Frequently Asked Questions Regarding Covered Agency Transaction Margin under FINRA Rule 4210

Published January 5, 2024.
Updated April 24, 2024.*

FINRA has announced¹ that the requirements relating to Covered Agency Transactions, as amended pursuant to SR-FINRA-2021-010,² will become effective on May 22, 2024. “Covered Agency Transactions,” as defined more fully under amended Rule 4210(e)(2)(H)(i)b., are (1) To Be Announced (TBA) transactions (inclusive of adjustable rate mortgage transactions) with settlement dates later than T+1, (2) Specified Pool Transactions with settlement dates later than T+1, and (3) transactions in Collateralized Mortgage Obligations (CMOs), issued in conformity with a program of an agency or Government-Sponsored Enterprise (GSE), with settlement dates later than T+3.

Below FINRA is providing guidance in the form of answers to frequently asked questions (FAQs) regarding the application of Rule 4210 as amended by SR-FINRA-2021-010. FINRA may update this guidance from time to time as appropriate. Updates will be marked “Modified” or “Added.”

FINRA has also published a separate set of Frequently Asked Questions Regarding Exchange Act Rules 15c3-1 and 15c3-3 in Connection with Covered Agency Transactions under FINRA Rule 4210 (September 15, 2017).

All references in this guidance to provisions of Rule 4210 are to the rule as amended by SR-FINRA-2021-010.

A. Excess Net Mark to Market Loss; Determination of Mark to Market Loss; Disputes

Question A1. If a counterparty has a net mark to market loss of $300,000, what is its “excess net mark to market loss” as defined in the rule?

Answer A1. $50,000.

As stated in Rule 4210(e)(2)(H)(ii)c. “[m]embers are not required to collect margin, or take capital charges, for counterparties’ mark to market losses on Covered Agency Transactions other than excess net mark to market losses,” which is defined under the rule to mean a counterparty’s net mark to market loss to the extent it exceeds $250,000. As such, there is no Rule 4210 requirement to collect margin for the first $250,000 of the counterparty’s net mark to market loss, or to take capital charges in lieu of collecting such margin. Although the rule does not require members to collect margin for the first $250,000 of a counterparty’s net mark to market loss, it does not prevent a member and its counterparty from entering into a contract under which the counterparty is obligated to provide margin that is not required by the rule. For example, a member and its counterparty could agree that, when the counterparty’s net mark to market loss exceeds $250,000, the counterparty will transfer to the member margin that covers the counterparty’s entire mark to market loss, rather than only enough to cover its excess net mark to market loss.

Question A2. How does a member determine the amount of a counterparty’s losses or gains resulting from marking to market a counterparty’s Covered Agency Transactions with the member?

Answer A2. FINRA does not mandate a particular methodology for marking Covered Agency Transactions to market. FINRA expects members would use a reasonable and consistent method for determining a counterparty’s mark to market losses or gains on Covered Agency Transactions.

Question A3. Is a member permitted to use valuation methods or pricing sources for valuing Covered Agency Transactions under its margining agreements that differ from the valuation methods or pricing sources that it uses to value those same Covered Agency Transactions to compute its net capital (or for other internal purposes)? If so, what are the consequences of marking the transaction to market differently for purposes of the margining agreement as opposed to for purposes of the net capital computations?

Answer A3. A member’s margining agreement with a counterparty is not required to use the same valuation method or pricing source to mark Covered Agency Transactions to market as the member’s margining agreements with other counterparties or as the member uses for its net capital computations or other internal purposes.

If a member (i) has an enforceable agreement with a counterparty under which it has a right to collect margin for the counterparty’s excess net mark to market loss and to liquidate that counterparty’s Covered Agency Transactions if any such excess net mark to market loss is not margined or eliminated within five business days from the date it arises and (ii) regularly collects the margin that it has a right to collect under that agreement, then the counterparty is not a “non-margin counterparty”. This is true even if the agreement specifies a reasonable and consistent method for marking Covered Agency Transactions to market that is different from the method the member uses for its net capital computations.

Question A4. A member has entered a written agreement with a counterparty under which the counterparty’s mark to market loss or gain on a Covered Agency Transaction as of any date is defined as the amount of loss or gain (if any) the member would incur upon cancelling the Covered Agency Transaction and entering into a replacement transaction by reference to the price for such replacement transaction on such date obtained from a specified pricing source. May the member use this definition to determine the counterparty’s mark to market loss or gain for the purposes of the margining agreement?

Answer A4. Yes, provided that the specified pricing source is a reasonable source for current market prices for Covered Agency Transactions (of the type the member enters with that counterparty³).

Question A5. A member’s margining agreement with a counterparty provides that either party may, on the basis of its own good faith estimates of mark to market losses (or gains) on Covered Agency Transactions, call for margin to cover the party’s excess net mark to market losses on their Covered Agency Transactions. The margining agreement requires the recipient of a margin call given by 10:00 a.m. New York time on a business day to deliver margin to satisfy the call by the close of business that day unless the recipient, in good faith, disagrees with the other party’s estimate of the net mark to market loss and notifies the other party of the dispute by noon on that business day. Following notice of a dispute over the amount of a party’s net mark to market loss, the parties are required to confer in an attempt to resolve the dispute. If no resolution is reached by 2:00 p.m., a party designated in the agreement is required to request bids from four dealers active in the relevant market for transactions with the same terms (except price) to the transactions with disputed mark to market values, determine the relevant current market prices by averaging the bids received, recompute mark to market losses based on those prices, and notify the other party no later than 3:30 p.m. of the bids received, the current market prices derived from those bids, and the amount of either party’s net mark to market loss computed on the basis of those prices. If that notice shows either party with an excess net mark to market loss, that party is required to deliver margin for that excess net mark to market loss no later than the close of business on that day. May the member use this process to determine the counterparty’s mark to market loss or gain for the purposes of the margining agreement?

Answer A5. Yes, provided that the member does not accept unreasonable prices from the counterparty.

Question A6. In the event of a mark to market dispute in connection with a Covered Agency Transaction, will FINRA staff provide guidance as to the correct mark to market?

Answer A6. FINRA expects members to act in good faith when marking their Covered Agency Transactions to market in accordance with a reasonable and consistent method for determining mark to market losses and gains. FINRA staff will not offer guidance as to the correct mark to market.

Question A7. On a business day (D), a member determines that a margin counterparty has a net mark to market loss of $300,000 and therefore an excess net mark to market loss of $50,000. On the next business day (D+1), the counterparty disputes the member’s determination, claiming a net mark to market loss of only $290,000. By the close of D+1, the dispute has not been resolved and the member has obtained only $40,000 of margin from the counterparty. Is the member required by Rule 4210(e)(2)(H)(ii)d.1. to deduct $10,000 in its computation of net capital as of the close of business on D+1? If so, is this deduction a specified net capital deduction?

Answer A7. The member is required to deduct the amount of the counterparty’s unmargined excess net mark to market loss, without regard to the existence of the dispute. The deduction is not a specified net capital deduction⁴ if the member in good faith expects that, by the close of business on the fifth business day after the excess net mark to market loss arose (D+5), the dispute will be resolved and excess net mark to market loss (as determined by the resolution of the dispute) will be fully margined.

B. Collateral Eligibility, Collateral Valuation and Haircuts

Question B1. What is eligible collateral for purposes of margining Covered Agency Transactions? May a counterparty satisfy a margin call with cash or with securities?

Answer B1. Subject to the agreement of the parties, cash or any margin securities may be used to margin Covered Agency Transactions.

Question B2. For purposes of determining a counterparty’s unmargined excess net mark to market loss, how is securities margin valued and what haircuts are applied to securities margin?

Answer B2. A counterparty’s unmargined excess net mark to market loss is determined by:

computing the counterparty’s excess net mark to market loss as defined in Rule 4210(e)(2)(H)(i)c.;
subtracting the amount of any cash margin;
subtracting the current market value, as defined in Rule 4210(a)(2), of any securities margin; and
adding the maintenance margin requirement applicable to any securities margin under Rules 4210(c) and 4210(e).

Pursuant to Rule 4210(a)(2):

“The term ‘current market value’ means the total cost or net proceeds of a security on the day it was purchased or sold or at any other time the preceding business day's closing price as shown by any regularly published reporting or quotation service. . . If there is no closing price, a member may use a reasonable estimate of the market value of the security as of the close of business on the preceding business day.”

C. Capital Charge Timing and Effect of Market Movements on Capital Charges

Question C1. On a business day (D), a member’s counterparty incurs a net mark to market loss of $300,000 and therefore an excess net mark to market loss of $50,000. No margin is posted by the close of business on the following business day (D+1) and the counterparty’s net mark to market loss remains constant at $300,000. What amounts are the member required by Rule 4210(e)(2)(H)(ii)d.1. to deduct in its computations of net capital as of the close of business on D and D+1?

Answer C1. The answer depends on the nature of the counterparty:

If the counterparty is specified in Rule 4210(e)(2)(H)(ii)a.1. (for purposes of these FAQs, an “excepted counterparty”), then no capital charges are required for the counterparty’s unmargined excess net mark to market loss.⁵
If the counterparty is a non-margin counterparty,⁶ then Rule 4210(e)(2)(H)(ii)d.1. requires the member to deduct $50,000 in its computation of net capital as of the close of business of both D and D+1.
If the counterparty is neither an excepted counterparty nor a non-margin counterparty (for purposes of these FAQs, a “margin counterparty”), Rule 4210(e)(2)(H)(ii)d.1. requires the member to deduct $50,000 in its computation of net capital as of the close of business of D+1, but requires no deduction in the computation of net capital as of the close of business of D.

Question C2. On a business day (D), a member’s counterparty has a net mark to market loss of $300,000 and therefore an excess net mark to market loss of $50,000. No margin is posted by the close of business on the following business day (D+1), when market movements reduce the counterparty’s net mark to market loss to $290,000 and therefore reduce the counterparty’s excess net mark to market loss to $40,000. What amount is the member required by Rule 4210(e)(2)(H)(ii)d.1. to deduct in its computation of net capital as of the close of business on D+1?

Answer C2. $40,000 (unless the counterparty is an excepted counterparty, in which case no capital charge is required).

