Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to Security-Based Swaps, 1962-1989 [2022-00376]

Download as PDF 1962 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–93914; File No. SR–FINRA– 2021–008] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, Relating to Security-Based Swaps January 6, 2022. I. Introduction On April 26, 2021, the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘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 Rules 0180, 4120, 4210, 4220, 4240 and 9610 to clarify the application of its rules to security-based swaps (‘‘SBS’’) following the Commission’s completion of its rulemaking regarding SBS dealers (‘‘SBSDs’’) and major SBS participants (‘‘MSBSPs’’) (collectively, ‘‘SBS Entities’’). The proposed rule change was published for comment in the Federal Register on May 12, 2021.3 On June 14, 2021, FINRA consented to an extension of 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 August 10, 2021.4 The Commission received two comments on the proposed rule change during the initial comment period.5 On August 9, 2021, FINRA responded to the comment letters received in response to the Notice and filed an amendment to the proposed 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Exchange Act Release No. 91789 (May 12, 2021), 86 FR 26084 (May 12, 2021) (File No. SR– FINRA–2021–008) (‘‘Notice’’). 4 Letter from Robert McNamee, Assistant General Counsel, Office of General Counsel, FINRA to Daniel Fisher, Division of Trading and Markets, Commission dated June 14, 2021. 5 Letter from Kyle L. Brandon, Managing Director, Head of Derivatives Policy, Securities Industry and Financial Markets Association (‘‘SIFMA’’) to Vanessa A. Countryman, Secretary, Commission, dated June 2, 2021 (‘‘SIFMA Letter’’) and Matthew R. Cohen, Chief Executive Officer and Richard C. Chase, Chief Compliance Officer, Provable Markets LLC to Jill M. Peterson, Assistant Secretary, Commission, dated June 7, 2021 (‘‘PML Letter’’). Letters are available at the Commission’s website at https://www.sec.gov/comments/sr-finra-2021-008/ srfinra2021008.htm. lotter on DSK11XQN23PROD with NOTICES2 2 17 VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 rule change (‘‘Amendment No. 1’’).6 On August 9, 2021, the Commission issued an Order Instituting Proceedings (‘‘OIP’’) to determine whether to approve or disapprove the proposed rule change, as modified by Amendment No.1.7 The Commission received an additional four comments in response to the OIP.8 On September 30, 2021, the FINRA consented to an extension of the time period in which the Commission must approve or disapprove the proposed rule change to January 7, 2022.9 This order approves the proposed rule change, as modified by Amendment No. 1. II. Description of the Proposed Rule Change A. Background Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Title VII’’ or ‘‘Dodd-Frank Act’’) 10 established a comprehensive new regulatory framework for over-thecounter (‘‘OTC’’) derivatives, commonly known in the industry as ‘‘swaps.’’ It divided regulatory jurisdiction over swap products between the Commodity Futures Trading Commission (‘‘CFTC’’) and the Commission, with the CFTC regulating ‘‘swaps’’ and the SEC regulating SBS, and the SEC and the CFTC regulating mixed swaps.11 The Dodd-Frank Act directed the SEC to 6 See letter from Robert McNamee, Associate General Counsel, Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated Aug. 9, 2021 (‘‘FINRA Letter’’). The FINRA Letter is available at the Commission’s website at https://www.sec.gov/comments/sr-finra-2021-008/ srfinra2021008-9125111-247215.pdf. Amendment No. 1 is available at https://www.finra.org/sites/ default/files/2021-08/SR-FINRA-2021-008Amendment_1.pdf. 7 See Exchange Act Release No. 92617 (Aug. 9, 2021), 86 FR 44761 (Aug. 13, 2021) (File No. SR– FINRA–2020–008) (‘‘OIP’’). 8 See Letters from Anonymous dated Aug. 10, 2021; Blake Daniels dated Aug. 10, 2021, Tristan Kifer dated Aug. 10, 2021; and Eileen Loh dated Aug. 10, 2021 (‘‘Letters’’). Letters are available at the Commission’s website at https://www.sec.gov/ comments/sr-finra-2021-008/srfinra2021008.htm. 9 Letter from Robert McNamee, Assistant General Counsel, Office of General Counsel, FINRA to Daniel Fisher, Division of Trading and Markets, Commission dated September 30, 2021. 10 Public Law 111–203, 124 Stat. 1376 (2010). 11 The terms ‘‘swap’’ and ‘‘security-based swap’’ are defined in Sections 721 and 761 of the DoddFrank Act. The Commission and the CFTC have jointly promulgated rules further defining these terms. See Exchange Act Release No. 67453 (Jul. 18, 2012), 77 FR 48208 (Aug. 13, 2012) (Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping) (‘‘Product Definitions’’). Very generally, SBS are swaps referencing a single security or loan, or a narrow-based security index. Certain products sharing characteristics of both swaps and SBS are regulated as ‘‘mixed swaps’’ subject to both CFTC and SEC jurisdiction. PO 00000 Frm 00002 Fmt 4701 Sfmt 4703 promulgate rulemakings implementing the new regulatory framework for SBS, including rules requiring SBS Entities to register with the Commission and to be subject to requirements related to business conduct and supervision, documentation standards; recordkeeping and financial reporting; and capital, and margin and segregation. The Dodd-Frank Act also directed the Commission to promulgate rules applicable to all market participants including requiring regulatory reporting and public dissemination of SBS transaction information; and those creating processes to require SBS to become subject to mandatory clearing and execution on a registered or exempt execution facility or exchange.12 The Commission has now finalized a majority of these rulemakings.13 As of October 6, 2021, SBS Entities are permitted to register with the Commission and are required to comply with the Title VII rulemakings.14 The deadline for the initial wave of SBS Entity registrations was November 1, 2021. Title VII also amended the definition of ‘‘security’’ under the Exchange Act to expressly encompass SBS.15 Therefore, 12 See Dodd-Frank Act Section 763. Exchange Act Release No. 74244 (Feb. 11, 2015), 80 FR 14564 (Mar. 19, 2015) (Final Rule: Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information) (‘‘Regulation SBSR Release’’); Exchange Act Release No. 75611 (Aug. 5, 2015), 80 FR 48964 (Aug. 14, 2015) (Final Rule: Registration Process for Security-Based Swap Dealers and Major Security-Based Swap Participants) (‘‘Registration Process Release’’); Exchange Act Release No. 77617 (Apr. 14, 2016), 81 FR 29960 (May 13, 2016) (Final Rule: Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants) (‘‘Business Conduct Standards Release’’); Exchange Act Release No. 78011 (Jun. 8, 2016), 81 FR 39808 (Jun. 17, 2016) (Final Rule: Trade Acknowledgment and Verification of Security-Based Swap Transactions) (‘‘Trade Acknowledgment and Verification Release’’); Exchange Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) (Final Rule: Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers) (‘‘Capital, Margin, and Segregation Release’’); Exchange Act Release No. 87005 (Sep. 19, 2019), 84 FR 68550 (Dec. 16, 2019) (Final Rule: Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers) (‘‘Recordkeeping Release’’); Exchange Act Release No. 87780 (Dec. 18, 2019), 85 FR 6270 (Feb. 4, 2020) (Final Rules; Guidance: Rule Amendments and Guidance Addressing Cross-Border Application of Certain Security-Based Swap Requirements) (‘‘Cross-Border Release’’); Exchange Act Release No. 87782 (Dec.18, 2019), 85 FR 6359 (Feb. 4, 2020) (Final Rule: Risk Mitigation Techniques for Uncleared Security-Based Swaps) (‘‘Risk Mitigation Release’’). 14 See Notice at 26085. 15 See Dodd-Frank Act Section 761(a)(2) (inserting ‘‘security-based swap’’ in the definition of ‘‘security’’ in Section 3(a)(10) of the Exchange Act); see also 15 U.S.C. 78c(a)(10). 13 See E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices in addition to the comprehensive new SBS-specific regulatory framework discussed above, SBS are now also defined as securities under the Exchange Act and the rules thereunder. As a result, according to FINRA, any FINRA rule applicable to FINRA members’ activities involving a security, securities business, a transaction involving a security or a securities position would apply to those activities involving SBS.16 Consistent with the SEC’s actions in this area, on July 8, 2011, FINRA filed for immediate effectiveness FINRA Rule 0180, which, with certain exceptions noted below, temporarily limits the application of FINRA rules with respect to SBS.17 This rule is currently set to expire on February 6, 2022.18 Current FINRA Rule 0180 broadly excepts SBS activities from most FINRA rules. Specifically, FINRA Rule 0180(a) provides that FINRA rules shall not apply to members’ activities and positions with respect to SBS, except for: (i) FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade); (ii) FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices); (iii) FINRA Rule 3310 (Anti-Money Laundering Compliance Program); and (iv) FINRA Rule 4240 (Margin Requirements for Credit Default Swaps).19 In addition, FINRA Rule 0180(b) provides that the following rules apply to members’ activities and positions with respect to SBS only to the extent they would have applied as of July 15, 2011 (i.e., the day before the effective date of Title VII): (i) NASD Rule 3110 (Supervision) and all 16 See Notice at 26085. Exchange Act Release No. 64884 (Jul. 14, 2011), 76 FR 42755 (Jul. 19, 2011) (Notice of Filing and Immediate Effectiveness of File No. SR– FINRA–2011–033). To allow sufficient time to consider the complex interpretative issues resulting from defining SBS as securities, the Commission also issued a number of temporary exemptive orders relating to the regulation of SBS as securities, all of which have either expired or been made permanent now that the October 6, 2021, registration compliance date for the Commission’s SBS regulatory framework has passed. See Exchange Act Release No. 92837 (Sep. 1, 2021), 86 FR 50391 (Sep. 8, 2021) (Notice of Filing and Immediate Effectiveness of File No. SR–FINRA– 2021–021) (‘‘Extension Notice’’). 18 FINRA has extended the expiration date of FINRA Rule 0180 a number of times, most recently in September 2021. See, e.g., Extension Notice, supra note 17. 19 FINRA Rule 4240 establishes an interim pilot program with respect to margin requirements for any transactions in credit default swaps (‘‘CDS’’) held in an account at a FINRA member. The interim pilot program under FINRA Rule 4240 will expire on April 6, 2022. See id.; see also FINRA Rule 4240(a). FINRA Rule 4240 Supplementary Material .02 clarifies that the rule does not apply to a member that is registered with the Commission as an SBSD. See id. lotter on DSK11XQN23PROD with NOTICES2 17 See VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 successor FINRA Rules to such NASD Rule; (ii) the FINRA Rule 4500 Series (Books, Records, and Reports); and (iii) the FINRA Rule 4100 Series (Financial Condition). Finally, FINRA Rule 0180(c) provides that certain other rules apply as necessary to effectuate members’ compliance with paragraphs (a) and (c) of the rule. In light of the Commission’s October 6, 2021, registration compliance date, FINRA proposed in April 2021 to amend FINRA Rules 0180, 4120, 4210, 4220, 4240 and 9610 to clarify the application of FINRA rules to members’ SBS activities after the Commission’s registration compliance date. These proposed amendments would: (1) Adopt a permanent FINRA Rule 0180 to replace the temporary rule set to expire on February 6, 2022; (2) amend FINRA’s financial responsibility and operational rules to conform to the SEC’s amendments to its capital, margin and segregation requirements for SBSDs and broker-dealers, and to otherwise take into account members’ SBS activities; (3) adopt a new margin rule specifically applicable to SBS, replacing the expiring interim pilot program establishing margin requirements for CDS; and (4) amend Rule 9610 to permit FINRA to exempt members from Rule 0180 under the process set forth in FINRA’s Rule 9600 series (Procedures for Exemptions). B. Proposed Rule 0180 (Application of FINRA Rules to Security-Based Swaps) Proposed Rule 0180(a) would provide that FINRA rules generally apply to members’ SBS activities unless otherwise specifically excepted. This would reverse the presumption of the applicability of FINRA rules to members’ SBS activities in the current, expiring temporary Rule 0180, which generally does not apply FINRA rules unless otherwise specified. Proposed Rule 0180 paragraphs (b) through (g) would then specify the exceptions from the general presumption of applicability of FINRA rules in proposed Rule 0180(a). These proposed exceptions fall into three general categories: (1) General exceptions based on impracticability or operational burdens; (2) exceptions for SBS Entities already registered with the Commission and associated persons of SBS Entities; and (3) exceptions in connection with the conditions to the SEC’s cross-border SBS counting exception. Proposed FINRA Rule 0180(i) would further authorize FINRA to exempt a person from the application of specific FINRA rules to SBS on a caseby-case basis, pursuant to the existing procedural framework set forth in the PO 00000 Frm 00003 Fmt 4701 Sfmt 4703 1963 FINRA Rule 9600 series and as FINRA deems appropriate consistent with the protection of investors and the public interest. C. Proposed Rule 0180(b) (General Exceptions From Applicability of FINRA Rules) Proposed Rule 0180(b) would provide that the following FINRA rules shall not apply to members’ activities and positions with respect to SBS: (1) The Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities); (2) the Rule 7000 Series (Clearing, Transaction, and Order Data Requirements, and Facility Charges); and (3) the Rule 11000 Series (the Uniform Practice Code or ‘‘UPC’’). The Rule 6000 and 7000 Series include rules relating to trading, quoting, clearing, and reporting for securities other than SBS (e.g., NMS stocks and over-the-counter equity securities), and therefore are not applicable to members’ SBS activities. According to FINRA, the UPC, contained in the Rule 11000 Series, is a series of rules, interpretations and explanations designed to make uniform, where practicable, custom, practice, usage, and trading technique in the investment banking and securities business, particularly with regard to operational and settlement issues.20 The Rule 11000 Series contains, for example, rules addressing matters relating to the delivery of securities, certificated security matters, delivery of bonds, and close-out procedures.21 According to FINRA, the UPC was created to simplify and facilitate cash securities transactions.22 By its terms, the UPC applies to all OTC secondary market transactions in securities between members, with enumerated exceptions.23 FINRA believes that, as a result, the UPC could be interpreted as applying to SBS transactions in a limited set of circumstances—e.g., an SBS transaction between two FINRA members.24 FINRA further believes that because the UPC could only be invoked for a small portion of the SBS market—particularly 20 See Notice at 26088. 21 Id. 22 See id. FINRA Rule 11100(a). Under FINRA Rule 11100(a)(1), transactions in securities between members which are compared, cleared or settled through the facilities of a registered clearing agency are not subject to the UPC, except to the extent that the rules of the clearing agency provide that rules of other organizations shall apply. Paragraphs (a)(2) through (a)(5) of FINRA Rule 11100 also provide exceptions for specific types of securities, including exempted securities, municipal securities, redeemable securities issued by investment companies and Direct Participation Program Securities. 24 See Notice at 26088. 23 See E:\FR\FM\12JAN2.SGM 12JAN2 1964 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices given that FINRA expects only a small number of its members to register as SBSDs or otherwise engage in SBS activities—applying the UPC to members’ SBS activities has the potential to create confusion and uncertainty in the SBS market.25 Because SBS transactions involve bilateral contractual negotiations, often utilizing industry-standard SBS documentation, FINRA believes that the operational and settlement risks of SBS transactions are more appropriately addressed through other means, including standardized contractual provisions in that industry documentation, as well as, where applicable, the Commission’s risk mitigation requirements.26 D. Proposed Rule 0180(c) and (d) (Exceptions for Registered SBS Entities and Associated Persons) lotter on DSK11XQN23PROD with NOTICES2 As discussed above, the Title VII rulemakings completed by the Commission, including business conduct standards, trade acknowledgement and verification requirements, risk mitigation techniques for uncleared SBS, and recordkeeping rules for SBS Entities, are now in effect for SBS Entities, which are now required to be registered with the Commission unless their dealing activity is below the de minimis registration threshold.27 As described below, certain of these new SBS-specific Commission rules are analogous to existing, generally applicable FINRA rules. Where the Commission has promulgated analogous rules applicable to registered SBS Entities, FINRA has proposed to provide exceptions from its rules for SBS Entities registered with the Commission and, in certain circumstances, associated persons of those SBS Entities.28 Proposed Rules 0180(c) and (d) would provide exceptions to specified FINRA rules for FINRA members that are also registered as SBS Entities with the Commission or the associated person of the member, where two conditions are satisfied: (1) The SBS Entity or associated person is acting in the capacity of an SBS Entity or associated person of that SBS Entity; and (2) the activities or positions relate to the business of the SBS Entity within the meaning of Exchange Act Rule 15Fh– 3(h)(1) (addressing supervisory 25 Id. 26 Id. at 26089. Business Conduct Standards Release; Trade Acknowledgment and Verification Release; Risk Mitigation Release; Recordkeeping Release, supra note 13. 28 Id. at 26089. 27 See VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 obligations of SBS Entities).29 The proposed exceptions are for FINRA rules that FINRA believes are analogous to SEC business conduct requirements,30 and are limited to the members’ SBS business and conditioned upon the application of the SEC’s supervision rule for SBS Entities.31 Under proposed FINRA Rules 0180(c) and (d), these proposed exceptions would be available for eight FINRA rules that FINRA believes are analogous to SEC rules, subject to the conditions described above. Specifically, proposed FINRA Rule 0180(c) would provide exceptions for the following five FINRA rules, for registered SBS Entities and their associated persons: 32 • FINRA Rule 2210(d) (Communications with the Public— Content Standards). Among other things, FINRA Rule 2210(d) requires that member communications be based on principles of fair dealing and good faith, be fair and balanced, and not omit any material facts or make false or exaggerated claims. FINRA believes that this rule is analogous to Exchange Act Rule 15Fh–3(g), which requires SBS Entities to, among other things, communicate with counterparties in a fair and balanced manner.33 • FINRA Rule 2232 (Customer Confirmations) generally requires members to provide customers with written confirmations in conformity with Exchange Act Rule 10b–10,34 along with specified additional disclosures for certain types of securities. FINRA believes this is analogous to Exchange Act Rule 15Fi–2, which requires SBS Entities to provide trade acknowledgements and to establish, maintain and enforce written policies and procedures reasonably designed to obtain prompt verification of the terms of such trade acknowledgments.35 • FINRA Rules 3110 (Supervision), 3120 (Supervisory Control System) and 3130 (Annual Certification of Compliance and Supervisory Processes) require, among other things, each member to establish and maintain a 29 See 17 CFR 240.15Fh–3(h)(1). The exceptions in Rule 0180(c) would apply to both SBSDs and MSBSPs or their associated persons, while the exceptions in Rule 0180(d) would apply only to SBSDs or their associated persons (and not MSBSPs or their associated persons). 30 See Notice at 26089. 31 17 CFR 240.15Fh–3(h)(1). 32 See Notice at 26089. 33 See Notice at 26089–90; see also 17 CFR 240.15Fh–3(g); Business Conduct Standards Release at 30000–02. 34 See 17 CFR 240.10b–10; see also Notice at 26089–90. 35 See 17 CFR 240.15Fi–2; see generally Trade Acknowledgment and Verification Release, supra note 13. PO 00000 Frm 00004 Fmt 4701 Sfmt 4703 supervisory system; establish, maintain and enforce written supervisory procedures; designate principals to establish, maintain and enforce a system of supervisory control policies and procedures; designate a chief compliance officer; and submit annual certifications to FINRA related to the member’s compliance policies and written supervisory procedures. FINRA believes this is analogous to the supervision rule for SBS Entities in Exchange Act Rule 15h–3(h), which requires, among other things, an SBS Entity to establish and maintain a system to supervise, and to diligently supervise, its business and the activities of its associated persons; designation of at least one person with authority to carry out supervisory responsibilities; and establishment, maintenance and enforcement of written policies and procedures addressing supervision of the SBS Entity’s SBS business.36 Additionally, Exchange Act Rule 15Fk– 1 requires each SBS Entity to designate a chief compliance officer and submit annual compliance reports to the SEC.37 In addition, proposed FINRA Rule 0180(d) would provide exceptions for the following three FINRA Rules for registered SBSDs and their associated persons, but not MSBSPs: 38 • FINRA Rule 2030 (Engaging in Distribution and Solicitation Activities with Government Entities) is FINRA’s ‘‘pay-to-play’’ rule, which imposes restrictions on member firms engaging in distribution or solicitation activities with government entities. FINRA believes that Exchange Act Rule 15Fh– 6 imposes analogous restrictions.39 • FINRA Rule 2090 (Know Your Customer) generally requires that each member use reasonable diligence to know and retain essential facts concerning every customer and the authority of each person acting on behalf of such customer. FINRA believes this rule is analogous to: Exchange Act Rule 15Fh–3(a), which generally requires SBS Entities to verify the status of their SBS counterparties, including verification that the counterparty is an eligible contract participant and whether the counterparty is a ‘‘special entity;’’ 40 and to Exchange Act Rule 15Fh–3(e), which requires each SBSD to 36 See Notice at 26089–90. 17 CFR 240.15Fk–1. 38 See Notice at 26089. 39 See id. at 26089–90; see also 17 CFR 240.15Fh– 6; Business Conduct Standards Release at 30045– 50. 40 See Notice at 26089–90. ‘‘Special entity’’ is defined in Exchange Act Rule 15Fh–2(d) and includes certain government entities, employee benefit plans and endowments. See 17 CFR 240.15Fh–2(d). 37 See E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices establish, maintain and enforce written policies and procedures reasonably designed to obtain and retain a record of the essential facts concerning each counterparty whose identity is known to the SBSD that are necessary for conducting business with such counterparty.41 • FINRA Rule 2111 (Suitability) generally requires a member or associated person to have a reasonable basis that a recommended transaction or investment strategy is suitable for at least some investors as well as for the customer receiving the recommendation. FINRA believes it is analogous to Exchange Act Rule 15Fh– 3(f), which imposes suitability obligations on SBSDs with respect to recommendations of SBS or trading strategies involving SBS.42 In addition, Exchange Act Rule 15Fh–5 applies special, enhanced requirements when SBS Entities act as counterparties to special entities.43 E. Proposed Rule 0180(e) (Exceptions in Connection With Arranging, Negotiating, and Executing Activity) Proposed Rule 0180(e) would provide that the following FINRA rules shall not apply to members’ activities and positions with respect to SBS, to the extent that the member or the associated person of the member, as applicable, is arranging, negotiating or executing SBS on behalf of a non-U.S. affiliate pursuant to, and in compliance with, the conditions of, Exchange Act Rule 3a71–3(d)(1): 44 (1) FINRA Rule 2111 (Suitability); (2) FINRA Rule 2210(d) (Communications with the Public— Content Standards); and (3) FINRA Rule 2232 (Customer Confirmations).45 The availability of the exceptions under proposed FINRA Rule 0180(e) would require the member’s compliance with the conditions specified in Exchange Act Rule 3a71–3(d)(1)(ii)(B) as if the member were the counterparty to the SBS transactions (as opposed the nonU.S. affiliate).46 In connection with finalizing certain Title VII rulemakings, the SEC also 41 See Notice at 26089–90; see 17 CFR 240.15Fh– 3(e). 42 See Notice at 26090; see 17 CFR 240.15Fh–3(f). Notice at 26091; see 17 CFR 240.15Fh–5. 44 See 17 CFR 240.3a71–3(d)(1). Rule 3a71–3(d)(1) provides an exception from counting certain SBS transactions against the thresholds associated with the de minimis exception to the SBSD definition. See id. 45 FINRA believes these proposed exceptions are appropriate for similar reasons as the proposed exceptions for SBS Entities in proposed FINRA Rules 0180(c) and (d). See Notice at 26093, n.64. 46 A member acting as the U.S. Registered Affiliate under Exchange Act Rule 3a71–3(d) would remain subject to all other FINRA rules applicable to such SBS brokerage activity. See supra note 44. lotter on DSK11XQN23PROD with NOTICES2 43 See VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 adopted a number of rules and provided guidance to address the cross-border application of various SBS requirements. One of these rules, Exchange Act Rule 3a71–3(d), provides a conditional exception to the provisions of Exchange Act Rule 3a71– 3 that otherwise would require non-U.S. persons to count—against the thresholds associated with the de minimis exception to the SBSD definition—SBS dealing transactions between non-U.S. counterparties when U.S. personnel arrange, negotiate or execute those transactions.47 To qualify for this exception, all such arranging, negotiating or executing activity must, among other things, be conducted by U.S. personnel in their capacity as persons associated with a registered broker that meets certain capital requirements, or a registered SBSD, in each case so long as such entity is a majority-owned affiliate of the non-U.S. person relying on the exception (the ‘‘U.S. Registered Affiliate’’).48 The U.S. Registered Affiliate also must comply with certain rules applicable to SBSDs with respect to such SBS transactions as if the counterparties to the non-U.S. person relying on the exception also were counterparties to the U.S. Registered Affiliate and as if the U.S. Registered Affiliate were registered as an SBSD, if not so registered.49 Specifically, Exchange Act Rule 3a71– 3(d)(1)(ii)(B) requires the U.S. Registered Affiliate to comply with, as a condition of the exception: (1) Section 15F(h)(3)(B)(i) and (ii) of the Exchange Act and Rule 15Fh–3(b) thereunder (disclosures of material risks and characteristics and material incentives or conflicts of interest), (2) Exchange Act Rule 15Fh–3(f)(1) (recommendations and suitability),50 (3) Section 15F(h)(3)(C) of the Exchange Act and Rule 15Fh–3(g) thereunder (fair and balanced communications); and (4) Exchange Act Rule 15Fi–2 (acknowledgement and verification of SBS transactions) and the underlying definitions in Exchange Act Rule 15Fi– 47 See 17 CFR 240.3a71–3(d); Cross-Border Release at 6276–92. 48 See 17 CFR 240.3a71–3(d)(1)(i). 49 See 17 CFR 240.3a71–3(d)(1)(ii)(A). 50 Rule 3a71–3(d)(1)(ii)(B)(2) does contain a limited exception from the requirement to comply with Exchange Act Rule 15Fh–3(f)(1). Specifically, if the U.S. Registered Entity reasonably determines that the counterparty to whom it recommends an SBS or trading strategy involving an SBS is an ‘‘institutional counterparty’’ as defined in Exchange Act Rule 15Fh–3(f)(4), the registered entity instead may fulfill its obligations under Rule 15Fh– 3(f)(1)(ii) if it discloses to the counterparty that it is not undertaking to assess the suitability of the SBS or trading strategy involving an SBS for the counterparty. PO 00000 Frm 00005 Fmt 4701 Sfmt 4703 1965 1.51 FINRA believes it is appropriate to provide exceptions from the parallel FINRA rules to provide clarity and avoid unnecessary regulatory duplication, but only where the member is in fact complying with the rules specified in Exchange Act Rule 3a71– 3(d)(1)(ii)(B).52 F. Proposed Rule 0180(f) (Exceptions From Rules 2231, Customer Account Statements, and 4512, Customer Account Information) Proposed FINRA Rule 0180(f) would provide that FINRA Rules 2231 (Customer Account Statements) and 4512 (Customer Account Information) shall not apply to members’ activities and positions with respect to SBS, to the extent that the member is acting in its capacity as an SBS Entity and the customer’s account solely holds SBS and collateral posted as margin in connection with such SBS, provided that the member complies with the portfolio reconciliation requirements of Exchange Act Rule 15Fi–3 with respect to such account and that such portfolio reconciliations include collateral posted as margin in connection with SBS in the account. FINRA Rule 2231 generally requires each member to provide, on at least a quarterly basis, an account statement to each customer containing a description of any securities positions, money balances or account activity during the period since the last customer account statement. FINRA Rule 4512 generally requires each member to maintain specified information for each customer account, including specified identifying information about the customer. FINRA believes that the customer account statements required under FINRA Rule 2231 generally should reflect a holistic view of a member’s relationship with its customer, including SBS transactions, positions and related collateral, if applicable.53 Therefore, to the extent that a customer’s account includes SBS along with other securities positions or activity, or related money balances, then FINRA believes that the account statement under FINRA Rule 2231 should include SBS.54 However, FINRA understands that members that are also registered as SBS Entities may have customer accounts that hold solely SBS and related collateral, and do not hold any other securities positions or have 51 See 17 CFR 240.3a71–3(d)(1)(ii)(B). Notice at 26093. 53 Id. at 26091. 54 Id. 52 See E:\FR\FM\12JAN2.SGM 12JAN2 1966 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices any other securities activity.55 While SBS Entities are not subject to a customer account statement requirement with respect to SBS, Exchange Act Rule 15Fi–3 includes requirements applicable to SBS Entities with respect to engaging in portfolio reconciliation with applicable counterparties on a periodic basis, which the Commission adopted as part of a broader set of risk mitigation requirements for SBS Entities.56 Exchange Act Rule 15Fi–3(a) generally requires SBS Entities to engage in portfolio reconciliation for all SBS with their SBS Entity counterparties, with the frequency of such portfolio reconciliations based on the size of the SBS portfolio with the applicable counterparty, ranging from once each business day (for SBS portfolios that include 500 or more SBS), to once each week (for SBS portfolios that include more than 50 but fewer than 500 SBS on any business day during the week), to once each calendar quarter (for SBS portfolios that include no more than 50 SBS at any time during the calendar quarter).57 Exchange Act Rule 15Fi–3(b) requires each SBS Entity to establish, maintain, and follow written policies and procedures reasonably designed to ensure that it engages in portfolio reconciliation for all SBS with non-SBS Entity counterparties, with the frequency of such portfolio reconciliations ranging from once each calendar quarter (for SBS portfolios that include more than 100 SBS at any time during the calendar quarter) to once annually (for SBS portfolios that include no more than 100 SBS at any time during the calendar year).58 FINRA acknowledges that the portfolio reconciliation requirements in Exchange Act Rule 15Fi–3 differ in some respects from the customer account statement requirements under FINRA Rule 2231.59 For example, the frequency of portfolio reconciliations varies as described above, while customer account statements must be delivered at least quarterly. In addition, lotter on DSK11XQN23PROD with NOTICES2 55 Id. 56 See 17 CFR 240.15Fi–3; Risk Mitigation Release at 6362–70. For purposes of Exchange Act Rule 15Fi–3, ‘‘portfolio reconciliation’’ is defined as ‘‘any process by which counterparties to one or more SBS’’ (1) exchange the material terms of all SBS in the SBS portfolio between the counterparties, (2) exchange each counterparty’s valuation of each SBS in the SBS portfolio between the counterparties as of the close of business on the immediately preceding day and (3) resolve any discrepancy in valuations or material terms. See 17 CFR 240.15Fi–1(l). 57 See 17 CFR 240.15Fi–3(a). 58 See 17 CFR 240.15Fi–3(b). 59 See Notice at 26091. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 as described above, an SBS Entity must have policies and procedures in place to ensure that it engages in portfolio reconciliation with non-SBS Entity counterparties, while a member must provide a customer account statement to each customer unless a specific exception under FINRA Rule 2231(b) applies. However, FINRA believes that, while not identical, Exchange Act Rule 15Fi–3 serves analogous purposes to FINRA Rule 2231, such that requiring members that are SBS Entities to also provide customer account statements for accounts holding solely SBS and related collateral would be unnecessarily duplicative.60 Accordingly, FINRA believes to promote regulatory clarity and avoid unnecessary duplication, proposed FINRA Rule 0180(f) would provide an exception from FINRA Rule 2231 in the limited circumstances where the member is acting in its capacity as an SBS Entity and the account holds solely SBS and collateral posted as margin in connection with such SBS.61 FINRA states that collateral in a customer’s account would be included in account statements provided under FINRA Rule 2231.62 Therefore, in FINRA’s view, the proposed rule change includes as a condition to the proposed exception that the member comply with Exchange Act Rule 15Fi–3 with respect to an account qualifying for the exception and include collateral in the portfolio reconciliation and dispute resolutions requirements as applied to such an account.63 SBS Entities also are subject to Exchange Act Rule 15Fi–5, which requires them to establish, maintain, and follow written policies and procedures reasonably designed to ensure that it executes written SBS trading relationship documentation with each of its counterparties prior to, or contemporaneously with, executing an SBS with any counterparty.64 In addition, SBS Entities that are also registered broker-dealers are subject to the SEC’s recordkeeping requirements under Exchange Act Rule 17a–3, which require, among other things, certain records to be kept for each SBS 60 Id. 61 Id. 62 Id. 63 Id. 64 See 17 CFR 240.15Fi–5; Risk Mitigation Release at 6372–6377. Such documentation also must include all terms governing the trading relationship between the SBS Entity and its counterparty, including, without limitation, certain terms specified in the rule. SBS Entities are also required to maintain records of SBS trading relationship documentation. See 17 CFR 17a–4(e)(12)(ii). PO 00000 Frm 00006 Fmt 4701 Sfmt 4703 account.65 These SEC rules generally require SBS Entities to obtain and keep records of certain information in connection with their SBS accounts, including SBS-specific identifying information. FINRA believes that, while not identical to FINRA Rule 4512, these SEC rules serve analogous purposes, and that also applying FINRA Rule 4512 to SBS-only accounts would be duplicative.66 Accordingly, in order to promote regulatory clarity and avoid unnecessary duplication, FINRA believes it is appropriate to provide an exception from FINRA Rule 4512 in the limited circumstances where the member is acting in its capacity as an SBS Entity and the account solely holds SBS and collateral posted as margin in connection with such SBS.67 Both exceptions under proposed FINRA Rule 0180(f) would not apply to accounts holding SBS together with other securities or to members that are not also registered SBS Entities. G. Proposed Rule 0180(g) (Exception From FINRA Registration for Certain Associated Persons of Registered SBS Entities) Proposed FINRA Rule 0180(g) would provide that persons associated with a member whose functions are related solely and exclusively to SBS, and undertaken in such person’s capacity as an associated person of an SBS Entity, are not required to be registered with FINRA.68 Generally, FINRA Rule 1210 requires that each person engaged in the investment banking or securities business of a member must be registered with FINRA as a representative or principal in each category of registration appropriate to his or her functions and responsibilities as specified in FINRA Rule 1220. Individuals seeking to become registered with FINRA generally must pass an appropriate qualification examination, and registered individuals are subject to continuing education (‘‘CE’’) requirements under FINRA Rule 65 See 17 CFR 240.17a–3; see generally Recordkeeping Release, supra note 13. FINRA states in particular Exchange Act Rule 17a–3(a)(9)(iv), which requires an SBS Entity to keep a record, for each SBS account, of the unique identification code of the counterparty, the name and address of the counterparty, and a record of the authorization of each person the counterparty has granted authority to transact business in the SBS account. See 17 CFR 240.17a–3(a)(9)(iv). 66 See Notice at 26092. 67 Id. 68 This proposed exception is structured similarly to existing exceptions from registration for persons associated with a member whose functions are related solely and exclusively to certain other product types (such as municipal securities, commodities or security futures), as found in FINRA Rule 1230. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices 1240.69 The exception from registration would apply only to individuals engaged solely in SBS activities on behalf of the SBS Entity (and potentially non-securities activities, such as swaps).70 Under FINRA’s proposed exception, if an associated person of the SBS Entity engaged in any other securities activities in addition to SBS, that individual must register with FINRA in accordance with FINRA Rule 1210.71 Associated persons of members that are not registered SBS Entities would also still be required to register with FINRA, even if those individuals engage solely in SBS activities.72 Additionally, although individuals qualifying for the proposed exception would not be required to register with FINRA, they would remain associated persons of the member subject to all FINRA and SEC rules applicable to such associated persons, including fingerprinting requirements under Exchange Act Rule 17f–2.73 FINRA stated that it structured this exception similarly to existing exceptions from registration for persons associated with a member whose functions are related solely and exclusively to certain other product types (such as municipal securities, commodities or security futures).74 FINRA also stated that it based the proposed exception in Rule 0180(g) on its analysis of existing registration and related requirements, and its understanding that the number of associated persons that would qualify for the exception is limited.75 FINRA stated that it will monitor developments with respect to the SBS activities of its members and will continue to consider whether it would be appropriate to tailor the registration and related requirements to SBS, for example through targeted SBS-related registration categories or the addition of SBS-specific content to qualification 69 See Notice at 26092. 70 Id. lotter on DSK11XQN23PROD with NOTICES2 71 Id. 72 FINRA states that associated persons of SBS Entities are not independently subject to registration, licensing or CE requirements. See id. at 26109, n.58. However, an SBS Entity is prohibited from permitting an associated person that is subject to a statutory disqualification to effect or be involved in effecting SBS on behalf of the SBS Entity. See 15 U.S.C. 78o–10(b)(6). The SEC’s SBS Entity registration rules also require an SBS Entity to certify that it neither knows, nor in the exercise of reasonable care should have known, of any such statutory disqualification. Such certifications must be supported by questionnaires or employment applications serving as the basis for background checks. See 17 CFR 240.15Fb6–2; Registration Process Release at 48973–79. 73 See 17 CFR 240.17F–2. 74 See Notice at 26092, n.57; see also FINRA Rule 1230. 75 See Notice at 26092. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 1967 examinations or CE content.76 FINRA stated that it will consider whether it would be appropriate to rescind the exception under proposed FINRA Rule 0180(g) in such circumstances.77 publicly available.84 A member would have the ability to appeal such a decision pursuant to FINRA Rule 9630.85 FINRA stated that it expects to apply heightened scrutiny to applications for exemptive relief from H. Proposed Rule 0180(i) (Authority To members that are not also registered Grant Exemptions From the Application with the SEC as SBS Entities, and of Rule 0180 Upon Member Application) therefore not subject to the SEC’s and 9610 (Application for Exemptive regulatory framework for SBS.86 FINRA Relief) believes it is appropriate and in the Proposed FINRA Rule 0180(i) would public interest to provide this provide that, pursuant to the FINRA exemptive authority so that FINRA can Rule 9600 Series (Procedures for account for specific situations that may Exemptions), FINRA may, taking into arise with respect to SBS in the future consideration all relevant factors, on a case-by-case basis.87 exempt a person unconditionally or on Finally, FINRA proposed a specified terms from the application of conforming change to Rule 9610 to add FINRA rules (other than an exemption Rule 0180 to the list of over 30 rules from the general application of pursuant to which FINRA already has proposed FINRA Rule 0180(a)) to the exemptive authority.88 person’s SBS activities or positions, as I. Financial Responsibility and it deems appropriate, consistent with Operational Requirements the protection of investors and the In June 2019, the Commission public interest.78 FINRA believes it is appropriate and in the public interest to adopted final capital, margin and provide this exemptive authority so that segregation requirements for SBS FINRA can account for specific Entities, along with amendments to the situations that may arise with respect to existing capital and segregation SBS in the future on a case-by-case requirements for broker-dealers, in the basis.79 In formulating the proposed rule Capital, Margin, and Segregation change, FINRA stated that it consulted Release.89 As with other Title VII with its members and reviewed its rulemakings, the SEC aligned the rulebook to determine whether compliance date for the amendments continuing exceptions from any of its under the Capital, Margin, and rules are appropriate.80 FINRA stated Segregation Release with the SBS Entity that it is proposing FINRA Rule 0180(i) registration compliance date.90 Among in recognition that the SBS market other things, the Capital, Margin, and continues to evolve and that particular Segregation Release amended the circumstances may arise in which existing net capital rule for brokerapplying specific FINRA rules not dealers, Exchange Act Rule 15c3–1,91 in otherwise covered by the proposed two key respects relevant to FINRA’s exceptions to SBS activities may not be rules: appropriate or feasible.81 • First, the SEC adopted new As proposed, FINRA would consider minimum net capital requirements for written applications for exemptive broker-dealers that are also registered as relief, on a rule-by-rule and member-by- SBSDs, but that do not operate pursuant member basis, under the existing to the alternative net capital (‘‘ANC’’) process set forth in FINRA Rule 9610.82 requirements of Exchange Act Rule Rule 9610 requires a member seeking 15c3–1 (‘‘Non-ANC Firms’’).92 Nonexemptive relief to file a written 84 See Notice at 26093. FINRA would consider application with the appropriate any such application based on the specific department or staff of FINRA circumstances described in the application and containing, among other things, a whether the requested exemptive relief would be detailed statement of the grounds for consistent with the protection of investors and the granting an exemption from the public interest. Id. at 26093, n.66. 85 Id. at 26093. application of a specific FINRA rule.83 86 Id. Pursuant to FINRA Rule 9620, FINRA 87 Id. staff is then required to issue a written 88 See FINRA Rule 9610(a); see also Notice at decision setting forth its findings and 26093. conclusions, which may be made 89 See Capital, Margin, and Segregation Release, supra note 13. 90 See id. at 43954. 91 See 17 CFR 240.15c3–1. 92 Generally, a broker-dealer may apply to the SEC for authorization to use the alternative method for computing net capital contained in Appendix E to Exchange Act Rule 15c3–1. See 17 CFR 240.15c3–1(a)(7). Such broker-dealers are known as 76 Id. 77 Id. 78 See Notice at 26093. 79 Id. 80 Id. 81 Id. 82 Id. 83 See PO 00000 FINRA Rule 9610(a) and (b). Frm 00007 Fmt 4701 Sfmt 4703 Continued E:\FR\FM\12JAN2.SGM 12JAN2 1968 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 ANC Firms that are also registered as SBSDs must comply with a new minimum dollar net capital requirement and a new component for determining their minimum capital requirement that is based on a percentage of initial margin computed for SBS (in addition to other minimum requirements applicable to the broker-dealer).93 These changes do not apply to broker-dealers that operate pursuant to the ANC requirements of the rule (‘‘ANC Firms’’). These new minimum net capital requirements also do not impact NonANC Firms that are not also registered as SBSDs, regardless of whether such Non-ANC Firms engage in SBS activities.94 • Second, the SEC changed the minimum net capital requirements for ANC Firms, regardless of whether they transact in SBS. For ANC Firms, the SEC increased the minimum dollar net capital requirement, added a new component for determining the minimum capital requirement that is based on a percentage of initial margin computed for SBS (in addition to other minimum requirements applicable to the broker-dealer), increased the minimum tentative net capital requirement and amended the early warning notification requirement for tentative net capital.95 FINRA Rule 4120 (Regulatory Notification and Business Curtailment) sets forth certain early warning notification and business curtailment requirements if a member’s capital falls below certain thresholds. Specifically, FINRA Rule 4120(a) requires each carrying or clearing member to notify FINRA if its net capital falls below certain specified levels.96 FINRA Rule ‘‘ANC broker-dealers.’’ There are currently five approved ANC broker-dealers. See SEC, BrokerDealers Using the Alternative Net Capital Computation under Appendix E to Rule 15c3–1, available at https://www.sec.gov/tm/broker-dealersalternative-net-capital-computation. Other brokerdealers are known as non-ANC broker-dealers and must compute net capital pursuant to the provisions of Exchange Act Rule 15c3–1. See Notice at 26093. 93 See 17 CFR 240.15c3–1(a)(10). 94 For example, the new minimum net capital requirements do not apply to a Non-ANC Firm engaged in SBS dealing activity below the de minimis threshold for SBSD registration, or to a Non-ANC Firm engaged in SBS brokerage activity or entering into non-dealing SBS transactions (e.g., hedging). FINRA stated that the SEC also adopted new minimum capital requirements for MSBSPs, including that such entities must at all times have and maintain a tangible net worth. See Capital, Margin, and Segregation Release at 43906–07. FINRA does not believe any changes to FINRA rules are necessary with respect to the new MSBSP capital requirements. See Notice at 26094, n.71. 95 See 17 CFR 240.15c3–1(a)(7). 96 As discussed below, FINRA also proposed to apply all requirements in the FINRA Rule 4000 Series applicable to carrying or clearing firms to VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 4120(b) allows FINRA to restrict a member from expanding its business in certain circumstances and FINRA Rule 4120(c) allows FINRA to require a member to reduce its business if its net capital falls below certain specified levels (generally lower than those required for notification under FINRA Rule 4120(a)). According to FINRA, these requirements are based on the minimum capital requirements applicable to a member broker-dealer under Exchange Act Rule 15c3–1.97 FINRA believes it is necessary to amend FINRA Rule 4120 to conform the rule to the new and increased minimum capital requirements for Non-ANC Firms that are also registered as SBSDs and for ANC Firms, as described above.98 FINRA Rule 4120(a) requires each carrying or clearing firm to promptly, but in any event within 24 hours, notify FINRA in writing if its net capital falls below any of the percentages specified in subparagraphs (A) through (F) of FINRA Rule 4120(a)(1). The proposed rule change would modify subparagraph (D), which applies to ANC Firms, and also add new subparagraph (E), applicable to Non-ANC Firm members that are also registered as SBSDs.99 Prior to the amendments in the Capital, Margin and Segregation Release, Exchange Act Rule 15c3– 1(a)(7)(i) required an ANC Firm to maintain minimum tentative net capital of not less than $1 billion and minimum net capital of not less than $500 million. In addition, Exchange Act Rule 15c3– 1(a)(7)(ii) required an ANC Firm to provide an ‘‘early warning’’ notice to the Commission when its tentative net capital fell below $5 billion (or a lower threshold, if the Commission has granted an ANC Firm’s application to use such lower threshold). Subparagraph (D) of FINRA Rule members that act as principal counterparty to an SBS, clear or carry an SBS, guarantee an SBS or otherwise have financial exposure to an SBS. See Notice at 26094, n.73. 97 See Notice at 26094. 98 As noted above, the SEC did not amend Exchange Act Rule 15c3–1 to apply increased minimum capital requirements to Non-ANC Firms that engage in SBS activities but that are not registered SBSDs. FINRA is therefore not proposing to amend FINRA Rule 4120 to impose any additional minimum thresholds on such members. However, FINRA states that, as a general matter, FINRA Rule 4120 would apply to all members that engage in SBS transactions (and any related transactions) because net capital is a holistic calculation based on a firm’s liquid net worth, which includes all of a firm’s activities. See Notice at 26094, n.74. 99 The proposed rule change would also make non-substantive and conforming changes to other subparagraphs of FINRA Rule 4120(a) to reflect the insertion of new subparagraph (E), update crossreferences to SEC rules that have been amended and reflect FINRA rulebook format conventions. PO 00000 Frm 00008 Fmt 4701 Sfmt 4703 4120(a) is based on these net capital requirements, requiring notification to FINRA if the member is an ANC Firm and (i) its tentative net capital under Exchange Act Rule 15c3–1(c)(15) is less than 50 percent of the early warning notification amount required by Exchange Act Rule 15c3–1(a)(7)(ii) or (ii) its net capital is less than $1.25 billion. In other words, notification to FINRA is required if an ANC Firm’s tentative net capital falls below $2.5 billion (or a lower amount, if the ANC Firm has been permitted to use a lower early warning notice threshold), which is half of the SEC’s early warning notification amount, or its net capital falls below $1.25 billion, which is 2.5 times the SEC’s net capital requirement for ANC Firms.100 In the Capital, Margin, and Segregation Release, the Commission amended the net capital requirements for ANC Firms in three ways. First, the Commission raised the tentative net capital requirement for ANC Firms from $1 billion to $5 billion. Second, the Commission raised the minimum net capital requirement for ANC Firms from $500 million to the greater of $1 billion or the sum of the applicable ratio requirement under Exchange Act Rule 15c3–1(a)(1) 101 and two percent of the risk margin amount.102 Third, the Commission raised the tentative net capital early warning notification threshold from $5 billion to $6 billion. In light of these increased capital requirements under the Commission’s net capital rule, FINRA believes it is appropriate to also modify the thresholds for required notification to FINRA for ANC Firms under FINRA Rule 4120(a)(1)(D).103 Specifically, under the proposed rule change, an ANC Firm would be required to notify FINRA if, in addition to the conditions currently prescribed under FINRA Rule 4120(a)(1)(A), (E) and (F): 104 100 See Notice at 26094. 17 CFR 240.15c3–1(a)(7)(i)(A). Under Exchange Act Rule 15c3–1(a)(1)(i), a broker-dealer generally may not permit its aggregate indebtedness to exceed 1500 percent of its net capital. A brokerdealer may elect not to be subject to the aggregate indebtedness standard if it complies with an alternative method of computing net capital. See 17 CFR 240.15c3–1(a)(1)(ii). 102 The ‘‘risk margin amount’’ means the total initial margin for SBS. See 17 CFR 15c3–1(c)(17). Exchange Act Rule 15c3–1(a)(7)(i)(A) provides that initially the requirement will be two percent of the risk margin amount. However, the SEC may issue an order raising the requirement to four percent on or after the third anniversary of the amended rule’s compliance date and to eight percent on or after the fifth anniversary of the amended rule’s compliance date. See 17 CFR 15c3–1(a)(7)(i)(A)(2) and (3) and 15c3–1(a)(7)(i)(B). 103 See Notice at 26094. 104 Id. 101 See E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 • Its tentative net capital is less than 150 percent of the minimum tentative net capital amount required by Exchange Act Rule 15c3–1(a)(7)(i)(A) (i.e., $5 billion, such that the notification amount would be $7.5 billion), • the member is subject to the aggregate indebtedness requirement of Exchange Act Rule 15c3–1(a)(1)(i), and its net capital is less than the sum of 1/ 10th of its aggregate indebtedness and 150 percent of the required percentage of the risk margin amount, or • the member elects to use the alternative method of computing net capital pursuant to Exchange Act Rule 15c3–1(a)(1)(ii), and its net capital is less than the sum of the level specified in Exchange Act Rule 17a–11(b)(2) 105 and 150 percent of the required percentage of the risk margin amount. FINRA believes these modified thresholds are appropriately calibrated to provide FINRA with sufficient early warning that an ANC Firm’s capital levels may be deteriorating.106 By revising the early warning levels as proposed, FINRA believes the proposed rule change aligns the historical thresholds in FINRA Rule 4120(a) for early warning notification for ANC Firms with the revised capital requirements applicable to such firms under the Commission’s amended rules.107 Additionally, according to FINRA, ANC Firms historically maintain capital far in excess of the proposed amounts, so FINRA does not expect these levels to be problematic for firms to maintain.108 In the Capital, Margin, and Segregation Release, the Commission also adopted a new minimum net capital requirement for Non-ANC Firms that are also registered as SBSDs.109 Specifically, a Non-ANC Firm that is registered as an SBSD must maintain minimum net capital of not less than the greater of $20 million or the sum of the ratio requirements under Exchange Act Rule 15c3–1(a)(1) and two percent of the risk margin amount.110 Accordingly, FINRA believes it is necessary to add corresponding new thresholds for 105 See 17 CFR 240.17a–11(b)(2). Exchange Act Rule 17a–11 requires broker-dealers to promptly notify the SEC after the occurrence of certain events. Exchange Act Rule 17a–11(b)(2) requires such notification for broker-dealers using the alternative method of computing net capital pursuant to Exchange Act Rule 15c3–1(a)(1)(ii) when net capital is less than five percent of aggregate debit items under the Exchange Act Rule 15c3–3 reserve formula. 106 See Notice at 26094. 107 See Notice at 26094–95. 108 Id. at 26095. 109 See 17 CFR 15c3–1(a)(10). 110 See Notice at 26095. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 required notification to FINRA for NonANC Firms that are also registered as SBSDs under new FINRA Rule 4120(a)(1)(E).111 Specifically, under the proposed rule change, a Non-ANC Firm that is also a registered SBSD would be required to notify FINRA if, in addition to the conditions currently prescribed under FINRA Rule 4120(a)(1)(A), (E) and (F): • The member is subject to the aggregate indebtedness requirement of Exchange Act Rule 15c3–1(a)(1)(i), and its net capital is less than the sum of 1/ 10th of its aggregate indebtedness and 150 percent of the required percentage of the risk margin amount, or • the member elects to use the alternative method of computing net capital pursuant to Exchange Act Rule 15c3–1(a)(1)(ii), and its net capital is less than the sum of the level specified in Exchange Act Rule 17a–11(b)(2) and 150 percent of the required percentage of the risk margin amount.112 FINRA believes it is appropriate to include specific thresholds for early notification to FINRA based on the new minimum net capital requirements for Non-ANC Firms that are registered SBSDs.113 FINRA also believes that the thresholds described above are appropriately calibrated to provide FINRA with sufficient early warning that such a firm’s capital levels may be deteriorating.114 By defining the early warning levels as proposed, the proposed rule change, in FINRA’s view, aligns the historical thresholds in FINRA Rule 4120(a) for early warning notification with the new capital requirements applicable to Non-ANC Firms that are registered SBSDs under the SEC’s amended rules.115 FINRA Rule 4120(b) allows FINRA to require a member that carries customer accounts or clears transactions to not expand its business during any period in which any of the conditions described in paragraph (a)(1) of FINRA Rule 4120 continue to exist for more than 15 consecutive business days, provided that such condition(s) has been known to FINRA or the member for at least five consecutive business days. Since the proposed rule change would modify the conditions specified in FINRA Rule 4120(a)(1) as described above, the triggers for the application of restrictions under FINRA Rule 4120(b) would be similarly affected. However, FINRA does not believe that any conforming changes are needed at this 111 Id. 112 Id. 113 Id. 114 Id. 115 Id. PO 00000 Frm 00009 Fmt 4701 Sfmt 4703 1969 time to the restrictions on business expansion requirements under FINRA Rule 4120(b).116 FINRA states that FINRA Rule 4120(b)(3)(A)–(G) includes a non-exclusive list of activities that may constitute an ‘‘expansion of business’’ for these purposes, and FINRA Rule 4120(b)(3)(H) provides that the term ‘‘expansion of business’’ may include such other activities as FINRA deems appropriate under the circumstances, in the public interest or for the protection of investors. FINRA believes that a member firm’s SBS activities would be within the scope of ‘‘other activities’’ contemplated by FINRA Rule 4120(b)(3)(H).117 FINRA Rule 4120(c) allows FINRA to require a member to reduce its business if its net capital falls below any of the percentages specified in subparagraphs (A) through (F) of FINRA Rule 4120(c)(1). Similar to the proposed modifications to FINRA Rule 4120(a) described above, the proposed rule change would modify subparagraph (D) of FINRA Rule 4120(c)(1), which applies to ANC Firms, and also add new subparagraph (E), applicable to NonANC Firm members that are also registered as SBSDs.118 Current subparagraph (D) of FINRA Rule 4120(c)(1) permits business curtailment if the member is an ANC Firm and (i) its tentative net capital under Exchange Act Rule 15c3–1(c)(15) is less than 40 percent of the early warning notification amount required by Exchange Act Rule 15c3–1(a)(7)(ii) or (ii) its net capital is less than $1 billion. These thresholds are based on the broker-dealer net capital rule prior to the amendments in the Capital, Margin, and Segregation Release. As described above, the Commission amended the net capital requirements for broker-dealers in the Capital, Margin, and Segregation Release.119 Accordingly, under the proposed rule change, a member that is an ANC Firm would be subject to the business curtailment provisions of FINRA Rule 4120(c)(1) if, in addition to the conditions currently prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F): 116 Id. 117 Id. 118 The proposed rule change would also make non-substantive and conforming changes to other subparagraphs of FINRA Rule 4120(c)(1) to reflect the insertion of new subparagraph (E), update crossreferences to SEC rules that have been amended and reflect FINRA rulebook format conventions. Similar non-substantive changes would be made to paragraph (b)(1) and Supplementary Material .01 to FINRA Rule 4120 to reflect FINRA rulebook format conventions. See id., n.87. 119 See Capital, Margin, and Segregation Release, supra note 13. E:\FR\FM\12JAN2.SGM 12JAN2 lotter on DSK11XQN23PROD with NOTICES2 1970 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices • Its tentative net capital is less than the amount specified under Exchange Act Rule 15c3–1(a)(7)(ii) (i.e., the early warning amount, $6 billion), • The member is subject to the aggregate indebtedness requirement of Exchange Act Rule 15c3–1(a)(1)(i), and its net capital is less than the sum of 1/ 12th of its aggregate indebtedness and 125 percent of the required percentage of the risk margin amount, or • the member elects to use the alternative method of computing net capital pursuant to Exchange Act Rule 15c3–1(a)(1)(ii), and its net capital is less than the sum of one percentage point below the level specified in Exchange Act Rule 17a–11(b)(2) and 125 percent of the required percentage of the risk margin amount.120 FINRA believes these modified thresholds are appropriately calibrated to provide FINRA with the ability to require ANC Firms to reduce their business when their capital levels have deteriorated to a level that may jeopardize their ability to continue to comply with their capital requirements.121 As described above, in the Capital, Margin, and Segregation Release, the Commission also added a new minimum net capital requirement for Non-ANC Firms that are also registered as SBSDs. Accordingly, the proposed rule change would add corresponding new thresholds for business curtailment for Non-ANC Firms that are also registered as SBSDs under new FINRA Rule 4120(c)(1)(E). Specifically, under the proposed rule change, a Non-ANC Firm that is also a registered SBSD would be subject to the business curtailment provisions of FINRA Rule 4120(c)(1) if, in addition to the conditions currently prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F): • The member is subject to the aggregate indebtedness requirement of Exchange Act Rule 15c3–1(a)(1)(i), and its net capital is less than the sum of 1/ 12th of its aggregate indebtedness and 125 percent of the required percentage of the risk margin amount,122 or • the member elects to use the alternative method of computing net capital pursuant to Exchange Act Rule 15c3–1(a)(1)(ii), and its net capital is less than the sum of one percentage point below the level specified in Exchange Act Rule 17a–11(b)(2) 123 and 125 percent of the required percentage of the risk margin amount.124 120 See FINRA believes it is appropriate to include specific thresholds for business curtailment based on the new minimum net capital requirements for Non-ANC Firms that are registered as SBSDs.125 FINRA also believes that the thresholds described above are appropriately calibrated to provide FINRA with the ability to require such firms to reduce their business when their capital levels have deteriorated to a level that may jeopardize their ability to continue to comply with their capital requirements.126 Lastly, FINRA states that FINRA Rule 4120(c)(3)(A)–(J) includes a nonexclusive list of activities that may constitute a ‘‘business reduction’’ for these purposes, and FINRA Rule 4120(c)(3)(K) provides that the term ‘‘business reduction’’ may include such other activities as FINRA deems appropriate under the circumstances, in the public interest or for the protection of investors.127 FINRA believes that a member firm’s SBS activities would be within the scope of ‘‘other activities’’ contemplated by FINRA Rule 4120(c)(3)(K).128 In addition to these conforming changes to FINRA Rule 4120, the proposed rule change would apply FINRA’s financial and operational rules more broadly to firms that enter into, or otherwise have exposure to, SBS. Specifically, certain rules in the FINRA Rule 4000 Series (Financial and Operational Rules) include provisions that impose higher standards, or provide FINRA the authority to impose additional requirements, on firms that carry or clear transactions or accounts (generally referred to as ‘‘carrying or clearing firms’’). This ‘‘tiering’’ structure was built into certain rules so that firms that only introduce their customer accounts and do not have exposure to the settlement system are provided relief from the higher standards required of firms that carry or clear transactions and accounts. Below is a list of rules in the FINRA Rule 4000 Series where tiering has been employed for carrying or clearing firms and a brief description of the tiered requirements for such firms: • FINRA Rule 4110 (Capital Compliance) includes requirements for carrying or clearing firms to keep greater net capital, seek permission for withdrawals of capital and seek approval for certain add-backs to net capital. Notice at 26095. 121 Id. 125 Id. 122 See 126 Id. supra note 101. 123 See supra note 105. 124 See Notice at 26095. VerDate Sep<11>2014 19:03 Jan 11, 2022 at 26096. 127 Id. 128 Id. Jkt 256001 PO 00000 Frm 00010 Fmt 4701 Sfmt 4703 • FINRA Rule 4120 (Regulatory Notification and Business Curtailment) includes restrictions on expanding, or requirements to reduce business, if sufficient capital levels are not maintained. • FINRA Rule 4521 (Notifications, Questionnaires and Reports) allows FINRA to collect additional data and require reporting of a material decline in tentative net capital. • FINRA Rule 4522 (Periodic Security Counts, Verification and Comparison) requires more frequent security counts, verifications and comparisons than would be required under Exchange Act Rule 17a–13. • Rule 4523 (Assignment of Responsibility for General Ledger Accounts and Identification of Suspense Accounts) requires a record of primary and supervisory named individuals over general ledger bookkeeping accounts.129 According to FINRA, the intent of the tiering employed in these rules in the FINRA Rule 4000 Series is to impose higher capital, recordkeeping and operational standards on firms that carry or clear transactions and accounts, and therefore may have financial exposure to customers, other brokerdealers, central counterparties or others.130 FINRA believes that similar considerations apply for members with exposure to SBS.131 FINRA states that SBS are complex transactions that will, by their nature, require detailed recordkeeping, margining, legal agreements, collateral management, reconciliation and risk management.132 FINRA therefore believes it is appropriate to also employ tiering in the FINRA Rule 4000 Series for members that enter into SBS on a principal basis or otherwise have financial exposure to SBS.133 Specifically, under the proposed rule change, proposed FINRA Rule 0180(h) would provide that, for purposes of the FINRA Rule 4000 Series, all requirements that apply to a member that clears or carries customer accounts shall also apply to any member that acts as a principal counterparty to an SBS, clears or carries an SBS, guarantees an SBS or otherwise has financial exposure to an SBS.134 FINRA believes that applying these higher 129 Id. 130 Id. 131 Id. 132 Id. 133 Id. 134 Although this proposed tiering provision relates to the financial responsibility and operational rules, FINRA believes it should be included as a paragraph in proposed FINRA Rule 0180 so that all provisions relating to the treatment of SBS under FINRA rules are found in a single, consolidated rule. See id. at 26096, n.95. