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Broker-Dealers Using the Alternative Net Capital Computation under Appendix E to Rule 15c3-1

Dec. 30, 2019

A broker-dealer may apply to the Commission for authorization to use the alternative method for computing net capital (alternative net capital, or ANC, computation) contained in Appendix E to Rule 15c3-1. Under Appendix E, firms with strong internal risk management practices may apply to use the mathematical modeling methods they use to manage their own business risk, including value-at-risk (VaR) models and scenario analysis, to compute deductions from net capital for market risks and for credit risks arising from OTC derivatives transactions.

As a condition of approval, applicants effectively must maintain an “early warning” level of at least $5 billion in tentative net capital[1] and minimum levels of at least $1 billion in tentative net capital and at least $500 million in net capital. If the tentative net capital of an approved broker-dealer falls below $5 billion, it must notify the Commission immediately.[2]

Application Process

A broker-dealer that wishes to use the ANC computation must file an application that outlines how it meets the requirements of Appendix E and Exchange Act Rule 15c3-4. Among other things, the application must describe:

  • The mathematical models to be used to compute deductions for market and credit risk, including how the models meet the requirements of Appendix E;
  • The broker-dealer’s system of internal risk management controls to assist in managing the risks associated with its business activities, including market, credit, leverage, liquidity, legal, and operational risks, and how the system satisfies the requirements of Rule 15c3-4;
  • Risk reports that are produced for the persons at the firm who are responsible for internal risk management; and
  • Certain information from its ultimate holding company:
    • A narrative description of the business and organization of the ultimate holding company;
    • Information about affiliates of the broker-dealer; and
    • Provided that they have a principal regulator, a written undertaking in which it agrees, among other things, to make available information about the ultimate holding company necessary to evaluate the financial and operational risk within the ultimate holding company and to evaluate eligibility of the broker-dealer in the ANC program, and to acknowledge that the Commission may impose additional supervisory conditions on the broker-dealer if it fails to comply with the undertaking.

SEC staff reviews the application and conducts on-site reviews prior to action by the Commission. The application may be supplemented by other information that may be requested to complete the review.

Ongoing Oversight of ANC Firms

Following approval, SEC staff conducts ongoing supervision of the ANC broker-dealer, including its internal risk management controls, financial and operational condition, and modeled net capital computation and ongoing monitoring of the financial, operational, and risk condition of the consolidated firm. SEC staff primarily accomplishes this through:

  • Reviews of monthly, quarterly, and annual filings containing financial, operations, risk management, and statistical data;
  • Regular meetings with firm personnel; and
  • Examinations of the books and records, capital calculations, and internal risk management controls of the ANC broker-dealer.

SEC staff focus includes:

  • Risk management of the broker-dealer, including market, credit, leverage, liquidity, legal, and operational risks;
  • Regulatory capital and risk model performance;
  • Stress test modeling and results;
  • Risk governance including setting and monitoring risk limits;
  • Management of outsized risk exposures;
  • Independent price verification function and results; and
  • Internal audit infrastructure and coverage of broker-dealer businesses and internal controls.

ANC firms are also members of self-regulatory organizations such as the Financial Industry Regulatory Authority (FINRA), which promulgate, administer, and examine for compliance with their membership rules.

Current Approved ANC Broker-Dealers

Other Resources

This overview of the Commission’s prudential supervision program for broker-dealers was prepared by staff of the Division of Trading and Markets. SEC staff statements represent the views of the SEC staff. They are not rules, regulations, or statements of the SEC. The SEC has neither approved nor disapproved their content. SEC staff statements, like all SEC staff guidance, have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person.

For further information, contact Michael A. Macchiaroli, Associate Director, at (202) 551-5525 or Thomas K. McGowan, Associate Director, at (202) 551-5521.

[1] “Tentative net capital” is defined in Exchange Act Rule 15c3-1(c)(15) as net capital before deductions for market and credit risk.

[2] Pursuant to Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers, effective 18 months after the later of: (1) the effective date of final rules establishing recordkeeping and reporting requirements for SBSDs and MSBSPs; or (2) the effective date of final rules addressing the cross-border application of certain security-based swap requirements, an ANC broker-dealer will have a $6 billion fixed-dollar early warning notification requirement, a $5 billion fixed-dollar minimum tentative net capital requirement, and a $1 billion fixed-dollar minimum net capital requirement.

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