Question C3. On a business day (D), a member’s counterparty has a net mark to market loss of $300,000 and therefore an excess net mark to market loss of $50,000. No margin is posted by the close of business on the following business day (D+1), when market movements increase the counterparty’s net mark to market loss to $320,000 and therefore increase the counterparty’s excess net mark to market loss to $70,000. What amount is the member required by Rule 4210(e)(2)(H)(ii)d.1. to deduct in its computations of net capital as of the close of business on D and D+1?

Answer C3. The answer depends on the nature of the counterparty:

No deductions are required by Rule 4210(e)(2)(H)(ii)d.1. if the counterparty is an excepted counterparty.
If the counterparty is a non-margin counterparty, then Rule 4210(e)(2)(H)(ii)d.1. requires the member to deduct $50,000 in its computation of net capital as of the close of business on D and $70,000 in its computation of net capital as of the close of business on D+1.
If the counterparty is a margin counterparty, then Rule 4210(e)(2)(H)(ii)d.1. does not require any deduction in the member’s computation of net capital as of the close of business on D, but requires the member to deduct $50,000 in its computation of net capital as of the close of business on D+1. If no margin is posted by the end of the next following business day (D+2) and the counterparty’s net mark to market loss remains at $320,000, the member would be required to deduct $70,000 in its computation of net capital as of the close of business on D+2.

Question C4. Assume:

A $100,000 excess net mark to market loss (a $350,000 net mark to market loss) arises on a counterparty’s Covered Agency Transactions on a business day (D).
On the following business day (D+1):
1. The counterparty delivers $100,000 of cash margin to the member; and
2. The counterparty’s excess net mark to market loss increases to $250,000 (a $500,000 net mark to market loss) and remains constant thereafter.
On the next following business day (D+2), the counterparty delivers an additional $150,000 of cash margin to the member.

In this scenario, is the member required to take a net capital charge under Rule 4210(e)(2)(H)(ii)d.1.?

Answer C4. No.

A member must take a capital charge under Rule 4210(e)(2)(H)(ii)d.1. for a counterparty’s unmargined excess net mark to market loss if either (i) the counterparty is a non-margin counterparty or (ii) the counterparty’s excess net mark to market loss is not margined or eliminated by the close of business on the business day after it arises. In this scenario, the counterparty is assumed to be a margin counterparty and the counterparty margins each excess net mark to market loss on the business day after it arose: the $100,000 excess net mark to market loss that arose on D is margined on D+1, and the additional $150,000 of excess net mark to market loss that arose on D+1 is margined on D+2.

The fact that the counterparty has an unmargined excess net mark to market loss on two consecutive business days is not dispositive; no capital charge is required so long as the counterparty is a margin counterparty and each business day’s unmargined excess net mark to market loss is margined or eliminated by the close of business on the following business day. (Added, April 24, 2024.)

D. Net Capital Deductions Exceeding Certain Thresholds: Computations and Notices

Question D1. Rule 4210(e)(2)(I) applies certain requirements when

“. . . the net capital deductions taken by a member as a result of marked to the market losses incurred under paragraphs (e)(2)(F), (e)(2)(G) (exclusive of the percentage requirements established thereunder), or (e)(2)(H)(ii)d.1. of this Rule, plus any unmargined net mark to market losses below $250,000 or of small cash counterparties. . .”

exceed specified percentages of the member’s tentative net capital (TNC). To determine whether the TNC thresholds have been exceeded, does the member compare its TNC separately to:

net capital deductions taken under Rule 4210(e)(2)(F);
net capital deductions taken under Rule 4210(e)(2)(G) (exclusive of the percentage requirements established thereunder); and
net capital deductions taken under Rule 4210(e)(2)(H)(ii)d.1., plus any unmargined net mark to market losses below $250,000 or of small cash counterparties,

or does the member compare its net capital to the sum of (a), (b) and (c)?

Answer D1. The member must compare its tentative net capital to the sum of (a), (b) and (c). If such sum exceeds 5% of TNC for any one account or group of commonly controlled accounts, or 25% of TNC for all accounts combined, and the excess continues to exist on the fifth business day after it was incurred, then the member shall give prompt written notice to FINRA and shall not enter into any new transaction(s) subject to the provisions of paragraphs (e)(2)(F), (e)(2)(G) or (e)(2)(H) of the rule that would result in an increase in the amount of such excess.

Question D2. If a member’s small cash counterparty has an excess net mark to market loss on its Covered Agency Transactions, would the member be required to collect margin for that excess net mark to market loss (or take a capital charge in lieu of collecting such margin)? Would the small cash counterparty’s unmargined excess net mark to market loss count towards the thresholds in Rule 4210(e)(2)(H)(ii)d.3.?

Answer D2. Pursuant to Rule 4210(e)(2)(H)(ii)a.1., “a member is not required to collect margin, or to take capital charges in lieu of collecting such margin, for a counterparty’s excess net mark to market loss if such counterparty is a small cash counterparty.” Because no capital charge is required for a small cash counterparty’s unmargined excess net mark to market loss, such an unmargined excess net mark to market loss does not generate a “specified net capital deduction”⁷ and therefore does not count towards the thresholds in Rule 4210(e)(2)(h)(II)d.3., which are triggered when the member’s specified net capital deductions exceed either $25 million or the lesser of $30 million or 25% of the member’s tentative net capital.

Question D3. Rule 4210(e)(2)(H)(ii)d.3. requires a member to give prompt written notice to FINRA if the member’s specified net capital deductions exceed $25 million for five consecutive business days. If the specified net capital deductions first exceed this threshold on a business day (D), when must the member give this notice to FINRA? How should this notice be given?

Answer D3. If the relevant net capital deductions first exceed $25 million as of the close of business on a business day (D), and remain above that threshold as of the close of business of each of the following four business days (D+1 through D+4), then notice to FINRA must be given promptly after the open of business on the following business day (D+5). The notification must identify itself as a report under Rule 4210(e)(2)(H)(ii)d.3. and contain the following information:

Date of Occurrence;
TNC;
Specified Net Capital Deductions as a dollar amount; and
Specified Net Capital Deductions as a percentage of TNC.

The notice should be provided to FINRA through the FINRA Gateway. (Added, April 24, 2024.)

Question D4. Rule 4210(e)(2)(I) requires a member to give prompt written notice to FINRA if certain net capital deductions exceed 5% of the member’s TNC for any one account or group of commonly controlled accounts or 25% of TNC for all accounts combined, and the excess continues to exist on the fifth business day after it was incurred. If the relevant net capital deductions first exceed the applicable threshold on a business day (D), when must the member give this notice to FINRA? How should this notice be given?

Answer D4. If the relevant net capital deductions first exceed the applicable threshold as of the close of business on a business day (D), and remain above that threshold as of the close of business of each of the following five business days (D+1 through D+5), then notice to FINRA must be given promptly after the open of business on the following business day (D+6). Also, beginning at the open of business of D+6, the member shall not enter into any new transaction(s) subject to the provisions of Rule 4210(e)(2)(F), (G) or (H) that would result in an increase in the amount by which the relevant net capital deductions exceed the applicable threshold. This limitation will cease when the relevant net capital deductions are below the applicable threshold at the close of business on a business day.

The notification must identify itself as a report under Rule 4210(e)(2)(I) and contain the following information:

Date of Occurrence;
TNC; and
The net capital deductions taken by a member as a result of marked to the market losses incurred under Rule 4210 (e)(2)(F), (e)(2)(G) (exclusive of the percentage requirements established thereunder), or (e)(2)(H)(ii)d.1., plus any unmargined net mark to market losses below $250,000 or of small cash counterparties:
- For any one account or group of commonly controlled accounts:
  - Largest amount in dollars; and
  - Largest amount as a percentage of TNC; and
- For all accounts combined:
  - Total amount in dollars; and
  - Total amount as a percentage of TNC.

The notice should be provided to FINRA through the FINRA Gateway.

E. Business Limitation, Margin Collection and Liquidation Requirements; Extensions

Question E1. When is a member required to limit its business because its specified net capital deductions have exceeded the lesser of $30 million or 25% of the member’s tentative net capital (the “25% TNC / $30MM Threshold”)?

Answer E1. Rule 4210(e)(2)(H)(ii)d.3. provides in relevant part:

“If the member’s specified net capital deductions exceed the lesser of $30 million or 25% of the member’s tentative net capital . . . for five consecutive business days, the member shall not enter into any new Covered Agency Transactions with any non-margin counterparty other than risk-reducing transactions . . .”

Accordingly, if the member first exceeds the 25% TNC / $30MM Threshold on a business day (D) and remains above that threshold for five consecutive business days (i.e., through the close of business on D+4), then, beginning on the next business day (D+5), the member must not enter into any new Covered Agency Transactions with non-margin counterparties, unless those new transactions are risk-reducing transactions. This business limitation will remain in effect until the first close of business at which the member’s specified net capital charges are below the 25% TNC / $30MM Threshold.

Note that this business limitation to risk-reducing transactions applies to all non-margin counterparties, without regard to whether the non-margin counterparty currently has an unmargined excess net mark to market loss.

For this purpose, a new Covered Agency Transaction is a “risk reducing transaction” if the member determines in good faith that the overall risk to the member of the counterparty’s Covered Agency Transactions with the member or guaranteed to a third party (including a clearing agency) by the member is reduced by the addition of the new transaction.

Question E2. When is a member required to collect margin to cover a counterparty’s excess net mark to market loss rather than take a capital charge in lieu of collecting that margin?

Answer E2. Rule 4210(e)(2)(H)(ii)d.3. provides in relevant part:

“If the member’s specified net capital deductions exceed the lesser of $30 million or 25% of the member’s tentative net capital . . . for five consecutive business days, the member... shall also, to the extent of its rights, promptly collect margin for each counterparty’s excess net mark to market loss . . .”

Accordingly, under the rule, a member is not obligated to collect margin to cover a counterparty’s excess net mark to market loss (rather than take a capital charge in lieu of collecting such margin) unless the member’s specified net capital deductions have exceeded the “25% TNC / $30MM Threshold” for five consecutive business days. If the member first exceeds the 25% TNC / $30MM Threshold on a business day (D) and remains above that threshold for five consecutive business days (i.e., through the close of business on D+4), then the member shall, to the extent of its rights, promptly (i.e., beginning on D+5) collect margin for each counterparty’s excess net mark to market loss. If the member does not have a right to collect margin from a particular counterparty (e.g., because it does not have a margin agreement with that counterparty) then it is not obligated to collect margin from that counterparty.