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices standards when a member enters into SBS or otherwise has exposure to SBS is appropriate and consistent with the protection of investors and the public interest.135 J. Margin Requirements As discussed above, in June 2019 the Commission adopted its final Capital, Margin, and Segregation Release.136 Among other things, the Capital, Margin, and Segregation Release adopted new Exchange Act Rule 18a–3, which prescribes margin requirements for uncleared SBS for SBSDs for which there is not a prudential regulator (‘‘nonbank SBSD’’).137 Generally, Exchange Act Rule 18a–3 requires a nonbank SBSD to calculate, for each account of an SBS counterparty as of the close of business of each day: (i) The amount of current exposure in the account (i.e., variation margin) and (ii) the initial margin amount for the account.138 Under Exchange Act Rule 18a–3, variation margin is calculated by marking the position to market, while initial margin must generally be calculated using standardized haircuts, which are prescribed in Exchange Act Rule 15c3–1 for nonbank SBSDs that are registered broker-dealers.139 Nonbank SBSDs may apply to the SEC for authorization to use models to calculate initial margin instead of the standardized haircuts (including the option to use the more risk sensitive methodology in Exchange Act Rule 15c3–1a), but nonbank SBSDs that are registered broker-dealers must use standardized haircuts to calculate initial margin for uncleared equity SBS.140 Based on these calculations, Exchange Act Rule 18a–3 generally requires a 135 See lotter on DSK11XQN23PROD with NOTICES2 136 See id. at 26096. Capital, Margin, and Segregation Release at 43954. 137 See 17 CFR 240.18a–3. Exchange Act Rule 18a–3 also prescribes margin requirements for nonbank MSBSPs with respect to uncleared SBS. As discussed above, Exchange Act Rule 18a–3 generally requires SBSDs to collect or deliver variation margin, and also to collect initial margin, with respect to its SBS counterparties. However, Exchange Act Rule 18a–3 requires that a nonbank MSBSP only collect and deliver variation margin, without prescribing any initial margin requirement. See Capital, Margin, and Segregation Release at 43877. As discussed below, FINRA believes it is appropriate to apply variation margin and initial margin requirements to all of its members that transact in uncleared SBS. Therefore, proposed FINRA Rule 4240 would provide an exception for members that are registered as SBSDs (and therefore subject to the variation and initial margin requirements of Exchange Act Rule 18a–3), but not for members that are registered as MSBSPs. See Notice at 26096, n.97. 138 See 17 CFR 240.18a–3(c)(1)(i); Capital, Margin, and Segregation Release at 43876. 139 See 17 CFR 240.18a–3(d). 140 See Capital, Margin, and Segregation Release at 43876. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 nonbank SBSD to collect and deliver variation margin, and to collect (but not deliver) initial margin.141 Exchange Act Rule 18a–3 also provides certain exceptions from the margin requirements, establishes thresholds and minimum transfer amounts, specifies collateral requirements (including collateral haircuts), establishes risk monitoring requirements and includes other miscellaneous provisions, such as definitions. All nonbank SBSDs, including nonbank SBSDs that are FINRA members, are subject to the margin requirements set forth in Exchange Act Rule 18a–3. The FINRA Rule 4200 Series sets forth margin requirements applicable to FINRA members. In particular, FINRA Rule 4210 describes the margin requirements that determine the amount of equity or ‘‘margin’’ customers are expected to maintain in their securities accounts, including margin requirements for equity and fixed income securities as well as options, warrants and security futures. Current FINRA Rule 4240 separately establishes an interim pilot program with respect to margin requirements for any transactions in CDS held in an account at a member (the ‘‘Interim Pilot Program’’). Under current FINRA Rule 0180, FINRA Rule 4210 does not apply to members’ activities and positions with respect to SBS, but current FINRA Rule 4240 does apply to activities and positions within its scope. Therefore, to the extent that a FINRA member enters into SBS that are CDS, the margin requirements under the Interim Pilot Program apply to such SBS.142 However, the Interim Pilot Program is a temporary rule, and SBS that are not CDS are not currently subject to any margin requirements under FINRA rules.143 The Interim Pilot Program was originally proposed by FINRA and approved by the Commission in 2009 specifically to address concerns arising from systemic risk posed by CDS.144 Pending the SEC’s final implementation of the Title VII rulemakings, FINRA has extended the expiration date of the Interim Pilot Program a number of times, most recently in September 2021.145 The Interim Pilot Program under current FINRA Rule 4240 is currently set to expire on April 6, 2022.146 In light of the finalization of the Commission’s margin requirements for nonbank SBSDs under Exchange Act Rule 18a–3 and the registration compliance date, FINRA believes it is appropriate and in the public interest for the Interim Pilot Program to expire and for FINRA to adopt a new margin rule specifically applicable to SBS.147 Accordingly, under the proposed rule change, current FINRA Rule 4240 would be replaced by a new FINRA Rule 4240 that would prescribe margin requirements for SBS. Consistent with Exchange Act Rule 18a–3—and unlike the Interim Pilot Program—proposed new Rule 4240 would apply margin requirements to all SBS, not just CDS. However, proposed new FINRA Rule 4240 would not apply to any member that is registered as an SBSD, as such members are subject to the margin requirements of Exchange Act Rule 18a– 3. Additionally, proposed FINRA Rule 4240 would defer to registered clearing agencies to set the margin requirements for cleared SBS, and as such would only specify new variation margin and initial margin requirements for uncleared SBS. Therefore, the specific new margin requirements prescribed under proposed FINRA Rule 4240 would only apply to uncleared SBS transacted by FINRA members that are not registered as SBSDs. FINRA believes that, by applying margin requirements in these circumstances, the proposed rule change would fill an important regulatory gap, protect FINRA members against counterparty credit risk, maintain a level playing field for members and prevent regulatory arbitrage.148 As described in further detail below, the margin requirements under proposed FINRA Rule 4240 would be structurally aligned with the margin requirements that will apply to nonbank SBSDs under Exchange Act Rule 18a–3, with certain modifications that FINRA believes are necessary given 145 See Extension Notice at 50392. supra note 19. 147 See Notice at 26097. FINRA states that, under the proposed rule change, proposed FINRA Rule 0180 would no longer provide an exception from current FINRA Rule 4210 applying to members’ activities and positions with respect to SBS. Absent additional changes, therefore, the general margin requirements under FINRA Rule 4210 would apply to SBS. However, as described above, FINRA proposed to specifically list SBS within the exceptions listed in FINRA Rule 4210, and adopt a separate, new FINRA Rule 4240 applicable to SBS. See id., n.106. 148 See id. at 26097. 146 See 141 See 17 CFR 240.18a–3(c)(1)(ii). purposes of current FINRA Rule 4240, the term ‘‘credit default swap’’ includes any product that is commonly known to the trade as a ‘‘credit default swap’’ and is an SBS as defined pursuant to Section 3(a)(68) of the Exchange Act or the rules and guidance of the SEC and its staff. See FINRA Rule 4240(a). 143 See Notice at 26097. 144 See Exchange Act Release No. 59955 (May 22, 2009), 74 FR 25586 (May 28, 2009) (Notice of Filing and Order Approving File No. SR–FINRA–2009– 012). 142 For PO 00000 Frm 00011 Fmt 4701 Sfmt 4703 1971 E:\FR\FM\12JAN2.SGM 12JAN2 1972 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices that such members will not be subject to the SEC’s comprehensive regulatory framework for SBSDs.149 Thus, subject to certain exceptions described in the proposed rule, proposed FINRA Rule 4240 would require members that are not SBSDs to collect and deliver variation margin on a daily basis to cover the member’s current exposure to or from each uncleared SBS counterparty, and also to collect (but not deliver) initial margin from each SBS counterparty. Proposed FINRA Rule 4240 is divided into a header followed by paragraphs (a) through (d). The header would specify the scope of the margin requirements under proposed FINRA Rule 4240. Paragraph (a) would describe the margin requirements for cleared SBS. Paragraph (b) would describe the margin requirements for uncleared SBS. Specifically, paragraph (b)(1) would set forth how variation margin must be calculated, paragraph (b)(2) would set forth how initial margin must be calculated, paragraph (b)(3) would prescribe the collection and delivery requirements for variation and initial margin, paragraph (b)(4) would specify the manner and time of collection or delivery of variation and initial margin, and paragraph (b)(5) would list certain exceptions from the margin requirements. Paragraph (c) would require members to employ specified risk monitoring procedures and guidelines for uncleared SBS. Finally, paragraph (d) would define certain terms used in proposed FINRA Rule 4240. Each of these aspects of the proposed rule change is described in further detail below. Proposed FINRA Rule 4240 would be entitled ‘‘Security-Based Swap Margin Requirements.’’ 150 The header text to lotter on DSK11XQN23PROD with NOTICES2 149 Id. 150 In addition to the new provisions under proposed FINRA Rule 4240 discussed above, the implementation of new margin requirements for SBS under proposed FINRA Rule 4240 would also require a conforming change to FINRA Rule 4220 (Daily Record of Required Margin). FINRA Rule 4220 requires each member carrying securities margin accounts for customers to make a record each day of every case in which initial or additional margin must be obtained in a customer’s account. To ensure that similar records are maintained for SBS margin required under proposed new FINRA Rule 4240, the proposed rule change would update FINRA Rule 4220 to also require such records for each member subject to proposed FINRA Rule 4240. In addition, the proposed rule change would add new Supplementary Material .06 to FINRA Rule 4210 to clarify that a Regulation T good faith account, other than a non-securities account, is a margin account for purposes of FINRA Rule 4210. This provision is intended merely to codify FINRA’s existing interpretation regarding the scope of FINRA Rule 4210. The proposed rule change would also include a parallel provision in new Supplementary Material .01 to proposed new Rule 4240. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 the rule would state that each member that is a party to an SBS with a customer, broker or dealer, or other Counterparty,151 or who has guaranteed or otherwise become responsible for any other person’s SBS obligations, shall comply with the requirements of proposed FINRA Rule 4240, except that a member that is registered as an SBSD shall instead comply with Exchange Act Rule 18a–3. This provision of the proposed rule is intended to clarify that the margin requirements under proposed FINRA Rule 4240 apply in all circumstances where a member is a party to an SBS, regardless of the type of counterparty, and also where a member has financial exposure to an SBS, whether through a guarantee or other arrangements under which the member is responsible for another person’s SBS obligations. FINRA believes that this provision is necessary to ensure that the proposed margin requirements adequately protect member firms against counterparty credit risk, regardless of the specific manner through which the member has become exposed to such risk.152 Additionally, as discussed above, this provision clarifies that members that are registered as SBSDs are not subject to the proposed margin requirements because they must comply with Exchange Act Rule 18a–3. FINRA believes it should defer to the SEC’s margin framework for registered SBSDs rather than impose additional or different requirements on such entities.153 Proposed FINRA Rule 4240(a), entitled ‘‘Cleared SBS Margin Requirements,’’ would state that, except as provided in paragraph (b)(5) (i.e., specified exceptions from proposed FINRA Rule 4240, discussed below), the margin to be maintained on any Cleared Finally, the proposed rule change would make two other conforming changes to FINRA Rule 4210, including to add proposed new FINRA Rule 4240(e)(9) and to make a technical adjustment to FINRA Rule 4240(g)(2)(H). See id. at 26097–98, n.107. 151 ‘‘Counterparty’’ would be defined under proposed FINRA Rule 4240(d)(5) to mean a person with whom a member has entered into an uncleared SBS. An ‘‘SBS’’ would be defined in proposed FINRA Rule 4240(d)(16) by reference to the definition of ‘‘security-based swap’’ under Section 3(a)(68) of the Exchange Act and ‘‘Uncleared’’ would be defined in proposed FINRA Rule 4240(d)(18) as an SBS that is not Cleared. Under proposed FINRA Rule 4240(d)(3), an SBS would be considered Cleared if it is cleared through a Clearing Agency by or on behalf of the member, and Clearing Agency would be defined under proposed FINRA Rule 4240(d)(4) as a clearing agency registered pursuant to Section 17A of the Exchange Act or exempted by the SEC from such registration by a rule or order pursuant to Section 17A of the Exchange Act. 152 See id. at 26098. 153 Id. PO 00000 Frm 00012 Fmt 4701 Sfmt 4703 SBS is the margin on such Cleared SBS required by the Clearing Agency through which such SBS is Cleared. As discussed above, this provision clarifies that proposed FINRA Rule 4240 defers to registered clearing agencies to set the margin requirements for cleared SBS. FINRA believes that it is appropriate to defer to clearing agencies to establish margin requirements for cleared SBS in light of the SEC’s comprehensive regulation of clearing agencies, including their required margin levels, under the Exchange Act.154 Proposed FINRA Rule 4240(b), entitled ‘‘Uncleared SBS Margin Requirements,’’ would set forth the substantive margin requirements applicable to members that are not SBSDs when such members transact in uncleared SBS. Paragraph (b)(1), entitled ‘‘Current Exposure Calculation,’’ would require that, as of the close of business of each business day, the member calculate, with respect to each Uncleared SBS Account,155 the Counterparty’s Current Exposure to the member (if positive) or the member’s Current Exposure to the Counterparty (if negative). Current Exposure would be calculated as an amount equal to the net Value 156 of all uncleared SBS in the Uncleared SBS Account plus the Value of all Variation Margin collected from the Counterparty minus the Value of all Variation margin delivered to the 154 Id. 155 Under proposed FINRA Rule 4240(d)(19), an ‘‘Uncleared SBS Account’’ would be defined to mean an account with respect to a Counterparty consisting of all Uncleared SBS between the member and the Counterparty, together with long or short positions for Variation Margin in the form of securities collected or delivered, respectively, credit or debit balances for Variation Margin in the form of cash collected or delivered, respectively, and long positions or credit balances for Initial Margin collected in the form of securities or cash, respectively. 156 ‘‘Value’’ would be defined in proposed FINRA Rule 4240(d)(20). Under this definition, the Value of one or more SBS would be the mid-market replacement cost for such SBS. The Value of a security position would be the current market value of such margin securities, as defined in FINRA Rule 4210(a)(2) and determined in accordance with FINRA Rule 4210(f)(1) (i.e., the provisions of FINRA’s general margin rule used to determine the current market value of margin securities). Alternatively, a member could elect to determine the Value of margin securities collected as Variation Margin or Initial Margin by applying a haircut to the current market value of such securities equal to the margin requirement that would be applicable to them under FINRA Rule 4210 if they were held in the Counterparty’s margin account (in which case, however, such margin securities would not be required to be themselves margined under proposed FINRA Rule 4240(b)(2)(A)(iii)). The Value of cash in U.S. dollars would be the amount of such cash, while the Value of freely convertible foreign currency would be the amount of U.S. dollars into which the currency could be converted, provided the currency is marked-to-market daily. See id. at 26098, n.110. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 Counterparty.157 This provision would define a member’s Current Exposure for purposes of collecting or delivering Variation Margin under proposed FINRA Rule 4240(b)(3), discussed below, by taking into account the net Value of SBS in the Counterparty’s account together with any Variation Margin that has already been collected or delivered. FINRA believes this calculation is consistent with the variation margin requirements under Exchange Act Rule 18a–3.158 Proposed FINRA Rule 4240(b)(2), entitled ‘‘Initial Margin Computation,’’ would require that, as of the close of business on each business day, the member compute the Initial Margin Requirement for each Uncleared SBS Account equal to the sum of the Initial Margin Requirements on the Uncleared SBS and securities positions in that Uncleared SBS Account. The remainder of proposed FINRA Rule 4240(b)(2) would describe how a member must calculate the Initial Margin Requirement, which is then used for purposes of collecting Initial Margin under proposed FINRA Rule 4240(b)(3), discussed below.159 Under the proposed rule change, the Initial Margin Requirement would depend on the type of uncleared SBS involved, with different requirements depending on whether the uncleared SBS is (i) a ‘‘plain vanilla’’ CDS; (ii) a ‘‘plain vanilla’’ SBS other than an CDS (i.e., an SBS that is the economic equivalent of a margin account containing a portfolio of long or short positions in securities or options, such as a ‘‘plain vanilla’’ equity total return swap (‘‘TRS’’)); or (iii) any other type of SBS (e.g., a 157 Under proposed FINRA Rule 4240(d)(21), ‘‘Variation Margin’’ would be defined to mean the cash or margin securities collected from, or delivered to, a Counterparty in accordance with proposed FINRA Rule 4240(b)(3)(A), as discussed below. Under proposed FINRA Rule 4240(b)(2)(A)(iii), all securities deposited as Variation Margin for uncleared SBS would themselves be margined in accordance with FINRA Rule 4210, unless the member has chosen to haircut them for purposes of determining their Value. 158 See id. at 26098. 159 Under proposed FINRA Rule 4240(d)(9), the term ‘‘Initial Margin’’ would be defined to mean all cash or marginable securities, excluding Variation Margin, received by the member for a Counterparty’s Uncleared SBS Account or transferred to the Counterparty’s Uncleared SBS Account from another account at the member, including margin collected from a Counterparty in accordance with proposed FINRA Rule 4240(b)(3)(B), as discussed below, that in each case have not been returned to the Counterparty or applied to an obligation of the Counterparty. Under proposed FINRA Rule 4240(b)(2)(A)(iii), all securities deposited as Initial Margin for uncleared SBS would themselves be margined in accordance with FINRA Rule 4210, unless the member has chosen to haircut them for purposes of determining their Value. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 complex CDS or equity TRS that would not be considered ‘‘plain vanilla’’ under the proposed rule, including for example a CDS swaption, or a dividend swap). FINRA believes that differentiation as to initial margin requirements among these different types of SBS is appropriate and necessary given the unique characteristics and risks posed by different SBS products.160 Proposed paragraphs (b)(2)(A)(i) and (ii) would define the Initial Margin Requirements for uncleared plain vanilla CDS (referred to as ‘‘Basic CDS’’) 161 and other uncleared ‘‘plain vanilla’’ SBS (referred to as ‘‘Basic SBS’’),162 respectively. First, the Initial Margin Requirement for an uncleared Basic CDS would generally be computed based on the term and spread of the uncleared Basic CDS, using the chart and offsets set out in Exchange Act Rule 15c3–1(c)(2)(vi)(P).163 In FINRA’s view, the proposed rule would therefore follow Exchange Act Rule 18a–3(d)(1)(i) by determining the Initial Margin Requirement for uncleared Basic CDS using the haircuts applicable to such SBS under the SEC’s net capital rule.164 FINRA believes that determining initial margin for CDS in this manner would promote regulatory consistency and reduce potential arbitrage.165 160 See id. at 26099. proposed FINRA Rule 4240(d)(1), a ‘‘Basic CDS’’ would be defined to mean a Basic Single Name Credit Default Swap or a Basic Narrow-Based Index Credit Default Swap. A Basic Single-Name Credit Default Swap would mean an SBS in which one party pays either a single fixed amount or periodic fixed amounts or floating amounts determined by reference to a specified notional amount, and the other party pays either a fixed amount or an amount determined by reference to the value of one or more loans, debt securities or other financial instruments issued, guaranteed or otherwise entered into by a third party (i.e., the ‘‘Reference Entity’’) upon the occurrence of one or more specified credit events with respect to the Reference Entity (for example, bankruptcy or payment default). The term ‘‘Basic Single-Name Credit Default Swap’’ would also include a swap that, upon the occurrence of one or more specified credit events with respect to the Reference Entity, is physically settled by payment of a specified fixed amount by one party against delivery by the other party of eligible obligations of the Reference Entity. A Basic Narrow-Based Index Credit Default Swap would be defined to mean an SBS consisting of multiple component Basic Single-Name Credit Default Swaps. See id. at 26099, n.113. 162 Under proposed FINRA Rule 4240(d)(2), a ‘‘Basic SBS’’ would be defined to mean an SBS, other than a CDS, under which each party is contractually obligated to provide the other the economic equivalent of a margin account containing a portfolio of long or short positions in securities or options (i.e., an ‘‘Equivalent Margin Account’’). See id. at 26099, n.114. 163 See 17 CFR 240.15c3–1(c)(2)(vi)(P). This provision of the SEC’s broker-dealer net capital rule prescribes the haircuts applicable to uncleared SBS. 164 See Notice at 26099. 165 Id. 161 Under PO 00000 Frm 00013 Fmt 4701 Sfmt 4703 1973 Additionally, in FINRA’s view, the haircuts prescribed in Exchange Act Rule 15c3–1(c)(2)(vi)(P) are analogous to existing FINRA Rule 4240 margin requirements, so in effect the proposed requirements have already been used during the Interim Pilot Program.166 Second, the Initial Margin Requirement for a Basic SBS would generally be computed by applying FINRA Rule 4210 to the Equivalent Margin Account. Since an uncleared Basic SBS would be the economic equivalent of a margin account that would otherwise be governed by the margin provisions of FINRA Rule 4210, FINRA believes it is appropriate to treat such SBS similarly.167 In addition, proposed FINRA Rule 4240(b)(2)(A) would permit the Initial Margin Requirements for both uncleared Basic CDS and uncleared Basic SBS to be computed based on a combination of multiple SBS and securities or options positions, as applicable and subject to certain conditions. Specifically, proposed FINRA Rule 4240(b)(2)(A)(i) would provide that, if the member has a netting or collateral agreement that is legally enforceable against the Counterparty and covers any combination of uncleared Basic CDS or securities specified in clause (iii), (iv) or (v) of Exchange Act Rule 15c3– 1(c)(2)(vi)(P)(1) (i.e., specified offsetting debt securities), the member may compute the Initial Margin Requirement on such combination of positions equal to the ‘‘haircut’’ on that combination under Exchange Act Rule 15c3– 1(c)(2)(vi)(P)(1). Proposed FINRA Rule 4240(b)(2)(A)(ii) would similarly provide that, if the member has a netting or collateral agreement that is legally enforceable against the Counterparty and covers any combination of uncleared Basic SBS, securities or options positions, the member may compute the Initial Margin Requirement on the combination of such positions equal to the margin that FINRA Rule 4210 would require to be maintained on the combination of Equivalent Margin Accounts for such uncleared Basic SBS and securities or options positions. Proposed FINRA Rule 4240(b)(2)(B) would impose conditions on computing the Initial Margin Requirement using these combination methods, including that (i) securities positions must be in the Counterparty’s uncleared SBS Account or margin account at the member; (ii) securities may not be included if the member has chosen to haircut them for purposes of determining their Value; (iii) options 166 Id. 167 Id. E:\FR\FM\12JAN2.SGM 12JAN2 1974 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices positions must be in the Counterparty’s margin account at the member; (iv) no SBS, security or option positions may be included in more than one combination; and (v) no combinations may include securities or options positions for which reduced margin requirements are computed under FINRA Rule 4210(e)(1) (i.e., reduced margin requirements for offsetting long and short positions) or 4210(f)(2)(F)(ii) through (f)(2)(l) (i.e., various reduced margin requirements for certain options, including covered options and offsetting options positions).168 FINRA believes these conditions would ensure that the Initial Margin Requirement calculated using the combination method is based on securities and options positions that the member actually has in its possession and does not reflect reductions in value that would inappropriately lower the margin requirement.169 In addition, proposed FINRA Rule 4240(b)(2)(B) would provide that if the Initial Margin Requirement is computed on a combination as described above, the Initial Margin Requirement on the uncleared SBS included in the combination shall be reduced (but not below zero) by the aggregate maintenance margin requirements under FINRA Rule 4210 applicable to such margin account positions. FINRA believes that this provision would appropriately take into account margin already collected under FINRA Rule 4210 with respect to such positions.170 The proposed rule change would not specify Initial Margin Requirements for other uncleared SBS that do not qualify as Basic CDS or Basic SBS. Instead, proposed FINRA Rule 4240(b)(2)(A)(iv) would provide that the Initial Margin Requirement for any uncleared SBS other than a Basic CDS or Basic SBS would be determined in a manner approved by FINRA pursuant to proposed FINRA Rule 4240(b)(2)(C), 168 Id. lotter on DSK11XQN23PROD with NOTICES2 169 Id. 170 Id. In connection with this proposed provision of FINRA Rule 4240(b)(2)(B), the proposed rule change would also add a new paragraph (e)(9) to FINRA Rule 4210, entitled ‘‘Security-Based Swaps; SBS Offsets.’’ Specifically, where the Initial Margin Requirement on the combination of SBS and securities or options position in the margin account would be less than the FINRA Rule 4210 maintenance requirement on the margin account positions, proposed FINRA Rule 4210(e)(9) would reduce the FINRA Rule 4210 maintenance requirement on the margin account positions to equal the computed Initial Margin Requirement. In addition, proposed FINRA Rule 4210(e)(9) would clarify that, except for SBS carried by a member in a portfolio margin account subject to the requirements of FINRA Rule 4210(g), as discussed below, margin requirements on SBS and positions in Uncleared SBS Accounts are determined by proposed FINRA Rule 4240, rather than FINRA Rule 4210. See id. at 26099, n.117. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 which would permit a member to apply to FINRA for the approval of an Initial Margin Requirement for any other type of SBS. Under the proposed rule change, any such application would be required to: • Define the specific type of SBS covered by the application; • describe the purpose(s) that the member and its Counterparties would have for entering that type of SBS; • identify all variables that influence the value of that type of SBS; • explain all risks of that type of SBS; • propose a specific Initial Margin Requirement (not a margin model) for that type of SBS; • explain how the proposed specific Initial Margin Requirement would adequately protect a member and its capital against each of those risks; • attach copies of the member’s SBS risk management procedures and describe the application of those procedures to that type of SBS; and • provide the results of backtesting of the proposed specific Initial Margin Requirement over periods of significant volatility in the variables influencing the value of that type of SBS.171 Proposed FINRA Rule 4240(b)(2)(C) would further provide that, if FINRA approves any such application, the approval may be unconditional or conditional, including in the form of a time-limited pilot program; may approve the use of the specific Initial Margin Requirement only by the applicant; or may take the form of a Regulatory Notice or other communication approving the use of the specific margin requirements by members generally. Under proposed FINRA Rule 4240(b)(2)(C), no member would be permitted to become a party to an SBS other than a Basic CDS or Basic SBS unless FINRA has approved an Initial Margin Requirement for such member’s use with respect to that type of SBS. As described above, FINRA states that the Initial Margin Requirements for Basic CDS are based on the Commission’s treatment of such SBS under its net capital rule, while the Initial Margin Requirements for Basic SBS are based on the margin that would be required for a margin account that would be the economic equivalent of such SBS.172 However, in FINRA’s view, other types of SBS—including CDS and equity TRS with complex features—may not be easily accommodated under these frameworks, and the specific risks that accompany such SBS may not be readily apparent or quantifiable to FINRA without 171 See Notice at 26100. 172 Id. PO 00000 Frm 00014 Fmt 4701 Sfmt 4703 additional information.173 Moreover, as noted above, SBS can be complex financial instruments that pose substantial risks to members and margin serves as an important means of protecting member firms, and thereby their customers and investors, from such risks. FINRA therefore believes that members that are not SBSDs (and therefore not subject to the SEC’s comprehensive regulatory framework for registrants under Title VII of DoddFrank) should not be permitted to enter into other types of SBS unless and until FINRA has evaluated the risks of such SBS and approved margin requirements that adequately address such risks.174 If FINRA determines that a proposed margin requirement does not adequately address the risks for a particular type of SBS, FINRA would not approve the application under proposed FINRA Rule 4240(b)(2)(C), and members would not be permitted to enter into such SBS. To FINRA’s knowledge, this SBS activity by members that do not plan to register as SBSDs is relatively limited.175 Proposed FINRA Rule 4240(b)(3), entitled ‘‘Collection or Delivery of Variation and Initial Margin,’’ would set forth a member’s obligation to collect or deliver margin as calculated pursuant to proposed FINRA Rule 4240(b)(1) and (2), as described above. Paragraph (b)(3)(A) would require each member to deliver or return to each Counterparty cash or margin securities with a Value equal to the Counterparty’s Current Exposure (if any) to the member, or collect or retrieve from the Counterparty cash or margin securities with a Value equal to the member’s Current Exposure (if any) to the Counterparty. Paragraph (b)(3)(B) would require each member to collect from each Counterparty cash or margin securities with a Value at least equal to any Initial Margin Deficit.176 Therefore, consistent with Exchange Act Rule 18a–3, proposed FINRA Rule 4240(b)(3) would require members that are not SBSDs to collect and deliver Variation Margin, and also to collect (but not deliver) Initial Margin, in amounts determined pursuant to the 173 Id. 174 Id. 175 Id. 176 Under proposed FINRA Rule 4240(d)(10), the term ‘‘Initial Margin Deficit’’ would be defined as the amount, if any, by which (A) the sum of the Value of the Initial Margin in an Uncleared SBS Account and the Counterparty’s Rule 4210 Excess is less than (B) the Initial Margin Requirement for the Uncleared SBS Account. A person’s ‘‘Rule 4210 Excess’’ would be defined in proposed FINRA Rule 4240(d)(15) to mean the amount, if any, by which the equity (as defined in FINRA Rule 4210(a)(5)) in the Counterparty’s margin account at the member exceeds the amount required by FINRA Rule 4210. See id. at 26100, n.118. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 provisions of FINRA Rule 4240(b)(1) and (2) as described above, for their transactions in uncleared SBS.177 Proposed FINRA Rule 4240(b)(4), entitled ‘‘Manner and Time of Collection or Delivery of Variation and Initial Margin; Prohibited Returns and Withdrawals,’’ would set forth additional detailed requirements and clarifications regarding the manner and time of collection or delivery of variation and initial margin, as calculated pursuant to proposed FINRA Rules 4240(b)(1) and (2) and collected or delivered in accordance with proposed FINRA Rule 4240(b)(3), as described above. Specifically, proposed FINRA Rule 4240(b)(4) would provide for the following: 178 • Under proposed FINRA Rule 4240(b)(4)(A), margin would be deemed collected or returned to the member when it is received in the Counterparty’s Uncleared SBS Account at the member (or transferred to such account from another account at the member). • Under proposed FINRA Rule 4240(b)(4)(B), margin would be deemed collected or returned to the Counterparty when it is transferred from the Counterparty’s Uncleared SBS Account at the member in accordance with the Counterparty’s instructions or agreement with the member, which could potentially include transfer to another account of the Counterparty carried by the member. • Under proposed FINRA Rule 4240(b)(4)(C), margin would be required to be collected or delivered pursuant to proposed FINRA Rule 4240(b)(3) as promptly as possible, but in any case no later than the close of business on the business day after the date on which the Current Exposure or Initial Margin Requirement was required to be computed in accordance with proposed FINRA Rule 4240(b)(1) or (2) (i.e., margin would generally be required to be delivered or collected on a T+1 basis). Further, unless FINRA has specifically granted the member additional time, a member that has not collected margin as required by the close of business on the third business day (i.e., by T+3) would be required to 177 To account for situations where a member is not the actual party to an SBS, but nonetheless has financial exposure for uncleared SBS (e.g., through a guarantee), proposed FINRA Rule 4240(b)(3)(C) would also require a member to collect both Variation Margin and Initial Margin from the party that has obligations under the uncleared SBS for which the member has responsibility, to the extent that such collection would be required if the member were a party to the uncleared SBS, unless the member can establish that such margin has been delivered to the other party. See id. at 26100, n.119. 178 See id. at 26100. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 take prompt steps to liquidate positions in the Counterparty’s Uncleared SBS Account to eliminate the margin deficiency. • Proposed FINRA Rule 4240(b)(4)(D) would require a member to net the delivery or return of Variation Margin against the collection of Initial Margin, if applicable, and would further permit a member to net the return of Initial Margin against the collection or retrieval of Variation Margin, if applicable. • Proposed FINRA Rule 4240(b)(4)(E) would prohibit a member from returning Initial Margin to a Counterparty, or permitting a Counterparty to make a withdrawal from the Counterparty’s margin account, if doing so would create or increase an Initial Margin Deficit. FINRA believes it is appropriate and consistent with the protection of member firms and investors to require margin for uncleared SBS to be delivered or collected, as applicable, on a T+1 basis, and to further require that uncleared SBS positions be liquidated if margin is not collected within a T+3 timeframe.179 FINRA also believes the other clarifications described above are necessary to ensure that members and their uncleared SBS counterparties have a clear and consistent understanding of when and how margin must be delivered or collected under the proposed rule change.180 Proposed FINRA Rule 4240(b)(5), entitled ‘‘Exceptions,’’ would provide eight specific exceptions from a member’s general obligation to collect or deliver margin, as applicable, under proposed FINRA Rule 4240(b)(3), as described above. FINRA believes the proposed exceptions would further align the requirements of proposed FINRA Rule 4240 with the margin requirements applicable to SBSDs under Exchange Act Rule 18a–3 and provide members with additional flexibility in managing their risk exposures, while still ensuring that the risks to members with respect to their uncleared SBS exposures are adequately addressed.181 The proposed exceptions under FINRA Rule 4240(b)(5) would include the following: • Clearing Agencies. A member would not be required to deliver Variation Margin to, or collect Initial Margin or Variation Margin from, any Clearing Agency, and would also not be required to deduct otherwise required Variation Margin or Initial Margin in the computation of its net capital under Exchange Act Rule 15c3–1 or, if 1975 applicable, FINRA Rule 4110(a). FINRA believes this exception is consistent with its determination to defer to Clearing Agency margin requirements with respect to Cleared SBS.182 • Legacy SBS. A member would be permitted to omit all (but not less than all) Legacy SBS with a Counterparty from the Counterparty’s Uncleared SBS Account when computing Current Exposure and the Initial Margin Requirement, provided that the member collects and delivers margin on Legacy SBS to the extent of its contractual rights and obligations to do so.183 However, a member would be required to take a capital deduction under Exchange Act Rule 15c3–1 or, if applicable, FINRA Rule 4110(a), to reflect the amount of any margin that it would have otherwise been required to collect if the Legacy SBS had been included in the Counterparty’s Uncleared SBS Account. FINRA believes it is appropriate to provide a general exception for legacy SBS, as members would not be in a position to require their counterparties to legacy SBS to exchange margin under existing SBS agreements as would otherwise be required under proposed FINRA Rule 4240.184 However, in such cases, FINRA believes it is appropriate to require a member to take a corresponding capital charge to account for the member’s ongoing risk exposure under such SBS.185 • Multilateral Organizations. A member would not be required to deliver Variation Margin to, or collect Initial Margin or Variation Margin from, any Multilateral Organization.186 182 Id. 180 Id. 183 Under proposed FINRA Rule 4240(d)(12), a ‘‘Legacy SBS’’ would be defined as an uncleared SBS entered into before April 6, 2022. See Amendment No. 1. Proposed FINRA Rule 4240(b)(2)(A)(iv) would also clarify that for any Legacy SBS for which proposed Rule 4240 does not specify an Initial Margin Requirement (i.e., an SBS other than a Basic CDS, Basic SBS or other SBS for which FINRA has approved specific margin requirements), the Initial Margin Requirement must be calculated using the applicable method specified in Exchange Act Rule 15c3–1(c)(2)(vi)(P). The Initial Margin Requirement for Legacy SBS calculated under this provision would be used for purposes of determining the appropriate corresponding capital charge, as well as to determine the Initial Margin Requirement for a Legacy SBS to the extent that a member elects not to utilize the Legacy SBS exception under proposed FINRA Rule 4240(b)(5). See id. at 26101, n.120. 184 See id. at 26101. 185 Id. 186 Under proposed FINRA Rule 4240(d)(13), a ‘‘Multilateral Organization’’ would be defined to mean the Bank for International Settlements, the European Stability Mechanism, the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter- 181 Id. Continued 179 See PO 00000 id. at 26101. Frm 00015 Fmt 4701 Sfmt 4703 E:\FR\FM\12JAN2.SGM 12JAN2 1976 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 However, a member would be required to take a capital deduction to reflect the amount of any margin that it would otherwise have been required to collect from such a Multilateral Organization. FINRA believes it is appropriate to follow Exchange Act Rule 18a–3 by providing an exception for Multilateral Organizations and requiring the risk posed by such SBS to be accounted for in a member’s capital computations.187 • Financial Market Intermediaries. A member would not be required to collect Initial Margin from a Counterparty that is a Financial Market Intermediary (but would still be required to collect or deliver Variation Margin, as applicable).188 In such case, a member would be required to take a capital deduction to reflect the amount of any Initial Margin that it would have otherwise been required to collect from such Financial Market Intermediary. A Counterparty that is a Financial Market Intermediary generally would be subject to a comprehensive regulatory framework, including capital requirements. FINRA therefore believes it is appropriate to account for the reduced counterparty credit risk posed by such Counterparties by permitting a member to take a capital charge in lieu of requiring such Counterparties to post Initial Margin.189 However, FINRA continues to believe that Variation Margin should be exchanged with such Counterparties to account for ongoing the market risk posed by such uncleared SBS.190 • Sovereign Counterparties. A member would generally be required to deliver Variation Margin to, and collect Initial Margin or Variation Margin from, a Sovereign Counterparty.191 However, under proposed FINRA Rule 4240(b)(5)(E), if the member has American Development Bank, the Asian Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development Bank, or any other multilateral development bank that provides financing for national or regional development in which the U.S. government is a shareholder or contributing member. See id. at 26101, n.121. 187 See id. at 26101. 188 Under proposed FINRA Rule 4240(d)(8), a ‘‘Financial Market Intermediary’’ would be defined to mean an SBSD, swap dealer, broker or dealer, FCM, bank, foreign bank, or foreign broker or dealer. See id. at 26101, n.122. 189 See id. at 26101. 190 Id. 191 Under proposed FINRA Rule 4240(d)(17), a ‘‘Sovereign Counterparty’’ would be defined as a Counterparty that is a central government (including the U.S. government) or an agency, department, ministry or central bank of a central government. See id. at 26101, n.122. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 determined pursuant to policies and procedures or credit risk models established pursuant to Exchange Act Rule 15c3–1(c)(2)(vi)(l) that the Sovereign Counterparty has only a minimal amount of credit risk, the member would not be required to collect Initial Margin from such Sovereign Counterparty (but would still be required to collect or deliver Variation Margin, as applicable). In such case, a member would be required to take a capital deduction to reflect the amount of any Initial Margin that it would have otherwise been required to collect from such Sovereign Counterparty. As for Financial Market Intermediaries, FINRA believes it is appropriate to account for the reduced counterparty credit risk posted by highly creditworthy Sovereign Counterparties by permitting a member to take a capital charge in lieu of requiring such Counterparties to post Initial Margin.192 However, FINRA continues to believe that Variation Margin should be exchanged with such Counterparties to account for ongoing the market risk posed by such uncleared SBS.193 • Majority Owners; ANC Firms Transacting with Majority Owners or Registered or Foreign SBS Dealers Under Common Ownership. FINRA states that it understands that members may enter into uncleared SBS with affiliated entities for a variety of reasons, including for risk management purposes.194 FINRA does not believe a broad exception from the proposed margin requirements for uncleared SBS with all affiliates would adequately account for the risks posed to its members by uncleared SBS in such circumstances.195 However, FINRA does believe that two specific, more limited exceptions for SBS entered into with certain affiliates would be appropriate.196 First, under proposed FINRA Rule 4240(b)(5)(F), a member would not be required to collect Initial Margin from a Counterparty that is a direct or indirect owner of a majority of the equity and voting interests in the member (a ‘‘Majority Owner’’) (but would still be required to collect or deliver Variation Margin, as applicable). In such case, a member would be required to take a capital deduction to reflect the amount of any Initial Margin that it would have otherwise been required to collect from such Majority Owner. Second, under proposed FINRA 192 See 193 Id. id. at 26101–102. at 26102. 194 Id. 195 Id. 196 Id. PO 00000 Frm 00016 Fmt 4701 Sfmt 4703 Rule 4240(b)(5)(G), a member that is an ANC Firm would not be required to collect Initial Margin from a Counterparty that is a Majority Owner or a Registered or Foreign SBS Dealer under common ownership (but would still be required to collect or deliver Variation Margin, as applicable).197 In such case, an ANC Firm member would be required to take a deduction for credit risk on such transactions computed in accordance with Exchange Act Rule 15c3–1e(c).198 FINRA believes that the proposed exception from the Initial Margin Requirements for uncleared SBS with Majority Owners, provided that the member takes a capital charge in lieu of collecting Initial Margin, would adequately protect members in such circumstances due to the lower risk presented by Majority Owners, which typically must satisfy capital and other requirements applicable to bank holding companies and similar entities.199 FINRA also believes that the proposed exception for ANC Firms with respect to SBS with Majority Owners and Registered or Foreign SBS Dealer affiliates, provided that the member takes a corresponding credit risk charge, would adequately protect such members while reducing potential competitive disparity as between ANC Firms that are registered as SBSDs (and therefore subject to Exchange Act Rule 18a–3) and ANC Firms that are not registered as SBSDs (and therefore would be subject to proposed FINRA Rule 4240 with respect to their uncleared SBS).200 • Portfolio Margin. Proposed FINRA Rule 4240(b)(5)(H) would provide that proposed FINRA Rule 4240 would not 197 Under proposed FINRA Rule 4240(d)(14), a ‘‘Registered or Foreign SBS Dealer’’ would be defined to mean (i) any person registered with the SEC as an SBSD or (ii) any foreign person if the SEC has made a substituted compliance determination under Exchange Act Rule 3a71–6(a)(1) that compliance by an SBSD or class thereof with specified requirements of a foreign regulatory system that are applicable to such foreign person may satisfy the capital requirements of Section 15F(e) of the Exchange Act and Exchange Act Rule 18a–1 that would otherwise apply to such SBSD or class thereof. Therefore, the definition would cover registered SBSDs and entities that are subject to equivalent SBSD capital requirements in a foreign jurisdiction. See id. at 26102, n.124. 198 FINRA states that an ANC Firm transacting with a Counterparty that is its Majority Owner would also benefit from the general exception for collecting Initial Margin from Majority Owners, as described above. However, under this additional exception, an ANC Firm would be permitted to take only a deduction for the credit risk on its transactions with Majority Owner counterparties as calculated in accordance with Exchange Act Rule 15c3–1e, rather than the full amount of the Initial Margin Requirement that would otherwise have applied. See id. at 26102, n.125. 199 See id. at 26102. 200 Id. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 apply to any unlisted derivative, as defined in FINRA Rule 4120(g)(2)(H), carried by the member in a portfolio margin account subject to the requirements of FINRA Rule 4210(g) if such unlisted derivative is of a type addressed in the comprehensive written risk analysis methodology filed by the member with FINRA in accordance with FINRA Rule 4210(g)(1).201 In addition, proposed FINRA Rule 4240 would not apply to any SBS carried in a commodity account or other account under the jurisdiction of the CFTC in accordance with an SEC rule, order or no-action letter permitting SBS and swaps to be carried and portfolio margined together in such an account. According to FINRA, portfolio margining provides members with the flexibility to manage their risk exposures based on a broader view of their overall relationship with a particular Counterparty.202 FINRA believes it is appropriate to provide an exception from proposed FINRA Rule 4240 for any SBS in a portfolio margin account if the SBS is of a type whose risk is appropriately addressed by an approved theoretical pricing model (e.g., TIMS) and covered by portfolio risk management procedures filed by the member with FINRA, as well as for SBS permitted by the SEC to be portfolio margined in a commodity account.203 In these circumstances, in FINRA’s view, the risks presented by such SBS would already be subject to a comprehensive risk management framework, and therefore FINRA does not believe it is necessary to apply the proposed new margin requirements to such SBS.204 Proposed FINRA Rule 4240(c), entitled ‘‘Risk Monitoring Procedures and Guidelines,’’ would require members to monitor the risk of any Uncleared SBS Accounts and maintain a comprehensive risk analysis methodology for assessing the potential risk to the member’s capital over a specified range of possible market movements over a specified time period. For purposes of this requirement, members would be required to employ the following risk monitoring procedures and guidelines: 205 • Obtaining and reviewing the required documentation and financial 201 FINRA is also proposing a technical adjustment to the definition of ‘‘unlisted derivative’’ under FINRA Rule 4210(g)(2)(H) to clarify that, to qualify under the definition, the option, forward contract or SBS must be able to be valued by a theoretical pricing model that is approved by the SEC for valuing that type of options, forward contract or SBS. 202 Id. 203 Id. 204 Id. 205 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 information necessary for assessing the amount of credit to be extended to SBS Counterparties; • determining and documenting the legal enforceability of netting or collateral agreements, including enforceability in the event a Counterparty becomes subject to bankruptcy or other insolvency proceedings; • assessing the determination, review and approval of credit limits to each Counterparty, and across all Counterparties; • monitoring credit risk exposure to the member from SBS, including the type, scope and frequency of reporting to senior management; • the use of stress testing of accounts containing SBS contracts in order to monitor market risk exposure from individual accounts and in the aggregate; • managing the impact of credit extended related to SBS contracts on the member’s overall risk exposure; • determining the need to collect additional margin from a particular customer or broker or dealer, including whether that determination was based upon the creditworthiness of the customer or broker or dealer and/or the risk of the specific contracts; • determining the need for higher margin requirements than required by proposed FINRA Rule 4240 and formulating the member’s own margin requirements, including procedures for identifying unusually volatile positions, concentrated positions (with a particular Counterparty and across all Counterparties and customers), or positions that cannot be liquidated promptly; • monitoring the credit exposure resulting from concentrated positions with a single Counterparty and across all Counterparties, and during periods of extreme volatility; • identifying any Uncleared SBS Accounts with intraday risk exposures that are not reflected in their end of day positions (e.g., Uncleared SBS Accounts that frequently establish positions and then trade out of, or hedge, those positions by the end of the day) and collecting appropriate margin to address those intraday risk exposures; • identifying any Uncleared SBS Account that, in light of current market conditions, could not be promptly liquidated for an amount corresponding to the Current Exposure computed with respect to such account and determining the need for higher margin requirements on such accounts or the positions therein; • maintaining sufficient Initial Margin in the accounts of each PO 00000 Frm 00017 Fmt 4701 Sfmt 4703 1977 Counterparty to protect against the largest individual potential future exposure of an Uncleared SBS in such Counterparty’s Uncleared SBS Account, as measured by computing the largest maximum possible loss that could result from the exposure; and • increasing the frequency of calculations of Current Exposure and Initial Margin Requirements during periods of extreme volatility and for accounts with concentrated positions. Proposed FINRA Rule 4240(c) would further require a member to review, in accordance with the member’s written procedures, at reasonable periodic intervals, the member’s SBS activities for consistency with these risk monitoring procedures and guidelines, and to determine whether the data necessary to apply the risk monitoring procedures and guidelines is accessible on a timely basis and information systems are available to adequately capture, monitor, analyze and report relevant data. In FINRA’s view, the risk monitoring procedures and guidelines under proposed FINRA Rule 4240(c) are analogous to the risk monitoring and procedure requirements applicable to nonbank SBSDs with respect to their uncleared SBS transactions under Exchange Act Rule 18a–3.206 These requirements are also based in part on aspects of FINRA Rule 4210, including procedures related to the need for additional margin under FINRA Rule 4210(d) and the portfolio margin risk monitoring requirements under FINRA Rule 4210(g)(1). In FINRA’s view, SBS are complex financial instruments that may expose a member to significant risks, including, for example, market risk, counterparty credit risk, operational risk and legal risk.207 FINRA accordingly believes it is appropriate and necessary, and consistent with the protection of investors, for members with exposure to uncleared SBS to maintain a comprehensive risk monitoring program, including the specific elements described above, to address such risks.208 K. Effective Date As discussed above in Section II.A., current FINRA Rule 0180 temporarily excepts the application of most FINRA rules to the SBS activities of its members. Now that the Commission has finalized the majority of its Title VII rulemakings, FINRA believes it is appropriate and in the public interest 206 See id. at 26103; see also 17 CFR 240.18a–3(e); Capital, Margin, and Segregation Release at 43930. 207 See Notice at 26103. 208 Id. E:\FR\FM\12JAN2.SGM 12JAN2 1978 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices for the current temporary FINRA Rule 0180 to expire and for FINRA to clarify the application of FINRA rules to SBS through a permanent FINRA rule.209 Additionally, since FINRA filed its proposed rule change, as modified by Amendment No. 1, the Commission’s regulatory framework governing SBS Entities has gone into effect. FINRA is proposing to amend FINRA Rules 0180, 4120, 4210, 4220, 4240 and 9610 to take into account members’ SBS activities.210 FINRA states that if the proposed rule change, as modified by Amendment No. 1, is approved by the Commission, the effective date for the proposed amendments to FINRA Rules 0180, 4120 and 9610 will be February 6, 2022, and the effective date for the proposed amendments to FINRA Rules 4210, 4220 and 4240 will be April 6, 2022.211 The proposed effective dates will also align with the new expiration dates of current FINRA Rules 0180 and 4240, such that the temporary rules will expire on the day the proposed permanent rules become effective.212 III. Discussion and Commission Findings After careful review of the proposed rule change, as modified by Amendment No. 1, the comment letters, and FINRA’s responses to the comments, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder that are applicable to a national securities association.213 Specifically, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with Section 209 See Notice at 26086. id. 211 A commenter expressed concern as to FINRA’s initial proposed effective date for the proposed rule change. See SIFMA Letter at 1–3, 11. In response, on August 9, 2021, FINRA filed Amendment No. 1, which: (1) Extended the effective date of the proposed amendments to FINRA Rules 0180, 4120 and 9610 to February 6, 2022; (2) extended the effective date of the proposed amendments to FINRA Rules 4210, 4220 and 4240 to April 6, 2022; and (3) conformed the proposed definition of ‘‘Legacy Swap’’ in proposed FINRA Rule 4240(d)(12) to reflect the new effective date of April 6, 2022. See FINRA Letter at 14–15. 212 As discussed above in Section II.A, in September 2021, the existing exceptions for current FINRA Rules 0180 and 4240 were extended to February 6, 2022 and April 6, 2022, respectively, and current Rule 4240 was amended to add Supplementary Material .02, which clarifies that the rule does not apply to a member that is registered with the Commission as an SBSD. See Extension Notice, supra note 17. 213 In approving this rule change, the Commission has considered the rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). lotter on DSK11XQN23PROD with NOTICES2 210 See VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 15A(b)(6) of the Exchange Act,214 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, to facilitate transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and, in general, to protect investors and the public interest. A. Proposed Rule 0180(a) (Application of FINRA Rules to Security-Based Swaps) As discussed above in Section II.B., the proposed rule change would replace current FINRA Rule 0180 with new FINRA Rule 0180 and would apply all FINRA rules to SBS activities and positions with respect to SBS, unless subject to specific exceptions set forth in proposed FINRA Rule 0180. Five commenters were supportive of the proposed rule change generally.215 One commenter suggested that, as an alternative, FINRA members be permitted to comply with the Commission’s SBS rules in lieu of a parallel FINRA rule.216 The commenter proposed that FINRA could either consider incorporating into the FINRA rules a reference to the analogous Commission rules or permit FINRAregulated broker-dealers not registered with the Commission as an SBSD to ‘‘opt-in’’ to the relevant Commission SBS rules.217 In its response, FINRA stated that neither of these alternatives would be appropriate.218 FINRA believes the limited exceptions in proposed Rules 0180(c) through (g) are appropriate only in the context of registered SBS Entities subject to the SEC’s full regulatory framework applicable to such registrants.219 FINRA does not believe that it would be appropriate to permit members that are not SBS Entities registered with the Commission to ‘‘optin’’ to the parallel SEC rules, or to incorporate SEC rules by reference for FINRA members not registered with the Commission as SBS Entities.220 FINRA stated that a FINRA member engaged in SBS activities below the de minimis threshold for registration with the Commission may nonetheless elect to 214 15 U.S.C. 78o–3(b)(6). Letters at 1 (stating the need for the proposed rule change ‘‘to be enacted, as is, for the protection and operation of free and fair markets.’’); see also SIFMA Letter at 1 (stating support for many aspects of the proposed rule change). 216 See PML Letter at 4. 217 Id. 218 See FINRA Letter at 3. 219 Id. 220 Id. register with the Commission on a voluntary basis, and thereby become subject to the Commission’s full regulatory framework for SBS.221 FINRA’s determination to generally apply FINRA rules to members’ activities and positions with respect to SBS,222 other than the specific enumerated exceptions discussed below, is reasonable. Specifically, FINRA reasonably determined that, because SBS are securities under the Exchange Act, FINRA’s existing rule framework, which is designed to regulate the securities activity of its members, should apply absent a specific exception. FINRA’s determination is consistent with the requirement in the Exchange Act that FINRA, as a registered securities association, have rules designed to, among other things, facilitate transactions in securities and enforce compliance with the Exchange Act by its members.223 Applying these rules to FINRA members’ SBS activities and positions with respect to SBS will help prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and protect investors and the public interest. The general presumption under Rule 0180(a) that FINRA rules apply to members’ SBS activities and positions, except where otherwise specified in the rule, would help ensure that FINRA members that are not also registered as an SBS Entity with the Commission will be subject to a comprehensive set of FINRA rules governing, among other things, conduct and communication by members, with respect to the members’ SBS activities and positions. It is appropriate that, with the exception of proposed Rule 0180(b),224 an exception to this general presumption will apply only where a FINRA member is registered with the Commission as an SBS Entity. This important limitation will provide appropriate regulatory oversight with respect to SBS activity— where the FINRA member is registered with the Commission as an SBS Entity, the comprehensive framework the Commission has adopted for regulation of SBS, including its examination program, will apply. Conversely, where the FINRA member is not registered with the Commission as an SBS Entity, it is appropriate for the member to 215 See PO 00000 Frm 00018 Fmt 4701 Sfmt 4703 221 Id. at 3–4. Notice at 26086. FINRA believes this determination is consistent with both Congress’s intent and FINRA’s regulatory responsibility. Id. 223 See Exchange Act Section 15A(b)(2); (6). 224 As discussed below, the proposed exception in FINRA Rule 0180(b) is not conditioned on registration as an SBS Entity but rather the general inapplicability of those rule sets to SBS activity. 222 See E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 comply with a comprehensive set of FINRA rules as set forth in the proposed rule change and be primarily subject to FINRA’s examination program. In the event a FINRA member that is not required to be registered with the Commission as an SBS Entity would prefer to instead comply with the Commission’s SBS regulatory framework (and avail itself of the exceptions specified in proposed FINRA Rule 0180(b)–(g)), the member may voluntarily elect to register as an SBS Entity with the Commission and thus become subject to the full regulatory framework for registered SBS Entities, which includes Commission examination authority for compliance with such rules. Accordingly, for the foregoing reasons, the Commission finds the proposed rule change is consistent with the protection of investors and in the public interest. B. Proposed Rule 0180(b) (General Exceptions From Applicability to FINRA Rules) Proposed FINRA Rule 0180(b) would specify certain exceptions from the general presumption of applicability of FINRA rules to SBS. Specifically, FINRA Rule 0180(b) would except members’ SBS activities and positions from the FINRA Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities); the FINRA Rule 7000 Series (Clearing, Transaction, and Order Data Requirements, and Facility Charges); and the FINRA Rule 11000 Series (Uniform Practice Code). All commenters expressed support for FINRA’s proposed rule change to exempt members’ SBS activities and positions from these rules.225 One commenter stated that ‘‘providing exceptions for [FINRA Rules 6000 Series, 7000 Series, and 11000 Series] will promote clarity, considering that these rules are not designed to apply to SBS, and arguably overlap with some of the [Commission’s] SBS rules (such as reporting and public dissemination under Regulation SBSR).’’ 226 As discussed above in Section II.C., FINRA believes that the 6000, 7000 and 11000 series rules are not designed to apply to SBS and are not particularly well-adapted to positions in or activities involving SBS.227 FINRA believes that while some of these rules could potentially be interpreted as applying to SBS activities by their terms, doing so could create operational difficulties and/or create confusion and uncertainty 225 See SIFMA Letter at 3; PML Letter at 2; Letters at 1. 226 See 227 See SIFMA Letter at 3. Notice at 26088. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 in the SBS market.228 FINRA believes the proposed rule change would provide legal certainty and clarity for its members by specifically excepting these rules from applying to members’ activities and positions with respect to SBS.229 The FINRA Rule 6000 and 7000 Series include various rules relating to trading, quoting, clearing and reporting for different types of securities. Many of these rules do not appear to apply to SBS by their terms.230 As discussed in Section II.C, the FINRA Rule 11000 Series sets forth the UPC, a series of rules, interpretations and explanations created to simplify and facilitate the day-to-day business of investment banking and securities between FINRA members, particularly with respect to operational and settlement issues.231 Because the UPC generally applies to all OTC secondary market transactions in securities, it could be interpreted as applying to SBS transactions. However, because the UPC applies only to transactions between FINRA members, even if the UPC were to apply, it could be invoked only for those specific transactions.232 FINRA believes that applying the UPC rules to such a limited subset of SBS in the overall SBS market could create confusion and uncertainty.233 The Commission finds that the proposed rule change would avoid unnecessary and potentially duplicative regulation in this area by specifically providing exceptions for SBS from the FINRA Rule 6000, 7000, and 11000 series, and is designed to protect investors and the public interest. These rules were not designed to provide regulatory oversight of SBS activity, and even if certain of these rules were interpreted to apply to SBS activity, they would apply only to a subset of SBS activity, leading to the potential for regulatory inconsistency. Accordingly, the Commission finds that the exceptions for the Rule 6000, 7000, and 11000 series in Rule 0180(b) is designed to protect investors and the public interest. C. Proposed Rules 0180(c) and (d) (Exceptions for Registered SBS Entities and Associated Persons) Proposed Rules 0180(c) and (d), as discussed above in Section II.D., would provide that specified FINRA Rules 228 See id. 229 See id. 230 See id.; see also FINRA Rules 6000 and 7000 series. 231 See Notice at 26088. 232 See id. 233 See supra note 23 and related text; see also Notice at 26088. PO 00000 Frm 00019 Fmt 4701 Sfmt 4703 1979 shall not apply to members’ activities and positions with respect to SBS, only where the following conditions are met: (1) The member is acting in its capacity as an SBS Entity or the associated person of the member is acting in his or her capacity as an associated person of an SBS Entity, as applicable; and (2) that such activities or positions relate to the business of the SBS Entity within the meaning of the Exchange Act Rule 15Fh–3(h)(1), the Commission’s supervision rule for SBS Entities. The exceptions in Rule 0180(c) would apply to both SBSDs and MSBSPs or their associated persons, while the exceptions in Rule 0180(d) would apply only to SBSDs or their associated persons (and not MSBSPs or their associated persons), consistent with whether the Commission rule that FINRA believes is analogous with a corresponding FINRA rule is applicable to all SBS Entities or their associated persons, or only SBSDs (and not MSBSPs or their associated persons).234 One commenter specifically addressed these exceptions, offering support for their inclusion in the proposed rule, subject to requests for clarifications as to some aspects of the proposed exceptions that are addressed below.235 1. Proposed Rule 0180(c) Proposed Rule 0180(c) would except five FINRA rules from applying to members’ SBS activities and positions where the conditions described above are met: (1) Rule 2210(d) (Communications with the Public— Content Standards); (2) Rule 2232 (Customer Confirmations); (3) Rule 3110 (Supervision); (4) Rule 3120 (Supervisory Control System); and (5) Rule 3130 (Certification of Compliance and Supervisory Procedures). As discussed below, FINRA believes that each of these rules is similar to a particular Commission rule or set of rules applicable to SBS Entities.236 FINRA further believes that these proposed exceptions are appropriate only to the extent that the Commission’s parallel SBS Entity rules will apply to the SBS activity, and only where the SBS activity relates to the business of the SBS Entity within the meaning of the Commission’s SBS Entity supervision rule.237 234 See Notice at 26089. SIFMA Letter at 3 (stating the rules to be excepted under the proposal and noting that ‘‘[a]s FINRA observes, these rules would unnecessarily duplicate certain of the Commission’s SBS rules if they applied to SBS Entities or their associated persons’’). 