
discipline. Specific disclosure requirements would apply to all
institutions that use the proposed New Basel Capital Accord and would
encompass capital, credit risk, credit risk mitigation, securitization,
market risk, operational risk, and interest rate risk.
We requested comment on whether U.S. broker-dealers and their
holding companies and affiliates should be required to make additional
disclosures to meet the requirements of the third pillar of the
proposed New Basel Capital Accord. No comments were received in
response to the request made in the Proposing Release.
The securities industry has taken important steps to enhance public
disclosure of material risks. For example, in June 1999, the
Counterparty Risk Management Policy Group (CRMPG) (representing 12
major securities firms and banks) published a report on Improving
Counterparty Risk Management Practices.\85\ In addition, a private-
sector Working Group on Public Disclosure (representing 11 major
securities firms and banks), issued a report in January 2001.\86\ The
group recommended enhanced and more frequent public disclosure of
financial information by banking and securities organizations. It also
said financial information should be disclosed based on a firm's
internal methodologies and exposure categories, and that quantitative
information on a firm's risk exposure should be balanced with
qualitative information describing its risk management process.
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\85\ CRMPG was formed in January 1999, after the near collapse
of Long-Term Capital Management. The group's mission was to
redevelop standards for strengthening risk management practices at
banks, securities firms and other dealers to avoid similar
difficulties in the future. Its findings were publicly released on
June 21, 1999, and are presently available at: http://financialservices.house.gov/banking/62499crm.pdf.
A hearing was held
on June 24, 1999, regarding the group's findings and
recommendations, before the U.S. House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored
Enterprises, Committee on Banking and Financial Services. A
transcript of the hearing, at which the CRMPG chairs gave testimony,
is presently available at: http://commdocs.house.gov/committees/bank/hba57791.000/hba57791_0f.htm
.
\86\ Walter V. Shipley, retired chairman of Chase Manhattan
Bank, chaired the working group. His letter to the Board of
Governor's of the Federal Reserve System, summarizing the group's
findings, is presently available at: http://www.federalreserve.gov/boarddocs/press/general/2001/20010111/DisclosureGroupLetter.pdf
(Jan. 11, 2001).
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The Commission staff has taken a leading role to enhance public
disclosure by financial intermediaries. It was a member of the
Multidisciplinary Working Group on Enhanced Disclosure (Fisher II
working group) that provided advice to its sponsoring organizations
\87\ on steps that would advance the state of financial institutions'
disclosures of financial risks in order to enhance the role of market
discipline. More recently, Commission staff chaired a Joint Forum \88\
Working Group on Enhanced Disclosure (JFWGED) established by the Basel
Committee, IAIS and IOSCO, seeking to follow up on the recommendations
contained in the Fisher II report.\89\ The JFWGED expects to publish
its report shortly.
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\87\ The Basel Committee, the Committee on the Global Financial
System of the G-10 central banks (CGFS), the International
Association of Insurance Supervisors (IAIS) and the International
Organisation of Securities Commissions (IOSCO).
\88\ The Joint Forum was established in 1996 under the aegis of
the BCBS, IOSCO and the IAIS to deal with issues common to the
banking, securities and insurance sectors.
\89\ Final Report of the Multidisciplinary Working Group on
Enhanced Disclosure (April 26, 2001). The report is presently
available at: http://www.bis.org/publ/joint01.pdf.
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However, some issues remain. For instance, broker-dealers are
concerned that under new, enhanced disclosure requirements they may be
required to disclose sensitive, proprietary information. As the
proposed New Basel Capital Accord has not yet been finalized, we do not
believe it would be appropriate to adopt additional disclosure
requirements as part of these amendments.
I. Rule 17i-8: Notification Requirements for SIBHCs
Paragraph (a) of new Rule 17i-8 requires that an SIBHC immediately
notify the Commission upon the occurrence of certain events. These
events include: (i) The occurrence of certain backtesting exceptions;
(ii) the early warning indications of low capital as the Commission may
agree; (iii) a material affiliate declares bankruptcy or otherwise
becomes insolvent; (iv) the SIBHC becomes aware that a credit rating
agency intends to decrease its evaluation of the creditworthiness of a
material affiliate or the credit rating assigned to one or more
outstanding short or long-term obligations of a material affiliate; (v)
the SIBHC files a Form 8-K with the Commission; (vi) the SIBHC becomes
aware that a financial regulatory agency or self-regulatory
organization has taken certain regulatory actions against a material
affiliate; or (vii) the SIBHC becomes ineligible to be supervised by
the Commission as a SIBHC (e.g., the SIBHC purchases an insured bank,
or the SIBHC's affiliated broker-dealer's tentative net capital falls
below $100 million).\90\ We believe that the events described in items
(i) through (vi) above would indicate a decline in the financial and
operational well-being of the firm. Were an SIBHC to file a
notification regarding these events, as required by new Rule 17i-8, the
Commission may be prompted to request additional reports, as
contemplated by Rule 17i-6(c), and otherwise begin to monitor the
SIBHC's condition more closely. Were an SIBHC to file a notification
regarding the event described in item (vii) above, the Commission would
review whether it should continue supervising the IBHC as an SIBHC.
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\90\ See paragraph (a) of Rule 17i-8.
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The Commission received no comments regarding proposed Rule 17i-8.
As proposed, paragraph (a) of Rule 17i-8 did not include a
requirement to notify the Commission when the supervised investment
bank holding company or any material affiliate files a Form 8-K with
the Commission. The Commission requested comment on the proposed
notification requirement, and in particular whether the events that
would trigger the notification requirement are appropriate and whether
other triggering events should be included. The Commission has given
additional consideration to the questions raised in its request for
comment and has determined that filing a Form 8-K may indicate that a
major change has occurred at the SIBHC or material affiliate, and that
the Commission may want to monitor the SIBHC more closely to determine,
for instance, that internal risk management controls remain robust
despite that change.
As proposed, paragraph (b) of Rule 17i-8 would have required that
an SIBHC file a written report with the Commission if there was a
material change (along with a description of that change) in the
ownership or organization of the affiliate group, the status of any
affiliate that is material, or the major business functions of any
material affiliate. Paragraph (b) no longer requires that an SIBHC
notify the
[[Page 34486]]
Commission of changes to mathematical models and changes in
organizational control because an SIBHC must amend its Notice of
Intention if it changes a mathematical model pursuant to new Rule 17i-
2(c)(2), and must file organizational charts with the Commission
annually (or quarterly if there has been a material change) pursuant to
new Rule 17i-6(b).\91\ Thus, we eliminated the notification requirement
of proposed paragraph (b) of Rule 17i-8, because the information was
duplicative of information already required to be filed with the
Commission.
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\91\ See paragraph (a)(5) of new Rule 17i-8. In addition, Form
8-K requires that a firm file form 8-K when it experiences a change
of control, and SIBHCs must now inform the Division of Market
Regulation when it files a Form 8-K pursuant to paragraph (a)(5) of
new Rule 17i-8.
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Paragraph (c) of new Rule 17i-8 specifies the manner in which these
notices and reports should be provided to the Commission. In addition,
paragraph (c) specifies that the notices and reports filed with the
Commission pursuant to Rule 17i-8 will be accorded confidential
treatment.\92\ We believe it is important to accord confidential
treatment to the notices and reports an SIBHC must provide pursuant to
new Rule 17i-8 because the information contained in those notices and
reports will generally be highly sensitive, non-public business
information.
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\92\ 15 U.S.C. 78q(j). See supra, note 24.
---------------------------------------------------------------------------
Paragraph (d) of new Rule 17i-8 allows the Commission to grant
extensions or exemptions from the notification provisions at the
request of the SIBHC, or on its own motion. This paragraph will provide
the Commission with flexibility to address firm-specific issues as they
arise.
We believe the requirements set forth in new Rule 17i-8 are
necessary to keep the Commission informed as to the SIBHC's activities,
financial condition, policies, systems for monitoring and controlling
financial and operational risks, and transactions and relationships
between any broker or dealer affiliate of the SIBHC and the extent to
which the SIBHC has complied with the provisions of the Act and the
regulations promulgated thereunder.
V. Amendment to Rule 30-3
The Commission has adopted amendments to Rule 30-3 of its Rules of
Organization and Program Management governing delegations of authority
to the Director of the Division of Market Regulation
(``Director'').\93\ The amendments delegate to the Director the
authority to: (1) Review amendments to a supervised investment bank
holding company's Notice of Intention required by paragraph (c)(2) of
Rule 17i-2 (17 CFR 240.17i-2(c)(2)), and to approve such amendments
pursuant to paragraph (d)(2)(ii) of Rule 17i-2 (17 CFR 240.17i-
2(d)(2)(ii)) after reviewing the amended notice of intention to
determine whether the amendment is necessary or appropriate in
furtherance of the purposes of section 17 of the Act (15 U.S.C. 78q);
(2) to consider requests by supervised investment bank holding
companies for exemptions from the requirement, and extensions of time
within which, to file reports required by Rule 17i-6 (17 CFR 240.17i-
6), and to grant or deny such requests pursuant to paragraph (f) of
that Rule (17 CFR 240.17i-6(f)); and (3) to consider requests by
supervised investment bank holding companies for exemptions from the
requirement, and extensions of time within which, to file notices
required by Rule 17i-8 (17 CFR 240.17i-8), and to grant or deny such
requests pursuant to paragraph (d) of that Rule (17 CFR 240.17i-8(d)).
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\93\ 17 CFR 200.30-3.
---------------------------------------------------------------------------
The Commission is delegating to the Director the authority to
approve amendments to SIBHCs' Notices of Intention regarding changes to
mathematical models used to calculate allowances for market or credit
risk, or to the SIBHC's internal risk management control system after
reviewing the amended notice of intention to determine whether the
amendment is necessary or appropriate in furtherance of the purposes of
section 17 of the Act (15 U.S.C. 78q). The Commission is delegating to
the Director its authority for the limited purposes described above.
These delegations of authority to the Director are intended to
conserve Commission resources by permitting the staff to review and to
issue orders regarding amendments to an SIBHC's Notice of Intention
pursuant to new Rule 17i-2, and consider and grant SIBHCs' requests for
exemptions from, and extensions of time within which to file, reports
required by new Rule 17i-6 and notices required to be filed by new Rule
17i-8. The Commission anticipates that the delegation of authority will
facilitate effective review. Nevertheless, the staff may submit matters
to the Commission for consideration as it deems appropriate.\94\
---------------------------------------------------------------------------
\94\ 17 CFR 200.30-3(e).
---------------------------------------------------------------------------
The Commission finds, in accordance with the Administrative
Procedure Act, 5 U.S.C. 553(b)(3)(A), that this amendment to Rule 30-3
relates solely to agency organization, procedure, or practice.
Accordingly, notice and opportunity for public comment, as well as
publication 30 days before its effective date are unnecessary.
VI. Paperwork Reduction Act
Certain provisions of new Rules 17i-1 through 17i-8 and the
amendments to Rules 17h1-T and 17h-2T contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995.\95\ Consequently, the Commission submitted the
proposed new rules and rule amendments to the Office of Management and
Budget (``OMB'') in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The titles for the collections of information are (i) Rules
17h-1T and 17h-2T Risk Assessment Rules; (ii) Rule 17i-2 Notice of
Intention to be Supervised by the Commission as a Supervised Investment
Bank Holding Company; (iii) Rule 17i-3 Withdrawal from Supervision as
an Supervised Investment Bank Holding Company; (iv) Rule 17i-4 Internal
Risk Management Control Systems Requirements for Supervised Investment
Bank Holding Companies; (v) Rule 17i-5 Record Creation, Maintenance,
and Access Requirements for Supervised Investment Bank Holding
Companies; (vi) Rule 17i-6 Reporting Requirements for Supervised
Investment Bank Holding Companies; and (vii) Rule 17i-8 Notification
Requirements for Supervised Investment Bank Holding Companies. OMB
approved these collections of information and assigned them OMB Control
Nos. 3235-0410, 3235-0592, 3235-0593, 3235-0594, 3235-0590, 3235-0588,
and 3235-0591, respectively. An agency may not conduct or sponsor, and
a person is not required to respond to, a collection of information
unless it displays a currently valid OMB control number.
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\95\ 44 U.S.C. 3501, et seq.
