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Federal Register / Vol. 86, No. 149 / Friday, August 6, 2021 / Notices
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Act rule 18a8 must simultaneously submit to the Commission any notifications relating to capital that it must submit to the UK authorities.
However, UK notification requirements do not address a failure to adhere to the simplified net liquid assets test required by the first prong of the second additional capital condition. Moreover, due to the differences between Exchange Act rule 18a1 and the Basel capital standard discussed above, a Covered Entity could fall out of compliance with the requirements of the first prong but still remain in compliance with the requirements of the Basel capital standard. Accordingly, the third prong requires the Covered Entity to notify the Commission if the firm fails to meet the requirements of the first prong. This will alert the Commission of potential issues with the Covered Entitys financial condition that could pose risks to the firms customers and counterparties.
The fourth prong of the additional capital condition in the proposed Order would have required the Covered Entity to include its most recently filed statement of financial condition whether audited or unaudited with its initial notice to the Commission of its intent to rely on substituted compliance.
No commenters raised specific concerns with this condition and the Order includes it as proposed, but now it is the fourth prong of the second additional capital condition.268
The commenter who opposed additional capital conditions stated that their burdens would be disruptive to market participants and could cause Covered Entities to exit the U.S.
security-based swap market.269
However, as discussed below, based on other comments and staff analysis of the balance sheets of the PRA-designated firms, this may not be case. For example, the commenter stated that the Covered Entities expected to register with the Commission transact predominantly in securities and derivatives and do not extensively engage in unsecured lending or other activities more typical of banks.270 The commenter based this statement on a high-level review of public information about the balance sheets of six Covered Entities undertaken to create the 268 See para. c1iiiA4 of the Order. As discussed above, a commenter objected to the capital conditions generally and provided specific comments with respect to the first three conditions, but not the fourth condition. See SIFMA 5/3/2021
Letter at 920. This commenter did support the fourth condition as part of its recommended incremental approach to implementing the capital conditions. See SIFMA 5/3/2021 Letter at 1920.
269 See SIFMA 5/3/2021 Letter at 19.
270 SIFMA 5/3/2021 Letter at 1011.

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Balance Sheet Table.271 Based on this review, the commenter stated that the vast majority of each firms total assets consists of cash and cash equivalents, collateralized agreements, trade and other receivables, and other trading and financial assets. The commenter characterized these assets as being liquid. The commenter stated further that the amount of illiquid assets held by these firms as a proportion of their balance sheets is comparable to the proportion of illiquid assets held by U.S. broker-dealers. The commenter also stated that the long-term debt, subordinated debt, and equity of the Covered Entities, as a proportion of their total liabilities and equity, also was comparable to U.S. broker-dealers.
Moreover, based on the Balance Sheet Table and the staffs analysis of the public financial reports of the PRAdesignated investment firms, these firms report total liquid assets that exceed total liabilities and, in most cases, substantially in excess of $100 million.
This information suggests that Covered Entities may be able to meet the second additional capital condition without having to significantly adjust their assets, liabilities, and equity.
Moreover, the modifications to the second additional capital condition that incorporate how Covered Entities categorize liquid and illiquid assets and calculate risk-weighted assets, will allow them to use existing processes to derive the measures needed to adhere to the condition. Therefore, while the condition imposes a simplified net liquid assets test and associated recordkeeping requirement, it may not cause Covered Entities to withdraw from the U.S. security-based swap market. Nonetheless, it is possible that the simplified net liquid assets test and associated recordkeeping burden could cause a Covered Entity to withdraw from the U.S. security-based swap market. However, as discussed above, this additional capital condition is designed to produce a comparable regulatory outcome with respect to SBS
Entities subject to Exchange Act rule 18a1 and Covered Entities applying substituted compliance with respect to that rule.
In response to a specific request for comment in the proposed Order, a commenter stated that the capital conditions would not be necessary if the balance sheets of the Covered Entities seeking to apply substituted compliance with respect to Exchange Act rule 18a 1 were similar to the balance sheets of 271 See SIFMA 5/3/2021 Letter at 1011, Appendix C.

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U.S. broker-dealers.272 However, the Commission also sought comment on whether the capital conditions would serve to ensure that these firms do not engage in non-securities business activities that could impair their liquidity.273 Two commenters expressed support for the capital conditions.274
The fact that today certain Covered Entities have liquid balance sheets does not mean this will hold true in the future or with respect to other potential registrants. For these reasons, it is appropriate to include the additional capital condition with respect to applying substituted compliance to Exchange Act rule 18a1.
It would not be appropriate to take a more incremental approach to the additional capital conditions as suggested by a commenter.275
Substituted compliance is premised on comparable regulatory outcomes. As discussed above, the additional capital condition is designed to supplement the UK capital laws in order to achieve a comparable regulatory outcome in terms of the net liquid assets test of Exchange Act rule 18a1. Delaying the implementation of the additional capital condition would mean that Covered Entities are operating as registered security-based swap dealers under a capital standard that does impose the net liquid assets test. This would be inconsistent with the objective of substituted compliance and could increase risk to the U.S. security-based swap markets and participants in those markets. Moreover, the modifications to the capital condition discussed above may ease the implementation burdens.
In addition, the Commission does not believe a commenters suggestion for an alternative capital condition requiring a Covered Entity to maintain $100 million of HQLA as defined in the LCR
requirements would be adequate in terms of achieving comparable regulatory outcomes with Exchange Act rule 18a1.276 The Balance Sheet Table indicates that Covered Entities have total liabilities of many billions of dollars.277 A condition requiring $100
million in HQLA would not cover these liabilities and would not impose a net liquid assets test.
Finally, the Commission has modified the citations to UK laws in the capital 272 See SIFMA 5/3/2021 Letter at 10; UK
Substituted Compliance Notice and Proposed Order, 86 FR at 18407.
273 UK Substituted Compliance Notice and Proposed Order, 86 FR at 18407.
274 See Better Markets Letter at 7; Americans for Financial Reform Education Fund Letter at 12.
275 See SIFMA 5/3/2021 Letter at 1920.
276 See SIFMA 5/3/2021 Letter at 1920.
277 See SIFMA 5/3/2021 Letter at Appendix C.

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