Question E3. Does Rule 4210(e)(2)(H)(ii)a.1. provide exceptions from the Rule 4210(e)(2)(H)(ii)d.3. requirement to enforce rights to collect margin or liquidate transactions? For example, if a member has a contractual right to collect margin from a small cash counterparty to cover its excess net mark to market loss, is the member required to enforce that right if the member has exceeded the 25% TNC / $30MM Threshold for five consecutive business days?

Answer E3. Rule 4210(e)(2)(H)(ii)a.1. excepts the member from any obligation to collect margin on Covered Agency Transactions from the counterparties specified therein (for purposes of these FAQs, “excepted counterparties”), to take capital charges for an excepted counterparty’s unmargined excess net mark to market loss, or to liquidate an excepted counterparty’s Covered Agency Transactions based on that counterparty’s unmargined excess net mark to market loss.

Question E4. If a counterparty’s excess net to market loss on Covered Agency Transactions has not been margined within five business days after the date it arises, is the member required to liquidate the counterparty’s Covered Agency Transactions?

Answer E4. There are limited circumstances in which liquidation of Covered Agency Transactions is required by Rule 4210. Rule 4210(e)(2)(H)(ii)d.3. provides in relevant part:

“If the member’s specified net capital deductions exceed the lesser of $30 million or 25% of the member’s tentative net capital . . . for five consecutive business days, the member... shall also, to the extent of its rights... promptly liquidate the Covered Agency Transactions of any counterparty whose excess net mark to market loss is not margined or eliminated within five business days from the date it arises, unless FINRA has specifically granted the member additional time.”

First, a member is not obligated under the rule to liquidate any Covered Agency Transactions unless the member’s specified net capital deductions have exceeded the 25% TNC / $30MM Threshold for five consecutive business days.

Second, a member that has exceeded the 25% TNC / $30MM Threshold for five consecutive business days is not obligated under the rule to liquidate a counterparty’s Covered Agency Transactions unless the counterparty has an excess net mark to market loss that has not been margined or eliminated within five business days from the date it arose.

Third, as stated in FAQ E3 above, a member is not obligated under the rule to liquidate an excepted counterparty’s Covered Agency Transactions.

Fourth, the obligation of a member that has exceeded the 25% TNC / $30MM Threshold for five consecutive business days to liquidate the Covered Agency Transactions of a (non-excepted) counterparty with an excess net mark to market loss that has not been margined or eliminated within five business days from the date it arose is limited by the member’s rights to effect that liquidation. If, for example, the member’s agreement with the counterparty does not allow the member to liquidate Covered Agency Transactions unless the unmargined net mark to market loss exceeds $400,000,⁸ then the member would not be obligated under the rule to liquidate the counterparty’s Covered Agency Transactions unless the counterparty’s unmargined net mark to market loss exceeds $400,000 (an unmargined excess net mark to market loss of $150,000).

Finally, if the member has exceeded the 25% TNC / $30MM Threshold for five consecutive business days, a (non-excepted) counterparty has an excess net mark to market loss that has not been margined or eliminated within five business days from the date it arose, and the member has a right to liquidate the counterparty’s Covered Agency Transactions, the member may request extensions of time from FINRA and no liquidation would be required until all extensions have expired.

Question E5. If market movements cause a member’s (non-excepted) counterparty to have an excess net mark to market loss on a business day (D) when the member has exceeded the 25% TNC / $30MM Threshold, on what day is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions?

Answer E5. If the counterparty’s excess net mark to market loss has not been margined or eliminated within five business days from the date it arose (i.e., by the close of business on D+5) and the member has remained above the 25% TNC / $30MM Threshold through the close of business on D+5, then the member would be required under the rule to begin exercising rights to take liquidating action promptly after the open of business on the following business day (D+6), unless the member has obtained an extension of time from FINRA or lacks rights to liquidate the counterparty’s Covered Agency Transactions.

Question E6. If a member first exceeds the 25% TNC / $30MM Threshold on a business day (D) when a (non-excepted) counterparty has an unmargined excess net mark to market loss that has been outstanding for several business days, on what day is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions?

Answer E6. If the member remains above the 25% TNC / $30MM Threshold through the close of business on the fourth business day after it exceeds that threshold (D+4) and the counterparty’s excess net mark to market loss has not been margined or eliminated by the close of business on D+4, then the member would be required under the rule to begin taking liquidating action promptly after the open of business on the following business day (D+5), unless the member has obtained an extension of time from FINRA or lacks rights to liquidate the counterparty’s Covered Agency Transactions.

Question E7. Does this mean that a member must begin taking action to liquidate a counterparty’s Covered Agency Transactions promptly after the open of business on the later of:

the fifth business day after the day on which the member exceeds the 25% TNC / $30MM Threshold; and
the sixth business day after the day on which the member’s counterparty incurs an excess net mark to market loss;

And that liquidating action would be required on that day unless:

the member dropped below the 25% TNC / $30MM Threshold by the close of business on the day before the liquidating action would be required;
the counterparty’s excess net mark to market loss was margined or eliminated by the close of business on the day before the liquidating action would be required;
the counterparty is an excepted counterparty;
the member does not have rights to liquidate the counterparty’s Covered Agency Transactions; or
the member has obtained an extension of time from FINRA (and such extension has not expired).

Answer E7. Yes.

In addition, beginning on the fifth business day after the day on which the member exceeds the 25% TNC / $30MM Threshold, the member will not be able to enter into new Covered Agency Transactions with non-margin counterparties, unless those new transactions are risk-reducing transactions. This business limitation applies to all non-margin counterparties, regardless of whether the non-margin counterparty currently has an unmargined excess net mark to market loss. See FAQ E1 above.

Question E8. If a member has exceeded the 25% TNC / $30MM Threshold for five consecutive business days, what is the effect of dropping back below that threshold?

Answer E8. If a member no longer exceeds the 25% TNC / $30MM Threshold, then Rule 4210(e)(2)(H)(ii)d.3. would no longer limit the member’s new Covered Agency Transactions with non-margin counterparties or require the member to collect margin or liquidate Covered Agency Transactions.

Question E9. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on a business day (D).
Two business days later (on D+2), market movements cause the counterparty’s unmargined net mark to market loss to decline below $250,000, eliminating the excess net mark to market loss.
On the next business day (D+3), market movements cause the counterparty’s unmargined net mark to market loss to increase above $250,000, creating an excess net mark to market loss.

On what day is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions (assuming that the member continues to exceed the 25% TNC / $30MM Threshold, the counterparty’s excess net mark to market loss is not margined or eliminated, and the member does not obtain an extension from FINRA)?

Answer E9. The excess net mark to market loss that arose on D was eliminated on D+2 and is therefore not relevant for purposes of determining a liquidation date. A new excess net mark to market loss arose on D+3. The member must, to the extent of its rights, promptly collect margin for the counterparty’s excess net mark to market loss. If that excess net mark to market loss has not been margined or eliminated within five business days from the date it arose (i.e., by the close of business on D+8), the member must promptly liquidate the counterparty’s Covered Agency Transactions (assuming that the member continues to exceed the 25% TNC / $30MM Threshold and the member does not obtain an extension from FINRA).

Question E10. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on D.
Two business days later (on D+2), market movements cause the counterparty’s unmargined net mark to market loss to decline below $250,000 at 11:00 a.m. but increase above $250,000 by the end of the day, so that the counterparty has an excess net mark to market loss at the end of the day.

Answer E10. Intraday market movements are ignored for purposes of Rule 4210(e)(2)(H). Accordingly, if the excess new mark to market loss has not been margined or eliminated (on an end of day basis) by the close of business on the fifth business day after it arose (i.e., D+5), the member must begin taking action to liquidate the counterparty’s Covered Agency Transactions promptly after the open of business on the following business day (D+6) (assuming that the member continues to exceed the 25% TNC / $30MM Threshold and the member does not obtain an extension from FINRA).

Question E11. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on a business day (D).
That excess net mark to market loss is not margined or eliminated by the fifth following business day (D+5), but the member obtains from FINRA an extension of 14 calendar days (to D+15).⁹
Two business days later (on D+7), market movements cause the counterparty’s unmargined net mark to market loss at the close of business to decline below $250,000, eliminating the excess net mark to market loss.
On the next business day (D+8), market movements cause the counterparty’s unmargined net mark to market loss to increase above $250,000, creating an excess net mark to market loss.

On what day is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions?

Answer E11. The excess net mark to market loss that arose on D was eliminated on D+7 and is therefore not relevant for purposes of determining a liquidation date. The extension obtained by the member related to the excess net mark to market loss that arose on D while the member’s specified net capital charges exceeded the 25% TNC / $30MM Threshold and is no longer relevant after that mark to market loss is eliminated on D+7. A new excess net mark to market loss arose on D+8. If that excess net mark to market loss has not been margined or eliminated within five business days from the date it arose (i.e., by D+13), the member be obligated to promptly exercise its rights to liquidate the counterparty’s Covered Agency Transactions, unless the member obtains a new extension from FINRA (assuming that the member continues to exceed the 25% TNC / $30MM Threshold).

Question E12. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
A $100,000 excess net mark to market loss (a $350,000 net mark to market loss) arises on a (non-excepted) counterparty’s Covered Agency Transactions on a business day (D).
The member gives the counterparty a margin call for $100,000 promptly after the open of business on the following business day (D+1).
Two business days later (on D+3), market movements cause the counterparty’s unmargined excess net mark to market loss to increase to $150,000.
The member gives the counterparty a margin call for $50,000 promptly after the open of business on the following business day (D+4).
On the next business day (D+5), the counterparty transfers $100,000 of cash margin to the member, reducing the counterparty’s unmargined excess net mark to market loss to $50,000.

Is the member required to take action on the next business day (D+6) to liquidate the counterparty’s Covered Agency Transactions because the member has had an unmargined excess net mark to market loss on each day from D through D+5 (assuming the member has not obtained an extension from FINRA)?

Answer E12. No. The $100,000 excess net mark to market loss that arose on D was margined by the counterparty’s transfer of cash margin to the member on D+5, so the counterparty did not have an excess net mark to market loss that was not margined or eliminated within five business days from the date it arose.

