5.3 Net Capital Rule

204. According to the Securities and Exchange Commission (SEC),1 the NCR’s primary purpose is to ensure that “registered broker-dealers maintain at all times sufficient liquid assets to (1) promptly satisfy their liabilities - the claims of customers, creditors, and other broker-dealers; and (2) to provide a cushion of liquid assets in excess of liabilities to cover potential market, credit, and other risks if they should be required to liquidate”2 The SEC feels that the NRC “thus enhances investor/customer confidence in the financial integrity of broker-dealers and the securities market”.3 As discussed above, the NCR aims to ensure that investment firms have sufficient liquid capital to repay their liabilities, and thus be able to provide their investment services and activities on an ongoing basis for their clients. The SEC has focused on defining which assets should qualify as liquid, and which assets are illiquid. To comply with the SEC’s net capital rule, “broker-dealers must perform two computations: one computation determines the broker-dealer’s net capital (liquid capital), and another computation determines the broker-dealer’s appropriate minimum net capital requirement (base capital requirement)”.4 The NCR capital requirement is based either on the indebtedness of the investment firm (basic method) or on the customer related receivables (alternative method). Both calculation methods seek to derive the risk profile of the investment firm based on the size of its business, i.e. its operational risk. The NCR does not analyse the balance sheet risks to assess whether the investment firm is exposed to market or credit risk. Instead it uses indebtedness or customer-related receivables as a proxy to determine the business risk of the investment firm.