Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed Rule Change To Amend the Requirements for Covered Agency Transactions Under FINRA Rule 4210 (Margin Requirements) as Approved Pursuant to SR-FINRA-2015-036

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, notice is hereby given that on May 7, 2021, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by FINRA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

FINRA is proposing to amend the requirements for Covered Agency Transactions under FINRA Rule 4210 (Margin Requirements) as approved by the SEC pursuant to SR-FINRA-2015-036. The proposed rule change would amend, under FINRA Rule 4210, paragraphs (e)(2)(H), (e)(2)(I), (f)(6), and Supplementary Material .02 through .05, each as amended or established pursuant to SR-FINRA-2015-036.

The text of the proposed rule change is available on FINRA's website at http://www.finra.org,, at the principal office of FINRA and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, FINRA included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. FINRA has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

1. Purpose

On October 6, 2015, FINRA filed with the Commission proposed rule change SR-FINRA-2015-036, which proposed to amend FINRA Rule 4210 to establish margin requirements for: (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, as further defined under FINRA Rule 4210(e)(2)(H)(i)c. pursuant to the rule change (collectively, defined under the rule change as “Covered Agency Transactions”).

In proposing the margin requirements, FINRA pointed out that the rulemaking was necessary to address the potential risk arising from unsecured credit exposures that exist in the Covered Agency Transaction market. FINRA noted that unsecured credit exposures in the Covered Agency Transaction market could lead to financial losses by dealers. Further, FINRA noted that permitting counterparties to participate in the Covered Agency Transaction market without posting margin can facilitate increased leverage by customers, thereby potentially posing a risk to the dealer extending credit and to the marketplace as a whole.

The Commission approved SR-FINRA-2015-036 on June 15, 2016 (the “Approval Date”). Pursuant to Partial Amendment No. 3 to SR-FINRA-2015-036, FINRA announced in Regulatory Notice 16-31 that the rule change would become effective on December 15, 2017, 18 months from the Approval Date, except that the risk limit determination requirements as set forth in paragraphs (e)(2)(F), (e)(2)(G) and (e)(2)(H) of Rule 4210 and in new Supplementary Material .05, each as respectively amended or established by SR-FINRA-2015-036 (collectively, the “risk limit determination requirements”), would become effective on December 15, 2016, six months from the Approval Date.

Industry participants requested that FINRA reconsider the potential impact of certain requirements pursuant to SR-FINRA-2015-036 on smaller and medium-sized firms, and that FINRA extend the implementation date of the requirements pending such reconsideration to reduce potential uncertainty in the Covered Agency Transaction market. In Partial Amendment No. 3 to SR-FINRA-2015-036, FINRA stated that it would monitor the impact of the requirements pursuant to that rulemaking and, if the requirements prove overly onerous or otherwise are shown to negatively impact the market, FINRA would consider revisiting such requirements as may be necessary to mitigate the rule's impact. In response to the concerns of industry participants, FINRA has engaged in extensive dialogue, both with industry participants and other regulators, including staff of the SEC and the Federal Reserve System, for the purpose of reconsidering the requirements. Further, pending this period of dialogue and reconsideration, FINRA has extended the implementation date of the requirements pursuant to SR-FINRA-2015-036 (other than the risk limit determination requirements that became effective on December 15, 2016) on several occasions, most recently to October 26, 2021 (the “October 26, 2021, implementation date”), and has published various guidance to assist members.

FINRA notes that, in the period since the Approval Date, there has been opportunity to discern with greater clarity the potential impact, on both firms and their customers, of the requirements pursuant to SR-FINRA-2015-036. Members have told FINRA that the requirements, as currently approved, favor larger firms over smaller firms because larger firms would have more market power to negotiate margin agreements with their customers. Members have pointed out that non-FINRA member bank dealers and other entities are able to participate in the Covered Agency Transaction market without being subject to FINRA Rule 4210, which thereby places FINRA member broker-dealers at a competitive disadvantage. Some smaller members told FINRA that, among other things, having the option to take a capital charge in lieu of collecting margin for their customers' mark to market losses would help alleviate this competitive disadvantage, though it would not fully resolve the disparity that results from being subject to Rule 4210 when non-FINRA member bank dealers are not.

A. Summary of Proposed Amendments

Taking into account FINRA's dialogue with members, and the overall purpose of the margin amendments, FINRA is proposing revisions to the Covered Agency Transaction requirements as approved pursuant to SR-FINRA-2015-036. Broadly, FINRA proposes:

• To eliminate the two percent maintenance margin requirement that applies to non-exempt accounts pursuant to paragraph (e)(2)(H)(ii)e. under 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 below, unless otherwise provided by the rule;

• 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. These conditions and limitations 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 in lieu of collecting margin to compete unfairly with smaller members; and
• to make revisions designed to streamline, consolidate and clarify the Covered Agency Transaction rule language. These revisions will preserve and clarify key exceptions to the requirements, including for example the $250,000 de minimis transfer exception and the $10 million gross open position exception established pursuant to SR-FINRA-2015-036.