If the counterparty does not provide an additional $50,000 of margin by the close of business on the fifth business day after the counterparty’s excess net mark to market loss increased to $150,000 (i.e., by the close of business on D+8), then the member would have an obligation to take action to liquidate the counterparty’s Covered Agency Transactions promptly after the open of business on the following business day (D+9) (assuming that the counterparty’s excess net mark to market loss remains at or above $150,000 and the member has the right to take such action, has not obtained an extension, and remains above the 25% TNC / $30MM Threshold.)

Question E12.5. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
A $100,000 excess net mark to market loss (a $350,000 net mark to market loss) arises on a margin counterparty’s Covered Agency Transactions on a business day (D).
On the following business day (D+1), the margin counterparty’s excess net mark to market loss increases to $250,000 (a $500,000 net mark to market loss) and remains constant thereafter.
Four business days later (on D+5), the counterparty deposits $100,000 of cash margin.
On the next following business day (D+6), the counterparty deposits $150,000 of additional cash margin.

In this scenario, is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions or obtain an extension from FINRA?

Answer E12.5. No.

A member that has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days is not required by Rule 4210(e)(2)(H)(ii)d.3. to exercise its rights to liquidate a counterparty’s Covered Agency Transactions (or obtain an extension from FINRA) unless the counterparty has an excess net mark to market loss that has not been margined or eliminated within five business days from the date it arises. In this scenario, the counterparty margins each excess net mark to market loss on the fifth business day after it arose: the $100,000 excess net mark to market loss that arose on D is margined on D+5, and the additional $150,000 of excess net mark to market loss that arose on D+1 is margined on D+6.

The fact that the counterparty has an unmargined excess net mark to market loss at the close of six consecutive business days is not dispositive; the exercise of liquidation rights is not required so long each business day’s unmargined excess net mark to market loss is margined or eliminated by the close of business on the fifth business day. In determining whether an excess net mark to market loss has been margined, margin deposits are applied to the oldest unmargined excess net mark to market loss first (i.e., on a “first in, first out” or “FIFO” basis).

Note that the member will have a capital charge under Rule 4210(e)(2)(H)(ii)d.1. for the counterparty’s unmargined excess net mark to market loss. That charge will be $100,000 as of the close of business on D+1, $250,000 from D+2 through D+4, and $150,000 on D+5. There would be no capital charge after the excess net mark to market loss is fully margined on D+6. (Added, April 24, 2024.)

Question E13. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days as of the close of business on a business day (D).
An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on that business day (D).
That excess net mark to market loss is not margined or eliminated by the fifth following business day (D+5), but the member obtains from FINRA an extension of 14 calendar days—ten business days—to D+15.
Market movements on transactions with other counterparties cause the member’s specified net capital charges as of the close of business two business days later (on D+7), to fall below the 25% TNC / $30MM Threshold.
Market movements on transactions with other counterparties on the next business day (D+8) cause the member’s specified net capital charges as of the close of business to again exceed the 25% TNC / $30MM Threshold.

On what day is the member required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions?

Answer E13. The fact that the member’s specified net capital charges had exceeded the 25% TNC / $30MM Threshold prior to D+7 is irrelevant because the member is below the threshold at the close of business on D+7. The extension obtained by the member related to the excess net mark to market loss that arose on D while the member’s specified net capital charges exceeded the 25% TNC / $30MM Threshold is also irrelevant once the member is below the threshold at the close of business on D+7. A new clock starts when the member’s specified net capital charges are once again above the 25% TNC / $30MM Threshold at the close of business on D+8. As set out in FAQ E6 above, if the member remains above the 25% TNC / $30MM Threshold through the close of business on the fifth business day after it exceeds that threshold (D+13) and the counterparty’s excess net mark to market loss has not been margined or eliminated by the close of business on D+13, then the member would need to begin taking liquidating action promptly after the open of business on the following business day (D+14), unless the member has obtained an extension of time from FINRA or lacks rights to liquidate the counterparty’s Covered Agency Transactions.

Question E14. Assume the following:

A member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days and continues to exceed that threshold at all times relevant to this question.
An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on a business day (D) and continues to exist at all times relevant to this question.
The member’s agreement with the counterparty does not allow the member to liquidate the counterparty’s Covered Agency Transactions unless the member has sent a notice calling for margin to cover the counterparty’s excess net mark to market loss and the counterparty has failed to transfer that margin by the close of business on the third business day following the business day on which such notice is given.

On what day is the member required to send the margin call? When is the member required to liquidate the counterparty’s Covered Agency Transactions if the counterparty’s excess net mark to market loss is not margined or eliminated?

Answer E14. Since the member has exceeded the 25% TNC / $30MM Threshold for more than five consecutive business days, Rule 4210(e)(2)(H)(ii)d.3. provides that “the member shall also, to the extent of its rights, promptly collect margin for each counterparty’s excess net mark to market loss.” The member therefore is required to send the margin call promptly after that notice is permitted to be sent under the agreement. Even if the member sends the margin call at the open of business on D+1, and would be permitted under the agreement to liquidate the counterparty’s Covered Agency Transactions at the close of business on D+3, Rule 4210(e)(2)(H)(ii)d.3. does not require the member to take liquidating action unless the excess net mark to market loss has not been margined or eliminated within five business days from the date it arose (i.e., by D+5). Promptly after the open of business on D+6, the member would be required to exercise its right to liquidate the counterparty’s Covered Agency Transactions (assuming that the member continues to exceed the 25% TNC / $30MM Threshold, the counterparty’s excess net mark to market loss is not margined or eliminated, and the member does not obtain an extension from FINRA).

Question E15. Assume the following:

An excess net mark to market loss arises on a (non-excepted) counterparty’s Covered Agency Transactions on a business day (D) and continues to exist at all times relevant to this question.
The member is below the 25% TNC / $30MM Threshold on D.
Three business days later (on D+3), the member crosses above the 25% TNC / $30MM Threshold.
The member’s agreement with the counterparty does not allow the member to liquidate the counterparty’s Covered Agency Transactions unless the member has sent a notice calling for margin to cover the counterparty’s excess net mark to market loss and the counterparty has failed to transfer that margin by the close of business on the third business day following the business day on which such notice is given.

Answer E15. The member is not required to exercise its right to collect margin for the counterparty’s excess net mark to market loss until it has exceeded the 25% TNC / $30MM Threshold for five consecutive business days. If the member remains above the 25% TNC / $30MM Threshold through the close of business on D+7, then it will have been above that threshold for five consecutive business days (D+3 through D+7) and will become obligated to exercise its rights to collect margin for the counterparty’s unmargined excess net mark to market loss. In that case, the member must send the margin call promptly after the open of business on the following business day (D+8) and liquidate the counterparty’s Covered Agency Transactions as soon thereafter as it can—promptly following the close of business on the third business day after the margin call was given (i.e., D+11) (assuming that the member continues to exceed the 25% TNC / $30MM Threshold, the counterparty’s excess net mark to market loss is not margined or eliminated, and the member does not obtain an extension from FINRA).

Question E16. The definition of “specified net capital deduction” uses the term “good faith.” What definition of “good faith” should members apply for this purpose?

Answer E16. Members should apply clause (2) of the definition in section 220.2 of Regulation T:

“Good faith with respect to: . . . (2) Making a determination or accepting a statement concerning a borrower means that the creditor is alert to the circumstances surrounding the credit, and if in possession of information that would cause a prudent person not to make the determination or accept the notice or certification without inquiry, investigates and is satisfied that it is correct.”

Question E17. How are extensions of time obtained from FINRA?

Answer E17. Members must use the Regulatory Extension (REX) system to request extension of the time before a counterparty’s Covered Agency Transactions are required to be liquidated under Rule 4210(e)(2)(H)(ii)d.3. See extension guidance at https://www.finra.org/rules-guidance/key-topics/margin-accounts/extension-guide for instructions.

Question E18. When does a member request an extension of time from FINRA in connection with Covered Agency Transactions?

Answer E18. A first extension of time should be requested from FINRA on the later of:

the fourth business day after the day on which the member exceeds the 25% TNC / $30MM Threshold; and
the fifth business day after the day on which the member’s (non-excepted) counterparty incurs an excess net mark to market loss.

An extension is required on this day because, in the absence of an extension, the member would be required to exercise its rights to liquidate the counterparty’s Covered Agency Transactions promptly after the open of business on the following business day (assuming that the member continues to exceed the 25% TNC / $30MM Threshold, the counterparty’s excess net mark to market loss is not margined or eliminated, and the member has a right to liquidate the counterparty’s Covered Agency Transactions).

If a member has already obtained an extension from FINRA of the time before a counterparty’s Covered Agency Transactions are required to be liquidated, an additional extension may be requested on the expiration date of the existing extension.

Note that a member that wishes to file an extension rather than enforce its rights to collect margin or liquidate a counterparty’s Covered Agency Transaction may in some cases need to file that extension before the date on which it is required to notify FINRA that it has exceeded the 25% TNC / $30MM Threshold. As discussed in FAQ D3 above, a member that first exceeds the 25% TNC / $30MM Threshold on a business day (D) and remains above that threshold for five consecutive business days (i.e., through D+4) is required to notify FINRA on the following business day (D+5). However, if the counterparty had incurred an excess net mark to market loss prior to D, the first extension would need to be filed on the fourth business day after the member exceeded 25% TNC / $30MM Threshold (i.e., D+4).

Question E19. Can a member’s counterparty request an extension of time before the member is required by Rule 4210(e)(2)(H)(ii)d.3. to liquidate the counterparty’s Covered Agency Transactions?

Answer E19. No. Only a member can request the extension of time before that member is required by Rule 4210(e)(2)(H)(ii)d.3. to liquidate a counterparty’s Covered Agency Transactions.

Question E20. How many consecutive extensions can a member obtain for an excess net market to the mark loss for a counterparty?

Answer E20. With respect to a member’s obligation under Rule 4210(e)(2)(H)(ii)d.3. to liquidate a counterparty’s Covered Agency Transactions, FINRA will permit two consecutive extensions of time for 14 calendar days each. Such requests will typically be granted if an acceptable reason is provided. Consistent with longstanding practice, FINRA will individually evaluate any additional extension requests beyond the initial two. See extension guidance at https://www.finra.org/rules-guidance/key-topics/margin-accounts/extension-guide for instructions.

