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Federal Register / Vol. 86, No. 145 / Monday, August 2, 2021 / Notices by a relevant authority in the EU.192 The Commission agrees with a commenter that the other proposed conditions to substituted compliance for trading relationship documentation should be retained.193
V. Substituted Compliance for Capital and Margin Requirements
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A. Proposed Approach The French Authorities Application in part requests substituted compliance in connection with requirements under the Exchange Act relating to:
CapitalCapital requirements pursuant to Exchange Act section 15Fe and Exchange Act rule 18a1 and its appendices collectively Exchange Act rule 18a1 applicable to certain SBS
Entities.194 Exchange Act rule 18a1
helps to ensure the SBS Entity maintains at all times sufficient liquid assets to promptly satisfy its liabilities, and to provide a cushion of liquid assets in excess of liabilities to cover potential market, credit, and other risks. The rules net liquid assets test standard protects customers and counterparties and mitigates the consequences of an SBS Entitys failure by promoting the ability of the firm to absorb financial shocks and, if necessary, to selfliquidate in an orderly manner.195 As 192 See paras. a5 and a6 of the Order; see also part III.B, supra. Commenters supported those additions. See FBF Letter II at 2 stating that the FBF is generally welcoming of the new general EMIR conditions that are introduced as a corollary to the above changes. As applied in the context of trading relationship documentation, trade acknowledgment and verification, they largely convey the manner in which EMIR has been interpreted.. See also SIFMA Letter II at 6 stating that we agree with the Commission that the cited provisions of EMIR are comparable to the Exchange Act trade acknowledgment and verification and trading relationship documentation requirements..
193 See Better Markets Letter at 12.
194 17 CFR 240.18a1 through 18a1d. Exchange Act rule 18a1 applies to security-based swap dealers that: 1 Do not have a prudential regulator;
and 2 are either a not dually registered with the Commission as a broker-dealer; or b are dually registered with the Commission as a special purpose broker-dealer known as an OTC derivatives dealer. Security-based swap dealers that are dually registered with the Commission as a full-service broker-dealer are subject to the capital requirements of Exchange Act rule 15c31 17 CFR 240.15c31
for which substituted compliance is not available.
See Exchange Act rule 3a716d4i making substituted compliance available only with respect to the capital requirements of Exchange Act section 15Fe and Exchange Act rule 18a1.
195 See Capital and Margin Adopting Release, 84
FR at 43879. The capital standard of Exchange Act rule 18a1 is based on the net liquid assets test of Exchange Act rule 15c31 applicable to brokerdealers. Id. The net liquid assets test seeks to promote liquidity by requiring that a firm maintain sufficient liquid assets to meet all liabilities, including obligations to customers, counterparties, and other creditors, and, in the event a firm fails financially, to have adequate additional resources to
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part of the capital requirements, security-based swap dealers without a prudential regulator also must comply with the internal risk management control requirements of Exchange Act rule 15c34 with respect to certain activities.196
MarginMargin requirements pursuant to Exchange Act section 15Fe and Exchange Act rule 18a3 for nonprudentially regulated SBS Entities.197
The margin requirements are designed to protect SBS Entities from the consequences of a counterpartys default.198
Taken as a whole, these capital and margin requirements help to promote market stability by mandating that SBS
Entities follow practices to manage the market, credit, liquidity, solvency, counterparty, and operational risks associated with their security-based swap businesses.
In proposing to provide conditional substituted compliance in connection with this part of the French Authorities Application, the Commissions preliminary view was that relevant French and EU requirements would produce regulatory outcomes that are comparable to those associated with the above capital and margin requirements, by subjecting Covered Entities to financial responsibility requirements that are appropriate to the risks associated with their security-based swap businesses.199 Substituted compliance accordingly would be conditioned on Covered Entities being subject to the French and EU provisions that, in the aggregate, establish a framework that produces outcomes comparable to those associated with the capital and margin requirements under the Exchange Act.200
However, the Commission also sought comment on whether substituted compliance with respect to Exchange Act capital requirements should be wind-down its business in an orderly manner without the need for a formal proceeding. See French Substituted Compliance Notice and Proposed Order, 85 FR at 85726. See French Authorities Application Annex 1 category 1 capital portion at 124.
196 See 17 CFR 240.15c34 and 18a1f.
197 17 CFR 240.18a3.
198 See Capital and Margin Adopting Release, 84
FR at 43947, 43949 Obtaining collateral is one of the ways OTC derivatives dealers manage their credit risk exposure to OTC derivatives counterparties. Prior to the financial crisis, in certain circumstances, counterparties were able to enter into OTC derivatives transactions without having to deliver collateral. When trigger events occurred during the financial crisis, those counterparties faced significant liquidity strains when they were required to deliver collateral.
199 See French Substituted Compliance Notice and Proposed Order, 85 FR at 85726.
200 Id. at 85726 n.49.

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subject to additional conditions.201 In particular, the Commission sought comment on the following potential conditions:
A condition that would require a Covered Entity to maintain a minimum amount of liquid assets, such as a minimum ratio of liquid assets to illiquid assets e.g., a ratio of liquid assets to illiquid assets of 80% to 20%, 70% to 30%, 60% to 40%. With respect to such a ratio, the Commission also requested comment on whether liquid and illiquid assets should be defined using the concept of assets that are allowable or not allowable as capital under Exchange Act rule 18a1.
A condition that would require a Covered Entity to be subject to a specific liquidity requirement, such as a requirement to maintain a pool of highly liquid assets to cover cash outflows during a 30-day period of stress.
A condition that a Covered Entity must maintain equity capital or Tier 1
capital at least equal to the minimum fixed-dollar capital requirements under Exchange Act rule 18a1 e.g., equity capital or Tier 1 capital of at least $20
million.
Additionally, in the Reopening Release, the Commission again sought comment on whether substituted compliance with respect to Exchange Act capital requirements should be subject to additional conditions.202 The Commission explained that the capital standard of Exchange Act rule 18a1 is a net liquid assets test. Under this standard, an SBS Entity will have more than a dollar of highly liquid assets for each dollar of unsubordinated liabilities. Covered Entities, however, are subject to capital requirements applicable to prudentially regulated entities based on the international capital standard for banks the Basel capital standard.203 The Basel capital standard counts as capital assets that Exchange Act rule 18a1 would exclude e.g., loans and most other types of uncollateralized receivables, furniture and fixtures, real estate, and initial margin posted to counterparties.
Consequently, because of the ability to include illiquid assets and margin posted away as capital, Covered Entities subject to the Basel capital standard may have less balance sheet liquidity than SBS Entities subject to Exchange Act rule 18a1. For this reason, the Commission sought comment on the following potential conditions to 201 Id.

at 8573637.
Reopening Release, 86 FR at 1834347.
203 See, e.g., Basel Committee on Banking Supervision BCBS, The Basel Framework, available at: https www.bis.org/basel_framework/.
202 See
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