[Federal Register Volume 87, Number 8 (Wednesday, January 12, 2022)]
[Notices]
[Pages 1962-1989]
[FR Doc No: 2022-00376]

Vol. 87

Wednesday,

No. 8

January 12, 2022

Part III

Securities and Exchange Commission

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Self-Regulatory Organizations; Financial Industry Regulatory Authority,
Inc.; Order Approving a Proposed Rule Change, as Modified by Amendment
No. 1, Relating to Security-Based Swaps; Notice

Federal Register / Vol. 87 , No. 8 / Wednesday, January 12, 2022 /
Notices

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-93914; File No. SR-FINRA-2021-008]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by
Amendment No. 1, Relating to Security-Based Swaps

January 6, 2022.

I. Introduction

    On April 26, 2021, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend FINRA Rules 0180, 4120,
4210, 4220, 4240 and 9610 to clarify the application of its rules to
security-based swaps (``SBS'') following the Commission's completion of
its rulemaking regarding SBS dealers (``SBSDs'') and major SBS
participants (``MSBSPs'') (collectively, ``SBS Entities'').
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal
Register on May 12, 2021.\3\ On June 14, 2021, FINRA consented to an
extension of the time period in which the Commission must approve the
proposed rule change, disapprove the proposed rule change, or institute
proceedings to determine whether to approve or disapprove the proposed
rule change to August 10, 2021.\4\ The Commission received two comments
on the proposed rule change during the initial comment period.\5\ On
August 9, 2021, FINRA responded to the comment letters received in
response to the Notice and filed an amendment to the proposed rule
change (``Amendment No. 1'').\6\ On August 9, 2021, the Commission
issued an Order Instituting Proceedings (``OIP'') to determine whether
to approve or disapprove the proposed rule change, as modified by
Amendment No.1.\7\ The Commission received an additional four comments
in response to the OIP.\8\ On September 30, 2021, the FINRA consented
to an extension of the time period in which the Commission must approve
or disapprove the proposed rule change to January 7, 2022.\9\ This
order approves the proposed rule change, as modified by Amendment No.
1.
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    \3\ See Exchange Act Release No. 91789 (May 12, 2021), 86 FR
26084 (May 12, 2021) (File No. SR-FINRA-2021-008) (``Notice'').
    \4\ Letter from Robert McNamee, Assistant General Counsel,
Office of General Counsel, FINRA to Daniel Fisher, Division of
Trading and Markets, Commission dated June 14, 2021.
    \5\ Letter from Kyle L. Brandon, Managing Director, Head of
Derivatives Policy, Securities Industry and Financial Markets
Association (``SIFMA'') to Vanessa A. Countryman, Secretary,
Commission, dated June 2, 2021 (``SIFMA Letter'') and Matthew R.
Cohen, Chief Executive Officer and Richard C. Chase, Chief
Compliance Officer, Provable Markets LLC to Jill M. Peterson,
Assistant Secretary, Commission, dated June 7, 2021 (``PML
Letter''). Letters are available at the Commission's website at
https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008.htm.
    \6\ See letter from Robert McNamee, Associate General Counsel,
Office of General Counsel, FINRA, to Vanessa Countryman, Secretary,
Commission, dated Aug. 9, 2021 (``FINRA Letter''). The FINRA Letter
is available at the Commission's website at https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008-9125111-247215.pdf.
Amendment No. 1 is available at https://www.finra.org/sites/default/files/2021-08/SR-FINRA-2021-008-Amendment_1.pdf.
    \7\ See Exchange Act Release No. 92617 (Aug. 9, 2021), 86 FR
44761 (Aug. 13, 2021) (File No. SR-FINRA-2020-008) (``OIP'').
    \8\ See Letters from Anonymous dated Aug. 10, 2021; Blake
Daniels dated Aug. 10, 2021, Tristan Kifer dated Aug. 10, 2021; and
Eileen Loh dated Aug. 10, 2021 (``Letters''). Letters are available
at the Commission's website at https://www.sec.gov/comments/sr-finra-2021-008/srfinra2021008.htm.
    \9\ Letter from Robert McNamee, Assistant General Counsel,
Office of General Counsel, FINRA to Daniel Fisher, Division of
Trading and Markets, Commission dated September 30, 2021.
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II. Description of the Proposed Rule Change