Question E21. Do the timing requirements for liquidations of positions make any allowance for differences in business days due to foreign holidays?

Answer E21. As discussed in FAQ E4 above, Rule 4210(e)(2)(H)(ii)d.3. requires a member to liquidate a counterparty’s Covered Agency Transactions only if:

the member has exceeded the 25% TNC / $30MM Threshold for five consecutive business days;
the counterparty has an excess net mark to market loss that has not been margined or eliminated within five business days from the date it arose;
the counterparty is not an excepted counterparty;
the member has a right to liquidate the counterparty’s Covered Agency Transactions; and
member has not obtained an extension of time from FINRA (or all extensions have expired).

Foreign holidays may impact a member’s obligation to liquidate a counterparty’s Covered Agency Transactions in two ways:

First, when the conditions are met, the member is required by the rule to liquidate the counterparty’s Covered Agency Transactions to the extent of the member’s rights to do so. If the member’s agreement with the counterparty includes notice or cure periods before the member is permitted to liquidate the counterparty’s Covered Agency Transactions, and such notice or cure periods make allowance for foreign holidays, then the existence of foreign holidays may limit the member’s rights to liquidate the counterparty’s Covered Agency Transactions.

Second, a member may request and obtain an extension of time from FINRA if a foreign holiday prevents a counterparty from margining its excess net mark to market loss within five business days from the date it arose. See extension guidance at https://www.finra.org/rules-guidance/key-topics/margin-accounts/extension-guide for instructions on requesting an extension on this basis.

F. Exceptions: Definition of Small Cash Counterparty; Multifamily Housing and Project Loan Program Securities

Question F1. Are sovereign wealth funds “foreign sovereigns” for purposes of the Rule 4210(e)(2)(H)(ii)a.1. exception? Does it matter whether the obligations of the sovereign wealth fund are guaranteed by the foreign sovereign?

Answer F1. No. Sovereign wealth funds are not “foreign sovereigns” for purposes of Rule 4210(e)(2)(H)(ii)a.1., whether or not they are guaranteed by a foreign sovereign.

Question F2. Is a counterparty automatically ineligible to be categorized as a “small cash counterparty” if it effects a Covered Agency Transaction in a Regulation T margin account or good faith account, or engages in a round robin trade, dollar roll, or uses another financing technique in connection with a Covered Agency Transaction? What systems should a member put in place to monitor its categorization of counterparties as small cash counterparties?

Answer F2. Under Rule 4210(e)(2)(H)(ii)a.1. a member is not required to collect margin, or take capital charges in lieu of collecting margin, from any small cash counterparty. Under Rule 4210(e)(2)(H)(i)h. a counterparty is classified as a “small cash counterparty” if:

the absolute dollar value of all of such counterparty’s open Covered Agency Transactions with, or guaranteed by, the member is $10 million or less in the aggregate, when computed net of any settled position of the counterparty held at the member that is deliverable under such open Covered Agency Transactions and which the counterparty intends to deliver;
the original contractual settlement date for all such open Covered Agency Transactions is in the month of the trade date for such transactions or in the month succeeding the trade date for such transactions;
the counterparty regularly settles its Covered Agency Transactions on a Delivery Versus Payment (“DVP”) basis or for “cash”; and
the counterparty does not, in connection with its Covered Agency Transactions with, or guaranteed by, the member, engage in dollar rolls, as defined in Rule 6710(z), or round robin trades, or use other financing techniques.

FINRA did not intend that a counterparty would automatically lose the benefit of the exception simply by engaging, for instance, in an occasional dollar roll, round robin trade or other financing technique, if the counterparty otherwise regularly settles in cash (that is, for full payment) on the settlement date. FINRA stated in Regulatory Notice 16-31 that the member may look to the prevailing or dominant pattern of the counterparty’s behavior, including the counterparty’s history of transactions with the member and any other information of which the member is aware. Further, FINRA stated that members should be able to rely on the reasonable representations of their customers for purposes of the requirement. The rule in this regard is designed to permit members flexibility to design policies and procedures as appropriate to implement the requirement, and to permit members scope for the reasonable use of their judgment in ascertaining the counterparty’s regular payment pattern.

Though FINRA expects that members would implement policies and procedures, FINRA also notes the amendments do not mandate that the member implement any particular system or systems for monitoring the behavior of its counterparties. FINRA believes that reasonable means by which the member is able to be familiar with the counterparty’s pattern of transactions should suffice for purposes of this requirement. Further, FINRA believes that recording a Covered Agency Transaction in a Regulation T margin account or good faith account would not, of itself, automatically render the transaction a financing transaction.

Question F3. If a member engages in Covered Agency Transactions with advisory clients of a registered investment adviser, is the term “small cash counterparty” applied to the investment adviser or separately to the advisory clients?

Answer F3. The term is applied to the advisory clients of the investment adviser. For example, if a registered investment adviser executes a $15 million TBA transaction allocated equally to three advisory clients, then those advisory clients could qualify as “small cash counterparties” if they meet the other requirements of Rule 4210(e)(2)(H)(i)h.

Question F4. If a member engages in Covered Agency Transactions with advisory clients of a registered investment adviser, may the member rely on representations by or information from the adviser when determining whether to consider a counterparty as a “small cash counterparty”?

Answer F4. Members, when evaluating whether an advisory client of a registered investment adviser qualifies as a small cash counterparty, should be able to rely on the reasonable representations of the adviser and to place reasonable reliance on documentation and other relevant information provided by the adviser. FINRA expects members to exercise appropriate diligence when relying upon such representations, documentation, or information.

Question F5. If the collateral backing a Collateralized Mortgage Obligation (CMO) consists solely of multifamily housing securities or project loan program securities is a transaction in such CMO eligible for the exception provided by Rule 4210(e)(2)(H)(ii)a.2.? Is there a process by which members may request designation by FINRA for products that are within the scope of this exception?

Answer F5. Rule 4210(e)(2)(H)(ii)a.2. provides that:

“[A] member is not required to include a counterparty’s Covered Agency Transactions in multifamily housing securities or project loan program securities in the computation of such counterparty’s net mark to market loss, provided such securities are issued in conformity with a program of an Agency, as defined in Rule 6710(k), or a Government-Sponsored Enterprise, as defined in Rule 6710(n), and are documented as Freddie Mac K Certificates, Fannie Mae Delegated Underwriting and Servicing bonds, or Ginnie Mae Construction Loan or Project Loan Certificates, as commonly known to the trade . . .”

FINRA expects that a Covered Agency Transaction in a CMO¹⁰ that is collateralized solely by multifamily housing securities or project loan program securities specified in Rule 4210(e)(2)(H)(ii)a.2. would be consistent with the scope of the exception. In addition to Covered Agency Transactions in the multifamily housing securities or project loan program securities specified in the rule, the exception under Rule 4210(e)(2)(H)(ii)a.2. is also available for Covered Agency Transactions in “such other multifamily housing securities or project loan program securities with substantially similar characteristics, issued in conformity with a program of an Agency or a Government-Sponsored Enterprise, as FINRA may designate by Regulatory Notice or similar communication.” Any requests for designation may be submitted to [email protected].

Note that, even if a counterparty’s only Covered Agency Transactions with a member are transactions in multifamily housing securities or project loan program securities specified in Rule 4210(e)(2)(H)(ii)a.2., the member is still required by Rule 4210(e)(2)(H)(ii)b. to make and enforce written risk limits for that counterparty. See FAQ H1 below.

G. Master Securities Forward Transaction Agreements (MSFTAs) and Other Documentation

Question G1. Does FINRA require the use of any agreement or other documentation between the parties to a Covered Agency Transaction, such as a Master Securities Forward Transaction Agreement (MSFTA) or other documentation? Can the provisions of an MSFTA override FINRA requirements?

Answer G1. FINRA rules do not require the parties to a Covered Agency Transaction to use any particular agreement, whether an MSFTA or otherwise.

FINRA members must comply with all FINRA rules, including Rule 4210. MSFTAs and other agreements between members and their counterparties cannot override FINRA rules. However, because Rule 4210(e)(2)(H) provides members with a limited right to take capital charges in lieu of collecting margin on Covered Agency Transactions, members do not have an absolute obligation under the rule to collect margin on Covered Agency Transactions or liquidate the Covered Agency Transactions of counterparties that do not provide margin. Instead, Rule 4210(e)(2)(H)d.3. provides that a member that has exceeded the 25% TNC / $30MM Threshold for five consecutive business days shall “to the extent of its rights” promptly collect margin for each counterparty’s excess net mark to market loss and promptly liquidate the Covered Agency Transactions of any counterparty whose excess net mark to market loss is not margined or eliminated within five business days from the date it arises (unless the member obtains an extension from FINRA). Members therefore are not required by Rule 4210 to collect margin on Covered Agency Transactions, or to liquidate Covered Agency Transactions, where they have no right to do so.

If a member does not have a right under a written agreement or otherwise to collect margin for a counterparty’s excess net mark to market loss and to liquidate such counterparty’s Covered Agency Transactions if any such excess net mark to market loss is not margined or eliminated within five business days from the date it arises, then that counterparty will be classified as a “non-margin counterparty” as defined in Rule 4210(e)(2)(H)(i)e., unless the counterparty is excluded by Rule 4210(e)(2)(H)(i)e.1.¹¹ (A counterparty may also be classified as a “non-margin counterparty” if the member has a right to collect margin for the counterparty’s excess net mark to market losses but does not regularly collect such margin.) A FINRA member with any non-margin counterparties is required by Rule 4210(e)(2)(H)(ii)d.2. to establish and enforce risk management procedures reasonably designed to ensure that the member would not exceed either of the limits specified in Rule 4210(e)(2)(I)(i)¹² and that the member’s aggregate net capital deductions for unmargined excess net mark to market losses under Rule 4210(e)(2)(H)(ii)d.1. will not exceed $25 million. In addition, if the member exceeds the 25% TNC / $30MM Threshold for five consecutive business days, it may not enter into new Covered Agency Transactions with a non-margin counterparty, other than risk-reducing transactions. See Rule 4210(e)(2)(H)(ii)d.3.

