[Federal Register Volume 87, Number 17 (Wednesday, January 26, 2022)]
[Notices]
[Pages 4076-4090]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-01471]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-94013; File No. SR-FINRA-2021-010]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Granting Approval of a Proposed Rule Change, as 
Modified by Amendment No. 1, To Amend the Requirements for Covered 
Agency Transactions Under FINRA Rule 4210 (Margin Requirements) as 
Approved Pursuant to SR-FINRA-2015-036

January 20, 2022.

I. Introduction

    On May 7, 2021, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change to amend the 
requirements for covered agency transactions under FINRA Rule 4210.\3\ 
The proposed rule change was published for comment in the Federal 
Register on May 25, 2021.\4\ The Commission received comments in 
response to the Notice.\5\ On June 30, 2021, FINRA extended the time 
period in which the Commission must approve the proposed rule change, 
disapprove the proposed rule change, or institute proceedings to 
determine whether to approve or disapprove the proposed rule change to 
August 23, 2021.\6\ On August 9, 2021, FINRA responded to the comments 
and submitted Amendment No. 1 to the proposed rule change.\7\ The 
Commission subsequently issued an Order Instituting Proceedings 
(``OIP'') to determine whether to approve or disapprove the proposed 
rule change, as modified by Amendment No. 1.\8\ The Commission received 
additional comment letters in response to the OIP.\9\ On September 16, 
2021, FINRA responded to these additional comment letters.\10\ On 
October 26, 2021, FINRA extended the time period in which the 
Commission must approve or disapprove the proposed rule change to 
January 20, 2022.\11\ This order approves the proposed rule change, as 
modified by Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The full text of the proposed rule change and the exhibits 
filed by FINRA (collectively referred to as the ``Proposal'') are 
available at: https://www.finra.org/sites/default/files/2021-05/sr-finra-2021-010.pdf.
    \4\ See Exchange Act Release No. 91937 (May 19, 2021), 86 FR 
28167 (``Notice'').
    \5\ Comments received on the Notice are available at: https://www.sec.gov/comments/sr-finra-2021-010/srfinra2021010.htm.
    \6\ See Extension No. 1, available at: https://www.finra.org/sites/default/files/2021-06/SR-FINRA-2021-010-extension1.pdf.
    \7\ See Amendment No. 1 to the proposed rule change, dated 
August 9, 2021 (``Amendment No. 1''). The full text of Amendment No. 
1 is available on the Commission's website at: https://www.sec.gov/comments/sr-finra-2021-010/srfinra2021010-9147461-247526.pdf.
    \8\ See Notice of Filing of Amendment No. 1 and Order 
Instituting Proceedings to Determine Whether to Approve or 
Disapprove a Proposed Rule Change, as Modified by Amendment No. 1, 
to Amend the Requirements for Covered Agency Transactions under 
FINRA Rule 4210 (Margin Requirements) as Approved Pursuant to SR-
FINRA-2015-036, Exchange Act Release No. 92713 (Aug. 20, 2021), 86 
FR 47655 (Aug. 26, 2021).
    \9\ Comments received on the OIP are available on the 
Commission's website at: https://www.sec.gov/comments/sr-finra-2021-010/srfinra2021010.htm.
    \10\ See Letter to Vanessa Countryman, Secretary, Commission, 
from Adam Arkel, Associate General Counsel, Office of General 
Counsel, FINRA (Sep. 16, 2021) (``FINRA Letter''), available at: 
https://www.sec.gov/comments/sr-finra-2021-010/srfinra2021010-9244962-250787.pdf.
    \11\ See Extension No. 2, available at https://www.finra.org/sites/default/files/2021-10/sr-finra-2021-010-extension2.pdf.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

A. Summary of Proposed Amendments

    FINRA has proposed revisions to the Covered Agency Transaction \12\ 
requirements as approved pursuant to SR-FINRA-2015-036.\13\ Broadly, 
FINRA has proposed:
---------------------------------------------------------------------------

    \12\ Covered Agency Transactions are: (1) To Be Announced 
(``TBA'') transactions, inclusive of adjustable rate mortgage 
(``ARM'') transactions; (2) Specified Pool Transactions; and (3) 
transactions in Collateralized Mortgage Obligations (``CMOs''), 
issued in conformity with a program of an agency or Government-
Sponsored Enterprise (``GSE''), with forward settlement dates 
transactions''). The proposed rule change would re-designate the 
current definition of Covered Agency Transactions, as set forth in 
paragraph (e)(2)(H)(i)c., as paragraph (e)(2)(H)(i)b., without any 
change. See Exhibit 5 to the Proposal. See also Notice, 86 FR 28161-
62.
    \13\ See Exchange Act Release No. 78081 (June 15, 2016), 81 FR 
40364 (June 21, 2016) (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; File No. SR-FINRA-2015-036) (approving SR-FINRA-2015-036, 
referred to as the ``2016 Approval Order''). The rule text as 
approved in the 2016 Approval Order is referred to in this order as 
the ``current rule'' or ``original rulemaking.'' The proposed rule 
change, as described in Section II.A. and B., is excerpted, in part, 
from the Notice, which was substantially prepared by FINRA.
---------------------------------------------------------------------------

     To eliminate the two percent maintenance margin 
requirement that applies to non-exempt \14\ accounts pursuant to 
paragraph (e)(2)(H)(ii)e. under FINRA Rule 4210. This would eliminate 
the need for members to distinguish exempt account customers from other 
customers (``non-exempt accounts'') for purposes of Covered Agency 
Transaction margin. As such, without regard to a counterparty's exempt 
or non-exempt account status, members would collect margin for each 
counterparty's excess mark to market loss, as discussed in further 
detail

[[Page 4077]]

below, unless otherwise provided by the rule;
---------------------------------------------------------------------------

    \14\ The term ``exempt account'' is defined under FINRA Rule 
4210(a)(13). Broadly, an exempt account means a FINRA member, non-
FINRA member registered broker-dealer, account that is a 
``designated account'' under FINRA Rule 4210(a)(4) (specifically, a 
bank as defined under Exchange Act Section 3(a)(6), a savings 
association as defined under Section 3(b) of the Federal Deposit 
Insurance Act, the deposits of which are insured by the Federal 
Deposit Insurance Corporation, an insurance company as defined under 
Section 2(a)(17) of the Investment Company Act, an investment 
company registered with the Commission under the Investment Company 
Act, a state or political subdivision thereof, or a pension plan or 
profit sharing plan subject to the Employee Retirement Income 
Security Act or of an agency of the United States or of a state or 
political subdivision thereof), and any person that has a net worth 
of at least $45 million and financial assets of at least $40 million 
for purposes of paragraphs (e)(2)(F), (e)(2)(G) and (e)(2)(H) of the 
rule, as set forth under paragraph (a)(13)(B)(i) of FINRA Rule 4210, 
and meets specified conditions as set forth under paragraph 
(a)(13)(B)(ii). See Notice, 86 FR 28163, n.18.
---------------------------------------------------------------------------

     Subject to specified conditions and limitations, to permit 
members to take a capital charge in lieu of collecting margin for 
excess net mark to market losses on Covered Agency Transactions. FINRA 
has designed these conditions and limitations to help protect the 
financial stability of members that opt to take capital charges while 
restricting the ability of the larger members to use their capital in 
lieu of collecting margin to compete unfairly with smaller members; 
\15\ and
---------------------------------------------------------------------------

    \15\ See Notice, 86 FR 28163.
---------------------------------------------------------------------------

     To make revisions designed to streamline, consolidate and 
clarify the Covered Agency Transaction rule language. FINRA believes 
these revisions will preserve and clarify key exceptions to the 
requirements, including for example the $250,000 de minimis transfer 
exception \16\ and the $10 million gross open position exception \17\ 
established pursuant to SR-FINRA-2015-036.\18\
---------------------------------------------------------------------------

    \16\ See Notice, 86 FR 28163. Subject to specified conditions, 
the current rule provides for an aggregate $250,000 de minimis 
transfer amount with a single counterparty, so that if the aggregate 
required but uncollected maintenance margin or mark to market loss 
does not exceed that amount, the margin need not be collected or 
charged to net capital. See 2016 Approval Order, 81 FR 40367; see 
also paragraph (e)(2)(H)(ii)f. of the current rule in Exhibit 5 to 
the Proposal.
    \17\ The current rule provides that the margin requirements for 
Covered Agency Transactions do not apply to a counterparty that has 
gross open positions in Covered Agency Transactions with the member 
amounting to $10 million or less if the counterparty regularly 
settles its Covered Agency Transactions on a Delivery Versus Payment 
(``DVP'') basis or for cash and meets other specified conditions. 
See paragraph (e)(2)(H)(ii)c. of the current rule in Exhibit 5 to 
the Proposal.
    \18\ See Notice, 86 FR 28163.
---------------------------------------------------------------------------

    The proposed amendments are discussed in detail below.\19\
---------------------------------------------------------------------------

    \19\ Section II.B. describes the proposed rule change prior to 
the proposed amendments in Amendment No. 1, which are summarized in 
Section II.C. below.
---------------------------------------------------------------------------

B. Detailed Discussion of Proposed Amendments

1. Elimination of Maintenance Margin Requirement; Application of Mark 
to Market Loss to Both Exempt and Non-Exempt Accounts
    Paragraph (e)(2)(H)(ii)e. of current FINRA Rule 4210 addresses 
Covered Agency Transactions with counterparties that are non-exempt 
accounts and broadly provides that maintenance margin, defined under 
the current rule to mean margin equal to two percent of the contract 
value of the net long or net short position, by CUSIP, with the 
counterparty, plus any net mark to market loss on such transactions, 
shall be required margin, subject to specified exceptions under the 
rule.\20\ By contrast, paragraph (e)(2)(H)(ii)d. of the current rule 
broadly provides that on transactions with counterparties that are 
exempt accounts no maintenance margin shall be required. Such 
transactions must be marked to the market daily and the member must 
collect any net mark to market loss, subject to specified exceptions 
under the current rule.\21\
---------------------------------------------------------------------------

    \20\ See 2016 Approval Order, 81 FR 40367; see also paragraph 
(e)(2)(H)(ii)e. of the current rule in Exhibit 5. The rule further 
sets forth specified requirements for net capital deductions and the 
liquidation of positions in the event the uncollected maintenance 
margin and mark to market loss (defined together under paragraph 
(e)(2)(H)(i)d. of the current rule as the ``deficiency'') is not 
satisfied. In short, the rule provides that if the deficiency is not 
satisfied by the close of business on the next business day after 
the business day on which the deficiency arises, the member shall be 
required to deduct the amount of the deficiency from net capital as 
provided in Exchange Act Rule 15c3-1 until such time the deficiency 
is satisfied; under the rule, if such deficiency is not satisfied 
within five business days from the date the deficiency was created, 
the member must promptly liquidate positions to satisfy the 
deficiency, unless FINRA has specifically granted the member 
additional time. As discussed in further detail below, the proposed 
rule change would eliminate current paragraph (e)(2)(H)(ii)e. in its 
entirety.
    \21\ See 2016 Approval Order, 81 FR 40367; see also paragraph 
(e)(2)(H)(ii)d. of the current rule in Exhibit 5 to the Proposal. 
Similar to paragraph (e)(2)(H)(ii)e., the current rule provides that 
if the mark to market loss is not satisfied by the close of business 
on the next business day after the business day on which the mark to 
market loss arises, the member is required to deduct the amount of 
the mark to market loss from net capital as provided in Exchange Act 
Rule 15c3-1 until such time the mark to market loss is satisfied; if 
such mark to market loss is not satisfied within five business days 
from the date the loss was created, the member must promptly 
liquidate positions to satisfy the mark to market loss, unless FINRA 
has specifically granted the member additional time. Again, as 
discussed in further detail below, the proposed rule change would 
eliminate current paragraph (e)(2)(H)(ii)d. in its entirety.
---------------------------------------------------------------------------

    According to FINRA, member firms expressed concern that the two-
track treatment of exempt versus non-exempt accounts is burdensome 
because members are obliged under the current rule to obtain and assess 
the financial information needed to determine which counterparties must 
be treated as non-exempt accounts.\22\ Further, based on feedback from 
members since the approval date and additional observation of market 
conditions, FINRA believes that the potential risk that the maintenance 
margin requirement was intended to address when originally proposed is 
not significant enough to warrant the burdens and competitive 
disadvantage that the requirement imposes.\23\ According to FINRA, 
members pointed out that, in practice, the maintenance margin 
requirement would apply to relatively few accounts that participate in 
the Covered Agency Transaction market. Yet, FINRA believes that 
monitoring and collecting maintenance margin for such accounts is 
operationally burdensome and out of proportion with the number and size 
of the affected accounts.\24\ Further, according to FINRA, bank dealers 
are not subject to the requirement to collect maintenance margin from 
their customers, which would significantly disadvantage FINRA members 
in competition with bank dealers.\25\ To address these concerns, FINRA 
is proposing to eliminate paragraph (e)(2)(H)(ii)d. and paragraph 
(e)(2)(H)(ii)e. of FINRA Rule 4210 as established pursuant to the 2016 
Approval Order, and to adopt in lieu new paragraph (e)(2)(H)(ii)c., 
which provides that members shall collect margin for each 
counterparty's \26\ excess net mark to market loss,\27\ unless

[[Page 4078]]

otherwise provided under proposed new paragraph (e)(2)(H)(ii)d. of the 
rule, as discussed further below. As such, both exempt and non-exempt 
accounts would receive the same margin treatment for purposes of 
Covered Agency Transactions under paragraph (e)(2)(H).\28\
---------------------------------------------------------------------------

