Would Relaxing The Rules On Capital Reserves Help Or Hurt Broker-Dealers?

Thursday, April 28, 2011 06:26
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Would Relaxing The Rules On Capital Reserves Help Or Hurt Broker-Dealers?

Tags: sec

Under Dodd-Frank, the SEC is working to remove the credit agencies from their central role in the industry, which includes calculating broker-dealer capital.

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The SEC has finalized a proposal that lets broker-dealers come up with their own ratings systems for evaluating commercial debt and other often thinly marketed securities when it comes to calculating their net capital.

 

This rule would cut Standard & Poor's, Moody's, and other credit agencies out of the process. However, BDs that fail to create a fairly stringent system to rate their own holdings will simply have to write off the full value of these securities -- they can't be considered part of a mandatory net capital position.

 

Under current rules, anything rated by two or more nationally recognized agencies gets counted at a 15% haircut.

 

Rating credit is a labor- and expertise-intensive business. Many broker-dealers are not going to have the resources to devote to this, so unless a system for outsourcing the "internal" rating process emerges -- effectively recreating the agencies -- they will have to scrounge for more capital to meet their targets.

 

If the rules are more relaxed, of course, it will be easier for troubled firms to treat illiquid holdings as "core capital," keeping them afloat in a disruption in the credit markets.

 

But in that event, from what we have seen, the credit agencies were happy to assign all manner of issuers AAA ratings, so we'd simply be back to the status quo.

 

The former prospect -- that weaker broker-dealers will no longer be able to lean on the agencies to approve their reserves, and so will have to raise cash or shut down -- is more likely and less pleasant.

 

 

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