FINRA Rule 4210: managing risks effectively
19 March 2024
Matrix Application’s Stephen Mellert speaks to Carmella Haswell on the upcoming FINRA Rule 4210 amendments which will come to market in May 2024 and is expected to represent a significant shift in the regulatory landscape for broker-dealers
Image: stock.adobe.com/ilyaf
After a seven-year extension, the US Securities and Exchange Commission (SEC) has approved the implementation of margin requirement rules relating to Covered Agency Transactions under the Financial Industry Regulatory Authority (FINRA) Rule 4210. Firms are now racing to prepare for the 22 May 2024 compliance deadline.
Speaking to SFT, Stephen Mellert, head of business development at Matrix Applications, anticipates that the implementation of this rule will represent a significant shift in the regulatory landscape for broker-dealers. The amendments aim to mitigate systemic risk and enhance the financial stability of the capital markets.
“For broker-dealers, it means adapting to a more stringent regulatory framework that requires careful management of credit exposures and liquidity planning. Overall, the impact on the wider market should be positive, promoting greater transparency and stability in the securities financing sector,” he adds.
Covered Agency Transactions are defined as to be announced (TBA) transactions, inclusive of adjustable rate mortgage (ARM) transactions and specified pool transactions, where the difference between the trade date and contractual settlement date is greater than one business day.
Thirdly, the term Covered Agency Transactions includes transactions in collateralised mortgage obligations, issues in conformity with a programme of an agency or government-sponsored enterprise. Here, the trade date and contractual settlement date is greater than three business days.
The FINRA Rule 4210 amendments present three main changes.
Maintenance margin requirements
From 22 May 2024, the two per cent maintenance margin requirement will be eliminated. Originally, the rule applied to covered agency transactions by non-exempt accounts. According to the Authority, this new rule removes the need for members to distinguish exempt account customers from other customers for the purpose of covered agency transaction margin.
FINRA indicates: “As such, without regard to a counterparty’s exempt or non-exempt account status, under the amendments members will collect margin for each counterparty’s excess mark to market loss…unless otherwise provided by the rule.”
The move to eliminate this margin requirement will provide more flexibility for broker-dealers in managing their margin lending practices, says Mellert. It can reduce the operational burden on firms and lower the cost of financing for clients. Mellert adds: “By focusing margin requirements more directly on the specific risks associated with Covered Agency Transactions, this amendment could lead to more efficient use of capital and liquidity across the market.”
Capital charge
The second amendment to the Rule 4210 involves permit members. Subject to specified conditions and limitations, these members will take a capital charge in lieu of collecting margin for excess net mark-to-market losses on Covered Agency Transactions.
The conditions and limitations are designed to protect the financial stability of members that opt to take capital charges, while restricting the ability of the larger members to use their capital in lieu of collecting margin to compete “unfairly” with smaller members.
Matrix Applications — a wholly-owned subsidiary of South Street Securities Holdings that provides collateral management, margining and clearing systems for fixed income trading and equities securities lending — believes this change provides an “innovative approach” that enables flexibility in how firms manage their risk.
Mellert explains: “This option can be particularly beneficial for firms with strong capital positions, offering a way to comply with the rule's intent while optimising their capital management strategies. It reflects a recognition of the diverse nature of market participants and their varying capacities to manage risk.”
Streamline, consolidate and clarify
The third alteration in the amended rules are designed to streamline, consolidate and clarify the Covered Agency Transactions rule language. In particular, the rule revisions preserve and clarify key exceptions including the US$250,000 de minimis transfer exception and the US$10 million gross open position exception established by the original rulemaking.
With respect to the US$10 million gross open position exception, the amendments revise paragraph (e)(2)(H)(ii)a of the rule. Under this paragraph, counterparties exempt from the rule’s margin requirements include a “small cash counterparty”. A small cash counterparty is defined under four terms, including if the “absolute dollar value” of all of such counterparty’s open Covered Agency Transactions with, or guaranteed by, the member is US$10 million or less in the aggregate.
