Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 3 and Order Granting Accelerated Approval to a Proposed Rule Change To Amend FINRA Rule 4210 (Margin Requirements) To Establish Margin Requirements for the TBA Market, as Modified by Amendment Nos. 1, 2, and 3, 40364-40377 [2016-14561]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 81, Number 119 (Tuesday, June 21, 2016)]
[Notices]
[Pages 40364-40377]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-14561]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-78081; File No. SR-FINRA-2015-036]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 3 and Order Granting 
Accelerated Approval to a Proposed Rule Change To Amend FINRA Rule 4210 
(Margin Requirements) To Establish Margin Requirements for the TBA 
Market, as Modified by Amendment Nos. 1, 2, and 3

June 15, 2016.

I. Introduction

    On October 6, 2015, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend FINRA Rule 4210 (Margin 
Requirements) to establish margin requirements for covered agency 
transactions, also referred to, for purposes of this proposed rule 
change as the To Be Announced (``TBA'') market.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on October 20, 2015.\3\ On November 10, 2015, FINRA extended 
the time period in which the Commission must approve the proposed rule 
change, disapprove the proposed rule change, or institute proceedings 
to determine whether to approve or disapprove the proposed rule change 
to January 15, 2016.\4\ The Commission received 109 comment letters, 
including 50 Type A comment letters and four Type B comment letters, in 
response to the proposal.\5\ On January 13, 2016, FINRA responded to 
the comments and filed Amendment No. 1 to the proposal.\6\ On January 
14, 2016, the Commission issued an order instituting proceedings 
pursuant to Section 19(b)(2)(B) of the Exchange Act \7\ to determine 
whether to approve or disapprove the proposed rule change, as modified 
by Amendment No. 1.\8\ The Order Instituting Proceedings was published 
in the Federal Register on January 21, 2016.\9\ The Commission received 
23 comment letters in response to the Order Instituting 
Proceedings.\10\ On March 21, 2016, FINRA responded to the comments and 
filed Amendment No. 2.\11\ On April 11, 2016, the Commission noticed 
Amendment No. 2 to the proposed rule change to solicit comments from 
interested persons and designated a longer period for

[[Page 40365]]

Commission action on the proposal, until June 16, 2016.\12\ The 
Commission received nine additional comment letters in response to the 
Amendment No. 2 Notice.\13\ On May 26, 2016, FINRA responded to the 
comments and filed Amendment No. 3.\14\ The Commission is publishing 
this notice and order to solicit comment on Amendment No. 3 and to 
approve the proposed rule change, as modified by Amendment Nos. 1, 2, 
and 3 on an accelerated basis.\15\
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    \3\ See Exchange Act Release No. 76148 (Oct. 14, 2015), 80 FR 
63603 (Oct. 20, 2015) (File No. SR-FINRA-2015-036) (``Notice'').
    \4\ See Extension No. 1, dated Nov. 10, 2015. FINRA's extension 
of time for Commission action, available at https://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-036-extension-1.pdf.
    \5\ The public comment file for the proposed rule change is on 
the Commission's Web site available at https://www.sec.gov/comments/sr-finra-2015-036/finra2015036.shtml. The Type A and B form letters 
generally contain language opposing the inclusion of multifamily 
housing and project loan securities within the scope of the proposed 
rule change, as originally proposed in the Notice. See Notice, supra 
note 3. The Commission staff also participated in numerous meetings 
and conference calls with certain commenters and other market 
participants.
    \6\ See Amendment No. 1 to the proposed rule change, dated Jan. 
13, 2016 (``Amendment No. 1''), available at https://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-036-amendment-1.pdf. FINRA's responses to comments received on the Notice and 
proposed amendments in response to those comments are included in 
Amendment No. 1.
    \7\ 15 U.S.C. 78s(b)(2)(B).
    \8\ See Exchange Act Release No. 76908 (Jan. 14, 2016), 81 FR 
3532 (Jan. 21, 2016) (Order Instituting Proceedings To Determine 
Whether To Approve or Disapprove Proposed Rule Change to Amend FINRA 
Rule 4210 (Margin Requirements) to Establish Margin Requirements for 
the TBA Market, as Modified by Partial Amendment No. 1) (``Order 
Instituting Proceedings'').
    \9\ Id.
    \10\ See comment file, supra note 5.
    \11\ See Amendment No. 2 to proposed rule change, dated Mar. 21, 
2016 (``Amendment No. 2''), available at https://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-036-ammendment2.pdf. 
FINRA's responses to comments received on the Order Instituting 
Proceedings and proposed amendments in response to those comments 
are included in Amendment No. 2.
    \12\ See Exchange Act Release No. 77579 (Apr. 11, 2016), 81 FR 
22347 (Apr. 15, 2016) (Notice of Filing of Amendment No. 2 and 
Designation of a Longer Period for Commission Action on Proceedings 
to Determine Whether to Approve or Disapprove Proposed Rule Change 
to Amend FINRA Rule 4210 (Margin Requirements) to Establish Margin 
Requirements for the TBA Market, as Modified by Amendment Nos. 1 and 
2) (``Amendment No. 2 Notice'').
    \13\ See Letters from Robert Fine, Brean Capital, LLC, dated 
April 27, 2016 (``Brean Capital 4 Letter''); Mortgage Bankers 
Association, dated May 2, 2016 (``MBA 3 Letter''); Securities 
Industry and Financial Markets Association, dated May 2, 2016 
(``SIFMA 3 Letter''); James M. Cain, Sutherland Asbill & Brennan LLP 
(on behalf of the banks of the Farm Credit System), dated May 2, 
2016 (``Sutherland 3 Letter''); James M. Cain, Sutherland Asbill & 
Brennan LLP (on behalf of the Federal Home Loan Banks, dated May 02, 
2016, (``Sutherland 4 Letter''); Chris Melton, Coastal Securities, 
dated May 2, 2016 (``Coastal 3 Letter''); Michael Nicholas, Bond 
Dealers of America, dated May 2, 2016 (``BDA 3 Letter''); Manisha 
Kimmel, Thomson Reuters, dated May 2, 2016 (``Thompson Reuters 
Letter''); and Bond Dealers of America, dated May 26, 2016 (``BDA 4 
Letter''). See also supra note 5.
    \14\ See Amendment No. 3 to proposed rule change, dated May 26, 
2016 (``Amendment No. 3''), available at https://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-036-amendment-3.pdf. 
FINRA's responses to comments received on the Amendment No. 2 Notice 
and proposed amendments in response to comments to Amendment No. 2 
are included in Amendment No. 3.
    \15\ The text of the proposed rule change, as modified by 
Amendment Nos. 1, 2, and 3 (the ``Amendments'') is available at the 
principal office of FINRA, on FINRA's Web site at https://www.finra.org, and at the Commission's Public Reference Room.
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II. Description of the Proposed Rule Change 16
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    \16\ The proposed rule change, as modified by Amendment Nos. 1 
and 2, as described in this Item II.A.-C., is excerpted, in part, 
from the Notice and Amendment Nos. 1 and 2, which were substantially 
prepared by FINRA, and the Order Instituting Proceedings and 
Amendment No. 2 Notice. See supra notes 3, 8, and 12. See also supra 
notes 6 and 11. Amendment No. 3 is described in section II.D. below.
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    FINRA proposed amendments to FINRA Rule 4210 (Margin Requirements) 
to establish requirements for: (1) TBA transactions,\17\ inclusive of 
adjustable rate mortgage (``ARM'') transactions; (2) Specified Pool 
Transactions; \18\ and (3) transactions in collateralized mortgage 
obligations (``CMOs''),\19\ issued in conformity with a program of an 
agency or Government-Sponsored Enterprise (``GSE''), with forward 
settlement dates, (collectively, ``Covered Agency Transactions,'' also 
referred to, for purposes of this order, as the ``TBA market'').
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    \17\ See FINRA Rule 6710(u) (defining TBA to mean a transaction 
in an Agency Pass-Through Mortgage-Backed Security (``MBS'') or a 
Small Business Administration (``SBA'')-Backed Asset-Backed Security 
(``ABS'') where the parties agree that the seller will deliver to 
the buyer a pool or pools of a specified face amount and meeting 
certain other criteria but the specific pool or pools to be 
delivered at settlement is not specified at the Time of Execution, 
and includes TBA transactions for good delivery and TBA transactions 
not for good delivery).
    \18\ FINRA Rule 6710(x) defines Specified Pool Transaction to 
mean a transaction in an Agency Pass-Through MBS or an SBA-Backed 
ABS requiring the delivery at settlement of a pool or pools that is 
identified by a unique pool identification number at the time of 
execution.
    \19\ FINRA Rule 6710(dd) defines CMO to mean a type of 
Securitized Product backed by Agency Pass-Through MBS, mortgage 
loans, certificates backed by project loans or construction loans, 
other types of MBS or assets derivative of MBS, structured in 
multiple classes or tranches with each class or tranche entitled to 
receive distributions of principal or interest according to the 
requirements adopted for the specific class or tranche, and includes 
a real estate mortgage investment conduit (``REMIC'').
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    FINRA stated that most trading of agency and GSE Mortgage-Backed 
Security (``MBS'') takes place in the TBA market, which is 
characterized by transactions with forward settlements as long as 
several months past the trade date.\20\ FINRA stated that historically, 
the TBA market is one of the few markets where a significant portion of 
activity is unmargined, thereby creating a potential risk arising from 
counterparty exposure. With a view to this gap between the TBA market 
versus other markets, FINRA took note of the TPMG recommended standards 
(the ``TMPG best practices'') regarding the margining of forward-
settling agency MBS transactions.\21\ FINRA stated that the TMPG best 
practices are recommendations and, as such, currently are not rule 
requirements. FINRA's existing margin requirements do not address the 
TBA market generally.
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    \20\ See, e.g., James Vickery & Joshua Wright, TBA Trading and 
Liquidity in the Agency MBS Market, Federal Reserve Bank of New York 
(``FRBNY'') Economic Policy Review, May 2013, available at https://www.newyorkfed.org/medialibrary/media/research/epr/2013/1212vick.pdf; see also Commission's Staff Report, Enhancing 
Disclosure in the Mortgage-Backed Securities Markets, Jan. 2003, 
available at https://www.sec.gov/news/studies/mortgagebacked.htm; 
see also Treasury Market Practices Group (``TMPG''), Margining in 
Agency MBS Trading, Nov. 2012, available at https://www.newyorkfed.org/medialibrary/microsites/tmpg/files/margining_tmpg_11142012.pdf (the ``TMPG Report''). The TMPG is a 
group of market professionals that participate in the TBA market and 
is sponsored by the FRBNY.
    \21\ See TMPG, Best Practices for Treasury, Agency, Debt, and 
Agency Mortgage-Backed Securities Markets, revised Feb. 2016, 
available at https://www.newyorkfed.org/medialibrary/microsites/tmpg/files/TMPG_BestPractices_2_19_16.pdf.
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    Accordingly, to establish margin requirements for Covered Agency 
Transactions, FINRA proposed to redesignate current paragraph (e)(2)(H) 
of FINRA Rule 4210 as new paragraph (e)(2)(I), to add new paragraph 
(e)(2)(H), to make conforming revisions to paragraphs (a)(13)(B)(i), 
(e)(2)(F), (e)(2)(G), (e)(2)(I), as redesignated by the rule change, 
and (f)(6), and to add to the rule new Supplementary Materials .02 
through .05. The proposed rule change, as modified by Amendments Nos. 1 
and 2, is described in further detail in sections A.-C. below. The 
changes proposed in Amendment No. 3 are described in section D. below.

