FINRA published new guidance on various issues stemming from amendments made to FINRA Rule 4210 (margin) for "Covered Agency Transactions." The amendments, which were approved by the SEC last year and largely are scheduled to become effective on December 15, 2017, establish margin requirements for various types of forward-settling agency transactions, including TBAs, specified pool and collateralized mortgage obligation transactions.

The FAQs are split into two documents: one specific to issues under Exchange Act Rules 15c3-1 (net capital) and 15c3-3 (custody) (which FINRA indicated was provided by SEC staff), and another covering issues under the amendments to 4210 generally. Among other things (the documents total over 25 pages), the FAQs address:

  • treatment of minimum transfer amounts with respect to when liquidation is required under the rule;
  • dispute resolution;
  • extension requests and FINRA "Regulatory Extension System";
  • treatment of foreign holidays;
  • documentation for Covered Agency Transactions;
  • qualification for the "small" and "cash" account exceptions under the rule;
  • introducing/clearing relationships;
  • allocation of responsibility; and
  • counterparty status determinations (e.g., as an "exempt account").

FINRA indicated that it intends to update these FAQs periodically.

Commentary / Nihal Patel

These FAQs are detailed and address a great many questions that market participants have been asking about these rule changes over the past year. The sheer volume of the questions addressed shows how many different issues the rule amendments raised. While further questions will undoubtedly arise, these FAQs go a long way in assisting broker-dealers and their counterparties establishing systems and contracts to implement the requirements of the rule amendments.

While there are a great many points to be analyzed in the FAQs, a handful of key issues are noted below. 

  • Liquidation Time Period and Minimum Transfer Amounts. Under the amendments to Rule 4210, a broker-dealer is required to liquidate counterparty positions, where a counterparty has not satisfied a margin deficiency within five business days from the day that the deficiency arose. In the FAQ, FINRA makes clear that this liquidation requirement generally does not arise if the counterparty's deficiency remains below $250,000 de minimis transfer amount specified in the rule (subject to policies and procedures and risk limits and other details set forth in the FAQ). This general stance flows through the first 6 questions of the FAQ, and answers a number of significant questions for market participants, who raised concerns that the rule change had the potential to force liquidations of relatively small amounts of open calls resulting from, among other things, pricing disputes and operational limitations (e.g., rounding).
  • Extension Request System. FINRA indicated that it will update its Extension Request System to address Covered Agency Transactions and expects that requests will "typically be granted" for up to two two-week extensions.
  • Rule 15c3-1  & 3-3  (BD Collecting Collateral). Broker-dealers collecting collateral from counterparties (as required under the rules) (i) are permitted to rehypothecate customer variation margin and (ii) are required to treat customer-posted margin other than variation margin as subject to the possession and control requirements of Rule 15c3-3, with allowances for haircuts on such collateral in accordance with Rule 15c3-1(c)(2)(vi). 
  • Rule 15c3-1  & 3-3  (BD Posting Collateral). Broker-dealers that post collateral to counterparties on Covered Agency Transactions (not required under the FINRA rules when facing non-BDs, but required under the Treasury Market Practices Group recommendations) (i) may not include a debit in their 15c3-3 customer reserve formula for such posting; (ii) need not take a deduction from net capital for variation margin collateral posted to a counterparty; (iii) must take a net capital deduction for collateral posted in excess of variation margin, with allowances for haircuts on such collateral in accordance with Rule 15c3-1(c)(2)(vi); and (iv) are permitted a one-business-day grace period before a net capital deduction is required, in the case where a counterparty is holding collateral in excess of the mark-to-market loss as result of market movements.

(Disclosure: Cadwalader represents the Securities Industry and Financial Markets Association (SIFMA) in connection with this rulemaking.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.