[ by Howard Haykin ]

The staff of the SEC's Division of Trading and Markets issued a "no-action letter" setting forth conditions under which broker-dealers may treat certain foreign equity securities as having a “ready market” under SEA Rule 15c3-1(c)(11)(i), and thus subject to haircuts under SEA Rule 15c3-1(c)(2)(vi)(J).

The immediate impact of the SEC staff's no-action letter will be to expand the number of foreign securities eligible as foreign margin stock under Regulation T of the Board of Governors of the Federal Reserve System.

Background & Discussion.   SEA Rule 15c3-1(c)(2)(vii) requires a broker-dealer to deduct 100% of the carrying value of - i.e., take a 100% haircut on - securities it holds in its proprietary account for which there is no ready market, as defined in paragraph (c)(11) of the rule, or which cannot be publicly offered or sold because of statutory, regulatory or contractual arrangements or other restrictions.

And what's a "ready market?"  According SEA Rule 15c3-1(c)(11)(i), “ready market” includes “a market in which there exists independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined for forming to trade cua particular security almost instantaneously and where payment will be received in settlement of a sale at such price within a relatively short time constom.”

Currently under SEA Rule 15c3-1, broker-dealers may treat foreign equity securities ...  that are listed on the FTSE World Index as having a “ready market,” and subject to the haircut requirements under paragraph  (c)(2)(vi)(J) of the rule.  The FTSE World Index currently is limited to about 2,300 securities.

Yet, limitations like this prompt FINRA member firms to express interest in expanding the criteria for recognizing foreign equity securities as having a “ready market” under SEA Rule 15c3-1 to include more than those that are listed on the FTSE World Index.  They suggest that there are many more issuers of a substantial size for which there is a ready market within the meaning of SEA Rule 15c3-1. 

FINRA has responded to such member firms - going to the SEC staff and requesting and obtaining no-action relief to expand the definition of “ready market” regarding foreign equity securities.

The SEC staff’s no-action letter states that foreign equity securities will be deemed as having a “ready market” ... under SEA Rule 15c3-1(c)(11) and subject to haircuts under paragraph  (c)(2)(vi)(J) of the rule if the following conditions are met:

1. The security is listed for trading on a foreign securities exchange located within a country that is recognized on the FTSE World Index, where the security has been trading on that exchange for at least the previous 90 days;
2. Daily quotations for both bid and ask or last sale prices for the security provided by the foreign securities exchange on which the security is traded are continuously available to broker-dealers in the U.S,, through an electronic quotation system;
3. The median daily trading volume (calculated over the preceding 20 business day period) of the foreign equity security on the foreign securities exchange on which the security is traded is either at least 100,000 shares or $500,0004; and
4. The aggregate unrestricted market capitalization in shares of such security exceeds $500 million over each of the preceding 10 business days.

Yet, what happens when a qualifying foreign equity security ceases to meet one or more of the conditions set forth above?  Will it continue to be considered to have a “ready market”?

Yes, for 5 business days from the date the security ceases to meet the conditions. After 5 business days, the security will be considered to have a “ready market” only if and when it again meets all of the conditions.  

The SEC staff’s no-action letter further provides:

• Broker-dealers ("B/D's") may utilize the provisions of SEC Rule 15c3-1(c)(2)(vi)(J) to calculate the haircuts for foreign equity securities that meet all of the conditions set forth in the letter.   However, a B/D should perform this calculation independent of the haircut calculation for other securities subject to the provisions of SEA Rule 15c3-1(c)(2) (vi)(J).
• B/D's choosing to utilize the no-action relief would need to demonstrate, upon examination or inquiry, that any foreign equity security used as collateral for a margin loan met all of the conditions set forth in the letter, and to make and keep current, and maintain all relevant records in accordance with SEA Rules 17a-3 and 17a-4.

The SEC staff acknowledges that FINRA pointed out that it expects that B/D's relying on the no-action relief will maintain appropriate risk management systems to monitor for concentration, volatility, and liquidity when extending credit secured by foreign securities, and should consider imposing higher “house” maintenance margin requirements as warranted.  Measurements for computing such exposure should be reviewed at the individual account level as well as across all accounts held at the B/D.

Finally, the no-action letter states that, pursuant to SEA Rule 15c3-1, if markets can absorb only a limited number of shares of an equity security for which a ready market exists, the non-marketable portion in the proprietary or other accounts of a B/D is subject to a 100% deduction to net capital and is treated as a non-allowable asset consistent with current interpretations.

Keep in Mind That :   The no-action letter addresses foreign equity securities - meaning that options on such securities remain subject to the initial and maintenance margin requirements as set forth in FINRA Rule 4210(f)(2)(E)(iii).
 

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SEC Staff Contacts.    Direct questions concerning this Notice to:

• Managing Direct Rudolph Verra, Risk Oversight and Operational Regulation (ROOR) - (646) 315-8811;
• Director Glen Garofalo, Credit Regulation - (646) 315-8464;
• Project Manager Steve Yannolo, Credit Regulation - (646) 315-8621; or,
• Managing Director Yui Chan, ROOR - (646) 315-8426.

For further details, go to:   [ FINRA RegNote 12-58, December 2012 ].

To access a copy of the no-action letter, go to:   [ SEC No Action Letters, Trading and Markets Division,  11/28/12 ]