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In the Proposing Release,\96\ the Commission solicited comment on
these ``collection of information'' requirements. The Commission
received no comments that specifically addressed the Paperwork
Reduction Act portion of the Proposing Release. Because Rules 17i-1
through 17i-8 and the amendments to Rules 17h1-T and 17h-2T, as
adopted, are substantially similar to those proposed, the SEC continues
to believe that the estimates published in the Proposing Release
regarding the proposed collection of information burdens associated
with new Rules 17i-1 through 17i-8 and the amendments to Rules 17h1-T
and 17h-2T are appropriate. However, we have decreased our estimate of
the number of
[[Page 34487]]
respondents because we expect fewer IBHC's to file Notices of Intention
to be supervised as SIBHCs than originally estimated in light of the
limited interest that has been expressed with regard to SIBHC
supervision.
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\96\ See supra, note 6 and accompanying text.
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A. Collection of Information Under the Amendments to Rules 17h-1T and
17h-2T and New Rules 17i-2 Through 17i-8
New Rules 17i-2 through 17i-8 create a framework for Commission
supervision of SIBHCs. The collections of information included in these
rules are necessary to allow the Commission to (1) effectively
determine whether SIBHC supervision is necessary or appropriate in
furtherance of the purposes of Sec. 17 of the Act and (2) supervise
the activities of these SIBHCs. These rules also enhance the
Commission's supervision of the SIBHCs' subsidiary broker-dealers
through collection of additional information and inspections of
affiliates of those broker-dealers. Regulatory oversight pursuant to
this system is voluntary, and eligible IBHCs are not required to be
supervised in this manner. This framework includes procedures through
which an IBHC may file a Notice of Intention to become supervised by
the Commission as an SIBHC, as well as recordkeeping and reporting
requirements for SIBHCs.
The amendments to Rules 17h-1T and 17h-2T \97\ exempt broker-
dealers that are affiliated with an SIBHC from those rules and thus
reduce their ``collection of information'' requirements. This exemption
was designed to eliminate duplicative recordkeeping and reporting
requirements.
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\97\ See supra, note 56.
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B. Proposed Use of Information
The Commission intends to use the information collected under the
new Rules to determine whether SIBHC supervision is necessary or
appropriate in furtherance of the purposes of Sec. 17 of the Act and
to monitor the financial condition, risk management, and activities of
SIBHCs on a group-wide basis. In particular, these rules allow the
Commission access to important information regarding activities of a
broker-dealer's affiliates that could impair the financial and
operational stability of the broker-dealer or the SIBHC.
C. Respondents
An IBHC is eligible to be supervised by the Commission as an SIBHC
only if it: (1) Has a subsidiary broker or dealer that can evidence
that it has a substantial presence in the securities business; and (2)
is not (i) affiliated with an insured bank (with certain exceptions) or
a savings association, (ii) a foreign bank, foreign company, or a
company that is described in section 8(a) of the International Banking
Act of 1978, or (iii) a foreign bank that controls a corporation
chartered under section 25A of the Federal Reserve Act.\98\ Pursuant to
paragraph (d)(2)(i)(B) of Rule 17i-2, the Commission would not consider
it to be necessary or appropriate to supervise an IBHC unless the IBHC
can demonstrate that it owns or controls a broker-dealer that has a
substantial presence in the securities business (which may be
demonstrated by a showing that the broker-dealer maintains tentative
net capital of at least $100 million).
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\98\ Federal Reserve Act Sec. 25A [12 U.S.C. 611].
---------------------------------------------------------------------------
As of September 30, 2003, approximately 115 registered broker-
dealers reported their tentative net capital as being between $100
million and $1 billion.\99\ Many of these broker-dealers are affiliated
with another broker-dealer that reported its tentative net capital as
being more than $100 million. Of these 115 registered broker-dealers,
approximately 35 could not be supervised by the Commission as an SIBHC
due to the fact that each is either: (i) Affiliated with an insured
bank (with certain exceptions) or a savings association,\100\ (ii) a
foreign bank, foreign company, or a company that is described in
section 8(a) of the International Banking Act of 1978, or (iii) a
foreign bank that controls a corporation chartered under section 25A of
the Federal Reserve Act.\101\ In addition, some broker-dealers may not
be active in jurisdictions that require securities firms to demonstrate
that they have consolidated supervision at the holding company level
that is equivalent to EU consolidated supervision, or may not find it
to be cost-effective to register as an SIBHC for other reasons. Thus,
the Commission estimates, for PRA and cost-benefit analysis purposes,
that three IBHCs will file notices of intent to be supervised by the
Commission as SIBHCs.
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\99\ This conclusion is based on the September 30, 2003, FOCUS
Report filings. Broker-dealers are required to file monthly and/or
quarterly reports on Form X-17A-5 pursuant to Rule 17a-5(a) (17 CFR
240.17a-5(a)), commonly referred to as FOCUS Reports. In addition,
we have adopted new rules and rule amendments that would allow a
holding company that owns or controls a broker-dealer that maintains
more than $1 billion in tentative net capital to elect to be
supervised as a consolidated supervised entity in the CSE Release
(see supra, note 61). The supervisory framework provided by those
new rules and rule amendments would allow the broker-dealers of
those entities to calculate market and credit risk capital charges
using mathematical modeling techniques. We believe firms that apply
for the CSE regulatory regime will do so and will not elect to be
supervised pursuant to these new rules for SIBHC election.
\100\ See Exchange Act Sec. 17(i)(1)(A)(i) [15 U.S.C.
78q(i)(1)(A)(i)].
\101\ Federal Reserve Act Sec. 25A [12 U.S.C. 611].
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D. Reporting and Recordkeeping Burdens
1. Amendments to Rules 17h-1T and 17h-2T
The amendments to Rules 17h-1T and 17h-2T \102\ exempt broker-
dealers that are affiliated with an SIBHC from those rules and thus
reduce their ``collection of information'' requirements. Rule 17h-1T
requires that a broker-dealer maintain and preserve records and other
information concerning the broker-dealer's holding companies,
affiliates, or subsidiaries that are likely to have a material impact
on the financial or operational condition of the broker-dealer. Rule
17h-2T requires broker-dealers to file with the Commission quarterly
reports concerning the information required to be maintained and
preserved under Rule 17h-1T. The present PRA burden for broker-dealers
that are presently reporting pursuant to Rules 17h-1T and 17h-2T is 24
hours per year for each broker-dealer respondent. The estimated three
firms therefore would have their annual burden reduced by an aggregate
of 72 hours per year.
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\102\ See supra, note 56.
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2. Rule 17i-2
New Rule 17i-2 requires that an IBHC file a Notice of Intention if
it wants to become supervised by the Commission as an SIBHC. The Notice
of Intention must set forth certain information and include a number of
documents. In addition, an SIBHC must submit amendments to its Notice
of Intention if certain information becomes incorrect or if it makes
certain material changes. The Commission designed Rule 17i-2 so an IBHC
could compile and submit existing documents with its Notice of
Intention (as opposed to requiring that an IBHC create additional
documents) in order to decrease any costs or burdens imposed by this
Rule.
As stated previously in section VI.C., we estimate that
approximately three IBHCs will file Notices of Intention to become
SIBHCs. We estimate that each IBHC that files a Notice of Intention to
become supervised by the Commission will take approximately 900 hours
to draft a Notice of Intention, compile the various documents to be
included with the Notice of Intention, and work with
[[Page 34488]]
the Commission staff. Further, we believe that an IBHC will have an
attorney review its Notice of Intention, and we estimate that it will
take the attorney approximately 100 hours to complete such a review.
Consequently, we estimate the total burden for all three firms to be
approximately 3,000 hours.\103\ We believe this will be a one-time
burden.
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\103\ We calculated this amount as follows: (900 hours + 100
hours) x 3 IBHCs/SIBHCs = 3,000 hours.
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Rule 17i-2 also requires that an IBHC/SIBHC \104\ amend its Notice
of Intention on an ongoing basis. We estimate that an IBHC/SIBHC will
take approximately 2 hours each month to update or amend its Notice of
Intention, as necessary. Thus, we estimate that it will take the three
IBHC/SIBHCs, in the aggregate, about 72 hours each year \105\ to update
or amend their Notices of Intention.
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\104\ An IBHC would be required to review and update its Notice
of Intention to the extent it becomes inaccurate prior to a
Commission determination, and an SIBHC would be required to amend
its Notice of Intention if it makes a material change to a
mathematical model or other method used to calculate its risk
allowances pursuant to Rule 17i-7 or its internal risk management
control system after a Commission determination was made.
\105\ We calculated this amount as follows: (2 hours x 12 months
each year) x 3 SIBHCs = 72.
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3. Rule 17i-3
Rule 17i-3 provides a method by which an SIBHC may withdraw from
Commission supervision as an SIBHC. An SIBHC that wishes to withdraw
from Commission supervision may do so by filing a notice of withdrawal
with the Commission.
Due to the benefits and costs associated with becoming supervised
by the Commission as an SIBHC, we believe that an IBHC will carefully
consider whether to file a notice of withdrawal. We estimate that one
SIBHC may wish to withdraw from Commission supervision as an SIBHC over
a ten-year period.
We estimate that, for an SIBHC that intends to withdraw from
Commission supervision as an SIBHC, it would take one attorney
approximately 24 hours to draft a withdrawal notice and submit it to
the Commission. Further, we believe the SIBHC will have a senior
attorney or executive officer review the notice of withdrawal before
submitting it to the Commission, and that it will take such person 8
hours to conduct such a review. Thus, we estimate that the annual,
aggregate burden of withdrawing from Commission supervision as an SIBHC
will be approximately 3.2 hours each year.\106\
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\106\ We calculated this amount as follows: (1 SIBHC/every 10
years) x (24 hours to draft + 8 hours to review) = 3.2 hours.
---------------------------------------------------------------------------
4. Rule 17i-4
Rule 17i-4 requires that an SIBHC have in place an internal risk
management control system appropriate for its business and
organization. An SIBHC must consider, among other things, the
sophistication and experience of its operations, risk management, and
audit personnel, as well as the separation of duties among these
personnel, when designing and implementing its internal control
system's guidelines, policies, and procedures. These requirements are
designed to result in control systems that adequately address the risks
posed by the firm's business and the environment in which it is being
conducted. In addition, these requirements enable an SIBHC to implement
specific policies and procedures unique to its circumstances.
Rule 17i-4 also requires that an SIBHC periodically review its
internal risk management control system for integrity of the risk
measurement, monitoring, and management process, and accountability, at
the appropriate organizational level, for defining the permitted scope
of activity and level of risk.
In implementing its policies and procedures, an SIBHC must document
and record its system of internal risk management controls. In
particular, an SIBHC must document its consideration of certain issues
affecting its business when designing its internal controls. An SIBHC
also must prepare and maintain written guidelines that discuss its
internal control system.
The information to be collected under Rule 17i-4 is essential to
the supervision of SIBHCs and their compliance with the Commission's
Rules. More specifically, the requirement that an SIBHC document the
planning, implementation, and periodic review of its risk management
controls is designed to ensure that all pertinent issues are
considered, that the risk management controls are implemented properly,
and that they continue to adequately address the risks faced by SIBHCs.
As stated previously in section VI.C., we estimate that
approximately three IBHCs will file Notices of Intention to be
supervised by the Commission as SIBHCs. We further estimate that the
average amount of time an SIBHC will spend assessing its present
structure, businesses, and controls, and establishing and documenting
its risk management control system will be about 3,600 hours, and that
this would be a one-time burden. In addition, we estimate that an SIBHC
will spend approximately 250 hours each year maintaining its internal
risk management control system. Thus, we estimate that the total
initial burden for all SIBHCs will be approximately 10,800 hours \107\
and the continuing annual burden would be about 750 hours.\108\
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\107\ We calculated this amount as follows: (3,600 hours x 3
SIBHCs) = 10,800 hours.
\108\ We calculated this amount as follows: (250 hours per year
x 3 SIBHCs) = 750 hours per year.
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Internationally active firms generally already have in place risk
management practices, and generally will review and improve their risk
management practices notwithstanding the requirements of these rules.
However, we recognize that, to the extent an IBHC presently has a
group-wide internal risk management control system, those systems may
not take into account all of the elements and issues required by Rule
17i-4. In addition, firms may not have documented their consideration
of these elements and issues, or other aspects of their internal risk
management control systems, as the Rule requires.