A. Proposed FINRA Rule 4210(e)(2)(H) (Covered Agency Transactions)

    The key requirements of the proposed rule change are set forth in 
new paragraph (e)(2)(H) of FINRA Rule 4210.
1. Definition of Covered Agency Transactions (Proposed FINRA Rule 
4210(e)(2)(H)(i)c)
    Proposed paragraph (e)(2)(H)(i)c. of the rule would define Covered 
Agency Transactions to mean:
     TBA transactions, as defined in FINRA Rule 6710(u), 
inclusive of ARM transactions, for which the difference between the 
trade date and contractual settlement date is greater than one business 
day;
     Specified Pool Transactions, as defined in FINRA Rule 
6710(x), for which the difference between the trade date and 
contractual settlement date is greater than one business day; and
     CMOs, as defined in FINRA Rule 6710(dd), issued in 
conformity with a program of an agency, as defined in FINRA Rule 
6710(k), or a GSE, as defined in FINRA Rule 6710(n), for which the 
difference between the trade date and contractual settlement date is 
greater than three business days.
2. Other Key Definitions Established by the Proposed Rule Change 
(Proposed FINRA Rule 4210(e)(2)(H)(i))
    In addition to Covered Agency Transactions, the proposed rule 
change would define the following key terms for purposes of new 
paragraph (e)(2)(H) of Rule 4210:
     The term ``bilateral transaction'' means a Covered Agency 
Transaction that is not cleared through a registered clearing agency as 
defined in paragraph (f)(2)(A)(xxviii) of Rule 4210;
     The term ``counterparty'' means any person that enters 
into a Covered Agency Transaction with a member and

[[Page 40366]]

includes a ``customer'' as defined in paragraph (a)(3) of Rule 4210;
     The term ``deficiency'' means the amount of any required 
but uncollected maintenance margin and any required but uncollected 
mark to market loss;
     The term ``gross open position'' means, with respect to 
Covered Agency Transactions, the amount of the absolute dollar value of 
all contracts entered into by a counterparty, in all CUSIPs; provided, 
however, that such amount shall be computed net of any settled position 
of the counterparty held at the member and deliverable under one or 
more of the counterparty's contracts with the member and which the 
counterparty intends to deliver;
     The term ``maintenance margin'' means margin equal to two 
percent of the contract value of the net long or net short position, by 
CUSIP, with the counterparty;
     The term ``mark to market loss'' means the counterparty's 
loss resulting from marking a Covered Agency Transaction to the market;
     The term ``mortgage banker'' means an entity, however 
organized, that engages in the business of providing real estate 
financing collateralized by liens on such real estate;
     The term ``round robin'' trade means any transaction or 
transactions resulting in equal and offsetting positions by one 
customer with two separate dealers for the purpose of eliminating a 
turnaround delivery obligation by the customer; and
     The term ``standby'' means contracts that are put options 
that trade over-the-counter (``OTC''), as defined in paragraph 
(f)(2)(A)(xxvii) of Rule 4210, with initial and final confirmation 
procedures similar to those on forward transactions.
3. Requirements for Covered Agency Transactions (Proposed FINRA Rule 
4210(e)(2)(H)(ii))
    The specific requirements that would apply to Covered Agency 
Transactions are set forth in proposed paragraph (e)(2)(H)(ii). These 
requirements would address the types of counterparties that are subject 
to the proposed rule, risk limit determinations, specified exceptions 
from the proposed margin requirements, transactions with exempt 
accounts,\22\ transactions with non-exempt accounts, the handling of de 
minimis transfer amounts, and the treatment of standbys.
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    \22\ The term ``exempt account'' is defined under FINRA Rule 
4210(a)(13). Broadly, an exempt account means a FINRA member, non-
FINRA member registered broker-dealer, account that is a 
``designated account'' under FINRA Rule 4210(a)(4) (specifically, a 
bank as defined under Section 3(a)(6) of the Exchange Act, a savings 
association as defined under Section 3(b) of the Federal Deposit 
Insurance Act, the deposits of which are insured by the Federal 
Deposit Insurance Corporation, an insurance company as defined under 
Section 2(a)(17) of the Investment Company Act, an investment 
company registered with the Commission under the Investment Company 
Act, a state or political subdivision thereof, or a pension plan or 
profit sharing plan subject to the Employee Retirement Income 
Security Act or of an agency of the United States or of a state or 
political subdivision thereof), and any person that has a net worth 
of at least $45 million and financial assets of at least $40 million 
for purposes of paragraphs (e)(2)(F) and (e)(2)(G) of the rule, as 
set forth under paragraph (a)(13)(B)(i) of Rule 4210, and meets 
specified conditions as set forth under paragraph (a)(13)(B)(ii). 
FINRA is proposing a conforming revision to paragraph (a)(13)(B)(i) 
so that the phrase ``for purposes of paragraphs (e)(2)(F) and 
(e)(2)(G)'' would read ``for purposes of paragraphs (e)(2)(F), 
(e)(2)(G) and (e)(2)(H).''
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Counterparties Subject to the Rule
    Paragraph (e)(2)(H)(ii)a. of the proposed rule provides that all 
Covered Agency Transactions with any counterparty, regardless of the 
type of account to which booked, are subject to the provisions of 
paragraph (e)(2)(H) of the rule. However, paragraph (e)(2)(H)(ii)a.1. 
of the proposed rule provides that with respect to Covered Agency 
Transactions with any counterparty that is a Federal banking agency, as 
defined in 12 U.S.C. 1813(z) under the Federal Deposit Insurance Act, 
central bank, multinational central bank, foreign sovereign, 
multilateral development bank, or the Bank for International 
Settlements, a member may elect not to apply the margin requirements 
specified in paragraph (e)(2)(H) provided the member makes a written 
risk limit determination for each such counterparty that the member 
shall enforce pursuant to paragraph (e)(2)(H)(ii)b., as discussed 
below.
    Paragraph (e)(2)(H)(ii)a.2. of the proposed rule provides that a 
member is not required to apply the margin requirements of paragraph 
(e)(2)(H) of the rule with respect to Covered Agency Transactions with 
a counterparty in multifamily housing securities or project loan 
program securities, provided that: (1) Such securities are issued in 
conformity with a program of an Agency, as defined in FINRA Rule 
6710(k), or a GSE, as defined in FINRA Rule 6710(n), and are documented 
as Freddie Mac K Certificates, Fannie Mae Delegated Underwriting and 
Servicing bonds, or Ginnie Mae Construction Loan or Project Loan 
Certificates, as commonly known to the trade, or are such other 
multifamily housing securities or project loan program securities with 
substantially similar characteristics, issued in conformity with a 
program of an Agency or a Government-Sponsored Enterprise, as FINRA may 
designate by Regulatory Notice or similar communication; and (2) the 
member makes a written risk limit determination for each such 
counterparty that the member shall enforce pursuant to paragraph 
(e)(2)(H)(ii)b. of Rule 4210.\23\
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    \23\ See Exhibit 4 and Exhibit 5 in Amendment No. 2. See also 
supra note 11.
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Risk Limits \24\
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    \24\ This section describes the proposed rule change prior to 
the proposed amendments to new Supplementary Material .05 in 
Amendment No. 3, which are described in section II.D. below.
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    Paragraph (e)(2)(H)(ii)b. of the rule provides that members that 
engage in Covered Agency Transactions with any counterparty shall make 
a determination in writing of a risk limit for each such counterparty 
that the member shall enforce. The rule provides that 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. Further, in connection with risk limit 
determinations, the proposed rule establishes new Supplementary 
Material .05. The new Supplementary Material provides that, for 
purposes of any risk limit determination pursuant to paragraphs 
(e)(2)(F), (e)(2)(G) or (e)(2)(H) of the rule:
    [cir] If a member engages in transactions with advisory clients of 
a registered investment adviser, the member may elect to make the risk 
limit determination at the investment adviser level, except with 
respect to any account or group of commonly controlled accounts whose 
assets managed by that investment adviser constitute more than 10 
percent of the investment adviser's regulatory assets under management 
as reported on the investment adviser's most recent Form ADV;
    [cir] Members of limited size and resources that do not have a 
credit risk officer or credit risk committee may designate an 
appropriately registered principal to make the risk limit 
determinations;
    [cir] The member may base the risk limit determination on 
consideration of all products involved in the member's business with 
the counterparty, provided the member makes a daily record of the 
counterparty's risk limit usage; and
    [cir] A member shall consider whether the margin required pursuant 
to the rule is adequate with respect to a particular counterparty 
account or all its counterparty accounts and, where appropriate, 
increase such requirements.

[[Page 40367]]

Exceptions From the Proposed Margin Requirements: (1) Registered 
Clearing Agencies; (2) Gross Open Positions of $2.5 Million or Less in 
Aggregate \25\
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    \25\ This section describes the proposed rule change prior to 
the proposed amendment to increase the $2.5 million to $10.0 million 
in Amendment No. 3, which is described in section II.D. below.
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    Paragraph (e)(2)(H)(ii)c. provides that the margin requirements 
specified in paragraph (e)(2)(H) of the rule shall not apply to:
    [cir] Covered Agency Transactions that are cleared through a 
registered clearing agency, as defined in FINRA Rule 
4210(f)(2)(A)(xxviii), and are subject to the margin requirements of 
that clearing agency; and
    [cir] any counterparty that has gross open positions in Covered 
Agency Transactions with the member amounting to $2.5 million or less 
in aggregate, if the original contractual settlement for all such 
transactions is in the month of the trade date for such transactions or 
in the month succeeding the trade date for such transactions and the 
counterparty regularly settles its Covered Agency Transactions on a 
Delivery Versus Payment (``DVP'') basis or for cash; provided, however, 
that such exception from the margin requirements shall not apply to a 
counterparty that, in its transactions with the member, engages in 
dollar rolls, as defined in FINRA Rule 6710(z), or round robin trades, 
or that uses other financing techniques for its Covered Agency 
Transactions.
Transactions With Exempt Accounts
    Paragraph (e)(2)(H)(ii)d. of the proposed rule provides that, on 
any net long or net short position, by CUSIP, resulting from bilateral 
transactions with a counterparty that is an exempt account, no 
maintenance margin shall be required. However, the rule provides that 
such transactions must be marked to the market daily and the member 
must collect any net mark to market loss, unless otherwise provided 
under paragraph (e)(2)(H)(ii)f. The rule provides that if the mark to 
market loss is not satisfied by the close of business on the next 
business day after the business day on which the mark to market loss 
arises, the member shall be required to deduct the amount of the mark 
to market loss from net capital as provided in Exchange Act Rule 15c3-1 
until such time the mark to market loss is satisfied. The rule requires 
that if such mark to market loss is not satisfied within five business 
days from the date the loss was created, the member must promptly 
liquidate positions to satisfy the mark to market loss, unless FINRA 
has specifically granted the member additional time. Under the rule, 
members may treat mortgage bankers that use Covered Agency Transactions 
to hedge their pipeline of mortgage commitments as exempt accounts for 
purposes of paragraph (e)(2)(H) of this Rule.
Transactions With Non-Exempt Accounts
    Paragraph (e)(2)(H)(ii)e. of the rule provides that, on any net 
long or net short position, by CUSIP, resulting from bilateral 
transactions with a counterparty that is not an exempt account, 
maintenance margin, plus any net mark to market loss on such 
transactions, shall be required margin, and the member shall collect 
the deficiency, as defined in paragraph (e)(2)(H)(i)d. of the rule, 
unless otherwise provided under paragraph (e)(2)(H)(ii)f. of the rule. 
The rule provides that if the deficiency is not satisfied by the close 
of business on the next business day after the business day on which 
the deficiency arises, the member shall be required to deduct the 
amount of the deficiency from net capital as provided in Exchange Act 
Rule 15c3-1 until such time the deficiency is satisfied. Further, the 
rule provides that if such deficiency is not satisfied within five 
business days from the date the deficiency was created, the member 
shall promptly liquidate positions to satisfy the deficiency, unless 
FINRA has specifically granted the member additional time.
    The rule provides that no maintenance margin is required if the 
original contractual settlement for the Covered Agency Transaction is 
in the month of the trade date for such transaction or in the month 
succeeding the trade date for such transaction and the customer 
regularly settles its Covered Agency Transactions on a DVP basis or for 
cash; provided, however, that such exception from maintenance margin 
requirement shall not apply to a non-exempt account that, in its 
transactions with the member, engages in dollar rolls, as defined in 
FINRA Rule 6710(z), or round robin trades, as defined in proposed FINRA 
Rule 4210(e)(2)(H)(i)i., or that uses other financing techniques for 
its Covered Agency Transactions.
De Minimis Transfer Amounts
    Paragraph (e)(2)(H)(ii)f. of the rule provides that any deficiency, 
as set forth in paragraph (e)(2)(H)(ii)e. of the rule, or mark to 
market losses, as set forth in paragraph (e)(2)(H)(ii)d. of the rule, 
with a single counterparty shall not give rise to any margin 
requirement, and as such need not be collected or charged to net 
capital, if the aggregate of such amounts with such counterparty does 
not exceed $250,000 (``the de minimis transfer amount'').
Unrealized Profits; Standbys
    Paragraph (e)(2)(H)(ii)g. of the rule provides that unrealized 
profits in one Covered Agency Transaction position may offset losses 
from other Covered Agency Transaction positions in the same 
counterparty's account and the amount of net unrealized profits may be 
used to reduce margin requirements.