236 See Notice at 26089. 237 Id. 235 See E:\FR\FM\12JAN2.SGM 12JAN2 1980 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 Rule 2210(d) (Communications With the Public—Content Standards). FINRA Rule 2210(d) governs the content standards of members’ communications with the public and requires communications be based on principles of fair dealing and good faith. Under FINRA’s proposed rule change, where Exchange Act Rule 15Fh–3(g) applies to SBS Entities—imposing communication standards on both registered SBS Entities that are modeled after several of the existing requirements in FINRA Rule 2210(d)—those FINRA requirements would not also apply. Exchange Act Rule 15Fh–3(g) requires SBS Entities to communicate with parties in a fair and balanced manner based on principles of fair dealing and good faith. As the Commission has previously noted, this standard is consistent with the similarly worded requirement in FINRA Rule 2210(d).238 Three additional Exchange Act Rule provisions supplement the required content standards of SBS Entities.239 Taken together, FINRA believes that these provisions are analogous to FINRA requirements contained in Rule 2210(d) that require, among other things, member communications be based on principles of fair dealing and good faith, be fair and balanced, and not omit any material facts or make false or exaggerated claims.240 Rule 2232 (Customer Confirmations). Proposed Rule 0180(c) would except members registered as SBS Entities from the application of FINRA Rule 2232 (Customer Confirmations) with respect to their SBS positions and activities when such activities or positions relate to their business as SBS Entities within the meaning of the SBS supervision rule.241 FINRA Rule 2232 (Customer Confirmations) generally requires members to provide customers with written confirmations in conformity with Exchange Act Rule 10b–10,242 238 See Exchange Act Release No. 64766 (Jun. 29, 2011) at 86–7, 76 FR 42396 at 42418 (Jul. 18, 2011) (Proposed Rule: Business Conduct Standards for Security-Based Swap Dealers and Major SecurityBased Swap Participants). 239 FINRA stated that the SEC’s business conduct rules also include requirements for SBS Entities to make certain disclosures to their SBS counterparties, including disclosures of material risks and characteristics and material incentives or conflicts of interest; daily mark disclosures; and disclosures regarding clearing rights. See Notice at 26090; see also Exchange Act Rules 15Fh–3(b)—(d) (addressing requirements for disclosures of material risks and characteristics and material incentives of conflicts of interest; daily mark disclosures; and disclosures regarding clearing rights). 240 See Notice at 26090; see also FINRA Rule 2210(d)(1)(A). 241 See Notice at 26089–90. 242 See Notice at 26090; see also 17 CFR 240.10b– 10. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 along with specified additional disclosures for certain types of securities. Exchange Act Rule 15Fi–2 requires SBS Entities to provide trade acknowledgments and to establish, maintain and enforce written policies and procedures reasonably designed to obtain prompt verification of the terms of such trade acknowledgments.243 FINRA states that the SEC’s trade acknowledgement and verification rule provides that an SBS Entity that is also a broker or dealer, is purchasing from or selling to any counterparty, and that complies with the relevant requirements of the trade acknowledgment and verification rule, is exempt from the requirements of Exchange Act Rule 10b– 10 with respect to the SBS transaction.244 In the Trade Acknowledgement and Verification Release, the Commission stated that requiring an SBS Entity that is also a broker or a dealer to comply with both Rule 10b–10 and Rule 15Fi– 2 could be duplicative and overly burdensome.245 In seeking the requested exemption from Rule 2232, FINRA has stated that FINRA similarly believes that applying both the SEC’s rules for SBS Entities and FINRA’s parallel rules for its members to the same SBS activity would result in unnecessary regulatory duplication.246 One commenter requested clarification concerning customer confirmations.247 The commenter stated that the Commission has adopted an exemption concerning a broker-dealer’s requirement to give or send the disclosure required by Exchange Act Rule 10b–10(a) at or before completion of the transaction in connection with such broker-dealer or its associated persons arranging, negotiating or executing an SBS transaction on behalf of an affiliated SBSD, provided that the broker-dealer gives or sends the customer written notification containing such disclosures in accordance with the time and form requirements for an SBSD’s trade acknowledgment under Exchange Act Rule 15Fi–2(b) and (c) and, as applicable, Rule 10b–10(c).248 The commenter requested that FINRA clarify that, to the extent a member would be eligible for this exemption, but not the proposed FINRA Rule 243 See Notice at 26090; see also 17 CFR 240.15Fi–2; see generally Trade Acknowledgment and Verification Release, supra note 13. 244 See Notice at 26090; see also 17 CFR 240.15Fi–2(g); Trade Acknowledgment and Verification Release at 39824–25. 245 Trade Acknowledgment and Verification Release at 39821. 246 See Notice at 26106. 247 See SIFMA Letter at 3. 248 See 17 CFR 240.3a71–3(d)(5). PO 00000 Frm 00020 Fmt 4701 Sfmt 4703 0180(c) exception from FINRA Rule 2232 (Customer Confirmations), it can satisfy Rule 2232 by giving and sending a written notification to its customer in accordance with the timing reflected in the exemption provided by the Commission in Exchange Act Rule 3a71–3(d)(5).249 In response, FINRA stated that FINRA Rule 2232(a) requires that a member shall, at or before the completion of any transaction in a security effected for or with an account of a customer, give or send to such customer a confirmation in conformity with the requirements of Exchange Act Rule 10b–10.250 FINRA further stated that since the Commission has provided an exemption permitting a broker-dealer to provide the disclosures required by Exchange Act Rule 10b– 10(a) in accordance with the time and form requirements for an SBSD’s trade acknowledgment, a member acting in conformity with the requirements of Exchange Act Rule 10b–10, including where the member is acting in accordance with an applicable SEC exemption, would satisfy the requirements of Rule 2232(a) (provided that the member complies with all other provisions of Rule 2232, as applicable).251 Rules 3110 (Supervision), 3120 (Supervisory Control System) and 3130 (Annual Certification of Compliance and Supervisory Processes). Proposed Rule 0180(c) would except FINRA members that are also registered SBS Entities from the application of FINRA Rules 3110 (Supervision), 3120 (Supervisory Control System) and 3130 (Annual Certification of Compliance and Supervisory Processes) with respect to their SBS positions and activities where the conditions described above are met. Taken together, these rules require, among other things, that FINRA members establish and maintain a supervisory system, designate a chief compliance officer, and submit annual certifications to FINRA related to the member’s compliance policies and written supervisory procedures.252 FINRA believes that the Commission has adopted an analogous framework for 249 See SIFMA Letter at 4; see also Exchange Act Release No. 90308 (Nov. 2, 2020), 85 FR 70667 (Nov. 5, 2020) (Order Granting Exemptions from Sections 8 and 15(a)(1) of the Securities Exchange Act of 1934 and Rules 3b–13(b)(2), 8c–1, 10b–10, 15a–1(c), 15a–1(d) and 15c2–1 Thereunder in Connection with the Revision of the Definition of ‘‘Security’’ to Encompass Security-Based Swaps and Determining the Expiration Date for a Temporary Exemption from Section 29(b) of the Securities Exchange Act of 1934 in Connection with Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants). 250 See FINRA Letter at 4. 251 Id. 252 See Notice at 26090. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices supervision of SBS Entities that applies to all FINRA members that are also registered SBS Entities.253 Exchange Act Rule 15h–3(h) requires, among other things, that an SBS Entity establish and maintain a system to supervise, and to diligently supervise, its business and the activities of its associated persons; designate at least one person with authority to carry out supervisory responsibilities; and establish, maintain and enforce written policies and procedures addressing supervision of the SBS Entity’s SBS business. Exchange Act Rule 15Fk–1 requires each SBS Entity to designate a chief compliance officer and submit annual compliance reports to the Commission. lotter on DSK11XQN23PROD with NOTICES2 2. Proposed Rule 0180(d) Proposed Rule 0180(d) would except three additional FINRA rules from applying to members’ SBS activities and positions where the conditions described above are met and the FINRA member is a registered SBSD (but not a MSBSP): (1) Rule 2030 (Engaging in Distribution and Solicitation Activities with Government Entities); (2) Rule 2090 (Know Your Customer); and (3) Rule 2111 (Suitability). As discussed below, FINRA believes that each of these rules is similar to a particular Commission rule or set of rules specifically applicable to SBSDs but not MSBSPs.254 FINRA further believes that these proposed exceptions are appropriate only to the extent that the Commission’s parallel rules applicable to SBSDs (but not MSBSPs) will apply to the SBS activity, and only where the SBS activity relates to the business of the SBSD (but not an MSBSP) within the meaning of the Commission’s SBS Entity supervision rule.255 Rule 2030 (Engaging in Distribution and Solicitation Activities with Government Entities). FINRA Rule 2030 governs ‘‘pay-to-play’’ activities by member firms that engage in distribution or solicitation activities for compensation with government entities on behalf of investment advisers. In particular, FINRA Rule 2030(a) prohibits a member from engaging in distribution or solicitation activities for compensation with a government entity within two years after a contribution to an official of the government entity is made by the covered member or a covered associate (including a person who becomes a covered associate within two years after the contribution is 253 See id. at 26089. 254 See Notice at 26089. 255 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 made).256 Similarly, Exchange Act Rule 15Fh–6 generally prohibits an SBSD from engaging in SBS transactions with a municipal entity within two years after certain political contributions have been made to officials of the municipal entity.257 Under FINRA’s proposed rule change, where Exchange Act Rule 15Fh–6 applies to SBS Entities, the SBS Entity would be excepted from FINRA Rule 2030. Rule 2090 (Know Your Customer). FINRA Rule 2090 requires members to use due diligence to know the essential facts concerning every customer (including the customer’s financial profile and investment objectives or policy). Under FINRA’s proposed rule change, where Exchange Act Rules 15Fh–3(a) and (e) applies to SBSDs, the SBSDs would be excepted from FINRA Rule 2090. Rule 15Fh–3(a) generally requires SBS Entities to verify the status of their SBS counterparties.258 Rule 15Fh–3(e) requires an SBSD to establish, maintain and enforce policies and procedures reasonably designed to obtain and retain a record of the essential facts that are necessary for conducting business with each counterparty that is known to the SBSD. Rule 15Fh–3(e) is a modified version of the ‘‘know your customer’’ requirements, such as those in FINRA Rule 2090, to which broker-dealers are subject.259 Under FINRA’s proposal, where SBSDs are subject to Rule 15Fh– 3(a) and (e), the analogous FINRA requirements would not also apply. Rule 2111 (Suitability). FINRA Rule 2111(a) requires members, when making a recommendation, to have a reasonable basis to believe that recommendation is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. FINRA Rule 2111(b) provides that a member fulfills this suitability obligation for an institutional account if the member has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently and the institutional customer exercises independent judgment in evaluating the 256 See FINRA Regulatory Notice 16–40 (October 2016). 257 Business Conduct Standards Release at 29962. 258 See Notice at 26090. Although Rule 15Fh–3(a) is applicable to both SBSDs and MSBSPs, FINRA Rule 2090 applies to requires members to use reasonable diligence ‘‘in regard to the opening or maintenance of’’ an account. FINRA Rule 2090. As MSBSPs are by definition not SBSDs, MSBSPs do not have customer accounts; therefore, Rule 2090 is inapplicable as to MSBSPs even if they are FINRA members. See, e.g., 17 CFR 240.3a67–1. 259 See Business Conduct Proposal at 42414. PO 00000 Frm 00021 Fmt 4701 Sfmt 4703 1981 recommendations. Where the institutional customer has delegated decision-making authority to an agent, such as an investment adviser, these suitability rule factors apply to the agent under FINRA’s rule. Exchange Act Rule 15h–3(f) creates a suitability obligation for SBSDs, including an institutional suitability alternative that is modeled after FINRA Rule 2111(b).260 Under FINRA’s proposed rule change, where Exchange Act Rule 15Fh–3(f) applies, the SBS Entity would be excepted from FINRA Rule 2111.261 As to each of the FINRA rules proposed to be excepted under Rule 0180(c) and Rule 0180(d), an analogous Commission rule already applies to a registered SBS Entity (under Rule 0180(c)) or SBSD (under Rule 0180(d)). Without these proposed exceptions, a FINRA member that is also registered with the Commission as an SBS entity (under Rule 0180(c)) or as an SBSD (under Rule 0180(d)) would be required to comply with both the Commission’s comprehensive framework enacted under Title VII as well as FINRA rules with analogous requirements. The Commission concludes it is generally unnecessary for FINRA rules to apply in circumstances where the SBS activities, and the SBS entities (under Rule 0180(c)) or SBSDs (under Rule 0180(d)), are already regulated directly by the Commission. The Commission further concludes it is reasonable that the exceptions in FINRA Rule 0180(d) do not apply to MSBSPs, because they are not subject to either the FINRA rule referenced in Rule 0180(d) and/or the analogous Commission rule. Therefore, FINRA’s proposal to provide the limited exceptions in proposed FINRA Rule 0180(c) and 0180(d), is a reasonable, tailored approach that reduces potentially unnecessary and duplicative regulatory requirements. D. Proposed Rule 0180(e) (Exceptions in Connection With Arranging, Negotiating, and Executing Activity) As discussed above in Section II.E., Proposed Rule 0180(e) would provide that the following FINRA rules shall not apply to members’ activities with respect to SBS, to the extent that the member or the associated person of the member, as applicable, is arranging, negotiating or executing SBS on behalf of a non-U.S. affiliate pursuant to, and in compliance with the conditions of, the exception from counting certain SBS 260 Business Conduct Standards Release at 29967, n.68. 261 FINRA also noted that Exchange Act Rule 15Fh–5 applies special, enhanced requirements when SBS Entities act as counterparties to special entities. See Notice at 26091. E:\FR\FM\12JAN2.SGM 12JAN2 1982 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 under Exchange Act Rule 3a71–3(d)(1): (1) FINRA Rule 2111 (Suitability); (2) FINRA Rule 2210(d) (Communications with the Public—Content Standards); and (3) FINRA Rule 2232 (Customer Confirmations). The availability of the exceptions under proposed FINRA Rule 0180(e) would require the member’s compliance with the conditions specified in Exchange Act Rule 3a71– 3(d)(1)(ii)(B) as if the member were the counterparty to the SBS transactions.262 Specifically, to satisfy the exception from counting certain SBS under Exchange Act Rule 3a71–3(d)(1), the member must comply with, among other things, Exchange Act Rule 15Fh–3(b) (disclosures of material risks and characteristics and material incentives or conflicts of interest), Exchange Act Rule 15Fh–3(f)(1) (recommendations and suitability), Exchange Act Rule 15Fh–3(g) (fair and balanced communications) and Exchange Act Rule 15Fi–2 (acknowledgement and verification of SBS transactions).263 If a member fails to comply with these Commission rules, the member’s foreign affiliate would be required to count each applicable SBS transaction toward its de minimis registration threshold.264 One commenter specifically addressed this exception, offering support for its inclusion in the proposed rule.265 The Commission believes that members whose foreign affiliates are seeking to rely on the exception from counting certain SBS transactions under Exchange Act Rule 3a71–3(d)(1), may have their own obligations to comply with FINRA’s rules governing suitability, customer communications, and customer confirmations, apart from any obligation to comply with analogous Commission rules noted above as a condition of Exchange Act Rule 3a71–3(d)(1). Without the exceptions in proposed FINRA Rule 0180(e), this could result in unnecessarily duplicative obligations. Where the member is in fact complying with the specified Commission rules, the proposed rule change is designed to help protect investors and the public interest by avoiding potential confusion 262 As discussed above, all other FINRA rules would remain applicable to a member acting as the U.S. Registered Affiliate under Exchange Act Rule 3a71–3(d). See supra note 46. 263 See Notice at 26092–93. 264 Id. at 26093. 265 See SIFMA Letter at 1 (stating, ‘‘[w]e support this exception, which appropriately avoids overlaps between FINRA’s suitability, communication standards, and confirmation requirements, on the one hand, and SEC Rules 15Fh–3(f)(1), 15Fh–3(g), and 15Fi–2, on the other hand, which the FINRA member would be required to satisfy when acting for its non-U.S. affiliate pursuant to SEC Rule 3a71– 3(d)(1)(ii).’’). VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 surrounding whether FINRA rules apply in addition to analogous Commission rules to regulate the same conduct. It is appropriate to provide exceptions from these FINRA rules to provide clarity and avoid unnecessary regulatory duplication. Accordingly, the Commission finds that the proposed rule change is designed to protect investors and the public interest. E. Proposed Rule 0180(f) (Exceptions From Rules 2231, Customer Account Statements, and 4512, Customer Account Information) Proposed Rule 0180(f), as discussed above in Section II.F., would provide that FINRA Rules 2231 (Customer Account Statements) and 4512 (Customer Account Information) shall not apply to members’ activities and positions with respect to SBS, to the extent that the member is acting in its capacity as an SBS Entity and the customer’s account solely holds SBS and collateral posted as margin in connection with such SBS, provided that the member complies with the portfolio reconciliation requirements of Exchange Act Rule 15Fi–3 with respect to such account and that such portfolio reconciliations include collateral posted as margin in connection with SBS in the account.266 A commenter requested that FINRA provide two clarifications with respect to proposed FINRA Rule 0180(f). First, the commenter stated that FINRA should clarify that a member may rely on the Rule 0180(f) exception in circumstances where the member’s SBS account for the customer also includes non-securities positions, such as swaps.267 Second, the commenter stated that FINRA should clarify that a member may rely on the Rule 0180(f) exception when, in addition to a customer’s SBS account, the member carries a non-SBS securities account for the customer and there is no portfolio margining or other commingling between the two accounts.268 In response, FINRA stated that the Commission, jointly with the CFTC, has published a request for comment on the portfolio margining of uncleared swaps and uncleared SBS.269 As such, FINRA 266 As a practical matter, the Commission states that most, if not all, requirements pertaining to the amount of collateral posted will be a ‘‘material term’’ for purposes of Exchange Act Rule 15Fi–1(i), such that this information would be required to be reconciled pursuant to Exchange Act Rule 15Fi–3. 267 See SIFMA Letter at 4. 268 See id. 269 See FINRA Letter at 5; see also Exchange Act Release No. 90246 (Oct. 22, 2020), 85 FR 70536 (Nov. 5, 2020) (Request for Comment: Portfolio Margining of Uncleared Swaps and Non-Cleared Security-Based Swaps). PO 00000 Frm 00022 Fmt 4701 Sfmt 4703 believes it would be premature to provide further guidance in this area at this time, but will consider addressing remaining questions through interpretive guidance when appropriate.270 Another commenter expressed support for eliminating the exceptions set forth in FINRA’s proposed Rule 0180(f), maintaining that there is potential for confusion and disparate treatment as it pertains to FINRA Rules 2231 (Customer Account Statements) and 4512 (Books and Records/Customer Account Information) relative to Exchange Act Rule 15Fi–3 (the Commission’s portfolio reconciliation rule for SBS Entities).271 While the commenter respected FINRA’s attempt to reduce burdens for participants, the commenter believes that with increased SBS activity, the exemption could be burdensome to some SBS Entities, while providing relief to other SBS Entities.272 The commenter further believes that differences between FINRA Rule 2231 and Exchange Act Rule 15Fi–3 are ‘‘stark.’’ 273 The commenter strongly supports portfolio reconciliation as a vital component to reducing systemic risk and other issues associated with SBS. However, as a practical matter this commenter believes that the burden of providing account statements based on a pre-defined methodology serves an important purpose for risk control as well.274 Further, the commenter stated that there is a high likelihood that an existing SBS Entity that solely holds SBS and related collateral also is an affiliate of larger organizations with sufficient infrastructure to comply with FINRA Rule 2231.275 FINRA responded that the exception in proposed Rule 0180(f) applies only where a member is acting in its capacity as a registered SBS Entity and a customer’s account solely holds SBS and collateral posted as margin in connection with SBS, provided that the member complies with the portfolio reconciliation requirements of Exchange Act Rule 15Fi–3 with respect to such account and that such portfolio reconciliations include collateral posted as margin in connection with SBS in the account.276 FINRA believes that the SEC’s portfolio reconciliation requirements set forth in Exchange Act Rule 15Fi–3 277 and the customer 270 See 271 See FINRA Letter at 5. PML Letter at 5. 272 Id. 273 See id. at 6. 274 Id. 275 Id. 276 See 277 See E:\FR\FM\12JAN2.SGM FINRA Letter at 5. supra note 56. 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices account statement requirements under FINRA Rule 2231 serve similar purposes such that requiring delivery of customer account statements for SBS-only accounts that are also subject to portfolio reconciliation would be unnecessary duplication.278 FINRA further believes that it does not anticipate that this exception would create confusion, as SBS customers of an SBS Entity would expect to engage in portfolio reconciliation for their SBS accounts in accordance with the Commission rules, rather than for such SBS to appear on the customer account statement they may receive because the firm is also a FINRA member brokerdealer.279 The Commission recognizes that there are differences with respect to the frequency and timing requirements under Exchange Act Rule 15Fi–3 and FINRA Rule 2231. For example, whereas Exchange Act Rule 15Fi–3 requires SBS Entities to reconcile their portfolios with other counterparties more frequently than FINRA Rule 2231 requires its members to deliver an account statement to its customers, in some limited circumstances the Commission’s rule would require portfolio reconciliation to occur less frequently than the timing requirements of FINRA’s account statement rule.280 Nevertheless, the Commission finds that under the limited circumstances in which the exception from FINRA Rule 2231 in proposed FINRA Rule 0180(f) applies, Exchange Act Rule 15Fi–3 should sufficiently serve similar purposes to FINRA Rule 2231, as it relates to providing information about an SBS with a customer who is a counterparty to an SBS, such that requiring members that are SBS Entities 278 Id. at 6. FINRA further explained that it believes that a member that is not an SBS Entity and thus not subject to the SEC’s portfolio reconciliation requirements—as well as other Commission rules related to risk mitigation, such as portfolio compression and trading relationship documentation—should include any SBS on a customer’s account statements, regardless of whether such SBS are in a separate account from other securities, because SBS are securities. See id. 280 Specifically, FINRA Rule 2231 requires each member to provide its customer with an account statement that satisfies the requirements of the rule on at least a quarterly basis. By contrast, the timing requirements in Exchange Act Rule 15Fi–3 vary, depending on whether the applicable counterparty is also an SBS Entity and the size of the SBS portfolio. The only time that portfolio reconciliation would be required to occur less frequently than quarterly would when an SBS Entity is facing a counterparty that is not also an SBS Entity and the size of the SBS portfolio does not exceed 100 SBS at any time during the calendar year, in which case the SBS Entity would only be required to have policies and procedures reasonably designed to ensure reconciliation on an annual basis. See 17 CFR 240.15Fi–3(b)(3)(ii). lotter on DSK11XQN23PROD with NOTICES2 279 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 to also provide customer account statements for accounts holding solely SBS and related collateral would be unnecessarily duplicative. Further, as the exception only applies to accounts holding solely SBS and related collateral, the portfolio reconciliation requirements of Rule 15Fi–3 should provide sufficient risk control. To the extent that a customer’s account includes SBS along with other securities positions or activity, or related money balances, then the account statement under FINRA Rule 2231 should include SBS. Thus, it is appropriate and consistent with the protection of investors and the public interest to provide an exception from FINRA Rule 2231 under circumstances when the Commission’s risk mitigation requirements for SBS Entities under Exchange Act Rule 15Fi–3 will apply to SBS Entities, subject to the conditions discussed above. The Commission also recognizes, however, that this is an evolving market and a new regulatory framework, and acknowledges FINRA’s commitment to consider providing interpretive guidance as appropriate.281 Similarly, the Commission’s requirements pertaining to written SBS trading relationship documentation pursuant to Exchange Act Rule 15Fi–5, and the books and records requirements for SBS Entities that are also registered broker-dealers Exchange Act Rule 17a– 3 will also continue to apply. These rules sufficiently serve similar purposes to FINRA Rule 4512, such that also applying FINRA Rule 4512 to SBS-only accounts would be duplicative. Accordingly, these limited circumstances in Proposed Rule 0180(f) reduce unnecessary and duplicative regulation. F. Proposed Rule 0180(g) (Exception From FINRA Registration for Certain Associated Persons of Registered SBS Entities) The FINRA qualification and registration requirements are set forth in the FINRA Rule 1200 series.282 Proposed Rule 0180(g), as discussed above in Section II.G., would provide that persons associated with a member whose functions are related solely and exclusively to SBS, and undertaken in such person’s capacity as an associated person of an SBS Entity, are not required to be registered with FINRA. One commenter generally supported the exception but requested clarification that an associated person relying on the exception set forth in FINRA’s proposed Rule 0810(g) may, in addition to their SBS activities, also engage in nonsecurities activities on behalf of the member, such as soliciting or accepting swaps in the capacity as an associated person or a swap dealer, and that additional activity would not otherwise trigger FINRA registration or continuing education requirements and would not prevent reliance on the proposed exception.283 Further, the commenter suggested that FINRA Rule 0180(g) should clarify that the person’s ‘‘securities-related functions’’ must be related solely and exclusively to SBS undertaken in such person’s capacity as an associated person of a registered SBS Entity.284 A second commenter questioned the exemptions provided in proposed Rule 0180(g) and whether there are likely many, or even any, individuals associated with a FINRA member who would trade in SBS exclusively without also engaging in transactions in the underlying equity.285 To the extent there are such individuals, the commenter further questioned whether such individuals should be exempt from FINRA’s qualifications and registration requirements.286 The commenter also expressed the belief that the likelihood of such individuals to enter the SBS market has the potential to increase.287 It is the commenter’s belief that, although the qualification examinations and continuing education (‘‘CE’’) requirements may not specifically address SBS, the examination and CE requirements do require an associated person to have familiarity with the characteristics of the underlying equity securities and regulatory framework, which the commenter considers important to have for anyone engaged in SBS activities.288 The commenter further maintained that the exemptions provided in proposed Rule 0180(g) may potentially cause ‘‘confusion for both exempt persons and ‘dual-hatted’ personnel,’’ and that such persons could avoid regulations such as FINRA Rule 2111 (Suitability) to which other registered persons are subject.289 The 283 See 281 See e.g., Exchange Act Release No. 90246 (Oct. 22, 2020), 85 FR 70536 (Nov. 5, 2020) (Request for Comment: Portfolio Margining of Uncleared Swaps and Non-Cleared Security-Based Swaps). 282 FINRA Rule 1210 requires that each person engaged in the securities business of a member register with FINRA unless an exemption applies. See FINRA Rule 1210. PO 00000 Frm 00023 Fmt 4701 Sfmt 4703 1983 SIFMA Letter at 5. 284 Id. 285 See PML Letter at 4. 286 Id. 287 Id. 288 Id. 289 Id. at 5. With respect to the applicable suitability standard specifically, the commenter E:\FR\FM\12JAN2.SGM Continued 12JAN2 1984 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 commenter also stated that it may be unclear if FINRA Rule 4530 (Reporting Requirements) would apply to a member if the potentially reportable conduct involved a person associated with a member whose functions are related solely and exclusively to SBS undertaken in the person’s capacity as an associated person of a registered SBS Entity.290 In response to the comments, FINRA stated that a member is responsible for monitoring the activities of each of its associated persons to determine whether such person is required to be registered with FINRA and, if so required, to ensure that each associated person is registered in the appropriate category or categories.291 FINRA cited to FINRA Rule 1210 (Registration Requirements), which requires persons engaged in the investment banking or securities business of a member to be registered ‘‘in each category of registration appropriate to his or her functions and responsibilities as specified’’ in FINRA Rule 1220.292 FINRA Rule 1210 further states that persons ‘‘shall not be qualified to function in any registered capacity other than that for which the person is registered, unless otherwise stated in the rules.’’ 293 FINRA also stated that the exception in proposed FINRA Rule 0180(g) would only apply to associated persons in the limited circumstances set forth in Rule 0180(g), and does not otherwise affect FINRA members’ responsibilities regarding the registration of their associated persons.294 Thus, according to FINRA, a member relying on the proposed exception with respect to one or more of its associated persons would still need to monitor the activities of all of its associated persons, including any associated persons relying on the exception, to determine whether any of the person’s activities require registration under FINRA rules.295 Accordingly, with respect to the commenter’s request for clarification, FINRA stated that it was not necessary stated that SBSDs are afforded different treatment under the proposed rule change, as the Commission’s suitability rules would apply, creating another disparity for a non-SBS Entities participating in SBS to manage competing regulations. Id. As explained further below, contrary to the commenter’s assertion, proposed Rule 0810(g) provides no exemption to FINRA Rule 2111 for an associated person (unless the FINRA member satisfied the conditions of the exception in proposed FINRA Rule 0180(d)). 290 Id. 291 FINRA Letter at 6. 292 Id. at 6, n.9. FINRA Rule 1220 sets forth registration categories. See FINRA Rule 1220. 293 Id.; see also FINRA Rule 1210. 294 FINRA Letter at 6. 295 Id. at 6–7. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 to change to the text of proposed FINRA Rule 0180(g).296 In so concluding, FINRA stated that the exception is structured similarly to existing exceptions from registration for persons associated with a member whose functions are related solely and exclusively to certain other products— specifically, associated persons transacting solely and exclusively in municipal securities, commodities, and security futures.297 FINRA stated that although it understands that the number of associated persons that would be eligible for the exception is likely to be limited, it believes the proposed exception is nonetheless appropriate to avoid unnecessary regulatory burdens with respect to even this limited set of individuals.298 FINRA further stated that, under Commission rules, associated persons of SBS Entities, while subject to statutory disqualification prohibitions (and related background check requirements), are not independently subject to registration, licensing or continuing education (‘‘CE’’) requirements imposed or administered by the Commission.299 FINRA believes that, at the current time, there would be limited benefit to requiring FINRA registration for the limited group of individuals that would qualify for the proposed exception.300 FINRA stated that it will monitor developments and continue to consider whether requiring registration for an associated person whose functions are related solely and exclusively to SBS in such person’s capacity as an associated person of a registered SBS Entity would be appropriate.301 In response to the comments concerning the potential for persons to avoid regulation, FINRA further stated that even in instances where an associated person is exempt from registration under proposed Rule 0180(g), the associated person would remain subject to all FINRA rules applicable to associated persons with respect to their SBS activities, unless another specific exception applied.302 For example, an associated person excepted under proposed Rule 0180(g) would remain subject to suitability obligations under FINRA Rule 2111 (as well as Exchange Act Rule 15Fh–3(f) and, as applicable Rule 15Fh–5) when 296 Id. at 7. at 7; see also FINRA Rule 1230. 298 Id. at 7–8. 299 Id. at 8. 300 Id. 301 Id. at 8, n.12. 302 Id. at 8. 297 Id. PO 00000 Frm 00024 Fmt 4701 Sfmt 4703 recommending SBS, unless the member satisfied the conditions of the exception in proposed FINRA Rule 0180(d) with respect to such activity.303 In such circumstances, the member and the associated person would be required to comply with the Commission’s business conduct obligations, which impose analogous requirements.304 FINRA also stated that, notwithstanding the proposed rule change, a member and its associated persons would still be subject to FINRA Rule 4530 and related guidance with respect to their SBS activities (regardless of whether a particular individual relies on the exception from registration under proposed Rule 0180(g)).305 The Commission finds that the proposed registration exception is reasonable. The exception is limited in scope and applies only to persons associated with a FINRA member that is also a Commission-registered SBS Entity, where the associated person’s functions are related solely and exclusively to SBS undertaken in such person’s capacity as an associated person of the registered SBS Entity. Additionally, not only is the exception expected to apply to a limited number of persons, those individuals are still subject to other regulatory obligations. In particular: (1) Persons qualifying for the Rule 0180(g) exceptions are still subject to all FINRA rules applicable to associated persons unless another specific exception applies; (2) all Commission rules applicable to associated persons of SBS Entities, including rules designed to prevent a statutorily disqualified person from associating with an SBS Entity, will apply; 306 and (3) FINRA members are obligated to monitor the activities of their associated persons and determine whether those activities give rise to an obligation to register the person under FINRA’s rules. For the foregoing reasons, the Commission finds that the proposed exemption in Rule 0180(g) is designed to protect investors and the public interest. The Commission also recognizes, however, that this is an evolving market and a new regulatory 303 Id. The Commission notes that Exchange Act Rules 15Fh–3(f) and 15Fh–5 contain requirements that extend beyond the requirements found in FINRA Rule 2111—for example, an explicit requirement that an SBSD have a reasonable basis to believe the counterparty have an ability to absorb potential losses associated with the recommendation. 304 Id. 305 Id. at 9. 306 For example, Exchange Act Rule 15Fh– 3(h)(2)(iii)(D) requires an SBS Entity to have procedures to conduct a reasonable investigation regarding, among other things, the qualifications and experience of any potential associated person. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices activities and positions unless specifically excepted elsewhere in the rule.314 Thus, as proposed, FINRA could not use its authority under FINRA Rule 0180(i) to grant an exemption from the general application of FINRA rules to G. Proposed Rule 0180(i) (Authority To 315 Rather, FINRA would Grant Exemptions From the Application SBS activities. only be permitted to grant exemptions of Rule 0180 Upon Member Application) only on a rule-by-rule, member-byand 9610 (Application for Exemptive member basis, consistent with the Relief) existing framework for granting Proposed FINRA Rule 0180(i), as exemptions for other FINRA rules as discussed above in Section II.H., would provided by Rule 9610.316 Furthermore, provide FINRA with authority to any exemption must consider ‘‘all consider exemptive relief from the relevant factors,’’ and FINRA may grant application of specific FINRA rules to exemptions only if FINRA deems the SBS on a rule-by-rule, member-byexemption consistent with the member basis, other than the general protection of investors and the public presumption of applicability contained interest.317 in proposed Rule 0180(a), which is not One commenter supported this subject to exemption.308 FINRA’s proposed exemptive authority, noting proposed rule change would also make that the exceptions described in the a conforming change to FINRA Rule proposed rule change are tailored to the 9610 to add FINRA Rule 0180 to the list existing SBS market, and that this of rules pursuant to which FINRA has market may evolve in a manner that exemptive authority.309 A member’s would justify further exceptions to application for an exemption under FINRA rules.318 As an example, the proposed FINRA Rule 0180(i) would be commenter noted that FINRA rules subject to FINRA’s existing procedures applicable to quoting and trading ‘‘may for all exemptive applications set forth become more relevant to SBS in the in its Rule 9600 Series and described in future if trading or execution of SBS on 310 more detail in Section II.G. Pursuant exchanges or SBS execution facilities to its procedures in FINRA Rule 9620, becomes prevalent,’’ and that it may FINRA would be required to issue a then be appropriate for FINRA to adopt written decision setting forth its additional exemptions ‘‘or otherwise findings and conclusions in response to clarify or tailor the application of those the request for an exemption, which rules to SBS.’’ 319 may be made publicly available.311 The Commission finds that the FINRA states that it needs the proposed exemptive authority under exemptive authority to respond to the Rule 0180(i) is designed to protect evolving SBS market and to particular investors and the public interest. The circumstances that may arise in which rule change will allow FINRA members applying specific FINRA rules to SBS to avail themselves of an existing activities or positions, not otherwise procedural vehicle—FINRA’s Rule 9600 excepted by the proposed rule change, Series—to apply for exemptive relief 312 may not be appropriate or feasible. from specific FINRA rules, on a case-byProposed Rule 0180(i) would allow case basis, to address unanticipated FINRA to exempt a person factual circumstances as market unconditionally or on specified terms participants navigate the newlyfrom the application of individual regulated SBS market. As stated above, FINRA rules beyond what is already the Commission agrees with FINRA proposed to be permitted under that, in light of Title VII’s amendment proposed Rule 0180.313 Notably, the proposed rule change would not permit of the Exchange Act to specifically encompass SBS as securities, FINRA any exemption from proposed Rule rules should generally apply to SBS in 0180(a), which would provide that the same manner that such rules apply FINRA Rules shall apply to members’ to securities generally, subject to the exceptions set forth elsewhere in 307 See FINRA Letter at 9, n.11–12; see also proposed FINRA Rule 0180.320 Notice at 26092. 308 See Notice at 26093. However, the Commission also 309 Id. recognizes the evolving nature of the lotter on DSK11XQN23PROD with NOTICES2 framework, and acknowledges FINRA’s commitment to monitor developments and to consider whether it would be appropriate to rescind the exception as the market develops further.307 310 Id. 311 Id. A FINRA member seeking a non-public exemption under Rule 9600 must include in its application a detailed statement, including supporting facts, showing good cause for treating the application or decision as confidential in whole or in part. See FINRA Rule 9610(b). 312 See Notice at 26093. 313 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 314 Id. 315 Id. 316 Id. 317 Id. 318 See SIFMA Letter at 6. SBS market, and that unanticipated factual circumstances may give rise to a need for FINRA to consider member applications for additional exceptions to specific FINRA rules on a case-by-case basis. The Commission expects that FINRA will, as it previously stated, apply heightened scrutiny to such applications for exemptive relief from its members not otherwise registered as SBS Entities with the Commission.321 To the extent that FINRA grants a number of exemptions pursuant to the process in its Rule 9600 Series for similar factual circumstances and/or identical FINRA rules, FINRA should consider filing a proposed rule change with the Commission to address those circumstances on a member-wide basis. Proposed Rule 0180(i) provides an appropriate vehicle that relies on an existing process for FINRA to consider providing limited exceptions on a member-by-member, case-by-case basis as warranted by specific facts, and only where FINRA deems appropriate consistent with the protection of investors and the public interest. The proposed exemptive authority is reasonably designed to allow FINRA to consider unanticipated and novel factual scenarios that may warrant additional exceptions from its rules, but only where FINRA finds that such relief is in the public interest and would protect investors. Thus, the Commission finds that the proposed FINRA Rule 0180(i) is designed to protect investors and the public interest. H. Financial Responsibility and Operational Requirements As discussed above in Section II.I., FINRA Rule 4120 (Regulatory Notification and Business Curtailment) sets forth certain early warning notification and business curtailment requirements if a member’s capital falls below certain thresholds. These thresholds are based on the minimum capital requirements applicable to a member broker-dealer under Exchange Act Rule 15c3–1. As discussed above in Section II.I., the proposed amendments to FINRA Rule 4120 would conform the rule to the new and increased minimum capital requirements for Non-ANC Firms that are also registered as SBSDs and for ANC Firms, adopted in the Capital, Margin, and Segregation Release. The proposed amendments to FINRA Rule 4120 will align FINRA’s historical early warning notification and business curtailment thresholds with the Commission’s amended capital requirements for Non-ANC Firms that 319 Id. 320 See PO 00000 Notice at 26086. Frm 00025 Fmt 4701 321 See Sfmt 4703 1985 E:\FR\FM\12JAN2.SGM Notice at 26093, n.66. 12JAN2 1986 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices are also registered as SBSDs and for ANC Firms, adopted in the Capital, Margin, and Segregation Release. The modified early warning thresholds are appropriately calibrated to provide FINRA with sufficient early warning that a FINRA member’s capital levels may be deteriorating. The modified business curtailment thresholds also are appropriately calibrated to provide FINRA with the ability to require a FINRA member to reduce its business activities when its capital levels have deteriorated to a level that may jeopardize its ability to comply with regulatory capital requirements. In addition, as discussed above in Section II.I., proposed FINRA Rule 0180(h) would provide that, for purposes of the FINRA Rule 4000 Series, all requirements that apply to a member that clears or carries customer accounts must also apply to any member that acts as a principal counterparty to an SBS, clears or carries an SBS, guarantees an SBS or otherwise has financial exposure to an SBS. Applying these higher standards when a member enters into SBS transactions, or otherwise has exposure to SBS is appropriate given that SBS are complex transactions that will require detailed recordkeeping, margining, legal agreements, collateral management, reconciliation and risk management. lotter on DSK11XQN23PROD with NOTICES2 I. Margin Requirements As discussed above in Section II.J., FINRA is proposing to adopt a new margin rule specifically applicable to SBS. Current FINRA Rule 4240 would be replaced by new FINRA Rule 4240 that would prescribe margin requirements for SBS, including CDS. However, proposed FINRA Rule 4240 would not apply to any FINRA member that is registered as an SBSD. FINRA members that are SBSDs are subject to the margin requirements of Exchange Act Rule 18a–3 discussed above in Section II.J. FINRA stated that by applying margin requirements in these circumstances, the proposed rule change would fill an important regulatory gap, protect FINRA members against counterparty credit risk, maintain a level playing field for members, and prevent regulatory arbitrage. As discussed above in Section II.J., the margin requirements under proposed FINRA Rule 4240 would be structurally aligned with the margin requirements that apply to SBSDs under Exchange Act Rule 18a–3, with certain modifications that FINRA believes are necessary because FINRA members that are not SBSDS will not be subject to the Commission’s comprehensive regulatory VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 framework for SBSDs.322 Thus, subject to certain exceptions in the proposed rule discussed above in Section II.J., proposed FINRA Rule 4240 would require members that are not SBSDs to collect and deliver variation margin on a daily basis to cover the member’s current exposure to or from each SBS counterparty, and also to collect (but not deliver) initial margin from each SBS counterparty. FINRA members that are not SBSDs would also be required to monitor the risk of any Uncleared SBS Account and maintain a comprehensive risk analysis methodology for assessing the potential risk to the member’s capital. Finally, FINRA is also proposing to amend FINRA Rules 4210 and 4220 to take into account members’ SBS activities.323 Applying the proposed margin requirements to FINRA members that are not registered as SBSDs will fill an important regulatory gap because it will prescribe margin requirements for uncleared SBS for FINRA members that are not SBSDs and not subject to Exchange Act Rule 18a–3. The margin requirements in the proposed rule change will protect FINRA members against counterparty credit risk with respect to transactions in uncleared SBS.324 In particular, the proposed margin requirements will address the risk of uncollateralized exposures in uncleared SBS for FINRA members that are not registered as SBSDs by prescribing variation and initial margin requirements, subject to certain exceptions, as well as requiring these firms to maintain a comprehensive written risk analysis methodology. In addition, adopting a stand-alone rule that applies margin requirements to uncleared SBS under proposed new FINRA Rule 4240 will reduce unnecessary and duplicative regulation for FINRA members regarding which FINRA margin requirements apply to uncleared SBS. A commenter stated that proposed FINRA Rule 4240 would differ in several material respects from Exchange Act Rule 18a–3.325 More specifically, the commenter stated that FINRA Rule 4240 would (1) not permit a member to use an approved model to calculate initial margin, (2) require a member to collect initial margin from affiliates that are not financial market intermediaries or majority owners, (3) not permit a member to apply an initial margin threshold, (4) not permit a member to apply a minimum transfer amount, and 322 See Notice at 26097. supra note 147. 324 See Notice at 26097. 325 See SIFMA Letter at 7–11. 323 See PO 00000 Frm 00026 Fmt 4701 Sfmt 4703 (5) not permit an ANC Firm to apply credit risk charges under paragraph (c) to Exchange Act Rule 15c3–1e in lieu of collecting margin, except for SBS with a majority owner, or a registered or foreign SBS Dealer affiliate.326 The commenter stated that these differences would present material issues for members subject to proposed FINRA Rule 4240, particularly in connection with certain inter-affiliate SBS designed to promote centralized, group-wide risk management, as well as SBS entered into with unaffiliated financial market intermediaries for hedging purposes. The commenter provided examples where it believed that the differences between Exchange Act Rule 18a–3 and proposed FINRA Rule 4240 would present material issues, including: (1) When a foreign dealer affiliate of a U.S. broker-dealer hedges risks of SBS based on U.S. securities with their foreign customers via offsetting SBS with the U.S. broker-dealer, (2) when a brokerdealer forms an affiliated special purpose vehicle to issue a structured note that references a security, and (3) when a broker-dealer, in order to hedge the risk of its securities inventory, enters into one or more SBS with unaffiliated financial market intermediaries.327 The commenter recommended that FINRA permit a broker-dealer to comply with Exchange Act Rule 18a–3 rather than proposed FINRA Rule 4240 to address these issues.328 However, the commenter also stated that it appreciates FINRA’s concerns regarding a smaller broker-dealer entering into uncleared SBS with margin requirements that differ from the requirements that would apply under FINRA Rule 4210 to equivalent securities positions.329 To address this consideration, the commenter proposed that, in order for a FINRA member to apply Exchange Act Rule 18a–3 in lieu of proposed FINRA Rule 4240, the member must satisfy the higher capital requirements applicable to an SBSD in Exchange Act Rule 15c3–1(a)(10) (or the higher capital requirements applicable to an ANC Firm in Exchange Act Rule 15c3–1(a)(7)). The commenter further proposed that for such a member to use a model to calculate initial margin, the Commission would need to approve the model for use by an affiliate of the member that is registered as an SBSD.330 The commenter also stated that if 326 Id.; see also supra note 197 (defining ‘‘Registered or Foreign SBS Dealer’’). 327 See SIFMA Letter at 8. 328 Id. 329 Id. 330 Id. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 FINRA does not adopt these recommendations, then it should further modify proposed FINRA Rule 4240 to align more closely with Exchange Act Rule 18a–3.331 The commenter stated that FINRA previously declined to incorporate this suggested modification because broker-dealers subject to the proposed margin requirements for uncleared SBS would not be subject to the regulatory framework applicable to SBSDs, in particular higher capital requirements applicable to registered SBSDs.332 FINRA responded to the comments stating that FINRA acknowledges that proposed FINRA Rule 4240 would differ from Exchange Act Rule 18a–3 in some respects.333 While such differences may in some cases result in increased costs for members that are not registered SBSDs when entering into uncleared SBS transactions with certain counterparties, FINRA responded that the requirements of proposed FINRA Rule 4240 as set forth in the Notice are important to protect the financial condition of its members, given that members subject to the rule would not be subject to the comprehensive regulatory framework applicable to SBSDs.334 FINRA also stated that a member can ‘‘opt-in’’ to Exchange Act Rule 18a–3 by registering as an SBSD.335 FINRA further stated that SBSD registration is an important precondition to margining pursuant to Exchange Act Rule 18a-3, because SBSD registration assures that the entity is fully regulated as an SBSD, including the higher minimum capital requirements applicable to SBSDs.336 Therefore, FINRA believes it would not be appropriate to incorporate Commission margin rules by reference or allow non-SBSD members to ‘‘opt-in’’ to the Commission margin rules as an alternative to FINRA margin rules.337 Further, FINRA stated the specific requirements of proposed FINRA Rule 4240 are appropriately calibrated to provide parity with both FINRA Rule 4210 and Exchange Act Rule 18a–3, where possible, but also to provide greater protection to the financial condition of members not subject to the Commission’s comprehensive requirements for registered SBSDs.338 The Commission concludes that it would not be appropriate for a FINRA 331 Id. 332 Id. 333 See FINRA Letter at 10. 334 Id. 335 Id. 336 Id. 337 Id. 338 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 member that is not registered as an SBSD to ‘‘opt in’’ to compliance with Exchange Act Rule 18a–3 in lieu of complying with proposed FINRA Rule 4240, including in cases where a member would comply with higher capital requirements. While the proposed margin requirements differ from Exchange Act Rule 18a–3 in some respects, FINRA proposed the amendments in part to reduce regulatory arbitrage between existing margin requirements under FINRA Rule 4210 and the proposed requirements for uncleared SBS under FINRA Rule 4240. For example, the margin requirements in proposed FINRA Rule 4240 do not contain any thresholds that are prescribed in Exchange Act Rule 18a–3 (such as the $50 million threshold below which initial margin need not be collected by an SBSD). Therefore, the proposed margin requirements should reduce the risk that a broker-dealer would be incentivized to restructure existing securities margin accounts as uncleared SBS, since existing FINRA Rule 4210 does not contain any margin thresholds for securities. In addition, while broker-dealers and SBSDs are subject to comprehensive financial responsibility requirements, FINRA member firms that are not SBSDs are not subject to the Commission’s specific regulatory framework for registered SBSDs under Title VII of the DoddFrank Act, and Exchange Act Rule 18a– 3, in particular, only applies to SBSDs and MSBSPs. For those same reasons, FINRA declined to adopt a number of specific modifications suggested by a commenter to align proposed Rule 4240 more closely with Exchange Act Rule 18a–3 in lieu of allowing members to comply with Exchange Act Rule 18a–3.339 FINRA stated that the commenter made a number of similar recommendations in its comments responding to the Concept Proposal.340 FINRA stated that it had responded previously to these recommendations, which included several modifications from the margin rule described in the Concept Proposal that were intended to address the 339 Id. Specifically, the commenter proposed that FINRA: (1) Adopt an initial margin exception for all majority-owned affiliates; (2) permit an ANC Firm to calculate credit risk charges in accordance with Exchange Act Rule 15c3–1e(c) for exposures to all counterparty types; (3) permit use of SEC-approved initial margin models for non-equity SBS; (4) adopt a $50 million initial margin threshold, applicable on a group-wide basis; (5) adopt a $500,000 minimum transfer amount; (6) align FINRA Rule 4240’s collateral haircuts with Exchange Act Rule 18a–3; and (7) extend the deadline for posting or collecting margin for counterparties in distant time zones. See SIFMA Letter at 9–11. 340 See Notice at 26107–09; see also FINRA Letter at 10. PO 00000 Frm 00027 Fmt 4701 Sfmt 4703 1987 comments and enhance competitive parity, while still providing appropriate protection for the financial condition of non-SBSD members entering into uncleared SBS.341 FINRA further stated that, as a general matter, proposed FINRA Rule 4240 is not intended to level the playing field between SBSDs and non-SBSD members entering into SBS, such as de minimis dealers.342 Rather, FINRA stated that the proposed rule is intended to adequately protect members from counterparty credit risk and prevent regulatory arbitrage, in particular by removing incentives for members to restructure their traditional extensions of credit (e.g., margin lending) subject to FINRA Rule 4210 as uncleared SBS.343 Further, with respect to a commenter’s request for FINRA to align proposed new FINRA Rule 4240’s collateral haircuts with Exchange Act Rule 18a–3, FINRA stated that it does not believe permitting the use of the haircuts applicable to SBS collateral under Exchange Act Rule 18a–3 would be appropriate.344 As FINRA previously stated, the proposed rule change is not intended to level the playing field between SBSDs and non-SBSD members entering into SBS, such as de minimis dealers, but rather to prevent regulatory arbitrage between members extending credit through SBS and members extending credit through traditional means.345 With respect to the request for FINRA to extend the deadline for posting or collecting margin for counterparties in distant time zones, FINRA stated that Exchange Act Rule 18a–3 requires that a member take an applicable capital charge on positions that do not meet the margin requirements generally within T+1, but extends that deadline to T+2 if the counterparty is located in another country and four time zones away.346 While proposed FINRA Rule 4240 would similarly require a capital charge if required margin is not collected on T+1, FINRA stated that FINRA Rule 4240 would not require liquidation of the position until T+3. FINRA stated that this timing follows the portfolio margin requirements under FINRA Rule 4210, and stated it is appropriate to require a capital charge on T+1 because the location of the counterparty does not affect the counterparty credit risk to the 341 FINRA Letter at 10. 342 Id. 343 Id. 344 Id. at 10–11. at 11. 345 Id. 346 In this context, ‘‘T+1’’ and similar terms refer to the number of business days after the date on which the person was required to compute the margin requirement. Id. E:\FR\FM\12JAN2.SGM 12JAN2 lotter on DSK11XQN23PROD with NOTICES2 1988 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices member.347 However, FINRA believes that, generally, the additional time before liquidation is required should be sufficient to accommodate counterparties in distant time zones.348 The Commission concludes that it is appropriate for FINRA to decline to adopt commenters suggestions to modify proposed new FINRA Rule 4240 to more closely align with the requirements of Exchange Act Rule 18a– 3, including the rule’s collateral haircuts. Proposed FINRA Rule 4240 will promote consistent margin requirements, including haircut requirements, between FINRA members extending credit through traditional means under FINRA Rule 4240 and FINRA members extending credit through SBS under FINRA Rule 4240. The requirements under new FINRA Rule 4240 will protect FINRA members from counterparty credit risk and prevent regulatory arbitrage by reducing incentives for members to restructure their traditional extensions of credit (e.g., margin lending) subject to FINRA Rule 4210 as uncleared SBS. Further, the proposed time period (T+3) with respect to required liquidations above should provide FINRA members that are not SBSDs the flexibility to accommodate counterparties in additional time zones. Another commenter raised concerns regarding the disparate treatment for SBSDs with respect to uncleared SBS. The commenter stated that proposed FINRA Rule 4240 and Exchange Act Rule 18a–3 impose different margin and collateral requirements, depending on whether an entity is designated as an SBSD or a FINRA broker-dealer.349 This commenter raised concerns that this difference could hinder the ability of a FINRA broker-dealer to compete with SBSDs or other SBS market participants on a level playing field. In particular, the commenter raised concerns that counterparties would potentially choose to transact with an SBSD rather than a similarly capitalized FINRA brokerdealer, in order to avoid the need for the daily collection of initial margin and variation margin, which could lead to reduced firm participation impacting overall costs and liquidity.350 In response, as discussed above in Section II.J., while proposed FINRA Rule 4240 would diverge from Exchange Act Rule 18a–3 in some respects, FINRA believes that proposed FINRA Rule 4240 appropriately protects members from counterparty credit risk and prevents 347 Id. 348 Id. 349 See PML Letter at 7. 350 Id. VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 regulatory arbitrage between different methods of extending credit.351 FINRA does not believe that the potential for increased market liquidity if more members functioned as de minimis dealers justifies replacing the specific margin requirements set forth in proposed FINRA Rule 4240.352 Moreover, FINRA stated that a FINRA member seeking to establish parity with other SBSDs with respect to margin requirements may elect to register as an SBSD and become subject to the Commission’s comprehensive SBSD regulatory framework. FINRA stated that the intent of proposed Rule 4240 is not to level the playing field between SBSDs and members engaged in de minimis SBS activity, but rather to prevent regulatory arbitrage as between members extending credit through SBS and members extending credit in the traditional fashion.353 The proposed rule change will serve to promote consistent and transparent margin requirements for the uncleared SBS market and traditional securities markets for FINRA members that are not SBSDs. Further, proposed Rule 4240 will require a FINRA member to collect initial margin, and collect or post variation margin, unless an exception applies.354 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 uncleared SBS transactions, with the potential costs and competitive impacts that may result from the proposed rule change. For example, FINRA has proposed a number of exceptions to the proposed margin requirements,355 which may lessen the competitive impacts and costs of the proposed margin requirements. A commenter further sought clarification regarding Non-Basic SBS, and more specifically uncleared TRS structures.356 The commenter stated that the SBS market is dynamic and that market developments, such as its proposed alternative trading system platform, may make commonplace transactions that today are limited. The commenter also stated that a key blocker to growth of this activity is potential ambiguity around timing and the openended nature of the approval process for margin requirements for Non-Basic SBS.357 Finally, this commenter stated 351 See FINRA Letter at 11. at 11–12. 353 Id. at 12. 354 See Notice at 26097. 355 Id. at 26101. 356 See PML Letter at 6. 357 Id. at 7. 352 Id. PO 00000 Frm 00028 Fmt 4701 Sfmt 4703 that SBSDs would be placed at a significant advantage under the proposed margin framework, and supported a more clearly defined process for FINRA members that are not SBSDs to evaluate new products within existing or potentially expanded lines of business.358 In response, FINRA stated that under proposed FINRA Rule 4240(b)(2)(C), a member may apply to FINRA for the approval of an Initial Margin Requirement for a type of SBS other than Basic CDS and Basic SBS. FINRA further stated that the proposed rule change sets forth the requirements for any such application, and provides that no member shall become a party to an SBS other than a Basic CDS or Basic SBS unless FINRA has approved an Initial Margin Requirement for such member’s use with respect to that type of SBS.359 In addition, FINRA believes other types of SBS—including CDS and equity TRS with complex features—may not be easily accommodated under the frameworks applicable to Basic CDS and Basic SBS, and that the specific risks of such SBS may not be readily apparent or quantifiable to FINRA without additional information. Further, FINRA stated that SBS can be complex financial instruments that pose substantial risks to the financial condition of members, and margin serves as an important means of protecting member firms, and thereby their customers and investors, from such risks.360 FINRA also believes that the application process under proposed FINRA Rule 4240(b)(2)(C) permits appropriate flexibility so that FINRA and its member firms may analyze all relevant risks that may be associated with a new type of SBS product. FINRA also stated that proposed FINRA Rule 4240 defers to registered clearing agencies with respect to the margin requirements for Cleared SBS. Therefore, FINRA believes that FINRA members that are not SBSDs may enter into Cleared SBS without seeking approval under Rule 4240(b)(2)(C); the application process would only be required before entering into new types of uncleared SBS.361 The proposed application process for margin requirements for SBS that are not Basic SBS or CDS provides specific detail with respect to the application’s requirements, while providing FINRA with the flexibility to determine if a proposed margin requirement adequately addresses the risks for a 358 Id. 359 See FINRA Letter at 12. 360 Id. 361 Id. E:\FR\FM\12JAN2.SGM 12JAN2 Federal Register / Vol. 87, No. 8 / Wednesday, January 12, 2022 / Notices lotter on DSK11XQN23PROD with NOTICES2 particular type of SBS, including through the ability to request additional information. These requirements will protect FINRA member firms from the risks associated with uncleared SBS with complex features by ensuring FINRA member firms that are not SBSDs set prudent margin levels for these instruments. In conclusion, the proposed changes to FINRA Rules 4210, 4420, and 4240 will help to ensure that the risks to FINRA members that are not SBSDs with respect to their uncleared SBS exposures are adequately addressed through the collection of margin. In VerDate Sep<11>2014 19:03 Jan 11, 2022 Jkt 256001 1989 addition, the proposed rule changes will enhance risk management practices at FINRA members that are not SBSDs and that participate in the SBS markets. They also will prevent unnecessary regulatory duplication by applying the proposed margin requirements in proposed FINRA Rule 4240 to FINRA members that are not SBSDs, and will not be subject to the margin requirements of Rule 18a–3. that the proposed rule change (SR– FINRA–2021–008), as modified by Amendment No. 1, be, and hereby is, approved. IV. Conclusion It is therefore ordered pursuant to Section 19(b)(2) of the Exchange Act 362 BILLING CODE 8011–01–P 362 15 PO 00000 U.S.C. 78s(b)(2). Frm 00029 Fmt 4701 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.363 J. Matthew DeLesDernier, Assistant Secretary. [FR Doc. 2022–00376 Filed 1–11–22; 8:45 am] 363 17 Sfmt 9990 E:\FR\FM\12JAN2.SGM CFR 200.30–3(a)(12). 12JAN2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 87, Number 8 (Wednesday, January 12, 2022)]
[Notices]
[Pages 1962-1989]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-00376]