5. Rule 17i-5
Pursuant to Rule 17i-5, an SIBHC must make and keep current certain
records relating to its business. In addition, it must preserve those
and other records for certain prescribed time periods. The purpose of
this rule is to require that the SIBHC create and maintain records that
would allow the Commission to evaluate SIBHC compliance with the rules
to which it is subject. We expect that any burden under the Rule would
be minimal because the information that is required under the Rule is
information a prudent IBHC that manages risk on a group-wide basis
would maintain in the ordinary course of its business.
Pursuant to Rule 17i-5, an SIBHC must make and keep records
reflecting (i) the results of quarterly stress tests; (ii) that the
firm had created a contingency plan to respond to certain possible
funding and liquidity difficulties; and (iii) the basis for credit risk
weights. We estimate that the average amount of time an SIBHC will
spend to create a record regarding stress tests is about 64 hours each
quarter, or approximately 256 hours each year. We further estimate that
the average amount of time an SIBHC will spend to create and document a
contingency plan
[[Page 34489]]
regarding funding and liquidity of the affiliate group (which we
believe an SIBHC will do only once, not on an ongoing basis) will be
about 40 hours. In addition, we estimate that the average amount of
time an SIBHC will spend to create a record regarding the basis for
credit risk weights will be about 30 minutes for each counterparty, and
that on average, an SIBHC will establish approximately 20 new
counterparty arrangements each year.\109\
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\109\ We estimate that, on average, each firm presently
maintains relationships with approximately 1,000 counterparties.
Further, it is our understanding that firms generally already
maintain documentation regarding their credit decisions, including
their determination of credit risk weights, for those
counterparties.
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In addition, requirements that were located in other proposed rules
were moved into new Rule 17i-5. Specifically, Rule 17i-5 now also
requires that an SIBHC make and keep records of the calculations of
allowable capital and allowances for market, credit, and operational
risk. An SIBHC will make a record of its calculations of allowable
capital, and allowances for market, credit, and operational risk when
performing the calculation in compliance with new Rule 17i-7 to comply
with the monthly reporting requirements contained in new Rule 17i-6.
Thus, SIBHCs should not incur any additional burden relative to this
paragraph.
Pursuant to Rule 17i-5, an SIBHC must maintain these and other
records for at least three years in an easily accessible place. We
estimate that the average amount of time an SIBHC would spend to
maintain these and other, specified records for three years would be
about 24 hours per year per SIBHC.
As stated previously in section VI.C., we estimate that
approximately three IBHCs will file Notices of Intention to be
supervised by the Commission as SIBHCs. Thus, the total initial burden
relating to new Rule 17i-5 for all SIBHCs would be approximately 120
hours \110\ and the continuing annual burden would be approximately 870
hours.\111\
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\110\ We calculated this amount as follows: (40 hours to create
and document a contingency plan regarding funding and liquidity of
the affiliate group) x 3 SIBHCs = 120 hours.
\111\ We calculated this amount as follows: ((256 hours to
create a record regarding stress tests) + ((30 minutes x 20
counterparties) to create a record regarding the basis for credit
risk weights) + (24 hours per year to maintain records)) x 3 SIBHCs
= 870 hours.
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6. Rule 17i-6
Rule 17i-6 requires an SIBHC to file certain monthly and quarterly
reports with the Commission, as well as an annual audit report. These
reporting requirements are necessary to keep the Commission informed as
to the activities of the SIBHC, as well as the financial condition,
transactions and relationships involving the affiliate group, and
policies, systems for monitoring and controlling financial and
operational risks. In addition, these requirements are essential to
keeping the Commission informed of the extent to which the SIBHC or its
affiliates have complied with section 17(i) of the Exchange Act and the
rules promulgated thereunder. Finally, these reports may also be used
to evaluate the activities conducted by these SIBHCs and to anticipate,
where possible, how they might be affected by significant economic
events.
As stated previously in section VI.C., we anticipate that the Rule
would affect approximately three SIBHCs. We estimate that, on average,
it will take an SIBHC about 8 hours each month to prepare and file the
monthly reports required by this rule (or approximately 96 hours per
year).\112\ We estimate that, on average, it will take an SIBHC about
16 hours each quarter (or 64 hours each year) \113\ to prepare and file
the quarterly reports required by this rule. We estimate that, on
average, it will take an SIBHC about 200 hours to prepare and file the
annual audit reports required by this rule. Thus, we estimate that the
total annual burden of Rule 17i-6 on all SIBHCs will be approximately
1,080 hours.\114\ However, we believe that most well-managed SIBHCs
already report to their senior management much of the information
required to be provided to the Commission pursuant to Rule 17i-6;
therefore, the burdens may be significantly lower.
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\112\ We calculated this amount as follows: (8 hours x 12 months
in a year) = 96 hours/year.
\113\ We calculated this amount as follows: (16 hours x 4
quarters in a year) = 64 hours/year.
\114\ We calculated this amount as follows: (96 hours per year
to prepare and file monthly reports + 64 hours each year to prepare
and file quarterly reports + 200 hours each year to prepare and file
annual audit reports) x 3 SIBHCs = 1,080 hours.
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7. Rule 17i-8
Rule 17i-8 requires SIBHCs to report on the occurrence of certain
events that may have a material adverse affect on the SIBHC. This early
warning system is modeled after the early warning system used with
respect to broker-dealers in Exchange Act Rule 17a-11. Like Exchange
Act Rule 17a-11, Rule 17i-8 is designed to give the Commission advance
warning of problems that may pose material risks to the financial and
operational capability of an SIBHC and its affiliated broker-dealers,
and is integral to the Commission's supervision of SIBHCs and their
affiliated broker-dealers.
We estimate that it would take an SIBHC approximately one hour to
create a notice required to be submitted to the Commission pursuant to
Rule 17i-8. We estimate that of the approximately three IBHCs that we
believe will register to be supervised as SIBHCs, one may be required
to file notice pursuant to Rule every four years. Thus, we estimate
that the annual burden of Rule 17i-8 for all SIBHCs will be about 15
minutes.
E. Collection of Information Is Mandatory
The collection of information requirements in new Rules 17i-2
through 17i-8 are mandatory for every IBHC that files a Notice of
Intention to be supervised by the Commission as an SIBHC and every
SIBHC that is supervised by the Commission.
F. Confidentiality
The information and documents collected, retained, and/or filed
pursuant to new Rules 17i-2 through 17i-8 will be accorded confidential
treatment to the extent permitted by law.
G. Record Retention Period
New Rule 17i-5(b) requires that an SIBHC preserve for three years
in an easily accessible place information relating to: (i) Its Notice
of Intention; (ii) its group-wide system of internal risk management
controls; (iii) the records it is required to make and keep current;
(iv) the reports it is required to file; and (v) its calculations of
allowable capital and allowances for market, credit, and operational
risk.
VII. Costs and Benefits of the Rules and Rule Amendments
The Commission has identified certain costs and benefits that will
result from this framework for supervising SIBHCs. Supervision pursuant
to this system is voluntary, and eligible IBHCs are not be required to
be supervised in this manner. This framework includes requirements for
SIBHCs that file Notices of Intention to be supervised by the
Commission as SIBHCs, as well as recordkeeping and reporting
requirements for SIBHCs, including a requirement that an SIBHC
calculate and report a calculation of allowable capital and allowances
for market, credit and operational risk.
In the Proposing Release \115\ the Commission solicited comment on
all aspects of the cost-benefit analysis to assist the Commission in
evaluating the
[[Page 34490]]
costs and benefits that may result from the supervisory framework for
SIBHCs. Specifically, the Commission requested comment on the potential
costs and benefits identified in the Proposing Release, as well as any
other costs or benefits that may result from the rules and rule
amendments. In particular, the Commission solicited comments on the
potential costs for any necessary modifications to accounting,
information and recordkeeping systems, and internal risk management
control systems required to implement the rules, and the potential
benefits arising from participation in this optional regulatory
framework, as well as the degree to which potential applicants under
this rule have already made, or are making, the necessary investments
in internal risk management control systems, information technology,
and mathematical modeling. The Commission requested that commenters
provide views and data comparing the costs and benefits discussed above
with the costs and benefits of the current regulatory framework, as
well as any analysis and data relating to the costs and benefits
associated with each of the Rules.
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\115\ See supra, note and accompanying text.
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The Commission received no comments that specifically addressed the
Cost-Benefit Analysis included in the Proposing Release. Because Rules
17i-1 through 17i-8 and the amendments to Rules 17h1-T and 17h-2T, as
adopted, are substantially similar to those proposed, the SEC believes
that the Cost-Benefit Analysis included in the Proposing Release
regarding the benefits and costs associated with new Rules 17i-1
through 17i-8 and the amendments to Rules 17h1-T and 17h-2T continues
to be appropriate.
A. Benefits
There are many quantifiable and non-quantifiable benefits that will
result from these rules. We discuss these benefits below.
U.S. securities firms that do business in the EU have indicated
that they may need to demonstrate that they are subject to consolidated
supervision at the holding company level that is ``equivalent'' to EU
consolidated supervision. Generally, EU ``consolidated supervision''
takes the form of a series of rules, imposed at the holding company
level, regarding firms' internal controls, capital adequacy, intra-
group transactions, and risk concentration. Without a demonstration of
``equivalent'' supervision, securities firms located in the EU have
stated that they may either be subject to additional capital charges or
required to form a sub-holding company that would be subject to
consolidated supervision by the EU.\116\ The regulatory framework for
SIBHCs set forth in the new rules and rule amendments is intended to
provide a basis for non-U.S. financial regulators to treat the
Commission as the principal U.S. consolidated, home-country supervisor
\117\ for SIBHCs and their affiliated broker-dealers. The Commission
estimates that it would cost an IBHC approximately $8 million to create
a new, non-U.S., regulated affiliate,\118\ or about $24 million in the
aggregate for the three IBHCs we believe will file Notices of Intention
to become supervised by the Commission as SIBHCs. We do not have
sufficient information to estimate what additional costs may be imposed
on securities firms that do business in the EU if they are not subject
to equivalent supervision.
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\116\ See ``Directive 2002/87/EC of the European Parliament and
of the Council of 16 December 2002.''
\117\ See supra note 2.
\118\ See Exchange Act Release No. 48694 [68 FR 62910, at 62928,
note 121 (Nov. 6, 2003)].
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Currently, certain broker dealers must create records and file
quarterly reports with the Commission regarding the financial
condition, organization, and risk management practices of the
affiliated group pursuant to Exchange Act Rules 17h-1T and 17h-2T.\119\
Broker-dealers affiliated with IBHCs that meet the criteria set forth
in Rules 17i-1 through 17i-8 generally already would be subject to
Rules 17h-1T and 17h-2T. To the extent that the information collected
or made and maintained pursuant to new Rule 17i-5 reports are made and
filed pursuant to Rule 17i-6 by the SIBHC of a broker-dealer that is
subject to Rules 17h-1T and 17h-2T, that broker-dealer will be exempted
from the provisions of Rules 17h-1T and 17h-2T. We estimate that, on
average, a broker-dealer affiliated with one of the three SIBHCs would
save about $2,208 due to this exemption.\120\ In the aggregate, the
total cost savings associated with these amendments would be
approximately $6,624.\121\
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\119\ See supra, note.
\120\ We estimate, based on the present burden for Rules 17h-1T
and 17h-2T, that each broker-dealer affiliated with an SIBHC that
will no longer have to maintain records or file reports will spend
24 hours less each year to perform these tasks. This estimate was
described in the Proposing Release, and they elicited no comments.
The staff believes that a broker-dealer would have a financial
reporting manager perform these tasks. According to the Securities
Industry Association's (``SIA'') Report on Management and
Professional Earnings in the Securities Industry--2003, the hourly
cost of a financial reporting manager is $92.00. We calculated this
amount as follows: (($92.00 x 24 hours) = $2,208). Generally, to
estimate an hourly cost using the SIA's Report on Management and
Professional Earnings in the Securities Industry--2003, the staff
will take the median (or, if no median is provided, the mean) salary
provided in that Report for the position cited, divide that amount
by 1,800 hours (in the average year), and then multiply the result
by 135% (to account for employee overhead costs).
\121\ We calculated this amount as follows: ($2,208 x three
affected broker-dealers) = $6,624.
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In addition, Rules 17i-1 through 17i-8 not only create a regulatory
framework for the Commission to supervise SIBHCs, but they improve the
Commission's ability to supervise the financial condition and
securities activities of SIBHCs' affiliated broker-dealers. The
requirement that an SIBHC establish, document and maintain an internal
risk management control system reduces the risk of significant losses
by the SIBHC's affiliated broker-dealers. The internal risk management
control system requirement also will reduce systemic risk. We have no
way to quantify this benefit.