    \22\ See Notice, 86 FR 28163. Further, members expressed concern 
that some asset manager counterparties face constraints with regard 
to custody of assets at broker-dealers and that, because of these 
constraints, some members need to enter into separate custodial 
agreements with third party banks to hold the maintenance margin 
that they collect from these asset managers. Members expressed 
concern that this imposes operational burdens both on themselves and 
their client counterparties, who may, as a consequence, choose to 
limit their dealings with smaller broker-dealers. Id., at n.23.
    \23\ See Notice, 86 FR 28163.
    \24\ Id.
    \25\ Id.
    \26\ Current paragraph (e)(2)(H)(i)b. defines the term 
``counterparty'' to mean any person that enters into a Covered 
Agency Transaction with a member and includes a ``customer'' as 
defined in paragraph (a)(3) under FINRA Rule 4210. The proposed rule 
change would redesignate the definition of counterparty as paragraph 
(e)(2)(H)(i)a. under the rule and revise the definition to provide 
that the term ``counterparty'' means any person, including any 
``customer'' as defined in paragraph (a)(3) of the rule, that is a 
party to a Covered Agency Transaction with, or guaranteed by, a 
member. FINRA believes that including transactions guaranteed by a 
member is a useful clarifying change in the context of Covered 
Agency Transactions. In connection with this change, FINRA proposes 
to add new Supplemental Material .02, which would provide that, for 
purposes of paragraph (e)(2)(H), a member is deemed to have 
``guaranteed'' a transaction if the member has become liable for the 
performance of either party's obligations under the transaction. See 
proposed new Supplemental Material .02 in Exhibit 5 to the Proposal. 
Accordingly, if a clearing broker were to guarantee to an introduced 
customer an introducing broker's obligations under a Covered Agency 
Transaction between that introducing firm and customer, the 
introducing broker would be considered a ``counterparty'' of the 
clearing broker for purposes of paragraph (e)(2)(H). See also 
Notice, 86 FR 28163-64, n.25.
    \27\ FINRA proposes to delete the current definition of ``mark 
to market loss'' under paragraph (e)(2)(H)(i)g. as adopted pursuant 
to the 2016 Approval Order and to replace it with a definition of 
``net mark to market loss'' under proposed new paragraph 
(e)(2)(H)(i)d. Under the new definition, a counterparty's ``net mark 
to market loss'' means (1) the sum of such counterparty's losses, if 
any, resulting from marking to market the counterparty's Covered 
Agency Transactions with the member, or guaranteed to a third party 
by the member, reduced to the extent of the member's legally 
enforceable right of offset or security by (2) the sum of such 
counterparty's gains, if any, resulting from: (a) marking to market 
the counterparty's Covered Agency Transactions with the member, 
guaranteed to the counterparty by the member, cleared by the member 
through a registered clearing agency, or in which the member has a 
first-priority perfected security interest; and (b) any ``in the 
money,'' as defined in paragraph (f)(2)(E)(iii) of FINRA Rule 4210, 
amounts of the counterparty's long standby transactions written by 
the member, guaranteed to the counterparty by the member, cleared by 
the member through a registered clearing agency, or in which the 
member has a first-priority perfected security interest. Under 
proposed new paragraph (e)(2)(H)(i)c., a counterparty's ``excess'' 
net mark to market loss is defined to mean such counterparty's net 
mark to market loss to the extent it exceeds $250,000. As such, by 
specifying excess net mark to market loss, FINRA stated that the 
proposed rule preserves the $250,000 de minimis transfer exception 
set forth under paragraph (e)(2)(H)(ii)f. as adopted pursuant to the 
2016 Approval Order. Further, FINRA stated that, in the interest of 
clarity, proposed new paragraph (e)(2)(H)(ii)c. expressly provides 
that members would not be required to collect margin, or take 
capital charges, for counterparties' mark to market losses on 
Covered Agency Transactions other than excess net mark to market 
losses. Last, as discussed further below, the proposed rule change 
would delete paragraph (e)(2)(H)(ii)f. in the interest of 
consolidating the rule language. See Notice, 86 FR 28164, n.26.
    \28\ Current paragraph (e)(2)(H)(ii)d. of the rule contains 
provisions designed to permit members to treat mortgage bankers, as 
defined pursuant to current paragraph (e)(2)(H)(i)h. of the rule, as 
exempt accounts under specified conditions. Because the proposed 
rule change eliminates the distinction between exempt and non-exempt 
accounts for purposes of Covered Agency Transactions, FINRA believes 
this language is no longer needed and will be deleted. See Notice, 
86 FR 28164, n.27.
---------------------------------------------------------------------------

2. Option for Capital Charge in Lieu of Mark to Market Margin
    Proposed new paragraph (e)(2)(H)(ii)d. of the rule is designed, 
subject to specified conditions and limitations, to permit members the 
option to take a capital charge in lieu of collecting margin for a 
counterparty's excess net mark to market loss (that is, as discussed 
above, the net mark to market loss to the extent it exceeds $250,000). 
Informed by FINRA's engagement with members, FINRA believes this 
approach is appropriate because it would help alleviate the competitive 
disadvantage of smaller firms vis-[agrave]-vis larger firms.\29\ 
According to FINRA, smaller firms expressed concern that larger firms 
can leverage their greater size and scale in obtaining margining 
agreements with their counterparties, and that counterparties would 
prefer to transact with larger firms with which margining agreements 
can more readily be obtained, or with banks that are not subject to 
margin requirements under FINRA Rule 4210. Smaller firms told FINRA 
that having the option to take a capital charge, in lieu of collecting 
margin, would help alleviate the competitive disadvantage of needing to 
obtain margining agreements with such counterparties because there 
would be an alternative to collecting margin.\30\ To this end, as 
stated above, the proposed rule change includes conditions and 
limitations that FINRA believes are designed to help protect the 
financial stability of members that opt to take capital charges while 
restricting the ability of the larger members to use their capital to 
compete unfairly with smaller members.\31\ Specifically, the proposed 
new paragraph provides that a member need not collect margin for a 
counterparty's excess net mark to market loss under paragraph 
(e)(2)(H)(ii)c. of the rule, provided that:
---------------------------------------------------------------------------

    \29\ See Notice, 86 FR 28164.
    \30\ See Notice, 86 FR 28164.
    \31\ See Notice, 86 FR 28164.
---------------------------------------------------------------------------

     The member must deduct the amount of the counterparty's 
unmargined excess net mark to market loss from the member's net capital 
computed as provided in Exchange Act Rule 15c3-1, if the counterparty 
is a non-margin counterparty \32\ or if the excess net mark to market 
loss has not been margined or eliminated by the close of business on 
the next business day after the business day on which such excess net 
mark to market loss arises; \33\
---------------------------------------------------------------------------

    \32\ Proposed new paragraph (e)(2)(H)(i)e. defines a 
counterparty as a ``non-margin counterparty'' if the member: (1) 
Does not have a right under a written agreement or otherwise to 
collect margin for such counterparty's excess net mark to market 
loss and to liquidate such counterparty's Covered Agency 
Transactions if any such excess net mark to market loss is not 
margined or eliminated within five business days from the date it 
arises; or (2) does not regularly collect margin for such 
counterparty's excess net mark to market loss. See Amendment No. 1 
discussed in Section II.C. below for discussions of modification to 
proposed definition of non-margin counterparty.
    \33\ See proposed paragraph (e)(2)(H)(ii)d.1. in Exhibit 5 to 
the Proposal.
---------------------------------------------------------------------------

     If the member has any non-margin counterparties, the 
member must establish and enforce risk management procedures reasonably 
designed to ensure that the member would not exceed either of the 
limits specified in paragraph (e)(2)(I)(i) of the rule, as proposed to 
be revised pursuant to this rule change,\34\ and that the member's net 
capital deductions under proposed paragraph (e)(2)(H)(ii)d.1. of the 
rule for all accounts combined will not exceed $25 million; \35\
---------------------------------------------------------------------------

    \34\ Current paragraph (e)(2)(I) sets forth specified 
concentration thresholds. As discussed further below, the rule 
change would make conforming revisions to the rule.
    \35\ See proposed paragraph (e)(2)(H)(ii)d.2. in Exhibit 5 to 
the Proposal.
---------------------------------------------------------------------------

     If the member's net capital deductions under paragraph 
(e)(2)(H)(ii)d.1. of the rule for all accounts combined exceed $25 
million for five consecutive business days, the member must give prompt 
written notice to FINRA. If the member's net capital deductions under 
paragraph (e)(2)(H)(ii)d.1. of the rule for all accounts combined 
exceed the lesser of $30 million or 25% of the member's tentative net 
capital, as such term is defined in Exchange Act Rule 15c3-1, for five 
consecutive business days, the member may not enter into any new 
Covered Agency Transactions with any non-margin counterparty other than 
risk-reducing transactions, and must also, to the extent of its rights, 
promptly collect margin for each counterparty's excess net mark to 
market loss and promptly liquidate the Covered Agency transactions of 
any counterparty whose excess net mark to market loss is not margined 
or eliminated within five business days from the date it arises, unless 
FINRA has specifically granted the member additional time; \36\ and
---------------------------------------------------------------------------

    \36\ See proposed paragraph (e)(2)(H)(ii)d.3. in Exhibit 5 to 
the Proposal.
---------------------------------------------------------------------------

     The member must submit to FINRA such information regarding 
its unmargined net mark to market losses, non-margin counterparties and 
related capital charges, in such form and manner, as FINRA shall 
prescribe by Regulatory Notice or similar communication.\37\
---------------------------------------------------------------------------

    \37\ See Notice, 86 FR 28164. See also proposed paragraph 
(e)(2)(H)(ii)d.4. in Exhibit 5 to the Proposal.
---------------------------------------------------------------------------

3. Streamlining and Consolidation of Rule Language; Conforming 
Revisions
    In support of the amendments discussed above, FINRA has proposed 
several amendments to the current rule designed to streamline and 
consolidate the rule language and otherwise make conforming revisions:
     The rule change consolidates language related to the 
$250,000 de minimis transfer exception and the $10 million gross open 
position exception while, as discussed above, preserving these 
exceptions in substance. The $250,000 de minimis transfer exception is 
preserved because paragraph (e)(2)(H)(ii)c. under the revised rule

[[Page 4079]]

specifies that the members shall collect margin for each counterparty's 
excess net mark to margin loss, unless otherwise provided under 
paragraph (e)(2)(H)(ii)d. of the rule (that is, as discussed above, the 
provisions under the proposed rule change that permit a member to take 
a capital charge in lieu of collecting margin, subject to specified 
conditions).\38\ The proposed rule change deletes paragraph 
(e)(2)(H)(ii)f., which currently addresses the de minimis exception and 
would be rendered redundant. With respect to the current $10 million 
gross open position exception, FINRA proposes to revise paragraph 
(e)(2)(H)(ii)a. of the rule, which specifies counterparties that are 
excepted from the rule's margin requirements, to include a ``small cash 
counterparty'' among the enumerated entities included in the exception. 
Proposed new paragraph (e)(2)(H)(i)h. would provide that a counterparty 
is a ``small cash counterparty'' if:
---------------------------------------------------------------------------

    \38\ See Notice, 86 FR 28165.
---------------------------------------------------------------------------

    [cir] The absolute dollar value of all of such counterparty's open 
Covered Agency Transactions with, or guaranteed by, the member is $10 
million or less in the aggregate, when computed net of any settled 
position of the counterparty held at the member that is deliverable 
under such open Covered Agency Transactions and which the counterparty 
intends to deliver; \39\
---------------------------------------------------------------------------

    \39\ See proposed paragraph (e)(2)(H)(i)h.1. in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

    [cir] The original contractual settlement date for all such open 
Covered Agency Transactions is in the month of the trade date for such 
transactions or in the month succeeding the trade date for such 
transactions; \40\
---------------------------------------------------------------------------

    \40\ See proposed paragraph (e)(2)(H)(i)h.2. in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

    [cir] The counterparty regularly settles its Covered Agency 
Transactions on a DVP basis or for cash; \41\ and
---------------------------------------------------------------------------

    \41\ See proposed paragraph (e)(2)(H)(i)h.3. in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

    [cir] The counterparty does not, in connection with its Covered 
Agency Transactions with, or guaranteed by, the member, engage in 
dollar rolls, as defined in Rule 6710(z), or round robin trades,\42\ or 
use other financing techniques.\43\
---------------------------------------------------------------------------

    \42\ The term ``round robin'' is defined under current paragraph 
(e)(2)(H)(i)i. of the rule and, pursuant to the rule change, would 
be redesignated as paragraph (e)(2)(H)(i)g., without any change.
    \43\ See proposed paragraph (e)(2)(H)(i)h.4. in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

    The above elements, according to FINRA, are substantially similar 
to the elements that are currently associated with the exception as set 
forth under current paragraph (e)(2)(H)(ii)c.2., which would be 
deleted, along with the definition of ``gross open position'' under 
paragraph (e)(2)(H)(i)e., which would be rendered redundant.\44\ The 
new proposed language reflects that the scope of transactions addressed 
by the rule include Covered Agency Transactions with a counterparty 
that are guaranteed by the member.
---------------------------------------------------------------------------

    \44\ See Notice, 86 FR 28165.
---------------------------------------------------------------------------

     FINRA proposes to delete the definition of ``bilateral 
transaction'' set forth in current paragraph (e)(2)(H)(i)a. The 
definition is in connection with the provisions under the current rule 
relating to margin treatment for exempt accounts under paragraph 
(e)(2)(H)(ii)d. and for non-exempt accounts under paragraph 
(e)(2)(H)(ii)e., both of which paragraphs, as discussed above, FINRA 
proposes to delete pursuant to the rule change. Further, FINRA notes 
that the term ``bilateral transaction'' is unduly narrow given that the 
proposed revised definition of ``counterparty,'' as discussed above, 
would have the effect of clarifying that the rule's scope includes 
transactions guaranteed by the member.\45\
---------------------------------------------------------------------------