[[Page 1961]]

Vol. 87

Wednesday,

No. 8

January 12, 2022

Part III





Securities and Exchange Commission





-----------------------------------------------------------------------





Self-Regulatory Organizations; Financial Industry Regulatory Authority, 
Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment 
No. 1, Relating to Security-Based Swaps; Notice

Federal Register / Vol. 87 , No. 8 / Wednesday, January 12, 2022 / 
Notices

[[Page 1962]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-93914; File No. SR-FINRA-2021-008]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by 
Amendment No. 1, Relating to Security-Based Swaps

January 6, 2022.

I. Introduction

    On April 26, 2021, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``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 Rules 0180, 4120, 
4210, 4220, 4240 and 9610 to clarify the application of its rules to 
security-based swaps (``SBS'') following the Commission's completion of 
its rulemaking regarding SBS dealers (``SBSDs'') and major SBS 
participants (``MSBSPs'') (collectively, ``SBS Entities'').
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    The proposed rule change was published for comment in the Federal 
Register on May 12, 2021.\3\ On June 14, 2021, FINRA consented to an 
extension of 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 August 10, 2021.\4\ The Commission received two comments 
on the proposed rule change during the initial comment period.\5\ On 
August 9, 2021, FINRA responded to the comment letters received in 
response to the Notice and filed an amendment to the proposed rule 
change (``Amendment No. 1'').\6\ On August 9, 2021, the Commission 
issued an Order Instituting Proceedings (``OIP'') to determine whether 
to approve or disapprove the proposed rule change, as modified by 
Amendment No.1.\7\ The Commission received an additional four comments 
in response to the OIP.\8\ On September 30, 2021, the FINRA consented 
to an extension of the time period in which the Commission must approve 
or disapprove the proposed rule change to January 7, 2022.\9\ This 
order approves the proposed rule change, as modified by Amendment No. 
1.
---------------------------------------------------------------------------

    \3\ See Exchange Act Release No. 91789 (May 12, 2021), 86 FR 
26084 (May 12, 2021) (File No. SR-FINRA-2021-008) (``Notice'').
    \4\ Letter from Robert McNamee, Assistant General Counsel, 
Office of General Counsel, FINRA to Daniel Fisher, Division of 
Trading and Markets, Commission dated June 14, 2021.
    \5\ Letter from Kyle L. Brandon, Managing Director, Head of 
Derivatives Policy, Securities Industry and Financial Markets 
Association (``SIFMA'') to Vanessa A. Countryman, Secretary, 
Commission, dated June 2, 2021 (``SIFMA Letter'') and Matthew R. 
Cohen, Chief Executive Officer and Richard C. Chase, Chief 
Compliance Officer, Provable Markets LLC to Jill M. Peterson, 
Assistant Secretary, Commission, dated June 7, 2021 (``PML 
Letter''). Letters are available at the Commission's website at 
https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008.htm.
    \6\ See letter from Robert McNamee, Associate General Counsel, 
Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, 
Commission, dated Aug. 9, 2021 (``FINRA Letter''). The FINRA Letter 
is available at the Commission's website at https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008-9125111-247215.pdf. 
Amendment No. 1 is available at https://www.finra.org/sites/default/files/2021-08/SR-FINRA-2021-008-Amendment_1.pdf.
    \7\ See Exchange Act Release No. 92617 (Aug. 9, 2021), 86 FR 
44761 (Aug. 13, 2021) (File No. SR-FINRA-2020-008) (``OIP'').
    \8\ See Letters from Anonymous dated Aug. 10, 2021; Blake 
Daniels dated Aug. 10, 2021, Tristan Kifer dated Aug. 10, 2021; and 
Eileen Loh dated Aug. 10, 2021 (``Letters''). Letters are available 
at the Commission's website at https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008.htm.
    \9\ Letter from Robert McNamee, Assistant General Counsel, 
Office of General Counsel, FINRA to Daniel Fisher, Division of 
Trading and Markets, Commission dated September 30, 2021.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

A. Background

    Title VII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Title VII'' or ``Dodd-Frank Act'') \10\ established a 
comprehensive new regulatory framework for over-the-counter (``OTC'') 
derivatives, commonly known in the industry as ``swaps.'' It divided 
regulatory jurisdiction over swap products between the Commodity 
Futures Trading Commission (``CFTC'') and the Commission, with the CFTC 
regulating ``swaps'' and the SEC regulating SBS, and the SEC and the 
CFTC regulating mixed swaps.\11\ The Dodd-Frank Act directed the SEC to 
promulgate rulemakings implementing the new regulatory framework for 
SBS, including rules requiring SBS Entities to register with the 
Commission and to be subject to requirements related to business 
conduct and supervision, documentation standards; recordkeeping and 
financial reporting; and capital, and margin and segregation. The Dodd-
Frank Act also directed the Commission to promulgate rules applicable 
to all market participants including requiring regulatory reporting and 
public dissemination of SBS transaction information; and those creating 
processes to require SBS to become subject to mandatory clearing and 
execution on a registered or exempt execution facility or exchange.\12\ 
The Commission has now finalized a majority of these rulemakings.\13\ 
As of October 6, 2021, SBS Entities are permitted to register with the 
Commission and are required to comply with the Title VII 
rulemakings.\14\ The deadline for the initial wave of SBS Entity 
registrations was November 1, 2021.
---------------------------------------------------------------------------

    \10\ Public Law 111-203, 124 Stat. 1376 (2010).
    \11\ The terms ``swap'' and ``security-based swap'' are defined 
in Sections 721 and 761 of the Dodd-Frank Act. The Commission and 
the CFTC have jointly promulgated rules further defining these 
terms. See Exchange Act Release No. 67453 (Jul. 18, 2012), 77 FR 
48208 (Aug. 13, 2012) (Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping) (``Product 
Definitions''). Very generally, SBS are swaps referencing a single 
security or loan, or a narrow-based security index. Certain products 
sharing characteristics of both swaps and SBS are regulated as 
``mixed swaps'' subject to both CFTC and SEC jurisdiction.
    \12\ See Dodd-Frank Act Section 763.
    \13\ See Exchange Act Release No. 74244 (Feb. 11, 2015), 80 FR 
14564 (Mar. 19, 2015) (Final Rule: Regulation SBSR--Reporting and 
Dissemination of Security-Based Swap Information) (``Regulation SBSR 
Release''); Exchange Act Release No. 75611 (Aug. 5, 2015), 80 FR 
48964 (Aug. 14, 2015) (Final Rule: Registration Process for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants) (``Registration Process Release''); Exchange Act 
Release No. 77617 (Apr. 14, 2016), 81 FR 29960 (May 13, 2016) (Final 
Rule: Business Conduct Standards for Security-Based Swap Dealers and 
Major Security-Based Swap Participants) (``Business Conduct 
Standards Release''); Exchange Act Release No. 78011 (Jun. 8, 2016), 
81 FR 39808 (Jun. 17, 2016) (Final Rule: Trade Acknowledgment and 
Verification of Security-Based Swap Transactions) (``Trade 
Acknowledgment and Verification Release''); Exchange Act Release No. 
86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) (Final Rule: 
Capital, Margin, and Segregation Requirements for Security-Based 
Swap Dealers and Major Security-Based Swap Participants and Capital 
and Segregation Requirements for Broker-Dealers) (``Capital, Margin, 
and Segregation Release''); Exchange Act Release No. 87005 (Sep. 19, 
2019), 84 FR 68550 (Dec. 16, 2019) (Final Rule: Recordkeeping and 
Reporting Requirements for Security-Based Swap Dealers, Major 
Security-Based Swap Participants, and Broker-Dealers) 
(``Recordkeeping Release''); Exchange Act Release No. 87780 (Dec. 
18, 2019), 85 FR 6270 (Feb. 4, 2020) (Final Rules; Guidance: Rule 
Amendments and Guidance Addressing Cross-Border Application of 
Certain Security-Based Swap Requirements) (``Cross-Border 
Release''); Exchange Act Release No. 87782 (Dec.18, 2019), 85 FR 
6359 (Feb. 4, 2020) (Final Rule: Risk Mitigation Techniques for 
Uncleared Security-Based Swaps) (``Risk Mitigation Release'').
    \14\ See Notice at 26085.
---------------------------------------------------------------------------

    Title VII also amended the definition of ``security'' under the 
Exchange Act to expressly encompass SBS.\15\ Therefore,

[[Page 1963]]

in addition to the comprehensive new SBS-specific regulatory framework 
discussed above, SBS are now also defined as securities under the 
Exchange Act and the rules thereunder. As a result, according to FINRA, 
any FINRA rule applicable to FINRA members' activities involving a 
security, securities business, a transaction involving a security or a 
securities position would apply to those activities involving SBS.\16\ 
Consistent with the SEC's actions in this area, on July 8, 2011, FINRA 
filed for immediate effectiveness FINRA Rule 0180, which, with certain 
exceptions noted below, temporarily limits the application of FINRA 
rules with respect to SBS.\17\ This rule is currently set to expire on 
February 6, 2022.\18\
---------------------------------------------------------------------------

    \15\ See Dodd-Frank Act Section 761(a)(2) (inserting ``security-
based swap'' in the definition of ``security'' in Section 3(a)(10) 
of the Exchange Act); see also 15 U.S.C. 78c(a)(10).
    \16\ See Notice at 26085.
    \17\ See Exchange Act Release No. 64884 (Jul. 14, 2011), 76 FR 
42755 (Jul. 19, 2011) (Notice of Filing and Immediate Effectiveness 
of File No. SR-FINRA-2011-033). To allow sufficient time to consider 
the complex interpretative issues resulting from defining SBS as 
securities, the Commission also issued a number of temporary 
exemptive orders relating to the regulation of SBS as securities, 
all of which have either expired or been made permanent now that the 
October 6, 2021, registration compliance date for the Commission's 
SBS regulatory framework has passed. See Exchange Act Release No. 
92837 (Sep. 1, 2021), 86 FR 50391 (Sep. 8, 2021) (Notice of Filing 
and Immediate Effectiveness of File No. SR-FINRA-2021-021) 
(``Extension Notice'').
    \18\ FINRA has extended the expiration date of FINRA Rule 0180 a 
number of times, most recently in September 2021. See, e.g., 
Extension Notice, supra note 17.
---------------------------------------------------------------------------

    Current FINRA Rule 0180 broadly excepts SBS activities from most 
FINRA rules. Specifically, FINRA Rule 0180(a) provides that FINRA rules 
shall not apply to members' activities and positions with respect to 
SBS, except for: (i) FINRA Rule 2010 (Standards of Commercial Honor and 
Principles of Trade); (ii) FINRA Rule 2020 (Use of Manipulative, 
Deceptive or Other Fraudulent Devices); (iii) FINRA Rule 3310 (Anti-
Money Laundering Compliance Program); and (iv) FINRA Rule 4240 (Margin 
Requirements for Credit Default Swaps).\19\ In addition, FINRA Rule 
0180(b) provides that the following rules apply to members' activities 
and positions with respect to SBS only to the extent they would have 
applied as of July 15, 2011 (i.e., the day before the effective date of 
Title VII): (i) NASD Rule 3110 (Supervision) and all successor FINRA 
Rules to such NASD Rule; (ii) the FINRA Rule 4500 Series (Books, 
Records, and Reports); and (iii) the FINRA Rule 4100 Series (Financial 
Condition). Finally, FINRA Rule 0180(c) provides that certain other 
rules apply as necessary to effectuate members' compliance with 
paragraphs (a) and (c) of the rule.
---------------------------------------------------------------------------

    \19\ FINRA Rule 4240 establishes an interim pilot program with 
respect to margin requirements for any transactions in credit 
default swaps (``CDS'') held in an account at a FINRA member. The 
interim pilot program under FINRA Rule 4240 will expire on April 6, 
2022. See id.; see also FINRA Rule 4240(a). FINRA Rule 4240 
Supplementary Material .02 clarifies that the rule does not apply to 
a member that is registered with the Commission as an SBSD. See id.
---------------------------------------------------------------------------

    In light of the Commission's October 6, 2021, registration 
compliance date, FINRA proposed in April 2021 to amend FINRA Rules 
0180, 4120, 4210, 4220, 4240 and 9610 to clarify the application of 
FINRA rules to members' SBS activities after the Commission's 
registration compliance date. These proposed amendments would: (1) 
Adopt a permanent FINRA Rule 0180 to replace the temporary rule set to 
expire on February 6, 2022; (2) amend FINRA's financial responsibility 
and operational rules to conform to the SEC's amendments to its 
capital, margin and segregation requirements for SBSDs and broker-
dealers, and to otherwise take into account members' SBS activities; 
(3) adopt a new margin rule specifically applicable to SBS, replacing 
the expiring interim pilot program establishing margin requirements for 
CDS; and (4) amend Rule 9610 to permit FINRA to exempt members from 
Rule 0180 under the process set forth in FINRA's Rule 9600 series 
(Procedures for Exemptions).