An additional benefit arises from the reduced borrowing costs, or
increased stock price that will result from better risk management
practices. Credit rating agencies analyze risk management practices,
among many factors, in determining credit ratings. A firm that has
better risk management systems may be rated better, and will therefore
pay lower interest rates to borrow and realize higher stock prices.
However it is unclear to what extent risk management factors into
credit ratings. In addition, present internal risk management control
systems vary widely from firm to firm. Therefore it is difficult to
quantify this benefit.
However, evolving industry best practice for internationally active
firms suggests that some of the firms already have group-wide internal
risk management control systems in place, and some firms will implement
the risk management practices in the near future.
B. Costs
Each IBHC that files a Notice of Intention to become supervised by
the Commission as an SIBHC would incur various on-going costs and one-
time costs.
1. Ongoing Costs
An SIBHC will incur costs complying with new Rules 17i-1 through
17i-8, including ongoing costs relating to: (i) Drafting and reviewing
a Notice of Intention; (ii) drafting and reviewing a notice of
withdrawal; (iii) updating its internal risk management control system;
(iv) creating a record regarding stress tests; (v) creating a record
regarding the basis for credit risk weights; (vi) maintaining its
records in
[[Page 34491]]
accordance with Rule 17i-5; (vii) preparing and filing monthly and
quarterly reports; (viii) preparing and filing its annual audit; (ix)
calculating allowable capital and allowances for market, credit, and
operational risk; (x) maintaining its models; (xi) conducting stress
tests on its models; and (xii) filing notices pursuant to Rule 17i-8.
New Rule 17i-2 requires that an SIBHC amend its Notice of Intention
on an ongoing basis. We estimate that each SIBHC will incur a cost of
approximately $1,704 each year to make any necessary amendments to its
Notice of Intention.\122\ Thus, we estimate that the total annual cost
to make any amendments to the notice will be, in aggregate, about
$5,112 each year for all SIBHCs.\123\
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\122\ We estimate that an SIBHC will take about 24 hours each
year to ensure that its Notice of Intention is accurate and make any
necessary amendments. We believe an SIBHC will have a senior
compliance person perform this task. According to the SIA's Report
on Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a senior compliance person is $71.00. (24
hours x $71.00) = $1,704. We described these estimates in the
Proposing Release, and they elicited no comments.
\123\ We calculated this amount as follows: ($1,704 x 3 SIBHCs)
= $5,112.
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Rule 17i-3 requires that an SIBHC file a notice of withdrawal with
the Commission if it wishes to withdraw from Commission supervision. We
estimate that each SIBHC that withdraws from Commission supervision
will incur a cost of about $2,130 to draft and review a notice or
withdrawal to submit to the Commission.\124\ However, we further
estimate that one SIBHC may withdraw from Commission supervision only
once every ten years. Thus, the annual cost of this rule will be
approximately $279.\125\
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\124\ We estimate, that it will take one attorney approximately
24 hours to draft a withdrawal notice and that it will take a senior
attorney or executive officer 8 hours to review the notice of
withdrawal before submitting it to the Commission. According to the
SIA's Report on Management and Professional Earnings in the
Securities Industry--2003, the hourly cost of an attorney is $82.00,
and the average hourly cost of a senior attorney and executive
officer is $102.00. ((24 hours x $82.00) + (8 hours x $102.00)) =
$2,784. We described these estimates in the Proposing Release, and
they elicited no comments.
\125\ We calculated this amount as follows: ($2,784/10 years) =
$279.
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New Rule 17i-4 requires that an SIBHC maintain an internal risk
management control system. We estimate that an SIBHC will incur a cost
of approximately $17,750 associated with maintaining its internal risk
management control system each year.\126\ Thus, the continuing annual
burden will be, in aggregate, approximately $53,250 for all three
SIBHCs.\127\
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\126\ We estimate that it will take each SIBHC 250 hours each
year to maintain its internal risk management control system, and
that an SIBHC would have a senior compliance person perform that
task. According to the SIA's Report on Management and Professional
Earnings in the Securities Industry--2003, the hourly cost of a
compliance examiner is $71.00. We calculated this amount as follows:
((250 hours x $71.00) = $17,750). We described these estimates in
the Proposing Release, and they elicited no comments.
\127\ We calculated this amount as follows: ($17,750 x 3 SIBHCs)
= $53,250.
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Pursuant to new Rule 17i-5, an SIBHC must create records regarding
stress tests and the basis for credit risk weights, and preserve those
and other records relating to its business for certain prescribed time
periods. We estimate that an SIBHC will incur an annual cost of about
$23,808 to create a record regarding stress tests as required by Rule
17i-5.\128\ Further, we estimate that, on average, an SIBHC will incur
an annual cost of approximately $370 to create a record regarding the
basis for credit risk weights.\129\ Further, we estimate that, on
average, an SIBHC will incur an annual cost of $1,440 to maintain
records pursuant to new Rule 17i-5.\130\ Thus, the aggregate annual
cost relating to new Rule 17i-5 for all SIBHCs will be approximately
$76,854.\131\
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\128\ We estimate that an SIBHC will spend approximately 256
hours each year to create a record regarding stress tests. We
believe that an SIBHC will have a trading floor supervisor or
equivalent create this record. According to the SIA's Report on
Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a trading floor supervisor is $93.00. We
calculated this amount as follows: (($93.00 x 256) = $23,808). We
described these estimates in the Proposing Release, and they
elicited no comments.
\129\ We estimate that an SIBHC will spend 30 minutes per
counterparty to create a record regarding credit risk weights, and
that, on average, each SIBHC will initiate relationships with 20 new
counterparties each year. We believe that an SIBHC would have an
intermediate accountant create this record. According to the SIA's
Report on Management and Professional Earnings in the Securities
Industry--2003, the hourly cost of an intermediate accountant is
$37.00. We calculated this amount as follows: ($37.00 x (30 minutes
x 20 counterparties)) = $370. We described these estimates in the
Proposing Release, and they elicited no comments.
\130\ We estimate that an SIBHC will spend about 24 hours per
year to maintain records as required pursuant to Rule 17i-5. The
staff believes that an SIBHC will have a programmer analyst perform
this task. According to the SIA's Report on Management and
Professional Earnings in the Securities Industry--2003, the hourly
cost of a programmer analyst is $60.00. We calculated this amount as
follows: ($60.00 x 24) = $1,440. We described these estimates in the
Proposing Release, and they elicited no comments.
\131\ We calculated this amount as follows: (($23,808 + $370 +
$1,440) x 3 SIBHCs) = $76,854.
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New Rule 17i-6 requires that an SIBHC file certain monthly and
quarterly reports with the Commission, as well as an annual audit
report. We estimate that the average cost for an SIBHC to prepare and
file the monthly reports will be about $440 per month, and thus
approximately $5,280 per year.\132\ We estimate that, on average, an
SIBHC will incur a quarterly cost of $880 to prepare and file the
required quarterly reports, and thus will incur an annual cost of
$3,520 to file these reports.\133\ Finally, we estimate that, on
average, an SIBHC will incur an annual cost of $9,800 to prepare and
file an annual audit.\134\ Thus, we estimate that the total cost that,
in aggregate, SIBHCs will incur that are associated with new Rule 17i-6
would be approximately $55,800.\135\
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\132\ We estimate that an SIBHC will spend about 8 hours per
month and 96 hours per year to prepare and file these monthly
reports. We believe that an SIBHC will have a senior accountant
prepare and file these reports. According to the SIA's Report on
Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a senior accountant is $55.00. ($55.00 x 8
hours) = $440. ($440 x 12 months) = $5,280. We described these
estimates in the Proposing Release, and they elicited no comments.
\133\ We estimate that an SIBHC will spend about 16 hours per
quarter and 64 hours per year to prepare and file these quarterly
reports. We believe that an SIBHC will have a senior accountant
prepare and file these reports. According to the SIA's Report on
Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a senior accountant is $55.00. ($55.00 x 16
hours) = $880. ($880 x 4 quarters) = $3,520. We described these
estimates in the Proposing Release, and they elicited no comments.
\134\ We estimate that an SIBHC would spend about 200 hours per
year to prepare and file an annual audit. We believe that an SIBHC
would have a senior internal auditor work with accountants to
prepare and file these reports. According to the SIA's Report on
Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a senior internal auditor is $49.00.
($49.00 x 200 hours) = $9,800. We described these estimates in the
Proposing Release, and they elicited no comments.
\135\ We calculated this amount as follows: (($5,280 + $3,520 +
$9,800) x 3 SIBHCs) = $55,800). We described these estimates in the
Proposing Release, and they elicited no comments.
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New Rule 17i-7 requires that an SIBHC calculate the affiliate
group's allowable capital and allowances for certain types of risk.
Once the appropriate systems and models are in place, we estimate that
each SIBHC will incur a cost of about $57,750 to calculate its group-
wide allowances for market, credit, and operational risk.\136\ In
addition, we estimate that each SIBHC will incur a cost of about
[[Page 34492]]
$378,000 to maintain its models.\137\ Finally, we estimate that each
SIBHC will incur an annual cost of approximately $32,000 to perform
stress tests on its models at least once each quarter.\138\ Thus, we
estimate that the annual cost that SIBHCs will incur, in aggregate,
will be approximately $1.4 million.\139\
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\136\ We estimate that, on average, each SIBHC will take
approximately 1,050 hours per year to calculate allowable capital
and allowances for market, credit, and operational risk and to
verify and review that data. We believe that an SIBHC will have a
senior accountant perform these calculations and verifications.
According to the SIA's Report on Management and Professional
Earnings in the Securities Industry--2003, the hourly cost of a
senior accountant is $55.00. (($55.00 x 1,050 hours) = $57,750). We
described these estimates in the Proposing Release, and they
elicited no comments.
\137\ We estimate that each SIBHC will spend an average of
approximately 5,600 hours per year maintaining its models. We
believe that an SIBHC will have a senior programmer and a senior
research analyst spend approximately 2,800 hours each maintaining
its models. According to the SIA's Report on Management and
Professional Earnings in the Securities Industry--2002, the hourly
cost of a senior programmer is $64.00 and the hourly cost of a
senior research analyst is $71.00. ($64.00 x 2,800 hours) + ($71.00
x 2,800 hours) = $378,000. We described these estimates in the
Proposing Release, and they elicited no comments. Due to a lack of
data points available in the SIA's Report on Management and
Professional Earnings in the Securities Industry--2003 guide
regarding salaries for this type of position, we used data obtained
from the SIA's 2002 guide to generate this estimate.
\138\ We estimate that each SIBHC will spend about 640 hours
each year to conduct stress tests on its models. We believe that an
SIBHC will have a junior research analyst conduct stress tests on
its models. According to the SIA's Report on Management and
Professional Earnings in the Securities Industry--2003, the hourly
cost of a junior research analyst is $50.00. (($50.00 x 640 hours) =
$32,000). We described these estimates in the Proposing Release, and
they elicited no comments.
\139\ We calculated this amount as follows: ($57,750 + $378,000
+ $32,000) x 3 SIBHCs = $1,403,250.
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New Rule 17i-8 requires that an SIBHC report to the Commission the
occurrence of certain material risks. We estimate that it will cost an
SIBHC approximately $82 to create a notice required to be submitted to
the Commission pursuant to Rule 17i-8.\140\ However, we estimate that
only one SIBHC may be required to send a notice as required by new Rule
17i-8 every three years. Thus, we estimate, for that the annual cost of
Rule 17i-8 for all SIBHCs will be about $27.\141\
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\140\ We estimate that it will take an SIBHC approximately one
hour to create a notice required to be submitted to the Commission
pursuant to Rule 17i-8. However, we further estimate that only one
SIBHC may be required to submit such notice every other year. We
believe that an SIBHC will have an attorney create a notice required
to be submitted to the Commission pursuant to Rule 17i-8. According
to the SIA's Report on Management and Professional Earnings in the
Securities Industry--2003, the hourly cost of an attorney is $82.00.
(($82.00 x 1 hour) = $82.00).
The hourly burden estimate for Rule 17i-8 is based on our
present estimates for Rule 17a-11. The Commission received 841 Rule
17a-11 Notices from 562 broker-dealers during the year ending
December 2003. At that time, there were approximately 6,800 active
broker-dealers that are registered with the Commission. Thus, 12%
(841/6,800) of active, registered broker-dealers had a situation
arise which caused them to file a notice pursuant to Rule 17a-11.
