In the United States, the agency mortgage-backed securities (MBS) market is the second largest after US treasuries. 90% of the agency MBS market consists of TBA (to-be-announced) forward-settling transactions, with a significant portion being executed on a bilateral basis and not cleared through a CCP.
About FINRA Rule 4210
While TBA transaction benefits are recognized widely (i.e. liquidity fuel for mortgage origination), they are exposed to counterparty default risk due to forward settlement dates that occur in the future (up to several months). As a result, addressing counterparty exposure to credit risk remains a priority for the regulators in their quest to secure global financial markets.
FINRA Rule 4210 is designed to enforce application of margin requirements (mark-to-market and maintenance margin) to covered agency transactions (bilateral forward-settling transactions in agency MBS), issued in conformity with a program of an agency or Government-Sponsored Enterprise. This regulation pursues the following objectives:
- Reduce exposure to counterparty default risk through collateralization process implementation
- Promote a harmonized margin requirements framework
- Establish monitoring of outstanding mark-to-market deficiency (uncollected margin)
- Address systemic risk concerns (hypothetically if several large TBA market participants were to fall, it may result in domino effect and contribute to mortgage loan market disruption)
Scope
Eligible transactions :
- To-be-announced (TBAs), adjustable rate mortgages (ARMs) and specified pools having contractual settlement at least one business day after trade date
- Collateralized mortgage obligations (CMOs) having contractual settlement date at least three business day after trade date
- Executed on a bilateral basis between a counterparty and a broker/dealer regulated by FINRA, not cleared through a registered clearing agency and having a gross open position greater than USD 10 million (per counterparty)
*Any counterparty, buy-side or sell-side (non-broker) participant, entering into buy/sell transactions (on these assets) with a FINRA member. A FINRA member is a US regulated broker/dealer.
Margin requirements (unless exceptions):
- Mark-to-market (variation margin) counterparty`s loss resulted from marking eligible transactions to the market (position valuation)
- Maintenance margin (initial margin) – 2% contract value of net long or net short position, by CUSIP per counterparty (this provision is expected to be repealed in the next amended version of the Rule)
Other provisions to be considered:
- Margin may not be exchanged if mark-to-market loss does not exceed a minimum transfer amount (MTA of USD 250,000) aggregated per single counterparty
- If mark-to-market loss is not collected by T+1 close of business, the dealer (FINRA member) must take a net capital deduction until such margin call is satisfied. If such loss is outstanding for 5 consecutive business days, a position liquidation process may be activated to satisfy the loss and reporting made to FINRA
- Some counterparties (certain mortgage banks, federal banking agencies) or assets (multifamily housing securities or project loan program securities) are exempt from margin requirements as long as the dealer`s credit risk department enforces due diligence on the counterparty
Industry implications
FINRA Rule 4210 is a step toward market integrity and avoidance of systemic event. Reducing overall exposure to credit risk and implementing best practices are key objectives for the industry as whole.
Nevertheless, financial actors may also face roll-out challenges. Finding a right balance between overall benefits and cost of regulation implementation is not always easy. For instance, dealers and service providers are facing substantial technological adaptations in order to support new margin requirements in an automated manner.
Late modifications in the blueprints affect an actor`s capacity to deliver a full automated solution in a timely manner and create additional operational dependencies. Further, because of the overlap of several ongoing compliance initiatives and deadlines, there is concern of “bottle-neck” situations on legal documentation and KYC framework processing.
Securities Services` view
We believe that the introduction of margin requirements on uncleared transactions and expansion of collateralization technique are key tools to mitigate risks. This initiative contributes to overall market health and transparency. However, FINRA Rule 4210 implementation may be delicate, with consultations continuing throughout 2020 and resulting in scope revision / effective date delay.
We welcome the proposal to repeal maintenance margin as a step forward in simplifying regulation. However, we think that regulators should address the evolving framework in an efficient manner that shields market players from additional costs due to late blueprint amendments.
It is expected that FINRA will revise the initial scope by proposing the following changes:
- Repeal of maintenance margin (also known as initial margin) requirement
- Allowance for capital charges by dealers in lieu of margin but limited to a certain threshold
- Clarification of exemption pertaining to cleared transactions
Key dates
December 2016 – phase 1, FINRA members to enforce written risk limit determination procedure (credit risk due diligence)
January 2019 – FINRA filed for effective date postponement, proposing March 2020 as go-live.
October 2019 – FINRA filed for new delay as to conduct additional consultations on the Rule content alterations
March 2021 – FINRA 4210 regulation new target go-live date