B. Proposed Rule 0180 (Application of FINRA Rules to Security-Based 
Swaps)

    Proposed Rule 0180(a) would provide that FINRA rules generally 
apply to members' SBS activities unless otherwise specifically 
excepted. This would reverse the presumption of the applicability of 
FINRA rules to members' SBS activities in the current, expiring 
temporary Rule 0180, which generally does not apply FINRA rules unless 
otherwise specified.
    Proposed Rule 0180 paragraphs (b) through (g) would then specify 
the exceptions from the general presumption of applicability of FINRA 
rules in proposed Rule 0180(a). These proposed exceptions fall into 
three general categories: (1) General exceptions based on 
impracticability or operational burdens; (2) exceptions for SBS 
Entities already registered with the Commission and associated persons 
of SBS Entities; and (3) exceptions in connection with the conditions 
to the SEC's cross-border SBS counting exception. Proposed FINRA Rule 
0180(i) would further authorize FINRA to exempt a person from the 
application of specific FINRA rules to SBS on a case-by-case basis, 
pursuant to the existing procedural framework set forth in the FINRA 
Rule 9600 series and as FINRA deems appropriate consistent with the 
protection of investors and the public interest.

C. Proposed Rule 0180(b) (General Exceptions From Applicability of 
FINRA Rules)

    Proposed Rule 0180(b) would provide that the following FINRA rules 
shall not apply to members' activities and positions with respect to 
SBS: (1) The Rule 6000 Series (Quotation, Order, and Transaction 
Reporting Facilities); (2) the Rule 7000 Series (Clearing, Transaction, 
and Order Data Requirements, and Facility Charges); and (3) the Rule 
11000 Series (the Uniform Practice Code or ``UPC''). The Rule 6000 and 
7000 Series include rules relating to trading, quoting, clearing, and 
reporting for securities other than SBS (e.g., NMS stocks and over-the-
counter equity securities), and therefore are not applicable to 
members' SBS activities.
    According to FINRA, the UPC, contained in the Rule 11000 Series, is 
a series of rules, interpretations and explanations designed to make 
uniform, where practicable, custom, practice, usage, and trading 
technique in the investment banking and securities business, 
particularly with regard to operational and settlement issues.\20\ The 
Rule 11000 Series contains, for example, rules addressing matters 
relating to the delivery of securities, certificated security matters, 
delivery of bonds, and close-out procedures.\21\ According to FINRA, 
the UPC was created to simplify and facilitate cash securities 
transactions.\22\
---------------------------------------------------------------------------

    \20\ See Notice at 26088.
    \21\ Id.
    \22\ See id.
---------------------------------------------------------------------------

    By its terms, the UPC applies to all OTC secondary market 
transactions in securities between members, with enumerated 
exceptions.\23\ FINRA believes that, as a result, the UPC could be 
interpreted as applying to SBS transactions in a limited set of 
circumstances--e.g., an SBS transaction between two FINRA members.\24\ 
FINRA further believes that because the UPC could only be invoked for a 
small portion of the SBS market--particularly

[[Page 1964]]

given that FINRA expects only a small number of its members to register 
as SBSDs or otherwise engage in SBS activities--applying the UPC to 
members' SBS activities has the potential to create confusion and 
uncertainty in the SBS market.\25\ Because SBS transactions involve 
bilateral contractual negotiations, often utilizing industry-standard 
SBS documentation, FINRA believes that the operational and settlement 
risks of SBS transactions are more appropriately addressed through 
other means, including standardized contractual provisions in that 
industry documentation, as well as, where applicable, the Commission's 
risk mitigation requirements.\26\
---------------------------------------------------------------------------

    \23\ See FINRA Rule 11100(a). Under FINRA Rule 11100(a)(1), 
transactions in securities between members which are compared, 
cleared or settled through the facilities of a registered clearing 
agency are not subject to the UPC, except to the extent that the 
rules of the clearing agency provide that rules of other 
organizations shall apply. Paragraphs (a)(2) through (a)(5) of FINRA 
Rule 11100 also provide exceptions for specific types of securities, 
including exempted securities, municipal securities, redeemable 
securities issued by investment companies and Direct Participation 
Program Securities.
    \24\ See Notice at 26088.
    \25\ Id.
    \26\ Id. at 26089.
---------------------------------------------------------------------------

D. Proposed Rule 0180(c) and (d) (Exceptions for Registered SBS 
Entities and Associated Persons)

    As discussed above, the Title VII rulemakings completed by the 
Commission, including business conduct standards, trade acknowledgement 
and verification requirements, risk mitigation techniques for uncleared 
SBS, and recordkeeping rules for SBS Entities, are now in effect for 
SBS Entities, which are now required to be registered with the 
Commission unless their dealing activity is below the de minimis 
registration threshold.\27\ As described below, certain of these new 
SBS-specific Commission rules are analogous to existing, generally 
applicable FINRA rules. Where the Commission has promulgated analogous 
rules applicable to registered SBS Entities, FINRA has proposed to 
provide exceptions from its rules for SBS Entities registered with the 
Commission and, in certain circumstances, associated persons of those 
SBS Entities.\28\
---------------------------------------------------------------------------

    \27\ See Business Conduct Standards Release; Trade 
Acknowledgment and Verification Release; Risk Mitigation Release; 
Recordkeeping Release, supra note 13.
    \28\ Id. at 26089.
---------------------------------------------------------------------------

    Proposed Rules 0180(c) and (d) would provide exceptions to 
specified FINRA rules for FINRA members that are also registered as SBS 
Entities with the Commission or the associated person of the member, 
where two conditions are satisfied: (1) The SBS Entity or associated 
person is acting in the capacity of an SBS Entity or associated person 
of that SBS Entity; and (2) the activities or positions relate to the 
business of the SBS Entity within the meaning of Exchange Act Rule 
15Fh-3(h)(1) (addressing supervisory obligations of SBS Entities).\29\ 
The proposed exceptions are for FINRA rules that FINRA believes are 
analogous to SEC business conduct requirements,\30\ and are limited to 
the members' SBS business and conditioned upon the application of the 
SEC's supervision rule for SBS Entities.\31\
---------------------------------------------------------------------------

    \29\ See 17 CFR 240.15Fh-3(h)(1). The exceptions in Rule 0180(c) 
would apply to both SBSDs and MSBSPs or their associated persons, 
while the exceptions in Rule 0180(d) would apply only to SBSDs or 
their associated persons (and not MSBSPs or their associated 
persons).
    \30\ See Notice at 26089.
    \31\ 17 CFR 240.15Fh-3(h)(1).
---------------------------------------------------------------------------

    Under proposed FINRA Rules 0180(c) and (d), these proposed 
exceptions would be available for eight FINRA rules that FINRA believes 
are analogous to SEC rules, subject to the conditions described above. 
Specifically, proposed FINRA Rule 0180(c) would provide exceptions for 
the following five FINRA rules, for registered SBS Entities and their 
associated persons: \32\
---------------------------------------------------------------------------

    \32\ See Notice at 26089.
---------------------------------------------------------------------------

     FINRA Rule 2210(d) (Communications with the Public--
Content Standards). Among other things, FINRA Rule 2210(d) requires 
that member communications be based on principles of fair dealing and 
good faith, be fair and balanced, and not omit any material facts or 
make false or exaggerated claims. FINRA believes that this rule is 
analogous to Exchange Act Rule 15Fh-3(g), which requires SBS Entities 
to, among other things, communicate with counterparties in a fair and 
balanced manner.\33\
---------------------------------------------------------------------------

    \33\ See Notice at 26089-90; see also 17 CFR 240.15Fh-3(g); 
Business Conduct Standards Release at 30000-02.
---------------------------------------------------------------------------

     FINRA Rule 2232 (Customer Confirmations) generally 
requires members to provide customers with written confirmations in 
conformity with Exchange Act Rule 10b-10,\34\ along with specified 
additional disclosures for certain types of securities. FINRA believes 
this is analogous to Exchange Act Rule 15Fi-2, which requires SBS 
Entities to provide trade acknowledgements and to establish, maintain 
and enforce written policies and procedures reasonably designed to 
obtain prompt verification of the terms of such trade 
acknowledgments.\35\
---------------------------------------------------------------------------

    \34\ See 17 CFR 240.10b-10; see also Notice at 26089-90.
    \35\ See 17 CFR 240.15Fi-2; see generally Trade Acknowledgment 
and Verification Release, supra note 13.
---------------------------------------------------------------------------

     FINRA Rules 3110 (Supervision), 3120 (Supervisory Control 
System) and 3130 (Annual Certification of Compliance and Supervisory 
Processes) require, among other things, each member to establish and 
maintain a supervisory system; establish, maintain and enforce written 
supervisory procedures; designate principals to establish, maintain and 
enforce a system of supervisory control policies and procedures; 
designate a chief compliance officer; and submit annual certifications 
to FINRA related to the member's compliance policies and written 
supervisory procedures. FINRA believes this is analogous to the 
supervision rule for SBS Entities in Exchange Act Rule 15h-3(h), which 
requires, among other things, an SBS Entity to establish and maintain a 
system to supervise, and to diligently supervise, its business and the 
activities of its associated persons; designation of at least one 
person with authority to carry out supervisory responsibilities; and 
establishment, maintenance and enforcement of written policies and 
procedures addressing supervision of the SBS Entity's SBS business.\36\ 
Additionally, Exchange Act Rule 15Fk-1 requires each SBS Entity to 
designate a chief compliance officer and submit annual compliance 
reports to the SEC.\37\
---------------------------------------------------------------------------

    \36\ See Notice at 26089-90.
    \37\ See 17 CFR 240.15Fk-1.
---------------------------------------------------------------------------

    In addition, proposed FINRA Rule 0180(d) would provide exceptions 
for the following three FINRA Rules for registered SBSDs and their 
associated persons, but not MSBSPs: \38\
---------------------------------------------------------------------------

    \38\ See Notice at 26089.
---------------------------------------------------------------------------

     FINRA Rule 2030 (Engaging in Distribution and Solicitation 
Activities with Government Entities) is FINRA's ``pay-to-play'' rule, 
which imposes restrictions on member firms engaging in distribution or 
solicitation activities with government entities. FINRA believes that 
Exchange Act Rule 15Fh-6 imposes analogous restrictions.\39\
---------------------------------------------------------------------------

    \39\ See id. at 26089-90; see also 17 CFR 240.15Fh-6; Business 
Conduct Standards Release at 30045-50.
---------------------------------------------------------------------------

     FINRA Rule 2090 (Know Your Customer) generally requires 
that each member use reasonable diligence to know and retain essential 
facts concerning every customer and the authority of each person acting 
on behalf of such customer. FINRA believes this rule is analogous to: 
Exchange Act Rule 15Fh-3(a), which generally requires SBS Entities to 
verify the status of their SBS counterparties, including verification 
that the counterparty is an eligible contract participant and whether 
the counterparty is a ``special entity;'' \40\ and to Exchange Act Rule 
15Fh-3(e), which requires each SBSD to

[[Page 1965]]

establish, maintain and enforce written policies and procedures 
reasonably designed to obtain and retain a record of the essential 
facts concerning each counterparty whose identity is known to the SBSD 
that are necessary for conducting business with such counterparty.\41\
---------------------------------------------------------------------------

    \40\ See Notice at 26089-90. ``Special entity'' is defined in 
Exchange Act Rule 15Fh-2(d) and includes certain government 
entities, employee benefit plans and endowments. See 17 CFR 
240.15Fh-2(d).
    \41\ See Notice at 26089-90; see 17 CFR 240.15Fh-3(e).
---------------------------------------------------------------------------

     FINRA Rule 2111 (Suitability) generally requires a member 
or associated person to have a reasonable basis that a recommended 
transaction or investment strategy is suitable for at least some 
investors as well as for the customer receiving the recommendation. 
FINRA believes it is analogous to Exchange Act Rule 15Fh-3(f), which 
imposes suitability obligations on SBSDs with respect to 
recommendations of SBS or trading strategies involving SBS.\42\ In 
addition, Exchange Act Rule 15Fh-5 applies special, enhanced 
requirements when SBS Entities act as counterparties to special 
entities.\43\
---------------------------------------------------------------------------

    \42\ See Notice at 26090; see 17 CFR 240.15Fh-3(f).
    \43\ See Notice at 26091; see 17 CFR 240.15Fh-5.
---------------------------------------------------------------------------

E. Proposed Rule 0180(e) (Exceptions in Connection With Arranging, 
Negotiating, and Executing Activity)

    Proposed Rule 0180(e) would provide that the following FINRA rules 
shall not apply to members' activities and positions with respect to 
SBS, to the extent that the member or the associated person of the 
member, as applicable, is arranging, negotiating or executing SBS on 
behalf of a non-U.S. affiliate pursuant to, and in compliance with, the 
conditions of, Exchange Act Rule 3a71-3(d)(1): \44\ (1) FINRA Rule 2111 
(Suitability); (2) FINRA Rule 2210(d) (Communications with the Public--
Content Standards); and (3) FINRA Rule 2232 (Customer 
Confirmations).\45\ The availability of the exceptions under proposed 
FINRA Rule 0180(e) would require the member's compliance with the 
conditions specified in Exchange Act Rule 3a71-3(d)(1)(ii)(B) as if the 
member were the counterparty to the SBS transactions (as opposed the 
non-U.S. affiliate).\46\
---------------------------------------------------------------------------

    \44\ See 17 CFR 240.3a71-3(d)(1). Rule 3a71-3(d)(1) provides an 
exception from counting certain SBS transactions against the 
thresholds associated with the de minimis exception to the SBSD 
definition. See id.
    \45\ FINRA believes these proposed exceptions are appropriate 
for similar reasons as the proposed exceptions for SBS Entities in 
proposed FINRA Rules 0180(c) and (d). See Notice at 26093, n.64.
    \46\ A member acting as the U.S. Registered Affiliate under 
Exchange Act Rule 3a71-3(d) would remain subject to all other FINRA 
rules applicable to such SBS brokerage activity. See supra note 44.
---------------------------------------------------------------------------

    In connection with finalizing certain Title VII rulemakings, the 
SEC also adopted a number of rules and provided guidance to address the 
cross-border application of various SBS requirements. One of these 
rules, Exchange Act Rule 3a71-3(d), provides a conditional exception to 
the provisions of Exchange Act Rule 3a71-3 that otherwise would require 
non-U.S. persons to count--against the thresholds associated with the 
de minimis exception to the SBSD definition--SBS dealing transactions 
between non-U.S. counterparties when U.S. personnel arrange, negotiate 
or execute those transactions.\47\ To qualify for this exception, all 
such arranging, negotiating or executing activity must, among other 
things, be conducted by U.S. personnel in their capacity as persons 
associated with a registered broker that meets certain capital 
requirements, or a registered SBSD, in each case so long as such entity 
is a majority-owned affiliate of the non-U.S. person relying on the 
exception (the ``U.S. Registered Affiliate'').\48\ The U.S. Registered 
Affiliate also must comply with certain rules applicable to SBSDs with 
respect to such SBS transactions as if the counterparties to the non-
U.S. person relying on the exception also were counterparties to the 
U.S. Registered Affiliate and as if the U.S. Registered Affiliate were 
registered as an SBSD, if not so registered.\49\
---------------------------------------------------------------------------

    \47\ See 17 CFR 240.3a71-3(d); Cross-Border Release at 6276-92.
    \48\ See 17 CFR 240.3a71-3(d)(1)(i).
    \49\ See 17 CFR 240.3a71-3(d)(1)(ii)(A).
---------------------------------------------------------------------------

    Specifically, Exchange Act Rule 3a71-3(d)(1)(ii)(B) requires the 
U.S. Registered Affiliate to comply with, as a condition of the 
exception: (1) Section 15F(h)(3)(B)(i) and (ii) of the Exchange Act and 
Rule 15Fh-3(b) thereunder (disclosures of material risks and 
characteristics and material incentives or conflicts of interest), (2) 
Exchange Act Rule 15Fh-3(f)(1) (recommendations and suitability),\50\ 
(3) Section 15F(h)(3)(C) of the Exchange Act and Rule 15Fh-3(g) 
thereunder (fair and balanced communications); and (4) Exchange Act 
Rule 15Fi-2 (acknowledgement and verification of SBS transactions) and 
the underlying definitions in Exchange Act Rule 15Fi-1.\51\ FINRA 
believes it is appropriate to provide exceptions from the parallel 
FINRA rules to provide clarity and avoid unnecessary regulatory 
duplication, but only where the member is in fact complying with the 
rules specified in Exchange Act Rule 3a71-3(d)(1)(ii)(B).\52\
---------------------------------------------------------------------------

    \50\ Rule 3a71-3(d)(1)(ii)(B)(2) does contain a limited 
exception from the requirement to comply with Exchange Act Rule 
15Fh-3(f)(1). Specifically, if the U.S. Registered Entity reasonably 
determines that the counterparty to whom it recommends an SBS or 
trading strategy involving an SBS is an ``institutional 
counterparty'' as defined in Exchange Act Rule 15Fh-3(f)(4), the 
registered entity instead may fulfill its obligations under Rule 
15Fh-3(f)(1)(ii) if it discloses to the counterparty that it is not 
undertaking to assess the suitability of the SBS or trading strategy 
involving an SBS for the counterparty.
    \51\ See 17 CFR 240.3a71-3(d)(1)(ii)(B).
    \52\ See Notice at 26093.
---------------------------------------------------------------------------

F. Proposed Rule 0180(f) (Exceptions From Rules 2231, Customer Account 
Statements, and 4512, Customer Account Information)

    Proposed FINRA Rule 0180(f) would provide that FINRA Rules 2231 
(Customer Account Statements) and 4512 (Customer Account Information) 
shall not apply to members' activities and positions with respect to 
SBS, to the extent that the member is acting in its capacity as an SBS 
Entity and the customer's account solely holds SBS and collateral 
posted as margin in connection with such SBS, provided that the member 
complies with the portfolio reconciliation requirements of Exchange Act 
Rule 15Fi-3 with respect to such account and that such portfolio 
reconciliations include collateral posted as margin in connection with 
SBS in the account. FINRA Rule 2231 generally requires each member to 
provide, on at least a quarterly basis, an account statement to each 
customer containing a description of any securities positions, money 
balances or account activity during the period since the last customer 
account statement. FINRA Rule 4512 generally requires each member to 
maintain specified information for each customer account, including 
specified identifying information about the customer.
    FINRA believes that the customer account statements required under 
FINRA Rule 2231 generally should reflect a holistic view of a member's 
relationship with its customer, including SBS transactions, positions 
and related collateral, if applicable.\53\ Therefore, to the extent 
that a customer's account includes SBS along with other securities 
positions or activity, or related money balances, then FINRA believes 
that the account statement under FINRA Rule 2231 should include 
SBS.\54\ However, FINRA understands that members that are also 
registered as SBS Entities may have customer accounts that hold solely 
SBS and related collateral, and do not hold any other securities 
positions or have

[[Page 1966]]

any other securities activity.\55\ While SBS Entities are not subject 
to a customer account statement requirement with respect to SBS, 
Exchange Act Rule 15Fi-3 includes requirements applicable to SBS 
Entities with respect to engaging in portfolio reconciliation with 
applicable counterparties on a periodic basis, which the Commission 
adopted as part of a broader set of risk mitigation requirements for 
SBS Entities.\56\
---------------------------------------------------------------------------

    \53\ Id. at 26091.
    \54\ Id.
    \55\ Id.
    \56\ See 17 CFR 240.15Fi-3; Risk Mitigation Release at 6362-70. 
For purposes of Exchange Act Rule 15Fi-3, ``portfolio 
reconciliation'' is defined as ``any process by which counterparties 
to one or more SBS'' (1) exchange the material terms of all SBS in 
the SBS portfolio between the counterparties, (2) exchange each 
counterparty's valuation of each SBS in the SBS portfolio between 
the counterparties as of the close of business on the immediately 
preceding day and (3) resolve any discrepancy in valuations or 
material terms. See 17 CFR 240.15Fi-1(l).
---------------------------------------------------------------------------

    Exchange Act Rule 15Fi-3(a) generally requires SBS Entities to 
engage in portfolio reconciliation for all SBS with their SBS Entity 
counterparties, with the frequency of such portfolio reconciliations 
based on the size of the SBS portfolio with the applicable 
counterparty, ranging from once each business day (for SBS portfolios 
that include 500 or more SBS), to once each week (for SBS portfolios 
that include more than 50 but fewer than 500 SBS on any business day 
during the week), to once each calendar quarter (for SBS portfolios 
that include no more than 50 SBS at any time during the calendar 
quarter).\57\ Exchange Act Rule 15Fi-3(b) requires each SBS Entity to 
establish, maintain, and follow written policies and procedures 
reasonably designed to ensure that it engages in portfolio 
reconciliation for all SBS with non-SBS Entity counterparties, with the 
frequency of such portfolio reconciliations ranging from once each 
calendar quarter (for SBS portfolios that include more than 100 SBS at 
any time during the calendar quarter) to once annually (for SBS 
portfolios that include no more than 100 SBS at any time during the 
calendar year).\58\
---------------------------------------------------------------------------

    \57\ See 17 CFR 240.15Fi-3(a).
    \58\ See 17 CFR 240.15Fi-3(b).
---------------------------------------------------------------------------

    FINRA acknowledges that the portfolio reconciliation requirements 
in Exchange Act Rule 15Fi-3 differ in some respects from the customer 
account statement requirements under FINRA Rule 2231.\59\ For example, 
the frequency of portfolio reconciliations varies as described above, 
while customer account statements must be delivered at least quarterly. 
In addition, as described above, an SBS Entity must have policies and 
procedures in place to ensure that it engages in portfolio 
reconciliation with non-SBS Entity counterparties, while a member must 
provide a customer account statement to each customer unless a specific 
exception under FINRA Rule 2231(b) applies. However, FINRA believes 
that, while not identical, Exchange Act Rule 15Fi-3 serves analogous 
purposes to FINRA Rule 2231, such that requiring members that are SBS 
Entities to also provide customer account statements for accounts 
holding solely SBS and related collateral would be unnecessarily 
duplicative.\60\ Accordingly, FINRA believes to promote regulatory 
clarity and avoid unnecessary duplication, proposed FINRA Rule 0180(f) 
would provide an exception from FINRA Rule 2231 in the limited 
circumstances where the member is acting in its capacity as an SBS 
Entity and the account holds solely SBS and collateral posted as margin 
in connection with such SBS.\61\ FINRA states that collateral in a 
customer's account would be included in account statements provided 
under FINRA Rule 2231.\62\ Therefore, in FINRA's view, the proposed 
rule change includes as a condition to the proposed exception that the 
member comply with Exchange Act Rule 15Fi-3 with respect to an account 
qualifying for the exception and include collateral in the portfolio 
reconciliation and dispute resolutions requirements as applied to such 
an account.\63\
---------------------------------------------------------------------------

    \59\ See Notice at 26091.
    \60\ Id.
    \61\ Id.
    \62\ Id.
    \63\ Id.
---------------------------------------------------------------------------

    SBS Entities also are subject to Exchange Act Rule 15Fi-5, which 
requires them to establish, maintain, and follow written policies and 
procedures reasonably designed to ensure that it executes written SBS 
trading relationship documentation with each of its counterparties 
prior to, or contemporaneously with, executing an SBS with any 
counterparty.\64\ In addition, SBS Entities that are also registered 
broker-dealers are subject to the SEC's recordkeeping requirements 
under Exchange Act Rule 17a-3, which require, among other things, 
certain records to be kept for each SBS account.\65\ These SEC rules 
generally require SBS Entities to obtain and keep records of certain 
information in connection with their SBS accounts, including SBS-
specific identifying information. FINRA believes that, while not 
identical to FINRA Rule 4512, these SEC rules serve analogous purposes, 
and that also applying FINRA Rule 4512 to SBS-only accounts would be 
duplicative.\66\ Accordingly, in order to promote regulatory clarity 
and avoid unnecessary duplication, FINRA believes it is appropriate to 
provide an exception from FINRA Rule 4512 in the limited circumstances 
where the member is acting in its capacity as an SBS Entity and the 
account solely holds SBS and collateral posted as margin in connection 
with such SBS.\67\ Both exceptions under proposed FINRA Rule 0180(f) 
would not apply to accounts holding SBS together with other securities 
or to members that are not also registered SBS Entities.
---------------------------------------------------------------------------

    \64\ See 17 CFR 240.15Fi-5; Risk Mitigation Release at 6372-
6377. Such documentation also must include all terms governing the 
trading relationship between the SBS Entity and its counterparty, 
including, without limitation, certain terms specified in the rule. 
SBS Entities are also required to maintain records of SBS trading 
relationship documentation. See 17 CFR 17a-4(e)(12)(ii).
    \65\ See 17 CFR 240.17a-3; see generally Recordkeeping Release, 
supra note 13. FINRA states in particular Exchange Act Rule 17a-
3(a)(9)(iv), which requires an SBS Entity to keep a record, for each 
SBS account, of the unique identification code of the counterparty, 
the name and address of the counterparty, and a record of the 
authorization of each person the counterparty has granted authority 
to transact business in the SBS account. See 17 CFR 240.17a-
3(a)(9)(iv).
    \66\ See Notice at 26092.
    \67\ Id.
---------------------------------------------------------------------------

G. Proposed Rule 0180(g) (Exception From FINRA Registration for Certain 
Associated Persons of Registered SBS Entities)

    Proposed FINRA Rule 0180(g) would provide that persons associated 
with a member whose functions are related solely and exclusively to 
SBS, and undertaken in such person's capacity as an associated person 
of an SBS Entity, are not required to be registered with FINRA.\68\ 
Generally, FINRA Rule 1210 requires that each person engaged in the 
investment banking or securities business of a member must be 
registered with FINRA as a representative or principal in each category 
of registration appropriate to his or her functions and 
responsibilities as specified in FINRA Rule 1220. Individuals seeking 
to become registered with FINRA generally must pass an appropriate 
qualification examination, and registered individuals are subject to 
continuing education (``CE'') requirements under FINRA Rule

[[Page 1967]]

1240.\69\ The exception from registration would apply only to 
individuals engaged solely in SBS activities on behalf of the SBS 
Entity (and potentially non-securities activities, such as swaps).\70\ 
Under FINRA's proposed exception, if an associated person of the SBS 
Entity engaged in any other securities activities in addition to SBS, 
that individual must register with FINRA in accordance with FINRA Rule 
1210.\71\ Associated persons of members that are not registered SBS 
Entities would also still be required to register with FINRA, even if 
those individuals engage solely in SBS activities.\72\ Additionally, 
although individuals qualifying for the proposed exception would not be 
required to register with FINRA, they would remain associated persons 
of the member subject to all FINRA and SEC rules applicable to such 
associated persons, including fingerprinting requirements under 
Exchange Act Rule 17f-2.\73\
---------------------------------------------------------------------------

    \68\ This proposed exception is structured similarly to existing 
exceptions from registration for persons associated with a member 
whose functions are related solely and exclusively to certain other 
product types (such as municipal securities, commodities or security 
futures), as found in FINRA Rule 1230.
    \69\ See Notice at 26092.
    \70\ Id.
    \71\ Id.
    \72\ FINRA states that associated persons of SBS Entities are 
not independently subject to registration, licensing or CE 
requirements. See id. at 26109, n.58. However, an SBS Entity is 
prohibited from permitting an associated person that is subject to a 
statutory disqualification to effect or be involved in effecting SBS 
on behalf of the SBS Entity. See 15 U.S.C. 78o-10(b)(6). The SEC's 
SBS Entity registration rules also require an SBS Entity to certify 
that it neither knows, nor in the exercise of reasonable care should 
have known, of any such statutory disqualification. Such 
certifications must be supported by questionnaires or employment 
applications serving as the basis for background checks. See 17 CFR 
240.15Fb6-2; Registration Process Release at 48973-79.
    \73\ See 17 CFR 240.17F-2.
---------------------------------------------------------------------------

    FINRA stated that it structured this exception similarly to 
existing exceptions from registration for persons associated with a 
member whose functions are related solely and exclusively to certain 
other product types (such as municipal securities, commodities or 
security futures).\74\ FINRA also stated that it based the proposed 
exception in Rule 0180(g) on its analysis of existing registration and 
related requirements, and its understanding that the number of 
associated persons that would qualify for the exception is limited.\75\ 
FINRA stated that it will monitor developments with respect to the SBS 
activities of its members and will continue to consider whether it 
would be appropriate to tailor the registration and related 
requirements to SBS, for example through targeted SBS-related 
registration categories or the addition of SBS-specific content to 
qualification examinations or CE content.\76\ FINRA stated that it will 
consider whether it would be appropriate to rescind the exception under 
proposed FINRA Rule 0180(g) in such circumstances.\77\
---------------------------------------------------------------------------

    \74\ See Notice at 26092, n.57; see also FINRA Rule 1230.
    \75\ See Notice at 26092.
    \76\ Id.
    \77\ Id.
---------------------------------------------------------------------------

H. Proposed Rule 0180(i) (Authority To Grant Exemptions From the 
Application of Rule 0180 Upon Member Application) and 9610 (Application 
for Exemptive Relief)

    Proposed FINRA Rule 0180(i) would provide that, pursuant to the 
FINRA Rule 9600 Series (Procedures for Exemptions), FINRA may, taking 
into consideration all relevant factors, exempt a person 
unconditionally or on specified terms from the application of FINRA 
rules (other than an exemption from the general application of proposed 
FINRA Rule 0180(a)) to the person's SBS activities or positions, as it 
deems appropriate, consistent with the protection of investors and the 
public interest.\78\ FINRA believes it is appropriate and in the public 
interest to provide this exemptive authority so that FINRA can account 
for specific situations that may arise with respect to SBS in the 
future on a case-by-case basis.\79\ In formulating the proposed rule 
change, FINRA stated that it consulted with its members and reviewed 
its rulebook to determine whether continuing exceptions from any of its 
rules are appropriate.\80\ FINRA stated that it is proposing FINRA Rule 
0180(i) in recognition that the SBS market continues to evolve and that 
particular circumstances may arise in which applying specific FINRA 
rules not otherwise covered by the proposed exceptions to SBS 
activities may not be appropriate or feasible.\81\
---------------------------------------------------------------------------

    \78\ See Notice at 26093.
    \79\ Id.
    \80\ Id.
    \81\ Id.
---------------------------------------------------------------------------

    As proposed, FINRA would consider written applications for 
exemptive relief, on a rule-by-rule and member-by-member basis, under 
the existing process set forth in FINRA Rule 9610.\82\ Rule 9610 
requires a member seeking exemptive relief to file a written 
application with the appropriate department or staff of FINRA 
containing, among other things, a detailed statement of the grounds for 
granting an exemption from the application of a specific FINRA 
rule.\83\ Pursuant to FINRA Rule 9620, FINRA staff is then required to 
issue a written decision setting forth its findings and conclusions, 
which may be made publicly available.\84\ A member would have the 
ability to appeal such a decision pursuant to FINRA Rule 9630.\85\ 
FINRA stated that it expects to apply heightened scrutiny to 
applications for exemptive relief from members that are not also 
registered with the SEC as SBS Entities, and therefore not subject to 
the SEC's regulatory framework for SBS.\86\ FINRA believes it is 
appropriate and in the public interest to provide this exemptive 
authority so that FINRA can account for specific situations that may 
arise with respect to SBS in the future on a case-by-case basis.\87\
---------------------------------------------------------------------------

    \82\ Id.
    \83\ See FINRA Rule 9610(a) and (b).
    \84\ See Notice at 26093. FINRA would consider any such 
application based on the specific circumstances described in the 
application and whether the requested exemptive relief would be 
consistent with the protection of investors and the public interest. 
Id. at 26093, n.66.
    \85\ Id. at 26093.
    \86\ Id.
    \87\ Id.
---------------------------------------------------------------------------

    Finally, FINRA proposed a conforming change to Rule 9610 to add 
Rule 0180 to the list of over 30 rules pursuant to which FINRA already 
has exemptive authority.\88\
---------------------------------------------------------------------------

    \88\ See FINRA Rule 9610(a); see also Notice at 26093.
---------------------------------------------------------------------------

I. Financial Responsibility and Operational Requirements

    In June 2019, the Commission adopted final capital, margin and 
segregation requirements for SBS Entities, along with amendments to the 
existing capital and segregation requirements for broker-dealers, in 
the Capital, Margin, and Segregation Release.\89\ As with other Title 
VII rulemakings, the SEC aligned the compliance date for the amendments 
under the Capital, Margin, and Segregation Release with the SBS Entity 
registration compliance date.\90\ Among other things, the Capital, 
Margin, and Segregation Release amended the existing net capital rule 
for broker-dealers, Exchange Act Rule 15c3-1,\91\ in two key respects 
relevant to FINRA's rules:
---------------------------------------------------------------------------

    \89\ See Capital, Margin, and Segregation Release, supra note 
13.
    \90\ See id. at 43954.
    \91\ See 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

     First, the SEC adopted new minimum net capital 
requirements for broker-dealers that are also registered as SBSDs, but 
that do not operate pursuant to the alternative net capital (``ANC'') 
requirements of Exchange Act Rule 15c3-1 (``Non-ANC Firms'').\92\ Non-

[[Page 1968]]

ANC Firms that are also registered as SBSDs must comply with a new 
minimum dollar net capital requirement and a new component for 
determining their minimum capital requirement that is based on a 
percentage of initial margin computed for SBS (in addition to other 
minimum requirements applicable to the broker-dealer).\93\ These 
changes do not apply to broker-dealers that operate pursuant to the ANC 
requirements of the rule (``ANC Firms''). These new minimum net capital 
requirements also do not impact Non-ANC Firms that are not also 
registered as SBSDs, regardless of whether such Non-ANC Firms engage in 
SBS activities.\94\
---------------------------------------------------------------------------

    \92\ Generally, a broker-dealer may apply to the SEC for 
authorization to use the alternative method for computing net 
capital contained in Appendix E to Exchange Act Rule 15c3-1. See 17 
CFR 240.15c3-1(a)(7). Such broker-dealers are known as ``ANC broker-
dealers.'' There are currently five approved ANC broker-dealers. See 
SEC, Broker-Dealers Using the Alternative Net Capital Computation 
under Appendix E to Rule 15c3-1, available at https://www.sec.gov/tm/broker-dealers-alternative-net-capital-computation. Other broker-
dealers are known as non-ANC broker-dealers and must compute net 
capital pursuant to the provisions of Exchange Act Rule 15c3-1. See 
Notice at 26093.
    \93\ See 17 CFR 240.15c3-1(a)(10).
    \94\ For example, the new minimum net capital requirements do 
not apply to a Non-ANC Firm engaged in SBS dealing activity below 
the de minimis threshold for SBSD registration, or to a Non-ANC Firm 
engaged in SBS brokerage activity or entering into non-dealing SBS 
transactions (e.g., hedging). FINRA stated that the SEC also adopted 
new minimum capital requirements for MSBSPs, including that such 
entities must at all times have and maintain a tangible net worth. 
See Capital, Margin, and Segregation Release at 43906-07. FINRA does 
not believe any changes to FINRA rules are necessary with respect to 
the new MSBSP capital requirements. See Notice at 26094, n.71.
---------------------------------------------------------------------------

     Second, the SEC changed the minimum net capital 
requirements for ANC Firms, regardless of whether they transact in SBS. 
For ANC Firms, the SEC increased the minimum dollar net capital 
requirement, added a new component for determining the minimum capital 
requirement that is based on a percentage of initial margin computed 
for SBS (in addition to other minimum requirements applicable to the 
broker-dealer), increased the minimum tentative net capital requirement 
and amended the early warning notification requirement for tentative 
net capital.\95\
---------------------------------------------------------------------------

    \95\ See 17 CFR 240.15c3-1(a)(7).
---------------------------------------------------------------------------

    FINRA Rule 4120 (Regulatory Notification and Business Curtailment) 
sets forth certain early warning notification and business curtailment 
requirements if a member's capital falls below certain thresholds. 
Specifically, FINRA Rule 4120(a) requires each carrying or clearing 
member to notify FINRA if its net capital falls below certain specified 
levels.\96\ FINRA Rule 4120(b) allows FINRA to restrict a member from 
expanding its business in certain circumstances and FINRA Rule 4120(c) 
allows FINRA to require a member to reduce its business if its net 
capital falls below certain specified levels (generally lower than 
those required for notification under FINRA Rule 4120(a)). According to 
FINRA, these requirements are based on the minimum capital requirements 
applicable to a member broker-dealer under Exchange Act Rule 15c3-
1.\97\ FINRA believes it is necessary to amend FINRA Rule 4120 to 
conform the rule to the new and increased minimum capital requirements 
for Non-ANC Firms that are also registered as SBSDs and for ANC Firms, 
as described above.\98\
---------------------------------------------------------------------------

    \96\ As discussed below, FINRA also proposed to apply all 
requirements in the FINRA Rule 4000 Series applicable to carrying or 
clearing firms to members that act as principal counterparty to an 
SBS, clear or carry an SBS, guarantee an SBS or otherwise have 
financial exposure to an SBS. See Notice at 26094, n.73.
    \97\ See Notice at 26094.
    \98\ As noted above, the SEC did not amend Exchange Act Rule 
15c3-1 to apply increased minimum capital requirements to Non-ANC 
Firms that engage in SBS activities but that are not registered 
SBSDs. FINRA is therefore not proposing to amend FINRA Rule 4120 to 
impose any additional minimum thresholds on such members. However, 
FINRA states that, as a general matter, FINRA Rule 4120 would apply 
to all members that engage in SBS transactions (and any related 
transactions) because net capital is a holistic calculation based on 
a firm's liquid net worth, which includes all of a firm's 
activities. See Notice at 26094, n.74.
---------------------------------------------------------------------------

    FINRA Rule 4120(a) requires each carrying or clearing firm to 
promptly, but in any event within 24 hours, notify FINRA in writing if 
its net capital falls below any of the percentages specified in 
subparagraphs (A) through (F) of FINRA Rule 4120(a)(1). The proposed 
rule change would modify subparagraph (D), which applies to ANC Firms, 
and also add new subparagraph (E), applicable to Non-ANC Firm members 
that are also registered as SBSDs.\99\
---------------------------------------------------------------------------

    \99\ The proposed rule change would also make non-substantive 
and conforming changes to other subparagraphs of FINRA Rule 4120(a) 
to reflect the insertion of new subparagraph (E), update cross-
references to SEC rules that have been amended and reflect FINRA 
rulebook format conventions.
---------------------------------------------------------------------------

    Prior to the amendments in the Capital, Margin and Segregation 
Release, Exchange Act Rule 15c3-1(a)(7)(i) required an ANC Firm to 
maintain minimum tentative net capital of not less than $1 billion and 
minimum net capital of not less than $500 million. In addition, 
Exchange Act Rule 15c3-1(a)(7)(ii) required an ANC Firm to provide an 
``early warning'' notice to the Commission when its tentative net 
capital fell below $5 billion (or a lower threshold, if the Commission 
has granted an ANC Firm's application to use such lower threshold). 
Subparagraph (D) of FINRA Rule 4120(a) is based on these net capital 
requirements, requiring notification to FINRA if the member is an ANC 
Firm and (i) its tentative net capital under Exchange Act Rule 15c3-
1(c)(15) is less than 50 percent of the early warning notification 
amount required by Exchange Act Rule 15c3-1(a)(7)(ii) or (ii) its net 
capital is less than $1.25 billion. In other words, notification to 
FINRA is required if an ANC Firm's tentative net capital falls below 
$2.5 billion (or a lower amount, if the ANC Firm has been permitted to 
use a lower early warning notice threshold), which is half of the SEC's 
early warning notification amount, or its net capital falls below $1.25 
billion, which is 2.5 times the SEC's net capital requirement for ANC 
Firms.\100\
---------------------------------------------------------------------------

    \100\ See Notice at 26094.
---------------------------------------------------------------------------

    In the Capital, Margin, and Segregation Release, the Commission 
amended the net capital requirements for ANC Firms in three ways. 
First, the Commission raised the tentative net capital requirement for 
ANC Firms from $1 billion to $5 billion. Second, the Commission raised 
the minimum net capital requirement for ANC Firms from $500 million to 
the greater of $1 billion or the sum of the applicable ratio 
requirement under Exchange Act Rule 15c3-1(a)(1) \101\ and two percent 
of the risk margin amount.\102\ Third, the Commission raised the 
tentative net capital early warning notification threshold from $5 
billion to $6 billion. In light of these increased capital requirements 
under the Commission's net capital rule, FINRA believes it is 
appropriate to also modify the thresholds for required notification to 
FINRA for ANC Firms under FINRA Rule 4120(a)(1)(D).\103\ Specifically, 
under the proposed rule change, an ANC Firm would be required to notify 
FINRA if, in addition to the conditions currently prescribed under 
FINRA Rule 4120(a)(1)(A), (E) and (F): \104\
---------------------------------------------------------------------------

    \101\ See 17 CFR 240.15c3-1(a)(7)(i)(A). Under Exchange Act Rule 
15c3-1(a)(1)(i), a broker-dealer generally may not permit its 
aggregate indebtedness to exceed 1500 percent of its net capital. A 
broker-dealer may elect not to be subject to the aggregate 
indebtedness standard if it complies with an alternative method of 
computing net capital. See 17 CFR 240.15c3-1(a)(1)(ii).
    \102\ The ``risk margin amount'' means the total initial margin 
for SBS. See 17 CFR 15c3-1(c)(17). Exchange Act Rule 15c3-
1(a)(7)(i)(A) provides that initially the requirement will be two 
percent of the risk margin amount. However, the SEC may issue an 
order raising the requirement to four percent on or after the third 
anniversary of the amended rule's compliance date and to eight 
percent on or after the fifth anniversary of the amended rule's 
compliance date. See 17 CFR 15c3-1(a)(7)(i)(A)(2) and (3) and 15c3-
1(a)(7)(i)(B).
    \103\ See Notice at 26094.
    \104\ Id.