Using this 12% figure, we estimate that of the approximately 3 IBHCs
that we believe will register to be supervised as SIBHCs, one may be
required to file notice pursuant to Rule 17i-8 every three years ((3
SIBHCs x 12%) = 0.36).
\141\ We calculated this amount as follows: (($82.00 x 1 hour) x
.33 (once every three years)) = $27.
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2. One-Time Costs
We believe that an SIBHC will incur five types of one-time costs
associated with becoming an SIBHC: (i) Costs associated with drafting a
Notice of Intention to submit to the Commission; (ii) costs associated
with assessing its present structure, businesses, and controls, and
designing and implementing an internal risk management control system
in order to comply with new Rule 17i-4; (iii) costs associated with
creating and documenting a contingency plan regarding funding and
liquidity of the affiliate group; (iv) costs associated with upgrading
the information technology (``IT'') systems it uses to manage group-
wide risk, make and retain records and reports, and calculate group-
wide capital; and (v) costs associated with developing mathematical
models to calculate its group-wide allowances for market and credit
risk as required by new Rule 17i-7.
New Rule 17i-2 requires that an IBHC file a Notice of Intention to
become supervised by the Commission that includes certain information
and documents. We estimate that each IBHC that files a Notice of
Intention to become supervised by the Commission as an SIBHC will incur
a cost of approximately $63,900 to draft a Notice of Intention, compile
the various documents to be included with the Notice of Intention, and
work with the Commission staff.\142\ Further, we believe that an IBHC
will have an attorney review the Notice of Intention, and that it will
incur a cost of approximately $8,200 relating to this review.\143\
Consequently, we estimate that the total costs that will be incurred by
the three IBHCs we believe will file Notices of Intention to become
supervised by the Commission as SIBHCs is about $216,300.\144\
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\142\ We estimate that an SIBHC will spend 900 hours to perform
this task. Further, we believe that an SIBHC will have a senior
compliance person perform this task. According to the SIA's Report
on Management and Professional Earnings in the Securities Industry--
2003, the hourly cost of a compliance examiner is $71.00. (($71.00 x
900 hours) = $63,900). We described these estimates in the Proposing
Release, and they elicited no comments.
\143\ We believe that an SIBHC will have an attorney review the
Notice of Intention and that it would take an attorney 100 hours to
complete this review. According to SIA's Report on Management and
Professional Earnings in the Securities Industry--2002, the hourly
cost of an attorney is $82.00. (($82.00 x 100 hours) = $8,200). We
described these estimates in the Proposing Release, and they
elicited no comments. Due to a lack of data points available in the
SIA's Report on Management and Professional Earnings in the
Securities Industry--2003 guide regarding salaries for this type of
position, we used data obtained from the SIA's 2002 guide to
generate this estimate.
\144\ ($63,900 + $8,200) x 3 SIBHCs = $216,300. We described
these estimates in the Proposing Release, and they elicited no
comments.
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Each SIBHC will incur a one-time cost to assess its present
structure, businesses, and controls, and establish, document and
maintain an internal risk management control system in order to comply
with new Rule 17i-4. We estimate that the one-time cost for an SIBHC to
assess its present structure, businesses, and controls, and establish,
document and maintain an internal risk management control system will
be approximately $255,600.\145\ Thus, we anticipate the total aggregate
cost for all SIBHCs would be about $766,800.\146\
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\145\ We estimate that the average amount of time an SIBHC will
spend assessing its present structure, businesses, and controls, and
designing and implementing a risk management control system would be
about 3,600 hours. We believe that an SIBHC will have a senior
compliance person performing this task. According to the SIA's
Report on Management and Professional Earnings in the Securities
Industry--2003, the hourly cost of a compliance examiner is $71.00.
(($71.00 x 3,600 hours) = $255,600). We described these estimates in
the Proposing Release, and they elicited no comments.
\146\ We calculated this amount as follows: ($255,600 per SIBHC
x 3 SIBHCs expected to apply) = $766,800. We described these
estimates in the Proposing Release, and they elicited no comments.
---------------------------------------------------------------------------
Pursuant to new Rule 17i-5, an SIBHC must document a contingency
plan regarding funding and liquidity of the affiliate group. We
estimate that it will cost each SIBHC about $4,160 to document such a
contingency plan.\147\ Consequently, it will cost the three SIBHCs we
expect to file Notices of Intention to be supervised by the Commission,
in aggregate, approximately $12,480.\148\
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\147\ We estimate that, on average, an SIBHC will spend about 40
hours to create and document a contingency plan regarding funding
and liquidity of the affiliate group. Further, we believe that an
SIBHC will have a senior treasury manager perform this task.
According to the SIA's Report on Management and Professional
Earnings in the Securities Industry--2003, the hourly cost of a
senior treasury manager is $104.00. ($104 x 40 hours) = $4,160. We
described these estimates in the Proposing Release, and they
elicited no comments.
\148\ We calculated this amount as follows: ($4,160 x 3 SIBHCs)
= $12,480.
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The IT systems used by IBHCs to manage risk, make and retain
records and reports, and calculate capital differ widely based on the
types of business and the size of the IBHC. In addition, these IT
systems may be in varying stages of readiness to meet the requirements
of the rules. We estimate that it will cost an IBHC that has well-
developed IT systems to manage group-wide risk, make and retain their
records,
[[Page 34493]]
provide reports, and calculate group-wide capital about $1 million to
upgrade its IT systems. We estimate that it will cost an IBHC that has
less well-developed IT systems approximately $10 million to upgrade its
IT systems. Thus, we estimate that, on average, it will cost each of
the three SIBHCs about $5.5 million to upgrade their IT systems, or
approximately $16.5 million in total. We believe that the costs for an
SIBHC to update information technology systems in order to comply with
new Rules 17i-1 through 17i-8 will be an initial, one-time cost. These
estimates are based on the experience of Commission staff, as well as
informal discussions with potential respondents.
Pursuant to new Rule 17i-7 an SIBHC must calculate its group-wide
allowances for market, credit, and operational risk on a monthly basis.
SIBHCs will generally use mathematical models to calculate market and
credit risk. The SIBHC's size, the types of business in which it
engages, and the complexity of its portfolio will all factor into the
cost of model development. We estimate, based on staff experience, our
experience with OTC derivatives dealers, and discussions with industry
participants, that it will cost an SIBHC between $6,750 (if the firm
already manages risks using mathematical models and simply needs to
adjust those models to assure they comply with the qualitative and
quantitative requirements set forth in the rules) and $675,000 (if the
firm is complex and does not presently use mathematical models to
manage risk) to update or create mathematical models.\149\ Thus, we
estimate that the additional cost to create new models will be, in
aggregate, between about $20,250 and about $2 million for all three
firms.\150\
---------------------------------------------------------------------------
\149\ We estimate that an SIBHC that already manages risk using
mathematical models may need to spend 100 hours to review its models
and adjust them to assure they comply with the qualitative and
quantitative requirements set forth in the rules. We believe that an
SIBHC will have a senior programmer and a senior research analyst
spend approximately 50 hours each to perform this task. According to
the SIA's Report on Management and Professional Earnings in the
Securities Industry--2002, the hourly cost of a senior programmer is
$63.75 and the hourly cost of a senior research analyst is $71.25.
(($64.00 x 50 hours) + ($71.00 x 50 hours) = $6,750). Due to a lack
of data points available in the SIA's Report on Management and
Professional Earnings in the Securities Industry--2003 guide
regarding salaries for this type of position, we used data obtained
from the SIA's 2002 guide to generate this estimate.
Further, we estimate that a complex SIBHC that does not
presently use mathematical models to manage risk will spend
approximately 10,000 hours to create mathematical models to use in
calculating market and credit risk as required by the rules. We
believe that an SIBHC will have a senior programmer and a senior
research analyst spend approximately 5,000 hours each to perform
this task. According to the SIA's Report on Management and
Professional Earnings in the Securities Industry--2002, the hourly
cost of a senior programmer is $64.00 and the hourly cost of a
senior research analyst is $71.00. (($64 x 5,000 hours) + ($71 x
5,000 hours) = $675,000. We described these estimates in the
Proposing Release, and they elicited no comments.
\150\ We calculated this amount as follows: ($6,750 x 3 SIBHCs)
= $20,250. ($675,000 x 3 SIBHCs) = $2,025,000.
---------------------------------------------------------------------------
The Commission notes that broker-dealers with tentative net capital
of between $100 million and $1 billion that are not affiliated with
banks generally do not report a VaR figure in their market risk
disclosure of their holding companies' annual reports. However, some
firms of this size do report a VaR figure in their market risk
disclosure of their holding companies' annual reports. IBHCs that do
not presently use VaR to manage group-wide risk may not find it to be
cost effective to file a Notice of Intention to be supervised by the
Commission as an SIBHC. However, this regulatory framework is available
to a wide range of firms as an alternative, and may allow some of them
to compete more effectively.
As stated previously, there are approximately 115 applicants who
qualify to elect SIBHC supervision based on the minimum tentative net
capital requirements. Evolving industry best practice for
internationally active firms suggests that some IBHCs will have already
made some or all the investments required by the rules, and some IBHCs
have plans to make those investments in the near future. As stated
previously in section VI.C., we believe that the three IBHCs that
qualify will file a Notice of Intention to become supervised by the
Commission as SIBHCs because it is cost effective and because they have
made or plan to make the necessary investments regardless of Commission
rule making. To the extent that a firm that elects SIBHC supervision,
the SIBHC will not incur additional costs to establish, document and
maintain an internal risk management control system, upgrade its IT, or
create mathematical models, our estimates with regard to the rules may
be reduced.
VIII. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition and Capital Formation
Section 3(f) of the Exchange Act \151\ requires the Commission,
whenever it engages in rulemaking and is required to consider or
determine if an action is necessary or appropriate in the public
interest, to consider if the action will promote efficiency,
competition, and capital formation. Section 23(a)(2) of the Exchange
Act \152\ requires the Commission, in adopting rules under the Exchange
Act, to consider the impact that any such rule would have on
competition. Exchange Act Section 23(a)(2) prohibits the Commission
from adopting any rule that would impose a burden on competition not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.
---------------------------------------------------------------------------
\151\ 15 U.S.C. 78c(f).
\152\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
In the Proposing Release,\153\ the Commission solicited comments on
whether the amendments to Rules 17h-1T and 17h-2T and new Rules 17i-1
through 17i-8 would have any effects on competition, efficiency and
capital formation. We received no comments in response to this
solicitation.
---------------------------------------------------------------------------
\153\ See supra, note 6 and accompanying text.
---------------------------------------------------------------------------
The Commission believes that Rules 17i-1 through 17i-8 promote both
efficiency and capital formation. The rules will provide qualifying
IBHCs an opportunity to increase operational efficiency by continuing
to compete effectively outside of the United States in countries that
require consolidated supervision as a condition of doing business.
Although the rules may impose new costs relating to: (i) Creation and
implementation of a group-wide system of internal management controls;
(ii) recordkeeping; and (iii) reporting, an IBHC that files a Notice of
Intention to be supervised by the Commission as an SIBHC will save
costs because it will not be subject to consolidated supervision in
non-U.S. marketplaces. Further, as this framework for oversight is
voluntary, we do not believe IBHCs will file Notices of Intention to be
supervised by the Commission as an SIBHC unless the benefits of such an
election outweigh the costs with respect to the applying IBHC.
The Commission notes that broker-dealers with tentative net capital
of between $100 million and $1 billion that are not affiliated with
banks generally do not report a VaR figure in their market risk
disclosure of their holding companies' annual reports. However, some
firms of this size do report a VaR figure in their market risk
disclosure of their holding companies' annual reports. IBHCs that do
not presently use VaR to manage group-wide risk may not find it to be
cost effective to file a Notice of Intention to be supervised by the
Commission as an SIBHC. However, this regulatory framework is available
to a wide range of firms as an alternative, and may allow
[[Page 34494]]
some of them to compete more effectively.
The Commission does not believe that the rules will have anti-
competitive effects on smaller broker-dealers because smaller broker-
dealers are generally not interested in consolidated supervision.\154\
In addition, the Commission believes that the benefits smaller broker-
dealers would realize though SIBHC supervision would not outweigh the
cost to establish procedures to comply with these rules. These rules
implement section 17(i) of the Exchange Act, and are designed, in part,
to allow U.S. broker-dealers to compete more effectively in the global
securities markets.
