The Securities and Exchange Commission (SEC) today voted unanimously to propose amendments that would remove references to credit ratings in several rules under the Exchange Act.

These proposals is the next step in a series of actions taken under the Dodd-Frank Act to eliminate references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria.

The agency is proposing to remove from the net capital rule all references to credit ratings and substitute an alternative standard of creditworthiness. Under the proposal, a broker-dealer must take a 15% haircut on its proprietary positions in commercial paper, nonconvertible debt, and preferred stock unless the broker-dealer has a process for determining creditworthiness that satisfies the criteria described below.

However, as is the requirement in the current rule, if these types of securities do not trade in a ready market as defined in the rule, they would be subject to a 100% haircut. This means that the broker-dealers cannot include the value of these securities in their net capital.  

If a broker-dealer establishes, maintains, and enforces written policies and procedures for determining creditworthiness under the proposed amendments, the broker-dealer would be permitted to apply the lesser haircut requirement which for commercial paper is between zero and ½ of 1%, for nonconvertible debt is between 2% and 9%, and for preferred stock is 10%; when the creditworthiness standard is satisfied.

A broker-dealer would also be required to establish, maintain, and enforce written policies and procedures designed to assess the credit and liquidity risks applicable to a security, and based on this process, would have to determine that the investment has only a “minimal amount of credit risk.”

Under Dodd-Frank, federal agencies must review how their existing regulations rely on credit ratings as an assessment of creditworthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references to replace them with alternative standards that the agency determined to be appropriate.

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