    \45\ See Notice, 86 FR 28165.
---------------------------------------------------------------------------

     FINRA proposes to delete the definition of the term 
``deficiency'' set forth in current paragraph (e)(2)(H)(i)d. Under the 
current rule, the term is designed in part to reference required but 
uncollected maintenance margin for Covered Agency Transactions. Because 
the rule change proposes to eliminate such maintenance margin, FINRA 
believes that the term is not needed.\46\
---------------------------------------------------------------------------

    \46\ See Notice, 86 FR 28165.
---------------------------------------------------------------------------

     Current paragraph (e)(2)(H)(ii)a. addresses the scope of 
paragraph (e)(2)(H) and certain types of counterparties that are 
excepted from the rule, provided the member makes and enforces written 
risk limits pursuant to paragraph (e)(2)(H)(ii)b. Current paragraph 
(e)(2)(H)(ii)b. contains the core language under the rule relating to 
risk limits. FINRA is proposing to revise both paragraphs so as to 
conform with the rule change and to consolidate the language relating 
to written risk limits in these paragraphs within paragraph 
(e)(2)(H)(ii)b. Paragraph (e)(2)(H)(ii)a.1. would be revised to read: 
``1. a member is not required to collect margin, or to take capital 
charges in lieu of collecting such margin, for a counterparty's excess 
net mark to market loss if such counterparty is a small cash 
counterparty, registered clearing agency, Federal banking agency, as 
defined in 12 U.S.C. 1813(z), central bank, multinational central bank, 
foreign sovereign, multilateral development bank, or the Bank for 
International Settlements; and . . .'' \47\ Paragraph (e)(2)(H)(ii)a.2. 
would be revised to read: ``2. a member is not required to include a 
counterparty's Covered Agency Transactions in multifamily housing 
securities or project loan program securities in the computation of 
such counterparty's net mark to market loss, provided . . .'' \48\ 
Paragraph (e)(2)(H)(ii)a.2.A. would not be changed, other than to be 
redesignated as part of part of (e)(2)(H)(ii)a.2. Paragraph 
(e)(2)(H)(ii)a.2.B. would be eliminated as redundant \49\ because, 
correspondingly, paragraph (e)(2)(H)(ii)b. would be revised to read: 
``A member that engages in Covered Agency Transactions with any 
counterparty shall make a determination in writing of a risk limit for 
each such counterparty, including any counterparty specified in 
paragraph (e)(2)(H)(ii)a.1. of this Rule, that the member shall 
enforce. The risk limit for a counterparty shall cover all of the 
counterparty's Covered Agency Transactions with the member or 
guaranteed to a third party by the member, including Covered Agency 
Transactions specified in paragraph (e)(2)(H)(ii)a.2. of this Rule. The 
risk limit determination shall be made by a designated credit risk 
officer or credit risk committee in accordance with the

[[Page 4080]]

member's written risk policies and procedures.'' \50\
---------------------------------------------------------------------------

    \47\ The proposed new term ``small cash counterparty'' is 
discussed above. The proposed language in the paragraph reflects 
FINRA's proposed establishment of the option to take a net capital 
charge in lieu of collecting margin. Further, FINRA stated that, for 
clarity, the proposed rule change adds registered clearing agencies 
to the types of counterparties that are within the exception 
pursuant to paragraph (e)(2)(H)(ii)a. as revised. FINRA believes 
that this preserves the treatment of registered clearing agencies 
under the rule in light of the proposed deletion of current 
paragraph (e)(2)(H)(ii)c. In this regard, also in the interest of 
clarity, FINRA proposes to add new paragraph (e)(2)(H)(i)f. by way 
of defining the term ``registered clearing agency.'' See Notice, 86 
FR 28165, n.39.
    \48\ Under current paragraph (e)(2)(H)(ii)a.2., a member is not 
required to apply the margin requirements of paragraph (e)(2)(H) to 
Covered Agency Transactions with a counterparty in multifamily 
housing securities or project loan program securities, provided the 
securities meet the specified conditions under the rule and the 
member makes and enforces the written risk limit determinations as 
specified under the rule. FINRA stated that the proposed rule change 
does not change the treatment of multifamily housing securities or 
project loan program securities under the current rule other than to 
clarify, in express terms, that a member is not required to include 
a counterparty's Covered Agency Transactions in multifamily housing 
securities or project loan program securities in the computation of 
such counterparty's net mark to market loss. See Notice, 86 FR 
28165, n.40.
    \49\ See proposed paragraph (e)(2)(H)(ii)a. in Exhibit 5 to the 
Proposal.
    \50\ See proposed paragraph (e)(2)(H)(ii)b. in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

     Paragraph (e)(2)(I) under FINRA Rule 4210 addresses 
concentration thresholds. FINRA is proposing to make revisions to align 
the paragraph with the proposed new language as to paragraph (e)(2)(H), 
in particular the elimination of the maintenance margin requirement and 
the introduction of the proposed new term ``small cash counterparty.'' 
Specifically, FINRA proposes to revise the opening sentence of the 
paragraph to read: ``In the event that (i) the net capital deductions 
taken by a member as a result of marked to the market losses incurred 
under paragraphs (e)(2)(F), (e)(2)(G) (exclusive of the percentage 
requirements established thereunder), or (e)(2)(H)(ii)d.1. of this 
Rule, plus any unmargined net mark to market losses below $250,000 or 
of small cash counterparties exceed . . .'' \51\ Current paragraph 
(e)(2)(I)(i)c. would be redesignated as (e)(2)(I)(ii) and would read: 
``(ii) such excess as calculated in paragraph (e)(2)(I)(i) of this Rule 
continues to exist on the fifth business day after it was incurred . . 
.'' The final clause of the paragraph would be revised to read: `` . . 
. the member shall give prompt written notice to FINRA and shall not 
enter into any new transaction(s) subject to the provisions of 
paragraphs (e)(2)(F), (e)(2)(G) or (e)(2)(H) of this Rule that would 
result in an increase in the amount of such excess.''
---------------------------------------------------------------------------

    \51\ See proposed paragraph (e)(2)(I) in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

     Paragraph (f)(6) under FINRA Rule 4210 addresses the time 
within which margin or ``mark to market'' must be obtained. FINRA 
proposes to delete the phrase ``other than that required under 
paragraph (e)(2)(H) of this Rule,'' so the rule, as revised, would 
read: ``The amount of margin or `mark to market' required by any 
provision of this Rule shall be obtained as promptly as possible and in 
any event within 15 business days from the date such deficiency 
occurred, unless FINRA has specifically granted the member additional 
time.'' FINRA believes this is appropriate given the proposed 
elimination of current paragraph (e)(2)(H)(ii)d. and paragraph 
(e)(2)(H)(ii)e. of the rule, both of which set forth, among other 
things, specified time frames for collection of mark to market losses 
or deficiencies, as appropriate, and liquidation of positions that are 
specific to Covered Agency Transactions.\52\
---------------------------------------------------------------------------

    \52\ See Notice, 86 FR 28166.
---------------------------------------------------------------------------

     Current Supplemental Material .02 addresses the 
requirement for monitoring procedures with respect to mortgage bankers, 
for purposes of treating them as exempt accounts pursuant to current 
paragraph (e)(2)(H)(ii)d. Current Supplemental Material .03 addresses 
how the cure of mark to market loss or deficiency, as defined under the 
current rule, may cure the need to liquidate positions. Current 
Supplemental Material .04 addresses determining whether an account 
qualifies as an exempt account. The proposed rule change would render 
each of these provisions unnecessary, given that the rule change 
eliminates the need to distinguish exempt versus non-exempt accounts, 
including, as discussed above, the language targeted toward mortgage 
bankers, and eliminates the liquidation provisions under current 
paragraph (e)(2)(H)(ii)d. and paragraph (e)(2)(H)(ii)e. of the 
rule.\53\ FINRA proposes to redesignate current Supplemental Material 
.05 as Supplemental Material .03.\54\
---------------------------------------------------------------------------

    \53\ See Notice, 86 FR 28166.
    \54\ See Supplemental Material provisions in Exhibit 5 to the 
Proposal.
---------------------------------------------------------------------------

    Subject to Commission approval of the proposed rule change, FINRA 
proposed it would announce the effective date of the proposed rule 
change in a Regulatory Notice to be published no later than 60 days 
following Commission approval. FINRA states that the effective date 
will be no later than 120 days following publication of the Regulatory 
Notice announcing Commission approval.\55\
---------------------------------------------------------------------------

    \55\ See discussion of Amendment No. 1 in Sections II.C. and 
III.B.12. below for discussion of the proposed adjustment of the 
implementation date. See also Amendment No. 1 at 20. FINRA stated 
that the proposed rule change would not impact members that are 
funding portals or that have elected to be treated as capital 
acquisition brokers (``CABs''), given that such members are not 
subject to FINRA Rule 4210. See Notice, 86 FR 28166, n.45.
---------------------------------------------------------------------------

C. Summary of Amendment No. 1

    In Amendment No. 1, FINRA proposed the following modifications to 
the proposed rule change: (1) Modify the definition of ``non-margin 
counterparty'' to exclude small cash counterparties and other exempted 
counterparties; and (2) define a FINRA member's ``specified net capital 
deductions'' as the net capital deductions required by paragraph 
(e)(2)(H)(ii)d.1. of FINRA Rule 4210 with respect to all unmargined 
excess net mark to market losses of its counterparties, except to the 
extent that the member, in good faith, expects such excess net mark to 
market losses to be margined by the close of business on the fifth 
business day after they arose.\56\ In addition, Amendment No. 1 states 
that, if the Commission approves the proposed rule change, as modified 
by Amendment No. 1, FINRA will announce the effective date of the 
proposed rule change, as modified by Amendment No. 1, in a Regulatory 
Notice to be published no later than 60 days following Commission 
approval. The effective date would be between nine and ten months 
following the Commission's approval.\57\
---------------------------------------------------------------------------

    \56\ Amendment No. 1 also contains several conforming changes to 
paragraph numbering to accommodate the proposed modifications to the 
rule text. See Exhibit 4 to Amendment No. 1.
    \57\ See Amendment No. 1. See also OIP, 86 FR 47665.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    After careful review of the proposed rule change, as modified by 
Amendment No. 1, comment letters, and FINRA's responses to the 
comments, the Commission finds that the proposed rule change, as 
modified by Amendment No. 1, is consistent with the requirements of the 
Exchange Act and the rules and regulations thereunder applicable to a 
national securities association.\58\ Specifically, the Commission finds 
that the proposed rule change, as modified by Amendment No. 1, is 
consistent with Section 15A(b)(6) of the Exchange Act,\59\ which 
requires, among other things, that FINRA rules be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to facilitate transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and, in general, to protect investors and the 
public interest.
---------------------------------------------------------------------------

    \58\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f). See, e.g., Section III.A. 
(discussing competitive concerns raised by commenters regarding 
smaller firms exiting the market resulting in a concentration of 
larger firms, and enhancements in efficiency in streamlining and 
consolidating the rule text).
    \59\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

A. Elimination of Maintenance Margin Requirement; Capital in Lieu of 
Margin Charges; and Streamlining of Rule Text

    As discussed above in Section II, FINRA has proposed: (1) To 
eliminate the two percent maintenance margin requirement that would 
apply to non-exempt accounts under current FINRA Rule 4210; (2) subject 
to specified conditions and limitations, to permit FINRA members to 
take a capital charge in lieu of collecting margin for excess net mark 
to market losses on Covered

[[Page 4081]]

Agency Transactions; and (3) to make revisions designed to streamline, 
consolidate and clarify the Covered Agency Transaction rule language.
    Some commenters stated that they appreciated the efforts that FINRA 
made to modify the Covered Agency Transaction margin requirements,\60\ 
and acknowledged the substantial efforts FINRA made to engage with 
industry participants and to adjust the Covered Agency Transaction 
margin requirements to address concerns about competitive equality, 
cost, and the impact on the market for mortgage securities.\61\ One 
commenter expressed support for the proposed change eliminating the 
maintenance margin requirement.\62\
---------------------------------------------------------------------------

    \60\ See Letter from Chris Melton, to Commission (Aug. 2, 2021) 
(``Melton Letter'').
    \61\ See Letter from Christopher B. Killian, Managing Director, 
Securitization, Corporate Credit, Libor, Securities Industry and 
Financial Markets Association, to J. Matthew DeLesDernier, Assistant 
Secretary, Commission (June 15, 2021) (``SIFMA Letter'') at 1.
    \62\ See Letter from Christopher B. Killian, Managing Director, 
Securitization, Corporate Credit, Libor, Asset Management Group of 
SIFMA, to Secretary, Commission (June 15, 2021) (``SIFMA AMG 
Letter'') at 1.
---------------------------------------------------------------------------

    Some commenters, however, raised concerns or objected to the 
proposed rule change on the grounds that imposing margin requirements 
with regard to Covered Agency Transactions would cause smaller and mid-
sized firms to exit the Covered Agency Transaction market, thereby 
causing greater concentration among fewer market participants, reducing 
access to the Covered Agency Transaction market or negatively affecting 
market liquidity.\63\ These commenters expressed concerns that 
customers would not be inclined to transact with smaller and mid-sized 
broker-dealers and would prefer to transact with banks that are not 
subject to margin requirements, that many customers would be unwilling 
to enter into margin agreements, that the costs of engaging in Covered 
Agency Transactions would increase significantly and excessive margin 
requirements and capital charges would be involved, or that the 
proposed requirements, either in whole or in part, are not suitable for 
Specified Pool Transactions and CMOs.\64\ Further, in response to the 
OIP, one commenter reiterated its position that the amendments that are 
the subject of the proposed rule change are unnecessary and an abuse of 
discretion in that they are unworkable, increase systemic risk, and 
will have a catastrophic effect on regional broker-dealers, and that 
the proposed rule change will impose burdens on competition that are 
neither necessary nor appropriate.\65\
---------------------------------------------------------------------------

