Meeting New TBA Margin Requirements: How You Can Prepare
As the June 25, 2018, implementation date approaches for the Financial Industry Regulatory Authority’s (FINRA’s) Rule 4210, firms engaged in to-be-announced (TBA) transactions in the U.S. secondary mortgage market have formidable work to do to prepare for compliance. Rule 4210, which aims to reduce counterparty credit risk by setting new requirements for daily calculation and posting of margin, will demand systems upgrades and new documentation, and now is not too early to get started.
By Amy Caruso
FINRA 4210 in brief
TBA transactions provide significant funding and liquidity for the U.S. mortgage market. According to FINRA’s 2016 TRACE Monthly Volume Report, the average daily par value of TBAs that year was approximately $194 billion.
Rule 4210 requires U.S.-registered broker-dealers to collect margin on TBA transactions.
In addition, if any required margin is not collected by the close of the following business day, the respective broker-dealer will have to deduct that amount from the firm’s regulatory net capital.
The rule has two parts: 1) credit risk limits to be assigned, which were put in place before December 15, 2016, and 2) margin calculation and collection and net capital impact, which must be implemented by June 25, 2018.
Daunting impacts on broker-dealers’ counterparties
Collecting margin is a routine process for most broker-dealers. After all, those that are swap dealers or even broker-dealers facing off to swap dealers have been calculating derivatives mark to market (MTM) and posting margin for quite some time--and with even more rigor since the global uncleared margin rules began to take effect in September 2016.
However, some entities that face the broker-dealers – and even some broker-dealers directly subjected to Rule 4210 - may have never calculated TBA MTMs in the past nor processed a margin call settlement. These processes can be quite daunting for firms that lack both the infrastructure to perform these daily tasks and the capacity to scale their derivatives middle office for the expected increase of TBA margin volume.
In addition, because it affects their liquidity, having to post margin to a TBA broker-dealer may negatively impact investment performance for these counterparties.
Documentation for each transaction
Under Rule 4210 each TBA transaction will be governed by documentation such as a Master Securities Financial Transaction Agreement (MSFTA). This document outlines the terms of the transaction, including margin calculation, margin posting and collection, and dispute resolution. For new MSFTAs, the documents will be necessary to manage counterparty relationships, and if existing MSFTAs are in place, updates may be needed to align with the new rules.
A checklist for successful implementation
Firms can smooth their path to Rule 4210 implementation through careful preparation on multiple fronts. The following checklist can help organize these efforts.
Resolving uncertainties through industry collaboration
Some aspects of Rule 4210 still need clarification from the regulator ahead of June implementation, and industry groups are creating opportunities for information exchanges to help drive this process.
For example, SIFMA has been organizing sessions with market participants and FINRA representatives. It has also submitted comment letters that summarize issues that need to be resolved before the rule takes effect. Kris Dailey of FINRA will lead a discussion of critical aspects of the rule on January 30th at the SIFMA Conference Center in NYC. Register to attend this event by visiting: https://www.sifma.org/event/securitization-spotlight-session-finra-rule-4210-implementation/#sessions
In addition, the ISITC Margin & Collateral Working Group will host a panel discussion on the operational impact of the rule at its March conference. Details for the conference are at: https://www.isitc.org/events/2018/securities-operations-summit
To help ensure a successful, industry-wide transition to the new margin requirements, firms should seek to participate in activities like these.