B. Conforming Amendments to FINRA Rule 4210(e)(2)(F) (Transactions With 
Exempt Accounts Involving Certain ``Good Faith'' Securities) and FINRA 
Rule 4210(e)(2)(G) (Transactions With Exempt Accounts Involving Highly 
Rated Foreign Sovereign Debt Securities and Investment Grade Debt 
Securities)

    The proposed rule change makes a number of revisions to paragraphs 
(e)(2)(F) and (e)(2)(G) of FINRA Rule 4210: \26\
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    \26\ See supra notes 3, 8, and 12; see also Exhibit 5 in 
Amendment No. 2, text of proposed rule change, as modified by 
Amendment Nos. 1 and 2.
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     The proposed rule change revises the opening sentence of 
paragraph (e)(2)(F) to clarify that the paragraph's scope does not 
apply to Covered Agency Transactions as defined pursuant to new 
paragraph (e)(2)(H). Accordingly, as amended, paragraph (e)(2)(F) 
states: ``Other than for Covered Agency Transactions as defined in 
paragraph (e)(2)(H) of this Rule . . .'' For similar reasons, the 
proposed rule change revises paragraph (e)(2)(G) to clarify that the 
paragraph's scope does not apply to a position subject to new paragraph 
(e)(2)(H) in addition to paragraph (e)(2)(F) as the paragraph currently 
states. As amended, the parenthetical in the opening sentence of the 
paragraph states: ``([O]ther than a position subject to paragraph 
(e)(2)(F) or (e)(2)(H) of this Rule).''
     Current, pre-revision paragraph (e)(2)(H)(i) provides that 
members must maintain a written risk analysis methodology for assessing 
the amount of credit extended to exempt accounts pursuant to paragraphs 
(e)(2)(F) and (e)(2)(G) of the rule which shall be made available to 
FINRA upon request. The proposed rule change places this language in 
paragraphs (e)(2)(F) and (e)(2)(G) and deletes it from its current 
location. Accordingly, FINRA proposes to move to paragraphs (e)(2)(F) 
and (e)(2)(G): ``Members shall maintain a written risk analysis 
methodology for

[[Page 40368]]

assessing the amount of credit extended to exempt accounts pursuant to 
[this paragraph], which shall be made available to FINRA upon 
request.'' Further, FINRA proposes to add to each: ``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.''
     The proposed rule change revises the references in 
paragraphs (e)(2)(F) and (e)(2)(G) to the limits on net capital 
deductions as set forth in current paragraph (e)(2)(H) to read 
``paragraph (e)(2)(I)'' in conformity with that paragraph's 
redesignation pursuant to the rule change.

C. Redesignated Paragraph (e)(2)(I) (Limits on Net Capital Deductions) 
27
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    \27\ This section describes the proposed rule change prior to 
the proposed amendments in Amendment No. 3 including increasing the 
$2.5 million cash account exception to $10.0 million. The proposed 
changes in Amendment No. 3 are described in section II.D. below.
---------------------------------------------------------------------------

    Under current paragraph (e)(2)(H) of FINRA Rule 4210, in brief, a 
member must provide prompt written notice to FINRA and is prohibited 
from entering into any new transactions that could increase the 
member's specified credit exposure if net capital deductions taken by 
the member as a result of marked to the market losses incurred under 
paragraphs (e)(2)(F) and (e)(2)(G), over a five day business period, 
exceed: (1) For a single account or group of commonly controlled 
accounts, five percent of the member's tentative net capital (as 
defined in Exchange Act Rule 15c3-1); or (2) for all accounts combined, 
25 percent of the member's tentative net capital (again, as defined in 
Exchange Act Rule 15c3-1). As discussed above, the proposed rule change 
redesignates current paragraph (e)(2)(H) of the rule as paragraph 
(e)(2)(I), deletes current paragraph (e)(2)(H)(i), and makes conforming 
revisions to paragraph (e)(2)(I), as redesignated, for the purpose of 
clarifying that the provisions of that paragraph are meant to include 
Covered Agency Transactions as set forth in new paragraph (e)(2)(H). In 
addition, the proposed rule change clarifies that de minimis transfer 
amounts must be included toward the five percent and 25 percent 
thresholds as specified in the rule, as well as amounts pursuant to the 
specified exception under paragraph (e)(2)(H) for gross open positions 
of $2.5 million or less in aggregate.
    Redesignated paragraph (e)(2)(I) of the rule provides that, in the 
event that the net capital deductions taken by a member as a result of 
deficiencies or marked to the market losses incurred under paragraphs 
(e)(2)(F) and (e)(2)(G) of the rule (exclusive of the percentage 
requirements established thereunder), plus any mark to market loss as 
set forth under paragraph (e)(2)(H)(ii)d. of the rule and any 
deficiency as set forth under paragraph (e)(2)(H)(ii)e. of the rule, 
and inclusive of all amounts excepted from margin requirements as set 
forth under paragraph (e)(2)(H)(ii)c.2. of the rule or any de minimis 
transfer amount as set forth under paragraph (e)(2)(H)(ii)f. of the 
rule, exceed: \28\
---------------------------------------------------------------------------

    \28\ See supra notes 3, 8, and 12; see also Exhibit 5 in 
Amendment No. 2, text of proposed rule change, as modified by 
Amendment Nos. 1 and 2.
---------------------------------------------------------------------------

     For any one account or group of commonly controlled 
accounts, 5 percent of the member's tentative net capital (as such term 
is defined in Exchange Act Rule 15c3-1), or
     for all accounts combined, 25 percent of the member's 
tentative net capital (as such term is defined in Exchange Act Rule 
15c3-1), and,
     such excess as calculated in paragraphs (e)(2)(I)(i)a. or 
b. of the rule continues to exist on the fifth business day after it 
was incurred,

the member must 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 the rule that would result in an 
increase in the amount of such excess under, as applicable, paragraph 
(e)(2)(I)(i) of the rule.
Implementation Date \29\
---------------------------------------------------------------------------

    \29\ See section II.D. below for a clarification in Amendment 
No. 3 regarding the specific provisions related to the risk limit 
determinations that become effective six months after Commission 
approval of the proposed rule change. See Amendment No. 3, supra 
note 14.
---------------------------------------------------------------------------

    FINRA proposed 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 proposed Supplementary Material .05 become effective six months 
from the date the proposed rule change is approved by the 
Commission.\30\ FINRA proposed that the remainder of the proposed rule 
change become effective 18 months from the date the proposed rule 
change is approved by the Commission.\31\
---------------------------------------------------------------------------

    \30\ See supra notes 8 and 12.
    \31\ Id.
---------------------------------------------------------------------------

D. Amendment No. 3

    In response to comments the Commission received on the Amendment 
No. 2 Notice,\32\ FINRA filed Amendment No. 3 to propose revisions to 
paragraph (e)(2)(H)(ii)c.2. and Supplementary Material .05(a)(1).\33\ 
Specifically, in Amendment No. 3, FINRA proposes to increase the 
specified amount for the gross open position exception from $2.5 
million or less in aggregate to $10 million and amend new Supplementary 
Material .05(a)(1) to revise the proposed language to delete the clause 
that reads ``except with respect to any account or group of commonly 
controlled accounts whose assets managed by that investment adviser 
constitute more than 10 percent of the investment adviser's regulatory 
assets under management as reported on the investment adviser's most 
recent Form ADV.'' Finally, FINRA clarified which provisions related to 
the risk limit determinations in the proposed rule change would become 
effective with regard to the six month implementation timeframe after 
the proposed rule change is approved by the Commission.
---------------------------------------------------------------------------

    \32\ See supra note 12. With the exception of the comments 
received on the gross open position exception, the $250,000 de 
minimis transfer amount, new Supplementary Material .05, and the 
clarification of which provisions of the proposed rule change become 
effective six months after Commission approval of the proposed rule 
change, FINRA's responses to comments received on the Amendment No. 
2 Notice are discussed in section III. below.
    \33\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

1. Gross Open Position Exception and the $250,000 De Minimis Transfer 
Amount
    As proposed in the Notice and modified by Amendment Nos. 1 and 2, 
the proposed rule would set forth an exception from the proposed margin 
requirements for counterparties whose gross open positions in Covered 
Agency Transactions with the FINRA member total $2.5 million or less in 
aggregate, subject to specified conditions.\34\ The proposed rule also 
sets forth, for a single counterparty, a $250,000 de minimis transfer 
amount up to which margin need not be collected or charged to net 
capital, subject to specified conditions.
---------------------------------------------------------------------------

    \34\ See supra notes 3, 8, and 12. See also description of 
proposed rule change in section II.A.-C. above.
---------------------------------------------------------------------------

    In response to the solicitation of comments on the Amendment No. 2 
Notice,\35\ and similar to comments received on the Notice and the 
Order Instituting Proceedings,\36\ commenters suggested increasing the 
$2.5 million gross open position amount and the $250,000 de minimis 
transfer amount.\37\ Two commenters recommended that the $2.5 million 
be increased to $10

[[Page 40369]]

million.\38\ One commenter suggested that increasing the gross open 
position amount to $10 million would have ``a material impact in 
reducing the level of automation and operations staff required to 
support TBA margining.'' \39\ Another commenter stated that the $2.5 
million threshold ``will likely serve as a barrier to entry for a large 
number of participants that might otherwise enter the market and add to 
the market's liquidity, system stability and competition,'' and 
suggested an increase to $10 million.\40\ With respect to the $250,000 
de minimis transfer amount, one commenter suggested increasing it to 
$500,000.\41\
---------------------------------------------------------------------------

    \35\ See Amendment No. 2 Notice, supra note 12.
    \36\ See discussion of comments received and FINRA's responses 
in the Order Instituting Proceedings and the Amendment No. 2 Notice, 
supra notes 8 and 12.
    \37\ See Brean Capital 4 Letter and Thomson Letter.
    \38\ Id.
    \39\ See Thomson Letter.
    \40\ See Brean Capital 4 Letter.
    \41\ See Thomson Letter.
---------------------------------------------------------------------------

