THE CAPITAL ADEQUACY REGULATION OF US BROKER‐DEALERS: A COMPARATIVE ANALYSIS — PART 1
| DOI | https://doi.org/10.1108/eb024823 |
| Date | 01 January 1995 |
| Published date | 01 January 1995 |
| Pages | 11-27 |
| Author | RICHARD DALE |
| Subject Matter | Accounting & finance |
THE
CAPITAL ADEQUACY REGULATION OF US BROKER-
DEALERS:
A COMPARATIVE ANALYSIS - PART 1
Received: 7th November, 1994
RICHARD
DALE
RICHARD
DALE
GRADUATED
FROM
THE
LONDON
SCHOOL
OF
ECONOMICS
AND
STUDIED
FOR THE BAR AT
LINCOLN'S
INN.
SUBSEQUENTLY
HE
SPENT
FIVE
YEARS
WITH
MERCHANT
BANKERS
N. M.
ROTHCHILD
AND
SONS
LIMITED.
IN
1982/83
HE
WAS
A
ROCKEFELLER
FOUNDATION
FELLOW
AT
THE
BROOKINGS
INSTITUTION
IN
WASHINGTON
DC AND IN 1994 HE WAS A
SENIOR
HOUBLON-NORMAN
FELLOW
AT THE
BANK
OF
ENGLAND.
HE IS
CURRENTLY
PROFESSOR
OF
INTERNATIONAL
BANKING
AND
FINANCIAL
INSTITUTIONS
AT
SOUTHAMPTON
UNIVERSITY.
ABSTRACT
As financial markets across the world
become more integrated, the potential for
financial shocks to be transmitted both
from one jurisdiction to another and from
one financial
sector to
another
increases.
At
the same time differences in national regu-
latory arrangements can be the source of
important competitive distortions between
financial institutions. Against this back-
ground national authorities have been
seeking to coordinate the regulation of
securities firms and of banks undertaking
securities business. This paper, which is
published in two parts, aims to clarify some
of the policy issues arising from recent con-
vergence initiatives by examining the US
capital adequacy rules for US investment
firms and contrasting the US approach
with European securities regulation as for-
mulated in the Capital Adequacy Direc-
tive.
The second part of this paper will be
published in the next issue of Journal of
Financial Regulation & Compliance.
The regulation of securities firms
has become a topic of increasing
concern to policy makers world-
wide. Partly this reflects the growing
interconnections between securities
markets and banking and associated
worries about possible systemic con-
sequences arising from the failure of
securities firms. At the same time the
globalisation of financial markets has
highlighted the potential for finan-
cial shocks to be transmitted across
borders, thereby exposing financial
institutions located in one jurisdic-
tion to problems originating else-
where. Finally, in the global financial
market place now evolving, dispari-
11
JOURNAL OF FINANCIAL REGULATION AND COMPLIANCE • VOLUME THREE NUMBER ONE
- DALE -
ties between national regulatory
regimes can be the cause of import-
ant competitive distortions, penalis-
ing those securities firms whose
national regulatory requirements are
most stringent.1
Against this background there
have been a number of recent initia-
tives aimed at international coordi-
nation of the regulation of securities
firms and of banks undertaking
securities business. At the regional
level, the European Union (EU) has
adopted a number of Directives, not-
ably the Capital Adequacy Directive
(CAD), which together impose a
common regulatory framework on
European institutions' securities
activities; in a global context the
Basle Committee on Banking Super-
vision has proposed common mini-
mum capital standards for
international banks' securities opera-
tions;
and the International Organi-
sation of Securities Commissions
(IOSCO) has provided a forum for
discussions on the regulatory coordi-
nation of non-bank securities firms.
However, the IOSCO negotiations
have revealed fundamental differ-
ences of approach between Euro-
pean and US securities regulators.
Furthermore discussions between
the Basle Committee and IOSCO,
aimed at achieving common capital
standards for banks and securities
firms, have exposed important
dif-
ferences of view between bank and
securities regulators.
This paper seeks to clarify some
of the policy issues arising from
recent convergence initiatives by
examining the US capital adequacy
rules for US investment firms
(broker-dealers in US parlance) and
contrasting the US approach with
European securities regulation as
formulated by the CAD. Section 1
deals with some general issues relat-
ing to the regulation of banks and
investment firms;2 Section 2 provides
an historical overview of regulation
by the US Securities and Exchange
Commission (SEC); Section 3
addresses the problem of consoli-
dated supervision; and Section 4
describes the SEC's Customer Pro-
tection Rule. The following Sections
(5-7) will be published in Part 2 in
the Journal of Financial
Regulation
and
Compliance, Volume 3 Number 2.
Section 5 will examine the SEC's Net
Capital Rule, Section 6 will cover the
treatment of derivatives and Section
7 will compare the US and European
approaches to regulating investing
firms.
SECTION
1:
THE REGULATION
OF BANKS AND SECURITIES
FIRMS
In examining the capital adequacy
issue, it is helpful to consider the
case for regulating financial institu-
tions.
In this context banks and
securities firms have contrasting
operational characteristics which
underline the need for different
regulator)' regimes.3 Traditional
banking involves the acquisition of
long-term non-marketable loans
which are typically held on the bal-
ance sheet until maturity. By way of
contrast, investment firms experi-
ence rapid asset turnover as a result
of their marketing-making, under-
writing and trading activities. The
main business risk for banks is credit
risk, whereas for investment firms it
is market risk.
Furthermore, securities firms are
evaluated on a liquidation basis and
their accounting is mark-to-market,
while banks are evaluated as going
12
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