This accounts for “when computed net of any settled position of the counterparty held at the member that is deliverable under such open Covered Agency Transactions and which the counterparty intends to deliver”.
A risk worth taking?
FINRA’s amendments to Rule 4210 were first proposed to address several concerns relating to the potential impact of the rulemaking. The amendments permit broker-dealers, subject to specified conditions and limitations, to take a capital charge in lieu of collecting margin for excess net mark-to-market losses on Covered Agency Transactions. This provides flexibility for broker-dealers in managing their capital. However, Mellert indicates that it may also present increased risk.
By allowing broker-dealers to take a capital charge in lieu of collecting margin, Mellert explains that “there could be an increased risk if the broker-dealer's net capital deductions for all accounts combined exceed US$25 million”. The changes may also present operational challenges, he adds, as firms will need to adjust their systems and procedures to comply with the new rules.
With two months to go until its implementation, Matrix Applications has been monitoring the developments of the FINRA Rule 4210 and has prepared its MarginCalculator platform to ensure compliance. The platform acts as a “straightforward solution” to assist clients in navigating these complexities.
“Our platform simplifies the process of calculating margin requirements for Covered Agency Transactions, ensuring that broker-dealers can meet their regulatory obligations efficiently,” says Mellert. MarginCalculator is live and provides margin calculation as well as margin tracking — components the firm says is crucial for compliance and risk management.
Mellert believes the platform differentiates itself from other competing platforms by “being the only solution in the market that focuses solely on covered agency transactions”. The system augments dealer’s existing trade processing systems that lack the particular requirements of Rule 4210. It is designed to offer a “highly intuitive and user-friendly interface”, combined with computational capabilities that ensure accuracy and compliance with the rule.
“Our commitment to client support ensures that users of MarginCalculator have access to expert guidance and assistance, making it not just a tool, but a comprehensive solution for managing compliance and risk associated with Covered Agency Transactions,” Mellert adds.
Aside from forming this platform, Matrix Applications has been engaging with its clients through training sessions and direct consultations to help them understand the implications of Rule 4210 and prepare their operations accordingly.
Mellert concludes: “Our aim is to ensure that our clients are not just compliant, but well-positioned to manage their risks effectively under the new regulatory framework.”
Speaking to SFT, Stephen Mellert, head of business development at Matrix Applications, anticipates that the implementation of this rule will represent a significant shift in the regulatory landscape for broker-dealers. The amendments aim to mitigate systemic risk and enhance the financial stability of the capital markets.
“For broker-dealers, it means adapting to a more stringent regulatory framework that requires careful management of credit exposures and liquidity planning. Overall, the impact on the wider market should be positive, promoting greater transparency and stability in the securities financing sector,” he adds.
Covered Agency Transactions are defined as to be announced (TBA) transactions, inclusive of adjustable rate mortgage (ARM) transactions and specified pool transactions, where the difference between the trade date and contractual settlement date is greater than one business day.
Thirdly, the term Covered Agency Transactions includes transactions in collateralised mortgage obligations, issues in conformity with a programme of an agency or government-sponsored enterprise. Here, the trade date and contractual settlement date is greater than three business days.
The FINRA Rule 4210 amendments present three main changes.
Maintenance margin requirements
From 22 May 2024, the two per cent maintenance margin requirement will be eliminated. Originally, the rule applied to covered agency transactions by non-exempt accounts. According to the Authority, this new rule removes the need for members to distinguish exempt account customers from other customers for the purpose of covered agency transaction margin.
FINRA indicates: “As such, without regard to a counterparty’s exempt or non-exempt account status, under the amendments members will collect margin for each counterparty’s excess mark to market loss…unless otherwise provided by the rule.”
The move to eliminate this margin requirement will provide more flexibility for broker-dealers in managing their margin lending practices, says Mellert. It can reduce the operational burden on firms and lower the cost of financing for clients. Mellert adds: “By focusing margin requirements more directly on the specific risks associated with Covered Agency Transactions, this amendment could lead to more efficient use of capital and liquidity across the market.”
