WASHINGTON - The Public Securities Association urged the Securities and Exchange Commission this week to refrain from writing special capital requirements for derivatives product companies that are affiliated with registered broker-dealers but unregulated.

"The PSA does not believe that it would be an appropriate initiative for the SEC to seek to extend its authority to prescribe capital rules for these unregistered entities," the association said in written comments to the SEC.

The PSA comments are a response to a "concept release" issued by the SEC last May. The release asked what net capital requirements would be appropriate for derivatives products.

The SEC's current net capital requirements were developed in the mid-1970s, long before the tremendous explosion of derivatives in the world financial markets. They were designed to ensure that broker-dealers keep enough liquid assets on hand to be able to satisfy the claims of their customers and creditors.

Although the SEC requirements have been modified some since the 1970s, they generally treat the payments from most over-the-counter derivative products as unsecured receivables that must be completely deducted from a firm's net worth.

In other words, a firm cannot include the payments from such products in determining its net worth and whether it has enough net capital on hand to meet SEC capital requirements.

The SEC requirements, which industry and SEC officials consider to be onerous for most over-the-counter derivatives products, have led some broker-dealers to conduct their derivatives businesses through unregulated or offshore affiliates.

In the concept release issued last May, the SEC asked for comments on whether it should: maintain the current net capital requirements; revise the current requirements to encourage broker-dealers to engage in derivatives activities in regulated entities; or write special rules that would apply to derivatives done in special products companies that are affiliated with registered broker-dealers.

"For the most part, these firms are not engaged in a securities business and it may be that the principal affiliate of the derivatives company is not the registered broker-dealer at all, but rather a bank or insurance company subject to the regulatory jurisdiction of another regulator," the PSA said.

The PSA encouraged the SEC to write capital requirements that "comprehensively address the credit and market risk posed by derivative products" and encourage firms to conduct their derivatives businesses in regulated entities.

At the same time, however, the PSA warned the SEC that new capital requirements will not discourage broker-dealers from doing business in certain derivatives products, such as interest rate swaps in regulated companies, because these products are currently not treated as securities and are not required to be transacted in regulated entities.

"No matter how reasonable the capital rule, firms will probably not want to subject themselves to regulation unless they have to, preferring to conduct business under their own prudential standards," the association said. "Regulation adds cost to the conduct of business."

The association said the current rules "penalize those broker-dealers that hedge their risks through derivative products or, because of customer preference, do transactions in the broker-dealer."

The SEC currently has the ability to monitor and assess the business products of derivatives products companies if they are "material affiliated persons," the PSA said.

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