---------------------------------------------------------------------------

[[Page 1969]]

     Its tentative net capital is less than 150 percent of the 
minimum tentative net capital amount required by Exchange Act Rule 
15c3-1(a)(7)(i)(A) (i.e., $5 billion, such that the notification amount 
would be $7.5 billion),
     the member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/10th of its aggregate indebtedness and 150 
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of the level specified in 
Exchange Act Rule 17a-11(b)(2) \105\ and 150 percent of the required 
percentage of the risk margin amount.
---------------------------------------------------------------------------

    \105\ See 17 CFR 240.17a-11(b)(2). Exchange Act Rule 17a-11 
requires broker-dealers to promptly notify the SEC after the 
occurrence of certain events. Exchange Act Rule 17a-11(b)(2) 
requires such notification for broker-dealers using the alternative 
method of computing net capital pursuant to Exchange Act Rule 15c3-
1(a)(1)(ii) when net capital is less than five percent of aggregate 
debit items under the Exchange Act Rule 15c3-3 reserve formula.
---------------------------------------------------------------------------

    FINRA believes these modified thresholds are appropriately 
calibrated to provide FINRA with sufficient early warning that an ANC 
Firm's capital levels may be deteriorating.\106\ By revising the early 
warning levels as proposed, FINRA believes the proposed rule change 
aligns the historical thresholds in FINRA Rule 4120(a) for early 
warning notification for ANC Firms with the revised capital 
requirements applicable to such firms under the Commission's amended 
rules.\107\ Additionally, according to FINRA, ANC Firms historically 
maintain capital far in excess of the proposed amounts, so FINRA does 
not expect these levels to be problematic for firms to maintain.\108\
---------------------------------------------------------------------------

    \106\ See Notice at 26094.
    \107\ See Notice at 26094-95.
    \108\ Id. at 26095.
---------------------------------------------------------------------------

    In the Capital, Margin, and Segregation Release, the Commission 
also adopted a new minimum net capital requirement for Non-ANC Firms 
that are also registered as SBSDs.\109\ Specifically, a Non-ANC Firm 
that is registered as an SBSD must maintain minimum net capital of not 
less than the greater of $20 million or the sum of the ratio 
requirements under Exchange Act Rule 15c3-1(a)(1) and two percent of 
the risk margin amount.\110\ Accordingly, FINRA believes it is 
necessary to add corresponding new thresholds for required notification 
to FINRA for Non-ANC Firms that are also registered as SBSDs under new 
FINRA Rule 4120(a)(1)(E).\111\ Specifically, under the proposed rule 
change, a Non-ANC Firm that is also a registered SBSD would be required 
to notify FINRA if, in addition to the conditions currently prescribed 
under FINRA Rule 4120(a)(1)(A), (E) and (F):
---------------------------------------------------------------------------

    \109\ See 17 CFR 15c3-1(a)(10).
    \110\ See Notice at 26095.
    \111\ Id.
---------------------------------------------------------------------------

     The member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/10th of its aggregate indebtedness and 150 
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of the level specified in 
Exchange Act Rule 17a-11(b)(2) and 150 percent of the required 
percentage of the risk margin amount.\112\
---------------------------------------------------------------------------

    \112\ Id.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for 
early notification to FINRA based on the new minimum net capital 
requirements for Non-ANC Firms that are registered SBSDs.\113\ FINRA 
also believes that the thresholds described above are appropriately 
calibrated to provide FINRA with sufficient early warning that such a 
firm's capital levels may be deteriorating.\114\ By defining the early 
warning levels as proposed, the proposed rule change, in FINRA's view, 
aligns the historical thresholds in FINRA Rule 4120(a) for early 
warning notification with the new capital requirements applicable to 
Non-ANC Firms that are registered SBSDs under the SEC's amended 
rules.\115\
---------------------------------------------------------------------------

    \113\ Id.
    \114\ Id.
    \115\ Id.
---------------------------------------------------------------------------

    FINRA Rule 4120(b) allows FINRA to require a member that carries 
customer accounts or clears transactions to not expand its business 
during any period in which any of the conditions described in paragraph 
(a)(1) of FINRA Rule 4120 continue to exist for more than 15 
consecutive business days, provided that such condition(s) has been 
known to FINRA or the member for at least five consecutive business 
days. Since the proposed rule change would modify the conditions 
specified in FINRA Rule 4120(a)(1) as described above, the triggers for 
the application of restrictions under FINRA Rule 4120(b) would be 
similarly affected. However, FINRA does not believe that any conforming 
changes are needed at this time to the restrictions on business 
expansion requirements under FINRA Rule 4120(b).\116\ FINRA states that 
FINRA Rule 4120(b)(3)(A)-(G) includes a non-exclusive list of 
activities that may constitute an ``expansion of business'' for these 
purposes, and FINRA Rule 4120(b)(3)(H) provides that the term 
``expansion of business'' may include such other activities as FINRA 
deems appropriate under the circumstances, in the public interest or 
for the protection of investors. FINRA believes that a member firm's 
SBS activities would be within the scope of ``other activities'' 
contemplated by FINRA Rule 4120(b)(3)(H).\117\
---------------------------------------------------------------------------

    \116\ Id.
    \117\ Id.
---------------------------------------------------------------------------

    FINRA Rule 4120(c) allows FINRA to require a member to reduce its 
business if its net capital falls below any of the percentages 
specified in subparagraphs (A) through (F) of FINRA Rule 4120(c)(1). 
Similar to the proposed modifications to FINRA Rule 4120(a) described 
above, the proposed rule change would modify subparagraph (D) of FINRA 
Rule 4120(c)(1), which applies to ANC Firms, and also add new 
subparagraph (E), applicable to Non-ANC Firm members that are also 
registered as SBSDs.\118\
---------------------------------------------------------------------------

    \118\ The proposed rule change would also make non-substantive 
and conforming changes to other subparagraphs of FINRA Rule 
4120(c)(1) to reflect the insertion of new subparagraph (E), update 
cross-references to SEC rules that have been amended and reflect 
FINRA rulebook format conventions. Similar non-substantive changes 
would be made to paragraph (b)(1) and Supplementary Material .01 to 
FINRA Rule 4120 to reflect FINRA rulebook format conventions. See 
id., n.87.
---------------------------------------------------------------------------

    Current subparagraph (D) of FINRA Rule 4120(c)(1) permits business 
curtailment if the member is an ANC Firm and (i) its tentative net 
capital under Exchange Act Rule 15c3-1(c)(15) is less than 40 percent 
of the early warning notification amount required by Exchange Act Rule 
15c3-1(a)(7)(ii) or (ii) its net capital is less than $1 billion. These 
thresholds are based on the broker-dealer net capital rule prior to the 
amendments in the Capital, Margin, and Segregation Release. As 
described above, the Commission amended the net capital requirements 
for broker-dealers in the Capital, Margin, and Segregation 
Release.\119\ Accordingly, under the proposed rule change, a member 
that is an ANC Firm would be subject to the business curtailment 
provisions of FINRA Rule 4120(c)(1) if, in addition to the conditions 
currently prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F):
---------------------------------------------------------------------------

    \119\ See Capital, Margin, and Segregation Release, supra note 
13.

---------------------------------------------------------------------------

[[Page 1970]]

     Its tentative net capital is less than the amount 
specified under Exchange Act Rule 15c3-1(a)(7)(ii) (i.e., the early 
warning amount, $6 billion),
     The member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/12th of its aggregate indebtedness and 125 
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of one percentage point below 
the level specified in Exchange Act Rule 17a-11(b)(2) and 125 percent 
of the required percentage of the risk margin amount.\120\
---------------------------------------------------------------------------

    \120\ See Notice at 26095.
---------------------------------------------------------------------------

    FINRA believes these modified thresholds are appropriately 
calibrated to provide FINRA with the ability to require ANC Firms to 
reduce their business when their capital levels have deteriorated to a 
level that may jeopardize their ability to continue to comply with 
their capital requirements.\121\
---------------------------------------------------------------------------

    \121\ Id.
---------------------------------------------------------------------------

    As described above, in the Capital, Margin, and Segregation 
Release, the Commission also added a new minimum net capital 
requirement for Non-ANC Firms that are also registered as SBSDs. 
Accordingly, the proposed rule change would add corresponding new 
thresholds for business curtailment for Non-ANC Firms that are also 
registered as SBSDs under new FINRA Rule 4120(c)(1)(E). Specifically, 
under the proposed rule change, a Non-ANC Firm that is also a 
registered SBSD would be subject to the business curtailment provisions 
of FINRA Rule 4120(c)(1) if, in addition to the conditions currently 
prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F):
     The member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/12th of its aggregate indebtedness and 125 
percent of the required percentage of the risk margin amount,\122\ or
---------------------------------------------------------------------------

    \122\ See supra note 101.
---------------------------------------------------------------------------

     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of one percentage point below 
the level specified in Exchange Act Rule 17a-11(b)(2) \123\ and 125 
percent of the required percentage of the risk margin amount.\124\
---------------------------------------------------------------------------

    \123\ See supra note 105.
    \124\ See Notice at 26095.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for 
business curtailment based on the new minimum net capital requirements 
for Non-ANC Firms that are registered as SBSDs.\125\ FINRA also 
believes that the thresholds described above are appropriately 
calibrated to provide FINRA with the ability to require such firms to 
reduce their business when their capital levels have deteriorated to a 
level that may jeopardize their ability to continue to comply with 
their capital requirements.\126\
---------------------------------------------------------------------------

    \125\ Id.
    \126\ Id. at 26096.
---------------------------------------------------------------------------

    Lastly, FINRA states that FINRA Rule 4120(c)(3)(A)-(J) includes a 
non-exclusive list of activities that may constitute a ``business 
reduction'' for these purposes, and FINRA Rule 4120(c)(3)(K) provides 
that the term ``business reduction'' may include such other activities 
as FINRA deems appropriate under the circumstances, in the public 
interest or for the protection of investors.\127\ FINRA believes that a 
member firm's SBS activities would be within the scope of ``other 
activities'' contemplated by FINRA Rule 4120(c)(3)(K).\128\
---------------------------------------------------------------------------

    \127\ Id.
    \128\ Id.
---------------------------------------------------------------------------

    In addition to these conforming changes to FINRA Rule 4120, the 
proposed rule change would apply FINRA's financial and operational 
rules more broadly to firms that enter into, or otherwise have exposure 
to, SBS. Specifically, certain rules in the FINRA Rule 4000 Series 
(Financial and Operational Rules) include provisions that impose higher 
standards, or provide FINRA the authority to impose additional 
requirements, on firms that carry or clear transactions or accounts 
(generally referred to as ``carrying or clearing firms''). This 
``tiering'' structure was built into certain rules so that firms that 
only introduce their customer accounts and do not have exposure to the 
settlement system are provided relief from the higher standards 
required of firms that carry or clear transactions and accounts. Below 
is a list of rules in the FINRA Rule 4000 Series where tiering has been 
employed for carrying or clearing firms and a brief description of the 
tiered requirements for such firms:
     FINRA Rule 4110 (Capital Compliance) includes requirements 
for carrying or clearing firms to keep greater net capital, seek 
permission for withdrawals of capital and seek approval for certain 
add-backs to net capital.
     FINRA Rule 4120 (Regulatory Notification and Business 
Curtailment) includes restrictions on expanding, or requirements to 
reduce business, if sufficient capital levels are not maintained.
     FINRA Rule 4521 (Notifications, Questionnaires and 
Reports) allows FINRA to collect additional data and require reporting 
of a material decline in tentative net capital.
     FINRA Rule 4522 (Periodic Security Counts, Verification 
and Comparison) requires more frequent security counts, verifications 
and comparisons than would be required under Exchange Act Rule 17a-13.
     Rule 4523 (Assignment of Responsibility for General Ledger 
Accounts and Identification of Suspense Accounts) requires a record of 
primary and supervisory named individuals over general ledger 
bookkeeping accounts.\129\
---------------------------------------------------------------------------

    \129\ Id.
---------------------------------------------------------------------------

    According to FINRA, the intent of the tiering employed in these 
rules in the FINRA Rule 4000 Series is to impose higher capital, 
recordkeeping and operational standards on firms that carry or clear 
transactions and accounts, and therefore may have financial exposure to 
customers, other broker-dealers, central counterparties or others.\130\ 
FINRA believes that similar considerations apply for members with 
exposure to SBS.\131\ FINRA states that SBS are complex transactions 
that will, by their nature, require detailed recordkeeping, margining, 
legal agreements, collateral management, reconciliation and risk 
management.\132\ FINRA therefore believes it is appropriate to also 
employ tiering in the FINRA Rule 4000 Series for members that enter 
into SBS on a principal basis or otherwise have financial exposure to 
SBS.\133\ Specifically, under the proposed rule change, proposed FINRA 
Rule 0180(h) would provide that, for purposes of the FINRA Rule 4000 
Series, all requirements that apply to a member that clears or carries 
customer accounts shall also apply to any member that acts as a 
principal counterparty to an SBS, clears or carries an SBS, guarantees 
an SBS or otherwise has financial exposure to an SBS.\134\ FINRA 
believes that applying these higher

[[Page 1971]]

standards when a member enters into SBS or otherwise has exposure to 
SBS is appropriate and consistent with the protection of investors and 
the public interest.\135\
---------------------------------------------------------------------------

    \130\ Id.
    \131\ Id.
    \132\ Id.
    \133\ Id.
    \134\ Although this proposed tiering provision relates to the 
financial responsibility and operational rules, FINRA believes it 
should be included as a paragraph in proposed FINRA Rule 0180 so 
that all provisions relating to the treatment of SBS under FINRA 
rules are found in a single, consolidated rule. See id. at 26096, 
n.95.
    \135\ See id. at 26096.
---------------------------------------------------------------------------

J. Margin Requirements

    As discussed above, in June 2019 the Commission adopted its final 
Capital, Margin, and Segregation Release.\136\ Among other things, the 
Capital, Margin, and Segregation Release adopted new Exchange Act Rule 
18a-3, which prescribes margin requirements for uncleared SBS for SBSDs 
for which there is not a prudential regulator (``nonbank SBSD'').\137\ 
Generally, Exchange Act Rule 18a-3 requires a nonbank SBSD to 
calculate, for each account of an SBS counterparty as of the close of 
business of each day: (i) The amount of current exposure in the account 
(i.e., variation margin) and (ii) the initial margin amount for the 
account.\138\ Under Exchange Act Rule 18a-3, variation margin is 
calculated by marking the position to market, while initial margin must 
generally be calculated using standardized haircuts, which are 
prescribed in Exchange Act Rule 15c3-1 for nonbank SBSDs that are 
registered broker-dealers.\139\ Nonbank SBSDs may apply to the SEC for 
authorization to use models to calculate initial margin instead of the 
standardized haircuts (including the option to use the more risk 
sensitive methodology in Exchange Act Rule 15c3-1a), but nonbank SBSDs 
that are registered broker-dealers must use standardized haircuts to 
calculate initial margin for uncleared equity SBS.\140\ Based on these 
calculations, Exchange Act Rule 18a-3 generally requires a nonbank SBSD 
to collect and deliver variation margin, and to collect (but not 
deliver) initial margin.\141\ Exchange Act Rule 18a-3 also provides 
certain exceptions from the margin requirements, establishes thresholds 
and minimum transfer amounts, specifies collateral requirements 
(including collateral haircuts), establishes risk monitoring 
requirements and includes other miscellaneous provisions, such as 
definitions. All nonbank SBSDs, including nonbank SBSDs that are FINRA 
members, are subject to the margin requirements set forth in Exchange 
Act Rule 18a-3.
---------------------------------------------------------------------------

    \136\ See Capital, Margin, and Segregation Release at 43954.
    \137\ See 17 CFR 240.18a-3. Exchange Act Rule 18a-3 also 
prescribes margin requirements for nonbank MSBSPs with respect to 
uncleared SBS. As discussed above, Exchange Act Rule 18a-3 generally 
requires SBSDs to collect or deliver variation margin, and also to 
collect initial margin, with respect to its SBS counterparties. 
However, Exchange Act Rule 18a-3 requires that a nonbank MSBSP only 
collect and deliver variation margin, without prescribing any 
initial margin requirement. See Capital, Margin, and Segregation 
Release at 43877. As discussed below, FINRA believes it is 
appropriate to apply variation margin and initial margin 
requirements to all of its members that transact in uncleared SBS. 
Therefore, proposed FINRA Rule 4240 would provide an exception for 
members that are registered as SBSDs (and therefore subject to the 
variation and initial margin requirements of Exchange Act Rule 18a-
3), but not for members that are registered as MSBSPs. See Notice at 
26096, n.97.
    \138\ See 17 CFR 240.18a-3(c)(1)(i); Capital, Margin, and 
Segregation Release at 43876.
    \139\ See 17 CFR 240.18a-3(d).
    \140\ See Capital, Margin, and Segregation Release at 43876.
    \141\ See 17 CFR 240.18a-3(c)(1)(ii).
---------------------------------------------------------------------------

    The FINRA Rule 4200 Series sets forth margin requirements 
applicable to FINRA members. In particular, FINRA Rule 4210 describes 
the margin requirements that determine the amount of equity or 
``margin'' customers are expected to maintain in their securities 
accounts, including margin requirements for equity and fixed income 
securities as well as options, warrants and security futures. Current 
FINRA Rule 4240 separately establishes an interim pilot program with 
respect to margin requirements for any transactions in CDS held in an 
account at a member (the ``Interim Pilot Program''). Under current 
FINRA Rule 0180, FINRA Rule 4210 does not apply to members' activities 
and positions with respect to SBS, but current FINRA Rule 4240 does 
apply to activities and positions within its scope. Therefore, to the 
extent that a FINRA member enters into SBS that are CDS, the margin 
requirements under the Interim Pilot Program apply to such SBS.\142\ 
However, the Interim Pilot Program is a temporary rule, and SBS that 
are not CDS are not currently subject to any margin requirements under 
FINRA rules.\143\
---------------------------------------------------------------------------

    \142\ For purposes of current FINRA Rule 4240, the term ``credit 
default swap'' includes any product that is commonly known to the 
trade as a ``credit default swap'' and is an SBS as defined pursuant 
to Section 3(a)(68) of the Exchange Act or the rules and guidance of 
the SEC and its staff. See FINRA Rule 4240(a).
    \143\ See Notice at 26097.
---------------------------------------------------------------------------

    The Interim Pilot Program was originally proposed by FINRA and 
approved by the Commission in 2009 specifically to address concerns 
arising from systemic risk posed by CDS.\144\ Pending the SEC's final 
implementation of the Title VII rulemakings, FINRA has extended the 
expiration date of the Interim Pilot Program a number of times, most 
recently in September 2021.\145\ The Interim Pilot Program under 
current FINRA Rule 4240 is currently set to expire on April 6, 
2022.\146\
---------------------------------------------------------------------------

    \144\ See Exchange Act Release No. 59955 (May 22, 2009), 74 FR 
25586 (May 28, 2009) (Notice of Filing and Order Approving File No. 
SR-FINRA-2009-012).
    \145\ See Extension Notice at 50392.
    \146\ See supra note 19.
---------------------------------------------------------------------------

    In light of the finalization of the Commission's margin 
requirements for nonbank SBSDs under Exchange Act Rule 18a-3 and the 
registration compliance date, FINRA believes it is appropriate and in 
the public interest for the Interim Pilot Program to expire and for 
FINRA to adopt a new margin rule specifically applicable to SBS.\147\ 
Accordingly, under the proposed rule change, current FINRA Rule 4240 
would be replaced by a new FINRA Rule 4240 that would prescribe margin 
requirements for SBS. Consistent with Exchange Act Rule 18a-3--and 
unlike the Interim Pilot Program--proposed new Rule 4240 would apply 
margin requirements to all SBS, not just CDS. However, proposed new 
FINRA Rule 4240 would not apply to any member that is registered as an 
SBSD, as such members are subject to the margin requirements of 
Exchange Act Rule 18a-3. Additionally, proposed FINRA Rule 4240 would 
defer to registered clearing agencies to set the margin requirements 
for cleared SBS, and as such would only specify new variation margin 
and initial margin requirements for uncleared SBS. Therefore, the 
specific new margin requirements prescribed under proposed FINRA Rule 
4240 would only apply to uncleared SBS transacted by FINRA members that 
are not registered as SBSDs. FINRA believes that, by applying margin 
requirements in these circumstances, the proposed rule change would 
fill an important regulatory gap, protect FINRA members against 
counterparty credit risk, maintain a level playing field for members 
and prevent regulatory arbitrage.\148\ As described in further detail 
below, the margin requirements under proposed FINRA Rule 4240 would be 
structurally aligned with the margin requirements that will apply to 
nonbank SBSDs under Exchange Act Rule 18a-3, with certain modifications 
that FINRA believes are necessary given

[[Page 1972]]

that such members will not be subject to the SEC's comprehensive 
regulatory framework for SBSDs.\149\ Thus, subject to certain 
exceptions described in the proposed rule, proposed FINRA Rule 4240 
would require members that are not SBSDs to collect and deliver 
variation margin on a daily basis to cover the member's current 
exposure to or from each uncleared SBS counterparty, and also to 
collect (but not deliver) initial margin from each SBS counterparty.
---------------------------------------------------------------------------

    \147\ See Notice at 26097. FINRA states that, under the proposed 
rule change, proposed FINRA Rule 0180 would no longer provide an 
exception from current FINRA Rule 4210 applying to members' 
activities and positions with respect to SBS. Absent additional 
changes, therefore, the general margin requirements under FINRA Rule 
4210 would apply to SBS. However, as described above, FINRA proposed 
to specifically list SBS within the exceptions listed in FINRA Rule 
4210, and adopt a separate, new FINRA Rule 4240 applicable to SBS. 
See id., n.106.
    \148\ See id. at 26097.
    \149\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240 is divided into a header followed by 
paragraphs (a) through (d). The header would specify the scope of the 
margin requirements under proposed FINRA Rule 4240. Paragraph (a) would 
describe the margin requirements for cleared SBS. Paragraph (b) would 
describe the margin requirements for uncleared SBS. Specifically, 
paragraph (b)(1) would set forth how variation margin must be 
calculated, paragraph (b)(2) would set forth how initial margin must be 
calculated, paragraph (b)(3) would prescribe the collection and 
delivery requirements for variation and initial margin, paragraph 
(b)(4) would specify the manner and time of collection or delivery of 
variation and initial margin, and paragraph (b)(5) would list certain 
exceptions from the margin requirements. Paragraph (c) would require 
members to employ specified risk monitoring procedures and guidelines 
for uncleared SBS. Finally, paragraph (d) would define certain terms 
used in proposed FINRA Rule 4240. Each of these aspects of the proposed 
rule change is described in further detail below.
    Proposed FINRA Rule 4240 would be entitled ``Security-Based Swap 
Margin Requirements.'' \150\ The header text to the rule would state 
that each member that is a party to an SBS with a customer, broker or 
dealer, or other Counterparty,\151\ or who has guaranteed or otherwise 
become responsible for any other person's SBS obligations, shall comply 
with the requirements of proposed FINRA Rule 4240, except that a member 
that is registered as an SBSD shall instead comply with Exchange Act 
Rule 18a-3. This provision of the proposed rule is intended to clarify 
that the margin requirements under proposed FINRA Rule 4240 apply in 
all circumstances where a member is a party to an SBS, regardless of 
the type of counterparty, and also where a member has financial 
exposure to an SBS, whether through a guarantee or other arrangements 
under which the member is responsible for another person's SBS 
obligations. FINRA believes that this provision is necessary to ensure 
that the proposed margin requirements adequately protect member firms 
against counterparty credit risk, regardless of the specific manner 
through which the member has become exposed to such risk.\152\ 
Additionally, as discussed above, this provision clarifies that members 
that are registered as SBSDs are not subject to the proposed margin 
requirements because they must comply with Exchange Act Rule 18a-3. 
FINRA believes it should defer to the SEC's margin framework for 
registered SBSDs rather than impose additional or different 
requirements on such entities.\153\ Proposed FINRA Rule 4240(a), 
entitled ``Cleared SBS Margin Requirements,'' would state that, except 
as provided in paragraph (b)(5) (i.e., specified exceptions from 
proposed FINRA Rule 4240, discussed below), the margin to be maintained 
on any Cleared SBS is the margin on such Cleared SBS required by the 
Clearing Agency through which such SBS is Cleared. As discussed above, 
this provision clarifies that proposed FINRA Rule 4240 defers to 
registered clearing agencies to set the margin requirements for cleared 
SBS. FINRA believes that it is appropriate to defer to clearing 
agencies to establish margin requirements for cleared SBS in light of 
the SEC's comprehensive regulation of clearing agencies, including 
their required margin levels, under the Exchange Act.\154\
---------------------------------------------------------------------------

    \150\ In addition to the new provisions under proposed FINRA 
Rule 4240 discussed above, the implementation of new margin 
requirements for SBS under proposed FINRA Rule 4240 would also 
require a conforming change to FINRA Rule 4220 (Daily Record of 
Required Margin). FINRA Rule 4220 requires each member carrying 
securities margin accounts for customers to make a record each day 
of every case in which initial or additional margin must be obtained 
in a customer's account. To ensure that similar records are 
maintained for SBS margin required under proposed new FINRA Rule 
4240, the proposed rule change would update FINRA Rule 4220 to also 
require such records for each member subject to proposed FINRA Rule 
4240.
    In addition, the proposed rule change would add new 
Supplementary Material .06 to FINRA Rule 4210 to clarify that a 
Regulation T good faith account, other than a non-securities 
account, is a margin account for purposes of FINRA Rule 4210. This 
provision is intended merely to codify FINRA's existing 
interpretation regarding the scope of FINRA Rule 4210. The proposed 
rule change would also include a parallel provision in new 
Supplementary Material .01 to proposed new Rule 4240.
    Finally, the proposed rule change would make two other 
conforming changes to FINRA Rule 4210, including to add proposed new 
FINRA Rule 4240(e)(9) and to make a technical adjustment to FINRA 
Rule 4240(g)(2)(H). See id. at 26097-98, n.107.
    \151\ ``Counterparty'' would be defined under proposed FINRA 
Rule 4240(d)(5) to mean a person with whom a member has entered into 
an uncleared SBS. An ``SBS'' would be defined in proposed FINRA Rule 
4240(d)(16) by reference to the definition of ``security-based 
swap'' under Section 3(a)(68) of the Exchange Act and ``Uncleared'' 
would be defined in proposed FINRA Rule 4240(d)(18) as an SBS that 
is not Cleared. Under proposed FINRA Rule 4240(d)(3), an SBS would 
be considered Cleared if it is cleared through a Clearing Agency by 
or on behalf of the member, and Clearing Agency would be defined 
under proposed FINRA Rule 4240(d)(4) as a clearing agency registered 
pursuant to Section 17A of the Exchange Act or exempted by the SEC 
from such registration by a rule or order pursuant to Section 17A of 
the Exchange Act.
    \152\ See id. at 26098.
    \153\ Id.
    \154\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b), entitled ``Uncleared SBS Margin 
Requirements,'' would set forth the substantive margin requirements 
applicable to members that are not SBSDs when such members transact in 
uncleared SBS. Paragraph (b)(1), entitled ``Current Exposure 
Calculation,'' would require that, as of the close of business of each 
business day, the member calculate, with respect to each Uncleared SBS 
Account,\155\ the Counterparty's Current Exposure to the member (if 
positive) or the member's Current Exposure to the Counterparty (if 
negative). Current Exposure would be calculated as an amount equal to 
the net Value \156\ of all uncleared SBS in the Uncleared SBS Account 
plus the Value of all Variation Margin collected from the Counterparty 
minus the Value of all Variation margin delivered to the

[[Page 1973]]

Counterparty.\157\ This provision would define a member's Current 
Exposure for purposes of collecting or delivering Variation Margin 
under proposed FINRA Rule 4240(b)(3), discussed below, by taking into 
account the net Value of SBS in the Counterparty's account together 
with any Variation Margin that has already been collected or delivered. 
FINRA believes this calculation is consistent with the variation margin 
requirements under Exchange Act Rule 18a-3.\158\
---------------------------------------------------------------------------

    \155\ Under proposed FINRA Rule 4240(d)(19), an ``Uncleared SBS 
Account'' would be defined to mean an account with respect to a 
Counterparty consisting of all Uncleared SBS between the member and 
the Counterparty, together with long or short positions for 
Variation Margin in the form of securities collected or delivered, 
respectively, credit or debit balances for Variation Margin in the 
form of cash collected or delivered, respectively, and long 
positions or credit balances for Initial Margin collected in the 
form of securities or cash, respectively.
    \156\ ``Value'' would be defined in proposed FINRA Rule 
4240(d)(20). Under this definition, the Value of one or more SBS 
would be the mid-market replacement cost for such SBS. The Value of 
a security position would be the current market value of such margin 
securities, as defined in FINRA Rule 4210(a)(2) and determined in 
accordance with FINRA Rule 4210(f)(1) (i.e., the provisions of 
FINRA's general margin rule used to determine the current market 
value of margin securities). Alternatively, a member could elect to 
determine the Value of margin securities collected as Variation 
Margin or Initial Margin by applying a haircut to the current market 
value of such securities equal to the margin requirement that would 
be applicable to them under FINRA Rule 4210 if they were held in the 
Counterparty's margin account (in which case, however, such margin 
securities would not be required to be themselves margined under 
proposed FINRA Rule 4240(b)(2)(A)(iii)). The Value of cash in U.S. 
dollars would be the amount of such cash, while the Value of freely 
convertible foreign currency would be the amount of U.S. dollars 
into which the currency could be converted, provided the currency is 
marked-to-market daily. See id. at 26098, n.110.
    \157\ Under proposed FINRA Rule 4240(d)(21), ``Variation 
Margin'' would be defined to mean the cash or margin securities 
collected from, or delivered to, a Counterparty in accordance with 
proposed FINRA Rule 4240(b)(3)(A), as discussed below. Under 
proposed FINRA Rule 4240(b)(2)(A)(iii), all securities deposited as 
Variation Margin for uncleared SBS would themselves be margined in 
accordance with FINRA Rule 4210, unless the member has chosen to 
haircut them for purposes of determining their Value.
    \158\ See id. at 26098.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(2), entitled ``Initial Margin 
Computation,'' would require that, as of the close of business on each 
business day, the member compute the Initial Margin Requirement for 
each Uncleared SBS Account equal to the sum of the Initial Margin 
Requirements on the Uncleared SBS and securities positions in that 
Uncleared SBS Account. The remainder of proposed FINRA Rule 4240(b)(2) 
would describe how a member must calculate the Initial Margin 
Requirement, which is then used for purposes of collecting Initial 
Margin under proposed FINRA Rule 4240(b)(3), discussed below.\159\ 
Under the proposed rule change, the Initial Margin Requirement would 
depend on the type of uncleared SBS involved, with different 
requirements depending on whether the uncleared SBS is (i) a ``plain 
vanilla'' CDS; (ii) a ``plain vanilla'' SBS other than an CDS (i.e., an 
SBS that is the economic equivalent of a margin account containing a 
portfolio of long or short positions in securities or options, such as 
a ``plain vanilla'' equity total return swap (``TRS'')); or (iii) any 
other type of SBS (e.g., a complex CDS or equity TRS that would not be 
considered ``plain vanilla'' under the proposed rule, including for 
example a CDS swaption, or a dividend swap). FINRA believes that 
differentiation as to initial margin requirements among these different 
types of SBS is appropriate and necessary given the unique 
characteristics and risks posed by different SBS products.\160\
---------------------------------------------------------------------------

    \159\ Under proposed FINRA Rule 4240(d)(9), the term ``Initial 
Margin'' would be defined to mean all cash or marginable securities, 
excluding Variation Margin, received by the member for a 
Counterparty's Uncleared SBS Account or transferred to the 
Counterparty's Uncleared SBS Account from another account at the 
member, including margin collected from a Counterparty in accordance 
with proposed FINRA Rule 4240(b)(3)(B), as discussed below, that in 
each case have not been returned to the Counterparty or applied to 
an obligation of the Counterparty. Under proposed FINRA Rule 
4240(b)(2)(A)(iii), all securities deposited as Initial Margin for 
uncleared SBS would themselves be margined in accordance with FINRA 
Rule 4210, unless the member has chosen to haircut them for purposes 
of determining their Value.
    \160\ See id. at 26099.
---------------------------------------------------------------------------

    Proposed paragraphs (b)(2)(A)(i) and (ii) would define the Initial 
Margin Requirements for uncleared plain vanilla CDS (referred to as 
``Basic CDS'') \161\ and other uncleared ``plain vanilla'' SBS 
(referred to as ``Basic SBS''),\162\ respectively. First, the Initial 
Margin Requirement for an uncleared Basic CDS would generally be 
computed based on the term and spread of the uncleared Basic CDS, using 
the chart and offsets set out in Exchange Act Rule 15c3-
1(c)(2)(vi)(P).\163\ In FINRA's view, the proposed rule would therefore 
follow Exchange Act Rule 18a-3(d)(1)(i) by determining the Initial 
Margin Requirement for uncleared Basic CDS using the haircuts 
applicable to such SBS under the SEC's net capital rule.\164\ FINRA 
believes that determining initial margin for CDS in this manner would 
promote regulatory consistency and reduce potential arbitrage.\165\ 
Additionally, in FINRA's view, the haircuts prescribed in Exchange Act 
Rule 15c3-1(c)(2)(vi)(P) are analogous to existing FINRA Rule 4240 
margin requirements, so in effect the proposed requirements have 
already been used during the Interim Pilot Program.\166\ Second, the 
Initial Margin Requirement for a Basic SBS would generally be computed 
by applying FINRA Rule 4210 to the Equivalent Margin Account. Since an 
uncleared Basic SBS would be the economic equivalent of a margin 
account that would otherwise be governed by the margin provisions of 
FINRA Rule 4210, FINRA believes it is appropriate to treat such SBS 
similarly.\167\
---------------------------------------------------------------------------

    \161\ Under proposed FINRA Rule 4240(d)(1), a ``Basic CDS'' 
would be defined to mean a Basic Single Name Credit Default Swap or 
a Basic Narrow-Based Index Credit Default Swap. A Basic Single-Name 
Credit Default Swap would mean an SBS in which one party pays either 
a single fixed amount or periodic fixed amounts or floating amounts 
determined by reference to a specified notional amount, and the 
other party pays either a fixed amount or an amount determined by 
reference to the value of one or more loans, debt securities or 
other financial instruments issued, guaranteed or otherwise entered 
into by a third party (i.e., the ``Reference Entity'') upon the 
occurrence of one or more specified credit events with respect to 
the Reference Entity (for example, bankruptcy or payment default). 
The term ``Basic Single-Name Credit Default Swap'' would also 
include a swap that, upon the occurrence of one or more specified 
credit events with respect to the Reference Entity, is physically 
settled by payment of a specified fixed amount by one party against 
delivery by the other party of eligible obligations of the Reference 
Entity. A Basic Narrow-Based Index Credit Default Swap would be 
defined to mean an SBS consisting of multiple component Basic 
Single-Name Credit Default Swaps. See id. at 26099, n.113.
    \162\ Under proposed FINRA Rule 4240(d)(2), a ``Basic SBS'' 
would be defined to mean an SBS, other than a CDS, under which each 
party is contractually obligated to provide the other the economic 
equivalent of a margin account containing a portfolio of long or 
short positions in securities or options (i.e., an ``Equivalent 
Margin Account''). See id. at 26099, n.114.
    \163\ See 17 CFR 240.15c3-1(c)(2)(vi)(P). This provision of the 
SEC's broker-dealer net capital rule prescribes the haircuts 
applicable to uncleared SBS.
    \164\ See Notice at 26099.
    \165\ Id.
    \166\ Id.
    \167\ Id.
---------------------------------------------------------------------------

    In addition, proposed FINRA Rule 4240(b)(2)(A) would permit the 
Initial Margin Requirements for both uncleared Basic CDS and uncleared 
Basic SBS to be computed based on a combination of multiple SBS and 
securities or options positions, as applicable and subject to certain 
conditions. Specifically, proposed FINRA Rule 4240(b)(2)(A)(i) would 
provide that, if the member has a netting or collateral agreement that 
is legally enforceable against the Counterparty and covers any 
combination of uncleared Basic CDS or securities specified in clause 
(iii), (iv) or (v) of Exchange Act Rule 15c3-1(c)(2)(vi)(P)(1) (i.e., 
specified offsetting debt securities), the member may compute the 
Initial Margin Requirement on such combination of positions equal to 
the ``haircut'' on that combination under Exchange Act Rule 15c3-
1(c)(2)(vi)(P)(1). Proposed FINRA Rule 4240(b)(2)(A)(ii) would 
similarly provide that, if the member has a netting or collateral 
agreement that is legally enforceable against the Counterparty and 
covers any combination of uncleared Basic SBS, securities or options 
positions, the member may compute the Initial Margin Requirement on the 
combination of such positions equal to the margin that FINRA Rule 4210 
would require to be maintained on the combination of Equivalent Margin 
Accounts for such uncleared Basic SBS and securities or options 
positions. Proposed FINRA Rule 4240(b)(2)(B) would impose conditions on 
computing the Initial Margin Requirement using these combination 
methods, including that (i) securities positions must be in the 
Counterparty's uncleared SBS Account or margin account at the member; 
(ii) securities may not be included if the member has chosen to haircut 
them for purposes of determining their Value; (iii) options

[[Page 1974]]

positions must be in the Counterparty's margin account at the member; 
(iv) no SBS, security or option positions may be included in more than 
one combination; and (v) no combinations may include securities or 
options positions for which reduced margin requirements are computed 
under FINRA Rule 4210(e)(1) (i.e., reduced margin requirements for 
offsetting long and short positions) or 4210(f)(2)(F)(ii) through 
(f)(2)(l) (i.e., various reduced margin requirements for certain 
options, including covered options and offsetting options 
positions).\168\ FINRA believes these conditions would ensure that the 
Initial Margin Requirement calculated using the combination method is 
based on securities and options positions that the member actually has 
in its possession and does not reflect reductions in value that would 
inappropriately lower the margin requirement.\169\ In addition, 
proposed FINRA Rule 4240(b)(2)(B) would provide that if the Initial 
Margin Requirement is computed on a combination as described above, the 
Initial Margin Requirement on the uncleared SBS included in the 
combination shall be reduced (but not below zero) by the aggregate 
maintenance margin requirements under FINRA Rule 4210 applicable to 
such margin account positions. FINRA believes that this provision would 
appropriately take into account margin already collected under FINRA 
Rule 4210 with respect to such positions.\170\
---------------------------------------------------------------------------

    \168\ Id.
    \169\ Id.
    \170\ Id. In connection with this proposed provision of FINRA 
Rule 4240(b)(2)(B), the proposed rule change would also add a new 
paragraph (e)(9) to FINRA Rule 4210, entitled ``Security-Based 
Swaps; SBS Offsets.'' Specifically, where the Initial Margin 
Requirement on the combination of SBS and securities or options 
position in the margin account would be less than the FINRA Rule 
4210 maintenance requirement on the margin account positions, 
proposed FINRA Rule 4210(e)(9) would reduce the FINRA Rule 4210 
maintenance requirement on the margin account positions to equal the 
computed Initial Margin Requirement.
     In addition, proposed FINRA Rule 4210(e)(9) would clarify that, 
except for SBS carried by a member in a portfolio margin account 
subject to the requirements of FINRA Rule 4210(g), as discussed 
below, margin requirements on SBS and positions in Uncleared SBS 
Accounts are determined by proposed FINRA Rule 4240, rather than 
FINRA Rule 4210. See id. at 26099, n.117.
---------------------------------------------------------------------------

    The proposed rule change would not specify Initial Margin 
Requirements for other uncleared SBS that do not qualify as Basic CDS 
or Basic SBS. Instead, proposed FINRA Rule 4240(b)(2)(A)(iv) would 
provide that the Initial Margin Requirement for any uncleared SBS other 
than a Basic CDS or Basic SBS would be determined in a manner approved 
by FINRA pursuant to proposed FINRA Rule 4240(b)(2)(C), which would 
permit a member to apply to FINRA for the approval of an Initial Margin 
Requirement for any other type of SBS. Under the proposed rule change, 
any such application would be required to:
     Define the specific type of SBS covered by the 
application;
     describe the purpose(s) that the member and its 
Counterparties would have for entering that type of SBS;
     identify all variables that influence the value of that 
type of SBS;
     explain all risks of that type of SBS;
     propose a specific Initial Margin Requirement (not a 
margin model) for that type of SBS;
     explain how the proposed specific Initial Margin 
Requirement would adequately protect a member and its capital against 
each of those risks;
     attach copies of the member's SBS risk management 
procedures and describe the application of those procedures to that 
type of SBS; and
     provide the results of backtesting of the proposed 
specific Initial Margin Requirement over periods of significant 
volatility in the variables influencing the value of that type of 
SBS.\171\
---------------------------------------------------------------------------

    \171\ See Notice at 26100.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(2)(C) would further provide that, if 
FINRA approves any such application, the approval may be unconditional 
or conditional, including in the form of a time-limited pilot program; 
may approve the use of the specific Initial Margin Requirement only by 
the applicant; or may take the form of a Regulatory Notice or other 
communication approving the use of the specific margin requirements by 
members generally. Under proposed FINRA Rule 4240(b)(2)(C), no member 
would be permitted to become a party to an SBS other than a Basic CDS 
or Basic SBS unless FINRA has approved an Initial Margin Requirement 
for such member's use with respect to that type of SBS. As described 
above, FINRA states that the Initial Margin Requirements for Basic CDS 
are based on the Commission's treatment of such SBS under its net 
capital rule, while the Initial Margin Requirements for Basic SBS are 
based on the margin that would be required for a margin account that 
would be the economic equivalent of such SBS.\172\ However, in FINRA's 
view, other types of SBS--including CDS and equity TRS with complex 
features--may not be easily accommodated under these frameworks, and 
the specific risks that accompany such SBS may not be readily apparent 
or quantifiable to FINRA without additional information.\173\ Moreover, 
as noted above, SBS can be complex financial instruments that pose 
substantial risks to members and margin serves as an important means of 
protecting member firms, and thereby their customers and investors, 
from such risks. FINRA therefore believes that members that are not 
SBSDs (and therefore not subject to the SEC's comprehensive regulatory 
framework for registrants under Title VII of Dodd-Frank) should not be 
permitted to enter into other types of SBS unless and until FINRA has 
evaluated the risks of such SBS and approved margin requirements that 
adequately address such risks.\174\ If FINRA determines that a proposed 
margin requirement does not adequately address the risks for a 
particular type of SBS, FINRA would not approve the application under 
proposed FINRA Rule 4240(b)(2)(C), and members would not be permitted 
to enter into such SBS. To FINRA's knowledge, this SBS activity by 
members that do not plan to register as SBSDs is relatively 
limited.\175\
---------------------------------------------------------------------------

    \172\ Id.
    \173\ Id.
    \174\ Id.
    \175\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(3), entitled ``Collection or Delivery 
of Variation and Initial Margin,'' would set forth a member's 
obligation to collect or deliver margin as calculated pursuant to 
proposed FINRA Rule 4240(b)(1) and (2), as described above. Paragraph 
(b)(3)(A) would require each member to deliver or return to each 
Counterparty cash or margin securities with a Value equal to the 
Counterparty's Current Exposure (if any) to the member, or collect or 
retrieve from the Counterparty cash or margin securities with a Value 
equal to the member's Current Exposure (if any) to the Counterparty. 
Paragraph (b)(3)(B) would require each member to collect from each 
Counterparty cash or margin securities with a Value at least equal to 
any Initial Margin Deficit.\176\ Therefore, consistent with Exchange 
Act Rule 18a-3, proposed FINRA Rule 4240(b)(3) would require members 
that are not SBSDs to collect and deliver Variation Margin, and also to 
collect (but not deliver) Initial Margin, in amounts determined 
pursuant to the

[[Page 1975]]

provisions of FINRA Rule 4240(b)(1) and (2) as described above, for 
their transactions in uncleared SBS.\177\
---------------------------------------------------------------------------

    \176\ Under proposed FINRA Rule 4240(d)(10), the term ``Initial 
Margin Deficit'' would be defined as the amount, if any, by which 
(A) the sum of the Value of the Initial Margin in an Uncleared SBS 
Account and the Counterparty's Rule 4210 Excess is less than (B) the 
Initial Margin Requirement for the Uncleared SBS Account. A person's 
``Rule 4210 Excess'' would be defined in proposed FINRA Rule 
4240(d)(15) to mean the amount, if any, by which the equity (as 
defined in FINRA Rule 4210(a)(5)) in the Counterparty's margin 
account at the member exceeds the amount required by FINRA Rule 
4210. See id. at 26100, n.118.
    \177\ To account for situations where a member is not the actual 
party to an SBS, but nonetheless has financial exposure for 
uncleared SBS (e.g., through a guarantee), proposed FINRA Rule 
4240(b)(3)(C) would also require a member to collect both Variation 
Margin and Initial Margin from the party that has obligations under 
the uncleared SBS for which the member has responsibility, to the 
extent that such collection would be required if the member were a 
party to the uncleared SBS, unless the member can establish that 
such margin has been delivered to the other party. See id. at 26100, 
n.119.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(4), entitled ``Manner and Time of 
Collection or Delivery of Variation and Initial Margin; Prohibited 
Returns and Withdrawals,'' would set forth additional detailed 
requirements and clarifications regarding the manner and time of 
collection or delivery of variation and initial margin, as calculated 
pursuant to proposed FINRA Rules 4240(b)(1) and (2) and collected or 
delivered in accordance with proposed FINRA Rule 4240(b)(3), as 
described above. Specifically, proposed FINRA Rule 4240(b)(4) would 
provide for the following: \178\
---------------------------------------------------------------------------

    \178\ See id. at 26100.
---------------------------------------------------------------------------

     Under proposed FINRA Rule 4240(b)(4)(A), margin would be 
deemed collected or returned to the member when it is received in the 
Counterparty's Uncleared SBS Account at the member (or transferred to 
such account from another account at the member).
     Under proposed FINRA Rule 4240(b)(4)(B), margin would be 
deemed collected or returned to the Counterparty when it is transferred 
from the Counterparty's Uncleared SBS Account at the member in 
accordance with the Counterparty's instructions or agreement with the 
member, which could potentially include transfer to another account of 
the Counterparty carried by the member.
     Under proposed FINRA Rule 4240(b)(4)(C), margin would be 
required to be collected or delivered pursuant to proposed FINRA Rule 
4240(b)(3) as promptly as possible, but in any case no later than the 
close of business on the business day after the date on which the 
Current Exposure or Initial Margin Requirement was required to be 
computed in accordance with proposed FINRA Rule 4240(b)(1) or (2) 
(i.e., margin would generally be required to be delivered or collected 
on a T+1 basis). Further, unless FINRA has specifically granted the 
member additional time, a member that has not collected margin as 
required by the close of business on the third business day (i.e., by 
T+3) would be required to take prompt steps to liquidate positions in 
the Counterparty's Uncleared SBS Account to eliminate the margin 
deficiency.
     Proposed FINRA Rule 4240(b)(4)(D) would require a member 
to net the delivery or return of Variation Margin against the 
collection of Initial Margin, if applicable, and would further permit a 
member to net the return of Initial Margin against the collection or 
retrieval of Variation Margin, if applicable.
     Proposed FINRA Rule 4240(b)(4)(E) would prohibit a member 
from returning Initial Margin to a Counterparty, or permitting a 
Counterparty to make a withdrawal from the Counterparty's margin 
account, if doing so would create or increase an Initial Margin 
Deficit.

