SEC drafts framework to monitor capital adequacy of brokers

The Securities and Exchange Commission (SEC) is developing a risk-based capital adequacy (RBCA) framework to ensure that stockbrokerage houses can meet contractual obligations and will have adequate capital to cover risks.

RBCA refers to the minimum level of capital that has to be maintained by broker-dealers, taking into consideration the firm’s size, complexity and business risk.

According to the SEC, the shift to the risk-based approach of supervision will allow it to develop monitoring and audit processes that will identify, assess, monitor and if necessary, direct specific market players to control specific risk areas.

The factors to be incorporated in the model for the measurement of the various risks should be based on the local market conditions, the SEC said.

The risks proposed to be covered for the RBCA will include position or market risk, credit risks such as counterparty risk, settlement risk, large exposure risk and margin financing risk and operational risk.

The SEC said the current net capital computation will be enhanced to align it with the capital requirements. For this purpose, the commission will be revisiting the current net capital model to fine-tune the provisions relating to the treatment of the various items of assets, liabilities and equity in the computation of net capital. This is intended to fully capture economic substance of the underlying risks and the available equity to cover them.

In calculating capital requirement, appropriate risk conversion factors will be applied to risk positions/exposures.

The SEC will be issuing the RBCA draft rules for comments by the first week of August.

"We hope that, with our reasonable assessment of the risk exposure of the various regulated entities, we can channel our limited financial resources and deploy our manpower complement on those entities that exhibit higher potential credit, market and operational risks," said Jose P. Aquino, head of the SEC’s Markets and Regulation Department.

The SEC said the capital adequacy scheme is particularly valid when the systemic cost of default may be unacceptably high.

The commission said the adoption of the risk-based capital adequancy standards will encourage market intermediaries to adopt a more relevant approach to risk management. With the system in place, stockbroker firms would have to assess their trading books more regularly in order to understand and monitor the risk profile of their respective businesses, the SEC added.