SEC, CFTC Approve Portfolio Margining Program by Broker-Dealers, FCMs.

[ by Howard Haykin ]

FINRA proposes to amend FINRA Rule 4210(g) and FINRA Rule 4240,  principally to permit members to elect to comply with portfolio margining programs that are approved by the CFTC and the SEC, subject to specified requirements.  FINRA intends for the amendments to become effective upon approval by the SEC. 

Section 713(a) of the Dodd-Frank Act amended ... the Exchange Act to generally permit a broker-dealer that is also registered as a futures commission merchant (“FCM”) under the CEA to hold cash and securities in a portfolio margining account that is carried as a futures account, pursuant to a portfolio margining program that is approved by the CFTC.

Reciprocally, Section 713(b) of Dodd-Frank amended the CEA to generally permit an FCM that is also registered as a broker-dealer to hold futures contracts and options on futures contracts - as well as money, securities or other property received from a customer to margin, guarantee or secure such contracts, or accruing to a customer as a result of such contracts - in a portfolio margining account that is carried as a securities account pursuant to a portfolio margining program that is approved by the SEC.

Portfolio Margining of Collateral with Respect to Credit Default Swaps (“CDS”).   The SEC and the CFTC recently have acted to grant specific exemptions to facilitate portfolio margining of collateral with respect to CDS's.  FINRA would facilitate the application of these exemptions by amending its rules - FINRA Rule 4210(g) and FINRA Rule 4240 - to permit members to elect to comply with portfolio margining programs that are approved by the CFTC or the SEC, subject to specified requirements. 

Specifically:

• FINRA Rule 4210(g), that sets forth FINRA requirements for portfolio margining, would be amended to provide that the rule’s portfolio margin provisions will not apply to an individual portfolio margin account in which the member elects to collect margin pursuant to a portfolio margining program that is in compliance with CFTC or SEC rules, regulations or exemptions, provided that the member notifies FINRA in advance in writing and demonstrates to the satisfaction of FINRA staff that the member has implemented an appropriate written risk analysis methodology as required by FINRA Rule 4210(g)(1).

• FINRA Rule 4240 implements an interim pilot program with respect to margin requirements for certain transactions in CDS that are security-based swaps.  The rule would be amended using largely identical language to the proposed amendment with respect to FINRA Rule 4210(g), to except members from the rule’s requirements with respect to portfolio margin accounts in which CDS that are security-based swaps are held.

Additional Amendments to FINRA Rule 4240.   FINRA would amend the margin requirements in paragraph (c)(2) and Supplementary Material .019 of FINRA Rule 4240 to clarify that, in addition to requiring the applicable minimum margin, a member must collect daily from each customer or broker-dealer counterparty an amount at least equal to the member’s current exposure, as defined in SEA Rule 15c3-1e(c)(4) - provided, however, that members not otherwise subject to SEA Rule 15c3-1e are not required to take into account paragraph (c)(4)(v)(G) of such Rule), arising from the daily mark to market of the CDS (“variation margin”).  FINRA notes that collection of variation margin has been implicitly required by the administration of Rule 4240; the amendments would be designed to make this variation margin requirement clear.

FINRA would amend the reference to “largest maximum possible loss” in paragraph (d)(8) of the rule by adding the phrase “(that is, the notional amount of the CDS less the estimated recovery given default).”  The additional language is intended to lessen the potential burdens from higher capital charges that could result absent the proposed language.  FINRA further proposes to clarify the first sentence of paragraph (a) and the first sentence of paragraph (c)(1) by removing the references to “matching transactions” and making other conforming edits so as to streamline the rule language.

Finally, FINRA would amend paragraphs (c)(2) and (e)11 and Supplementary Material .01 of Rule 4240 by adding the phrase “Unless otherwise permitted by FINRA in writing.”  FINRA believes this language will make the rule’s administration more flexible and efficient, and facilitate the transition to such new requirements, by enabling FINRA staff to, for example, permit members, where appropriate, to take capital charges in lieu of collecting the margin required by the rule.

For further details, go to:   [ FINRA Rule Filing 13-17, 2/15/13 ].