FOR IMMEDIATE RELEASE 98-112 Commission to Consider One Item at an Open Meeting Washington, D.C., October 21, 1998 -- The Securities and Exchange Commission will consider one item at an open meeting conducted under the Government in the Sunshine Act on Wednesday, October 21, at 10:00 a.m. The meeting will be held in Room 1C30 at the Commission's headquarters building, 450 Fifth Street, N.W., Washington, D.C. The item for discussion is: - whether to adopt Rules 3b-12, 3b-13, 3b-14, 3b-15, 11a1-6, 15a-1, 15b9-2, 15c3-4, 17a-12, 36a1-1, and 36a1-2 under the Securities Exchange Act of 1934 (Exchange Act) and amendments to Rule 30-3 and Exchange Act Rules 8c-1, 15b1-1, 15c2-1, 15c2-5, 15c3-1, 15c3-3, 17a-3, 17a-4, 17a-5, 17a-11, and Form X-17A-5 (FOCUS report). The rules and rule amendments tailor capital, margin, and other broker-dealer regulatory requirements to a class of registered dealers, called OTC derivatives dealers, that are active in over-the-counter derivatives markets. Registration as an OTC derivatives dealer is an alternative to registration as a fully regulated broker-dealer, and is available to entities that engage in dealer activities in eligible OTC derivative instruments and that meet certain financial responsibility and other requirements. # # # Any member of the public who requires auxiliary aids such as a sign language interpreter or material on tape to attend a public meeting should contact Rochelle Franks, office of Administrative and Personnel Management, to make arrangements. Ms. Franks can be reached at TTY number (202) 942-9558. If you are calling from a non-TTY number, please call the Relay Service at 1-800-877- 8339. SUMMARY OF ALTERNATIVE REGULATORY FRAMEWORK FOR OVER-THE-COUNTER DERIVATIVES DEALERS Open Meeting of the Securities and Exchange Commission October 21, 1998 The Commission today is considering the adoption of an alternative regulatory framework for a class of registered dealers active in over-the-counter ("OTC") derivatives markets. Participation in this alternative regulatory framework is voluntary. Dealers that confine their activities to eligible OTC derivatives and related securities trading may choose to register as OTC derivatives dealers or as fully regulated broker-dealers. This new framework will allow U.S. securities firms to compete more effectively in global OTC derivatives markets by carefully tailoring capital and other regulatory requirements for the OTC derivatives business. Need for a Regulatory Framework Tailored to the OTC Derivatives Business. Currently, a firm that wants to do business in OTC derivative securities in the United States, such as in OTC options on government securities, is required to register with the SEC as a broker-dealer. As a registered broker-dealer, a firm becomes subject to all of the rules applicable to other securities firms, including rules governing margin and capital. In general, the costs of broker-dealer regulation for firms conducting an OTC derivatives business have encouraged firms to divide their activities, placing their non-securities activities in separate, unregistered affiliates, and conducting their securities activities abroad. In some instances, fragmenting a firm's OTC derivatives business can hinder a firm's ability to compete for business and to manage risk. For example, some counterparties prefer to deal with a firm only through one affiliate which is capable of transacting business across a broad range of OTC derivative products. Dealers are also better able to reduce their credit exposure to a single counterparty by entering into agreements that provide for the netting of all outstanding financial obligations between the dealer and the counterparty. These netting agreements, however, work best if all securities and non- securities transactions are done through a single entity. Regulatory Framework for OTC Derivatives Dealers. Under the regulatory regime the Commission is considering today, dealers conducting an OTC derivatives business may choose to register with the Commission as an OTC derivatives dealer, rather than as a broker-dealer. OTC derivatives dealers will be permitted to conduct transactions involving both securities and non-securities OTC derivative products. They will have to limit their securities activities to dealing in eligible OTC derivative instruments, and to engaging in certain securities activities relating to conducting an OTC derivatives business. OTC derivatives dealers will also have to meet certain financial responsibility and other requirements. OTC derivatives dealers will primarily act as counterparties in individually negotiated OTC derivatives transactions. These dealers may also issue and reacquire securities they have issued, and engage in other related activities, including cash management and portfolio management. The new framework, however, limits an OTC derivatives dealer from acting like a hedge fund or from