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Federal Register / Vol. 86, No. 149 / Friday, August 6, 2021 / Notices away as capital without the need to enter into a special loan arrangement with an affiliate. 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 these reasons, the Commission disagrees with the commenter who stated that additional capital conditions were unnecessary and inconsistent with the Commissions substituted compliance framework.228 As discussed above, there are key differences between the net liquid assets test of Exchange Act rule 18a1 and the Basel capital standard applicable to Covered Entities.
Those differences in terms of the types of assets that count as regulatory capital and how regulatory capital is calculated lead to different regulatory outcomes.229
In particular, the net liquid assets test produces a regulatory outcome in which the SBS Entity has more than one dollar of highly liquid assets for each dollar of unsubordinated liabilities.230 The Basel capital standardwhile having measures designed to promote liquiditydoes not produce this regulatory outcome.231 Therefore, an additional capital condition is needed to bridge the gap between these two capital standards and thereby achieve more comparable regulatory outcomes in terms of promoting liquid balance sheets for SBS Entities and Covered Entities.
However, in seeking to bridge this regulatory gap, the additional condition should take into account that Covered Entities are or will be subject to UK laws and measures designed to promote liquidity. As a commenter stated, Covered Entities are or will be subject to: 1 Requirements to hold an amount of HQLA to meet expected payment obligations under stressed conditions for thirty days LCR requirement; 232
228 SIFMA

5/3/2021 Letter at 10.
Better Markets Letter at 67 comparing the differences between Exchange Act rule 18a1
and the Basel capital standard and stating that not only are the UKs capital requirements different from the SECs in both form and substance, but the regulatory outcome is not comparable.
230 As discussed above, highly liquid assets under Exchange Act rule 18a1 are also known as allowable assets and generally are consistent the LCRs HQLA.
231 The Basel capital standard does not preclude a firm from having more than a dollar of highly liquid assets for each dollar of unsubordinated liabilities. Thus, a firm operating pursuant to the standard may structure its assets and liabilities in a manner that achieves this result. However, the standard does not mandate this result. Rather, it will accommodate a firm that seeks to maintain this level of liquidity on its own accord.
232 See Liquidity Coverage RequirementUK
Designated Investment Firms part of PRA Rulebook.

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229 See
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2 requirements to hold a diversity of stable funding instruments sufficient to meet long-term obligations under both normal and stressed conditions NSFR
requirements; 233 3 requirements to perform liquidity stress tests and manage liquidity risk internal liquidity assessment requirements; 234
and 4 regular PRA reviews of a Covered Entitys liquidity risk management processes PRA liquidity review process.235 These UK laws and measures will require Covered Entities to hold significant levels of liquid assets. However, the laws and measures on their own, do not impose a net liquid assets test. Therefore, an additional condition is necessary to supplement these requirements.
The Commission has taken into account the UK liquidity laws and measures discussed above in making a substituted compliance determination with respect to Exchange Act rule 18a 1, and in tailoring additional capital conditions designed to achieve comparable regulatory outcomes. The LCR, NSFR, and internal liquidity assessment requirements collectively will require Covered Entities to maintain pools of unencumbered HQLA
to cover potential cash outflows during a 30-day stress period, to fund long-term obligations with stable funding instruments, and to manage liquidity risk. These requirementscoupled with the PRAs supervisory reviews of the liquidity risk management practices of Covered Entitieswill require Covered Entities to hold significant levels of liquid assets. These requirements and measures in combination with the other capital requirements applicable to Covered Entities provide a starting foundation for making a positive substituted compliance determination with respect to the capital requirements of Exchange Act section 15Fe and Exchange Act rule 18a1.236 However, more is needed to achieve a comparable regulatory outcome to the net liquid assets test of Exchange Act rule 18a1.
For these reasons, the Order includes an additional capital condition that will impose a simplified net liquid assets test.237 This simplified test will require 233 See UK CRR, Article 413; see also PRA, Consultation Paper CP5/21, Implementation of Basel Standards February 2021 proposed to take effect on January 1, 2022.
234 See Internal Liquidity Adequacy Assessment part of the PRA Rulebook.
235 See SIFMA 5/3/2021 Letter at 1215.
236 See Better Markets Letter at 8 recommending that the Commission consider denying substituted compliance with respect to these Exchange Act capital requirements.
237 See Americans for Financial Reform Education Fund Letter at 1 The Commission should require
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the Covered Entity to hold more than one dollar of liquid assets for each dollar of liabilities. The simplified net liquid assets testwhen coupled with the PRA capital requirements,238 LCR
requirements, NSFR requirements, internal liquidity assessment requirements, and PRA liquidity review processis designed to produce a regulatory outcome that is comparable to the net liquid assets test of Exchange Act rule 18a1 i.e., sufficient liquidity to cover liabilities and to promote the maintenance of highly liquid balance sheets.
In response to comments, the Commission has modified the first three prongs of the additional capital condition from the proposed Order.239
In particular, the first and third prongs are being combined into a single prong of the second additional capital condition.240 Under this prong, the Covered Entity must maintain liquid assets as defined in the capital condition that have an aggregate market value that exceeds the amount of the Covered Entitys total liabilities by at least: 1 $100 million before applying a deduction specified in the capital condition; and 2 $20 million after applying the deduction.241 Thus, the condition increases the scope of the liquid assets requirement so that it must that SBS entities who want to operate in the U.S.
comply with the Net Liquid Assets test under the Exchange Act rule 18a1 rather than the Basel capital standards applicable under UK and EU
regulations..
238 See, e.g., CRR, Part 1 Own Funds, including Tier 1 capital and Part 2 Capital Requirements.
239 See Americans for Financial Reform Education Fund Letter at 1 The Commission should require that SBS entities who want to operate in the U.S.
comply with the Net Liquid Assets test under the Exchange Act rule 18a1 rather than the Basel capital standards; SIFMA 5/3/2021 Letter at 17
raising concerns that the use of the concept of allowable assets under Exchange Act rule 18a1
in the first condition would require Covered Entities to re-categorize every asset on their balance sheets, which also pertains to the second condition, and seeking clarification on to how to calculate equity capital and allocate it to highly liquid assets equal to or greater than $100 million.
240 The first prong of the proposed capital condition would have required a Covered Entity to maintain an amount of assets that are allowable under Exchange Act rule 18a1, after applying applicable haircuts under the Basel capital standard, that equals or exceeds the Covered Entitys current liabilities coming due in the next 365 days. The second prong would have required the Covered Entity to make a quarterly record related to the first prong. The third prong would have required the Covered Entity to maintain at least $100 million of equity capital composed of highly liquid assets as defined in the Basel capital standard. See UK Substituted Compliance Notice and Proposed Order, 86 FR at 1838788.
241 See para. c1iiiA1 of the Order. The definition of liquid assets and the method of calculating the deductions are discussed below.

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