H. Risk Limits

Question H1. Does Rule 4210(e)(2)(H)(ii)b. require members to make written risk limit determinations for counterparties excepted by Rule 4210(e)(2)(H)(ii)(a)1., for counterparties whose Covered Agency Transactions with (or guaranteed by) the member are limited to transactions in multifamily housing securities or project loan program securities described in Rule 4210(e)(2)(H)(ii)(a)2., or for counterparties whose net mark to market losses are below $250,000 (so they have no excess net mark to market loss)? Is a member required to make and enforce a separate risk limit determination for each counterparty?

Answer H1. Rule 4210(e)(2)(H)(ii)b. requires members to make and enforce a written risk limit determination for each of their Covered Agency Transaction counterparties. This requirement by its terms applies to all counterparties, including those from which the member in not required to collect margin (or take a capital charge in lieu of collecting margin).

The rule is not intended to prescribe a particular methodology as to how members devise the written risk limits, provided the member complies with the requirements set forth in Rule 4210 (e)(2)(H)(ii)b. and Supplementary Material .03. FINRA believes, from the standpoint of managing a member’s risk and in the interest of efficiency, it is reasonable that, in devising risk limits for multiple or large numbers of counterparty accounts, similarly situated counterparties would be treated similarly. As such, it may be reasonable for members to establish risk limits for a counterparty based upon the aggregate characteristics of similar counterparties, rather than performing an individual risk analysis of each individual counterparty.

Question H2. If an investment adviser allocates its Covered Agency Transactions among multiple accounts, may the member make the risk limit determination at the adviser level, or must risk limit determinations be made at the individual accounts level?

Answer H2. Paragraph (a) of Supplementary Material .03 states that “If a member engages in transactions with advisory clients of a registered investment adviser, the member may elect to make the risk limit determination at the investment adviser level.” This provision is intended to reduce the potential regulatory burdens that members otherwise would face. In making risk limit determinations as to advisory accounts, FINRA expects members to exercise appropriate diligence in understanding the extent of their risk and to craft their risk limit determinations accordingly.

I. Multiple Accounts: Use of Maintenance Excess in Other Accounts

Question I1. If a counterparty maintains an account at a member that is separate from the account in which the member records the counterparty’s Covered Agency Transactions, can Rule 4210 maintenance excess in that other account be treated as margining the counterparty’s net mark to market loss on Covered Agency Transactions for purposes of Rule 4210(e)(2)(H)(ii)?

Answer I1. Yes. If the counterparty has agreed that the money and securities in the counterparty’s other account may be used to carry or pay the counterparty’s obligations with respect to the Covered Agency Transactions, Rule 4210(f)(5) would permit the Rule 4210 maintenance excess in that other account to be treated as margining the counterparty’s net mark to market loss on Covered Agency Transactions (and therefore reducing or eliminating the counterparty’s unmargined excess net mark to market loss). Such maintenance excess would not be available for any other purposes (e.g., it would not be available to reduce a Rule 4210 margin requirement for any other account).

Note that Rule 4210(f)(5) only applies if the other account is maintained for the counterparty, rather than some third party. FINRA therefore expects that the other account will be maintained for a person with the same legal name and tax ID as the counterparty.

Question I2. If a counterparty is subject to a prohibition, by virtue of regulatory requirements, from posting collateral directly to a broker-dealer, is it permissible for such a counterparty, in connection with its Covered Agency Transactions, to post the required collateral by means of a third party custodial arrangement?

Answer I2. FINRA has stated that the amendments do not address third party custodial arrangements. However, FINRA believes that, under the amendments, any third party custodial arrangements that are currently permissible under SEC rules and SEC staff guidance, or were otherwise permissible under FINRA Rule 4210 prior to the rule change, should also be permissible for Covered Agency Transactions. For reference, FINRA has addressed a similar Question in FINRA’s Portfolio Margin FAQ, under “Portfolio Margin Account Management.” (Added, January 26, 2024, incorporated without change from the “Frequently Asked Questions & Guidance: Covered Agency Transactions Under FINRA Rule 4210” published September 15, 2017.)

Question I3. Are there circumstances in which a single person could be treated as multiple counterparties for purposes of Rule 4210(e)(2)(H)?

Answer I3. As a general matter, a person (a natural person, company, etc.¹³) is a single counterparty for purposes of Rule 4210(e)(2)(H) and all of such person’s Covered Agency Transactions with (or guaranteed by) a member must be included in that member’s computation of the counterparty’s net mark to market loss (subject to the exception in Rule 4210(e)(2)(H)(ii)a.2.). However, Regulation T specifies limited circumstances in which a member may establish separate margin accounts for the same person,¹⁴ including to distinguish accounts that are under the discretion of separate third party investment advisers. In those limited circumstances, a member may similarly separate the person’s Covered Agency Transactions into different accounts (margin accounts or good faith accounts for Regulation T purposes) and treat each such account as a separate counterparty for purposes of Rule 4210(e)(2)(H). For example, if a pension plan engages two third party investment advisers, each with discretion to cause the pension plan to enter Covered Agency Transactions with (or guaranteed by) the member, then the member may segregate the pension plan’s Covered Agency Transactions into two separate accounts (each under the discretion of one third party investment adviser) and treat each such account as a separate counterparty for purposes of Rule 4210(e)(2)(H).
(Added, February 28, 2024.)

J. Long and Short Standbys

Question J1. How should members treat standbys?

Answer J1. Standbys are OTC put options on the types of securities that are the subject of Covered Agency Transactions.

A counterparty that is long a standby (a counterparty to which a standby commitment is made or written) is subject to Rule 4210(f)(2)(D), under which the purchase price must be paid in full for any long option with nine months or less remaining until expiration. In the computation of a counterparty’s net mark to market loss pursuant to Rule 4210(e)(2)(H)(i)d., the in the money amount of the counterparty’s long standby transactions written by the member, guaranteed to the counterparty by the member, cleared by the member through a registered clearing agency, or in which the member has a first-priority perfected security interest is subtracted from the counterparty’s total mark to market losses.

A counterparty that is short a standby (a counterparty that has made or written a standby commitment) is subject to Rule 4210(f)(2)(E).

K. Clearing, Carrying, and Similar Arrangements

Question K1. Are Covered Agency Transactions matched at the FICC “in scope” for the Covered Agency Transaction margin requirements?

Answer K1. If the FICC is a counterparty (i.e., a party to a Covered Agency Transaction with, or guaranteed by, a member), the member is not required to collect margin (or take a capital charge in lieu of collecting margin) from the FICC. Rule 4210(e)(2)(H)(ii)a.1. provides an exception for counterparties, like the FICC, that are registered clearing agencies.

However, if a member is clearing a Covered Agency Transaction at the FICC on behalf of a client (i.e., novation under FICC rules has resulted in a Covered Agency Transaction between the FICC and the member as agent for the client), then FICC rules provide that the member is liable as principal for the performance of the client’s obligations on the Covered Agency Transaction. This means that the client is party to a Covered Agency Transaction guaranteed by the member (see Supplementary Material .02 to Rule 4210) and therefore a “counterparty” as defined in Rule 4210(e)(2)(H)(i)a. Accordingly, unless an exception is available, Rule 4210(e)(2)(H)(ii)c. requires the member to collect margin from the client for the client’s excess net mark to market loss (if any) or take a capital charge in lieu of collecting such margin. This requirement applies regardless of whether the client is a customer or another broker-dealer.

See also the discussion of Hypothetical 3 in FAQ K2 below. (Added, April 24, 2024.)

Question K2. When a non-self-clearing broker-dealer (Ace Trading) executes a Covered Agency Transaction with a (non-exempted) counterparty (Beneficial Investments), does the responsibility for collecting margin for the counterparty’s excess net mark to market loss (or taking capital charges in lieu of collection) fall on the dealer (Ace Trading) or its clearing broker (Capital Clearing) if both are FINRA members?

Answer K2. There is no simple answer to this question because there is no uniform set of responsibilities that applies to all clearing arrangements involving Covered Agency Transactions.

Rule 4210(e)(2)(H)(ii)c. generally requires FINRA members to collect margin for each counterparty’s excess net mark to market loss. Accordingly, to determine the application of the Covered Agency Transaction margin requirements, each FINRA member must identify each person that is a “counterparty” as defined in Rule 4210(e)(2)(H)(i)a. Under that definition, a “counterparty” is any person that is a party to a Covered Agency Transaction with, or guaranteed by, a member, and Supplementary Material .02 to Rule 4210 explains that “a member is deemed to have ‘guaranteed’ a transaction if such member has become liable for the performance of either party’s obligations under such transaction.” Identifying a member’s “counterparties” in connection with any clearing arrangement therefore will require a careful review of the applicable clearing agreement, along with any other agreements and communications related to the Covered Agency Transaction, to identify each person that is party to a Covered Agency Transaction with, or guaranteed by, the member.

The following illustrates the application of the Covered Agency Transaction margin requirements to four hypothetical clearing arrangements. These hypothetical arrangements are presented for illustrative purposes only. The inclusion of an arrangement in this FAQ is neither an endorsement by FINRA of the arrangement nor a statement by FINRA that the arrangement is consistent with applicable laws, rules and regulations.

Clearing Broker Acting Solely as Settlement Agent: In this hypothetical clearing arrangement, Capital Clearing acts solely as settlement agent for Ace Trading with respect to Covered Agency Transactions. A clear and unambiguous agreement between Ace Trading and Capital Clearing provides that Capital Clearing is responsible only for using securities (or money) deposited by Ace Trading to deliver securities against receipt of payment (or pay money against the receipt of securities) as instructed by Ace Trading; Capital Clearing has no obligation to make any delivery (or payment) to the extent Ace Trading has not deposited the relevant securities (or funds).¹⁵ All parties to Covered Agency Transactions with Ace Trading are explicitly notified of Capital Clearing’s role and its limitations, and no agreements, notices or other communications from Capital Clearing or Ace Trading could reasonably be interpreted to indicate that Capital Clearing’s role is broader than the settlement agent role set out in the agreement between Capital Clearing and Ace Trading.

