April 30, 2021

FINRA Proposes Applying Its Rules to Security-Based Swaps

Nihal Patel Commentary by Nihal Patel

FINRA proposed amendments to clarify the application of FINRA rules to security-based swaps ("SBS"). The proposal would take effect once SEC rules concerning SBS dealers ("SBSDs") and major SBS participants ("MSBSPs") become effective.

Specifically, FINRA stated that it is proposing to amend FINRA Rules 0180 ("Application of Rules to Security-Based Swaps"), 4120 ("Regulatory Notification and Business Curtailment"), 4210 ("Margin Requirements"), 4220 ("Daily Record of Required Margin"), 4240 ("Margin Requirements for Credit Default Swaps") and 9610 ("Application") in order to account for its members' SBS activities as SBS entities start to register with the SEC on October 6, 2021 (i.e., the compliance date for the SEC SBS rulemaking).

Among other things, the proposed amendments would:

  • amend FINRA Rule 0180 to provide a general presumption that FINRA rules apply to SBS (as they are also "securities"), subject to exceptions, including:

    • general exceptions from the FINRA Rule 6000 series (quotation, order, and transaction reporting facilities), Rule 7000 series (clearing, transaction and order data requirements, and facility charges) and Rule 11000 series (uniform practice code);

    • exceptions from certain FINRA conduct rules applicable only to FINRA members also registered as SBSDs or MSBSPs and such firms' associated persons ("APs") (including Rules 2030, 2090, 2110, 2210(d), 2232, 3110, 3120, 3130 and 4512), with carve-outs for Rules 2111, 2210(d) and 2232 where a broker-dealer ("BD") is "arranging, negotiating or executing" SBS on behalf of a non-U.S. affiliate pursuant to SEA Rule 3a71-3(d)(1); and

    • an exception from status as a BD AP if a person's functions are solely and exclusively related to SBS;

  • conform FINRA's operational and financial responsibility rules to the SEC's amended capital, margin and segregation SBSD and BD requirements as to SBS activities; and

  • amend FINRA margin requirements, by:

    • replacing current Rule 4240 ("Margin Requirements for Credit Default Swaps") with a new rule that would prescribe margin requirements for SBS intended to be consistent with Exchange Act Rule 18a-3, but not applicable to firms registered as SBSDs (including daily two-way variation margin and initial margin collection); and

    • generally excluding SBS from Rule 4210, subject to changes permitted under existing portfolio margin rules.

The amendments have a proposed effective date of October 6, 2021, and comments must be submitted within 21 days of the proposal's publication in the Federal Register.


While the FINRA proposal is generally about clarifications, given that SBS are also "securities" under the Exchange Act, the 276-page proposal requires close reading for any BD engaged in SBS activities, including those BDs that act solely in an agency capacity (e.g., on behalf of an affiliated SBSD). Among other things, the following should be noted:

  • FINRA proposes to make its amendments effective October 6, 2021, notwithstanding the fact that most firms registering as SBSDs will not do so until November 1 (or later).

  • In footnote 37, FINRA provides an interpretation relating to the use of "dual-hatted" employees - i.e., where a person is an AP of both an SBSD and an affiliated BD. FINRA said that it intends proposed exceptions in Rule 0180(c) to apply only as to the SBS activities of such a person, notwithstanding they also serve as a BD AP. However, FINRA also cautioned that whether a person is acting as an AP solely of the SBSD is a "facts and circumstances determination and is not dependent on the particular method in which such arrangements are documented."

  • BDs engaged in SBS with customers that seek to use "portfolio" margining under Rule 4210 should consider the proposed amendments, as well as the FINRA responses to comments on the proposal (in particular on pages 211-212), which provide interpretations of the current portfolio margin requirements.

  • Finally, BDs that are not registering as SBSDs should closely consider what impact the proposed margin rules might have on their use of SBS. While the FINRA proposal is similar to SEC Rule 18a-3 in many respects, it differs in significant ways, including as to the use of thresholds and minimum transfer amounts (MTAs) and its treatment of affiliates.

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