    In response to these comments, with respect to the amount of the 
proposed gross open position exception, FINRA stated it has 
reconsidered and proposed to increase the specified amount from $2.5 
million or less to $10 million or less.\42\ FINRA stated that it has 
``taken note of the ongoing concerns expressed in comments and believes 
that increasing the amount to $10 million is consistent with the goal, 
as noted in the original filing, of ameliorating the rule's impact on 
business activity and addressing the concerns of smaller firms and 
customers.'' \43\
---------------------------------------------------------------------------

    \42\ See proposed paragraph (e)(2)(H)(ii)c.2. in Exhibit 4 in 
Amendment No. 3.
    \43\ See Amendment No. 3, supra note 14. See also Notice, supra 
note 3.
---------------------------------------------------------------------------

    To estimate the likely impact of the proposed increase for the 
gross open position amount to $10 million, FINRA staff analyzed the 
dataset that was provided to FINRA by a major clearing broker and 
contained 5,201 open positions as of May 30, 2014, in 375 customer 
accounts from ten introducing broker-dealers.\44\ FINRA stated that, in 
this dataset, only 66 accounts had gross open positions less than the 
originally proposed threshold of $2.5 million. FINRA stated, according 
to its analysis, increasing the gross open position exception to $10 
million would include within the proposed exception an additional 150 
accounts that had exposures greater than $2.5 million but less than or 
equal to $10 million. FINRA concluded that a greater number of smaller 
firms and customers would be subject to the gross open position 
exception for the proposed margin obligations, and, therefore, not 
subject to the margin requirements under the rule.\45\
---------------------------------------------------------------------------

    \44\ See Amendment No. 3, supra note 14. FINRA made use of this 
dataset in the original filing. See Notice, supra note 3. The 
dataset provides account-level information.
    \45\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

    Based on the sample of data available, FINRA stated that it 
estimated that neither the number of the accounts that would be 
required to post margin under the proposed rule, nor the estimated 
margin that would have to be posted for those accounts, would change 
due to the proposed increase in the gross open position amount.\46\ 
FINRA stated this result is mainly due to the proposed $250,000 de 
minimis transfer amount, which already provides significant relief to 
customers with smaller aggregate positions. Therefore, to the extent 
the sample examined is representative of the activity in Covered Agency 
Transactions more generally, FINRA stated that it believes that the 
proposed change is not likely to have significant impact on the 
expected margin obligations of firms and customers with large gross 
open positions.\47\ However, FINRA stated the proposed increase for the 
gross open position amount is expected to benefit smaller firms and 
customers, as the higher aggregate amount limits the costs to 
increasing business activity in Covered Agency Transactions without 
having to post margin under the proposed rule requirements for smaller 
firms.\48\
---------------------------------------------------------------------------

    \46\ Id.
    \47\ Id.
    \48\ See Amendment No. 3, supra note 14. In other words, the 
increase of the gross open position amount from $2.5 million to 
$10.0 million may reduce costs for smaller counterparties, as well 
as potentially reduce compliance costs for smaller firms, without 
significantly impacting the overall amount of margin expected to be 
posted under the proposed rule by counterparties with large gross 
open positions.
---------------------------------------------------------------------------

    With respect to the $250,000 de minimis transfer amount, as FINRA 
noted in Amendment Nos. 1 and 2, FINRA stated that it believes that the 
proposed threshold is appropriate for the rule's purposes and does not 
propose to amend the requirement at this time.\49\ However, FINRA 
stated that it will reconsider the requirement as appropriate when the 
Commission completes its rulemaking as to margin requirements for 
security-based swaps.\50\
---------------------------------------------------------------------------

    \49\ See supra notes 8 and 12. See also Notice, supra note 3.
    \50\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers; Proposed 
Rule, Exchange Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214 
(Nov. 23, 2012).
---------------------------------------------------------------------------

2. Risk Limit Determinations
    As proposed in the Notice, proposed Supplementary Material 
.05(a)(1) requires that, for purposes of any risk limit determination 
pursuant to paragraphs (e)(2)(F), (e)(2)(G), or (e)(2)(H) of Rule 4210, 
if a member engages in transactions with advisory clients of a 
registered investment adviser, the member may elect to make the risk 
limit determination at the investment adviser level, except with 
respect to any account or group of commonly controlled accounts whose 
assets managed by that investment adviser constitute more than 10 
percent of the investment adviser's regulatory assets under management 
as reported on the investment adviser's most recent Form ADV.\51\
---------------------------------------------------------------------------

    \51\ See Notice, supra note 3. See also description of proposed 
rule change in section II.A.-C. above.
---------------------------------------------------------------------------

    In response to the solicitation of comments on the Amendment No. 2 
Notice,\52\ and similar to comments received on the Order Instituting 
Proceedings,\53\ one commenter expressed concern that FINRA members may 
have difficulty determining which accounts constitute more than 10 
percent of an investment adviser's regulatory assets, because this 
``information is frequently maintained confidentially by an investment 
adviser due to privacy practices and regulations.'' \54\ This commenter 
proffered rule language to address this issue.\55\
---------------------------------------------------------------------------

    \52\ See Amendment No. 2 Notice, supra note 12.
    \53\ See Order Instituting Proceedings, supra note 8.
    \54\ See Brean Capital 4 Letter.
    \55\ Id.
---------------------------------------------------------------------------

    In response to comments received, FINRA stated that it has 
reconsidered the proposed requirements set forth in Supplementary 
Material .05(a)(1) and is revising the proposed language to delete the 
clause that reads ``except with respect to any account or group of 
commonly controlled accounts whose assets managed by that investment 
adviser constitute more than 10 percent of the investment adviser's 
regulatory assets under management as reported on the investment 
adviser's most recent Form ADV.'' \56\ As such, for purposes of any 
risk limit determination pursuant to paragraphs (e)(2)(F), (e)(2)(G) or 
(e)(2)(H) of Rule 4210, the proposed requirement under Supplementary 
Material .05(a)(1) as revised would read: ``If a member engages in 
transactions with advisory clients of a registered investment adviser, 
the member may elect to make the risk limit determination at the 
investment adviser level; . . .'' \57\ FINRA stated that it is mindful 
of the concerns its members have expressed as to potential burdens 
under the rule, and believes the revision is appropriate. However, 
FINRA noted that it expects

[[Page 40370]]

members to be mindful of their obligations as to making and enforcing 
risk limits under the rule. In making risk limit determinations as to 
advisory accounts, FINRA stated that it expects members to exercise 
appropriate diligence in understanding the extent of their risk and to 
craft their risk limit determinations accordingly.\58\
---------------------------------------------------------------------------

    \56\ See Amendment No. 3, supra note 14.
    \57\ See Exhibit 4 in Amendment No. 3.
    \58\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

    FINRA stated that it does not have data to assess the number of 
accounts, investment advisers or firms that might be impacted by this 
amendment. FINRA also stated that it anticipates that this change to 
the proposed rule will reduce the regulatory burden since it reduces 
the regulatory compliance costs associated with making the required 
risk limit determinations. FINRA further stated that the change does 
create the potential for firms to accept higher risk limits than they 
otherwise would, given that FINRA proposes to delete the 10 percent 
threshold. However, FINRA believes this additional risk is mitigated by 
the firms' obligations to make and enforce appropriate risk limits as 
described in section II.A.3. above.\59\
---------------------------------------------------------------------------

    \59\ Id.
---------------------------------------------------------------------------

3. Implementation Period
    In response to solicitation of comments on the Amendment No. 2 
Notice,\60\ and similar to comments received on the Notice and the 
Order Instituting Proceedings,\61\ one commenter stated that a 24-month 
implementation period for the proposed rule should be permitted so as 
to permit ``adequate interpretative guidance that is likely to impact 
system requirements.'' \62\ This commenter also believed a 24-month 
period would be needed to implement the rule because of other 
significant regulatory initiatives, such as the T+2 migration and the 
new conflict of interest rule promulgated by the Department of 
Labor.\63\
---------------------------------------------------------------------------

    \60\ See Amendment No. 2 Notice, supra note 12.
    \61\ See Notice, and Order Instituting Proceedings, supra notes 
3 and 8.
    \62\ See Thomson Letter.
    \63\ See Thomson Letter.
---------------------------------------------------------------------------

    In response to this comment, FINRA stated that it is mindful of the 
implementation challenges posed by various regulatory initiatives.\64\ 
However, FINRA stated that it continues to believe that the rule change 
should become effective 18 months from the date the proposed rule 
change is approved by the Commission, 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 proposed Supplementary 
Material .05 would become effective six months from the date the 
proposed rule change is approved by the Commission.\65\ FINRA also 
noted the rule change has been under consideration in the public domain 
for a period of more than two years. FINRA stated that it does not 
believe it would serve the public interest to extend the rule's 
implementation beyond 18 months once approved by the Commission.\66\
---------------------------------------------------------------------------

    \64\ See Amendment No. 3, supra note 14.
    \65\ In the interest of clarity, FINRA noted that the following 
provisions would become effective six months after the proposed rule 
change is approved by the Commission: (1) under paragraph (e)(2)(F) 
and paragraph (e)(2)(G), each as revised by the proposed rule 
change, the sentences that begin ``Members shall maintain a written 
risk analysis methodology . . .'' and ``The risk limit determination 
shall be made . . .''; (2) under proposed paragraph (e)(2)(H), as 
set forth in the proposed rule change, proposed paragraph 
(e)(2)(H)(ii)b.; and (3) proposed Supplementary Material .05, as 
revised by Amendment No. 3. To help effectuate the application of 
these provisions, the proposed definitions of ``counterparty,'' as 
set forth in proposed paragraph (e)(2)(H)(i)b., and ``Covered Agency 
Transactions,'' as set forth in proposed paragraph (e)(2)(H)(i)c., 
would also become effective six months after the proposed rule 
change is approved by the Commission. To ensure clarity of cross-
references within the rule, under paragraph (e)(2)(F) and paragraph 
(e)(2)(G), each as revised by the proposed rule change, the proposed 
phrase ``subject to the limits provided in paragraph (e)(2)(I) of 
this Rule'' in the final sentence of the first paragraph of 
paragraph (e)(2)(F) and paragraph (e)(2)(G) would become effective 
six months after the proposed rule change is approved by the 
Commission, as would: (1) The proposed header for new paragraph 
(e)(2)(H), which, as set forth in the rule change, would read 
``Covered Agency Transactions''; (2) under new paragraph (e)(2)(H), 
as set forth in the proposed rule change, the proposed designation 
``(i) Definitions'' and the proposed designation ``(ii) Margin 
Requirements for Covered Agency Transactions''; (3) the phrase ``For 
purposes of paragraph (e)(2)(H) of this Rule:'' Under proposed new 
paragraph (e)(2)(H)(i); and (4) the proposed redesignation of 
current paragraph (e)(2)(H) as new paragraph (e)(2)(I), except that 
the proposed revision to the header of paragraph (e)(2)(I) would 
become effective 18 months from the date the proposed rule change is 
approved by the Commission. See Exhibit 5 in Amendment No. 3.
    \66\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