Under this hypothetical clearing arrangement, neither Ace Trading nor Beneficial Investments would be counterparties of Capital Clearing, so Capital Clearing would have no Rule 4210 obligation to collect margin for Beneficial Investments’ excess net mark to market loss (or take capital charges in lieu of collection); that regulatory obligation would fall solely on Ace Trading.¹⁶

Covered Agency Transactions Novated to Clearing Broker: In this hypothetical clearing arrangement, Covered Agency Transactions executed by Ace Trading and permitted counterparties, including Beneficial Investments, are novated to Capital Clearing. Under clear and unambiguous agreements among Ace Trading, Capital Clearing and the permitted third parties, any Covered Agency Transaction executed by Ace Trading with one of the permitted third parties is transformed into two Covered Agency Transactions: one between Ace Trading and Capital Clearing and an identical offsetting transaction between Capital Clearing and the relevant third party.¹⁷

Under this hypothetical clearing arrangement, the Covered Agency Transaction executed between Ace Trading and Beneficial Investments would be transformed into two identical Covered Agency Transactions, one between Ace Trading and Capital Clearing and one between Capital Clearing and Beneficial Investments. Both Ace Trading and Beneficial Investments would be counterparties of Capital Clearing, so Capital Clearing would generally be obligated to collect margin for any excess net mark to market loss of either Ace Trading or Beneficial Investments (or take a capital charge in lieu of collecting that margin). Capital Clearing would also be a counterparty to Ace Trading, so Ace Trading would generally be obligated to collect margin for any excess net mark to market loss Capital Clearing may have on the transactions between Ace Trading and Capital Clearing (or take a capital charge in lieu of collecting that margin).

Ace Trading generally would not have any obligation with respect to the collection of margin from Beneficial Investments since Ace Trading would not be party to a Covered Agency Transaction with Beneficial Investments once the original transaction is novated as described above. However, if Ace Trading were to guarantee Beneficial Investments’ obligations to Capital Clearing under the transaction between them, then Ace Trading would be responsible for the collection of margin for Beneficial Investments’ excess net mark to market loss (or for taking a capital charge in lieu of collection). That would not mean that Beneficial Investments must post margin twice in order for the members to avoid a capital charge: if Beneficial Investments posts margin to Capital Clearing to cover its excess net mark to market loss, then it will not have an unmargined excess net mark to market loss and neither member would be required to take a capital charge under Rule 4210(e)(2)(H)(ii)d.1. If Ace Trading has guaranteed Beneficial Investments’ obligations to Capital Clearing and Beneficial Investments does not post margin to Capital Clearing to cover its excess net mark to market, then both Ace Trading and Capital Clearing would have a capital charge for Beneficial Investments’ unmargined excess net mark to market loss—unless Ace Trading has provided deposits to Capital Clearing that can be legally applied to cover Beneficial Investments’ excess net mark to market loss, in which case only Ace Trading would have to take the capital charge; c.f., FINRA Interpretation Rule 15c3-1(c)(2)(iv)(B) /111 Customers’ Unsecured/Partly Secured Deficits Offset by Correspondent’s Deposits.

Clearing Broker Clears Covered Agency Transactions through FICC: In this hypothetical clearing arrangement, Capital Clearing is a member of the Fixed Income Clearing Corporation (FICC), Beneficial Investments’ Covered Agency Transactions are cleared through another FICC member (Delta Clearing), and the Covered Agency Transaction executed by Ace Trading with Beneficial Investments is eligible to be cleared by the FICC. In this case, Capital Clearing and Delta Clearing would submit the transaction to the FICC. That would result in the transaction being novated to the FICC, transforming it into two Covered Agency Transactions: one transaction between the FICC and Capital Clearing as agent for Ace Trading and an offsetting identical transaction between the FICC and Delta Clearing as agent for Beneficial Investments.¹⁸ Since the FICC has replaced Beneficial Investments as party to Ace Trading’s Covered Agency Transaction, neither Ace Trading nor Capital Clearing would have an obligation to collect margin from Beneficial Investments (or take a capital charge in lieu of collection). Furthermore, neither Ace Trading nor Capital Clearing would have an obligation to collect margin from the FICC (or take a capital charge in lieu of collection) because Rule 4210(e)(2)(H)(i)e.1. provides an exception for registered clearing agencies. However, since Capital Clearing’s submission of the Covered Agency Transaction to the FICC makes Capital Clearing responsible to the FICC for the performance of the Covered Agency Transaction, Capital Clearing will have guaranteed Ace Trading’s obligations under the Covered Agency Transaction (see Supplementary Material .02 to Rule 4210). Ace Trading would therefore be a “counterparty” as defined in Rule 4210(e)(2)(H)(i)a. to Capital Clearing, and Capital Clearing would be obligated to collect margin from Ace Trading to cover its excess net mark to market loss (or take a capital charge in lieu of collection).¹⁹
Clearing Broker Guarantees Covered Agency Transactions: In this hypothetical clearing arrangement, the Covered Agency Transaction remains between Ace Trading and Beneficial Investments, but Capital Clearing guarantees both sides of the Covered Agency Transaction—guaranteeing Ace Trading’s performance to Beneficial Investments and Beneficial Investments’ performance to Ace Trading. In this case, Beneficial Investments would be a “counterparty” of both Ace Trading (because Beneficial Investments is a party to a Covered Agency Transaction with Ace Trading) and Capital Clearing (because Capital Clearing guarantees Beneficial Investments’ obligations under the Covered Agency Transaction), and therefore both Ace Trading and Capital Clearing would have a responsibility for the collection of margin to cover Beneficial Investments’ excess net mark to market loss. That does not mean that Beneficial Investments must post margin twice in order for the members to avoid a capital charge; if Beneficial Investments posts margin to Ace Trading to cover its excess net mark to market loss, then it will not have an unmargined excess net mark to market loss and neither member would be required to take a capital charge.

Similarly, Ace Trading is also a “counterparty” of Capital Clearing (because Capital Clearing guarantees Ace Trading’s obligations under the Covered Agency Transaction), and therefore Capital Clearing would have a responsibility for the collection of margin to cover Ace Trading’s excess net mark to market loss. If Ace Trading is also required to post margin to Beneficial Investments (whether because Beneficial Investments is a FINRA member with an obligation to collect margin or because the contract between Ace Trading and Beneficial Investments requires Ace Trading to post margin), that would not mean Ace Trading must post margin twice in order for Capital Clearing (and Beneficial Investments, if it is a member) to avoid a capital charge; if Ace Trading posts margin to Beneficial Investments to cover its excess net mark to market loss, then it will not have an unmargined excess net mark to market loss and Capital Clearing would not be required to take a capital charge (nor, would Beneficial Investments be required to take a capital charge if it’s a member). (Added, April 24, 2024.)

Question K3. How do the Covered Agency Transaction margin requirements apply in the context of “step-in,” “prime brokerage,” or other multiparty arrangements?

Answer K3. This will depend on the details of the arrangement. As discussed in FAQ K2 above, Rule 4210(e)(2)(H)(ii)c. generally requires FINRA members to collect margin for each counterparty’s excess net mark to market loss. Accordingly, to determine the application of the Covered Agency Transaction margin requirements, each FINRA member must identify each person that is a “counterparty” as defined in Rule 4210(e)(2)(H)(i)a. Under that definition, a “counterparty” is any person that is a party to a Covered Agency Transaction with, or guaranteed by, a member, and Supplementary Material .02 to Rule 4210 explains that “a member is deemed to have ‘guaranteed’ a transaction if such member has become liable for the performance of either party’s obligations under such transaction.” Identifying a member’s “counterparties” in connection with any these arrangements therefore will require a careful review of the applicable agreements structuring the arrangement, along with any other agreements and communications related to the Covered Agency Transactions, to identify each person that is party to a Covered Agency Transaction with, or guaranteed by, the member.

See FAQ K2 above for illustrations of the application of the Covered Agency margin requirements to four hypothetical clearing arrangements. Other multiparty arrangements would need to be analyzed in a similar fashion. (Added, April 24, 2024.)

Question K4. If an introducing broker is party to Covered Agency Transactions with its clearing broker and determines that the clearing broker has an excess net mark to market loss, will the introducing broker’s margin collection obligation be satisfied if the clearing broker credits the introducing broker’s account with an amount equal to that excess net mark to market loss?

Answer K4. Yes. Note that this credit should be a credit (or reduce a debit) in the carrying broker’s PAB reserve computation while it remains in the introducing broker’s account. (Added, April 24, 2024.)

Question K5. Suppose:

An introducing broker is party to Covered Agency Transactions with a customer;
That customer is introduced to a clearing broker by the introducing broker; and
The clearing broker acts solely as settlement agent²⁰ for the introducing broker and the customer.

In this situation, can the introducing broker’s obligation to collect margin for the customer’s excess net mark to market loss be satisfied by the customer’s deposit of cash or securities into an account of the customer at the clearing broker?

Answer K5. Yes, subject to certain conditions. The customer’s deposit into an account of the customer at the clearing broker of cash or securities with a value (after deduction of the maintenance margin requirement applicable to any securities margin under Rules 4210(c) and 4210(e)) equal to the customer’s excess net mark to market loss will satisfy the introducing broker’s Rule 4210(e)(2)(H)(ii)c. obligation to collect margin for the customer’s excess net mark to market loss, provided that:

The introducing broker has a lien on that account²¹ and on the cash and securities held therein;
The introducing broker has perfected that lien through control of the account and the cash and securities held therein;
The introducing broker’s lien is a first priority lien; if the clearing broker also has a lien on the account or the cash and securities held therein, such lien has been expressly subordinated to the introducing broker's lien; and
For purposes of Rule 15c3-3, the clearing broker treats cash in the account as a credit balance and securities in the account as fully-paid securities (while such cash and securities remain in the customer’s account). (Added, April 24, 2024.)

Question K6. Suppose:

An introducing broker has a net mark to market loss on Covered Agency Transactions with its clearing broker (or guaranteed by its clearing broker to the FICC); and
The introducing broker also has a mark to market gain on a Covered Agency Transaction with a customer that the introducing broker introduces to the clearing broker.

In this case, can the introducing broker’s mark to market gain on the customer transaction be subtracted from the sum of the introducing broker’s mark to market losses when the clearing broker calculates the introducing broker’s net mark to market loss?

Answer K6. Yes, if the clearing broker has a first-priority perfected security interest in the customer transaction.