    \63\ See SIFMA Letter at 2-3; Letter from Michael Decker, Senior 
Vice President, Public Policy, Bond Dealers of America, to Vanessa 
Countryman, Secretary, Commission (June 15, 2021) (``BDA Letter'') 
at 2-5; Letter from Thomas J. Fleming & Adrienne M. Ward, Olshan, on 
behalf of Brean Capital, LLC, to Vanessa Countryman, Secretary, 
Commission (June 15, 2021) (``Brean Capital Letter'') at 10-21. See 
also Letter from Kirk R. Malmberg, President and Chief Executive 
Officer, Federal Home Loan Bank of Atlanta, to Vanessa Countryman, 
Secretary, Commission at 1-2 (Jan. 18, 2022); Letter from Senator 
John Boozman, Senator Thom Tillis, and Senator Cynthia M. Lummis, to 
Gary Gensler, Chairman, Commission (Jan. 10, 2022) (``Boozman et al 
Letter'') at 1-2.
    \64\ Id. See also Melton Letter at 1 (stating Specified Pools do 
not represent systemic risk in and among themselves and should not 
be included in the definition of ``Covered Agency Transaction'').
    \65\ See Letter from Thomas J. Fleming and Adrienne M. Ward, 
Olshan, and David H. Thompson and Harold Reeves, Cooper & Kirk, PLLC 
on behalf of Brean Capital, LLC, and the Bond Dealers of America, 
Inc. to Vanessa Countryman, Secretary, Commission (Sep. 10, 2021) 
(``BDA and Brean Capital Letter'') at 20-42. The BDA and Brean 
Capital Letter appears twice in the comment file.
---------------------------------------------------------------------------

    In response to the comments to the Notice, FINRA stated that it has 
engaged with industry participants extensively on these concerns, and 
has addressed them on multiple occasions, since the process of 
soliciting comment on requirements for Covered Agency Transactions 
began in January 2014 with the publication of Regulatory Notice 14-02 
and in 2015 with FINRA's original rulemaking for Covered Agency 
Transactions.\66\ FINRA also stated that it believes that the 
rulemaking is necessary because of the risks posed by unsecured credit 
exposures in the Covered Agency Transactions market.\67\ FINRA also 
stated that it has addressed, on multiple occasions, the need to 
include Specified Pool Transactions and CMOs within the scope of the 
requirements,\68\ and stated that it made key revisions in finalizing 
the original rulemaking expressly to mitigate any potential impact on 
smaller firms and on activity in the Covered Agency Transaction market, 
including the following:
---------------------------------------------------------------------------

    \66\ See Exchange Act Release No. 76148 (Oct. 14, 2015), 80 FR 
63603 (Oct. 20, 2015) (Notice of Filing of a Proposed Rule Change to 
Amend FINRA Rule 4210 (Margin Requirements) to Establish Margin 
Requirements for the TBA Market; File No. SR-FINRA-2015-036) (``2015 
Notice''); see also Regulatory Notice 14-02 (Jan. 2014). Even before 
the publication of these materials, as discussed in SR-FINRA-2015-
036, FINRA highlighted that it had engaged in extensive outreach and 
consultation with market participants and staff of the Federal 
Reserve Bank of New York and the Commission staff. See 2015 Notice, 
80 FR, at 63604-05. In Partial Amendment No. 3 to SR-FINRA-2015-036, 
FINRA stated that up to that point there had been four opportunities 
for public comment on the original rulemaking, beginning with 
Regulatory Notice 14-02, available at: https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036. See also Amendment No. 1 at 
4.
    \67\ See, e.g., 2015 Notice, 80 FR 63615-16. See also Amendment 
No. 1 at 4-5.
    \68\ See 2016 Approval Order, 81 FR 40371.
---------------------------------------------------------------------------

     FINRA initially proposed an exception in the original 
rulemaking pursuant to which the new margin requirements would not 
apply to a counterparty if its gross open positions in Covered Agency 
Transactions with a FINRA member is $2.5 million or less, subject to 
specified conditions. In response to commenters on the original 
rulemaking, and to ensure that a greater number of smaller firms and 
counterparties would benefit from the exception, FINRA increased the 
amount from $2.5 million to $10 million; \69\
---------------------------------------------------------------------------

    \69\ See Partial Amendment No. 3 to SR-FINRA-2015-036, available 
at: https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
---------------------------------------------------------------------------

     FINRA modified the two percent maintenance margin 
requirement, as adopted pursuant to the original rulemaking, to create 
an exception for cash investors that otherwise, by virtue of not being 
``exempt accounts'' as defined under FINRA's margin rules, would have 
been subject to the requirement.\70\ FINRA also made an exception from 
the maintenance margin requirements available to mortgage bankers in 
the original rulemaking;
---------------------------------------------------------------------------

    \70\ See 2015 Notice, 80 FR 63608.
---------------------------------------------------------------------------

     FINRA excepted multifamily housing securities and project 
loan program securities from the new margin requirements; \71\
---------------------------------------------------------------------------

    \71\ See Partial Amendment No. 1 to SR-FINRA-2015-036, available 
at: https://www.finra.org/rules-guidance/rule-filings/sr-finra-2015-036.
---------------------------------------------------------------------------

     FINRA established a $250,000 de minimis transfer amount, 
for a single counterparty, subject to specified conditions, up to which 
members would not need to collect margin or take a charge to their net 
capital.\72\
---------------------------------------------------------------------------

    \72\ See 2016 Approval Order, 81 FR 40368. See also Amendment 
No. 1 at 5-6.
---------------------------------------------------------------------------

    Additionally, FINRA stated that the 2016 Approval Order was issued 
for the original rulemaking on June 15, 2016, and FINRA stated that, 
upon the Commission's approval (of the original rulemaking), FINRA 
would monitor the impact of the new requirements and, if the 
requirements prove overly onerous or otherwise are shown to negatively 
impact the market, would consider revisiting such requirements as may 
be necessary to mitigate the rule's impact.\73\ Industry participants 
requested that FINRA reconsider the potential impact of the 
requirements pursuant to SR-FINRA-2015-036 on smaller and mid-sized 
firms, and that FINRA extend the implementation date of the 
requirements pending such reconsideration. In response to the

[[Page 4082]]

concerns of industry participants, FINRA engaged in extensive dialogue, 
both with industry participants and other regulators, including staff 
of Commission and the Federal Reserve System, for the purpose of 
reconsidering the requirements.\74\ Further, FINRA has extended the 
implementation date of the margin collection requirements pursuant to 
SR-FINRA-2015-036 on multiple occasions.\75\
---------------------------------------------------------------------------

    \73\ See Partial Amendment No. 3 to SR-FINRA-2015-036. See also 
Amendment No. 1 at 6.
    \74\ See Amendment No. 1 at 6.
    \75\ See Notice, 86 FR 28162. See also Amendment No. 1 at 6.
---------------------------------------------------------------------------

    FINRA stated that it developed the proposed rule change in direct 
response to the concerns of industry participants, and in citing the 
risks posed by unsecured credit exposures that exist in the Covered 
Agency Transaction market, stated that it has proposed two key 
revisions designed to afford relief to industry participants.\76\ 
Specifically, FINRA proposed to eliminate the two percent maintenance 
margin requirement with respect to non-exempt accounts for purposes of 
their Covered Agency Transactions and, subject to specified conditions 
and limits, to permit members to take a capital charge in lieu of 
collecting margin for each counterparty's excess mark to market 
loss.\77\ FINRA believes that, over the course of prolonged engagement 
with industry participants, and in light of the multiple rounds of 
responding to concerns already expressed, and answered, in connection 
with the original rulemaking, and as further addressed in the proposed 
rule change, it does not serve the public interest to further delay the 
proposed rule change. FINRA believes the revisions to the original 
rulemaking as set forth more fully in the proposed rule change, with 
the additional clarifications provided to commenters, afford industry 
participants appropriate relief and clarity, and that the rulemaking 
should proceed.\78\
---------------------------------------------------------------------------

    \76\ See Notice, 86 FR 28162-63. See also Amendment No. 1 at 6.
    \77\ See Amendment No. 1 at 6-7.
    \78\ See Amendment No. 1 at 7.
---------------------------------------------------------------------------

    Further, in response to the additional comments received in 
response to the OIP, FINRA stated that commenters have expressed these 
same points repeatedly, including during the original rulemaking. FINRA 
further stated these concerns have repeatedly been addressed.\79\ FINRA 
also stated that the rulemaking is necessary because of the risk posed 
by unsecured credit exposures in the Covered Agency Transaction market, 
and that FINRA has addressed concerns of industry participants in 
finalizing the original rulemaking, as well as through this proposed 
rule change.\80\ FINRA also stated that events in connection with 
market volatility and other stress stemming from the COVID-19 pandemic 
have once again illustrated the importance of risk and exposure 
limits.\81\ FINRA stated that the recent default of Archegos Capital 
Management, and related multi-billion dollar losses incurred by Credit 
Suisse, is yet another case in point. FINRA stated that these events 
reinforce that FINRA's attention to unsecured exposures in the Covered 
Agency Transaction market, in view of its significance to the U.S. 
mortgage market and financial system generally, is rationally founded. 
FINRA stated that the Covered Agency Transaction market today is 
substantial. As of the second quarter of 2021, FINRA stated that total 
average daily dollar trading volume for these types of products as 
reflected in FINRA Trade Reporting and Compliance Engine (``TRACE'') 
data was approximately $300 billion.\82\ FINRA stated that the 
regulatory need for attention to this area is no less than when FINRA 
initiated the original rulemaking.\83\
---------------------------------------------------------------------------

    \79\ See FINRA Letter at 3.
    \80\ See FINRA Letter at 4-7.
    \81\ See FINRA Letter at 5.
    \82\ See FINRA Letter at 5-6.
    \83\ See FINRA Letter at 6.
---------------------------------------------------------------------------

    In the proposed rule change, FINRA has reasonably balanced the goal 
of reducing firm exposure to counterparty credit risk stemming from 
unsecured credit exposures in the Covered Agency Transaction market, 
with the potential competitive impacts and costs on smaller and medium-
sized broker-dealers. The risks posed by unsecured credit exposures in 
the Covered Agency Transaction market justify the imposition of margin 
requirements on Covered Agency Transactions. Further, as highlighted by 
FINRA above, the current rule, as approved in the 2016 Approval Order, 
already incorporates a number of exceptions designed to alleviate the 
impact of the Covered Agency Margin requirements on smaller firms and 
counterparties, including the small cash counterparty exception.\84\ 
These exceptions remain in the rule as modified by the proposed rule 
change.
---------------------------------------------------------------------------

    \84\ See 2016 Approval Order, 81 FR 40375.
---------------------------------------------------------------------------

    Moreover, while the proposed rule change will not fully resolve the 
disparity that results from being subject to FINRA Rule 4210, when non-
FINRA member banks are not, the proposed rule change to eliminate the 
maintenance margin requirement and the option to take a capital charge 
in lieu of margin should help to alleviate this disparity. The 
continued requirement to collect mark to market losses or take a 
capital charge in lieu of collecting margin will mitigate the risk that 
FINRA members will compete by implementing lower margin levels for 
Covered Agency Transactions and will help ensure that margin levels are 
set at sufficiently prudent levels across FINRA members.
    The Commission agrees with FINRA that some comments have been 
previously addressed in the original rulemaking, including whether to 
impose any margin requirements on Covered Agency Transactions or 
exclude certain products from the scope of the rule, such as Specified 
Pools and CMOs.\85\ These commenters provided comments about the rules 
that the Commission has previously approved, but those rules are not 
before the Commission in this filing.\86\ As described above, the only 
amendments to the current rule before the Commission under the proposed 
rule change are to eliminate the maintenance margin requirement, permit 
capital in lieu of margin charges subject to a cap, and to reorganize 
and streamline the rule text. Because the margin requirements set forth 
in the original rulemaking were approved in the 2016 Approval Order, 
without this proposed rule change, the margin collection requirements 
in the original rule would become effective in 2022.
---------------------------------------------------------------------------

    \85\ See, e.g., 2016 Approval Order, 81 FR 40375-76 
(``[E]xcluding additional products from the rule or modifying the 
settlement dates in the definition of Covered Agency Transactions 
potentially may ``undermine the effectiveness of the proposal'' if 
counterparties are permitted to maintain unsecured credit exposures 
on these positions'').
    \86\ See 2016 Approval Order.
---------------------------------------------------------------------------

    Further, the Commission agrees with FINRA that the regulatory need 
for attention to this area is no less than when FINRA initiated the 
original rulemaking. Recent events have reinforced the need to address 
unsecured exposures in the Covered Agency Transaction market, in view 
of its significance to the U.S. mortgage market and the financial 
system, more generally. Moreover, permitting counterparties to 
participate in the Covered Agency Transaction market without posting 
variation margin could facilitate increased leverage by customers, 
thereby posing a risk to the broker-dealer engaging in an unsecured 
transaction with a counterparty, and to the marketplace as a whole. The 
imposition of margin requirements on Covered Agency Transactions also 
is consistent with other regulatory efforts that have sought to address 
the risk of uncollateralized exposures arising from

[[Page 4083]]

different types of bilateral transactions with counterparties.\87\
---------------------------------------------------------------------------