III. Summary of Comments Received on the Amendment No. 2 Notice and 
FINRA's Responses

    As noted above, the Commission received 109 comment letters, 
including 50 Type A letters and four Type B letters, on the Notice; 23 
comment letters on the Order Instituting Proceedings; and an additional 
nine comment letters on the Amendment No. 2 Notice.\67\ The comments 
received on the Notice and FINRA's response to those comments are 
described in detail in the Order Instituting Proceedings.\68\ The 
comments received on the Order Instituting Proceedings and FINRA's 
response to those comments are described in detail in the Amendment No. 
2 Notice.\69\ The nine comment letters received in response to the 
Amendment No. 2 Notice and FINRA's response to comments are summarized 
below.\70\
---------------------------------------------------------------------------

    \67\ See discussion in section I. above. See also comment file, 
supra note 5.
    \68\ The topics covered by commenters in response to the Notice 
and in FINRA's response to those comments included: Multi-family and 
project loan securities; implementation time period; impact and 
scope of the proposal; maintenance margin; cash account exceptions; 
bilateral margining; $2.5 million gross open position amount and the 
$250,000 de minimis transfer amount; timing of margin collection and 
position liquidation; concentration limits; mortgage bankers; risk 
limit determinations; advisory clients of registered investment 
advisors; Federal Home Loan Banks and Farm Credit Banks and other 
comments. See Order Instituting Proceedings, supra note 8. See also 
Amendment No. 1, supra note 6.
    \69\ The topics covered by commenters in response to the Order 
Instituting Proceedings and in FINRA's response to those comments 
included: Multifamily and project loan securities; impact and costs 
of the proposal; scope of the proposal; creation of account types; 
maintenance margin; cash account exceptions; de minimis transfer 
amount; timing of margin collection and position liquidation; 
bilateral margining; third party custodians; exempt account 
treatment; third party providers; netting services; scope of FINRA's 
authority; and the implementation period. See Amendment No. 2 
Notice, supra note 12. See also Amendment No. 2, supra note 11.
    \70\ See Amendment No. 3, supra note 14. Comments related to the 
increase in the gross open position exception to $10 million; the 
clarification of the treatment of the risk limit determinations for 
investment advisers in new Supplementary Material .05; and the 
clarification of specific rule language that takes effect six months 
after the date of Commission approval with regard to the risk limit 
determinations are addressed in section II.D. above.
---------------------------------------------------------------------------

A. Scope of the Proposal

1. Multifamily and Project Loan Securities \71\
---------------------------------------------------------------------------

    \71\ See Order Instituting Proceedings, supra note 8 and 
Amendment No. 2 Notice, supra note 12 (for a full discussion of the 
comments related to the proposed inclusion of multifamily housing 
securities within the scope of the rule, FINRA's responses to these 
comments, and FINRA's analysis of the impact of excluding 
multifamily housing securities from the scope of the rule).
---------------------------------------------------------------------------

    In the Notice, FINRA included multifamily and project loan 
securities within the scope of Covered Agency Transactions noting it 
intended that the scope of products to be consistent with the scope of 
products addressed by the TMPG best practices.\72\ In response to the 
publication of the Notice, many commenters expressed concerns with 
FINRA including multifamily and project loan securities within the 
scope of the proposed margin requirements.\73\ These commenters 
generally stated that the proposed rule change would impose undue 
burdens on participants in the multifamily housing securities market, 
that the multifamily housing securities market is small relative to the 
overall

[[Page 40371]]

TBA market, and that the regulatory benefits gained from any reduction 
of systemic risk and counterparty exposure would be outweighed by the 
harms caused to the market.\74\ Commenters also stated that multifamily 
housing and project loan securities are not widely traded and often 
difficult to mark to the market.\75\ In response to comments on the 
Notice, FINRA amended the proposed rule, in Amendment No. 1, to provide 
that the margin requirements would not apply to multifamily family 
housing and project loan securities, subject to the conditions 
described above.\76\
---------------------------------------------------------------------------

    \72\ See Notice, supra note 3.
    \73\ See Order Instituting Proceedings, supra note 8.
    \74\ Id.
    \75\ See Order Instituting Proceedings, supra note 8.
    \76\ FINRA proposed in Amendment No. 1 to add to FINRA Rule 4210 
new paragraph (e)(2)(H)(ii)a.2. to provide that a member may elect 
not to apply the margin requirements of paragraph (e)(2)(H) of the 
rule with respect to Covered Agency Transactions with a counterparty 
in multifamily housing securities or project loan program 
securities; see Exhibit 4 and Exhibit 5 in Amendment No. 1. Proposed 
Rule 4210(e)(2)(H)(ii)b. sets forth the proposed rule's requirements 
as to written risk limits. See also Order Instituting Proceedings, 
supra note 8.
---------------------------------------------------------------------------

    In response to the Order Instituting Proceedings, commenters 
expressed support for the proposed exception for multifamily and 
project loan securities as set forth in proposed paragraph 
(e)(2)(H)(ii)a.2. in Amendment No. 1.\77\ Some commenters suggested 
FINRA clarify the intent of the proposed exception by changing ``a 
member may elect not to apply the margin requirements'' to ``a member 
is not required to apply the margin requirements.'' \78\ Other 
commenters expressed concern that, because of changes in nomenclature 
or other future action by the agencies or GSEs, some securities that 
have the characteristics of multifamily and project loan securities may 
not be documented as Freddie Mac K Certificates, Fannie Mae Delegated 
Underwriting and Servicing bonds, or Ginnie Mae Construction Loan or 
Project Loan Certificates, and may thereby inadvertently not be 
included within the proposed exception.\79\ In response to these 
comments, FINRA amended the proposed rule, as modified by Amendment No. 
1, in Amendment No. 2, to revise the phrase ``a member may elect not to 
apply the margin requirements . . .'' in paragraph (e)(2)(H)(ii)a.2. to 
read ``a member is not required to apply the margin requirements . . 
.'' \80\ In Amendment No. 2, FINRA also proposed to revise proposed 
paragraph (e)(2)(H)(ii)a.2.A. to add the phrase ``or are such other 
multifamily housing securities or project loan program securities with 
substantially similar characteristics, issued in conformity with a 
program of an Agency or a Government-Sponsored Enterprise, as FINRA may 
designate by Regulatory Notice or similar communication.'' \81\
---------------------------------------------------------------------------

    \77\ See Order Instituting Proceedings, and Amendment No. 2 
Notice, supra notes 8 and 12.
    \78\ Id. See also comment file, supra note 5.
    \79\ Id.
    \80\ See Amendment No. 2 Notice, supra note 12; see also, 
Exhibit 4 and Exhibit 5 in Amendment No. 2.
    \81\ Id.
---------------------------------------------------------------------------

    The Commission received one comment on this topic in response to 
the solicitation of comments on the Amendment No. 2 Notice.\82\ This 
commenter stated that it strongly supports the modifications in the 
Amendments as to multifamily housing securities and project loan 
program securities and that it appreciates FINRA's response to this 
issue.\83\
---------------------------------------------------------------------------

    \82\ See MBA 3 Letter.
    \83\ Id.
---------------------------------------------------------------------------

2. Covered Agency Transactions
    Similar to comments received on the Notice and the Order 
Instituting Proceedings,\84\ in response to the solicitation of 
comments on the Amendment No. 2 Notice, one commenter stated the 
proposal should not include Specified Pool Transactions because these 
products do not share the same risk as other Covered Agency 
Transactions.\85\ This commenter stated that ``FINRA has not provided 
any evidence that transactions in specified pools that do not settle in 
one business day represent the same class of risk as TBA 
transactions.'' \86\ Another commenter stated that the proposed 
definition of Covered Agency Transactions should be revised to focus on 
long-dated settlements and that Specified Pool Transactions should not 
be included within the rule's scope.\87\ This commenter proffered a 
definition of Covered Agency Transactions.\88\
---------------------------------------------------------------------------

    \84\ See supra notes 3, 8, and 12.
    \85\ See Coastal 3 Letter.
    \86\ Id.
    \87\ See BDA 3 Letter.
    \88\ Id.
---------------------------------------------------------------------------

    As discussed in more detail in Amendment Nos. 1 and 2, in response 
to these comments, FINRA stated it does not believe there is a 
compelling reason to revise the proposed definition and settlement 
scope of Covered Agency Transactions, nor except Specified Pool 
Transactions from the definition of Covered Agency Transactions.\89\ 
FINRA stated that it is mindful of the concerns of commenters, and is 
proposing in Amendment No. 3 to increase the $2.5 million gross open 
position exception to $10 million, which FINRA believes should benefit 
smaller firms and customers.\90\
---------------------------------------------------------------------------

    \89\ See Amendment No. 3, supra note 14. See also supra notes 8 
and 12.
    \90\ See Amendment No. 3, supra note 14. See also section II.D. 
above.
---------------------------------------------------------------------------

B. General Comments on the Proposal and Its Impact

    Similar to comments received on the Notice and the Order 
Instituting Proceedings,\91\ in response to the solicitation of 
comments on the Amendment No. 2 Notice, FINRA stated that commenters 
expressed continued opposition to the proposal on account of its 
potential impact.\92\ One commenter stated that it believes there is a 
basic disagreement between FINRA and the industry as the cost and 
difficulties of the proposal.\93\ Another commenter stated that FINRA 
``has failed to address recommendations to simplify the implementation 
of the TBA Margining proposal in a manner consistent with its intent to 
address systemic concerns in the TBA market.'' \94\ In a similar vein, 
one commenter stated that FINRA has not made any meaningful adjustments 
to the proposal and that it is not tailored to reduce counterparty risk 
without undue burdens on members and their clients.\95\ In addition, 
this commenter stated that the proposal fundamentally differs from the 
TMPG best practices, requirements that apply to other fixed income 
products under current Rule 4210, and requirements that apply to swaps 
under other regulatory regimes.\96\ This commenter also stated that the 
risk profile of Covered Agency Transactions is not greater than that of 
other fixed income transactions, but that Covered Agency Transactions 
are being treated under the proposal in a manner that is more 
burdensome than these other products.\97\ This commenter further stated 
that, based on conversations with its members, FINRA's estimates of the 
cost of implementing the proposal are at the low end and that smaller 
firms will need to decide whether they can remain in business involving 
Covered Agency Transactions.\98\ In a similar vein, another commenter 
stated that the proposal is anti-competitive and costly,\99\ and a 
different commenter said that the proposal would negatively

[[Page 40372]]

impact small-to medium-sized firms.\100\ This commenter stated that 
FINRA's estimates of the costs of implementing the rule are unfair and 
biased.\101\ One commenter stated the proposal would drive business 
away from introducing firms and toward larger firms.\102\ This 
commenter also stated that it has observed instances where larger firms 
are using margin to gain competitive advantage.\103\
---------------------------------------------------------------------------

    \91\ See supra notes 3, 8, and 12.
    \92\ See SIFMA 3 Letter, Thomson Letter, Coastal 3 Letter, BDA 3 
Letter, and Brean Capital 4 Letter.
    \93\ See SIFMA 3 Letter.
    \94\ See Thomson Letter.
    \95\ See SIFMA 3 Letter.
    \96\ Id.
    \97\ Id.
    \98\ Id.
    \99\ See Coastal 3 Letter.
    \100\ See BDA 3 Letter.
    \101\ See BDA 3 Letter.
    \102\ See Brean Capital 4 Letter.
    \103\ Id.
---------------------------------------------------------------------------

    In response to these comments, FINRA stated that it has actively 
sought input from the industry and other members of the public 
throughout the rulemaking process. In total, FINRA noted that there 
have been four opportunities to comment on the proposal, beginning with 
the comment on the proposal as originally published in Regulatory 
Notice 14-02.\104\ FINRA stated that it engaged in discussions with 
industry participants and analyzed the potential economic impact of the 
proposal, including the potential costs of implementation.\105\ In 
response to the input received from commenters, FINRA stated that it 
made several changes to the proposal, including the establishment of an 
exception for gross open positions for cash accounts, up to an 
aggregate specified amount, as specified by the rule,\106\ and an 
exception, again for cash accounts as specified by the rule, from the 
rule's maintenance margin requirements.\107\
---------------------------------------------------------------------------

