Executive Director of Derivatives Strategy and External Relations
FINRA’s proposed changes to margin requirements will create operational and technical challenges that come with implementing an efficient, comprehensive collateral management process. Even one single missed margin call among thousands of properly processed calls will have a negative financial impact on a firm.
In January, FINRA proposed changes to the existing Rule 4210 on margin requirements. These proposed changes, if enacted, will require the collateralization of most forward-settling agency mortgage-backed securities (most commonly traded as “To Be Announced,” or TBAs). While this may seem like old news since the Treasury Market Practice Group (TMPG) of the New York Fed implemented similar recommendations that took effect at the end of 2013, there are differences both in the approach and specifics around the rule that will likely create challenges for asset managers and brokers alike.
What’s likely to be new in the FINRA regulation? While there will be several changes, it is likely that the FINRA regulation will:
Establish a firm compliance date.
Implement consequences for lack of compliance after this date.
Address maintenance margins for deals with non-exempt clearing counterparties, among other things.
Each of these new requirements, if enacted, would have a significant impact on operations. As mentioned, there is an assumption that the FINRA mandate will establish a “drop dead” compliance date, as opposed to the more loosely-defined TMPG guideline of being “substantially complete” by the deadline. This is significant because the TMPG advised the community to take a risk-based approach toward implementation. This resulted in the smaller broker-to-buy-side relationships being de-prioritized while firms focused on implementing collateralization processes with their larger clients that held the greatest amount of risk.
However, in the case of the updated FINRA rule, one can assume that the mandate will have an implementation date that governs nearly all relationships that exceed a certain exposure amount. Therefore, if you are a firm with a limited number of trading accounts that works with a broker that has your firm lower on the TMPG implementation list, you will still likely need to begin addressing the operational and technical challenges that come with implementing an efficient, comprehensive collateral management process.
It is important to also note that FINRA is suggesting more certain consequences for not making/meeting your calls on time (i.e., non-compliance). Aside from the implied assumption that there will be immediate financial penalties tied to non-compliance, the proposed rules specifically include capital charges for non-collected margin. Therefore, even a good-faith effort to implement and maintain a daily collateral management process that might otherwise be acceptable under TMPG will likely not protect a sell-side firm from financial detriment. Even one single missed call among thousands of properly processed calls will have a negative financial impact on a firm. Firms that planned to leverage manual processes to satisfy the TMPG recommendation should revisit that decision in light of the new FINRA rules.
Another area that is different is that the FINRA rule includes a requirement to assess maintenance margin for deals with non-exempt counterparties. While the determination of who is an exempt or non-exempt counterparty is defined in another section of the guidelines, the rule states that a collection of “maintenance margin” of 2% of the market value of the securities is required. This “maintenance margin” is more akin to an independent amount and may be challenging not only from a liquidity standpoint, but also from an operational one. Any calculation and processing of maintenance margin will likely require the implementation of a robust set of procedures and technical capabilities that may not be currently present in a firm’s existing toolset.
There are a few other specifics in the updated rule proposal that may be challenging as well, especially for those that do not have an electronic means to process and store MSFTA terms.
The new proposal grants a ‘de minimus’ exposure level of $250k, which implies that any current exposure exceeding $250,000 must be collateralized. This could cause a significant “repapering” exercise to adjust any MSFTAs that were executed with higher thresholds and Minimum Transfer amounts.
FINRA takes the position that all marketable securities should be acceptable as collateral with the appropriate haircut. This may lead to significant renegotiation of MSFTAs currently in place.
Furthermore, the utilization of a range of securities as collateral will likely require a robust dynamic collateral system. Such a system will be required to automatically apply haircuts on call date, as well as re-apply them daily as ratings and other factors change.
While FINRA is currently reviewing a significant amount of comments from the industry on these and many other topics raised by the updated proposed rule – i.e., mandatory liquidation actions and margin settlement periods – it is clear that this is not just a re-hashing of last year’s TMPG guidelines. Firms must once again review their current operational practices and capabilities to determine that they are prepared to remain compliant and open for business under the proposed FINRA rules.
This article first appeared in TABBForum on 18 June, 2014.
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