---------------------------------------------------------------------------
\154\ Generally, smaller broker-dealers are organized in a
simpler manner, and they do not engage in international transactions
that could cause them to be subject to regulation by international
securities regulatory agencies.
---------------------------------------------------------------------------
IX. Summary of Regulatory Flexibility Act Certification
Pursuant to section 605(b) of the Regulatory Flexibility Act,\155\
the Commission has certified that the new Rules 17i-1 through 17i-8,
and amendments to Rules 17h-1T, 17h-2T, and 17a-12(l) under the
Exchange Act, if adopted, would not have a significant economic impact
on a substantial number of small entities. This certification was
included in the Proposing Release.\156\ The Commission solicited
comments concerning the impact on small entities and the Regulatory
Flexibility Act certification, but received no comments.
---------------------------------------------------------------------------
\155\ 5 U.S.C. 605(b).
\156\ See supra, note 6 and accompanying text.
---------------------------------------------------------------------------
X. Statutory Authority
The amendments are made pursuant to the authority conferred on the
Securities and Exchange Commission by the Exchange Act (15 U.S.C. 78a,
et seq.) (particularly sections 17, 23, and 24(b) thereof (15 U.S.C.
78q and 78w)).
List of Subjects
17 CFR Part 200
Administrative practice and procedure, Authority delegations
(Government Agencies).
17 CFR Part 240
Brokers, OTC derivatives dealers, Reporting and recordkeeping
requirements, Securities, Supervised investment bank holding companies.
Text of Rules and Rule Amendments
0
In accordance with the foregoing, the Securities and Exchange
Commission hereby amends title 17 chapter II of the Code of Federal
Regulations as follows:
PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND
REQUESTS
Subpart A--Organization and Program Management
0
1. The authority citation for Part 200, subpart A, continues to read,
in part, as follows:
Authority: 15 U.S.C. 77s, 77o, 77sss, 78d, 78d-1, 78d-2, 78w,
78ll(d), 78mm, 79t, 80a-37, 80b-11, and 7202, unless otherwise
noted.
* * * * *
0
2. Section 200.30-3 is amended by adding paragraphs (a)(79), (a)(80)
and (a)(81) to read as follows:
Sec. 200.30-3 Delegationof authority to Director of Division of
Market Regulation.
* * * * *
(a) * * *
(79) To review amendments to a supervised investment bank holding
company's Notice of Intention, and to approve such amendments pursuant
to paragraph (d)(2)(ii) of Rule 17i-2 (17 CFR 240.17i-2(d)(2)(ii))
after reviewing the amended notice of intention to determine whether
the amendment is necessary or appropriate in furtherance of the
purposes of section 17 of the Act (15 U.S.C. 78q).
(80) To consider requests by supervised investment bank holding
companies for exemptions from the requirement, and extensions of time
within which, to file reports and notices required by Rule 17i-6 (17
CFR 240.17i-6), and to grant or deny such requests pursuant to
paragraph (f) of that Rule (17 CFR 240.17i-6(f)).
(81) To consider requests by supervised investment bank holding
companies for exemptions from the requirement, and extensions of time
within which, to file notices required by Rule 17i-8 (17 CFR 240.17i-
8), and to grant or deny such requests pursuant to paragraph (d) of
that Rule (17 CFR 240.17i-8(d)).
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
3. The authority citation for part 240 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless
otherwise noted.
* * * * *
0
4. Section 240.17a-12 is amended by revising paragraph (l) to read as
follows:
Sec. 240.17a-12 Reports to be made by certain OTC derivatives
dealers.
* * * * *
(l) Accountant's report on management controls.
(1) The OTC derivatives dealer shall file concurrently with the
annual audit report a supplemental report by the certified public
accountant indicating the results of the certified public accountant's
review of the OTC derivatives dealer's internal risk management control
system with respect to the requirements of Sec. 240.15c3-4. This
review shall be conducted in accordance with procedures agreed to by
the OTC derivatives dealer and the certified public accountant
conducting the review. The purpose of the review is to confirm that the
OTC derivatives dealer has established, documented, and maintained an
internal risk management control system in accordance with Sec.
240.15c3-4, and is in compliance with that internal risk management
control system.
(2) The agreed-upon procedures are to be performed, and the report
is to be prepared, in accordance with U.S. Generally Accepted
Attestation Standards.
(3) Prior to the commencement of the initial review, every OTC
derivatives dealer shall file the procedures to be performed pursuant
to paragraph (l)(1) of this section with the Commission's principal
office in Washington, DC. Prior to the commencement of any subsequent
review, every OTC derivatives dealer shall file with the Commission's
principal office in Washington, DC a notice of changes to the agreed-
upon procedures.
* * * * *
0
5. Section 240.17h-1T is amended by:
0
a. Redesignating paragraph (d)(5) as paragraph (d)(6); and
0
b. Adding new paragraph (d)(5).
The addition reads as follows:
Sec. 240.17h-1T Risk assessment recordkeeping requirements for
associated persons of brokers and dealers.
* * * * *
(d) * * *
(5) The provisions of this section shall not apply to a broker or
dealer affiliated with a supervised investment bank holding company, as
defined in Sec. 240.17i-1(a).
* * * * *
0
6. Section 240.17h-2T is amended by:
0
a. Redesignating paragraph (b)(5) as paragraph (b)(6); and
0
b. Adding new paragraph (b)(5).
[[Page 34495]]
The addition reads as follows:
Sec. 240.17h-2T Risk assessment reporting requirements for brokers
and dealers.
* * * * *
(b) * * *
(5) The provisions of this section shall not apply to a broker or
dealer affiliated with a supervised investment bank holding company, as
defined in Sec. 240.17i-1(a).
* * * * *
0
7. Sections 240.17i-1 through 240.17i-8 are added to read as follows:
Supervised Investment Bank Holding Company Rules
Sec.
240.17i-1 Definitions.
240.17i-2 Notice of Intention to be Supervised by the Commission as
an SIBHC.
240.17i-3 Withdrawal of Supervision as an SIBHC.
240.17i-4 Internal Risk Management Control System Requirements for
SIBHCs.
240.17i-5 Record Creation, Maintenance, and Access Requirements for
SIBHCs.
240.17i-6 Reporting Requirements for SIBHCs.
240.17i-7 Calculations of Allowable Capital and Risk Allowances or
Alternative Capital Assessment.
240.17i-8 Notification Requirements for SIBHCs.
Supervised Investment Bank Holding Company Rules
Preliminary Note: Rules 17i-1 through 17i-8 set forth a program
of supervision at the holding company level for supervised
investment bank holding companies. This program is designed to
reduce the likelihood that financial and operational weakness in a
supervised investment bank holding company will destabilize broker
or dealer or the broader financial system. The focus of this
supervision of the supervised investment bank holding company is its
financial and operational condition and its risk management controls
and methodologies.
Sec. 240.17i-1. Definitions.
(a) For purposes of Sec. Sec. 240.17i-1 through 240.17i-8, the
terms investment bank holding company, supervised investment bank
holding company, affiliate, bank, bank holding company, company,
control, savings association, insured bank, foreign bank, person
associated with an investment bank holding company and associated
person of an investment bank holding company shall have the same
meaning as set forth in section 17(i)(5) of the Act (15 U.S.C.
78q(i)(5)).
(b) For purposes of Sec. Sec. 240.17i-2 through 240.17i-8, the
term affiliate group shall include the supervised investment bank
holding company and every affiliate of the supervised investment bank
holding company.
(c) For purposes of Sec. Sec. 240.17i-1 through 240.17i-8, the
term material affiliate shall mean any member of the affiliate group
that is material to the supervised investment bank holding company.
Sec. 240.17i-2. Notice of intention to be supervised by the
Commission as a supervised investment bank holding company.
(a) An investment bank holding company that owns or controls a
broker or dealer may file with the Commission a written notice of
intention to become supervised by the Commission pursuant to section
17(i) of the Act (15 U.S.C. 78q(i)), provided that the investment bank
holding company is not:
(1) An affiliate of an insured bank (other than an institution
described in paragraph (D), (F), or (G) of section 2(c)(2), or held
under section 4(f), of the Bank Holding Company Act of 1956) (12 U.S.C.
1841(c)(2)(D), (F), or (G) and 12 U.S.C. 1843(f)) or a savings
association;
(2) A foreign bank, foreign company, or company that is described
in section 8(a) of the International Banking Act of 1978 (12 U.S.C.
3106(a)); or
(3) A foreign bank that controls, directly or indirectly, a
corporation chartered under section 25A of the Federal Reserve Act (12
U.S.C. 611).
(b) To become supervised as a supervised investment bank holding
company an investment bank holding company shall file a notice of
intention that includes the following:
(1) A request to become supervised by the Commission as a
supervised investment bank holding company;
(2) A statement certifying that the investment bank holding company
is not an entity described in section 17(i)(1)(A)(i)-(iii) of the Act
(15 U.S.C. 78q(i)(1)(A)(i)-(iii));
(3) Documentation demonstrating that the investment bank holding
company owns or controls a broker or dealer that maintains a
substantial presence in the securities business as evidenced either by
its holding $100 million or more in tentative net capital as calculated
pursuant to Sec. 240.15c3-1 or by any other information that the
Commission determines is appropriate; and
(4) Supplemental information including:
(i) A description of the business and organization of the
investment bank holding company;
(ii) An alphabetical list of each member of the affiliate group,
with an identification of the financial regulator, if any, by whom the
affiliate is regulated, and a designation as to whether the affiliate
is a material affiliate;
(iii) An organizational chart that identifies the investment bank
holding company, each broker or dealer owned or controlled by the
investment bank holding company, and each material affiliate;
(iv) Consolidated and consolidating financial statements of the
affiliate group as of the end of the quarter preceding the filing of
the notice of intention;
(v) Sample computations for the supervised investment bank holding
company of allowable capital and allowances for market risk, credit
risk, and operational risk made in accordance with Sec. 240.17i-7(a)-
(d);
(vi) A list of the categories of positions that the affiliate group
holds in its proprietary accounts and a brief description of the method
that the investment bank holding company proposes to use to calculate
allowances for market and credit risk on those categories of positions
pursuant to Sec. 240.17i-7(b) and (c);
(vii) A description of mathematical models that the investment bank
holding company proposes to use to price positions and to compute
allowances for market and credit risk (as specified in Sec. 240.17i-
7(b) and (c)), including:
(A) A description of the creation, use, and maintenance of the
mathematical models;
(B) A description of the internal risk management controls over
those models, including a description of each category of persons who
may input data into the model;
(C) If the mathematical model incorporates correlations across risk
factors, a description of the process used to measure those
correlations;
(D) A description of the backtesting procedures the investment bank
holding company proposes to use to backtest the models, including a
description of the backtest and procedures instituted to respond to
test results;
(E) A description of how each mathematical model satisfies the
applicable qualitative and quantitative requirements listed in Sec.
240.15c3-1e(d); and
(F) A statement describing the extent to which each mathematical
model that it is used to analyze risk and report risk to senior
management;
(viii) A description of any positions for which the investment bank
holding company proposes to use a method other than Value at Risk to
compute an allowance for market risk and a description of how that
allowance would be determined;
[[Page 34496]]
(ix) A description of how the investment bank holding company
proposes to calculate the credit equivalent amount and maximum
potential exposure (as defined in Sec. Sec. 240.17i-7(c)(1)(i) and
240.17i-7(c)(1)(i)(E), respectively);
(x) A description of how the investment bank holding company
proposes to calculate credit risk weights and internal credit ratings,
if applicable;
(xi) A description of the method the investment bank holding
company proposes to use to calculate its allowance for operational risk
pursuant to Sec. 240.17i-7(d);
(xii) A comprehensive description of the internal risk management
control system the investment bank holding company has established to
manage the risks of the affiliate group, including market, credit,
leverage, liquidity, legal, and operational risks, and how that system
satisfies the requirements of Sec. 240.17i-4;
(xiii) Sample risk reports the supervised investment bank holding
company regularly provides to the persons responsible for managing risk
for the affiliate group that the investment bank holding company
proposes to provide to the Commission pursuant to Sec. 240.17i-
6(a)(1)(iv);
(xiv) A written undertaking, in a form acceptable to the Commission
and signed by a duly authorized person, that provides that if the
disclosure of any information with regard to Sec. Sec. 240.17i-1
through 240.17i-8 would be prohibited by law or otherwise, the
supervised investment bank holding company will cooperate with the
Commission as needed, including by describing any secrecy laws or other
impediments that could restrict the ability of the supervised
investment bank holding company or any material affiliate from
providing information on its operations or activities and by discussing
the manner in which the supervised investment bank holding company
proposes to provide the Commission with adequate assurances of access
to information; and
(xv) Any other information or documents relating to the investment
bank holding company's activities, financial condition, policies,
systems for monitoring and controlling financial and operational risks,
and transactions and relationships among members of the affiliate group
that the Commission may request to complete its review of the notice of
intention.