    \104\ See Amendment No. 3, supra note 14. See also, Regulatory 
Notice 14-02 (FINRA Requests Comment on Proposed Amendments to FINRA 
Rule 4210 for Transactions in the TBA Market) (January 2014). In the 
Notice, FINRA discussed comments received in response to Regulatory 
Notice 14-02. See Notice, supra note 3.
    \105\ See Amendment No. 3, supra note 14. See also supra notes 
3, 8, and 12.
    \106\ See proposed paragraph (e)(2)(H)(ii)c.2. in Exhibit 4 and 
Exhibit 5 in Amendment No. 3. As discussed more fully in Amendment 
No. 3, in response to ongoing concerns expressed in comments about 
the rule's potential impact, FINRA is amending the exception from 
the proposed margin requirements for counterparties whose gross open 
positions in Covered Agency Transactions with the member amount to 
$2.5 million or less in aggregate, so as to increase the $2.5 
million amount to $10 million. See also section II.D. above 
discussing proposed changes in Amendment No. 3.
    \107\ See Amendment No. 3, supra note 14. See also proposed 
paragraph (e)(2)(H)(ii)e. in Exhibit 5 in Amendment No. 3.
---------------------------------------------------------------------------

    FINRA stated that these measures were expressly intended to address 
the concerns of smaller participants in the TBA market. FINRA stated 
that with such concerns in mind, it included the $250,000 de minimis 
transfer amount.\108\ In arriving at this amount, FINRA stated it gave 
careful consideration to the needs of small firms that could otherwise 
potentially be at a disadvantage, if the de minimis amount were higher, 
vis-[agrave]-vis larger, more highly capitalized firms, while at the 
same time taking into account the need to reduce the risk of material 
credit exposure. In addition, FINRA stated that to address the rule's 
potential impact on mortgage bankers, the rule permits members to treat 
such market participants as exempt accounts, subject to specified 
conditions, and thereby not subject to the maintenance margin 
requirement.\109\ FINRA further stated that to address concerns 
regarding the rule's potential impact on the market for multifamily 
housing securities and project loan program securities, FINRA revised 
the proposal to expressly provide that members are not required to 
apply the rule's margin requirements to such securities, subject to 
specified conditions.\110\ FINRA stated that it does not believe that 
the commenters, in the most recent round of comment on the proposal in 
response to the Amendment No. 2 Notice, have raised new issues as to 
the rule's impact that have not been previously addressed. However, 
FINRA stated it is mindful of the concerns of market participants that 
believe smaller firms may be adversely affected by the proposal. To 
that end, FINRA stated that in Amendment No. 3, it proposed to increase 
the threshold exception from the proposed margin requirements \111\ 
from $2.5 million to $10 million in gross open positions in Covered 
Agency Transactions with the member. Further, FINRA noted that, if 
approved by the Commission, it will monitor the proposal's impact when 
the new rule takes effect and, if the requirements prove overly onerous 
or otherwise are shown to negatively impact the market, will consider 
revisiting such requirements as may be necessary to mitigate the rule's 
impact.\112\
---------------------------------------------------------------------------

    \108\ See proposed paragraph (e)(2)(H)(ii)f. in Exhibit 5 in 
Amendment No. 3.
    \109\ See Amendment No. 3, supra note 14. See also proposed 
paragraph (e)(2)(H)(ii)d. and Supplementary Material .02 in Exhibit 
5 in Amendment No. 3.
    \110\ See proposed paragraph (e)(2)(H)(ii)a.2. in Exhibit 5 in 
Amendment No. 3.
    \111\ In the interest of clarity, FINRA noted that the 
``proposed margin requirements'' refers to the margin requirements 
as to Covered Agency Transactions as set forth in the original 
filing, as modified by Amendment Nos. 1, 2 and 3. Products or 
transactions that are outside the scope of Covered Agency 
Transactions are otherwise subject to the requirements of FINRA Rule 
4210, as applicable.
    \112\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

C. ``Cash Account'' Exceptions

    As set forth more fully in the Notice,\113\ and revised in this 
Amendment No. 3, the proposed margin requirements would not apply to 
any counterparty that has gross open positions \114\ in Covered Agency 
Transactions with the FINRA member amounting to $10 million or less in 
aggregate, if the original contractual settlement for all such 
transactions is in the month of the trade date for such transactions or 
in the month succeeding the trade date for such transactions and the 
counterparty regularly settles its Covered Agency Transactions on a DVP 
basis or for cash. Similarly, a non-exempt account would be excepted 
from the rule's proposed two percent maintenance margin requirement, 
for any size transaction, if the original contractual settlement for 
the Covered Agency Transaction is in the month of the trade date for 
such transaction or in the month succeeding the trade date for such 
transaction and the customer regularly settles its Covered Agency 
Transactions on a DVP basis or for cash. The proposed rule uses 
parallel language with respect to both of these exceptions to provide 
that they are not available to a counterparty that, in its transactions 
with the member, engages in dollar rolls, as defined in FINRA Rule 
6710(z),\115\ or ``round robin'' \116\ trades, or that uses other 
financing techniques for its Covered Agency Transactions. FINRA noted 
that these exceptions are intended to address the concerns relating to 
smaller customers engaging in a non-margined, cash account 
business.\117\
---------------------------------------------------------------------------

    \113\ See Notice, supra note 3.
    \114\ Paragraph (e)(2)(H)(i)e. of the proposed rule defines 
``gross open position'' to mean, with respect to Covered Agency 
Transactions, the amount of the absolute dollar value of all 
contracts entered into by a counterparty, in all CUSIPs; provided, 
however, that such amount shall be computed net of any settled 
position of the counterparty held at the member and deliverable 
under one or more of the counterparty's contracts with the member 
and which the counterparty intends to deliver. See Exhibit 5 in 
Amendment No. 3, supra note 14.
    \115\ FINRA Rule 6710(z) defines ``dollar roll'' to mean a 
simultaneous sale and purchase of an Agency Pass-Through MBS for 
different settlement dates, where the initial seller agrees to take 
delivery, upon settlement of the re-purchase transaction, of the 
same or substantially similar securities.
    \116\ Paragraph (e)(2)(H)(i)i. defines ``round robin'' trade to 
mean any transaction or transactions resulting in equal and 
offsetting positions by one customer with two separate dealers for 
the purpose of eliminating a turnaround delivery obligation by the 
customer. See Exhibit 5 in this Amendment No. 3.
    \117\ See Notice, supra note 3.
---------------------------------------------------------------------------

    Similar to comments received on the Notice and the Order 
Instituting Proceedings,\118\ in response to the Amendment No. 2 
Notice, one commenter stated that it is concerned about implementing 
the cash account exceptions and that the proposed rule's

[[Page 40373]]

provisions as to dollar rolls and round robin trades are not feasible 
to implement.\119\ In response to the comment, FINRA noted that it 
previously addressed this issue in Amendment Nos. 1 and 2.\120\ FINRA 
stated that it believes that dollar roll and round robin provisions are 
appropriate given that these are types of financing techniques.\121\ As 
such, FINRA stated that it does not propose to modify the proposed 
requirements, other than, to increase the amount for the gross open 
position exception from $2.5 million or less to $10 million or less, as 
described above.
---------------------------------------------------------------------------

    \118\ See supra notes 3, 8, and 12.
    \119\ See Thomson Letter.
    \120\ See supra notes 8 and 12.
    \121\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

D. Timing of Margin Collection and Position Liquidation

    As set forth more fully in the Notice, and reiterated in the Order 
Instituting Proceedings and the Amendment No. 2 Notice,\122\ FINRA 
noted that the proposed rule provides that, with respect to exempt 
accounts, if a mark to market loss, or, with respect to non-exempt 
accounts, a deficiency,\123\ is not satisfied by the close of business 
on the next business day after the business day on which the mark to 
market loss or deficiency arises, the member must deduct the amount of 
the mark to market loss or deficiency from net capital as provided in 
Exchange Act Rule 15c3-1.\124\ Further, FINRA stated that unless FINRA 
has granted a member additional time to collect the mark to market loss 
or deficiency, the member is required to liquidate positions if, with 
respect to exempt accounts, a mark to market loss is not satisfied 
within five business days, or, with respect to non-exempt accounts, a 
deficiency is not satisfied within such period.\125\
---------------------------------------------------------------------------

    \122\ See supra notes 3, 8, and 12.
    \123\ The term ``deficiency'' means the amount of any required 
but uncollected maintenance margin and any required but uncollected 
mark to market loss. See proposed FINRA Rule 4210(e)(2)(H)(i)d. in 
Exhibit 5 to Amendment No. 3.
    \124\ See Amendment No. 3, supra note 14.
    \125\ See Amendment No. 3, supra note 14. See also Notice, supra 
note 3.
---------------------------------------------------------------------------

    Similar to comments received on the Notice and the Order 
Instituting Proceedings,\126\ in response to the solicitation of 
comment on the Amendment No. 2 Notice, one commenter stated that the 
proposed requirements are difficult to implement and are not compatible 
with existing systems and procedures for other fixed income 
products.\127\ A different commenter stated that these differences 
reduce the ability to leverage the functionality of existing 
systems.\128\ In response to these comments, FINRA stated that it does 
not propose to modify the proposed requirements. FINRA reiterated that 
the proposed language as to timing of margin collection is consistent 
with existing language under Rule 4210.\129\ With respect to the 
liquidation requirement, FINRA stated that it believes that the five 
business day period, along with the opportunity to seek an extension of 
time when circumstances warrant, should provide sufficient time for 
members to resolve issues.\130\
---------------------------------------------------------------------------

    \126\ See supra notes 3, 8, and 12.
    \127\ See SIFMA 3 Letter.
    \128\ See Thomson Letter.
    \129\ See Amendment No. 3, supra note 14. See also FINRA Rule 
4210(g)(10)(B).
    \130\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

E. Two-Way (Bilateral) Margin and Third Party Custodians

    Similar to comments received on the Notice and the Order 
Instituting Proceedings, in the comments in response to the Amendment 
No. 2 Notice, some commenters stated that they oppose the proposed rule 
change because it does not require two-way margin.\131\ These 
commenters stated that the TMPG best practices expressly calls for two-
way margining to mitigate counterparty risk and requiring only one-way 
margin increases systemic risk.\132\ These commenters also stated that 
the proposal fails to recognize the counterparty credit risk to non- 
FINRA members, and that the prudential regulators have adopted two-way 
margining in the context of requirements for swaps.\133\ Finally, these 
commenters stated that providing for two- way margining and affording 
the counterparties the right to segregate, by means of third party 
custodian relationships, the margin they post to a FINRA member would 
provide heightened protection.\134\
---------------------------------------------------------------------------

    \131\ See Sutherland 3 Letter and Sutherland 4 Letter.
    \132\ Id.
    \133\ Id.
    \134\ Id.
---------------------------------------------------------------------------

    In response to these comments, FINRA noted in the original filing, 
and Amendment Nos. 1 and 2, that though FINRA supports the use of two-
way margining, FINRA does not propose to address such a requirement at 
this time as part of the proposed rule change.\135\ With respect to 
third party custodial arrangements, FINRA stated that these are best 
addressed in a separate rulemaking or guidance, as appropriate. FINRA 
reiterated that it is mindful of the concerns that commenters have 
expressed, and will revisit two-way margining and related issues when 
the Commission completes its rulemaking as to margin requirements for 
security-based swaps.\136\ FINRA noted that the proposed rule does not 
prevent parties from entering into agreements that provide for two-way 
margining should they wish to do so, provided those parties comply with 
all applicable requirements.
---------------------------------------------------------------------------

