FINRA requested feedback on a concept proposal setting forth how the FINRA rules might apply to security-based swaps ("SBS").
In its Notice, FINRA suggested a number of changes that would involve revising FINRA Rule 0180 ("Application of Rules to Security-Based Swaps"), which will expire in September 2021 and currently sets forth a broad exception for SBS pending relevant SEC rulemaking on SBS. Instead, FINRA suggested setting forth "limited, targeted exceptions," and certain new amendments and requirements that would apply to SBS.
Key proposals include:
- Timing. FINRA indicated it will extend current Rule 0180 through the registration compliance date for security-based swap dealers (which is expected to be Oct. 6, 2021).
- Presumption That FINRA Rules Apply. Rule 0180 would be amended to presume the FINRA rules apply to SBS, with exceptions applying only where specifically noted. FINRA suggested, among other things, exceptions for the 6000 series (quotation, order and transaction reporting facilities), the 7000 series (clearing, transaction and order data requirements, and facility charges) and the rule 11000 series (uniform practice code).
- Compliance with SBSD Rules. FINRA would permit registered security-based swap dealers ("SBSDs") to comply with relevant SEC SBSD requirements in lieu of certain existing FINRA rules. FINRA indicated that this would apply at the entity and associated-person level. In particular, FINRA would apply this exception to (i) rules on soliciting government entities, (ii) certain business conduct requirements (KYC and suitability), (iii) confirmations, and (iv) various supervision and internal compliance matters.
- Capital. FINRA would make certain changes to Rule 4120 to conform it to SEC amendments to the broker-dealer net capital requirements under Rule 15c3-1. FINRA proposes, among other things, to treat firms entering into SBS as principals the same as firms that are self-clearing for purposes of Rule 4110/4120.
- Margin. FINRA is proposing to adopt a new margin rule to apply to SBS. The rule would not apply to SBSDs or to SBS entered into by broker-dealers in portfolio margin accounts with risk that is "appropriately addressed by" an approved model (e.g., "TIMs") and covered by FINRA-approved risk management procedures. The new rule would require (i) daily collection of variation margin and (ii) daily collection of initial margin for "plain-vanilla" SBS in amounts equivalent to cash positions under Rule 4210.
Comments on the concept proposal are due by November 16, 2020.
Commentary
FINRA's suggested approach raises many questions and will require close reading by any broker-dealer that expects to be involved in security-based swap activities. As noted in connection with the request for comment, FINRA's actions will have a significant impact on competitive balance and the ability for broker-dealers to maintain a business of any kind in security-based swaps.
For example, under the FINRA proposal, a broker-dealer would be subject to margin collection requirements on its SBS that are stricter in ways than the requirements adopted by the SEC (e.g., no thresholds) or the banking regulators (e.g., no initial margin required for most counterparties). While the FINRA proposal is, in broad strokes, sensible (it seems to generally seek to apply similar margin for SBS as it would apply for cash positions), it could make broker-dealers unappealing counterparties for these transactions.
Another issue that seems to be less explicitly considered in the FINRA release: the circumstances in which FINRA rules attach to "brokerage" activities in SBS. Given the often "counterparty"-based rules of the Title VII regime, applying a second set of business-conduct and other requirements based on the entity that brokers a transaction could be unnecessary. This might be the case where a broker-dealer acts as a broker for SBS entered into by a foreign affiliated SBSD.
Primary Sources
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