FINRA believes it is appropriate and consistent with the protection of 
member firms and investors to require margin for uncleared SBS to be 
delivered or collected, as applicable, on a T+1 basis, and to further 
require that uncleared SBS positions be liquidated if margin is not 
collected within a T+3 timeframe.\179\ FINRA also believes the other 
clarifications described above are necessary to ensure that members and 
their uncleared SBS counterparties have a clear and consistent 
understanding of when and how margin must be delivered or collected 
under the proposed rule change.\180\
---------------------------------------------------------------------------

    \179\ See id. at 26101.
    \180\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(5), entitled ``Exceptions,'' would 
provide eight specific exceptions from a member's general obligation to 
collect or deliver margin, as applicable, under proposed FINRA Rule 
4240(b)(3), as described above. FINRA believes the proposed exceptions 
would further align the requirements of proposed FINRA Rule 4240 with 
the margin requirements applicable to SBSDs under Exchange Act Rule 
18a-3 and provide members with additional flexibility in managing their 
risk exposures, while still ensuring that the risks to members with 
respect to their uncleared SBS exposures are adequately addressed.\181\ 
The proposed exceptions under FINRA Rule 4240(b)(5) would include the 
following:
---------------------------------------------------------------------------

    \181\ Id.
---------------------------------------------------------------------------

     Clearing Agencies. A member would not be required to 
deliver Variation Margin to, or collect Initial Margin or Variation 
Margin from, any Clearing Agency, and would also not be required to 
deduct otherwise required Variation Margin or Initial Margin in the 
computation of its net capital under Exchange Act Rule 15c3-1 or, if 
applicable, FINRA Rule 4110(a). FINRA believes this exception is 
consistent with its determination to defer to Clearing Agency margin 
requirements with respect to Cleared SBS.\182\
---------------------------------------------------------------------------

    \182\ Id.
---------------------------------------------------------------------------

     Legacy SBS. A member would be permitted to omit all (but 
not less than all) Legacy SBS with a Counterparty from the 
Counterparty's Uncleared SBS Account when computing Current Exposure 
and the Initial Margin Requirement, provided that the member collects 
and delivers margin on Legacy SBS to the extent of its contractual 
rights and obligations to do so.\183\ However, a member would be 
required to take a capital deduction under Exchange Act Rule 15c3-1 or, 
if applicable, FINRA Rule 4110(a), to reflect the amount of any margin 
that it would have otherwise been required to collect if the Legacy SBS 
had been included in the Counterparty's Uncleared SBS Account. FINRA 
believes it is appropriate to provide a general exception for legacy 
SBS, as members would not be in a position to require their 
counterparties to legacy SBS to exchange margin under existing SBS 
agreements as would otherwise be required under proposed FINRA Rule 
4240.\184\ However, in such cases, FINRA believes it is appropriate to 
require a member to take a corresponding capital charge to account for 
the member's ongoing risk exposure under such SBS.\185\
---------------------------------------------------------------------------

    \183\ Under proposed FINRA Rule 4240(d)(12), a ``Legacy SBS'' 
would be defined as an uncleared SBS entered into before April 6, 
2022. See Amendment No. 1. Proposed FINRA Rule 4240(b)(2)(A)(iv) 
would also clarify that for any Legacy SBS for which proposed Rule 
4240 does not specify an Initial Margin Requirement (i.e., an SBS 
other than a Basic CDS, Basic SBS or other SBS for which FINRA has 
approved specific margin requirements), the Initial Margin 
Requirement must be calculated using the applicable method specified 
in Exchange Act Rule 15c3-1(c)(2)(vi)(P). The Initial Margin 
Requirement for Legacy SBS calculated under this provision would be 
used for purposes of determining the appropriate corresponding 
capital charge, as well as to determine the Initial Margin 
Requirement for a Legacy SBS to the extent that a member elects not 
to utilize the Legacy SBS exception under proposed FINRA Rule 
4240(b)(5). See id. at 26101, n.120.
    \184\ See id. at 26101.
    \185\ Id.
---------------------------------------------------------------------------

     Multilateral Organizations. A member would not be required 
to deliver Variation Margin to, or collect Initial Margin or Variation 
Margin from, any Multilateral Organization.\186\

[[Page 1976]]

However, a member would be required to take a capital deduction to 
reflect the amount of any margin that it would otherwise have been 
required to collect from such a Multilateral Organization. FINRA 
believes it is appropriate to follow Exchange Act Rule 18a-3 by 
providing an exception for Multilateral Organizations and requiring the 
risk posed by such SBS to be accounted for in a member's capital 
computations.\187\
---------------------------------------------------------------------------

    \186\ Under proposed FINRA Rule 4240(d)(13), a ``Multilateral 
Organization'' would be defined to mean the Bank for International 
Settlements, the European Stability Mechanism, the International 
Bank for Reconstruction and Development, the Multilateral Investment 
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African 
Development Bank, the European Bank for Reconstruction and 
Development, the European Investment Bank, the European Investment 
Fund, the Nordic Investment Bank, the Caribbean Development Bank, 
the Islamic Development Bank, the Council of Europe Development 
Bank, or any other multilateral development bank that provides 
financing for national or regional development in which the U.S. 
government is a shareholder or contributing member. See id. at 
26101, n.121.
    \187\ See id. at 26101.
---------------------------------------------------------------------------

     Financial Market Intermediaries. A member would not be 
required to collect Initial Margin from a Counterparty that is a 
Financial Market Intermediary (but would still be required to collect 
or deliver Variation Margin, as applicable).\188\ In such case, a 
member would be required to take a capital deduction to reflect the 
amount of any Initial Margin that it would have otherwise been required 
to collect from such Financial Market Intermediary. A Counterparty that 
is a Financial Market Intermediary generally would be subject to a 
comprehensive regulatory framework, including capital requirements. 
FINRA therefore believes it is appropriate to account for the reduced 
counterparty credit risk posed by such Counterparties by permitting a 
member to take a capital charge in lieu of requiring such 
Counterparties to post Initial Margin.\189\ However, FINRA continues to 
believe that Variation Margin should be exchanged with such 
Counterparties to account for ongoing the market risk posed by such 
uncleared SBS.\190\
---------------------------------------------------------------------------

    \188\ Under proposed FINRA Rule 4240(d)(8), a ``Financial Market 
Intermediary'' would be defined to mean an SBSD, swap dealer, broker 
or dealer, FCM, bank, foreign bank, or foreign broker or dealer. See 
id. at 26101, n.122.
    \189\ See id. at 26101.
    \190\ Id.
---------------------------------------------------------------------------

     Sovereign Counterparties. A member would generally be 
required to deliver Variation Margin to, and collect Initial Margin or 
Variation Margin from, a Sovereign Counterparty.\191\ However, under 
proposed FINRA Rule 4240(b)(5)(E), if the member has determined 
pursuant to policies and procedures or credit risk models established 
pursuant to Exchange Act Rule 15c3-1(c)(2)(vi)(l) that the Sovereign 
Counterparty has only a minimal amount of credit risk, the member would 
not be required to collect Initial Margin from such Sovereign 
Counterparty (but would still be required to collect or deliver 
Variation Margin, as applicable). In such case, a member would be 
required to take a capital deduction to reflect the amount of any 
Initial Margin that it would have otherwise been required to collect 
from such Sovereign Counterparty. As for Financial Market 
Intermediaries, FINRA believes it is appropriate to account for the 
reduced counterparty credit risk posted by highly creditworthy 
Sovereign Counterparties by permitting a member to take a capital 
charge in lieu of requiring such Counterparties to post Initial 
Margin.\192\ However, FINRA continues to believe that Variation Margin 
should be exchanged with such Counterparties to account for ongoing the 
market risk posed by such uncleared SBS.\193\
---------------------------------------------------------------------------

    \191\ Under proposed FINRA Rule 4240(d)(17), a ``Sovereign 
Counterparty'' would be defined as a Counterparty that is a central 
government (including the U.S. government) or an agency, department, 
ministry or central bank of a central government. See id. at 26101, 
n.122.
    \192\ See id. at 26101-102.
    \193\ Id. at 26102.
---------------------------------------------------------------------------

     Majority Owners; ANC Firms Transacting with Majority 
Owners or Registered or Foreign SBS Dealers Under Common Ownership. 
FINRA states that it understands that members may enter into uncleared 
SBS with affiliated entities for a variety of reasons, including for 
risk management purposes.\194\ FINRA does not believe a broad exception 
from the proposed margin requirements for uncleared SBS with all 
affiliates would adequately account for the risks posed to its members 
by uncleared SBS in such circumstances.\195\ However, FINRA does 
believe that two specific, more limited exceptions for SBS entered into 
with certain affiliates would be appropriate.\196\ First, under 
proposed FINRA Rule 4240(b)(5)(F), a member would not be required to 
collect Initial Margin from a Counterparty that is a direct or indirect 
owner of a majority of the equity and voting interests in the member (a 
``Majority Owner'') (but would still be required to collect or deliver 
Variation Margin, as applicable). In such case, a member would be 
required to take a capital deduction to reflect the amount of any 
Initial Margin that it would have otherwise been required to collect 
from such Majority Owner. Second, under proposed FINRA Rule 
4240(b)(5)(G), a member that is an ANC Firm would not be required to 
collect Initial Margin from a Counterparty that is a Majority Owner or 
a Registered or Foreign SBS Dealer under common ownership (but would 
still be required to collect or deliver Variation Margin, as 
applicable).\197\ In such case, an ANC Firm member would be required to 
take a deduction for credit risk on such transactions computed in 
accordance with Exchange Act Rule 15c3-1e(c).\198\ FINRA believes that 
the proposed exception from the Initial Margin Requirements for 
uncleared SBS with Majority Owners, provided that the member takes a 
capital charge in lieu of collecting Initial Margin, would adequately 
protect members in such circumstances due to the lower risk presented 
by Majority Owners, which typically must satisfy capital and other 
requirements applicable to bank holding companies and similar 
entities.\199\ FINRA also believes that the proposed exception for ANC 
Firms with respect to SBS with Majority Owners and Registered or 
Foreign SBS Dealer affiliates, provided that the member takes a 
corresponding credit risk charge, would adequately protect such members 
while reducing potential competitive disparity as between ANC Firms 
that are registered as SBSDs (and therefore subject to Exchange Act 
Rule 18a-3) and ANC Firms that are not registered as SBSDs (and 
therefore would be subject to proposed FINRA Rule 4240 with respect to 
their uncleared SBS).\200\
---------------------------------------------------------------------------

    \194\ Id.
    \195\ Id.
    \196\ Id.
    \197\ Under proposed FINRA Rule 4240(d)(14), a ``Registered or 
Foreign SBS Dealer'' would be defined to mean (i) any person 
registered with the SEC as an SBSD or (ii) any foreign person if the 
SEC has made a substituted compliance determination under Exchange 
Act Rule 3a71-6(a)(1) that compliance by an SBSD or class thereof 
with specified requirements of a foreign regulatory system that are 
applicable to such foreign person may satisfy the capital 
requirements of Section 15F(e) of the Exchange Act and Exchange Act 
Rule 18a-1 that would otherwise apply to such SBSD or class thereof. 
Therefore, the definition would cover registered SBSDs and entities 
that are subject to equivalent SBSD capital requirements in a 
foreign jurisdiction. See id. at 26102, n.124.
    \198\ FINRA states that an ANC Firm transacting with a 
Counterparty that is its Majority Owner would also benefit from the 
general exception for collecting Initial Margin from Majority 
Owners, as described above. However, under this additional 
exception, an ANC Firm would be permitted to take only a deduction 
for the credit risk on its transactions with Majority Owner 
counterparties as calculated in accordance with Exchange Act Rule 
15c3-1e, rather than the full amount of the Initial Margin 
Requirement that would otherwise have applied. See id. at 26102, 
n.125.
    \199\ See id. at 26102.
    \200\ Id.
---------------------------------------------------------------------------

     Portfolio Margin. Proposed FINRA Rule 4240(b)(5)(H) would 
provide that proposed FINRA Rule 4240 would not

[[Page 1977]]

apply to any unlisted derivative, as defined in FINRA Rule 
4120(g)(2)(H), carried by the member in a portfolio margin account 
subject to the requirements of FINRA Rule 4210(g) if such unlisted 
derivative is of a type addressed in the comprehensive written risk 
analysis methodology filed by the member with FINRA in accordance with 
FINRA Rule 4210(g)(1).\201\ In addition, proposed FINRA Rule 4240 would 
not apply to any SBS carried in a commodity account or other account 
under the jurisdiction of the CFTC in accordance with an SEC rule, 
order or no-action letter permitting SBS and swaps to be carried and 
portfolio margined together in such an account. According to FINRA, 
portfolio margining provides members with the flexibility to manage 
their risk exposures based on a broader view of their overall 
relationship with a particular Counterparty.\202\ FINRA believes it is 
appropriate to provide an exception from proposed FINRA Rule 4240 for 
any SBS in a portfolio margin account if the SBS is of a type whose 
risk is appropriately addressed by an approved theoretical pricing 
model (e.g., TIMS) and covered by portfolio risk management procedures 
filed by the member with FINRA, as well as for SBS permitted by the SEC 
to be portfolio margined in a commodity account.\203\ In these 
circumstances, in FINRA's view, the risks presented by such SBS would 
already be subject to a comprehensive risk management framework, and 
therefore FINRA does not believe it is necessary to apply the proposed 
new margin requirements to such SBS.\204\
---------------------------------------------------------------------------

    \201\ FINRA is also proposing a technical adjustment to the 
definition of ``unlisted derivative'' under FINRA Rule 4210(g)(2)(H) 
to clarify that, to qualify under the definition, the option, 
forward contract or SBS must be able to be valued by a theoretical 
pricing model that is approved by the SEC for valuing that type of 
options, forward contract or SBS.
    \202\ Id.
    \203\ Id.
    \204\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(c), entitled ``Risk Monitoring Procedures 
and Guidelines,'' would require members to monitor the risk of any 
Uncleared SBS Accounts and maintain a comprehensive risk analysis 
methodology for assessing the potential risk to the member's capital 
over a specified range of possible market movements over a specified 
time period. For purposes of this requirement, members would be 
required to employ the following risk monitoring procedures and 
guidelines: \205\
---------------------------------------------------------------------------

    \205\ Id.
---------------------------------------------------------------------------

     Obtaining and reviewing the required documentation and 
financial information necessary for assessing the amount of credit to 
be extended to SBS Counterparties;
     determining and documenting the legal enforceability of 
netting or collateral agreements, including enforceability in the event 
a Counterparty becomes subject to bankruptcy or other insolvency 
proceedings;
     assessing the determination, review and approval of credit 
limits to each Counterparty, and across all Counterparties;
     monitoring credit risk exposure to the member from SBS, 
including the type, scope and frequency of reporting to senior 
management;
     the use of stress testing of accounts containing SBS 
contracts in order to monitor market risk exposure from individual 
accounts and in the aggregate;
     managing the impact of credit extended related to SBS 
contracts on the member's overall risk exposure;
     determining the need to collect additional margin from a 
particular customer or broker or dealer, including whether that 
determination was based upon the creditworthiness of the customer or 
broker or dealer and/or the risk of the specific contracts;
     determining the need for higher margin requirements than 
required by proposed FINRA Rule 4240 and formulating the member's own 
margin requirements, including procedures for identifying unusually 
volatile positions, concentrated positions (with a particular 
Counterparty and across all Counterparties and customers), or positions 
that cannot be liquidated promptly;
     monitoring the credit exposure resulting from concentrated 
positions with a single Counterparty and across all Counterparties, and 
during periods of extreme volatility;
     identifying any Uncleared SBS Accounts with intraday risk 
exposures that are not reflected in their end of day positions (e.g., 
Uncleared SBS Accounts that frequently establish positions and then 
trade out of, or hedge, those positions by the end of the day) and 
collecting appropriate margin to address those intraday risk exposures;
     identifying any Uncleared SBS Account that, in light of 
current market conditions, could not be promptly liquidated for an 
amount corresponding to the Current Exposure computed with respect to 
such account and determining the need for higher margin requirements on 
such accounts or the positions therein;
     maintaining sufficient Initial Margin in the accounts of 
each Counterparty to protect against the largest individual potential 
future exposure of an Uncleared SBS in such Counterparty's Uncleared 
SBS Account, as measured by computing the largest maximum possible loss 
that could result from the exposure; and
     increasing the frequency of calculations of Current 
Exposure and Initial Margin Requirements during periods of extreme 
volatility and for accounts with concentrated positions.
    Proposed FINRA Rule 4240(c) would further require a member to 
review, in accordance with the member's written procedures, at 
reasonable periodic intervals, the member's SBS activities for 
consistency with these risk monitoring procedures and guidelines, and 
to determine whether the data necessary to apply the risk monitoring 
procedures and guidelines is accessible on a timely basis and 
information systems are available to adequately capture, monitor, 
analyze and report relevant data.
    In FINRA's view, the risk monitoring procedures and guidelines 
under proposed FINRA Rule 4240(c) are analogous to the risk monitoring 
and procedure requirements applicable to nonbank SBSDs with respect to 
their uncleared SBS transactions under Exchange Act Rule 18a-3.\206\ 
These requirements are also based in part on aspects of FINRA Rule 
4210, including procedures related to the need for additional margin 
under FINRA Rule 4210(d) and the portfolio margin risk monitoring 
requirements under FINRA Rule 4210(g)(1). In FINRA's view, SBS are 
complex financial instruments that may expose a member to significant 
risks, including, for example, market risk, counterparty credit risk, 
operational risk and legal risk.\207\ FINRA accordingly believes it is 
appropriate and necessary, and consistent with the protection of 
investors, for members with exposure to uncleared SBS to maintain a 
comprehensive risk monitoring program, including the specific elements 
described above, to address such risks.\208\
---------------------------------------------------------------------------

    \206\ See id. at 26103; see also 17 CFR 240.18a-3(e); Capital, 
Margin, and Segregation Release at 43930.
    \207\ See Notice at 26103.
    \208\ Id.
---------------------------------------------------------------------------

K. Effective Date

    As discussed above in Section II.A., current FINRA Rule 0180 
temporarily excepts the application of most FINRA rules to the SBS 
activities of its members. Now that the Commission has finalized the 
majority of its Title VII rulemakings, FINRA believes it is appropriate 
and in the public interest

[[Page 1978]]

for the current temporary FINRA Rule 0180 to expire and for FINRA to 
clarify the application of FINRA rules to SBS through a permanent FINRA 
rule.\209\ Additionally, since FINRA filed its proposed rule change, as 
modified by Amendment No. 1, the Commission's regulatory framework 
governing SBS Entities has gone into effect. FINRA is proposing to 
amend FINRA Rules 0180, 4120, 4210, 4220, 4240 and 9610 to take into 
account members' SBS activities.\210\ FINRA states that if the proposed 
rule change, as modified by Amendment No. 1, is approved by the 
Commission, the effective date for the proposed amendments to FINRA 
Rules 0180, 4120 and 9610 will be February 6, 2022, and the effective 
date for the proposed amendments to FINRA Rules 4210, 4220 and 4240 
will be April 6, 2022.\211\
---------------------------------------------------------------------------

    \209\ See Notice at 26086.
    \210\ See id.
    \211\ A commenter expressed concern as to FINRA's initial 
proposed effective date for the proposed rule change. See SIFMA 
Letter at 1-3, 11. In response, on August 9, 2021, FINRA filed 
Amendment No. 1, which: (1) Extended the effective date of the 
proposed amendments to FINRA Rules 0180, 4120 and 9610 to February 
6, 2022; (2) extended the effective date of the proposed amendments 
to FINRA Rules 4210, 4220 and 4240 to April 6, 2022; and (3) 
conformed the proposed definition of ``Legacy Swap'' in proposed 
FINRA Rule 4240(d)(12) to reflect the new effective date of April 6, 
2022. See FINRA Letter at 14-15.
---------------------------------------------------------------------------

    The proposed effective dates will also align with the new 
expiration dates of current FINRA Rules 0180 and 4240, such that the 
temporary rules will expire on the day the proposed permanent rules 
become effective.\212\
---------------------------------------------------------------------------

    \212\ As discussed above in Section II.A, in September 2021, the 
existing exceptions for current FINRA Rules 0180 and 4240 were 
extended to February 6, 2022 and April 6, 2022, respectively, and 
current Rule 4240 was amended to add Supplementary Material .02, 
which clarifies that the rule does not apply to a member that is 
registered with the Commission as an SBSD. See Extension Notice, 
supra note 17.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    After careful review of the proposed rule change, as modified by 
Amendment No. 1, the comment letters, and FINRA's responses to the 
comments, the Commission finds that the proposed rule change, as 
modified by Amendment No. 1, is consistent with the requirements of the 
Exchange Act and the rules and regulations thereunder that are 
applicable to a national securities association.\213\ Specifically, the 
Commission finds that the proposed rule change, as modified by 
Amendment No. 1, is consistent with Section 15A(b)(6) of the Exchange 
Act,\214\ 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, to facilitate 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and, in general, to protect 
investors and the public interest.
---------------------------------------------------------------------------

    \213\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \214\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

A. Proposed Rule 0180(a) (Application of FINRA Rules to Security-Based 
Swaps)

    As discussed above in Section II.B., the proposed rule change would 
replace current FINRA Rule 0180 with new FINRA Rule 0180 and would 
apply all FINRA rules to SBS activities and positions with respect to 
SBS, unless subject to specific exceptions set forth in proposed FINRA 
Rule 0180. Five commenters were supportive of the proposed rule change 
generally.\215\ One commenter suggested that, as an alternative, FINRA 
members be permitted to comply with the Commission's SBS rules in lieu 
of a parallel FINRA rule.\216\ The commenter proposed that FINRA could 
either consider incorporating into the FINRA rules a reference to the 
analogous Commission rules or permit FINRA-regulated broker-dealers not 
registered with the Commission as an SBSD to ``opt-in'' to the relevant 
Commission SBS rules.\217\
---------------------------------------------------------------------------

    \215\ See Letters at 1 (stating the need for the proposed rule 
change ``to be enacted, as is, for the protection and operation of 
free and fair markets.''); see also SIFMA Letter at 1 (stating 
support for many aspects of the proposed rule change).
    \216\ See PML Letter at 4.
    \217\ Id.
---------------------------------------------------------------------------

    In its response, FINRA stated that neither of these alternatives 
would be appropriate.\218\ FINRA believes the limited exceptions in 
proposed Rules 0180(c) through (g) are appropriate only in the context 
of registered SBS Entities subject to the SEC's full regulatory 
framework applicable to such registrants.\219\ FINRA does not believe 
that it would be appropriate to permit members that are not SBS 
Entities registered with the Commission to ``opt-in'' to the parallel 
SEC rules, or to incorporate SEC rules by reference for FINRA members 
not registered with the Commission as SBS Entities.\220\ FINRA stated 
that a FINRA member engaged in SBS activities below the de minimis 
threshold for registration with the Commission may nonetheless elect to 
register with the Commission on a voluntary basis, and thereby become 
subject to the Commission's full regulatory framework for SBS.\221\
---------------------------------------------------------------------------

    \218\ See FINRA Letter at 3.
    \219\ Id.
    \220\ Id.
    \221\ Id. at 3-4.
---------------------------------------------------------------------------

    FINRA's determination to generally apply FINRA rules to members' 
activities and positions with respect to SBS,\222\ other than the 
specific enumerated exceptions discussed below, is reasonable. 
Specifically, FINRA reasonably determined that, because SBS are 
securities under the Exchange Act, FINRA's existing rule framework, 
which is designed to regulate the securities activity of its members, 
should apply absent a specific exception. FINRA's determination is 
consistent with the requirement in the Exchange Act that FINRA, as a 
registered securities association, have rules designed to, among other 
things, facilitate transactions in securities and enforce compliance 
with the Exchange Act by its members.\223\ Applying these rules to 
FINRA members' SBS activities and positions with respect to SBS will 
help prevent fraudulent and manipulative acts and practices, promote 
just and equitable principles of trade, and protect investors and the 
public interest.
---------------------------------------------------------------------------

    \222\ See Notice at 26086. FINRA believes this determination is 
consistent with both Congress's intent and FINRA's regulatory 
responsibility. Id.
    \223\ See Exchange Act Section 15A(b)(2); (6).
---------------------------------------------------------------------------

    The general presumption under Rule 0180(a) that FINRA rules apply 
to members' SBS activities and positions, except where otherwise 
specified in the rule, would help ensure that FINRA members that are 
not also registered as an SBS Entity with the Commission will be 
subject to a comprehensive set of FINRA rules governing, among other 
things, conduct and communication by members, with respect to the 
members' SBS activities and positions. It is appropriate that, with the 
exception of proposed Rule 0180(b),\224\ an exception to this general 
presumption will apply only where a FINRA member is registered with the 
Commission as an SBS Entity. This important limitation will provide 
appropriate regulatory oversight with respect to SBS activity--where 
the FINRA member is registered with the Commission as an SBS Entity, 
the comprehensive framework the Commission has adopted for regulation 
of SBS, including its examination program, will apply. Conversely, 
where the FINRA member is not registered with the Commission as an SBS 
Entity, it is appropriate for the member to

[[Page 1979]]

comply with a comprehensive set of FINRA rules as set forth in the 
proposed rule change and be primarily subject to FINRA's examination 
program. In the event a FINRA member that is not required to be 
registered with the Commission as an SBS Entity would prefer to instead 
comply with the Commission's SBS regulatory framework (and avail itself 
of the exceptions specified in proposed FINRA Rule 0180(b)-(g)), the 
member may voluntarily elect to register as an SBS Entity with the 
Commission and thus become subject to the full regulatory framework for 
registered SBS Entities, which includes Commission examination 
authority for compliance with such rules. Accordingly, for the 
foregoing reasons, the Commission finds the proposed rule change is 
consistent with the protection of investors and in the public interest.
---------------------------------------------------------------------------

    \224\ As discussed below, the proposed exception in FINRA Rule 
0180(b) is not conditioned on registration as an SBS Entity but 
rather the general inapplicability of those rule sets to SBS 
activity.
---------------------------------------------------------------------------

B. Proposed Rule 0180(b) (General Exceptions From Applicability to 
FINRA Rules)

    Proposed FINRA Rule 0180(b) would specify certain exceptions from 
the general presumption of applicability of FINRA rules to SBS. 
Specifically, FINRA Rule 0180(b) would except members' SBS activities 
and positions from the FINRA Rule 6000 Series (Quotation, Order, and 
Transaction Reporting Facilities); the FINRA Rule 7000 Series 
(Clearing, Transaction, and Order Data Requirements, and Facility 
Charges); and the FINRA Rule 11000 Series (Uniform Practice Code). All 
commenters expressed support for FINRA's proposed rule change to exempt 
members' SBS activities and positions from these rules.\225\ One 
commenter stated that ``providing exceptions for [FINRA Rules 6000 
Series, 7000 Series, and 11000 Series] will promote clarity, 
considering that these rules are not designed to apply to SBS, and 
arguably overlap with some of the [Commission's] SBS rules (such as 
reporting and public dissemination under Regulation SBSR).'' \226\
---------------------------------------------------------------------------

    \225\ See SIFMA Letter at 3; PML Letter at 2; Letters at 1.
    \226\ See SIFMA Letter at 3.
---------------------------------------------------------------------------

    As discussed above in Section II.C., FINRA believes that the 6000, 
7000 and 11000 series rules are not designed to apply to SBS and are 
not particularly well-adapted to positions in or activities involving 
SBS.\227\ FINRA believes that while some of these rules could 
potentially be interpreted as applying to SBS activities by their 
terms, doing so could create operational difficulties and/or create 
confusion and uncertainty in the SBS market.\228\ FINRA believes the 
proposed rule change would provide legal certainty and clarity for its 
members by specifically excepting these rules from applying to members' 
activities and positions with respect to SBS.\229\
---------------------------------------------------------------------------

    \227\ See Notice at 26088.
    \228\ See id.
    \229\ See id.
---------------------------------------------------------------------------

    The FINRA Rule 6000 and 7000 Series include various rules relating 
to trading, quoting, clearing and reporting for different types of 
securities. Many of these rules do not appear to apply to SBS by their 
terms.\230\ As discussed in Section II.C, the FINRA Rule 11000 Series 
sets forth the UPC, a series of rules, interpretations and explanations 
created to simplify and facilitate the day-to-day business of 
investment banking and securities between FINRA members, particularly 
with respect to operational and settlement issues.\231\ Because the UPC 
generally applies to all OTC secondary market transactions in 
securities, it could be interpreted as applying to SBS transactions. 
However, because the UPC applies only to transactions between FINRA 
members, even if the UPC were to apply, it could be invoked only for 
those specific transactions.\232\ FINRA believes that applying the UPC 
rules to such a limited subset of SBS in the overall SBS market could 
create confusion and uncertainty.\233\
---------------------------------------------------------------------------

    \230\ See id.; see also FINRA Rules 6000 and 7000 series.
    \231\ See Notice at 26088.
    \232\ See id.
    \233\ See supra note 23 and related text; see also Notice at 
26088.
---------------------------------------------------------------------------

    The Commission finds that the proposed rule change would avoid 
unnecessary and potentially duplicative regulation in this area by 
specifically providing exceptions for SBS from the FINRA Rule 6000, 
7000, and 11000 series, and is designed to protect investors and the 
public interest. These rules were not designed to provide regulatory 
oversight of SBS activity, and even if certain of these rules were 
interpreted to apply to SBS activity, they would apply only to a subset 
of SBS activity, leading to the potential for regulatory inconsistency. 
Accordingly, the Commission finds that the exceptions for the Rule 
6000, 7000, and 11000 series in Rule 0180(b) is designed to protect 
investors and the public interest.

C. Proposed Rules 0180(c) and (d) (Exceptions for Registered SBS 
Entities and Associated Persons)

    Proposed Rules 0180(c) and (d), as discussed above in Section 
II.D., would provide that specified FINRA Rules shall not apply to 
members' activities and positions with respect to SBS, only where the 
following conditions are met: (1) The member is acting in its capacity 
as an SBS Entity or the associated person of the member is acting in 
his or her capacity as an associated person of an SBS Entity, as 
applicable; and (2) that such activities or positions relate to the 
business of the SBS Entity within the meaning of the Exchange Act Rule 
15Fh-3(h)(1), the Commission's supervision rule for SBS Entities. The 
exceptions in Rule 0180(c) would apply to both SBSDs and MSBSPs or 
their associated persons, while the exceptions in Rule 0180(d) would 
apply only to SBSDs or their associated persons (and not MSBSPs or 
their associated persons), consistent with whether the Commission rule 
that FINRA believes is analogous with a corresponding FINRA rule is 
applicable to all SBS Entities or their associated persons, or only 
SBSDs (and not MSBSPs or their associated persons).\234\ One commenter 
specifically addressed these exceptions, offering support for their 
inclusion in the proposed rule, subject to requests for clarifications 
as to some aspects of the proposed exceptions that are addressed 
below.\235\
---------------------------------------------------------------------------

    \234\ See Notice at 26089.
    \235\ See SIFMA Letter at 3 (stating the rules to be excepted 
under the proposal and noting that ``[a]s FINRA observes, these 
rules would unnecessarily duplicate certain of the Commission's SBS 
rules if they applied to SBS Entities or their associated 
persons'').
---------------------------------------------------------------------------

1. Proposed Rule 0180(c)
    Proposed Rule 0180(c) would except five FINRA rules from applying 
to members' SBS activities and positions where the conditions described 
above are met: (1) Rule 2210(d) (Communications with the Public--
Content Standards); (2) Rule 2232 (Customer Confirmations); (3) Rule 
3110 (Supervision); (4) Rule 3120 (Supervisory Control System); and (5) 
Rule 3130 (Certification of Compliance and Supervisory Procedures). As 
discussed below, FINRA believes that each of these rules is similar to 
a particular Commission rule or set of rules applicable to SBS 
Entities.\236\ FINRA further believes that these proposed exceptions 
are appropriate only to the extent that the Commission's parallel SBS 
Entity rules will apply to the SBS activity, and only where the SBS 
activity relates to the business of the SBS Entity within the meaning 
of the Commission's SBS Entity supervision rule.\237\
---------------------------------------------------------------------------

    \236\ See Notice at 26089.
    \237\ Id.

---------------------------------------------------------------------------

[[Page 1980]]

    Rule 2210(d) (Communications With the Public--Content Standards). 
FINRA Rule 2210(d) governs the content standards of members' 
communications with the public and requires communications be based on 
principles of fair dealing and good faith. Under FINRA's proposed rule 
change, where Exchange Act Rule 15Fh-3(g) applies to SBS Entities--
imposing communication standards on both registered SBS Entities that 
are modeled after several of the existing requirements in FINRA Rule 
2210(d)--those FINRA requirements would not also apply. Exchange Act 
Rule 15Fh-3(g) requires SBS Entities to communicate with parties in a 
fair and balanced manner based on principles of fair dealing and good 
faith. As the Commission has previously noted, this standard is 
consistent with the similarly worded requirement in FINRA Rule 
2210(d).\238\ Three additional Exchange Act Rule provisions supplement 
the required content standards of SBS Entities.\239\ Taken together, 
FINRA believes that these provisions are analogous to FINRA 
requirements contained in Rule 2210(d) that require, among other 
things, member communications be based on principles of fair dealing 
and good faith, be fair and balanced, and not omit any material facts 
or make false or exaggerated claims.\240\
---------------------------------------------------------------------------

    \238\ See Exchange Act Release No. 64766 (Jun. 29, 2011) at 86-
7, 76 FR 42396 at 42418 (Jul. 18, 2011) (Proposed Rule: Business 
Conduct Standards for Security-Based Swap Dealers and Major 
Security-Based Swap Participants).
    \239\ FINRA stated that the SEC's business conduct rules also 
include requirements for SBS Entities to make certain disclosures to 
their SBS counterparties, including disclosures of material risks 
and characteristics and material incentives or conflicts of 
interest; daily mark disclosures; and disclosures regarding clearing 
rights. See Notice at 26090; see also Exchange Act Rules 15Fh-3(b)--
(d) (addressing requirements for disclosures of material risks and 
characteristics and material incentives of conflicts of interest; 
daily mark disclosures; and disclosures regarding clearing rights).
    \240\ See Notice at 26090; see also FINRA Rule 2210(d)(1)(A).
---------------------------------------------------------------------------

    Rule 2232 (Customer Confirmations). Proposed Rule 0180(c) would 
except members registered as SBS Entities from the application of FINRA 
Rule 2232 (Customer Confirmations) with respect to their SBS positions 
and activities when such activities or positions relate to their 
business as SBS Entities within the meaning of the SBS supervision 
rule.\241\
---------------------------------------------------------------------------

    \241\ See Notice at 26089-90.
---------------------------------------------------------------------------

    FINRA Rule 2232 (Customer Confirmations) generally requires members 
to provide customers with written confirmations in conformity with 
Exchange Act Rule 10b-10,\242\ along with specified additional 
disclosures for certain types of securities. Exchange Act Rule 15Fi-2 
requires SBS Entities to provide trade acknowledgments and to 
establish, maintain and enforce written policies and procedures 
reasonably designed to obtain prompt verification of the terms of such 
trade acknowledgments.\243\ FINRA states that the SEC's trade 
acknowledgement and verification rule provides that an SBS Entity that 
is also a broker or dealer, is purchasing from or selling to any 
counterparty, and that complies with the relevant requirements of the 
trade acknowledgment and verification rule, is exempt from the 
requirements of Exchange Act Rule 10b-10 with respect to the SBS 
transaction.\244\
---------------------------------------------------------------------------

    \242\ See Notice at 26090; see also 17 CFR 240.10b-10.
    \243\ See Notice at 26090; see also 17 CFR 240.15Fi-2; see 
generally Trade Acknowledgment and Verification Release, supra note 
13.
    \244\ See Notice at 26090; see also 17 CFR 240.15Fi-2(g); Trade 
Acknowledgment and Verification Release at 39824-25.
---------------------------------------------------------------------------

    In the Trade Acknowledgement and Verification Release, the 
Commission stated that requiring an SBS Entity that is also a broker or 
a dealer to comply with both Rule 10b-10 and Rule 15Fi-2 could be 
duplicative and overly burdensome.\245\ In seeking the requested 
exemption from Rule 2232, FINRA has stated that FINRA similarly 
believes that applying both the SEC's rules for SBS Entities and 
FINRA's parallel rules for its members to the same SBS activity would 
result in unnecessary regulatory duplication.\246\
---------------------------------------------------------------------------

    \245\ Trade Acknowledgment and Verification Release at 39821.
    \246\ See Notice at 26106.
---------------------------------------------------------------------------

    One commenter requested clarification concerning customer 
confirmations.\247\ The commenter stated that the Commission has 
adopted an exemption concerning a broker-dealer's requirement to give 
or send the disclosure required by Exchange Act Rule 10b-10(a) at or 
before completion of the transaction in connection with such broker-
dealer or its associated persons arranging, negotiating or executing an 
SBS transaction on behalf of an affiliated SBSD, provided that the 
broker-dealer gives or sends the customer written notification 
containing such disclosures in accordance with the time and form 
requirements for an SBSD's trade acknowledgment under Exchange Act Rule 
15Fi-2(b) and (c) and, as applicable, Rule 10b-10(c).\248\ The 
commenter requested that FINRA clarify that, to the extent a member 
would be eligible for this exemption, but not the proposed FINRA Rule 
0180(c) exception from FINRA Rule 2232 (Customer Confirmations), it can 
satisfy Rule 2232 by giving and sending a written notification to its 
customer in accordance with the timing reflected in the exemption 
provided by the Commission in Exchange Act Rule 3a71-3(d)(5).\249\
---------------------------------------------------------------------------

    \247\ See SIFMA Letter at 3.
    \248\ See 17 CFR 240.3a71-3(d)(5).
    \249\ See SIFMA Letter at 4; see also Exchange Act Release No. 
90308 (Nov. 2, 2020), 85 FR 70667 (Nov. 5, 2020) (Order Granting 
Exemptions from Sections 8 and 15(a)(1) of the Securities Exchange 
Act of 1934 and Rules 3b-13(b)(2), 8c-1, 10b-10, 15a-1(c), 15a-1(d) 
and 15c2-1 Thereunder in Connection with the Revision of the 
Definition of ``Security'' to Encompass Security-Based Swaps and 
Determining the Expiration Date for a Temporary Exemption from 
Section 29(b) of the Securities Exchange Act of 1934 in Connection 
with Registration of Security-Based Swap Dealers and Major Security-
Based Swap Participants).
---------------------------------------------------------------------------

    In response, FINRA stated that FINRA Rule 2232(a) requires that a 
member shall, at or before the completion of any transaction in a 
security effected for or with an account of a customer, give or send to 
such customer a confirmation in conformity with the requirements of 
Exchange Act Rule 10b-10.\250\ FINRA further stated that since the 
Commission has provided an exemption permitting a broker-dealer to 
provide the disclosures required by Exchange Act Rule 10b-10(a) in 
accordance with the time and form requirements for an SBSD's trade 
acknowledgment, a member acting in conformity with the requirements of 
Exchange Act Rule 10b-10, including where the member is acting in 
accordance with an applicable SEC exemption, would satisfy the 
requirements of Rule 2232(a) (provided that the member complies with 
all other provisions of Rule 2232, as applicable).\251\
---------------------------------------------------------------------------

    \250\ See FINRA Letter at 4.
    \251\ Id.
---------------------------------------------------------------------------

    Rules 3110 (Supervision), 3120 (Supervisory Control System) and 
3130 (Annual Certification of Compliance and Supervisory Processes). 
Proposed Rule 0180(c) would except FINRA members that are also 
registered SBS Entities from the application of FINRA Rules 3110 
(Supervision), 3120 (Supervisory Control System) and 3130 (Annual 
Certification of Compliance and Supervisory Processes) with respect to 
their SBS positions and activities where the conditions described above 
are met. Taken together, these rules require, among other things, that 
FINRA members establish and maintain a supervisory system, designate a 
chief compliance officer, and submit annual certifications to FINRA 
related to the member's compliance policies and written supervisory 
procedures.\252\
---------------------------------------------------------------------------

    \252\ See Notice at 26090.
---------------------------------------------------------------------------

    FINRA believes that the Commission has adopted an analogous 
framework for

[[Page 1981]]

supervision of SBS Entities that applies to all FINRA members that are 
also registered SBS Entities.\253\ Exchange Act Rule 15h-3(h) requires, 
among other things, that an SBS Entity establish and maintain a system 
to supervise, and to diligently supervise, its business and the 
activities of its associated persons; designate at least one person 
with authority to carry out supervisory responsibilities; and 
establish, maintain and enforce written policies and procedures 
addressing supervision of the SBS Entity's SBS business. Exchange Act 
Rule 15Fk-1 requires each SBS Entity to designate a chief compliance 
officer and submit annual compliance reports to the Commission.
---------------------------------------------------------------------------

    \253\ See id. at 26089.
---------------------------------------------------------------------------

2. Proposed Rule 0180(d)
    Proposed Rule 0180(d) would except three additional FINRA rules 
from applying to members' SBS activities and positions where the 
conditions described above are met and the FINRA member is a registered 
SBSD (but not a MSBSP): (1) Rule 2030 (Engaging in Distribution and 
Solicitation Activities with Government Entities); (2) Rule 2090 (Know 
Your Customer); and (3) Rule 2111 (Suitability). As discussed below, 
FINRA believes that each of these rules is similar to a particular 
Commission rule or set of rules specifically applicable to SBSDs but 
not MSBSPs.\254\ FINRA further believes that these proposed exceptions 
are appropriate only to the extent that the Commission's parallel rules 
applicable to SBSDs (but not MSBSPs) will apply to the SBS activity, 
and only where the SBS activity relates to the business of the SBSD 
(but not an MSBSP) within the meaning of the Commission's SBS Entity 
supervision rule.\255\
---------------------------------------------------------------------------

    \254\ See Notice at 26089.
    \255\ Id.
---------------------------------------------------------------------------

    Rule 2030 (Engaging in Distribution and Solicitation Activities 
with Government Entities). FINRA Rule 2030 governs ``pay-to-play'' 
activities by member firms that engage in distribution or solicitation 
activities for compensation with government entities on behalf of 
investment advisers. In particular, FINRA Rule 2030(a) prohibits a 
member from engaging in distribution or solicitation activities for 
compensation with a government entity within two years after a 
contribution to an official of the government entity is made by the 
covered member or a covered associate (including a person who becomes a 
covered associate within two years after the contribution is 
made).\256\ Similarly, Exchange Act Rule 15Fh-6 generally prohibits an 
SBSD from engaging in SBS transactions with a municipal entity within 
two years after certain political contributions have been made to 
officials of the municipal entity.\257\ Under FINRA's proposed rule 
change, where Exchange Act Rule 15Fh-6 applies to SBS Entities, the SBS 
Entity would be excepted from FINRA Rule 2030.
---------------------------------------------------------------------------

    \256\ See FINRA Regulatory Notice 16-40 (October 2016).
    \257\ Business Conduct Standards Release at 29962.
---------------------------------------------------------------------------

    Rule 2090 (Know Your Customer). FINRA Rule 2090 requires members to 
use due diligence to know the essential facts concerning every customer 
(including the customer's financial profile and investment objectives 
or policy). Under FINRA's proposed rule change, where Exchange Act 
Rules 15Fh-3(a) and (e) applies to SBSDs, the SBSDs would be excepted 
from FINRA Rule 2090. Rule 15Fh-3(a) generally requires SBS Entities to 
verify the status of their SBS counterparties.\258\ Rule 15Fh-3(e) 
requires an SBSD to establish, maintain and enforce policies and 
procedures reasonably designed to obtain and retain a record of the 
essential facts that are necessary for conducting business with each 
counterparty that is known to the SBSD. Rule 15Fh-3(e) is a modified 
version of the ``know your customer'' requirements, such as those in 
FINRA Rule 2090, to which broker-dealers are subject.\259\ Under 
FINRA's proposal, where SBSDs are subject to Rule 15Fh-3(a) and (e), 
the analogous FINRA requirements would not also apply.
---------------------------------------------------------------------------

    \258\ See Notice at 26090. Although Rule 15Fh-3(a) is applicable 
to both SBSDs and MSBSPs, FINRA Rule 2090 applies to requires 
members to use reasonable diligence ``in regard to the opening or 
maintenance of'' an account. FINRA Rule 2090. As MSBSPs are by 
definition not SBSDs, MSBSPs do not have customer accounts; 
therefore, Rule 2090 is inapplicable as to MSBSPs even if they are 
FINRA members. See, e.g., 17 CFR 240.3a67-1.
    \259\ See Business Conduct Proposal at 42414.
---------------------------------------------------------------------------

    Rule 2111 (Suitability). FINRA Rule 2111(a) requires members, when 
making a recommendation, to have a reasonable basis to believe that 
recommendation is suitable for the customer, based on the information 
obtained through the reasonable diligence of the member or associated 
person to ascertain the customer's investment profile. FINRA Rule 
2111(b) provides that a member fulfills this suitability obligation for 
an institutional account if the member has a reasonable basis to 
believe that the institutional customer is capable of evaluating 
investment risks independently and the institutional customer exercises 
independent judgment in evaluating the recommendations. Where the 
institutional customer has delegated decision-making authority to an 
agent, such as an investment adviser, these suitability rule factors 
apply to the agent under FINRA's rule. Exchange Act Rule 15h-3(f) 
creates a suitability obligation for SBSDs, including an institutional 
suitability alternative that is modeled after FINRA Rule 2111(b).\260\ 
Under FINRA's proposed rule change, where Exchange Act Rule 15Fh-3(f) 
applies, the SBS Entity would be excepted from FINRA Rule 2111.\261\
---------------------------------------------------------------------------

    \260\ Business Conduct Standards Release at 29967, n.68.
    \261\ FINRA also noted that Exchange Act Rule 15Fh-5 applies 
special, enhanced requirements when SBS Entities act as 
counterparties to special entities. See Notice at 26091.
---------------------------------------------------------------------------

    As to each of the FINRA rules proposed to be excepted under Rule 
0180(c) and Rule 0180(d), an analogous Commission rule already applies 
to a registered SBS Entity (under Rule 0180(c)) or SBSD (under Rule 
0180(d)). Without these proposed exceptions, a FINRA member that is 
also registered with the Commission as an SBS entity (under Rule 
0180(c)) or as an SBSD (under Rule 0180(d)) would be required to comply 
with both the Commission's comprehensive framework enacted under Title 
VII as well as FINRA rules with analogous requirements. The Commission 
concludes it is generally unnecessary for FINRA rules to apply in 
circumstances where the SBS activities, and the SBS entities (under 
Rule 0180(c)) or SBSDs (under Rule 0180(d)), are already regulated 
directly by the Commission. The Commission further concludes it is 
reasonable that the exceptions in FINRA Rule 0180(d) do not apply to 
MSBSPs, because they are not subject to either the FINRA rule 
referenced in Rule 0180(d) and/or the analogous Commission rule. 
Therefore, FINRA's proposal to provide the limited exceptions in 
proposed FINRA Rule 0180(c) and 0180(d), is a reasonable, tailored 
approach that reduces potentially unnecessary and duplicative 
regulatory requirements.

D. Proposed Rule 0180(e) (Exceptions in Connection With Arranging, 
Negotiating, and Executing Activity)

    As discussed above in Section II.E., Proposed Rule 0180(e) would 
provide that the following FINRA rules shall not apply to members' 
activities with respect to SBS, to the extent that the member or the 
associated person of the member, as applicable, is arranging, 
negotiating or executing SBS on behalf of a non-U.S. affiliate pursuant 
to, and in compliance with the conditions of, the exception from 
counting certain SBS

[[Page 1982]]

under Exchange Act Rule 3a71-3(d)(1): (1) FINRA Rule 2111 
(Suitability); (2) FINRA Rule 2210(d) (Communications with the Public--
Content Standards); and (3) FINRA Rule 2232 (Customer Confirmations). 
The availability of the exceptions under proposed FINRA Rule 0180(e) 
would require the member's compliance with the conditions specified in 
Exchange Act Rule 3a71-3(d)(1)(ii)(B) as if the member were the 
counterparty to the SBS transactions.\262\ Specifically, to satisfy the 
exception from counting certain SBS under Exchange Act Rule 3a71-
3(d)(1), the member must comply with, among other things, Exchange Act 
Rule 15Fh-3(b) (disclosures of material risks and characteristics and 
material incentives or conflicts of interest), Exchange Act Rule 15Fh-
3(f)(1) (recommendations and suitability), Exchange Act Rule 15Fh-3(g) 
(fair and balanced communications) and Exchange Act Rule 15Fi-2 
(acknowledgement and verification of SBS transactions).\263\ If a 
member fails to comply with these Commission rules, the member's 
foreign affiliate would be required to count each applicable SBS 
transaction toward its de minimis registration threshold.\264\ One 
commenter specifically addressed this exception, offering support for 
its inclusion in the proposed rule.\265\
---------------------------------------------------------------------------

    \262\ As discussed above, all other FINRA rules would remain 
applicable to a member acting as the U.S. Registered Affiliate under 
Exchange Act Rule 3a71-3(d). See supra note 46.
    \263\ See Notice at 26092-93.
    \264\ Id. at 26093.
    \265\ See SIFMA Letter at 1 (stating, ``[w]e support this 
exception, which appropriately avoids overlaps between FINRA's 
suitability, communication standards, and confirmation requirements, 
on the one hand, and SEC Rules 15Fh-3(f)(1), 15Fh-3(g), and 15Fi-2, 
on the other hand, which the FINRA member would be required to 
satisfy when acting for its non-U.S. affiliate pursuant to SEC Rule 
3a71-3(d)(1)(ii).'').
---------------------------------------------------------------------------

    The Commission believes that members whose foreign affiliates are 
seeking to rely on the exception from counting certain SBS transactions 
under Exchange Act Rule 3a71-3(d)(1), may have their own obligations to 
comply with FINRA's rules governing suitability, customer 
communications, and customer confirmations, apart from any obligation 
to comply with analogous Commission rules noted above as a condition of 
Exchange Act Rule 3a71-3(d)(1). Without the exceptions in proposed 
FINRA Rule 0180(e), this could result in unnecessarily duplicative 
obligations. Where the member is in fact complying with the specified 
Commission rules, the proposed rule change is designed to help protect 
investors and the public interest by avoiding potential confusion 
surrounding whether FINRA rules apply in addition to analogous 
Commission rules to regulate the same conduct. It is appropriate to 
provide exceptions from these FINRA rules to provide clarity and avoid 
unnecessary regulatory duplication. Accordingly, the Commission finds 
that the proposed rule change is designed to protect investors and the 
public interest.