    \135\ See Amendment No. 3, supra note 14.
    \136\ See supra note 50.
---------------------------------------------------------------------------

F. Scope of FINRA's Authority

    Similar to comments received on the Notice and the Order 
Instituting Proceedings,\137\ some commenters stated FINRA does not 
have authority to impose the proposed margin requirements, as it is not 
consistent with the intent of section 7 of the Exchange Act.\138\ Some 
commenters cited the Senate Report in connection with the adoption of 
the Secondary Mortgage Market Enhancement Act of 1984 (``SMMEA'') in 
support of this view.\139\ As discussed in more detail in the Order 
Instituting Proceedings and Amendment No. 2 Notice, FINRA stated that 
it believes the proposed rule change is consistent with the provisions 
of section 15A(b)(6) of the Exchange Act.\140\ FINRA further stated 
that section 7 of the Exchange Act sets forth the parameters of the 
margin setting authority of the Federal Reserve Board and does not bar 
action by FINRA.\141\
---------------------------------------------------------------------------

    \137\ See supra notes 3, 8, and 12.
    \138\ See BDA 3 Letter and Coastal 3 Letter; see also supra note 
12.
    \139\ Pub. L. 98-440, 98 Stat. 1689 (1984).
    \140\ See Notice, supra note 3. Section 15A(b)(6) of the 
Exchange Act 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. See also supra notes 8 
and 12. See Amendment No. 3, supra note 14.
    \141\ See Order Instituting Proceedings, supra note 8.
---------------------------------------------------------------------------

G. Cleared Covered Agency Transactions

    In response to the Amendment No. 2 Notice, one commenter expressed 
concern that the proposed rule would impose a double margin requirement 
on introducing firms that are already required to post margin pursuant 
to agreements with clearing firms.\142\ This commenter proffered 
language to exempt such transactions from the rule's margin 
requirements.\143\ Another commenter said that FINRA should coordinate 
with the Mortgage-Backed Securities Division (``MBSD'') of Fixed

[[Page 40374]]

Income Clearing Corporation to leverage MBSD's infrastructure.\144\
---------------------------------------------------------------------------

    \142\ See Brean Capital 3 Letter.
    \143\ Id.
    \144\ See Thomson Letter.
---------------------------------------------------------------------------

    In response to these comments, FINRA stated that paragraph 
(e)(2)(H)(ii)c.1. of the proposed rule provides that the margin 
requirements of paragraph (e)(2)(H) do not apply to Covered Agency 
Transactions that are cleared through a registered clearing agency, as 
specified by the rule.\145\ Furthermore, FIRNA stated it is not the 
rule's intent to regulate the commercial agreements of members, 
provided the rule's requirements are met. As such, FINRA stated that it 
does not propose to adopt the proffered language. FINRA noted, that the 
MBSD infrastructure is outside the scope of the proposed rule change, 
which, is not intended to apply the proposed margin requirements to 
Covered Agency Transactions cleared through a registered clearing 
agency.\146\
---------------------------------------------------------------------------

    \145\ See Exhibit 5 in Amendment No. 3.
    \146\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

H. Trading Activity and Alternative Requirements

    One commenter expressed a number of concerns with respect to 
trading activity under the proposed rule.\147\ This commenter proffered 
language to exempt from the rule's margin requirements transactions 
that are offset by bilateral transactions with investment companies, to 
amend the position liquidation requirements to apply solely to TBA 
transactions (as opposed to the other types of Covered Agency 
Transactions), to exclude from the margin requirements any mark to 
market losses that are offset by gains on a cleared trade, and to 
prescribe required procedures as to position marking that would require 
reference to a ``generally recognized source'' and agreement of the 
parties.\148\ Another commenter suggested the rule should permit 
members to take a capital charge as an alternative to collecting 
maintenance margin.\149\
---------------------------------------------------------------------------

    \147\ See Brean Capital 3 Letter.
    \148\ Id.
    \149\ See Thomson Letter.
---------------------------------------------------------------------------

    In response to these comments, FINRA stated that it does not 
believe that the proffered language is consistent with the rule's 
purposes. FINRA also stated that it does not believe there is a public 
policy purpose in writing into the rule an exemption for offsets with 
investment companies or cleared trades, or to confine the liquidation 
requirements to TBA transactions only.\150\ FINRA stated that it does 
not propose to incorporate the proffered language as to position 
marking given that, for purposes of the rule, this is a matter to be 
addressed by the parties' commercial relations. Further, FINRA stated 
that it does not propose to revise the rule to permit members to take a 
capital charge as an alternative to the collection of maintenance 
margin from counterparties, as FINRA believes this would not protect 
members from the risk of counterparty default.\151\
---------------------------------------------------------------------------

    \150\ See Amendment No. 3, supra note 14.
    \151\ Id.
---------------------------------------------------------------------------

    Moreover, FINRA stated that a capital charge in lieu of collecting 
maintenance margin could have the effect of disadvantaging small firms 
that are not in a position to absorb capital charges to the same extent 
as larger, more highly capitalized firms. As such, FINRA stated that it 
believes the rule as proposed puts all firms on an equal footing, 
leveling the playing field between large and small firms, since all 
firms can collect maintenance margin, but not all firms can absorb the 
same amount of capital charges.\152\
---------------------------------------------------------------------------

    \152\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    The Commission has carefully considered the proposed rule change, 
as modified by Amendment Nos. 1, 2, and 3, the comments received, and 
FINRA's responses to the comments. Based on its review of the record, 
the Commission finds that the proposal is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to a national securities association.\153\ In 
particular, the Commission finds that the proposed rule change is 
consistent with section 15A(b)(6) of the Exchange Act, which requires, 
among other things, that FINRA rules 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.\154\
---------------------------------------------------------------------------

    \153\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \154\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    As discussed above, the proposed rule change would amend FINRA Rule 
4210 to establish margin requirements for the TBA market that are 
designed to ``to reduce firm exposure to counterparty credit risk 
stemming from unsecured credit exposure that exists in the [TBA] market 
today.'' \155\ The Commission agrees with FINRA that ``[p]ermitting 
counterparties to participate in the TBA market without posting margin 
could facilitate increased leverage by customers, thereby potentially 
posing a risk to the broker-dealer extending credit and to the 
marketplace as a whole.'' \156\ The proposed rule change also is 
expected to ``enhance sound risk management practices'' for FINRA 
members and their counterparties involved in the TBA market.\157\ The 
stated goals of the proposal are consistent with the purposes of the 
Exchange Act and with FINRA's authority to impose margin requirements 
on its members.\158\ The proposed rule change will serve to promote 
consistent and transparent margin requirements for the TBA market for 
FINRA members and their counterparties. Moreover, the proposed rule 
change will mitigate the risk that FINRA members will compete by 
implementing lower margin levels for Covered Agency Transactions and 
will help ensure that margin levels are set at sufficiently prudent 
levels across FINRA members.
---------------------------------------------------------------------------

    \155\ See Notice, supra note 3.
    \156\ Id.
    \157\ Id.
    \158\ See, e.g., 12 CFR 220.1(b)(2).
---------------------------------------------------------------------------

    As outlined above, the Commission received 141 comment letters on 
the proposed rule change, as well as FINRA responses to these 
comments.\159\ The Commission notes that while commenters generally 
supported the goals of the proposed rule change ``of addressing the 
counterparty credit risk and systemic risk posed to broker-dealers by 
TBA Transactions,'' \160\ various commenters disagreed with FINRA over 
the proposed approach to achieve this goal and recommended changes to 
it.\161\ Other commenters requested that the Commission disapprove the 
proposed rule change.\162\ Finally, numerous commenters were concerned 
about the potential cost burden and competitive impact of the proposed 
rule change on FINRA members and other market participants.\163\
---------------------------------------------------------------------------

    \159\ See comment file supra note 5. The 141 comment letters 
include the 54 Type A and B form letters that generally contain 
language opposing the inclusion of multifamily housing and project 
loan securities within the scope of the proposed rule change, as 
originally published in the Notice, and prior to the exclusion of 
these types of securities from the rule, as modified in Amendment 
Nos. 1 and 2.
    \160\ See, e.g., SIFMA 3 Letter.
    \161\ See comment file supra note 5.
    \162\ Id.
    \163\ See supra note 5. See also Notice, Order Instituting 
Proceedings, Amendment No. 2 Notice, and Amendment No. 3, supra 
notes 3, 8, 12, and 14.
---------------------------------------------------------------------------

    While the Commission appreciates the recommendations made by 
various commenters, and recognizes that new margin requirements for 
Covered Agency Transactions may result in increased costs for some 
FINRA

[[Page 40375]]

members and their counterparties, the Commission believes that FINRA 
responded appropriately to their concerns. Taking into consideration 
the comments and FINRA's responses, the Commission believes that the 
proposal is consistent with the Exchange Act. In structuring the 
proposed rule, FINRA has reasonably balanced the goal of reducing firm 
exposure to counterparty credit risk stemming from unsecured credit 
exposures in the TBA market, with the potential costs and competitive 
impacts that may result from the proposed rule change. Specifically, 
the Commission notes that FINRA has incorporated a number of exceptions 
into its proposal to mitigate the impact of the proposed rule change, 
particularly on smaller firms and counterparties. For example, in 
Amendment No. 3, FINRA proposed to increase the exception from the 
margin requirements for any counterparty with gross open positions of 
$2.5 million or less in aggregate to $10 million to ameliorate the 
proposed rule change's impact on the TBA market and to address the 
concerns of how the rule would impact small firms and customers that do 
not take large positions in Covered Agency Transactions.\164\
---------------------------------------------------------------------------

    \164\ See Amendment No. 3, supra note 14.
---------------------------------------------------------------------------

    In addition, FINRA has proposed an additional cash account 
exception available to FINRA members that would not require them to 
collect maintenance margin from counterparties that are non-exempt 
accounts, as well as a $250,000 de minimis transfer amount that would 
mitigate the need for counterparties to transfer small amounts of 
margin to a FINRA member. Moreover, under the proposed rule change, 
mortgage bankers may be treated as exempt accounts under specified 
conditions, resulting in these counterparties being subject only to the 
variation margin requirements under the proposal. In Amendment No. 3, 
FINRA also proposed to simplify new Supplementary Material .05 related 
to risk limit determinations at the investment adviser level to reduce 
regulatory burdens.\165\ These provisions, in totality, should lessen 
the competitive impact and compliance costs of the rule on FINRA 
members and their counterparties, while reducing the risk of 
uncollateralized credit exposures arising from Covered Agency 
Transactions given the size of the TBA market.\166\ Finally, the 
Commission notes that FINRA has stated that it will monitor the 
proposed rule's impact and, if the requirements prove overly onerous or 
otherwise are shown to negatively impact the TBA market, it will 
consider modifications to mitigate the rule's impact.\167\
---------------------------------------------------------------------------

    \165\ See Amendment No. 3, supra note 14, and discussion in 
Section II.D. above.
    \166\ See Notice, supra note 3.
    \167\ See Amendment No. 3, supra note 14, and discussion in 
Section II.D. above.
---------------------------------------------------------------------------