    \87\ See, e.g., Exchange Act Rule 18a-3 (imposing margin 
requirements on non-cleared security-based swap transactions for 
security-based swap dealers and major security-based swap 
participants).
---------------------------------------------------------------------------

    Eliminating the two percent maintenance margin requirement will 
reduce operational burdens on FINRA member firms by eliminating the 
need to obtain and assess information regarding a counterparty's exempt 
or non-exempt status. Further, FINRA member firms will continue to be 
required to collect variation margin under the proposed rule change 
from a counterparty or take a capital charge, subject to a cap. This 
requirement will further the goal of reducing firm exposure to 
counterparty credit risk stemming from unsecured credit exposures in 
the Covered Agency Transaction market. The elimination of the two 
percent maintenance margin charge also reduces potential competitive 
disparities between FINRA broker-dealers and large bank dealers that 
are not subject to a maintenance margin requirement.\88\
---------------------------------------------------------------------------

    \88\ See Treasury Market Practices Group (``TMPG''), Margining 
in Agency MBS Trading (Nov. 2012), available at https://www.newyorkfed.org/medialibrary/microsites/tmpg/files/margining_tmpg_11142012.pdf (``TMPG Report''). The TMPG report 
recommends the exchange of variation margin for dealer banks. The 
TMPG is a group of market professionals that participate in the 
Covered Agency Transaction market and is sponsored by the Federal 
Reserve Bank of New York.
---------------------------------------------------------------------------

    The proposed rule change to permit FINRA members to take a capital 
charge in lieu of collecting margin, subject to a cap, will provide an 
alternative for firms that are concerned, due to their size, about 
facing competitive disadvantages. For example, to the extent smaller 
broker-dealers face difficulties obtaining margin agreements with 
counterparties, the capital charge provides an alternative. The capital 
in lieu of margin charges under the proposed rule change will require a 
broker-dealer to set aside net capital to address the risk of unsecured 
exposures in the Covered Agency Transaction market that can otherwise 
be mitigated through the collection of variation margin. The set aside 
of net capital will serve as an alternative to obtaining margin 
collateral for this purpose.
    Additionally, the proposed caps and concentration limits on the 
proposed capital in lieu of margin charges will permit smaller broker-
dealers to utilize the capital charge alternative, while limiting the 
amount of capital charges that large firms would be able to take under 
the proposed rule change. This will prohibit larger broker-dealers from 
using their size advantage (and larger capital base) to compete with 
smaller firms by using the capital charge in lieu of margin charge. 
Moreover, by providing the choice of either the collection of variation 
margin or a capital charge for the amount of the variation margin, the 
proposed rule change provides alternatives to broker-dealers with 
respect to their counterparties, while also protecting FINRA members 
from risks of unsecured credit exposures to Covered Agency 
Transactions.
    Some commenters stated that a member with a Covered Agency 
Transaction position that is hedged from a market risk perspective, but 
is unhedged from a credit risk perspective, would have significantly 
higher capital charges or margin requirements under the proposed rule 
change than they would otherwise have absent the rule. The commenters 
described scenarios to illustrate this result.\89\ FINRA stated that 
some of the scenarios involve firms that are fully hedged from a market 
risk perspective, like a firm that purchases a TBA, Specified Pool, or 
CMO from one party and enters into an offsetting sale transaction with 
another party, with the same settlement date. Commenters described 
these transactions as ``riskless,'' but FINRA stated that it disagrees 
with such characterization. FINRA stated that such a firm is exposed to 
the credit risk of both the buyer and seller, and the offsetting 
transactions provide no protection against those risks. FINRA stated 
that paragraph (e)(2)(H) of FINRA Rule 4210 requires members to protect 
themselves against that counterparty credit risk by collecting margin 
for their counterparties' excess net mark to market losses or taking 
capital charges in lieu of such collection.\90\
---------------------------------------------------------------------------

    \89\ See BDA Letter at 2-4; Brean Capital Letter at 15-18.
    \90\ See Amendment No. 1 at 7.
---------------------------------------------------------------------------

    According to FINRA, in some of these scenarios, commenters 
attributed the higher margin or capital requirements to the fact that 
the transactions (termed ``non-netting'' by one commenter and ``non-
nettable'' by another) will not net under the proposed rule change. 
Under the proposed rule change, however, FINRA stated there is no 
category of transactions that cannot be netted in the determination of 
a counterparty's ``net mark to market loss.'' According to FINRA, the 
only requirement is that the member have a legal right to offset losses 
on one transaction against gains on the other (or a security interest 
that would allow it to apply gains on one transaction to the 
counterparty's losses on the other).\91\
---------------------------------------------------------------------------

    \91\ See Amendment No. 1 at 7-8.
---------------------------------------------------------------------------

    FINRA stated that the ``non-netting'' or ``non-nettable'' 
transactions, as referenced by the commenters, appear to be 
transactions that are not eligible to be cleared by the Mortgage-Backed 
Securities Division of the Fixed Income Clearing Corporation 
(``MBSD''). However, FINRA stated that when an eligible transaction is 
submitted to the MBSD for clearing, that transaction is novated to the 
MBSD, so that instead of a transaction between the original buyer and 
seller, there are two mirror transactions: One in which the original 
buyer is buying from the MBSD; and one in which the original seller is 
selling to the MBSD. Accordingly, FINRA stated that when a firm 
executes with a single counterparty an MBSD-eligible transaction and a 
transaction that is not MBSD-eligible, and the eligible transaction is 
submitted for clearing (but the non-eligible transaction is not), the 
firm ends up with two transactions with two separate counterparties. 
These transactions cannot be netted against each other, according to 
FINRA, because they are with separate counterparties, rather than 
because of FINRA's proposed rule change, which in fact would allow 
gains and losses on the transactions to be netted to the extent of a 
perfected, first priority, security interest in the transaction with 
the gain.\92\
---------------------------------------------------------------------------

    \92\ See Amendment No. 1 at 8.
---------------------------------------------------------------------------

    Further, according to FINRA, the current rule, as approved under 
the 2016 Approval Order, would, subject to specified exceptions, 
require members to collect margin whenever their counterparties' mark 
to market losses (and two percent maintenance margin deficiency, where 
applicable) exceeds $250,000, and would require them to take a capital 
charge to the extent such margin is not collected by the close of 
business on the business day after such mark to market loss (or 
maintenance margin deficiency) arose.\93\ FINRA stated that the 
proposed rule change preserves all of the exceptions in the current 
rule, eliminates the two percent maintenance margin requirement, 
provides an option, subject to specified conditions, to take capital 
charges in lieu of collecting margin for net mark to market losses in 
excess of $250,000, and requires a capital charge to the extent margin 
for excess net mark to mark losses has not been collected by the close 
of business on the business day after such mark to market losses arose. 
Because the proposed rule change

[[Page 4084]]

eliminates the two percent maintenance margin requirement (and as such 
eliminates the related capital charges for uncollected maintenance 
margin), FINRA stated that the margin requirements and capital charges 
under the proposed rule change are less than the requirements under the 
current rule.\94\
---------------------------------------------------------------------------

    \93\ See Amendment No. 1 at 8.
    \94\ See Amendment No. 1 at 8.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's analysis. The proposed rule 
change will reduce the current rule's requirements by permitting 
capital charges in lieu of margin and eliminating the two percent 
maintenance margin requirement. In addition, all of the exceptions in 
the current rule are preserved in the proposed rule change. Further, 
the proposed rule change allows a FINRA member to offset transactions 
where the member has a legal right to offset losses on one transaction 
against gains on the other. This permits a member the flexibility to 
net certain transactions, while protecting broker-dealers against 
counterparty credit risk by requiring them to collect margin for each 
counterparty's excess net mark to market losses or taking capital 
charges in lieu of such collection when transactions cannot be netted. 
Where transactions cannot be legally netted, the broker-dealer would be 
exposed to counterparty credit risk and, consequently, should collect 
variation margin from its counterparty or take a capital charge in lieu 
of collecting margin, unless an exception applies.
    FINRA acknowledged that the margin requirements and capital charges 
under both the proposed rule change and the current rule are higher in 
certain scenarios (and lower in others) than they would be under a 
commenter's suggestion that (1) there should be no margin requirements 
applicable to Covered Agency Transactions (up to the second monthly 
SIFMA settlement date), and (2) members should be required to take 
capital charges for only ten percent of their counterparties' 
unmargined mark to market losses.\95\ FINRA stated that it believes 
that this suggestion would significantly undercut the objective of the 
rule.\96\ FINRA also stated that a proposed alternative approach a 
commenter suggested that would not require margin to be posted until 
the next two ``SIFMA good day settlements'' and apply capital charges 
for 10 percent of the mark to market loss, instead of the 100 percent 
of the mark to market loss set forth in the proposed rule change, would 
significantly undercut the objective of the Covered Agency Transaction 
margin requirements.\97\
---------------------------------------------------------------------------

    \95\ According to FINRA, under the current rule and the proposed 
rule change, members are not required to collect margin, or take 
capital charges in lieu of collecting margin, to cover the net mark 
to market losses of small cash counterparties, registered clearing 
agencies, Federal banking agencies (as defined in 12 U.S.C. 
1813(z)), central banks, multinational central banks, foreign 
sovereigns, multilateral development banks, or the Bank for 
International Settlements. FINRA stated that these exceptions mean 
that some members engaging in Covered Agency Transactions with these 
counterparties may have lower margin and capital requirements under 
the current rule and the proposed rule change than they would under 
the commenter's suggestion. See Amendment No. 1 at 9.
    \96\ See Amendment No. 1 at 9.
    \97\ See Amendment No. 1 at 8-9.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's analysis regarding the proposed 
capital charges or margin requirements. Reducing the proposed capital 
charges or margin requirements, or extending the time under which 
margin would not need to be collected until the next two good 
settlement dates would undermine the purposes of the rule to reduce the 
risk of unsecured exposures from Covered Agency Transactions. The 
proposed rule change will require a broker-dealer to collect variation 
margin from a customer or take a dollar-for-dollar capital charge for 
variation margin that is not collected from a counterparty, unless an 
exception applies. This requirement addresses the risk of a broker-
dealer's unsecured exposures in the Covered Agency Transaction market 
that can be mitigated through the collection of variation margin or the 
set aside of net capital.
    Some commenters raised concerns that FINRA and the Commission lack 
the authority to prescribe margin requirements for Covered Agency 
Transactions.\98\ The commenters argued that Section 7 of the Exchange 
Act identifies the Board of Governors of the Federal Reserve System 
(``Federal Reserve Board'') as the entity responsible for regulating 
margin, and that Congress never intended the Commission to administer 
margin regimes.\99\ Further, one commenter stated that Section 3(a)(12) 
of the Exchange Act defines Covered Agency Transactions as ``exempted 
securities'' and, therefore, not subject to the authority of the 
Federal Reserve Board or the Commission.\100\ Another commenter stated 
that Senate Report in connection with the adoption of the Secondary 
Mortgage Market Enhancement Act of 1984 (including Section 7(g) of the 
Exchange Act) supports the view that the Federal Reserve Board has sole 
authority, and that Congress did not intend to grant FINRA authority to 
require margin for trades in exempt securities.\101\
---------------------------------------------------------------------------

    \98\ See Brean Capital Letter at 21-23; Melton Letter; BDA and 
Brean Capital Letter at 20-25. See also Boozman et al Letter at 2.
    \99\ See Brean Capital Letter at 22-23; Melton Letter.
    \100\ See Brean Capital Letter at 22.
    \101\ See Melton Letter; BDA and Brean Capital Letter at 21-22.
---------------------------------------------------------------------------

    FINRA addressed this assertion in the original rulemaking, and 
stated that the requirements are consistent with the provisions of 
Section 15A(b)(6) of the Securities Exchange Act.\102\ FINRA stated 
that Section 7 of Securities Exchange Act sets forth the parameters of 
the margin setting authority of the Federal Reserve Board and does not 
bar action by FINRA.\103\ The Commission agrees with FINRA that it is 
within FINRA's authority to impose margin requirements on its 
members.\104\
---------------------------------------------------------------------------

    \102\ See 2016 Approval Order, 81 FR 40373.
    \103\ See Amendment No. 1 at 7.
    \104\ See 12 CFR 220.1(b)(2) (``This [Regulation T] . . . does 
not preclude any exchange, national securities association, or 
creditor from imposing additional requirements or taking action for 
its own protection.''); See also 2016 Approval Order, 81 FR 40374 
(``The stated goals of the proposal are consistent with the purposes 
of the Exchange Act and with FINRA's authority to impose margin 
requirements on its members.''); paragraphs (e)(2)(A), (B), and (F) 
of FINRA Rule 4210 (imposing maintenance margin requirements on 
exempted securities, and requirements on transactions with exempt 
accounts involving certain good faith securities); and Federal 
Reserve Board Ruling (June 28, 1972), FRRS 5-622 (``Although the 
Board does not have authority to set margin requirements on exempted 
securities (FNMA stock is an exempted security), brokers and 
national securities exchanges can establish margin requirements more 
restrictive than those of the Board.'').
---------------------------------------------------------------------------

    The Commission agrees with FINRA that the proposed rule change 
relating to streamlining and reorganizing the current rule enhances the 
transparency of the Covered Agency Transaction margin requirements. The 
consolidation of the rule text and deletion of unnecessary language may 
reduce costs and enhance efficiencies for broker-dealers, while 
preserving the exceptions in the current rule, such as the exception 
from collecting variation margin for net mark to market losses below 
$250,000 and the small cash counterparty exception. For example, the 
proposed rule change streamlines the language regarding the $250,000 
exception making it easier to determine the applicable margin, which in 
turn, may reduce costs associated with calculating margin requirements 
when establishing trading relationships.