E. Proposed Rule 0180(f) (Exceptions From Rules 2231, Customer Account 
Statements, and 4512, Customer Account Information)

    Proposed Rule 0180(f), as discussed above in Section II.F., would 
provide that FINRA Rules 2231 (Customer Account Statements) and 4512 
(Customer Account Information) shall not apply to members' activities 
and positions with respect to SBS, to the extent that the member is 
acting in its capacity as an SBS Entity and the customer's account 
solely holds SBS and collateral posted as margin in connection with 
such SBS, provided that the member complies with the portfolio 
reconciliation requirements of Exchange Act Rule 15Fi-3 with respect to 
such account and that such portfolio reconciliations include collateral 
posted as margin in connection with SBS in the account.\266\
---------------------------------------------------------------------------

    \266\ As a practical matter, the Commission states that most, if 
not all, requirements pertaining to the amount of collateral posted 
will be a ``material term'' for purposes of Exchange Act Rule 15Fi-
1(i), such that this information would be required to be reconciled 
pursuant to Exchange Act Rule 15Fi-3.
---------------------------------------------------------------------------

    A commenter requested that FINRA provide two clarifications with 
respect to proposed FINRA Rule 0180(f). First, the commenter stated 
that FINRA should clarify that a member may rely on the Rule 0180(f) 
exception in circumstances where the member's SBS account for the 
customer also includes non-securities positions, such as swaps.\267\ 
Second, the commenter stated that FINRA should clarify that a member 
may rely on the Rule 0180(f) exception when, in addition to a 
customer's SBS account, the member carries a non-SBS securities account 
for the customer and there is no portfolio margining or other 
commingling between the two accounts.\268\ In response, FINRA stated 
that the Commission, jointly with the CFTC, has published a request for 
comment on the portfolio margining of uncleared swaps and uncleared 
SBS.\269\ As such, FINRA believes it would be premature to provide 
further guidance in this area at this time, but will consider 
addressing remaining questions through interpretive guidance when 
appropriate.\270\
---------------------------------------------------------------------------

    \267\ See SIFMA Letter at 4.
    \268\ See id.
    \269\ See FINRA Letter at 5; see also Exchange Act Release No. 
90246 (Oct. 22, 2020), 85 FR 70536 (Nov. 5, 2020) (Request for 
Comment: Portfolio Margining of Uncleared Swaps and Non-Cleared 
Security-Based Swaps).
    \270\ See FINRA Letter at 5.
---------------------------------------------------------------------------

    Another commenter expressed support for eliminating the exceptions 
set forth in FINRA's proposed Rule 0180(f), maintaining that there is 
potential for confusion and disparate treatment as it pertains to FINRA 
Rules 2231 (Customer Account Statements) and 4512 (Books and Records/
Customer Account Information) relative to Exchange Act Rule 15Fi-3 (the 
Commission's portfolio reconciliation rule for SBS Entities).\271\ 
While the commenter respected FINRA's attempt to reduce burdens for 
participants, the commenter believes that with increased SBS activity, 
the exemption could be burdensome to some SBS Entities, while providing 
relief to other SBS Entities.\272\ The commenter further believes that 
differences between FINRA Rule 2231 and Exchange Act Rule 15Fi-3 are 
``stark.'' \273\ The commenter strongly supports portfolio 
reconciliation as a vital component to reducing systemic risk and other 
issues associated with SBS. However, as a practical matter this 
commenter believes that the burden of providing account statements 
based on a pre-defined methodology serves an important purpose for risk 
control as well.\274\ Further, the commenter stated that there is a 
high likelihood that an existing SBS Entity that solely holds SBS and 
related collateral also is an affiliate of larger organizations with 
sufficient infrastructure to comply with FINRA Rule 2231.\275\
---------------------------------------------------------------------------

    \271\ See PML Letter at 5.
    \272\ Id.
    \273\ See id. at 6.
    \274\ Id.
    \275\ Id.
---------------------------------------------------------------------------

    FINRA responded that the exception in proposed Rule 0180(f) applies 
only where a member is acting in its capacity as a registered SBS 
Entity and a customer's account solely holds SBS and collateral posted 
as margin in connection with SBS, provided that the member complies 
with the portfolio reconciliation requirements of Exchange Act Rule 
15Fi-3 with respect to such account and that such portfolio 
reconciliations include collateral posted as margin in connection with 
SBS in the account.\276\ FINRA believes that the SEC's portfolio 
reconciliation requirements set forth in Exchange Act Rule 15Fi-3 \277\ 
and the customer

[[Page 1983]]

account statement requirements under FINRA Rule 2231 serve similar 
purposes such that requiring delivery of customer account statements 
for SBS-only accounts that are also subject to portfolio reconciliation 
would be unnecessary duplication.\278\ FINRA further believes that it 
does not anticipate that this exception would create confusion, as SBS 
customers of an SBS Entity would expect to engage in portfolio 
reconciliation for their SBS accounts in accordance with the Commission 
rules, rather than for such SBS to appear on the customer account 
statement they may receive because the firm is also a FINRA member 
broker-dealer.\279\
---------------------------------------------------------------------------

    \276\ See FINRA Letter at 5.
    \277\ See supra note 56.
    \278\ Id. at 6.
    \279\ Id. FINRA further explained that it believes that a member 
that is not an SBS Entity and thus not subject to the SEC's 
portfolio reconciliation requirements--as well as other Commission 
rules related to risk mitigation, such as portfolio compression and 
trading relationship documentation--should include any SBS on a 
customer's account statements, regardless of whether such SBS are in 
a separate account from other securities, because SBS are 
securities. See id.
---------------------------------------------------------------------------

    The Commission recognizes that there are differences with respect 
to the frequency and timing requirements under Exchange Act Rule 15Fi-3 
and FINRA Rule 2231. For example, whereas Exchange Act Rule 15Fi-3 
requires SBS Entities to reconcile their portfolios with other 
counterparties more frequently than FINRA Rule 2231 requires its 
members to deliver an account statement to its customers, in some 
limited circumstances the Commission's rule would require portfolio 
reconciliation to occur less frequently than the timing requirements of 
FINRA's account statement rule.\280\ Nevertheless, the Commission finds 
that under the limited circumstances in which the exception from FINRA 
Rule 2231 in proposed FINRA Rule 0180(f) applies, Exchange Act Rule 
15Fi-3 should sufficiently serve similar purposes to FINRA Rule 2231, 
as it relates to providing information about an SBS with a customer who 
is a counterparty to an SBS, such that requiring members that are SBS 
Entities to also provide customer account statements for accounts 
holding solely SBS and related collateral would be unnecessarily 
duplicative. Further, as the exception only applies to accounts holding 
solely SBS and related collateral, the portfolio reconciliation 
requirements of Rule 15Fi-3 should provide sufficient risk control. To 
the extent that a customer's account includes SBS along with other 
securities positions or activity, or related money balances, then the 
account statement under FINRA Rule 2231 should include SBS. Thus, it is 
appropriate and consistent with the protection of investors and the 
public interest to provide an exception from FINRA Rule 2231 under 
circumstances when the Commission's risk mitigation requirements for 
SBS Entities under Exchange Act Rule 15Fi-3 will apply to SBS Entities, 
subject to the conditions discussed above. The Commission also 
recognizes, however, that this is an evolving market and a new 
regulatory framework, and acknowledges FINRA's commitment to consider 
providing interpretive guidance as appropriate.\281\
---------------------------------------------------------------------------

    \280\ Specifically, FINRA Rule 2231 requires each member to 
provide its customer with an account statement that satisfies the 
requirements of the rule on at least a quarterly basis. By contrast, 
the timing requirements in Exchange Act Rule 15Fi-3 vary, depending 
on whether the applicable counterparty is also an SBS Entity and the 
size of the SBS portfolio. The only time that portfolio 
reconciliation would be required to occur less frequently than 
quarterly would when an SBS Entity is facing a counterparty that is 
not also an SBS Entity and the size of the SBS portfolio does not 
exceed 100 SBS at any time during the calendar year, in which case 
the SBS Entity would only be required to have policies and 
procedures reasonably designed to ensure reconciliation on an annual 
basis. See 17 CFR 240.15Fi-3(b)(3)(ii).
    \281\ See e.g., Exchange Act Release No. 90246 (Oct. 22, 2020), 
85 FR 70536 (Nov. 5, 2020) (Request for Comment: Portfolio Margining 
of Uncleared Swaps and Non-Cleared Security-Based Swaps).
---------------------------------------------------------------------------

    Similarly, the Commission's requirements pertaining to written SBS 
trading relationship documentation pursuant to Exchange Act Rule 15Fi-
5, and the books and records requirements for SBS Entities that are 
also registered broker-dealers Exchange Act Rule 17a-3 will also 
continue to apply. These rules sufficiently serve similar purposes to 
FINRA Rule 4512, such that also applying FINRA Rule 4512 to SBS-only 
accounts would be duplicative. Accordingly, these limited circumstances 
in Proposed Rule 0180(f) reduce unnecessary and duplicative regulation.

F. Proposed Rule 0180(g) (Exception From FINRA Registration for Certain 
Associated Persons of Registered SBS Entities)

    The FINRA qualification and registration requirements are set forth 
in the FINRA Rule 1200 series.\282\ Proposed Rule 0180(g), as discussed 
above in Section II.G., would provide that persons associated with a 
member whose functions are related solely and exclusively to SBS, and 
undertaken in such person's capacity as an associated person of an SBS 
Entity, are not required to be registered with FINRA.
---------------------------------------------------------------------------

    \282\ FINRA Rule 1210 requires that each person engaged in the 
securities business of a member register with FINRA unless an 
exemption applies. See FINRA Rule 1210.
---------------------------------------------------------------------------

    One commenter generally supported the exception but requested 
clarification that an associated person relying on the exception set 
forth in FINRA's proposed Rule 0810(g) may, in addition to their SBS 
activities, also engage in non-securities activities on behalf of the 
member, such as soliciting or accepting swaps in the capacity as an 
associated person or a swap dealer, and that additional activity would 
not otherwise trigger FINRA registration or continuing education 
requirements and would not prevent reliance on the proposed 
exception.\283\ Further, the commenter suggested that FINRA Rule 
0180(g) should clarify that the person's ``securities-related 
functions'' must be related solely and exclusively to SBS undertaken in 
such person's capacity as an associated person of a registered SBS 
Entity.\284\
---------------------------------------------------------------------------

    \283\ See SIFMA Letter at 5.
    \284\ Id.
---------------------------------------------------------------------------

    A second commenter questioned the exemptions provided in proposed 
Rule 0180(g) and whether there are likely many, or even any, 
individuals associated with a FINRA member who would trade in SBS 
exclusively without also engaging in transactions in the underlying 
equity.\285\ To the extent there are such individuals, the commenter 
further questioned whether such individuals should be exempt from 
FINRA's qualifications and registration requirements.\286\ The 
commenter also expressed the belief that the likelihood of such 
individuals to enter the SBS market has the potential to increase.\287\ 
It is the commenter's belief that, although the qualification 
examinations and continuing education (``CE'') requirements may not 
specifically address SBS, the examination and CE requirements do 
require an associated person to have familiarity with the 
characteristics of the underlying equity securities and regulatory 
framework, which the commenter considers important to have for anyone 
engaged in SBS activities.\288\ The commenter further maintained that 
the exemptions provided in proposed Rule 0180(g) may potentially cause 
``confusion for both exempt persons and `dual-hatted' personnel,'' and 
that such persons could avoid regulations such as FINRA Rule 2111 
(Suitability) to which other registered persons are subject.\289\ The

[[Page 1984]]

commenter also stated that it may be unclear if FINRA Rule 4530 
(Reporting Requirements) would apply to a member if the potentially 
reportable conduct involved a person associated with a member whose 
functions are related solely and exclusively to SBS undertaken in the 
person's capacity as an associated person of a registered SBS 
Entity.\290\
---------------------------------------------------------------------------

    \285\ See PML Letter at 4.
    \286\ Id.
    \287\ Id.
    \288\ Id.
    \289\ Id. at 5. With respect to the applicable suitability 
standard specifically, the commenter stated that SBSDs are afforded 
different treatment under the proposed rule change, as the 
Commission's suitability rules would apply, creating another 
disparity for a non-SBS Entities participating in SBS to manage 
competing regulations. Id. As explained further below, contrary to 
the commenter's assertion, proposed Rule 0810(g) provides no 
exemption to FINRA Rule 2111 for an associated person (unless the 
FINRA member satisfied the conditions of the exception in proposed 
FINRA Rule 0180(d)).
    \290\ Id.
---------------------------------------------------------------------------

    In response to the comments, FINRA stated that a member is 
responsible for monitoring the activities of each of its associated 
persons to determine whether such person is required to be registered 
with FINRA and, if so required, to ensure that each associated person 
is registered in the appropriate category or categories.\291\ FINRA 
cited to FINRA Rule 1210 (Registration Requirements), which requires 
persons engaged in the investment banking or securities business of a 
member to be registered ``in each category of registration appropriate 
to his or her functions and responsibilities as specified'' in FINRA 
Rule 1220.\292\ FINRA Rule 1210 further states that persons ``shall not 
be qualified to function in any registered capacity other than that for 
which the person is registered, unless otherwise stated in the rules.'' 
\293\ FINRA also stated that the exception in proposed FINRA Rule 
0180(g) would only apply to associated persons in the limited 
circumstances set forth in Rule 0180(g), and does not otherwise affect 
FINRA members' responsibilities regarding the registration of their 
associated persons.\294\ Thus, according to FINRA, a member relying on 
the proposed exception with respect to one or more of its associated 
persons would still need to monitor the activities of all of its 
associated persons, including any associated persons relying on the 
exception, to determine whether any of the person's activities require 
registration under FINRA rules.\295\ Accordingly, with respect to the 
commenter's request for clarification, FINRA stated that it was not 
necessary to change to the text of proposed FINRA Rule 0180(g).\296\ In 
so concluding, FINRA stated that the exception is structured similarly 
to existing exceptions from registration for persons associated with a 
member whose functions are related solely and exclusively to certain 
other products--specifically, associated persons transacting solely and 
exclusively in municipal securities, commodities, and security 
futures.\297\
---------------------------------------------------------------------------

    \291\ FINRA Letter at 6.
    \292\ Id. at 6, n.9. FINRA Rule 1220 sets forth registration 
categories. See FINRA Rule 1220.
    \293\ Id.; see also FINRA Rule 1210.
    \294\ FINRA Letter at 6.
    \295\ Id. at 6-7.
    \296\ Id. at 7.
    \297\ Id. at 7; see also FINRA Rule 1230.
---------------------------------------------------------------------------

    FINRA stated that although it understands that the number of 
associated persons that would be eligible for the exception is likely 
to be limited, it believes the proposed exception is nonetheless 
appropriate to avoid unnecessary regulatory burdens with respect to 
even this limited set of individuals.\298\ FINRA further stated that, 
under Commission rules, associated persons of SBS Entities, while 
subject to statutory disqualification prohibitions (and related 
background check requirements), are not independently subject to 
registration, licensing or continuing education (``CE'') requirements 
imposed or administered by the Commission.\299\ FINRA believes that, at 
the current time, there would be limited benefit to requiring FINRA 
registration for the limited group of individuals that would qualify 
for the proposed exception.\300\ FINRA stated that it will monitor 
developments and continue to consider whether requiring registration 
for an associated person whose functions are related solely and 
exclusively to SBS in such person's capacity as an associated person of 
a registered SBS Entity would be appropriate.\301\
---------------------------------------------------------------------------

    \298\ Id. at 7-8.
    \299\ Id. at 8.
    \300\ Id.
    \301\ Id. at 8, n.12.
---------------------------------------------------------------------------

    In response to the comments concerning the potential for persons to 
avoid regulation, FINRA further stated that even in instances where an 
associated person is exempt from registration under proposed Rule 
0180(g), the associated person would remain subject to all FINRA rules 
applicable to associated persons with respect to their SBS activities, 
unless another specific exception applied.\302\ For example, an 
associated person excepted under proposed Rule 0180(g) would remain 
subject to suitability obligations under FINRA Rule 2111 (as well as 
Exchange Act Rule 15Fh-3(f) and, as applicable Rule 15Fh-5) when 
recommending SBS, unless the member satisfied the conditions of the 
exception in proposed FINRA Rule 0180(d) with respect to such 
activity.\303\ In such circumstances, the member and the associated 
person would be required to comply with the Commission's business 
conduct obligations, which impose analogous requirements.\304\ FINRA 
also stated that, notwithstanding the proposed rule change, a member 
and its associated persons would still be subject to FINRA Rule 4530 
and related guidance with respect to their SBS activities (regardless 
of whether a particular individual relies on the exception from 
registration under proposed Rule 0180(g)).\305\
---------------------------------------------------------------------------

    \302\ Id. at 8.
    \303\ Id. The Commission notes that Exchange Act Rules 15Fh-3(f) 
and 15Fh-5 contain requirements that extend beyond the requirements 
found in FINRA Rule 2111--for example, an explicit requirement that 
an SBSD have a reasonable basis to believe the counterparty have an 
ability to absorb potential losses associated with the 
recommendation.
    \304\ Id.
    \305\ Id. at 9.
---------------------------------------------------------------------------

    The Commission finds that the proposed registration exception is 
reasonable. The exception is limited in scope and applies only to 
persons associated with a FINRA member that is also a Commission-
registered SBS Entity, where the associated person's functions are 
related solely and exclusively to SBS undertaken in such person's 
capacity as an associated person of the registered SBS Entity. 
Additionally, not only is the exception expected to apply to a limited 
number of persons, those individuals are still subject to other 
regulatory obligations. In particular: (1) Persons qualifying for the 
Rule 0180(g) exceptions are still subject to all FINRA rules applicable 
to associated persons unless another specific exception applies; (2) 
all Commission rules applicable to associated persons of SBS Entities, 
including rules designed to prevent a statutorily disqualified person 
from associating with an SBS Entity, will apply; \306\ and (3) FINRA 
members are obligated to monitor the activities of their associated 
persons and determine whether those activities give rise to an 
obligation to register the person under FINRA's rules. For the 
foregoing reasons, the Commission finds that the proposed exemption in 
Rule 0180(g) is designed to protect investors and the public interest. 
The Commission also recognizes, however, that this is an evolving 
market and a new regulatory

[[Page 1985]]

framework, and acknowledges FINRA's commitment to monitor developments 
and to consider whether it would be appropriate to rescind the 
exception as the market develops further.\307\
---------------------------------------------------------------------------

    \306\ For example, Exchange Act Rule 15Fh-3(h)(2)(iii)(D) 
requires an SBS Entity to have procedures to conduct a reasonable 
investigation regarding, among other things, the qualifications and 
experience of any potential associated person.
    \307\ See FINRA Letter at 9, n.11-12; see also Notice at 26092.
---------------------------------------------------------------------------

G. Proposed Rule 0180(i) (Authority To Grant Exemptions From the 
Application of Rule 0180 Upon Member Application) and 9610 (Application 
for Exemptive Relief)

    Proposed FINRA Rule 0180(i), as discussed above in Section II.H., 
would provide FINRA with authority to consider exemptive relief from 
the application of specific FINRA rules to SBS on a rule-by-rule, 
member-by-member basis, other than the general presumption of 
applicability contained in proposed Rule 0180(a), which is not subject 
to exemption.\308\ FINRA's proposed rule change would also make a 
conforming change to FINRA Rule 9610 to add FINRA Rule 0180 to the list 
of rules pursuant to which FINRA has exemptive authority.\309\ A 
member's application for an exemption under proposed FINRA Rule 0180(i) 
would be subject to FINRA's existing procedures for all exemptive 
applications set forth in its Rule 9600 Series and described in more 
detail in Section II.G.\310\ Pursuant to its procedures in FINRA Rule 
9620, FINRA would be required to issue a written decision setting forth 
its findings and conclusions in response to the request for an 
exemption, which may be made publicly available.\311\
---------------------------------------------------------------------------

    \308\ See Notice at 26093.
    \309\ Id.
    \310\ Id.
    \311\ Id. A FINRA member seeking a non-public exemption under 
Rule 9600 must include in its application a detailed statement, 
including supporting facts, showing good cause for treating the 
application or decision as confidential in whole or in part. See 
FINRA Rule 9610(b).
---------------------------------------------------------------------------

    FINRA states that it needs the exemptive authority to respond to 
the evolving SBS market and to particular circumstances that may arise 
in which applying specific FINRA rules to SBS activities or positions, 
not otherwise excepted by the proposed rule change, may not be 
appropriate or feasible.\312\
---------------------------------------------------------------------------

    \312\ See Notice at 26093.
---------------------------------------------------------------------------

    Proposed Rule 0180(i) would allow FINRA to exempt a person 
unconditionally or on specified terms from the application of 
individual FINRA rules beyond what is already proposed to be permitted 
under proposed Rule 0180.\313\ Notably, the proposed rule change would 
not permit any exemption from proposed Rule 0180(a), which would 
provide that FINRA Rules shall apply to members' activities and 
positions unless specifically excepted elsewhere in the rule.\314\ 
Thus, as proposed, FINRA could not use its authority under FINRA Rule 
0180(i) to grant an exemption from the general application of FINRA 
rules to SBS activities.\315\ Rather, FINRA would only be permitted to 
grant exemptions only on a rule-by-rule, member-by-member basis, 
consistent with the existing framework for granting exemptions for 
other FINRA rules as provided by Rule 9610.\316\ Furthermore, any 
exemption must consider ``all relevant factors,'' and FINRA may grant 
exemptions only if FINRA deems the exemption consistent with the 
protection of investors and the public interest.\317\
---------------------------------------------------------------------------

    \313\ Id.
    \314\ Id.
    \315\ Id.
    \316\ Id.
    \317\ Id.
---------------------------------------------------------------------------

    One commenter supported this proposed exemptive authority, noting 
that the exceptions described in the proposed rule change are tailored 
to the existing SBS market, and that this market may evolve in a manner 
that would justify further exceptions to FINRA rules.\318\ As an 
example, the commenter noted that FINRA rules applicable to quoting and 
trading ``may become more relevant to SBS in the future if trading or 
execution of SBS on exchanges or SBS execution facilities becomes 
prevalent,'' and that it may then be appropriate for FINRA to adopt 
additional exemptions ``or otherwise clarify or tailor the application 
of those rules to SBS.'' \319\
---------------------------------------------------------------------------

    \318\ See SIFMA Letter at 6.
    \319\ Id.
---------------------------------------------------------------------------

    The Commission finds that the proposed exemptive authority under 
Rule 0180(i) is designed to protect investors and the public interest. 
The rule change will allow FINRA members to avail themselves of an 
existing procedural vehicle--FINRA's Rule 9600 Series--to apply for 
exemptive relief from specific FINRA rules, on a case-by-case basis, to 
address unanticipated factual circumstances as market participants 
navigate the newly-regulated SBS market. As stated above, the 
Commission agrees with FINRA that, in light of Title VII's amendment of 
the Exchange Act to specifically encompass SBS as securities, FINRA 
rules should generally apply to SBS in the same manner that such rules 
apply to securities generally, subject to the exceptions set forth 
elsewhere in proposed FINRA Rule 0180.\320\ However, the Commission 
also recognizes the evolving nature of the SBS market, and that 
unanticipated factual circumstances may give rise to a need for FINRA 
to consider member applications for additional exceptions to specific 
FINRA rules on a case-by-case basis. The Commission expects that FINRA 
will, as it previously stated, apply heightened scrutiny to such 
applications for exemptive relief from its members not otherwise 
registered as SBS Entities with the Commission.\321\
---------------------------------------------------------------------------

    \320\ See Notice at 26086.
    \321\ See Notice at 26093, n.66.
---------------------------------------------------------------------------

    To the extent that FINRA grants a number of exemptions pursuant to 
the process in its Rule 9600 Series for similar factual circumstances 
and/or identical FINRA rules, FINRA should consider filing a proposed 
rule change with the Commission to address those circumstances on a 
member-wide basis. Proposed Rule 0180(i) provides an appropriate 
vehicle that relies on an existing process for FINRA to consider 
providing limited exceptions on a member-by-member, case-by-case basis 
as warranted by specific facts, and only where FINRA deems appropriate 
consistent with the protection of investors and the public interest. 
The proposed exemptive authority is reasonably designed to allow FINRA 
to consider unanticipated and novel factual scenarios that may warrant 
additional exceptions from its rules, but only where FINRA finds that 
such relief is in the public interest and would protect investors. 
Thus, the Commission finds that the proposed FINRA Rule 0180(i) is 
designed to protect investors and the public interest.

H. Financial Responsibility and Operational Requirements

    As discussed above in Section II.I., FINRA Rule 4120 (Regulatory 
Notification and Business Curtailment) sets forth certain early warning 
notification and business curtailment requirements if a member's 
capital falls below certain thresholds. These thresholds are based on 
the minimum capital requirements applicable to a member broker-dealer 
under Exchange Act Rule 15c3-1. As discussed above in Section II.I., 
the proposed amendments to FINRA Rule 4120 would conform the rule to 
the new and increased minimum capital requirements for Non-ANC Firms 
that are also registered as SBSDs and for ANC Firms, adopted in the 
Capital, Margin, and Segregation Release.
    The proposed amendments to FINRA Rule 4120 will align FINRA's 
historical early warning notification and business curtailment 
thresholds with the Commission's amended capital requirements for Non-
ANC Firms that

[[Page 1986]]

are also registered as SBSDs and for ANC Firms, adopted in the Capital, 
Margin, and Segregation Release. The modified early warning thresholds 
are appropriately calibrated to provide FINRA with sufficient early 
warning that a FINRA member's capital levels may be deteriorating. The 
modified business curtailment thresholds also are appropriately 
calibrated to provide FINRA with the ability to require a FINRA member 
to reduce its business activities when its capital levels have 
deteriorated to a level that may jeopardize its ability to comply with 
regulatory capital requirements.
    In addition, as discussed above in Section II.I., proposed FINRA 
Rule 0180(h) would provide that, for purposes of the FINRA Rule 4000 
Series, all requirements that apply to a member that clears or carries 
customer accounts must also apply to any member that acts as a 
principal counterparty to an SBS, clears or carries an SBS, guarantees 
an SBS or otherwise has financial exposure to an SBS. Applying these 
higher standards when a member enters into SBS transactions, or 
otherwise has exposure to SBS is appropriate given that SBS are complex 
transactions that will require detailed recordkeeping, margining, legal 
agreements, collateral management, reconciliation and risk management.

I. Margin Requirements

    As discussed above in Section II.J., FINRA is proposing to adopt a 
new margin rule specifically applicable to SBS. Current FINRA Rule 4240 
would be replaced by new FINRA Rule 4240 that would prescribe margin 
requirements for SBS, including CDS. However, proposed FINRA Rule 4240 
would not apply to any FINRA member that is registered as an SBSD. 
FINRA members that are SBSDs are subject to the margin requirements of 
Exchange Act Rule 18a-3 discussed above in Section II.J. FINRA stated 
that by applying margin requirements in these circumstances, the 
proposed rule change would fill an important regulatory gap, protect 
FINRA members against counterparty credit risk, maintain a level 
playing field for members, and prevent regulatory arbitrage. As 
discussed above in Section II.J., the margin requirements under 
proposed FINRA Rule 4240 would be structurally aligned with the margin 
requirements that apply to SBSDs under Exchange Act Rule 18a-3, with 
certain modifications that FINRA believes are necessary because FINRA 
members that are not SBSDS will not be subject to the Commission's 
comprehensive regulatory framework for SBSDs.\322\ Thus, subject to 
certain exceptions in the proposed rule discussed above in Section 
II.J., proposed FINRA Rule 4240 would require members that are not 
SBSDs to collect and deliver variation margin on a daily basis to cover 
the member's current exposure to or from each SBS counterparty, and 
also to collect (but not deliver) initial margin from each SBS 
counterparty. FINRA members that are not SBSDs would also be required 
to monitor the risk of any Uncleared SBS Account and maintain a 
comprehensive risk analysis methodology for assessing the potential 
risk to the member's capital. Finally, FINRA is also proposing to amend 
FINRA Rules 4210 and 4220 to take into account members' SBS 
activities.\323\
---------------------------------------------------------------------------

    \322\ See Notice at 26097.
    \323\ See supra note 147.
---------------------------------------------------------------------------

    Applying the proposed margin requirements to FINRA members that are 
not registered as SBSDs will fill an important regulatory gap because 
it will prescribe margin requirements for uncleared SBS for FINRA 
members that are not SBSDs and not subject to Exchange Act Rule 18a-3. 
The margin requirements in the proposed rule change will protect FINRA 
members against counterparty credit risk with respect to transactions 
in uncleared SBS.\324\ In particular, the proposed margin requirements 
will address the risk of uncollateralized exposures in uncleared SBS 
for FINRA members that are not registered as SBSDs by prescribing 
variation and initial margin requirements, subject to certain 
exceptions, as well as requiring these firms to maintain a 
comprehensive written risk analysis methodology. In addition, adopting 
a stand-alone rule that applies margin requirements to uncleared SBS 
under proposed new FINRA Rule 4240 will reduce unnecessary and 
duplicative regulation for FINRA members regarding which FINRA margin 
requirements apply to uncleared SBS.
---------------------------------------------------------------------------

    \324\ See Notice at 26097.
---------------------------------------------------------------------------

    A commenter stated that proposed FINRA Rule 4240 would differ in 
several material respects from Exchange Act Rule 18a-3.\325\ More 
specifically, the commenter stated that FINRA Rule 4240 would (1) not 
permit a member to use an approved model to calculate initial margin, 
(2) require a member to collect initial margin from affiliates that are 
not financial market intermediaries or majority owners, (3) not permit 
a member to apply an initial margin threshold, (4) not permit a member 
to apply a minimum transfer amount, and (5) not permit an ANC Firm to 
apply credit risk charges under paragraph (c) to Exchange Act Rule 
15c3-1e in lieu of collecting margin, except for SBS with a majority 
owner, or a registered or foreign SBS Dealer affiliate.\326\ The 
commenter stated that these differences would present material issues 
for members subject to proposed FINRA Rule 4240, particularly in 
connection with certain inter-affiliate SBS designed to promote 
centralized, group-wide risk management, as well as SBS entered into 
with unaffiliated financial market intermediaries for hedging purposes. 
The commenter provided examples where it believed that the differences 
between Exchange Act Rule 18a-3 and proposed FINRA Rule 4240 would 
present material issues, including: (1) When a foreign dealer affiliate 
of a U.S. broker-dealer hedges risks of SBS based on U.S. securities 
with their foreign customers via offsetting SBS with the U.S. broker-
dealer, (2) when a broker-dealer forms an affiliated special purpose 
vehicle to issue a structured note that references a security, and (3) 
when a broker-dealer, in order to hedge the risk of its securities 
inventory, enters into one or more SBS with unaffiliated financial 
market intermediaries.\327\
---------------------------------------------------------------------------

    \325\ See SIFMA Letter at 7-11.
    \326\ Id.; see also supra note 197 (defining ``Registered or 
Foreign SBS Dealer'').
    \327\ See SIFMA Letter at 8.
---------------------------------------------------------------------------

    The commenter recommended that FINRA permit a broker-dealer to 
comply with Exchange Act Rule 18a-3 rather than proposed FINRA Rule 
4240 to address these issues.\328\ However, the commenter also stated 
that it appreciates FINRA's concerns regarding a smaller broker-dealer 
entering into uncleared SBS with margin requirements that differ from 
the requirements that would apply under FINRA Rule 4210 to equivalent 
securities positions.\329\ To address this consideration, the commenter 
proposed that, in order for a FINRA member to apply Exchange Act Rule 
18a-3 in lieu of proposed FINRA Rule 4240, the member must satisfy the 
higher capital requirements applicable to an SBSD in Exchange Act Rule 
15c3-1(a)(10) (or the higher capital requirements applicable to an ANC 
Firm in Exchange Act Rule 15c3-1(a)(7)). The commenter further proposed 
that for such a member to use a model to calculate initial margin, the 
Commission would need to approve the model for use by an affiliate of 
the member that is registered as an SBSD.\330\ The commenter also 
stated that if

[[Page 1987]]

FINRA does not adopt these recommendations, then it should further 
modify proposed FINRA Rule 4240 to align more closely with Exchange Act 
Rule 18a-3.\331\ The commenter stated that FINRA previously declined to 
incorporate this suggested modification because broker-dealers subject 
to the proposed margin requirements for uncleared SBS would not be 
subject to the regulatory framework applicable to SBSDs, in particular 
higher capital requirements applicable to registered SBSDs.\332\
---------------------------------------------------------------------------

    \328\ Id.
    \329\ Id.
    \330\ Id.
    \331\ Id.
    \332\ Id.
---------------------------------------------------------------------------

    FINRA responded to the comments stating that FINRA acknowledges 
that proposed FINRA Rule 4240 would differ from Exchange Act Rule 18a-3 
in some respects.\333\ While such differences may in some cases result 
in increased costs for members that are not registered SBSDs when 
entering into uncleared SBS transactions with certain counterparties, 
FINRA responded that the requirements of proposed FINRA Rule 4240 as 
set forth in the Notice are important to protect the financial 
condition of its members, given that members subject to the rule would 
not be subject to the comprehensive regulatory framework applicable to 
SBSDs.\334\ FINRA also stated that a member can ``opt-in'' to Exchange 
Act Rule 18a-3 by registering as an SBSD.\335\ FINRA further stated 
that SBSD registration is an important precondition to margining 
pursuant to Exchange Act Rule 18a-3, because SBSD registration assures 
that the entity is fully regulated as an SBSD, including the higher 
minimum capital requirements applicable to SBSDs.\336\ Therefore, FINRA 
believes it would not be appropriate to incorporate Commission margin 
rules by reference or allow non-SBSD members to ``opt-in'' to the 
Commission margin rules as an alternative to FINRA margin rules.\337\ 
Further, FINRA stated the specific requirements of proposed FINRA Rule 
4240 are appropriately calibrated to provide parity with both FINRA 
Rule 4210 and Exchange Act Rule 18a-3, where possible, but also to 
provide greater protection to the financial condition of members not 
subject to the Commission's comprehensive requirements for registered 
SBSDs.\338\
---------------------------------------------------------------------------

    \333\ See FINRA Letter at 10.
    \334\ Id.
    \335\ Id.
    \336\ Id.
    \337\ Id.
    \338\ Id.
---------------------------------------------------------------------------

    The Commission concludes that it would not be appropriate for a 
FINRA member that is not registered as an SBSD to ``opt in'' to 
compliance with Exchange Act Rule 18a-3 in lieu of complying with 
proposed FINRA Rule 4240, including in cases where a member would 
comply with higher capital requirements. While the proposed margin 
requirements differ from Exchange Act Rule 18a-3 in some respects, 
FINRA proposed the amendments in part to reduce regulatory arbitrage 
between existing margin requirements under FINRA Rule 4210 and the 
proposed requirements for uncleared SBS under FINRA Rule 4240. For 
example, the margin requirements in proposed FINRA Rule 4240 do not 
contain any thresholds that are prescribed in Exchange Act Rule 18a-3 
(such as the $50 million threshold below which initial margin need not 
be collected by an SBSD). Therefore, the proposed margin requirements 
should reduce the risk that a broker-dealer would be incentivized to 
restructure existing securities margin accounts as uncleared SBS, since 
existing FINRA Rule 4210 does not contain any margin thresholds for 
securities. In addition, while broker-dealers and SBSDs are subject to 
comprehensive financial responsibility requirements, FINRA member firms 
that are not SBSDs are not subject to the Commission's specific 
regulatory framework for registered SBSDs under Title VII of the Dodd-
Frank Act, and Exchange Act Rule 18a-3, in particular, only applies to 
SBSDs and MSBSPs.
    For those same reasons, FINRA declined to adopt a number of 
specific modifications suggested by a commenter to align proposed Rule 
4240 more closely with Exchange Act Rule 18a-3 in lieu of allowing 
members to comply with Exchange Act Rule 18a-3.\339\ FINRA stated that 
the commenter made a number of similar recommendations in its comments 
responding to the Concept Proposal.\340\ FINRA stated that it had 
responded previously to these recommendations, which included several 
modifications from the margin rule described in the Concept Proposal 
that were intended to address the comments and enhance competitive 
parity, while still providing appropriate protection for the financial 
condition of non-SBSD members entering into uncleared SBS.\341\ FINRA 
further stated that, as a general matter, proposed FINRA Rule 4240 is 
not intended to level the playing field between SBSDs and non-SBSD 
members entering into SBS, such as de minimis dealers.\342\ Rather, 
FINRA stated that the proposed rule is intended to adequately protect 
members from counterparty credit risk and prevent regulatory arbitrage, 
in particular by removing incentives for members to restructure their 
traditional extensions of credit (e.g., margin lending) subject to 
FINRA Rule 4210 as uncleared SBS.\343\
---------------------------------------------------------------------------

    \339\ Id. Specifically, the commenter proposed that FINRA: (1) 
Adopt an initial margin exception for all majority-owned affiliates; 
(2) permit an ANC Firm to calculate credit risk charges in 
accordance with Exchange Act Rule 15c3-1e(c) for exposures to all 
counterparty types; (3) permit use of SEC-approved initial margin 
models for non-equity SBS; (4) adopt a $50 million initial margin 
threshold, applicable on a group-wide basis; (5) adopt a $500,000 
minimum transfer amount; (6) align FINRA Rule 4240's collateral 
haircuts with Exchange Act Rule 18a-3; and (7) extend the deadline 
for posting or collecting margin for counterparties in distant time 
zones. See SIFMA Letter at 9-11.
    \340\ See Notice at 26107-09; see also FINRA Letter at 10.
    \341\ FINRA Letter at 10.
    \342\ Id.
    \343\ Id. at 10-11.
---------------------------------------------------------------------------

    Further, with respect to a commenter's request for FINRA to align 
proposed new FINRA Rule 4240's collateral haircuts with Exchange Act 
Rule 18a-3, FINRA stated that it does not believe permitting the use of 
the haircuts applicable to SBS collateral under Exchange Act Rule 18a-3 
would be appropriate.\344\ As FINRA previously stated, the proposed 
rule change is not intended to level the playing field between SBSDs 
and non-SBSD members entering into SBS, such as de minimis dealers, but 
rather to prevent regulatory arbitrage between members extending credit 
through SBS and members extending credit through traditional 
means.\345\
---------------------------------------------------------------------------

    \344\ Id. at 11.
    \345\ Id.
---------------------------------------------------------------------------

    With respect to the request for FINRA to extend the deadline for 
posting or collecting margin for counterparties in distant time zones, 
FINRA stated that Exchange Act Rule 18a-3 requires that a member take 
an applicable capital charge on positions that do not meet the margin 
requirements generally within T+1, but extends that deadline to T+2 if 
the counterparty is located in another country and four time zones 
away.\346\ While proposed FINRA Rule 4240 would similarly require a 
capital charge if required margin is not collected on T+1, FINRA stated 
that FINRA Rule 4240 would not require liquidation of the position 
until T+3. FINRA stated that this timing follows the portfolio margin 
requirements under FINRA Rule 4210, and stated it is appropriate to 
require a capital charge on T+1 because the location of the 
counterparty does not affect the counterparty credit risk to the

[[Page 1988]]

member.\347\ However, FINRA believes that, generally, the additional 
time before liquidation is required should be sufficient to accommodate 
counterparties in distant time zones.\348\
---------------------------------------------------------------------------

    \346\ In this context, ``T+1'' and similar terms refer to the 
number of business days after the date on which the person was 
required to compute the margin requirement. Id.
    \347\ Id.
    \348\ Id.
---------------------------------------------------------------------------

    The Commission concludes that it is appropriate for FINRA to 
decline to adopt commenters suggestions to modify proposed new FINRA 
Rule 4240 to more closely align with the requirements of Exchange Act 
Rule 18a-3, including the rule's collateral haircuts. Proposed FINRA 
Rule 4240 will promote consistent margin requirements, including 
haircut requirements, between FINRA members extending credit through 
traditional means under FINRA Rule 4240 and FINRA members extending 
credit through SBS under FINRA Rule 4240. The requirements under new 
FINRA Rule 4240 will protect FINRA members from counterparty credit 
risk and prevent regulatory arbitrage by reducing incentives for 
members to restructure their traditional extensions of credit (e.g., 
margin lending) subject to FINRA Rule 4210 as uncleared SBS. Further, 
the proposed time period (T+3) with respect to required liquidations 
above should provide FINRA members that are not SBSDs the flexibility 
to accommodate counterparties in additional time zones.
    Another commenter raised concerns regarding the disparate treatment 
for SBSDs with respect to uncleared SBS. The commenter stated that 
proposed FINRA Rule 4240 and Exchange Act Rule 18a-3 impose different 
margin and collateral requirements, depending on whether an entity is 
designated as an SBSD or a FINRA broker-dealer.\349\ This commenter 
raised concerns that this difference could hinder the ability of a 
FINRA broker-dealer to compete with SBSDs or other SBS market 
participants on a level playing field. In particular, the commenter 
raised concerns that counterparties would potentially choose to 
transact with an SBSD rather than a similarly capitalized FINRA broker-
dealer, in order to avoid the need for the daily collection of initial 
margin and variation margin, which could lead to reduced firm 
participation impacting overall costs and liquidity.\350\
---------------------------------------------------------------------------

    \349\ See PML Letter at 7.
    \350\ Id.
---------------------------------------------------------------------------

    In response, as discussed above in Section II.J., while proposed 
FINRA Rule 4240 would diverge from Exchange Act Rule 18a-3 in some 
respects, FINRA believes that proposed FINRA Rule 4240 appropriately 
protects members from counterparty credit risk and prevents regulatory 
arbitrage between different methods of extending credit.\351\ FINRA 
does not believe that the potential for increased market liquidity if 
more members functioned as de minimis dealers justifies replacing the 
specific margin requirements set forth in proposed FINRA Rule 
4240.\352\ Moreover, FINRA stated that a FINRA member seeking to 
establish parity with other SBSDs with respect to margin requirements 
may elect to register as an SBSD and become subject to the Commission's 
comprehensive SBSD regulatory framework. FINRA stated that the intent 
of proposed Rule 4240 is not to level the playing field between SBSDs 
and members engaged in de minimis SBS activity, but rather to prevent 
regulatory arbitrage as between members extending credit through SBS 
and members extending credit in the traditional fashion.\353\
---------------------------------------------------------------------------

    \351\ See FINRA Letter at 11.
    \352\ Id. at 11-12.
    \353\ Id. at 12.
---------------------------------------------------------------------------

    The proposed rule change will serve to promote consistent and 
transparent margin requirements for the uncleared SBS market and 
traditional securities markets for FINRA members that are not SBSDs. 
Further, proposed Rule 4240 will require a FINRA member to collect 
initial margin, and collect or post variation margin, unless an 
exception applies.\354\ 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 uncleared SBS 
transactions, with the potential costs and competitive impacts that may 
result from the proposed rule change. For example, FINRA has proposed a 
number of exceptions to the proposed margin requirements,\355\ which 
may lessen the competitive impacts and costs of the proposed margin 
requirements.
---------------------------------------------------------------------------

    \354\ See Notice at 26097.
    \355\ Id. at 26101.
---------------------------------------------------------------------------

    A commenter further sought clarification regarding Non-Basic SBS, 
and more specifically uncleared TRS structures.\356\ The commenter 
stated that the SBS market is dynamic and that market developments, 
such as its proposed alternative trading system platform, may make 
commonplace transactions that today are limited. The commenter also 
stated that a key blocker to growth of this activity is potential 
ambiguity around timing and the open-ended nature of the approval 
process for margin requirements for Non-Basic SBS.\357\ Finally, this 
commenter stated that SBSDs would be placed at a significant advantage 
under the proposed margin framework, and supported a more clearly 
defined process for FINRA members that are not SBSDs to evaluate new 
products within existing or potentially expanded lines of 
business.\358\
---------------------------------------------------------------------------

    \356\ See PML Letter at 6.
    \357\ Id. at 7.
    \358\ Id.
---------------------------------------------------------------------------

    In response, FINRA stated that under proposed FINRA Rule 
4240(b)(2)(C), a member may apply to FINRA for the approval of an 
Initial Margin Requirement for a type of SBS other than Basic CDS and 
Basic SBS. FINRA further stated that the proposed rule change sets 
forth the requirements for any such application, and provides that no 
member shall become a party to an SBS other than a Basic CDS or Basic 
SBS unless FINRA has approved an Initial Margin Requirement for such 
member's use with respect to that type of SBS.\359\ In addition, FINRA 
believes other types of SBS--including CDS and equity TRS with complex 
features--may not be easily accommodated under the frameworks 
applicable to Basic CDS and Basic SBS, and that the specific risks of 
such SBS may not be readily apparent or quantifiable to FINRA without 
additional information. Further, FINRA stated that SBS can be complex 
financial instruments that pose substantial risks to the financial 
condition of members, and margin serves as an important means of 
protecting member firms, and thereby their customers and investors, 
from such risks.\360\ FINRA also believes that the application process 
under proposed FINRA Rule 4240(b)(2)(C) permits appropriate flexibility 
so that FINRA and its member firms may analyze all relevant risks that 
may be associated with a new type of SBS product. FINRA also stated 
that proposed FINRA Rule 4240 defers to registered clearing agencies 
with respect to the margin requirements for Cleared SBS. Therefore, 
FINRA believes that FINRA members that are not SBSDs may enter into 
Cleared SBS without seeking approval under Rule 4240(b)(2)(C); the 
application process would only be required before entering into new 
types of uncleared SBS.\361\
---------------------------------------------------------------------------

    \359\ See FINRA Letter at 12.
    \360\ Id.
    \361\ Id.
---------------------------------------------------------------------------

    The proposed application process for margin requirements for SBS 
that are not Basic SBS or CDS provides specific detail with respect to 
the application's requirements, while providing FINRA with the 
flexibility to determine if a proposed margin requirement adequately 
addresses the risks for a

[[Page 1989]]

particular type of SBS, including through the ability to request 
additional information. These requirements will protect FINRA member 
firms from the risks associated with uncleared SBS with complex 
features by ensuring FINRA member firms that are not SBSDs set prudent 
margin levels for these instruments.
    In conclusion, the proposed changes to FINRA Rules 4210, 4420, and 
4240 will help to ensure that the risks to FINRA members that are not 
SBSDs with respect to their uncleared SBS exposures are adequately 
addressed through the collection of margin. In addition, the proposed 
rule changes will enhance risk management practices at FINRA members 
that are not SBSDs and that participate in the SBS markets. They also 
will prevent unnecessary regulatory duplication by applying the 
proposed margin requirements in proposed FINRA Rule 4240 to FINRA 
members that are not SBSDs, and will not be subject to the margin 
requirements of Rule 18a-3.

IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the 
Exchange Act \362\ that the proposed rule change (SR-FINRA-2021-008), 
as modified by Amendment No. 1, be, and hereby is, approved.
---------------------------------------------------------------------------

    \362\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\363\
---------------------------------------------------------------------------

    \363\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-00376 Filed 1-11-22; 8:45 am]
BILLING CODE 8011-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.