On Friday, May 7, 2021, the Financial Industry Regulatory Authority (FINRA) filed a proposal with the Securities and Exchange Commission (SEC) to amend the provisions of a yet-to-become effective version of FINRA Rule 4210 that will require the margining of Covered Agency Transactions (the Proposal).1 The Proposal is the most recent development in FINRA’s implementation of margining for Covered Agency Transactions, which was first proposed in 2014 and is based on recommendations from the Treasury Market Practices Group (TMPG) of the Federal Reserve Bank of New York. Comments in respect of the Proposal must be submitted to the SEC within twenty-one (21) days of the publication of the Proposal in the Federal Register, which, as of May 19, 2021, has not occurred.
Background
FINRA first proposed to subject Covered Agency Transactions to margining in 2014. After filing a proposed rule change in respect of FINRA Rule 4210 with the SEC in 2015,2 FINRA’s changes were approved by the SEC (after several amendments) in 2016.3 Compliance with revised Rule 4210’s margining requirements was supposed to take place beginning at the end of 2017, but, since then, FINRA has delayed the compliance date numerous times. As of now, the stated compliance date for Rule 4210’s margining requirements is October 26, 2021.4
The version of FINRA Rule 42105 that would impose margining requirements on Covered Agency Transactions defines that term to mean the following transaction types:
- To-Be-Announced (TBA) transactions, which are transactions in Fannie Mae or Freddie Mac (each, an Agency) pass-through Mortgage-Backed Securities (MBS), or Small Business Administration (SBA) backed Asset-Backed Securities (ABS), where the parties agree that the seller will deliver to the buyer a pool or pools of a specified face amount and meeting certain other criteria but the specific pool or pools to be delivered at settlement is not specified at the time of execution, inclusive of adjustable-rate mortgage transactions, for which the difference between the trade date and contractual settlement date is greater than one business day;
- “Specified Pool Transactions,” which are transactions in Agency MBS or SBA ABS requiring the delivery at settlement of a pool or pools that is identified by a unique pool identification number at the time of execution, for which the trade date and contractual settlement date is greater than one business day; and
- Transactions in “Collateralized Mortgage Obligations” or “CMOs,” which are a type of securitized product backed by Agency pass-through MBS, mortgage loans, certificates backed by project loans or construction loans, other types of MBS or assets derivative of MBS, that are structured in multiple classes of tranches with each class or tranche entitled to receive distributions of principal or interest according to the requirements adopted for the specific class or tranche, and includes a real estate mortgage investment conduit, for which the difference between the trade date and contractual settlement date is greater than three business days.
At a high level, the version of FINRA Rule 4210 slated to take effect in October 2021 would require FINRA members to collect, but not to post,6 from non-exempt accounts,7 “maintenance margin” (i.e., initial margin) in respect of Covered Agency Transactions in an amount equal to two percent (2%) of the contract value of the net long or short position, by CUSIP, with the counterparty and, with all counterparties, net mark to market loss (i.e., variation margin). These requirements would be subject to a $250,000 minimum transfer amount, and certain exemptions would be afforded, including for “small accounts,” i.e., any counterparty that has gross open positions in Covered Agency Transactions with a FINRA member amounting to $10 million or less in aggregate.
Changes proposed
Late last year, FINRA filed a rule amendment with the SEC to extend the compliance date for Rule 4210’s Covered Agency Transactions margining provisions to October 26, 2021. The stated rationale for the extension was to allow FINRA time to propose revisions that would afford relief to smaller market participants.8 The Proposal reflects this. If adopted in its current form, the Proposal would make two key changes to the version of FINRA Rule 4210 slated to take effect in October 2021:
- Maintenance margin (i.e., initial margin) would no longer be required, irrespective of whether a FINRA member’s counterparty is an exempt account.
- FINRA members would have discretion to take a capital charge (up to a $25 million cap) in lieu of collecting mark to market margin from those counterparties for which the FINRA member deems it appropriate to do so.
Additional clarifying and conforming changes are also contemplated by the Proposal.
Timing
As it stands, were the Proposal to be approved by the SEC, market participants should expect to have to come into compliance with the margining provisions of FINRA Rule 4210 this fall.
As noted above, the Proposal will be open for public comment for twenty-one (21) days following its publication in the Federal Register. The SEC has forty-five (45) days from publication to approve or disapprove the Proposal, although it has discretion to extend this period by an additional forty-five days. The Proposal indicates that, if the SEC approves the Proposal, FINRA will announce an effective date for the revised Rule 4210 within sixty (60) days, via publication of a FINRA Regulatory Notice, which effective date will be no later than 120 days following publication of the FINRA Regulatory Notice. Assuming that the Proposal is published in the Federal Register in the near term and that notice periods described above are adhered to, compliance would be required beginning in November 2021. To illustrate, assuming a May 20, 2021 publication date for the Proposal:
Hypothetical compliance timing for FINRA Rule 4210
Conclusion
If approved, the Proposal would have the intended effect of affording some breathing room to smaller market participants. However, changes to the Proposal may be made in light of public comments. Nevertheless, it is our view that additional extended delays of the margining requirements for Covered Agency Transactions past October 2021 are unlikely; the Proposal’s stated timeline for effectiveness closely aligns with the existing October 26, 2021 and, in our view, evidences an intent on the part of FINRA to finally have the margining of Covered Agency Transactions take effect. Accordingly, market participants who have yet to begin negotiating documentation to comply with the margining obligations that FINRA Rule 4210 would impose may wish to begin doing so now.
2 See Release No. 34-76148 (October 14, 2015), 80 Fed. Reg. 63,603 (October 20, 2015).
3 Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 3 and Order Granting Accelerated Approval to a Proposed Rule Change To Amend FINRA Rule 4210 (Margin Requirements) To Establish Margin Requirements for the TBA Market, as Modified by Amendment Nos. 1, 2 and 3, 81 Fed. Reg. 40,364 (June 21, 2016).
4 See Release No. 34-90852 (January 5, 2021), 86 Fed. Reg. 2021 (January 11, 2021).
6 Although FINRA Rule 4210 does not require FINRA members to post initial and/or variation margin to their counterparties, it is our experience that FINRA members have generally agreed to documentation that requires the exchange of initial and/or variation margin.
7 FINRA Rule 4210 includes a discrete list of persons that are” exempt accounts,” including, among others, persons who have a net worth of at least $45 million and financial assets of at least $40 million. See FINRA Rule 4210(a)(13)(B).
8 See Release No. 34-90852 (January 5, 2021), 86 Fed. Reg. 2021 (January 11, 2021).
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