B. Other Comments, Clarifications; Technical Revisions to the Proposed 
Rule Change

    In response to the Notice and the OIP, commenters raised additional 
issues regarding other aspects of the proposed

[[Page 4085]]

rule change or requested clarifications or technical revisions to the 
proposed rule change. These comments are discussed in the following 
sections below.
1. Concerns Regarding Liquidation
    Commenters expressed concern about requirements to liquidate 
Covered Agency Transactions stating that market participants often 
engage in long ``chains'' of Specified Pool or CMO transactions, where 
the initial seller contracts to sell a Specified Pool or CMO to the 
initial buyer, the initial buyer contracts to sell the Specified Pool 
or CMO to a second buyer, who contracts to sell it to a third buyer, 
who contracts to sell it to a fourth buyer, etc.\105\ The commenters 
stated that if any party in the chain (except for the last buyer) 
terminates its purchase or sale transaction, the buyer in the 
terminated transaction is unlikely to be able to buy the Specified Pool 
or CMO elsewhere, and therefore will be unable to perform on its sale 
transaction--and so will every subsequent buyer and seller in the 
chain. These commenters stated that FINRA should eliminate or suspend 
the liquidation requirement under the proposed rule change to avoid the 
prospect of a ``daisy chain'' of fails.
---------------------------------------------------------------------------

    \105\ See Brean Capital Letter at 12-13, 20; SIFMA Letter at 3.
---------------------------------------------------------------------------

    FINRA responded that, under the current rule, if a counterparty's 
unmargined mark to market loss (and two percent maintenance margin 
deficiency, where applicable) exceeds $250,000 and is not margined or 
eliminated within five business days from the date it arises, the 
member is required to liquidate the counterparty's positions to satisfy 
the mark to market loss (and two percent maintenance margin deficiency 
where applicable), unless FINRA specifically grants additional time. 
FINRA also stated that the proposed rule change has eliminated this 
liquidation requirement.\106\
---------------------------------------------------------------------------

    \106\ See Amendment No. 1 at 9.
---------------------------------------------------------------------------

    In addition, FINRA stated that, under the proposed rule change, a 
member can opt to take a capital charge in lieu of collecting margin to 
cover a counterparty's excess net mark to market loss. FINRA stated 
that if these capital charges \107\ exceed the lesser of 25 percent of 
the member's tentative net capital or $30 million \108\ for five 
consecutive business days, then the member:
---------------------------------------------------------------------------

    \107\ As discussed in more detail in Section II.C. above, FINRA 
stated that it is modifying the proposed rule change so that capital 
charges for a counterparty's unmargined excess net mark to market 
loss do not count toward this threshold to the extent that the 
member, in good faith, expects such excess net mark to market loss 
to be margined by the close of business on the fifth business day 
after it arose. See Amendment No. 1 at 10.
    \108\ Collectively referred to as the ``25% TNC/$30MM 
Threshold''.
---------------------------------------------------------------------------

     May not enter into new Covered Agency Transactions with 
non-margin counterparties other than risk reducing transactions;
     Must, to the extent of its rights, promptly collect margin 
for each counterparty's excess net mark to market loss; and
     Must, to the extent of its rights, promptly liquidate the 
Covered Agency Transactions of any counterparty whose excess net mark 
to market loss is not margined or eliminated within five business days 
from the date it arises, unless FINRA has specifically granted the 
member additional time.\109\
---------------------------------------------------------------------------

    \109\ See Amendment No. 1 at 10.
---------------------------------------------------------------------------

    Moreover, FINRA stated that if the member does not have the right 
to liquidate a counterparty's Covered Agency Transactions, the proposed 
rule change does not require the member to liquidate those 
transactions, even after the member has exceeded the threshold for five 
business days.\110\ However, according to FINRA, if the member has 
exceeded the threshold for five business days and the member does have 
a right to liquidate a counterparty's Covered Agency Transactions and 
the counterparty's excess mark to market loss has not been margined or 
eliminated within five business days, only then would a member be 
required to enforce its liquidation right or obtain an extension from 
FINRA.\111\
---------------------------------------------------------------------------

    \110\ FINRA stated that a member is not required to have a right 
to liquidate a counterparty's Covered Agency Transactions. However, 
if the member does not have that right, the counterparty would be a 
``non-margin counterparty,'' and paragraph (e)(2)(H)(ii)d.1. under 
the proposed rule change would require the member to establish and 
enforce risk management procedures reasonably designed to ensure 
that the member would not exceed either of the limits specified in 
paragraph (e)(2)(I)(i) of the rule as amended by the proposed rule 
change and that the member's capital charges in lieu of margin on 
Covered Agency Transactions for all accounts combined will not 
exceed $25 million. These procedures would likely involve 
limitations on the extent of the member's business with such non-
margin counterparties. FINRA stated that when the firm's risk 
management procedures function as they are required to be designed, 
the member will rarely cross the 25% TNC/$30MM Threshold, much less 
exceed it for five consecutive business days. See Amendment No. 1 at 
10.
    \111\ See Amendment No. 1 at 10.
---------------------------------------------------------------------------

    The Commission agrees with FINRA that the changes described above 
provide for greater flexibility with respect to the liquidation 
requirement, and also provide an appropriate amount of time, via the 
ability take a capital charge in lieu of margin and to obtain an 
extension from FINRA, to permit firms to adequately address unmargined 
positions without requiring an immediate liquidation of positions. The 
proposed rule change eliminates the liquidation requirement under the 
current rule and replaces it with a requirement to liquidate a 
counterparty's Covered Agency Transactions in limited circumstances 
(e.g., only if the broker-dealer has a right to liquidate the 
transaction and only if certain conditions are met, including exceeding 
the specified cap on net capital deductions).
    FINRA has also stated that this limited liquidation obligation 
should not lead to a daisy chain of fails, except possibly in 
circumstances where a counterparty's unwillingness or inability to 
perform its undisputed obligations makes it equally likely that a daisy 
chain or fails will occur whether or not the member liquidates a 
transaction with the counterparty.\112\ According to FINRA, there are 
four categories of reasons why a counterparty would fail to margin its 
excess net mark to market loss by the fifth business day after it 
arises, and FINRA stated that it believes only one of them has any 
prospect of leading to a liquidation requirement under the proposed 
rule change:
---------------------------------------------------------------------------

    \112\ See Amendment No. 1 at 10-11.
---------------------------------------------------------------------------

     First Category--The counterparty may not have an 
obligation, under an agreement or otherwise, to margin its excess net 
mark to market losses within five business days after they arise. In 
this case, the member would not have a right to liquidate the 
counterparty's Covered Agency Transactions when excess net mark to 
market losses are not margined or eliminated within five business days 
after they arise, and so would have no obligation under the proposed 
rule change to liquidate the counterparty's Covered Agency 
Transactions.
     Second Category--An operational issue may cause the 
counterparty to fail to satisfy its obligation to margin its excess net 
mark to market losses. FINRA believes that five business days should be 
more than enough time to resolve any operational issue. However, in the 
event an extended operational issue, or series of operational issues, 
prevents a counterparty from providing margin for its excess net mark 
to market loss within five business days after it arises, a 14-day 
extension can be obtained from FINRA if the member has exceeded the 25% 
TNC/$30MM Threshold for five consecutive business days and would 
otherwise be under an obligation to enforce a right to liquidate the 
counterparty's Covered Agency

[[Page 4086]]

Transactions. FINRA expects that an operational issue should not 
continue long enough to prevent a counterparty from satisfying its 
margin obligation past the expiration of a 14-day extension.\113\
---------------------------------------------------------------------------

    \113\ See Amendment No. 1 at 11.
---------------------------------------------------------------------------

     Third Category--There may be a disagreement over the 
amount of the counterparty's excess mark to market loss, leading the 
counterparty to believe that it has satisfied its obligation to provide 
margin but the firm to believe that it has not. Commenters suggested 
that relatively unique assets, like Specified Pools and CMOs, are more 
likely to be the subject of valuation disputes. FINRA stated that five 
business days should be more than enough time to resolve any valuation 
dispute. Firms whose business involves a significant volume of 
transactions that are prone to operational disputes should analyze 
whether their risk management procedures should require their contracts 
for such transactions to include or incorporate a procedure for the 
prompt resolution of valuation disputes.\114\ FINRA stated that if an 
extended valuation dispute leads a counterparty to fail to provide 
margin for its excess net mark to market loss within five business days 
after it arises, a 14-day extension can be obtained from FINRA if the 
member has exceeded the 25% TNC/$30MM Threshold for five consecutive 
business days and would otherwise be under an obligation to enforce a 
right to liquidate the counterparty's Covered Agency Transactions. 
FINRA stated that a margin valuation dispute should not continue past 
the expiration of a 14-day extension.
---------------------------------------------------------------------------

    \114\ FINRA stated, by way of example, the current Credit 
Support Annex to the ISDA Master Agreement contains a provision 
under which the parties generally agree to resolve disputes over the 
valuation of over-the-counter derivatives for margin purposes by 
seeking four actual quotations at mid-market from third parties and 
taking the average of those obtained. FINRA stated that the OTC 
derivatives documented under ISDA Master Agreements can be much more 
difficult to value than any Specified Pool or CMO transaction. See 
Amendment No. 1 at 11-12.
---------------------------------------------------------------------------

     Fourth Category--The counterparty may be unwilling or 
unable to satisfy an undisputed obligation to margin its excess net 
mark to market loss. FINRA believes that, when a counterparty is 
unwilling or unable to satisfy its undisputed margin obligations, there 
is also reason for significant doubt that the counterparty would be 
willing and able to satisfy its obligations to pay or deliver on the 
settlement date of the transaction. When facing such an unreliable 
counterparty, FINRA stated that it believes it is possible the daisy 
chain of fails may occur even if the member does not liquidate. FINRA 
further stated that this could be just as easily triggered by the 
counterparty's unwillingness or inability to perform its obligations as 
by the member's liquidation of its transaction.\115\
---------------------------------------------------------------------------

    \115\ See Amendment No. 1 at 12.
---------------------------------------------------------------------------

    According to FINRA, with regard to this fourth category, to the 
extent feasible, members should terminate transactions with such 
counterparties in order to protect themselves against further exposure. 
However, FINRA stated that if a member believes that it would not be 
feasible to terminate a transaction with such a counterparty, or that 
such termination would be unduly disruptive to the member's business or 
the market, extensions may be available from FINRA if the member has 
exceeded the 25% TNC/$30MM Threshold for five consecutive business days 
and would otherwise be under an obligation to enforce a right to 
liquidate the counterparty's Covered Agency Transactions.\116\
---------------------------------------------------------------------------

    \116\ FINRA stated that although an initial 14-day extension 
will be granted upon application citing the applicable 
circumstances, any application for a lengthy extension, or series of 
extensions, must describe the reason for the request and the 
member's plans for protecting itself (now and in the future) against 
the risk posed by a counterparty that has demonstrated itself to be 
unwilling or unable to perform its undisputed obligations. See 
Amendment No. 1 at 12.
---------------------------------------------------------------------------

    According to FINRA, as described above, in the first category, 
members have no liquidation obligation under the proposed rule change. 
In the second and third categories, FINRA believes that the reason why 
the counterparty has not margined its excess net mark to market loss 
should be eliminated before the five business day period has ended, and 
generally before the expiration of a 14-day extension from FINRA. FINRA 
stated that only in the fourth category, where the counterparty is 
demonstrably unwilling or unable to perform its obligations to the 
member, should liquidation of counterparty's Covered Agency 
Transactions be required under the proposed rule change, provided that 
the member has exceeded the 25% TNC/$30MM Threshold for five 
consecutive business days--and, even in that case, extensions may be 
available if liquidation is infeasible or would unduly disrupt the 
member's business or the market.\117\
---------------------------------------------------------------------------

    \117\ See Amendment No. 1 at 12-13.
---------------------------------------------------------------------------

    The Commission agrees that the responses provided by FINRA 
appropriately address the concerns raised by commenters concerning the 
potential for daisy chain fails. As described above, the requirement to 
liquidate a counterparty's position is limited under the proposed rule 
change to instances where the member has the right to liquidate a 
counterparty's Covered Agency Transactions. Otherwise, the proposed 
rule change does not require the member to liquidate those transactions 
where the member does not have a right to liquidate, even after the 
member has exceeded the 25% TNC/$30MM Threshold for five consecutive 
business days. Further, FINRA members may apply to FINRA to receive an 
extension of time beyond the five business day period. The ability to 
receive extensions of time beyond the five business day period will 
help to protect broker-dealers where liquidation is infeasible or would 
unduly disrupt the FINRA member's business or the market. Finally, in 
cases where a counterparty is unlikely or unwilling to satisfy a 
variation margin requirement, the broker-dealer's counterparty credit 
risk to its counterparty may increase, as well as the risk that the 
counterparty may be unable or unwilling to settle the transaction. In 
such cases, the likelihood of counterparty default may occur even if 
the broker-dealer does not liquidate the Covered Agency position or if 
it is not part of a chain of transactions.
2. Definition of ``Excess Net Mark to Market Loss''
    Some commenters requested confirmation that, under the proposed 
rule change, members would only be required to collect margin (or take 
capital charges for uncollected margin) to cover the amount by which a 
counterparty's net mark to market loss exceeds the $250,000 
threshold.\118\
---------------------------------------------------------------------------

    \118\ See SIFMA Letter at 4; SIFMA AMG Letter at 4.
---------------------------------------------------------------------------