A. Background

    Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Title VII'' or ``Dodd-Frank Act'') \10\ established a
comprehensive new regulatory framework for over-the-counter (``OTC'')
derivatives, commonly known in the industry as ``swaps.'' It divided
regulatory jurisdiction over swap products between the Commodity
Futures Trading Commission (``CFTC'') and the Commission, with the CFTC
regulating ``swaps'' and the SEC regulating SBS, and the SEC and the
CFTC regulating mixed swaps.\11\ The Dodd-Frank Act directed the SEC to
promulgate rulemakings implementing the new regulatory framework for
SBS, including rules requiring SBS Entities to register with the
Commission and to be subject to requirements related to business
conduct and supervision, documentation standards; recordkeeping and
financial reporting; and capital, and margin and segregation. The Dodd-
Frank Act also directed the Commission to promulgate rules applicable
to all market participants including requiring regulatory reporting and
public dissemination of SBS transaction information; and those creating
processes to require SBS to become subject to mandatory clearing and
execution on a registered or exempt execution facility or exchange.\12\
The Commission has now finalized a majority of these rulemakings.\13\
As of October 6, 2021, SBS Entities are permitted to register with the
Commission and are required to comply with the Title VII
rulemakings.\14\ The deadline for the initial wave of SBS Entity
registrations was November 1, 2021.
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    \10\ Public Law 111-203, 124 Stat. 1376 (2010).
    \11\ The terms ``swap'' and ``security-based swap'' are defined
in Sections 721 and 761 of the Dodd-Frank Act. The Commission and
the CFTC have jointly promulgated rules further defining these
terms. See Exchange Act Release No. 67453 (Jul. 18, 2012), 77 FR
48208 (Aug. 13, 2012) (Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping) (``Product
Definitions''). Very generally, SBS are swaps referencing a single
security or loan, or a narrow-based security index. Certain products
sharing characteristics of both swaps and SBS are regulated as
``mixed swaps'' subject to both CFTC and SEC jurisdiction.
    \12\ See Dodd-Frank Act Section 763.
    \13\ See Exchange Act Release No. 74244 (Feb. 11, 2015), 80 FR
14564 (Mar. 19, 2015) (Final Rule: Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information) (``Regulation SBSR
Release''); Exchange Act Release No. 75611 (Aug. 5, 2015), 80 FR
48964 (Aug. 14, 2015) (Final Rule: Registration Process for
Security-Based Swap Dealers and Major Security-Based Swap
Participants) (``Registration Process Release''); Exchange Act
Release No. 77617 (Apr. 14, 2016), 81 FR 29960 (May 13, 2016) (Final
Rule: Business Conduct Standards for Security-Based Swap Dealers and
Major Security-Based Swap Participants) (``Business Conduct
Standards Release''); Exchange Act Release No. 78011 (Jun. 8, 2016),
81 FR 39808 (Jun. 17, 2016) (Final Rule: Trade Acknowledgment and
Verification of Security-Based Swap Transactions) (``Trade
Acknowledgment and Verification Release''); Exchange Act Release No.
86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) (Final Rule:
Capital, Margin, and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap Participants and Capital
and Segregation Requirements for Broker-Dealers) (``Capital, Margin,
and Segregation Release''); Exchange Act Release No. 87005 (Sep. 19,
2019), 84 FR 68550 (Dec. 16, 2019) (Final Rule: Recordkeeping and
Reporting Requirements for Security-Based Swap Dealers, Major
Security-Based Swap Participants, and Broker-Dealers)
(``Recordkeeping Release''); Exchange Act Release No. 87780 (Dec.
18, 2019), 85 FR 6270 (Feb. 4, 2020) (Final Rules; Guidance: Rule
Amendments and Guidance Addressing Cross-Border Application of
Certain Security-Based Swap Requirements) (``Cross-Border
Release''); Exchange Act Release No. 87782 (Dec.18, 2019), 85 FR
6359 (Feb. 4, 2020) (Final Rule: Risk Mitigation Techniques for
Uncleared Security-Based Swaps) (``Risk Mitigation Release'').
    \14\ See Notice at 26085.
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    Title VII also amended the definition of ``security'' under the
Exchange Act to expressly encompass SBS.\15\ Therefore,

