FINRA’s TBA Margin Rules: Stuck in Government Limbo

(Editor’s update 1/31/2019) The Financial Industry Regulatory Authority has decided to give collateral operations and compliance managers a temporary break from complying with new margin requirements for covered agency transactions. FINRA has filed with the Securities and Exchange Commission a request to extend by an extra year to March 25, 2020 the implementation date of the margin requirements of FINRA Rule 4210 as it considers potential revisions). 

Published on January 28, 2019:

Collateral operations and compliance managers at US broker-dealers, fund managers and banks are on edge over the status of a critical margin rule stuck in the pile of countless unresolved measures during the partial government shutdown.

At issue is whether the Financial Industry Regulatory Authority’s new Rule 4210 affecting agency mortgage-backed securities and similar assets will become effective in March 2019, as planned, or whether it will be delayed once again after several postponements? It is also unclear which version of the rule will be adopted.

Last fall FINRA, the broker-dealer self-regulatory agency, adopted two critical amendments easing operational burdens for buy and sell-side firms. However, with the US Securities and Exchange Commission working with a skeleton crew, those amendments have not been approved, leaving collateral operations managers in limbo. Only about 285 of the SEC’s 4,436 employees were kept on dutry during the partial government shutdown. The SEC will be unable to process filings, provide interpretative guidance, issue no-action letters or conduct any other normal division and office activities,” the SEC said.

The SEC must approve of any FINRA rule changes and as of the time FinOps Report (www.finops.co) went to press, there partial government shutdown was reversed for only three weeks. That’s unlikely to be enough time to get anything accomplished and it remains to be seen whether another shutdown is imminent as President Donald Trump didn’t win his US$5.7 billion Congressional funding for the US to build a wall or any kind of barrier on the US-Mexican border.

Collateral operations managers are predicting yet another delay in implementing Rule 4210 which has created countless rounds of debate been FINRA and industry groups. FINRA has been quick to postpone the rulne’s implementation in the past, but as of press time, FINRA wouldn’t reveal its strategy. “FINRA is aware of the concerns firms have in connection with the March 25 effective date and the uncertainty this gives during the government shutdown,” says a statement issued to FinOps Report late last week. “FINRA is working to provide a resolution in advance of this date.”

FINRA’s Rule 4210 requires that broker-dealers collect initial and variation margin for trades in US agency mortgage-backed securities and similar instruments which are not processed through the US Fixed Income Clearing Corporation’s Mortgage-Backed Securities Division. The unit serves as a middleman between broker-dealer counterparties to ensure the trade is settled in the event of a counterparty default. Not so for any trades with a fund manager acting on behalf of its client. That gap could leave counterparties with plenty of exposure to each other, because agency mortgage-backed securities and similar assets are settled at least one month after they are executed. That’s far longer than the typical two days for other securities. Hence the securities are often described using th acronym, TBA, short for to-be-announced.

Although fund managers don’t fall directly under FINRA’s jurisdiction, they are affected by Rule 4210 if they enter into trades with broker-dealers on behalf of their fund clients. Previous margin recommendations made by the Treasury Market Practice Group of the Federal Reserve Bank of New York in 2012 only applied to primary dealers. Those rules, effective in 2013, called for two-way margining for variation margin but no initial or maintenance margin. Variation margin reflects the daily price changes in the value of the contract.

Last fall, bowing to industry pressure FINRA agreed to eliminate the initial margin requirement which represents two percent of the value of a TBA contract and to eliminate all margin requirements under a limited number of circumstances if the broker-dealer takes a capital charge. For those fund managers and broker-dealers uncertain about which version of FINRA 4210 to prepare for, legal experts recommend following the original version.

Sitting on one’s hands waiting until the SEC approves the two amendments isn’t a good idea. “Fund managers and broker-dealers still have plenty of work to do when it comes to contract talks,” says Andrew Cross, a partner in the law firm of Perkins Coie in Washington DC. “Fund managers and broker-dealers will still need to negotiate provisions in trading agreements that are likely to be unaffected by the proposed changes to the margin rule and can redraft any affected terms based on lanugage proposed by the broker-dealer trade group Securities Industry and Financial Markets Association.” The unaffected terms inlude representations from the fund manager about the type of client assets under management and which law applies.

Fund managers which represent either mutual funds and to a lesser extent funds governed by the Employee Retirement Income Act of 1974 will have additional tri-party contracts to work out with each client and its broker-dealer counterparty governing the safekeeping of margin with the fund’s custodian bank. Those triparty account control agreements are legally required in the case of mutual funds, because those funds are not allowed to keep collateral with broker-dealer counterparties. “Fund advisors could end up having to negotiate dozens of control agreements with each fund and broker-dealer,” says Cross. “It will be a time-consuming process so they need to be in the final stages from now.”

What about fund management and brokerage operations and technology folks who have already set their middle and back-office systems to the previous version of the FINRA Rule 4210? Several who spoke with FinOps Report say they just want a quick resolution. “We have been debating this rule for at least five years, so at this point we are looking for a done deal,” says a broker-dealer operations manager. “We can’t keep making continual changes to middle and back office systems and procedures.”

His peer at a fund management firm was even more adamant. “We need to get the show on the road. We don’t know whether to be upset or grateful about the government shutdown and resurrection,” he says. “It’s causing us just as much angst as it is relief.”