    The Commission acknowledges that the requirements of FINRA's 
proposed rule change are more prescriptive than the TMPG best 
practices, including, for example, the proposed maintenance margin 
requirement for non-exempt accounts, as well as the timing of margin 
collection and mandatory liquidation requirements.\168\ The Commission 
notes FINRA's approach is generally consistent with the margining of 
other securities transactions under Rule 4210.\169\ For example, 
securities transactions margined under FINRA Rule 4210 are generally 
subject to maintenance margin, which is a ``mainstay of regimes in the 
securities industry.'' \170\ With respect to the maintenance margin 
requirement, the Commission agrees with FINRA that most accounts at 
broker-dealers engaging in Covered Agency Transactions likely will be 
exempt accounts, and therefore, only subject to the variation margin 
requirements under the rule.\171\ In the alternative, where maintenance 
margin requirements apply, FINRA has proposed specific exceptions which 
should mitigate the impact on a counterparty, including the cash 
account exceptions and the $250,000 de minimis transfer amount. 
Finally, with respect to the proposed mandatory five-business day 
liquidation time period, FINRA members may request and receive 
extensions from FINRA under its Regulatory Extension System and FINRA 
has stated it ``will consider additional guidance as needed.'' \172\ 
The Commission believes these proposed requirements are consistent with 
the Exchange Act and are appropriate ``in view of the potential 
counterparty risk in the TBA market.'' \173\
---------------------------------------------------------------------------

    \168\ See TPMG best practices, supra note 21. The proposed rule 
provides for specific times by which margin must be collected, or an 
account liquidated unless FINRA specifically grants the member 
additional time (for the account liquidation purposes only).
    \169\ See FINRA Rule 4210.
    \170\ See FINRA Rule 4210. See also Amendment No. 2 Notice, 
supra note 12.
    \171\ See Notice, supra note 3.
    \172\ See Amendment No. 2 Notice, supra note 12.
    \173\ See Order Instituting Proceedings, supra note 8.
---------------------------------------------------------------------------

    FINRA's stated purposes for proposing margin requirements on 
Covered Agency Transactions is consistent with other regulatory efforts 
that have sought to address the risk of uncollateralized credit 
exposure arising in different types of bilateral credit transactions 
following the financial crisis, in particular, after the passage of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.\174\ 
The Commission agrees with FINRA that imposing mandatory margin 
requirements on FINRA members transacting business with counterparties 
in the TBA market addresses a gap between margining in the TBA market 
and margin practices and regulatory developments in other markets.\175\ 
Margin collateral collected by a FINRA member may mitigate a broker-
dealer's financial losses in the event of a counterparty default, and, 
in turn, serve to protect the broker-dealer's other customers. 
Consequently, the Commission believes that the proposed rule change 
would further the purposes of the Exchange Act as it is reasonably 
designed to protect investors and the public interest.\176\
---------------------------------------------------------------------------

    \174\ See Public Law 111-203, 124 Stat. 1376 (2010). See also 
TPMG best practices, supra note 21; see also Capital, Margin, and 
Segregation Requirements for Security- Based Swap Dealers and Major 
Security-Based Swap Participants and Capital Requirements for 
Broker-Dealers, Exchange Act Release No. 68071 (Oct. 18, 2012), 77 
FR 70213, 70258 (Nov. 23, 2012) (``The Dodd-Frank Act seeks to 
address the risk of uncollateralized credit exposure arising from 
OTC derivatives by, among other things, mandating margin 
requirements for non-cleared security-based swaps and swaps.'')
    \175\ See Notice, supra note 3.
    \176\ See 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The Commission further believes that excluding multifamily and 
project loan program securities from the scope of the rule, if a FINRA 
member makes a written risk limit determination for a counterparty 
trading in such securities, is appropriate. While included in the scope 
of the TPMG best practices, these types of securities only are a small 
part of the overall TBA market, and may be difficult to mark to market 
because they are often backed by a single project or loan.\177\ 
Further, existing safeguards in the multi-family housing market, 
including the provision of good faith deposits by the borrower, may 
serve to mitigate the counterparty credit risk to a FINRA member with 
respect to a counterparty engaging trading in multifamily and project 
loan securities.\178\
---------------------------------------------------------------------------

    \177\ See Order Instituting Proceedings, supra note 8. 
Commenters provided data with respect to the multifamily housing 
securities market in comparison to the overall TBA market, and FINRA 
conducted an analysis of transactional data. Id.
    \178\ Id.
---------------------------------------------------------------------------

    In addition to the exclusions for multifamily housing and project 
loan securities, the Commission notes that numerous commenters believed 
other product types should be excluded from

[[Page 40376]]

the scope of the rule, or that FINRA should revise the definition of 
Covered Agency Transaction to focus on long-dated settlements.\179\ The 
Commission agrees with FINRA that excluding additional products from 
the rule or modifying the settlement dates in the definition of Covered 
Agency Transactions potentially may ``undermine the effectiveness of 
the proposal'' if counterparties are permitted to maintain unsecured 
credit exposures on these positions.\180\ Furthermore, as described 
above, FINRA's rationale for excluding multifamily and project loan 
securities is distinct from the issues raised by commenters with 
respect to the other suggested modifications to the definition of 
Covered Agency Transaction under the rule, due, in part, to the unique 
characteristics of multi-family housing and project loan 
securities.\181\ The Commission believes that FINRA's proposed approach 
to establish a $10 million or less in aggregate per counterparty 
exception is appropriate in that it will continue to subject products 
with forward settlement dates to the rule's margin requirements, while 
reducing potential burdens on smaller FINRA member firms and 
counterparties that do not take on large positions in Covered Agency 
Transactions.
---------------------------------------------------------------------------

    \179\ See comment file supra note 5. See also Order Instituting 
Proceedings, supra note 8.
    \180\ See Notice, supra note 3.
    \181\ See Amendment No. 2 Notice, supra note 12.
---------------------------------------------------------------------------

    The Commission acknowledges the comments raised by market 
participants that the scope of the TPMG's best practices includes two-
way variation margin, in contrast to the proposed rule change which 
would require FINRA members to collect margin from their counterparties 
(without a corresponding posting requirement). Current FINRA Rule 4210 
is a collection rule and does not require broker-dealers to post margin 
to their customers for securities transactions margined under the 
rule.\182\ The Commission notes that the broker-dealer margin 
requirements have been in place for many years.\183\ In its response to 
comments, FINRA stated it supports two-way margining but does not 
propose to address two-way margining as part of the proposed rule 
change.\184\ However, FINRA indicated it would re-examine this issue 
``when the Commission completes its rulemaking as to margin 
requirements for security-based swaps.'' \185\ The Commission believes 
FINRA's approach is appropriate.\186\
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    \182\ See FINRA Rule 4210.
    \183\ See Capital, Margin, and Segregation Requirements for 
Security- Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213, 70259 (Nov. 23, 
2012) (``In the securities markets, margin rules have been set by 
relevant regulatory authorities (the Federal Reserve and the SROs) 
since the 1930s.'')
    \184\ See Amendment No. 3, supra note 14.
    \185\ See Amendment No. 3, supra note 14. See also Capital, 
Margin, and Segregation Requirements for Security- Based Swap 
Dealers and Major Security-Based Swap Participants and Capital 
Requirements for Broker-Dealers, Exchange Act Release No. 68071 
(Oct. 18, 2012), 77 FR 70213 (Nov. 23, 2012)
    \186\ FINRA also noted ``that the proposed rule does not prevent 
parties from entering into agreements that provide for two-way 
margining should they wish to do so, provided those parties comply 
with all applicable requirements.'' See Amendment No. 3, supra note 
14.
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    The Commission believes that FINRA's proposed implementation 
schedule is appropriate and consistent with the requirements of the 
Exchange Act. The Commission notes that FINRA proposed to extend the 
implementation timeframe in Amendment No. 1 in response to comments 
that considerable operational and systems work will be needed to comply 
with the proposed rule change.\187\ The Commission believes that the 
proposed six-month timeframe for the risk limit determination 
requirements \188\ and 18-month timeframe for implementation of the 
remainder of the rule should provide sufficient time for FINRA firms to 
comply with the rule's requirements.\189\
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    \187\ See Order Instituting Proceedings, supra note 8.
    \188\ See supra note 65 (clarifying the specific rule provisions 
related to the risk limit determinations that become effective six 
months after Commission approval of the proposed rule change).
    \189\ The Commission notes that this proposal has been noticed 
for comment three times. See Notice, Order Instituting Proceedings, 
and Amendment No. 2 Notice, supra notes 3, 8, and 12. In addition, 
FINRA originally sought comment on proposal prior to filing it with 
the Commission in in 2014 through publication of a Regulatory 
Notice. See Regulatory Notice 14-02 (FINRA Requests Comment on 
Proposed Amendments to FINRA Rule 4210 for Transactions in the TBA 
Market) (Jan. 2014).
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    In conclusion, the Commission believes that the proposal will help 
protect investors and the public interest by establishing margin 
requirements for the TBA market to reduce the risk that unsecured 
credit exposures could potentially lead to losses by FINRA members, and 
by enhancing risk management practices at FINRA members that 
participate in the TBA market. The Commission also believes that FINRA 
gave due consideration to the proposal and met the requirements of the 
Exchange Act. For these reasons, the Commission finds that the proposed 
rule change is consistent with the Exchange Act and the rules and 
regulations thereunder.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 3, 
is consistent with the Exchange Act. Comments may be submitted by any 
of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2015-036 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-2015-036. 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 Web site (https://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 Web site 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 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-FINRA-2015-036 and should be 
submitted on or before July 12, 2016.

[[Page 40377]]

VI. Accelerated Approval of Proposed Rule Change, as Modified by 
Amendment Nos. 1, 2, and 3

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Exchange Act, to approve the proposed rule change, as modified by 
Amendment Nos. 1, 2, and 3, prior to the 30th day after the date of 
publication of Amendment No. 3 in the Federal Register. FINRA proposed 
the changes in Amendment No. 3 in response to issues raised by 
commenters.\190\
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    \190\ See Amendment No. 3, supra note 14.
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    More specifically, Amendment No. 3 revised the proposal to increase 
the gross open position exception from $2.5 million or less to $10 
million or less. Second, FINRA revised the proposed language in new 
Supplementary Material .05(a)(1) to delete the clause ``except with 
respect to any account or group of commonly controlled accounts whose 
assets managed by that investment adviser constitute more than 10 
percent of the investment adviser's regulatory assets under management 
as reported on the investment adviser's most recent Form ADV.'' The 
Commission believes that the changes proposed in Amendment No. 3 do not 
raise any novel regulatory issues because they provide greater clarity 
with respect to the application of the proposed rule change and will 
reduce the regulatory burden on FINRA members, particularly smaller 
firms and counterparties. Therefore, the Commission finds that 
Amendment No. 3 is consistent with the protection of investors and the 
public interest.
    Amendment No. 3 also clarified which paragraphs related to the 
required written risk limit determinations become effective six months 
after Commission approval of the proposed rule change. The Commission 
believes that these are technical clarifications and do not change the 
substance of the proposed implementation timeframe as proposed in the 
Order Instituting Proceedings and the Amendment No. 2 Notice.
    Accordingly, the Commission finds good cause pursuant to Section 
19(b)(2) of the Exchange Act,\191\ for approving the proposed rule 
change, as modified by Amendment Nos. 1, 2, and 3, on an accelerated 
basis.
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    \191\ 15 U.S.C. 78s(b)(2).
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VII. Conclusion

    IT IS THEREFORE ORDERED, pursuant to section 19(b)(2) of the 
Exchange Act,\192\ that the proposed rule change, as modified by 
Amendment Nos. 1, 2, and 3 (SR-FINRA-2015-036) be, and hereby is 
approved on an accelerated basis.
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    \192\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\193\
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    \193\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-14561 Filed 6-20-16; 8:45 am]
 BILLING CODE 8011-01-P