On January 14, 2016, the Securities and Exchange Commission (“SEC”) solicited comments on a proposal by Financial Industry Regulatory Authority, Inc. (“FINRA”) to revise its proposed changes to FINRA Rule 4210. If implemented, FINRA’s proposal will result in the margining of certain trades in the To Be Announced (“TBA”) market. This posting will provide a summary of FINRA’s proposed amendments, which relate to:
1) the types of transactions that will be subject to the new margin requirements; and
2) the implementation schedule for the margin proposal.
This posting will give specific consideration to the issue of how these proposed amendments could affect buy side firms.
Comments on the partial amendments are due to the SEC by February 11, 2016 with any rebuttal comments subsequently due on March 7, 2016.
Timeline of Key Regulatory Developments As of February 2016; Comment Due Date
The following are the key dates and related regulatory developments with respect to FINRA’s TBA margin proposal:
October 6, 2015 – FINRA submitted a proposal to the SEC that, if implemented, will amend FINRA Rule 4210 (Margin Requirements) to establish margin requirements for certain agency transactions involving mortgage-backed securities traded on a delayed delivery basis in what are commonly referred to as the TBA market. This proposal was published in the Federal Register on October 20, 2015 (available here).
January 13, 2016 – FINRA submitted “Partial Amendment No. 1” to the SEC. As more fully discussed below, this amendment will revise the pending TBA margining proposal.
January 14, 2016 – The SEC solicited comments on FINRA’s Partial Amendment No. 1. The text of this amendment and the related solicitation for comments from the SEC was published in the Federal Register on January 21, 2016 (available here).
February 11, 2016 – Comments due on Partial Amendment No. 1.
March 7, 2016 – Rebuttal comments due.
As a procedural matter, it is worth emphasizing that FINRA’s TBA margin rules (as well as the January 2016 amendments to those rules) are still in the proposal stage, which means that the SEC has the opportunity to provide its views on the rule proposal. In fact, the January 2016 comment solicitation in the Federal Register is the beginning part of the formal process of the SEC’s consideration of the rule proposal.
What Will Change Under Partial Amendment No. 1
FINRA proposed Partial Amendment No. 1 in response to comments made by market participants with respect to the October 2015 proposal to revise FINRA Rule 4210. The January 2016 amendments are relatively limited in its scope and will only change two aspects of the October 2015 TBA margin proposal:
- Multi-family housing and project loan securities will not be subject to the proposed margin requirements. The following are examples of these exempt transactions: Freddie Mac K Certificates, Fannie Mae Delegated Underwriting and Servicing bonds, and Ginnie Mae Construction Loan or Project Loan Certificates; and
- A phased-in implementation schedule would be used, such that broker-dealers would have:6 months after the rule goes into effect in order to make a “risk limit determination” for each of its customers; and18 months after the rule goes into effect before they would have to collect margin from their customers.
As is always the case with a partial amendment to a rule proposal, it is sometimes more telling to pay attention to what has not changed (i.e., the industry comments that did not result in an adjustment to the regulatory proposal). In this instance, the list of what has not changed is relatively long, but the status of the proposed TBA margin rule revamp can be summarized in a few words:
the October 2015 proposal largely remains in tact.
In short, the comments and concerns expressed by buy side firms and trade groups were acknowledged by FINRA, but did not result in any meaningful changes to the proposal.
How These Changes Could Impact Buy Side Firms
The proposed amendments could impact buy side firms in a number of ways. First, the amendment to exempt multi-family housing and project loan securities from the proposed margin requirements will benefit firms that trade in these particular securities on a delayed delivery basis. Although, this is likely to be a relatively small number of buy side firms.
Second, the proposed 18-month deferral on the margin requirements may provide market participants with additional time to bring their operational systems and business processes into line with the new margin requirements. Although, the “real world benefit” of this 18-month implementation period for margin may or may not be as valuable as it seems at first glance.
In particular, the proposed 6-month deferral on the risk limit determination may impact the amount of time that market participants have to get their trading documentation (MSFTAs) negotiated and into place. As background, the October 2015 rule proposal, if implemented, will require a broker-dealer to make a risk-limit determination with respect to each customer’s trading of delayed delivery and related TBA transactions, as well as other related transactions that may be beyond the scope of the TBA margin requirements. In general, the purpose of this determination is to allow the broker-dealer to gauge the risk presented by a particular customer’s trading activity. It seems plausible that one of the considerations that may impact the risk-limit determination is whether or not the particular customer has an MSFTA in place. Or, put another way, 6 months after the new rules go into effect could become the de facto “runway” for completing MSFTA negotiations. For buy-side firms that also have to negotiate tri-party account control agreements (i.e., mutual funds or the investment adviser negotiating the MSFTA on behalf of the mutual fund), 6 months is not that much time at all.
So, perhaps as a practical matter, maybe there will not be a phased-in implementation schedule after all? That remains to be seen.
Good day. Good luck with those MSFTAs and, as applicable, account control agreements. DR2