The SEC issued Release No. 34-64352, proposing amendments to rules and forms under the Securities Exchange Act of 1934 (the “1934 Act”) that would remove references to credit ratings by rating agencies (including nationally recognized statistical rating agencies or NRSROs). This rulemaking is mandated by Section 939A of the Dodd-Frank Act, which requires the SEC to “remove any reference to or requirement of reliance on credit ratings, and to substitute in such regulations such standard of credit-worthiness” as the SEC determines to be appropriate. The SEC is also seeking comment, in advance of proposed rulemaking, with respect to the appropriate tests to be used in the definitions of “mortgage‑related security” (Section 3(a)(41) of the 1934 Act) and “small business related security” (Section 3(a)(53) of the 1934 Act) in lieu of credit ratings by an NRSRO.
Internal Credit and Liquidity Risk Assessment
In several of the proposed rule changes where references to NRSRO ratings would be deleted as a measure of creditworthiness, broker-dealers would be permitted to use internally generated credit and liquidity risk assessments, provided that they establish, maintain and enforce written policies and procedures designed to assess such risks. Among the factors the broker-dealer could consider in making risk assessments would be credit spreads, securities-related research, internal or external credit risk assessments (including those of credit rating agencies, whether or not they are NRSROs), default statistics and inclusion on a recognized index of instruments that are subject to a minimal amount of credit risk. The rules and forms under the 1934 Act that fall in this category are:
The SEC has also requested comment on whether internal credit ratings should be used, in rulemaking to supplement the definitions of “mortgage related securities” and “small business related securities” in Sections 3(a)(41) and 3(a)(53) of the 1934 Act, to replace the NRSRO credit rating standard deleted by the Dodd-Frank Act.
Major Market Foreign Currency
Appendix A to Rule 15c3-1 provides favorable treatment, for purposes of the Net Capital Rule, to currency options involving “major market foreign currency,” which is currently defined with reference to NRSRO credit ratings. The proposed amendment would change the definition to refer to foreign currencies for which there is a substantial inter-bank forward currency market.
Customer Protection Rule
Rule 15c3-3, Note G, permits a broker-dealer to include required customer margin for transactions in securities products as a debit in the reserve formula computation if that margin is required and on deposit at a clearing agency or derivatives clearing organization that meets any one of four criteria, including maintaining the highest investment-grade rating from an NRSRO. That criterion would be deleted, leaving the remaining three, which do not reference NRSRO ratings.
Rules 101 and 102 of Regulation M currently except transactions in “investment grade nonconvertible and asset-backed securities” from their prohibitions. That standard would be replaced with an exception for non-convertible debt securities, non-convertible preferred securities and asset-backed securities if they:
A person seeking to rely on this exception would be required to obtain third party verification of its determination. The SEC seeks comment on whether it should impose qualification standards on persons providing third party verification, what those qualification standards should be, and whether there should be limitations on how often a particular third party verifier can be used by a person seeking to use the exception.
Rule 10b-10 Confirmations
Rule 10b-10(a)(8) currently requires a broker-dealer to inform the customer in the confirmation if a debt security, other than a government security, is unrated by an NRSRO. Although the SEC believes that deletion of this requirement is not technically required by Section 939A of the Dodd-Frank Act, because the reference is not designed to establish a standard of creditworthiness, the SEC proposes to delete the requirement as a change consistent with the intent of the Dodd-Frank Act.
The SEC also proposes non-substantive conforming changes to other rules and forms. Comments on the proposal are due 60 days after its publication in the Federal Register.
For more information about the contents of this alert, please contact:
Elizabeth Shea Fries
Consumer Financial Services
© 2015 Goodwin Procter LLP. All rights reserved. This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP, Goodwin Procter (UK) LLP or their attorneys. Prior results do not guarantee similar outcome.
Goodwin Procter LLP is a limited liability partnership which operates in the United States and has a principal law office located at 53 State Street, Boston, MA 02109. Goodwin Procter (UK) LLP is a separate limited liability partnership registered in England and Wales with registered number OC362294. Its registered office is at Tower 42, 25 Old Broad Street, London EC2N 1HQ. A list of the names of the members of Goodwin Procter (UK) LLP is available for inspection at the registered office. Goodwin Procter (UK) LLP is authorized and regulated by the Solicitors Regulation Authority.