    In response, FINRA stated that this is correct. According to FINRA, 
under the proposed rule change, paragraph (e)(2)(H)(ii)c. of FINRA Rule 
4210 states that members are not required by the rule ``to collect 
margin, or take capital charges, for counterparties' mark to market 
losses on Covered Agency Transactions other than excess net mark to 
market losses'' and a counterparty's ``excess net mark to market 
losses'' are defined in paragraph (e)(2)(H)(i)c. as ``such 
counterparty's net mark to market loss to the extent it exceeds 
$250,000.'' \119\ FINRA stated that, for example, if a member's 
counterparty has a net mark to market loss of $300,000, its excess net 
mark to market loss is $50,000, which would be the amount of margin the 
proposed rule change would require the member to collect, or take a

[[Page 4087]]

capital charge in lieu of collecting (unless there is an applicable 
exemption). FINRA stated that the counterparty's excess net mark to 
market loss is the minimum amount of margin that (subject to the 
exceptions set forth in the proposed rule change) the member must 
collect (or take a capital charge in lieu of collecting). According to 
FINRA, the proposed rule change does not prevent members and their 
counterparties from agreeing that the counterparty will transfer 
additional margin. For example, FINRA stated that a member and its 
counterparty could agree that, when the counterparty's net mark to 
market loss exceeds $250,000, the counterparty will transfer to the 
member margin that covers the counterparty's entire mark to market 
loss, rather than only enough to cover its excess net mark to market 
loss. Similarly, FINRA stated that a member may exclude a 
counterparty's in the money amounts on long standby positions from its 
computation of net mark to market.\120\
---------------------------------------------------------------------------

    \119\ See Amendment No. 1 at 13.
    \120\ See Amendment No. 1 at 13-14.
---------------------------------------------------------------------------

    FINRA's response appropriately responds to the commenters' request 
for confirmation by specifically confirming that under the proposed 
rule change members would only be required to collect margin to cover 
the amount by which a counterparty's net mark to market loss exceeds 
the $250,000. Also, FINRA's response is consistent with the definition 
of the term excess net mark to market losses under the proposed rule 
change.
3. Definition of ``Net Mark to Market Loss''
    A commenter requested confirmation that the definition of ``net 
mark to market loss'' would include the calculations used under the 
form of Master Securities Forward Transaction Agreement (``MSFTA'') 
published by SIFMA.\121\ In response, FINRA stated that it does not 
require or endorse any particular form of agreement for margining 
Covered Agency Transactions, and as such declines to provide the 
requested confirmation, as this relates to what is a commercial matter 
among the parties.\122\
---------------------------------------------------------------------------

    \121\ See SIFMA Letter at 4.
    \122\ See Amendment No. 1 at 14. Similarly, FINRA stated that it 
also declines a commenter's request to confirm that an MSFTA with a 
cure period (or similar provision after the expiration of which 
liquidating action may be taken) of less than or equal to five 
business days would provide the rights described in the definition 
of ``non-margin counterparty'' under paragraph (e)(2)(H)(i)e. under 
the proposed rule change. See Amendment No. 1 at 14 and SIFMA AMG 
Letter at 4.
---------------------------------------------------------------------------

    A commenter also suggested that FINRA should remove the phrase 
``legally enforceable right of offset or security'' from the definition 
of ``net mark to market loss.'' \123\ In response, FINRA stated that 
this phrase is necessary.\124\ According to FINRA, if the phrase is 
removed, then the amount of the counterparty's mark to market losses 
which are subject to margining would be reduced by the counterparty's 
mark to market gains on other transactions, without regard to whether 
the member has any legally enforceable right to apply those gains to 
cover the counterparty's losses. FINRA stated, for example, that if a 
counterparty defaults when it has a mark to market loss of $10 million 
on one transaction and a mark to market gain of $10 million on another 
transaction, having a legally enforceable right of offset would allow 
the member to apply the counterparty's gains to cover its losses. In 
the absence of a legally enforceable right of offset or security, 
however, FINRA stated that the member could face the prospect of having 
an obligation to pay the counterparty $10 million for its gains, 
without any guaranty of collecting the full amount of the 
counterparty's $10 million loss. According to FINRA, if the 
counterparty enters insolvency proceedings, the lack of a legally 
enforceable right of offset or security could result in the member 
being obliged to pay the full $10 million of the defaulted 
counterparty's gains and being only able to collect cents on the dollar 
for the counterparty's losses.\125\
---------------------------------------------------------------------------

    \123\ See SIFMA Letter at 4.
    \124\ See Amendment No. 1 at 14.
    \125\ See Amendment No. 1 at 14. In response to a commenter, 
FINRA stated that the phrase ``first-priority perfected security 
interest'' in paragraph (e)(2)(H)(i)d.2. under the proposed rule 
change only applies to pledges of a counterparty's rights under 
Covered Agency Transactions with third parties. See Amendment No. 1 
at 14-15 and SIFMA Letter at 4.
---------------------------------------------------------------------------

    The Commission agrees that FINRA's response to the commenter's 
request for confirmation regarding the MSFTA as the proposed rule 
change does not require any particular form of agreement or contract. 
Further, the Commission agrees with FINRA that including the phrase 
``legally enforceable right of offset or security'' in the definition 
of net mark to market loss is appropriate because it will allow a FINRA 
member to apply the counterparty's gains to cover its losses, which 
will reduce a broker-dealer's financial exposure to a counterparty in 
the event the counterparty enters insolvency.
4. Definition of ``Non-Margin Counterparty''
    With respect to the five business day period, paragraph 
(e)(2)(h)(i)e.1. under FINRA Rule 4210 under the proposed rule change 
provides in part that a counterparty is a non-margin counterparty if 
the member ``does not have a right under a written agreement or 
otherwise to collect margin for such counterparty's excess net mark to 
market loss and to liquidate such counterparty's Covered Agency 
Transactions if any such excess net mark to market loss is not margined 
or eliminated within five business days from the date it arises.'' 
\126\ A commenter stated that this effectively requires imposing a 
margin collection timing which is stricter than required under other 
rules or the standard under FINRA Rule 4210(f)(6).\127\
---------------------------------------------------------------------------

    \126\ In response to a commenter, FINRA stated that if a member 
has a right under a written agreement to collect margin for a 
counterparty's entire net mark to market loss whenever the amount of 
that loss exceeds $250,000. FINRA stated that, for purposes of the 
proposed rule change, it would view this as a right under a written 
agreement to collect margin for such counterparty's excess net mark 
to market loss, since the counterparty's excess net mark to market 
loss is $250,000 less than the counterparty's entire net mark to 
market loss (or zero if the net mark to market loss does not exceed 
$250,000). See Amendment No. 1 at 15 and SIFMA AMG Letter at 4.
    \127\ See SIFMA Letter at 4.
---------------------------------------------------------------------------

    In response, FINRA stated that it disagrees for several reasons. 
First, FINRA stated that current rule requires members to liquidate 
positions whenever a mark to market loss (or maintenance deficiency) on 
Covered Agency Transactions is not margined or otherwise eliminated 
within five business days (and no extension has been obtained). 
According to FINRA, the proposed rule change uses a five business day 
period but, as discussed above, applies it more flexibly than the 
current rule.\128\ FINRA stated that if the member lacks a right to 
liquidate a counterparty's Covered Agency Transactions if the 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days, that counterparty is a ``non-
margin counterparty.'' As consequence, the member would become subject 
to the risk management requirements under paragraph (e)(2)(H)(ii)d.2. 
of the rule as modified by the proposed rule change (if not already 
subject to that requirement); and if the member's specified net capital 
deductions \129\ exceed the 25% TNC/$30MM Threshold for five 
consecutive business days, FINRA stated that the member would not be 
able to enter into transactions with the non- margin counterparty, 
other than risk reducing transactions, while those net capital 
deductions continue to exceed the 25% TNC/

[[Page 4088]]

$30MM Threshold.\130\ According to FINRA, if the member has a right to 
liquidate a counterparty's Covered Agency Transactions if the 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days, the member is not required to 
enforce that right (that is, not required to liquidate the 
counterparty's Covered Agency Transactions if the counterparty's excess 
net mark to market loss has not been margined or eliminated within five 
business days), unless and until the member's specified net capital 
deductions exceed the 25% TNC/$30MM Threshold for five consecutive 
business days (and the member has not obtained an extension from 
FINRA).\131\
---------------------------------------------------------------------------

    \128\ See Amendment No. 1 at 15.
    \129\ See infra note 143.
    \130\ See Amendment No. 1 at 16.
    \131\ See Amendment No. 1 at 16. In response to a commenter, 
FINRA stated that classification of a counterparty as a non-margin 
counterparty depends on (a) whether the member has the right to 
collect margin for the counterparty's excess net mark to market 
loss, (b) whether the member regularly collects margin for the 
counterparty's excess net mark to market loss, and (c) whether the 
member has the right to liquidate such counterparty's Covered Agency 
Transactions if the counterparty's excess net mark to market loss is 
not margined or eliminated within five business days from the date 
it arises. According to FINRA, classification of a counterparty as a 
margin counterparty (that is, as not a non-margin counterparty) does 
not require the member to exercise the right to liquidate whenever 
that counterparty's excess net mark to market loss is not margined 
or eliminate within five business days. However, FINRA stated that 
the counterparty would need to be reclassified as a non-margin 
counterparty if the member does not regularly collect margin for the 
counterparty's excess net mark to market loss. FINRA stated that the 
exercise of the right to liquidate is only required by the proposed 
rule change if the member's capital charges have exceeded the 25% 
TNC/$30MM Threshold for five consecutive business days (and the 
member has not obtained an extension from FINRA). See Amendment No. 
1 at 16 and SIFMA Letter at 4-5.
---------------------------------------------------------------------------

    Second, FINRA also stated that even if members were required to 
have a contractual right to liquidate when margin is not collected 
within five business days, that would not, in the commenter's terms, 
``impos[e] a margin collection timing that is stricter than that which 
is required under the rules (or other aspects of FINRA Rule 4210 
generally).'' Further, FINRA stated that FINRA Rule 4210(f)(6) requires 
margin to be collected ``as promptly as possible,'' and the rule as 
approved pursuant to the original rulemaking (as stated above) requires 
liquidation when a mark to market or maintenance deficiency has not 
been margined or eliminated within five business days (unless an 
extension has been obtained).\132\
---------------------------------------------------------------------------

    \132\ See Amendment No. 1 at 16-17.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's response to a comment that the 
reference to a five business day requirement in the definition of non-
margin counterparty effectively imposes a margin collection timing 
requirement that is stricter than under current rules. A counterparty 
is a non-margin counterparty under the proposed rule change if the 
broker-dealer does not have a right under a written agreement or 
otherwise to collect margin for such counterparty's excess net mark to 
market loss and to liquidate such counterparty's Covered Agency 
Transactions if any such excess net mark to market loss is not margined 
or eliminated within five business days from the date it arises. The 
five business day reference in the definition of non-margin 
counterparty is used to classify counterparties as non-margin 
counterparties and does not impose a five-day margin collection 
requirement.
    Further, the current rule contains a liquidation requirement if a 
mark to market loss (or maintenance deficiency) on Covered Agency 
Transactions is not margined or otherwise eliminated within five 
business days (and no extension has been obtained). The proposed rule 
eliminates this requirement and provides for more flexibility with 
respect to whether a broker-dealer must liquidate a counterparty's 
positions if it has a right to do so, (i.e., only after certain 
conditions occur and only if no extensions of time have been granted). 
Therefore, the proposed rule changes does not effectively impose a 
margin collection or liquidation requirement whenever that 
counterparty's excess net mark to market loss is not margined or 
eliminated within five business days.
5. Exempted Counterparties
    A commenter suggested that FINRA should explicitly exclude small 
cash counterparties and other counterparties covered by paragraph 
(e)(2)(H)(ii)a.1. under the proposed rule change from the definition of 
``non- margin counterparty.'' \133\ FINRA stated that this request is 
consistent with the purpose of paragraph (e)(2)(H)(ii)a.1. and has 
modified the definition of ``non-margin counterparty'' to implement the 
requested exclusion.\134\
---------------------------------------------------------------------------

    \133\ See SIFMA Letter at 5.
    \134\ See Amendment No. 1 at 17 and Exhibit 4 to Amendment No. 
1.
---------------------------------------------------------------------------

    Modifying the definition of ``non-margin counterparty'' is 
appropriate as it enhances transparency of the scope of the term to 
specifically exclude small cash counterparties.
6. Exemption for Certain Counterparties
    A commenter suggested that the exceptions in paragraph 
(e)(2)(H)(ii)a.1. be expanded to encompass the U.S. Federal Home Loan 
Banks.\135\ FINRA responded that it does not propose to make the 
suggested modification because it would undermine the rule's purpose of 
reducing risk.\136\ The Commission agrees with FINRA's response 
regarding the expansion of the exceptions in paragraph 
(e)(2)(H)(ii)a.1., as including U.S. Federal Home Loan Banks in the 
exceptions would undermine the effectiveness of the proposed rule 
change, and would not be consistent with the purpose of the proposed 
rule change of reducing risk of unsecured exposures to Covered Agency 
Transactions.\137\
---------------------------------------------------------------------------

    \135\ See SIFMA Letter at 6.
    \136\ See Amendment No. 1 at 17.
    \137\ See also 2016 Approval Order, 81 FR 40375-76 (discussion 
scope of exemptions under the current rule).
---------------------------------------------------------------------------

