Brokers Need More Capital for Crisis, SEC’s Stein Says

June 13 (Bloomberg) --The biggest Wall Street brokerages should face stricter capital requirements as regulators search for tools to limit the impact of a firm’s failure on the broader financial system, a member of the U.S. Securities and Exchange Commission said.

The agency should update its capital rules for large broker-dealers such as those owned by Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS) to help prevent a repeat of the 2008 financial crisis, when similar firms became heavy users of the Federal Reserve’s emergency-lending facilities, Commissioner Kara M. Stein said yesterday. The SEC’s rules should better account for the risk posed by short-term funding markets on which brokers rely, Stein said.

Stein’s comments come as the SEC has said it’s considering new funding rules for brokers as well as limits on leverage like those used by the Federal Reserve and other regulators for banks. SEC Commissioner Daniel M. Gallagher also has called for updating the capital rules without restricting the use of secured funding such as repurchase agreements, or repos.

“The SEC should consider whether, it, too, should be focused on preventing the collateral impact of the collapse of a systemically significant firm,” Stein told an audience at the Peterson Institute for International Economics in Washington. “Given the systemic risks posed by some of the firms we regulate, I think it’s about time for the SEC to revise its reasoning for imposing capital requirements.”

Fed Warnings

Federal Reserve officials have warned for years that the $4.5 trillion web of repo deals remains prone to unravel during a panic, potentially leading to fire sales of assets that could spread losses across the financial system. The failure of Lehman Brothers Holdings Inc. in 2008 was partly attributed to its inability to renew short-term funding arrangements as the value of its collateral dwindled.

In calling for stricter capital requirements, Stein also criticized the goal of the SEC’s current approach, which seeks to protect customers without regard to keeping companies afloat. The SEC has in the past allowed broker-dealers to use financial models that reduced the amount of capital they needed to hold, Stein said.

The SEC should consider basing its capital rules, at least for the largest brokers, on the objective of “preventing the collapse of a systemically significant firm,” she said.

“While the SEC may have been agnostic as to whether its regulations should help prevent a large firm’s collapse in the past, we cannot afford to be agnostic now,” she said.

Faster Progress

Stein also said the agency needs to accelerate its progress on rules required by the 2010 Dodd-Frank Act, which called for most swap contracts to be centrally cleared and traded on exchanges. The SEC hasn’t adopted many of the required rules intended to curb the risks posed by swaps, complex derivatives once dubbed “financial weapons of mass destruction” by Warren Buffett.

“Many of the most important systemic risk reforms of the Dodd-Frank Act just aren’t done,” Stein said. “We need to finish these rules now.”

SEC Chair Mary Jo White has said finishing Dodd-Frank requirements are her priority, while the agency has only proposed two new rules this year. Senator Carl Levin, a Michigan Democrat, said in a statement that he supported Stein’s remarks.

“Four years after the law went on the books, the SEC still hasn’t finalized rules to stop financial firms from betting against their clients, ensure swap dealers have adequate capital, or cure the conflicts of interest undermining the reliability of credit ratings,” Levin said. “The SEC needs to stop procrastinating and get the job done.”

To contact the reporter on this story: Dave Michaels in Washington at dmichaels5@bloomberg.net

To contact the editors responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net Anthony Gnoffo, Gregory Mott

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