(c) Amendments to the notice of intention.
(1) Prior to a Commission determination. If any of the information
filed with the Commission as part of the notice of intention described
in paragraph (b) of this section is found to be or becomes inaccurate
before the Commission makes a determination, the investment bank
holding company must promptly notify the Commission and provide the
Commission with a description of the circumstances in which the
information was found to be or has become inaccurate along with
updated, accurate information.
(2) Subsequent to a Commission determination. A supervised
investment bank holding company must amend and resubmit to the
Commission its notice of intention, and obtain Commission approval of
the amendment, as set forth in paragraph (d)(2)(ii) of this section,
before it may make a material change to a mathematical model or other
method used to compute allowable capital or allowance for market,
credit, or operational risk, or its internal risk management control
systems as described in its notice of intention, as modified from time
to time.
(d) Process for review of notice of intention.
(1) When filed. A notice of intention to be supervised by the
Commission as a supervised investment bank holding company and any
amendments thereto shall not be complete until the investment bank
holding company has filed with the Commission all the documentation and
information specified in this section. The notice of intention, and any
amendments thereto, shall be considered filed when received at the
Office of the Secretary at the Commission's principal office in
Washington DC. All notices of intention, amendments thereto, and other
information filed in connection with the notice of intention shall be
accorded confidential treatment to the extent permitted by law.
(2) Commission determination.
(i) An investment bank holding company shall become a supervised
investment bank holding company pursuant to section 17(i) of the Act
(15 U.S.C. 78q(i)) 45 calendar days after the Commission receives a
completed notice of intention to be supervised by the Commission as a
supervised investment bank holding company pursuant to paragraph (a) of
this section, unless the Commission issues an order determining either
that:
(A) The Commission will begin to supervise the investment bank
holding company prior to 45 calendar days after the Commission receives
the completed notice of intention; or
(B) The Commission will not supervise the investment bank holding
company because supervision of the investment bank holding company as a
supervised investment bank holding company is not necessary or
appropriate in furtherance of the purposes of section 17 of the Act (15
U.S.C. 78q). In addition, the Commission will not consider such
supervision necessary or appropriate unless the investment bank holding
company demonstrates that it owns or controls a broker or dealer that
has a substantial presence in the securities business, which may be
demonstrated by a showing that the broker or dealer maintains tentative
net capital of $100 million or more.
(ii) The Commission, upon receipt of an amendment to the notice of
intention submitted by a supervised investment bank holding company
pursuant to paragraph (c)(2) of this section, may approve the amendment
after reviewing the amended notice of intention to determine whether
the amendment is necessary or appropriate in furtherance of the
purposes of section 17 of the Act (15 U.S.C. 78q).
Sec. 240.17i-3. Withdrawal from supervision by the Commission as a
supervised investment bank holding company.
(a) A supervised investment bank holding company may withdraw from
supervision by the Commission as a supervised investment bank holding
company by filing a notice of withdrawal with the Commission. The
notice of withdrawal shall include a statement regarding whether the
supervised investment bank holding company is in compliance with Sec.
240.17i-2(c).
(b) A notice of withdrawal from supervision as a supervised
investment bank holding company shall become effective one year after
it is filed with the Commission, unless the Commission issues an order
determining that it is necessary or appropriate for the Commission to
terminate its supervision of the supervised investment bank holding
company within a shorter or longer period to help ensure effective
supervision of the material risks to the supervised investment bank
holding company and to any associated person of the supervised
investment bank holding company that is a broker or dealer, or to
prevent evasion of the purposes of section 17 of the Act (15 U.S.C.
78q).
(c) Notwithstanding paragraphs (a) and (b) of this section, the
Commission, by order, may discontinue supervision of any supervised
investment bank holding company if the Commission finds that:
(1) The supervised investment bank holding company is no longer in
existence;
[[Page 34497]]
(2) The supervised investment bank holding company has ceased to be
an investment bank holding company; or
(3) Continued supervision by the Commission of the supervised
investment bank holding company is not necessary or appropriate in
furtherance of the purposes of section 17 of the Act (15 U.S.C. 78q).
Sec. 240.17i-4. Internal risk management control system requirements
for supervised investment bank holding companies.
(a) A supervised investment bank holding company shall comply with
Sec. 240.15c3-4 as though it were an OTC derivatives dealer with
respect to all of its business activities, except paragraphs
(c)(5)(xiii), (c)(5)(xiv), (d)(8), and (d)(9) will not apply; and
(b) As part of its internal risk management control system, a
supervised investment bank holding company must establish, document,
and maintain procedures for the detection and prevention of money
laundering and terrorist financing.
Sec. 240.17i-5. Record creation, maintenance, and access requirements
for supervised investment bank holding companies.
(a) A supervised investment bank holding company shall make and
keep current the following records:
(1) A record reflecting the results of stress tests, conducted by
the supervised investment bank holding company at least once each
quarter, of the affiliate group's funding and liquidity with respect to
the following events:
(i) A credit rating downgrade of the supervised investment bank
holding company;
(ii) An inability of the supervised investment bank holding company
to access capital markets for unsecured short-term funding;
(iii) An inability of the supervised investment bank holding
company to move liquid assets across international borders when the
events described in paragraphs (a)(1)(i) or (ii) of this section occur;
and
(iv) An inability of the supervised investment bank holding company
to access credit or assets held at a particular institution when the
events described in paragraphs (a)(1)(i) or (ii) of this section occur;
(2) The supervised investment bank holding company's contingency
plan to respond to the events outlined in paragraphs (a)(1)(i) through
(iv) of this section;
(3) A record of the basis for the determination of the credit risk
weight and internal credit rating, if applicable, for each
counterparty; and
(4) A record of the calculations of allowable capital and
allowances for market, credit, and operational risk computed currently
at least once each month on a consolidated basis.
(b) Except as provided in paragraph (c) of this section, the
supervised investment bank holding company shall preserve for a period
of not less than three years in an easily accessible place using any
storage media acceptable under Sec. 240.17a-4(f):
(1) The documents created in accordance with paragraph (a) of this
section;
(2) All notices of intention, amendments thereto, and other
documentation and information filed with the Commission pursuant to
Sec. 240.17i-2, and any responses thereto;
(3) All reports and notices filed by the supervised investment bank
holding company pursuant to Sec. 240.17i-6;
(4) All notices filed by the supervised investment bank holding
company pursuant to Sec. 240.17i-8; and
(5) Records documenting the system of internal risk management
controls required to be established pursuant to Sec. 240.17i-4,
including written guidelines, policies, and procedures.
(c) A supervised investment bank holding company may maintain the
records specified in paragraph (b) of this section either at the
supervised investment bank holding company, at an affiliate, or at a
records storage facility, provided that the records are located within
the United States. If the records are maintained by an entity other
than the supervised investment bank holding company, the supervised
investment bank holding company shall file with the Commission a
written undertaking in a form acceptable to the Commission from the
entity, signed by a duly authorized person at the entity maintaining
the records, to the effect that the records will be treated as if the
supervised investment bank holding company were maintaining the records
pursuant to this section and that the entity maintaining the records
undertakes to permit examination of those records at any time or from
time to time during business hours by representatives or designees of
the Commission and to promptly furnish the Commission or its designee a
true, correct, complete and current copy of all or any part of those
records in paper, or electronically if the records are stored
electronically, as specified by the Commission's representative or
designee. The election to store records pursuant to the provisions of
this paragraph (c) shall not relieve the supervised investment bank
holding company from any of its responsibilities under this section or
Sec. 240.17i-6.
(d) All information created pursuant to this section and obtained
by the Commission from the supervised investment bank holding company
shall be accorded confidential treatment to the extent permitted by
law.
Sec. 240.17i-6. Reporting requirements for supervised investment bank
holding companies.
(a) Monthly and quarterly reports. The supervised investment bank
holding company shall file:
(1) A report as of the end of each month, filed not later than 30
calendar days after the end of the month, Except that the monthly
report need not be filed for a month-end that coincides with a fiscal
quarter-end. The monthly report shall include:
(i) A consolidated balance sheet and income statement (including
notes to the financial statements) and statements of allowable capital
and allowances for market, credit, and operational risk computed
pursuant to Sec. 240.17i-7 for the affiliate group, Except that the
consolidated balance sheet and income statement for the first month of
the fiscal year may be filed at a time to which the Commission agrees
(when making a determination pursuant to Sec. 240.17i-2(d)(2));
(ii) A graph reflecting, for each business line, the daily intra-
month Value at Risk;
(iii) Consolidated credit risk information, including:
(A) Aggregate current exposure and current exposures (including
commitments) for the 15 largest exposures listed by counterparty;
(B) Aggregate maximum potential exposure and maximum potential
exposures for the 15 largest exposures listed by counterparty; and
(C) A summary report reflecting the geographic distribution of the
supervised investment bank holding company's exposures, on a
consolidated basis, for each of the top ten countries to which it is
exposed (by residence of the main operating group of the counterparty);
and
(iv) Certain risk reports the supervised investment bank holding
company regularly provides to the persons responsible for managing risk
for the affiliate group that the Commission may request from time to
time.
(2) A report as of the end of each fiscal quarter, filed not later
than 35 calendar days after the end of the quarter, which shall include
(except as provided in paragraph (a)(3) below):
(i) The information contained in the monthly report, as set forth
in paragraph (1) above;
(ii) A consolidating balance sheet and income statement for the
affiliate group,
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which shall break out information regarding each material affiliate
into separate columns, but may consolidate information regarding
affiliate group entities that are not material affiliates into one
column;
(iii) The results of backtesting of all models used to compute
allowable capital and allowances for market and credit risk indicating,
for each model, the number of backtesting exceptions;
(iv) A description of all material pending legal or arbitration
proceedings involving the supervised investment bank holding company or
any member of the affiliate group that are required to be disclosed by
the supervised investment bank holding company under generally accepted
accounting principles; and
(v) The aggregate amount of unsecured borrowings and lines of
credit, segregated into categories, scheduled to mature within twelve
months from the most recent fiscal quarter as to each material
affiliate.
(3) For a quarter-end that coincides with the supervised investment
bank holding company's fiscal year-end, the supervised investment bank
holding company need not include in its filing consolidated and
consolidating balance sheets and income statements.
(b) Organizational chart. The supervised investment holding company
shall file, concurrently with its quarterly report for the quarter-end
that coincides with the supervised investment bank holding company's
fiscal year-end, an organizational chart, as of the investment bank
holding company's fiscal year end. Quarterly updates should be provided
where a material change in the information provided to the Commission
has occurred.
(c) Additional reports. Upon receiving notice from the Commission,
the supervised investment bank holding company shall file other
information as the Commission may request in order to monitor the
supervised investment bank holding company's financial or operational
condition, risk management system, and transactions and relationships
among members of the affiliate group.
(d) Annual audit report.
(1) A supervised investment bank holding company shall file an
annual audit report as of the end of the supervised investment bank
holding company's fiscal year, that includes:
(i) Consolidated financial statements (including notes to the
financial statements) for the supervised investment bank holding
company. The audited financial statements must include a supporting
schedule containing statements of allowable capital and allowances for
market, credit and operational risk computed in accordance with Sec.
240.17i-7. The audit must be conducted by a registered public
accounting firm (as that term is defined at 15 U.S.C. 7201(a)(12)) in
accordance the rules promulgated by the Public Company Accounting
Oversight Board; and
(ii) A supplemental report entitled ``Accountant's Report on
Internal Risk Management Control System'' prepared by the registered
public accounting firm (as that term is defined at 15 U.S.C.
7201(a)(12)) indicating the results of the accountant's review of the
internal risk management control system established and documented by
the supervised investment bank holding company in accordance with Sec.