Capital charge
The second amendment to the Rule 4210 involves permit members. Subject to specified conditions and limitations, these members will take a capital charge in lieu of collecting margin for excess net mark-to-market losses on Covered Agency Transactions.
The conditions and limitations are designed to protect the financial stability of members that opt to take capital charges, while restricting the ability of the larger members to use their capital in lieu of collecting margin to compete “unfairly” with smaller members.
Matrix Applications — a wholly-owned subsidiary of South Street Securities Holdings that provides collateral management, margining and clearing systems for fixed income trading and equities securities lending — believes this change provides an “innovative approach” that enables flexibility in how firms manage their risk.
Mellert explains: “This option can be particularly beneficial for firms with strong capital positions, offering a way to comply with the rule's intent while optimising their capital management strategies. It reflects a recognition of the diverse nature of market participants and their varying capacities to manage risk.”
Streamline, consolidate and clarify
The third alteration in the amended rules are designed to streamline, consolidate and clarify the Covered Agency Transactions rule language. In particular, the rule revisions preserve and clarify key exceptions including the US$250,000 de minimis transfer exception and the US$10 million gross open position exception established by the original rulemaking.
With respect to the US$10 million gross open position exception, the amendments revise paragraph (e)(2)(H)(ii)a of the rule. Under this paragraph, counterparties exempt from the rule’s margin requirements include a “small cash counterparty”. A small cash counterparty is defined under four terms, including if the “absolute dollar value” of all of such counterparty’s open Covered Agency Transactions with, or guaranteed by, the member is US$10 million or less in the aggregate.
This accounts for “when computed net of any settled position of the counterparty held at the member that is deliverable under such open Covered Agency Transactions and which the counterparty intends to deliver”.
A risk worth taking?
FINRA’s amendments to Rule 4210 were first proposed to address several concerns relating to the potential impact of the rulemaking. The amendments permit broker-dealers, subject to specified conditions and limitations, to take a capital charge in lieu of collecting margin for excess net mark-to-market losses on Covered Agency Transactions. This provides flexibility for broker-dealers in managing their capital. However, Mellert indicates that it may also present increased risk.
By allowing broker-dealers to take a capital charge in lieu of collecting margin, Mellert explains that “there could be an increased risk if the broker-dealer's net capital deductions for all accounts combined exceed US$25 million”. The changes may also present operational challenges, he adds, as firms will need to adjust their systems and procedures to comply with the new rules.
With two months to go until its implementation, Matrix Applications has been monitoring the developments of the FINRA Rule 4210 and has prepared its MarginCalculator platform to ensure compliance. The platform acts as a “straightforward solution” to assist clients in navigating these complexities.
“Our platform simplifies the process of calculating margin requirements for Covered Agency Transactions, ensuring that broker-dealers can meet their regulatory obligations efficiently,” says Mellert. MarginCalculator is live and provides margin calculation as well as margin tracking — components the firm says is crucial for compliance and risk management.
Mellert believes the platform differentiates itself from other competing platforms by “being the only solution in the market that focuses solely on covered agency transactions”. The system augments dealer’s existing trade processing systems that lack the particular requirements of Rule 4210. It is designed to offer a “highly intuitive and user-friendly interface”, combined with computational capabilities that ensure accuracy and compliance with the rule.
“Our commitment to client support ensures that users of MarginCalculator have access to expert guidance and assistance, making it not just a tool, but a comprehensive solution for managing compliance and risk associated with Covered Agency Transactions,” Mellert adds.
Aside from forming this platform, Matrix Applications has been engaging with its clients through training sessions and direct consultations to help them understand the implications of Rule 4210 and prepare their operations accordingly.
Mellert concludes: “Our aim is to ensure that our clients are not just compliant, but well-positioned to manage their risks effectively under the new regulatory framework.”
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