FINRA established new margin requirements for exchange-traded notes ("ETNs") and options on ETNs.
According to FINRA, additional margin requirements are necessary due to the "complex nature of these products." The new requirements are as follows.
- Notwithstanding that they may qualify for treatment as "investment grade" or "other margin eligible non-equity securities" under Rule 4210, ETNs are subject to initial and maintenance margin requirements of 25 percent of current market value for ETNs held long and 30 percent of current market value for ETNs held short.
- Options on ETNs are subject to an initial and maintenance margin requirement of 20 percent of the current market value of the ETN and a minimum margin requirement of 10 percent of the current market value of the ETN, for purposes of the listed options and warrants requirements chart in Rule 4210(f)(2)(E)(i). In a footnote, FINRA adds that the listed option margin requirements in 4210(f)(2)(E) do not contemplate listed options on non-Treasury/Government Sponsored Enterprise debt, and that the requirements prescribed are 5 percent greater than the requirements for OTC options on listed non-equity securities under 4210(f)(2)(E)(iii), and equal to the requirements for listed options on equities and convertible debt.
- Leveraged ETNs are subject to increased margin by a factor commensurate with the leverage on the exchange-traded fund ("ETF"), with a maximum of 100 percent of the value for a long position. (There is no maximum for short positions.) This treatment is intended to be applied similarly to requirements for leveraged ETFs under FINRA Notice 09-53.
- ETNs and options on ETNs may not be margined under the portfolio margin provisions of Rule 4210(g). (And any such products currently captured in the Options Clearing Corporation's TIMS model are to be removed, effective on August 16, 2019.)
If the new rules result in "undue hardships" for a firm or its customers, firms must submit written requests for relief no later than July 26, 2019. The firm must include an explanation of the circumstances leading to the request for additional time in which to comply with the new measures.
Commentary / Nihal Patel
FINRA Rule 4210 is a messy one. It is complicated and difficult to read, is subject to interpretations, many of which have not been updated in decades (e.g. the published version on the FINRA site has not been updated since 2010), and has been supplemented by margin requirements imposed by FINRA through regulatory notices such as this one, under authority pursuant to FINRA Rule 4210(f)(8)(A). That provision permits FINRA to prescribe additional requirements "whenever it shall determine that market conditions so warrant."
As a process matter, it is difficult to see where FINRA has made the case that "market conditions" merit this change. There is less than a page of explanation, and little to suggest that there are any particular conditions in the market, as opposed to a basic disfavoring for a type of product. "Market conditions" also suggests something temporary. But there is nothing in this Regulatory Notice to suggest that these changes are temporary, and FINRA has made a habit of making "temporary" changes to its margin requirements through regulatory notices. See, e.g., Notices 08-08 (Auction Rate Securities), 08-60 (Money Market Mutual Funds), 09-53 (Non-Traditional ETFs) and 11-16 (Treatment of Non-Margin Eligible Equities).
This is not to say that there isn't a case to be made that ETNs should be subject to higher requirements. It is correct that ETNs can be of a different nature than typical corporate debt. But that would seem to be something that could be addressed through a rule change or, at worst, through a temporary increase followed by a formal rule change. Further, FINRA provided no lead time (other than a request as to an "undue hardship") for firms to adjust their margin systems or to reach out to affected customers. A customer with positions in ETNs could see their margin requirements go from 3% to 25% overnight.
Finally, this regulatory notice also does not make distinctions that otherwise apply in Rule 4210 as to the type of customer. The regulatory notice applies the new margin requirements to all accounts, regardless of whether they are "exempt accounts" under Rule 4210. For many other types of non-junk debt, the rule provides differing treatment (generally with lower requirements and, in some cases, an option to take capital charge) for transactions with exempt accounts.
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