240.17i-4 and utilized by the affiliate group. This review must be
conducted by the accountant in accordance with procedures agreed to by
the supervised investment bank holding company and the accountant
conducting the review. The agreed-upon procedures are to be performed
and the report is to be prepared in accordance with the rules
promulgated by the Public Company Accounting Oversight Board. The
purpose of the review is to confirm that the internal risk management
control system complies with the requirements of Sec. 240.17i-4 and
that the supervised investment bank holding company and its affiliate
group are adhering to the requirements of that internal risk management
control system. The supervised investment bank holding company must
file, prior to the commencement of the review, the procedures for
conducting the audit agreed to by the supervised investment bank
holding company and the accountant (pursuant to paragraph (d)(1) of
this section). Prior to the commencement of each subsequent review, the
supervised investment bank holding company shall file with the
Commission a notice of any changes to the agreed-upon procedures.
(2) Annual audit reports prepared pursuant to this paragraph (d)
shall be prepared as of the same date as the annual audit of the
supervised investment bank holding company's affiliated broker or
dealer.
(3) Annual audit reports prepared pursuant to this paragraph (d)
shall be filed not later than 65 calendar days after the end of the
fiscal year.
(e) Consolidating Balance Sheet and Income Statement. The
supervised investment bank holding company shall file, concurrently
with the annual audit report, an unaudited consolidating balance sheet
and income statement, as of the supervised investment bank holding
company's fiscal year-end, for the affiliate group.
(f) Extensions and exemptions. Upon the written request of the
supervised investment bank holding company, or on its own motion, the
Commission may conditionally or unconditionally grant or deny an
extension of time or an exemption from any of the requirements of
paragraphs (a) through (e) of this section to the extent that such
exemption or extension of time is necessary or appropriate in the
public interest or for the protection of investors.
(g) When filed. The reports required to be filed pursuant to this
section shall be considered filed when two copies are received at the
Commission's principal office in Washington, DC. The copies shall be
addressed to the Division of Market Regulation, Office of Financial
Responsibility.
(h) Confidentiality. All reports and statements filed by the
supervised investment bank holding company with the Commission pursuant
to this section shall be accorded confidential treatment to the extent
permitted by law.
Sec. 240.17i-7. Calculations of allowable capital and risk allowances
or alternative capital assessment.
(a) Computation of allowable capital. The supervised investment
bank holding company must compute allowable capital on a consolidated
basis as the aggregate of the following:
(1) Common shareholders' equity on the consolidated balance sheet
of the supervised investment bank holding company less:
(i) Goodwill;
(ii) Deferred tax assets, except those permitted for inclusion in
Tier 1 capital by the Board of Governors of the Federal Reserve (12 CFR
225, Appendix A);
(iii) Other intangible assets; and
(iv) Other deductions from common stockholders' equity as required
by the Board of Governors of the Federal Reserve in calculating Tier 1
capital (as defined in 12 CFR 225, Appendix A).
(2) Cumulative and non-cumulative preferred stock, except that the
amount of cumulative preferred stock may not exceed 33% of the items
included in allowable capital pursuant to paragraph (a)(1) of this
section, excluding cumulative preferred stock, provided that:
(i) The stock does not have a maturity date;
(ii) The stock cannot be redeemed at the option of the holder of
the instrument;
(iii) The stock has no other provisions that will require future
redemption of the issue; and
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(iv) The issuer of the stock can defer or eliminate dividends; and
(3) The sum of the following items on the consolidated balance
sheet, to the extent that sum does not exceed the sum of the items
included in allowable capital pursuant to paragraphs (a)(1) and (a)(2)
of this section:
(i) Cumulative preferred stock in excess of the 33% limit specified
in paragraph (a)(2) and subject to the conditions of paragraphs
(a)(2)(i) through (iv) of this section;
(ii) Subordinated debt if the original weighted average maturity of
the subordinated debt is at least five years; each subordinated debt
instrument states clearly on its face that repayment of the debt is not
protected by any Federal agency or the Securities Investor Protection
Corporation; the subordinated debt is unsecured and subordinated in
right of payment to all senior indebtedness of the holding company; and
the subordinated debt instrument permits acceleration only in the event
of bankruptcy or reorganization of the holding company under Chapters 7
(liquidation) (11 U.S.C. 7) and 11 (reorganization) (11 U.S.C. 11) of
the U.S. Bankruptcy Code; and
(iii) As part of the investment bank holding company's notice of
intention, the investment bank holding company may request to include,
for a period of three years after the adoption of this Rule (or such
other period as the Commission may approve) long-term debt that has an
original weighted average maturity of at least five years and that
cannot be accelerated, except upon the occurrence of certain events as
the Commission may approve. As part of an amendment to the investment
bank holding company's notice of intention, the supervised investment
bank holding company may request permission to include long-term debt
that meets these criteria in allowable capital for an additional two
years; and
(4) Hybrid capital instruments that are permitted for inclusion in
Tier 2 capital by the Board of Governors of the Federal Reserve (12 CFR
225, Appendix A).
(b) Allowance for market risk. The supervised investment bank
holding company must compute an allowance for market risk on a
consolidated basis for all proprietary positions, including debt
instruments, equity instruments, commodity instruments, foreign
exchange contracts, and derivative contracts as the aggregate of the
following:
(1) Value at risk. The Value at Risk measures obtained by applying
one or more approved Value at Risk models to each position and
multiplying the result by the appropriate multiplication factor. Each
Value at Risk model shall meet the applicable qualitative and
quantitative requirements set forth in Sec. 240.15c3-1e(d); and
(2) Alternative method. For each position for which there is not
adequate historical data to support a Value at Risk model, the measure
obtained by computing the allowance for market risk using a method
described in the supervised investment bank holding company's notice of
intention that produces a suitable allowance for market risk for those
positions.
(c) Allowance for credit risk. The supervised investment bank
holding company must compute an allowance for credit risk for certain
assets on the consolidated balance sheet and certain off-balance sheet
items, including loans and loan commitments, exposures due to
derivatives contracts, structured financial products, other extensions
of credit, and credit substitutes in as follows:
(1) By multiplying the credit equivalent amount of the supervised
investment bank holding company's exposure to the counterparty, as
determined according to sub-paragraph (c)(1)(i) below, by the
appropriate credit risk weight of the asset or off-balance sheet item
or counterparty, as determined according to sub-paragraph (c)(1)(ii)
below, then multiplying the product by 8%, in accordance with the
following:
(i) Credit equivalent amount:
(A) Certain loans and loan commitments receivable. The credit
equivalent amount for exposures relating to certain loans and loan
commitments is determined by multiplying the nominal amount of the
contract by the following credit conversion factors:
(1) 0% credit conversion factor for loan commitments that:
(i) May be unconditionally cancelled by the lender; or
(ii) May be cancelled by the lender due to credit deterioration of
the borrower;
(2) 20% credit conversion factor for:
(i) Loan commitments of less than one year; or
(ii) Short term self-liquidating trade related contingencies,
including letters of credit;
(3) 50% credit conversion factor for loan commitments with an
original maturity of greater than one year that contain transaction
contingencies, including performance bonds, revolving underwriting
facilities, note issuance facilities and bid bonds; and
(4) 100% credit conversion factor for loans and bankers'
acceptances, stand-by letters of credit, and forward purchases of
assets, and similar direct credit substitutes;
(B) Receivables relating to derivative contracts, repurchase
agreements, reverse repurchase agreements, stock loans, stock borrows,
and other similar collateralized transactions. The credit equivalent
amount for exposures relating to derivative contracts, repurchase
agreements, reverse repurchase agreements, stock loans, stock borrows,
and other similar collateralized transactions is the sum of:
(1) The supervised investment bank holding company's current
exposure to the counterparty (as defined in paragraph (c)(1)(i)(D) of
this section); and
(2) The supervised investment bank holding company's maximum
potential exposure to the counterparty (as defined in paragraph
(c)(1)(i)(E) of this section) multiplied by the appropriate
multiplication factor. The initial multiplication factor shall be one,
unless the Commission determines pursuant to Sec. 240.17i-2(d)(2),
based on a review of the supervised investment bank holding company's
internal risk management control system and practices, including a
review of the Value at Risk model used to determine maximum potential
exposure, that another multiplication factor is appropriate;
(C) Credit equivalent amount for other assets. The credit
equivalent amount for other assets shall be the book value of the
exposure on the supervised investment bank holding company's
consolidated balance sheet or other amount as determined according to
the standards published by the Basel Committee on Banking Supervision,
as amended from time to time;
(D) The current exposure is the current replacement value of a
counterparty's positions, after applying the effect of netting
agreements with that counterparty meeting the requirements of Sec.
240.15c3-1e(c)(4)(iv) and taking into account the value of collateral
from the counterparty in accordance with Sec. 240.15c3-1e(c)(4)(v);
(E) The maximum potential exposure is the Value at Risk of the
counterparty's positions with the member of the affiliate group, after
applying netting agreements with that counterparty meeting the
requirements of Sec. 240.15c3-1e(c)(4)(iv) and taking into account the
value of collateral from the counterparty in accordance with Sec.
240.15c3-1e(c)(4)(v)) obtained using a Value at Risk model that meets
the applicable requirements of Sec. 240.15c3-1e(d) and the current
replacement value of the counterparty's positions with the
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member of the affiliate group, Except that for repurchase agreements,
reverse repurchase agreements, stock lending and borrowing, and similar
collateralized transactions, maximum potential exposure shall be
calculated using a time horizon of not less than five days;
(ii) Credit risk weights.
(A) General. The credit risk weights that shall be applied to
certain assets and counterparties shall be determined according to
standards published by the Basel Committee on Banking Supervision, as
modified from time to time;
(B) Receivables covered by guarantees. For the portion of a current
exposure covered by a written guarantee, where that guarantee is an
unconditional and irrevocable guarantee of the due and punctual payment
and performance of the obligation and the supervised investment bank
holding company or member of the affiliate group can demand payment
after any payment is missed without having to make collection efforts,
the supervised investment bank holding company or member of the
affiliate group may substitute the credit risk weight of the guarantor
for the credit risk weight of the counterparty; and
(iii) Credit derivatives. Upon a determination by the Commission
pursuant to Sec. 240.17i-2(d), the supervised investment bank holding
company may use credit derivatives to reduce its allowance for credit
risk; or
(2) Upon a determination by the Commission pursuant to Sec.
240.17i-2(d), using a calculation consistent with standards published
by the Basel Committee on Banking Supervision in International
Convergence of Capital Measurement and Capital Standards (July 1988),
as modified from time to time;
(d) Allowance for operational risk. A supervised investment bank
holding company shall compute an allowance for operational risk on a
consolidated basis in accordance with the standards published by the
Basel Committee on Banking Supervision, as amended from time to time.
Sec. 240.17i-8. Notification provisions for supervised investment
bank holding companies.
(a) A supervised investment bank holding company shall send notice
promptly (but within 24 hours), in accordance with paragraph (c) of
this section, after the occurrence of the following events:
(1) The occurrence of any backtesting exception, determined in
accordance with Sec. 240.15c3-1e(d)(1)(iii) or (iv), that would
require that the supervised investment bank holding company use a
higher multiplication factor in the calculation of its allowances for
market or credit risk;
(2) The early warning indications of low capital as the Commission
may agree;
(3) A material affiliate declares bankruptcy or otherwise becomes
insolvent;
(4) The supervised investment bank holding company becomes aware
that a nationally recognized statistical rating organization has
determined to reduce materially its assessment of the creditworthiness
of a material affiliate or the credit rating(s) assigned to one or more
outstanding short or long-term obligations of an material affiliate;
(5) The supervised investment bank holding company files a Form 8-K
(Sec. 249.308) with the Commission;
(6) The supervised investment bank holding company becomes aware
that any financial regulatory agency or self-regulatory organization
has taken significant enforcement or regulatory action against a
material affiliate; or
(7) The supervised investment bank holding company becomes
ineligible to be supervised by the Commission as a supervised
investment bank holding company.
(c) Every notice required to be given or transmitted pursuant to
this section shall be given or transmitted by telegraphic notice or
facsimile transmission to the Division of Market Regulation, Office of
Financial Responsibility at the principal office of the Commission in
Washington, DC. The notices filed under this section shall be accorded
confidential treatment to the extent permitted by law.
(d) Upon the written request of the supervised investment bank
holding company, or on its own motion, the Commission may conditionally
or unconditionally grant or deny an extension of time or an exemption
from any of the requirements of this Rule 17i-8 to the extent that such
exemption or extension of time is necessary or appropriate in the
public interest or for the protection of investors.
Dated: June 8, 2004.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-13413 Filed 6-18-04; 8:45 am]
BILLING CODE 8010-01-P