The proposed amendments are discussed in detail 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 the rule 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. By contrast, paragraph (e)(2)(H)(ii)d. of the 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 rule.

Members 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. 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. 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, monitoring and collecting maintenance margin for such accounts is operationally burdensome and out of proportion with the number and size of the affected accounts. Further, bank dealers are not subject to the requirement to collect maintenance margin from their customers, which significantly would disadvantage FINRA members in competition with bank dealers. To address these concerns, FINRA is proposing to eliminate paragraph (e)(2)(H)(ii)d. and paragraph (e)(2)(H)(ii)e. of Rule 4210 as established pursuant to the 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 excess net mark to market loss, unless 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).

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-à-vis larger firms. 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 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. To this end, as noted above, the proposed rule includes conditions and limitations that 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. 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:

• 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 SEA Rule 15c3-1, if the counterparty is a non-margin counterparty 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;

• 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, 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;

• 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 SEA 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; and

• 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.

3. Streamlining and Consolidation of Rule Language; Conforming Revisions

In support of the amendments discussed above, FINRA is proposing 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 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 that permit a member to take a capital charge in lieu of collecting margin, subject to specified conditions). The 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:

○ 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;

○ 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;

○ the counterparty regularly settles its Covered Agency Transactions on a DVP basis or for cash; and

○ 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, or use other financing techniques.

The above elements 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. 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.

• 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.
• 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, the term is not needed.
• 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 . . .” 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 . . .” 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 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 member's written risk policies and procedures.”

• Paragraph (e)(2)(I) under 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 . . .” 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.”

• Paragraph (f)(6) under 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.
• 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. FINRA proposes to redesignate current Supplemental Material .05 as Supplemental Material .03.

If the Commission approves the proposed rule change, FINRA will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 60 days following Commission approval. The effective date will be no later than 120 days following publication of the Regulatory Notice announcing Commission approval. Further, FINRA plans to file a separate proposed rule change that would adjust the October 26, 2021, implementation date for the requirements pursuant to SR-FINRA-2015-036 (other than the risk limit determination requirements that became effective on December 15, 2016) to align with the effective date of the amendments to SR-FINRA-2015-036 as set forth in this proposed rule change. FINRA believes this alignment is appropriate in the interest of regulatory clarity.

2. Statutory Basis

FINRA believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act, which requires, among other things, that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. Based on extensive engagement with industry participants, FINRA believes that the proposed rule change is consistent with the Act because, by eliminating the maintenance margin requirement for Covered Agency Transactions and by permitting members, under specified conditions, to take a capital charge in lieu of collecting margin, the proposed amendments will alleviate the negative competitive impact that the requirements pursuant to SR-FINRA-2015-036 could have for smaller firms. Smaller firms told FINRA that the requirements pursuant to SR-FINRA-2015-036, absent the proposed revisions by FINRA, would have the effect of favoring larger firms that could leverage their greater size and scale and non-member banks that are not subject to the requirements of FINRA rules. The proposed rule change, by alleviating this disadvantage, would help promote competition by leveling the playing field among participants in the Covered Agency Transaction market, thereby reducing disruption in the Covered Agency Transaction market without the loss of investor protection.

B. Self-Regulatory Organization's Statement on Burden on Competition

FINRA does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.

Economic Impact Assessment

FINRA has undertaken an economic impact assessment, as set forth below, to further analyze the regulatory need for the proposed rule change, its potential economic impacts, including anticipated costs, benefits, and distributional and competitive effects, relative to the current baseline, and the alternatives FINRA considered in assessing how best to meet its regulatory objective.

A. Regulatory Need

In Partial Amendment No. 3 to SR-FINRA-2015-036, FINRA stated that it would monitor the impact of the requirements specified in the rule change, inclusive of any potential intended or unintended regulatory, economic or competitive consequences. In response to concerns raised by industry participants regarding the impacts of the requirements, FINRA has engaged in extensive dialogue with industry participants, staff of the SEC and the Federal Reserve System, to reconsider the specified requirements, and to propose any necessary amendments to the requirements adopted pursuant to SR-FINRA-2015-036.