7. The 25% TNC/$30 MM Threshold
    Regarding small cash counterparties, a commenter requested 
confirmation that margin not collected from small cash counterparties 
does not count toward the 25% TNC/$30MM Threshold.\138\ In response, 
FINRA stated that margin not collected from small cash counterparties 
does not count toward the 25% TNC/$30MM Threshold.\139\ Further FINRA 
stated that paragraph (e)(2)(H)(ii)d.3. only counts capital charges 
under paragraph (e)(2)(H)(ii)d.1. toward the 25% TNC/$30MM Threshold. 
And, pursuant to paragraph (e)(2)(H)(ii)a.1., FINRA stated that members 
are not required under the proposed rule change ``to collect margin, or 
to take capital charges in lieu of collecting such margin, for a 
counterparty's excess net mark to market loss if such counterparty is a 
small cash counterparty, registered clearing agency, Federal banking 
agency, as defined in 12 U.S.C. 1813(z), central bank, multinational 
central bank, foreign sovereign, multilateral development bank, or the 
Bank for International Settlements.'' FINRA stated that because the 
proposed rule change does not require members to take capital charges 
for these counterparties' unmargined excess net mark to market losses, 
they do not count toward the 25% TNC/$30MM Threshold.\140\
---------------------------------------------------------------------------

    \138\ See SIFMA Letter at 5.
    \139\ See Amendment No. 1 at 17.
    \140\ See Amendment No. 1 at 17.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's response to the commenter's 
request for confirmation regarding whether margin not collected from 
small cash

[[Page 4089]]

counterparties counts toward the 25% TNC/$30MM Threshold. FINRA's 
response appropriately addresses the commenter's concerns and is 
consistent with the purposes of the proposed rule change, because the 
proposed rule change also prescribes overall concentration thresholds 
under paragraph (e)(2)(I) of FINRA Rule 4210.\141\
---------------------------------------------------------------------------

    \141\ See Section II.B. above (discussing paragraph (e)(2)(I) of 
FINRA Rule 4210 under the proposed rule change).
---------------------------------------------------------------------------

    With respect to counterparties yet to post margin, a commenter 
suggested that the proposed rule change be modified so that any capital 
charge under paragraph (e)(2)(H)(ii)d.1. of FINRA Rule 4210 not count 
toward the 25% TNC/$30MM Threshold until the fifth business day after 
the relevant excess net mark to market loss arose. The capital charge 
is required whenever a counterparty's excess net mark to market loss is 
not margined or eliminated by the close of business on the business day 
after the business day on which it arises. The commenter stated that 
many counterparties that are regularly margined are unable to post 
margin on a consistent T+1 basis due, for example, to those 
counterparties being in an overseas jurisdiction or to operational or 
custodial issues. Moreover, the commenter stated good faith disputes 
over the amount of margin to be posted may mean that a counterparty 
does not post margin by T+1 even when the counterparty is ready, 
willing, and able to post margin promptly after the proper amount is 
determined. Finally, the commenter stated that, without the grace 
period the commenter is requesting, members may be continuously over 
the 25% TNC/$30MM Threshold solely based on ordinary course levels of 
margin not yet collected from counterparties who are expected to post 
required margin.\142\
---------------------------------------------------------------------------

    \142\ See SIFMA Letter at 5-6.
---------------------------------------------------------------------------

    In response, FINRA stated that it agrees that the purpose of the 
proposed rule change does not require counting toward the 25% TNC/$30MM 
Threshold capital charges taken for excess net mark to market losses 
that the member in good faith expects to be margined by the fifth 
business day after they arise. Accordingly, FINRA revised paragraph 
(e)(2)(H)(ii)d.3. so that capital charges under paragraph 
(e)(2)(H)(ii)d.1. with respect to a counterparty's unmargined excess 
net mark to market loss do not count towards the thresholds in 
paragraph (e)(2)(H)(ii)d.3. to the extent that the member, in good 
faith, expects such unmargined excess net mark to market losses to be 
margined within five business days.\143\ According to FINRA, members 
would still be required to protect themselves by taking net capital 
deductions while the excess net mark to market losses are unmargined, 
but, under the proposed rule change, as modified by Amendment No.1, 
will have more flexibility to address operational issues and valuation 
disputes before they impact the 25% TNC/$30MM Threshold.\144\
---------------------------------------------------------------------------

    \143\ See Amendment No. 1 at 18. More specifically, FINRA has 
revised paragraph (e)(2)(H)(ii)d.3. of FINRA Rule 4210 to refer to a 
member's ``specified net capital deductions'' (rather than to all 
net capital deductions under paragraph (e)(2)(H)(ii)d.1.) and 
inserted the following definition into paragraph (e)(2)(H)(i): i. A 
member's ``specified net capital deductions'' are the net capital 
deductions required by paragraph (e)(2)(H)(ii)d.1. of this Rule with 
respect to all unmargined excess net mark to market losses of its 
counterparties, except to the extent that the member, in good faith, 
expects such excess net mark to market losses to be margined by the 
close of business on the fifth business day after they arose. Id.
    \144\ See Amendment No. 1 at 18.
---------------------------------------------------------------------------

    The proposed change related to the 25% TNC/$30 MM Threshold is 
appropriate as it provides additional time and flexibility for member 
firms to address operational and related issues related to the 
collection of margin, thereby avoiding unnecessary disruptions to the 
Covered Agency Transaction market. The proposed change related to the 
25% TNC/$30 MM Threshold also enhances transparency with respect to the 
scope of transactions which count toward such threshold.
8. Requirement To Enforce Rights To Collect Margin and Liquidate 
Covered Agency Transactions
    A commenter requested clarification with respect to the scope of 
the requirement under paragraph (e)(2)(H)(ii)d.3. of the proposed rule 
change, which provides that a member whose specified net capital 
deductions \145\ exceed the 25% TNC/$30MM Threshold for five 
consecutive business days ``shall also, to the extent of its rights, 
promptly collect margin for each counterparty's excess net mark to 
market loss and promptly liquidate the Covered Agency Transactions of 
any counterparty whose excess net mark to market loss is not margined 
or eliminated within five business days from the date it arises, unless 
FINRA has specifically granted the member additional time.'' \146\
---------------------------------------------------------------------------

    \145\ See supra note 143.
    \146\ See SIFMA Letter at 5-6.
---------------------------------------------------------------------------

    According to FINRA, these requirements begin to apply once the 
member's specified net capital deductions exceed the 25% TNC/$30MM 
Threshold for five consecutive business days and cease to apply as soon 
as those capital charges fall below that threshold. Accordingly, FINRA 
stated, once the member's specified net capital deductions fall below 
that threshold (for example, because of market movements, or because 
the member collects enough margin from some, but not all, of its 
counterparties), the member is under no further obligation to enforce 
its contractual rights to collect margin or liquidate Covered Agency 
Transactions (and could, if it chooses, rescind outstanding margin 
calls and halt any liquidations of its counterparties' Covered Agency 
Transactions).\147\
---------------------------------------------------------------------------

    \147\ See Amendment No. 1 at 19. FINRA also stated that a 
member, so long as it acts promptly to bring itself below the 25% 
TNC/$30MM Threshold, may choose the manner and order in which it 
enforces its rights to collect margin or liquidate Covered Agency 
Transactions, and may halt those actions once its specified net 
capital deductions fall below the 25% TNC/$30MM Threshold. Id.
---------------------------------------------------------------------------

    FINRA's clarification relating to requirement to enforce rights to 
collect margin and liquidate Covered Agency Transactions appropriately 
addresses the commenter's request for clarification and enhances 
transparency with respect to the application of the proposed rule 
change as to when a FINRA member is under no further obligation to 
enforce its contractual rights to collect margin or liquidate 
positions.
9. Reporting by Members With Non-Margin Counterparties
    FINRA stated that, pursuant to paragraph (e)(2)(H)(ii)d.4. under 
the proposed rule change, members with non-margin counterparties would 
be required to ``submit to FINRA such information regarding its 
unmargined net mark to market losses, non-margin counterparties and 
related capital charges, in such form and manner, as FINRA shall 
prescribe by Regulatory Notice or similar communication.'' A commenter 
stated that the building of systems and information tracking is a 
significant build for many firms and requested FINRA to clarify in 
advance what information may be required.\148\ FINRA stated that it is 
considering what information will be required to be submitted and 
expects to engage members and industry participants in developing 
appropriately tailored reporting pursuant to this provision.\149\
---------------------------------------------------------------------------

    \148\ See SIFMA Letter at 6.
    \149\ See Amendment No. 1 at 19.
---------------------------------------------------------------------------

    The Commission believes that FINRA's response is appropriate. FINRA 
is currently considering what information will be required and FINRA 
expects to engage with member firms and industry participants in 
developing

[[Page 4090]]

tailored reporting requirements. This engagement will provide industry 
participants the opportunity to provide input into the reporting 
requirements.
10. Introducing and Clearing Firm Issues
    A commenter stated said that the proposed rule change does not 
address the role of the clearing broker or reflect that FINRA has 
considered the actual way in which introducing brokers clear 
trades.\150\ Another commenter suggested that FINRA should continue to 
facilitate dialogue among introducing and clearing firms to facilitate 
the implementation of the proposed rule change.\151\
---------------------------------------------------------------------------

    \150\ See Brean Capital Letter at 13.
    \151\ See SIFMA Letter at 3.
---------------------------------------------------------------------------

    FINRA responded by stating that it has conducted extensive dialogue 
with introducing and clearing firms regarding the requirements of the 
current rule and the proposed rule change in the context of introducing 
and clearing arrangements, and several of the proposed rule change's 
clarifying changes to the original rulemaking were informed by such 
dialogue.\152\ Further, FINRA stated that it intends to continue to 
discuss the proposed rule change and its implementation with clearing 
and introducing firms, and to facilitate dialogue among them as the 
Covered Agency Transaction margin requirements are implemented.\153\
---------------------------------------------------------------------------

    \152\ See Amendment No. 1 at 20.
    \153\ Id.
---------------------------------------------------------------------------

    FINRA's response regarding issues involving clearing and 
introducing firms appropriately addresses the commenters' concerns. 
Specifically, FINRA has engaged in extensive dialogue with introducing 
and clearing firms regarding the requirements of the original 
rulemaking and with respect to the proposed rule change. Further, FINRA 
has indicated it will continue to facilitate dialogue with introducing 
and clearing firms as the margin requirements for Covered Agency 
Transactions are implemented.
11. Status of Published Frequently Asked Questions (``FAQs'')
    A commenter requested confirmation as to whether the FAQs regarding 
Covered Agency Transactions, maintained on FINRA's website,\154\ will 
apply in the event the proposed rule change is approved.\155\ FINRA 
stated that if the Commission approves the proposed rule change, FINRA 
will revisit the FAQs with Commission staff, members, and industry 
participants as appropriate.\156\ The Commission agrees that FINRA's 
response to the status of the FAQs appropriately addresses the 
commenter's request for confirmation with respect to the application of 
the FAQs under the proposed rule change.
---------------------------------------------------------------------------

    \154\ After the original rulemaking was approved, FINRA made 
available a set of FAQs and guidance clarify certain of the 
requirements, available at: www.finra.org.
    \155\ See SIFMA Letter at 6-7.
    \156\ See Amendment No. 1 at 20.
---------------------------------------------------------------------------

12. Implementation Period
    In response to the proposed rule change, several commenters 
requested that FINRA provide an implementation period of at least 18 
months after publication of a final rule text before compliance is 
required, stating that a constrained time period for implementation 
could present market access risk, and citing the need to build 
operations and technology and to negotiate necessary 
documentation.\157\ FINRA responded to these concerns as part of 
Amendment No. 1 by stating while it believes that the subject matter is 
well understood by member firms and industry participants, FINRA would 
announce the effective date no later than 60 days following approval, 
if the Commission approves the proposed rule change, and would provide 
an effective date between nine and ten months following such 
approval.\158\
---------------------------------------------------------------------------

    \157\ See SIFMA AMG letter at 1-3; SIFMA Letter at 2; BDA Letter 
at 5.
    \158\ See Amendment No. 1 at 20.
---------------------------------------------------------------------------

    In response to Amendment No. 1, a commenter reiterated its previous 
comments regarding the implementation date, again requesting that FINRA 
provide an implementation period of 18 months, or in the alternative an 
implementation timeframe of at least one year.\159\ FINRA responded to 
the comment stating that in connection with Amendment No. 1, it 
provided a longer implementation timeframe than originally proposed as 
part of the proposed rule change. FINRA stated that Covered Agency 
Transactions have been under discussion for a considerable time, both 
prior to and since approval of the original rulemaking in 2016, and 
that this subject matter is well understood by members and industry 
participants. As a result FINRA believes that the public interest would 
not be served by continuing delay and that the timeframe set forth in 
Amendment No. 1 is appropriate.\160\
---------------------------------------------------------------------------

    \159\ See Letter from Chris Killian, Managing Director, 
Securitization, Corporate Credit, Libor, Securities Industry and 
Financial Markets Association, to Secretary, Commission (Sep. 10, 
2021). The comment letter was submitted jointly by SIFMA and SIFMA 
AMG.
    \160\ See FINRA Letter at 7-8.
---------------------------------------------------------------------------

    FINRA's proposed implementation schedule is appropriate and 
consistent with the requirements of the Exchange Act. The Covered 
Agency Transaction margin requirements were approved in 2016 under the 
2016 Approval Order. FINRA member firms and industry participants are 
aware of the requirements of the Covered Agency Transaction margin rule 
and have had time to work toward implementation. Consequently, the 
proposed implementation timeframe of nine to ten months from the 
approval date as described in Amendment No. 1 should provide sufficient 
time for FINRA firms to comply with the rule's requirements.

IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the 
Exchange Act \161\ that the proposed rule change (SR-FINRA-2021-010), 
as modified by Amendment No. 1, be, and hereby is, approved.
---------------------------------------------------------------------------

    \161\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\162\
---------------------------------------------------------------------------

    \162\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-01471 Filed 1-25-22; 8:45 am]
BILLING CODE 8011-01-P