When the clearing broker computes the introducing broker’s “net mark to market loss,” clause 2.A. of the definition in Rule 4210(e)(2)(H)(i)d. allows gains on the introducing broker’s “Covered Agency Transactions … in which the member [i.e., the clearing broker] has a first-priority perfected security interest” to be subtracted from the sum of the introducing broker’s mark to market losses. (Added, April 24, 2024.)

Question K7. Suppose:

An introducing broker has a net mark to market loss on Covered Agency Transactions with its clearing broker (or guaranteed by its clearing broker to the FICC);
The introducing broker also has a mark to market gain on a Covered Agency Transaction with a customer that the introducing broker introduces to the clearing broker;
The clearing broker has a perfected security interest in the introducing broker’s transactions with the customer; and
The clearing broker’s security interest has first priority, except that it is subject to subject to the customer’s rights to setoff the introducing broker’s gains on those transactions against:
1. the introducing broker’s losses on other Covered Agency Transactions with the customer; and
2. the introducing broker’s obligation to return or repay margin that the customer delivered or paid to the introducing broker (or to cover damages from the introducing broker’s failure to return or repay that margin).

Answer K7. Yes, provided that, before being subtracted from the sum of the introducing broker’s mark to market losses, the introducing broker’s mark to market gains on Covered Agency Transactions with the customer are reduced by (i) the introducing broker’s mark to market losses on other Covered Agency Transactions with the customer and (ii) the value of any margin that the customer delivered or paid to the introducing broker (but not including the value of margin held in the customer’s account at the carrying broker as described in FAQ K5 above).

For example, if the introducing broker has two Covered Agency Transactions with the customer, with a $700,000 mark to market gain on one transaction and a $150,000 mark to market loss on the other transaction, and has also received $100,000 of cash margin from the customer, then clearing broker can subtract $450,000 ($700,000 of mark to market gains, minus $150,000 of mark to market losses and $100,000 of cash margin) from the introducing broker’s mark to market losses in the computation of the introducing broker’s net mark to market loss. (Added, April 24, 2024.)

*The FAQ was originally published on January 5, 2024.

Question and Answer I2 were incorporated without change on January 26, 2024 from the “Frequently Asked Questions & Guidance: Covered Agency Transactions Under FINRA Rule 4210” published on September 15, 2017.
Question and Answer I3 were incorporated on February 28, 2024.
Question and Answer C4 were added on April 24, 2024.
Question and Answer D3 were modified on April 24, 2024 to correct the filing requirements.
Question and Answer E12.5 were added on April 24, 2024.
Section K with Questions and Answers K1 to K7 were added on April 24, 2024.

¹See Regulatory Notice 23-14 (August 18, 2023); see also Securities Exchange Act Release No. 98349 (September 11, 2023), 88 FR 63633 (September 15, 2023) (Notice of Filing for Immediate Effectiveness; File No. SR-FINRA-2023-011).

²See Securities Exchange Act Release No. 98003 (July 27, 2023), 88 FR 50205 (August 1, 2023) (Order Setting Aside Action by Delegated Authority and Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 1, to Amend the Requirements for Covered Agency Transactions under FINRA Rule 4210 (Margin Requirements) as Approved Pursuant to SR-FINRA-2015-036; File No. SR-FINRA-2021-010).

³For example, if the member only enters TBA transactions with the counterparty, it would not be relevant whether the specified source is a reasonable pricing source for specified pool or CMO transactions.

⁴Rule 4210(e)(2)(H)(i)i. provides that:

"i. A member’s ‘specified net capital deductions’ are the net capital deductions required by paragraph (e)(2)(H)(ii)d.1. of this Rule with respect to all unmargined excess net market losses of its counterparties, except to the extent that the member, in good faith, expects such excess net mark to market losses to be margined by the close of business on the fifth business day after they arose.”

⁵Rule 4210(e)(2)(H)(ii)a.1. provides that:

“. . . a member is not required to collect margin, or to take capital charges in lieu of collecting such margin, for a counterparty’s excess net mark to market loss if such counterparty is a small cash counterparty, registered clearing agency, Federal banking agency, as defined in 12 U.S.C. 1813(z), central bank, multinational central bank, foreign sovereign, multilateral development bank, or the Bank for International Settlements.”

⁶Pursuant to Rule 4210(e)(2)(H)(i)e.:

“e. A counterparty is a “non-margin counterparty” if
the counterparty is not a small cash counterparty, registered clearing agency, Federal banking agency, as defined in 12 U.S.C. 1813(z), central bank, multinational central bank, foreign sovereign, multilateral development bank, or the Bank for International Settlements; and
the member:
does not have a right under a written agreement or otherwise to collect margin for such counterparty’s excess net mark to market loss and to liquidate such counterparty’s Covered Agency Transactions if any such excess net mark to market loss is not margined or eliminated within five business days from the date it arises; or
does not regularly collect margin for such counterparty’s excess net mark to market loss.”

⁷Rule 4210(e)(2)(H)(i)i. provides that:

“i. A member’s ’specified net capital deductions’ are the net capital deductions required by paragraph (e)(2)(H)(ii)d.1. of this Rule with respect to all unmargined excess net market losses of its counterparties, except to the extent that the member, in good faith, expects such excess net mark to market losses to be margined by the close of business on the fifth business day after they arose.”

⁸Since the member does not have a right to liquidate this counterparty’s Covered Agency Transactions if its excess net mark to market loss is not margined or eliminated within five business days from the date it arises, this counterparty would be a “non-margin counterparty” as defined in Rule 4210(e)(2)(H)(i)e. unless excluded by clause 1 of that definition.

⁹A 14 calendar day extension is generally a 10 business day extension as assumed in this question, but the extension could be for fewer business days if there are holidays in the extension period.

¹⁰Under Rule 4210(e)(2)(H)(i)b., a CMO transaction is not a “Covered Agency Transaction” unless the CMO is “issued in conformity with a program of an Agency, as defined in Rule 6710(k), or a Government-Sponsored Enterprise, as defined in Rule 6710(n).”

¹¹Rule 4210(e)(2)(H)(i)e.1. excludes small cash counterparties, registered clearing agencies, Federal banking agencies, central banks, multinational central banks, foreign sovereigns, multilateral development banks and the Bank for International Settlements from the definition of “non-margin counterparty.”

¹²Under Rule 4210(e)(2)(I)(i), the net capital deductions taken by a member as a result of marked to the market losses incurred under Rule 4210(e)(2)(F), (e)(2)(G) (exclusive of the percentage requirements established thereunder), or (e)(2)(H)(ii)d.1., plus any unmargined net mark to market losses below $250,000 or of small cash counterparties are limited to (a) 5 percent of the member’s tentative net capital for any one account or group of commonly controlled accounts, and (b) 25 percent of the member’s tentative net capital for all accounts combined.

¹³SEA Section 3(a)(9) defines “person” to mean “a natural person, company, government, or political subdivision, agency, or instrumentality of a government.”

¹⁴Paragraph (a)(2) of Section 220.4 of Regulation T, 12 CFR 220.4(a)(2), provides:

(2) A creditor [broker-dealer] may establish separate margin accounts for the same person to:

Clear transactions for other creditors where the transactions are introduced to the clearing creditor by separate creditors; or
Clear transactions through other creditors if the transactions are cleared by separate creditors; or
Provide one or more accounts over which the creditor or a third party investment adviser has investment discretion.

¹⁵Capital Clearing may also agree to provide related or ancillary services to Ace Trading while still being considered to be acting solely as settlement agent with respect to the transactions, including (but not limited to) those listed in the following footnote.

¹⁶Even though Capital Clearing has no regulatory responsibility for collecting margin in this hypothetical, the related or ancillary services it provides to Ace Trading may include things like:

running calculations of margin due to Ace Trading from its counterparties or due from Ace Trading to its counterparties;
creating notices which Ace Trading could use to notify its counterparties (including Beneficial Investments) of margin they are obligated to provide to Ace Trading;
sending such notices to Ace Trading’s counterparties (on Ace Trading’s behalf and in Ace Trading’s name);
receiving as Ace Trading’s custodian any margin transferred by Ace Trading’s counterparties for credit to Ace Trading’s accounts at Capital Clearing and maintaining records of such receipts;
transferring margin out of Ace Trading’s account at Capital Clearing to Ace Trading’s counterparties (on individual or standing instructions from Ace Trading) and maintaining records of such transfers.

If Beneficial Investments is also a Capital Clearing client, then Capital Clearing may also provide similar settlement agent services (and related or ancillary services) to Beneficial Investments without changing this analysis.

¹⁷The contractual arrangements may be more complex in some cases. For example, two or more clearing firms could enter into an agreement with each other and separate agreements with their clients, under which they all agree that any Covered Agency Transaction between the clients of any of the contracting clearing firms will be novated to the clients’ respective clearing firm(s), resulting in identical transactions between each of the original parties and its respective clearing firm and (if the clearing firms are different) an identical transaction between the two clearing firms. For example, if Ace Trading clears through Capital Clearing and Beneficial Investments clears through Delta Clearing, the arrangement could provide that any Covered Agency Transaction between Ace Trading and Beneficial Investments is novated into three identical, back-to-back transactions: one between Ace Trading and Capital Clearing, one between Capital Clearing and Delta Clearing, and one between Delta Clearing and Beneficial Investments. An arrangement like this could be considered analogous to prime brokerage under the SIFMA (SIA) forms 150 and 151. The remainder of this hypothetical will focus on the simpler arrangement involving only one clearing firm.

¹⁸Under an alternative hypothetical, the arrangement between Ace Trading and Capital Clearing provides that transactions submitted to FICC are novated to Capital Clearing, resulting in a transaction between Ace Trading and Capital Clearing and an identical transaction between Capital Clearing and the FICC. Under this hypothetical, Capital Clearing and Ace Trading would each have an obligation to collect margin for the others’ excess net mark to market loss (or take a capital charge in lieu of collection).

¹⁹See also FAQ K1 above.

²⁰See Hypothetical 1 in FAQ K2 above for what it means for the clearing broker to act “solely as settlement agent.”

²¹This account could be maintained separately from the customer’s other accounts at the clearing broker. The introducing broker does not need to have a lien on, or control of, all of the customer’s accounts at the clearing broker and the clearing broker may have a lien on the customer’s other accounts at the clearing broker.