B. Economic Baseline

The economic baseline for the proposed rule change is based on (1) the existing state of the market and firm practices, (2) Rule 4210 prior to the amendments pursuant to SR-FINRA-2015-036 (for convenience, “pre-revision Rule 4210”), and (3) the amendments pursuant to SR-FINRA-2015-036 that, other than the risk limit determination requirements that became effective on December 15, 2016, would be implemented on the October 26, 2021, implementation date.

Through several discussions and consultations with member firms and other relevant stakeholders since the SEC approved SR-FINRA-2015-036, FINRA has learned about some of the unintended consequences identified as part of the rulemaking. A particular aspect that has been identified is with respect to competition among FINRA members firms, and between member and non-member firms. The outbreak of the COVID-19 pandemic in early 2020 affected the financial system, increasing volatility in different markets, including the Covered Agency Transaction market. This exogenous shock to the market took place while FINRA was well into the process of evaluating feedback and concerns raised regarding the margin requirements for trading in this market. FINRA sought feedback, and discussed with several firms, the impact on the Covered Agency Transaction market of the increased volatility, including the impact of the margin requirements pursuant to SR-FINRA-2015-036 and the requirements as they would be amended pursuant to this rule filing. Overall, firms that participated in the outreach were supportive of the proposed rule amendments as set forth in this filing.

Market participants indicated that the order and timing of official sector activities, including the Federal Reserve Board's federal funds rate cut and its quantitative easing measures, including purchases of U.S. Treasury securities (“UST”) and mortgage-based securities (“MBS”), and the mortgage loan forbearance relief provided under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), as amended, were coincident with short-term significant increases in volatility in UST and MBS pricing, resulting in increased margin calls, lower counterparty liquidity, and an adverse effect on related hedges. Most of the firms that participated in FINRA's outreach efforts had signed with their counterparties margining agreements (MSFTAs or customer account agreements), giving the firms the ability to collect margin when necessary. These firms reported that in most cases, clients met their margin calls, with uncollected margin amounts being charged against the firm's capital, in accordance with pre-revision Rule 4210 and, in some cases, the requirements pursuant to SR-FINRA-2015-036 and the SEC staff's related guidance regarding SEA Rule 15c3-1 and Rule 15c3-3. Thus, FINRA learned that firms have in principle already adjusted to the requirements of SR-FINRA-2015-036, which as such is an appropriate baseline for the proposed rule change.

The economic baseline considers the impact of the proposed rule change against the obligations, costs, and benefits associated with the requirements of SR-FINRA-2015-036. FINRA recognizes that some firms might continue to operate under the requirements of pre-revision Rule 4210, versus the requirements of SR-FINRA-2015-036. In establishing the rule change pursuant to SR-FINRA-2015-036, FINRA provided an analysis of the economic baseline that existed pre-2015 (the year that FINRA filed SR-FINRA-2015-036 with the SEC), and the potential economic impacts of the proposed changes pursuant to SR-FINRA-2015-036. FINRA understands that the individual impacts experienced as a result of the proposed rule change as set forth is this filing will depend upon the extent to which member firms wholly adopted, partially adopted or are waiting to implement the requirements of SR-FINRA-2015-036.

C. Economic Impacts

FINRA has analyzed the potential costs and benefits of the proposed rule change, and the different parties that are expected to be affected. FINRA has identified member firms that engage in Covered Agency Transactions and their customers as the parties to be mainly affected by the proposed rule change. The proposed rule change is expected to provide relief to member firms, while promoting competition without diminishing investor protections.

Anticipated Benefits

FINRA believes that the proposed rule change would provide several direct benefits to member firms. First, the removal of the two percent maintenance margin requirement on non-exempt accounts would benefit member firms by reducing costs arising from two main channels. First, firms would no longer incur costs associated with distinguishing between exempt and non-exempt accounts. Second, the proposed rule change would provide operational relief with respect to obtaining custody and related agreements in connection with the need to collect maintenance margin. FINRA understands that the requirement to collect maintenance margin has led firms to enter into separate custodial agreements with third party banks to hold the maintenance margin where counterparties are constrained from custodying assets direct with broker-dealers. This resulted in an operational burden to both the member firms and their counterparties. Anecdotally, mid-size and smaller member firms have claimed an additional indirect cost to the current rule, specifically, that this operational burden has resulted in counterparties reducing the number of member firms with which they transact.

Second, the proposed rule change would permit member firms the option to take a capital charge in lieu of collecting margin for a counterparty's excess net mark to market loss. The proposal would allow member firms to do so subject to specified conditions and limitations as discussed above, and would preserve the substance of the exceptions permitted under the current rule. These conditions and limitations are designed to help protect the financial stability of members that opt to take capital charges. The proposed limit on the capital charges taken by the firm in lieu of collecting margin provides guardrails to ensure that large member firms do not use this provision to corner the market in these securities.

