2.7.1.3.2. Haircuts
Haircuts are a discount that the SEC applies to the market value of securities held by a broker-dealer. Since the value of a security is constantly fluctuating, the SEC discounts its current market value to provide a cushion to account for a possible decrease in value at the time of a firm’s liquidation.
Once you have a total amount of all haircuts taken, deduct that from the tentative net capital amount. The result will be the firm’s net capital.
Let’s see that formula again.
net capital = net worth + subordinated debt – non-allowable assets – haircuts
= assets – liabilities + subordinated debt – non-allowable assets – haircuts
= (assets – non-allowable assets – haircuts) – (liabilities – subordinated debt)
= tentative net capital – haircuts
Haircut amounts vary depending on the type of security—riskier securities tend to have higher haircuts. Here is a list of the most common haircuts:
• Equity securities, commonly traded = 15% of their current market value.
• Equity securities, limited trading market = 40% of their current market value.
• Equity securities, aged fail to deliver = 15% of its current market value. An aged fail to deliver means that the security has not been delivered within four days after the settlement date.
• Nonmarketable securities = 100% of their current market value. A nonmarketable security is one in which there are no buyers other than your firm.
• Undue concentration = 15% of the excess concentration amount. A firm is allowed to have only up to 10% of its tentative net capital invested in one security. Any amount over the 10% allowed must be deducted by 15% when calculating net capital.
Once you have a total amount of all haircuts taken, deduct that from the tentative net capital amount. The result will be the firm’s net capital.
Example: XYZ