engaging in excessive levels of proprietary trading. Perhaps the most significant aspect of this new framework involves the modified capital treatment of OTC derivatives dealers, including the use of value-at-risk ("VAR") models for determining market risk charges. In order to use a VAR model, an OTC derivatives dealer must establish a comprehensive system of internal controls for monitoring and managing risks associated with its business activities, including operational, market, credit, liquidity, leverage, and legal risks. This is a major step in the Commission's approach to capital that promises to give the Commission valuable experience in evaluating the broader use of models for regulatory capital purposes. Finally, OTC derivatives dealers will be exempted from certain margin requirements typically applied to broker-dealers, provided they comply with the more flexible margin provisions customarily applied to banks. They will also be exempted from the Securities Investor Protection Act, as well as from SRO membership. This new regulatory framework uses the Commission's exemptive authority to creatively respond to market conditions. The Commission expects that the framework it is considering today will provide U.S. securities firms with greater flexibility in structuring their OTC derivatives activities. Chairman Arthur Levitt Jr. U.S. Securities and Exchange Commission S.E.C. Open Meeting October 21, 1998 Opening Statement Good morning. This is an open meeting of the Securities and Exchange Commission. We are here today to consider adoption of a new regulatory framework for the regulation of a class of broker- dealers active in the over-the-counter derivatives markets. This new framework is part of the Commission's continuing effort to update its regulations to keep pace with market innovations. Technology and globalization have had a significant impact on the operation of the securities markets. Recent events in Asia and other emerging markets underscore the fact that securities markets are becoming increasingly inter-related and complex. These economic and technological changes provide new opportunities for securities firms and investors. But they also pose new challenges to regulators in meeting the demands of an evolving, global marketplace. To ensure that our markets can continue to operate fairly and efficiently, it is essential that we, as regulators, adapt to these innovations. In modernizing our approach, the Commission must ensure that regulation does not stifle the ability of securities firms to compete effectively. At the same time, we must ensure that well-focused regulation continues to protect investors. The alternative framework we are considering responds to the changes in the way business is being conducted today. Currently, a significant portion of the over-the-counter derivatives business is conducted in overseas or domestic unregistered affiliates of U. S. broker-dealers. This is due to the high costs that U. S. regulation currently imposes on this business. The alternative framework is specifically crafted to reduce these costs. It addresses the need to improve the efficiency and competitiveness of U.S. securities firms in the global marketplace. Most importantly, it achieves these goals without compromising the Commission's high standards for investor protection and financial integrity. Under this new regulation, securities firms may, at their choice, combine all of their OTC derivatives activities in one entity that will be subject to requirements carefully tailored to that business. Such a structure would help bring the Commission's regulation more closely in line with the way the OTC derivatives business has evolved -- thus allowing U.S. firms to compete more effectively in the global marketplace. And, by encouraging firms to move their OTC derivative securities business back to the U.S., we will be able to more effectively monitor those activities. The framework also recognizes the securities industry's development of new risk-management techniques. Firms that become subject voluntarily to the framework will be permitted to use statistical models that measure risk to calculate their regulatory capital charges. I believe that this alternative framework is a significant contribution to our efforts to modernize the way we regulate our securities markets. Flexibility, choice and investor protection are the goals underlying this rule. By balancing the competitive needs of U.S. securities firms with responsible regulation, the alternative framework represents the new frontier in global regulatory risk management. I want to commend the staff for its superb work on this rule. You have established a firm foundation for further regulatory innovation in the global marketplace. I would now like to ask Richard Lindsey, Director of the Division of Market Regulation, to describe, in more detail, these new regulations before the Commission.