FINRA has learned that allowing firms to take a capital charge in lieu of collecting margin would further benefit them by decreasing operational burdens. These burdens arise from the costs associated with obtaining the required margin agreements from counterparties, and from the competitive advantage large dealers have, stemming from their ability to enter into MSFTAs with trading counterparties. Finally, FINRA believes that this provision would result in a transfer of the risk from the customer to the member firm. This would benefit the firm's customers and trading counterparties by reducing their costs and decreasing their risk exposure. As such, this could serve as an additional incentive to establishing trading relationships.

FINRA believes that, in addition to the main benefits discussed above, member firms would benefit from the streamlining of the rule text and clarifications provided throughout, including the provisions and exceptions as discussed above and set forth by the rule. One such example is the proposed change to the definition of counterparty in the rule. The proposed definition is expected to reduce costs associated with determining liability and responsibilities when establishing the contractual relationship between the member firm and its counterparty. A second example is the proposed amendment that defines the required margin by reference to the proposed new defined term “excess net mark to market loss.” The proposed language streamlines and clarifies the language pursuant to SR-FINRA-2015-036 with regard to the $250,000 de minimis transfer amount, thereby making it easier to determine the applicable margin. This is expected to reduce the costs associated with determining the margin requirements when establishing trading relationships.

Anticipated Costs

FINRA notes that while the choice by member firms to commit capital in lieu of margin has anticipated benefits, as discussed above, such choice can also potentially result in some costs. The magnitude of these costs depends on the firm's trading activity, its access to capital, and the capital reserves necessary to fulfill the firm's margin obligations. As firms are not required to commit capital in lieu of margin, FINRA expects that firms will only do so when they believe it appropriately balances benefits and risks.

Moreover, the member firm's decision to take a capital charge in lieu of capital has additional associated costs. Taking a capital charge reduces the amount of excess net capital a firm has available for other uses and exposes the firm to financial and business risk if its counterparties fails to deliver. Additional related costs could stem from the necessary compliance systems needed to make sure the permitted limits on taking such capital charges are met, and the costs related to when the firm needs to keep to these limits for an extended period, as set forth in the proposed rule text.

Anticipated Competitive Effects

Collectively, the proposed rule change is expected to potentially level the playing field both between regional and primary broker-dealer members and between member firms and non-FINRA member regional banks. While FINRA has no direct measure of trading activity by non-member firms, it is expected that the main provisions of the proposed rule change would reduce incentives to limit trading relationships with FINRA member firms on account of the regulatory-imposed costs. Decreasing the costs associated with the collection of maintenance margin, and the ability to take a capital charge in lieu of collecting margin, would lower the overall costs associated with engaging in Covered Agency Transactions. FINRA believes that this would ultimately lower the barriers to entry into the Covered Agency Transaction market and increase competition. The magnitude of the competitive impact depends on the extent to which the requirements pursuant to SR-FINRA-2015-036 have already impacted market participant behavior. Finally, the collective impacts described above are expected to benefit the investor community, by providing investors more options for trading in this market.

D. Alternatives Considered

FINRA considered various alternatives to the proposed rule amendments. For example, with regard to the provisions under proposed paragraph (e)(2)(H)(ii)d.3. that specify the $30 million or 25% of tentative net capital thresholds, FINRA considered imposing the specified consequences as set forth under the proposal as soon as a member exceeds a limit of $25 million in capital charges in lieu of collecting margin. Industry participants expressed concern that the abrupt imposition of such consequences in cases of market stress, without allowing time for the member to collect margin, would be burdensome to firms. FINRA believes this concern is valid and as such is proposing that incurring capital charges in excess of $25 million for five consecutive business days will require notice to FINRA, while incurring capital charges in excess of $30 million or 25% of a firm's tentative net capital for five consecutive business days will also require firms to take the specified steps to manage their risk.

FINRA believes that the proposal strikes an appropriate balance between regulatory burdens and the ability of member firms to compete in these markets, as well as member firms' financial responsibility and operational risk considerations and compliance.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others

Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

Within 45 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will:

(A) By order approve or disapprove such proposed rule change, or

(B) institute proceedings to determine whether the proposed rule change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's internet comment form ( http://www.sec.gov/rules/sro.shtml ); or
• Send an email to rule-comments@sec.gov. Please include File Number SR-FINRA-2021-010 on the subject line.

Paper Comments

• Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2021-010. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's internet website ( http://www.sec.gov/rules/sro.shtml ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of FINRA. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-FINRA-2021-010 and should be submitted on or before June 15, 2021.