in addition to the comprehensive new SBS-specific regulatory framework
discussed above, SBS are now also defined as securities under the
Exchange Act and the rules thereunder. As a result, according to FINRA,
any FINRA rule applicable to FINRA members' activities involving a
security, securities business, a transaction involving a security or a
securities position would apply to those activities involving SBS.\16\
Consistent with the SEC's actions in this area, on July 8, 2011, FINRA
filed for immediate effectiveness FINRA Rule 0180, which, with certain
exceptions noted below, temporarily limits the application of FINRA
rules with respect to SBS.\17\ This rule is currently set to expire on
February 6, 2022.\18\
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    \15\ See Dodd-Frank Act Section 761(a)(2) (inserting ``security-
based swap'' in the definition of ``security'' in Section 3(a)(10)
of the Exchange Act); see also 15 U.S.C. 78c(a)(10).
    \16\ See Notice at 26085.
    \17\ See Exchange Act Release No. 64884 (Jul. 14, 2011), 76 FR
42755 (Jul. 19, 2011) (Notice of Filing and Immediate Effectiveness
of File No. SR-FINRA-2011-033). To allow sufficient time to consider
the complex interpretative issues resulting from defining SBS as
securities, the Commission also issued a number of temporary
exemptive orders relating to the regulation of SBS as securities,
all of which have either expired or been made permanent now that the
October 6, 2021, registration compliance date for the Commission's
SBS regulatory framework has passed. See Exchange Act Release No.
92837 (Sep. 1, 2021), 86 FR 50391 (Sep. 8, 2021) (Notice of Filing
and Immediate Effectiveness of File No. SR-FINRA-2021-021)
(``Extension Notice'').
    \18\ FINRA has extended the expiration date of FINRA Rule 0180 a
number of times, most recently in September 2021. See, e.g.,
Extension Notice, supra note 17.
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    Current FINRA Rule 0180 broadly excepts SBS activities from most
FINRA rules. Specifically, FINRA Rule 0180(a) provides that FINRA rules
shall not apply to members' activities and positions with respect to
SBS, except for: (i) FINRA Rule 2010 (Standards of Commercial Honor and
Principles of Trade); (ii) FINRA Rule 2020 (Use of Manipulative,
Deceptive or Other Fraudulent Devices); (iii) FINRA Rule 3310 (Anti-
Money Laundering Compliance Program); and (iv) FINRA Rule 4240 (Margin
Requirements for Credit Default Swaps).\19\ In addition, FINRA Rule
0180(b) provides that the following rules apply to members' activities
and positions with respect to SBS only to the extent they would have
applied as of July 15, 2011 (i.e., the day before the effective date of
Title VII): (i) NASD Rule 3110 (Supervision) and all successor FINRA
Rules to such NASD Rule; (ii) the FINRA Rule 4500 Series (Books,
Records, and Reports); and (iii) the FINRA Rule 4100 Series (Financial
Condition). Finally, FINRA Rule 0180(c) provides that certain other
rules apply as necessary to effectuate members' compliance with
paragraphs (a) and (c) of the rule.
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    \19\ FINRA Rule 4240 establishes an interim pilot program with
respect to margin requirements for any transactions in credit
default swaps (``CDS'') held in an account at a FINRA member. The
interim pilot program under FINRA Rule 4240 will expire on April 6,
2022. See id.; see also FINRA Rule 4240(a). FINRA Rule 4240
Supplementary Material .02 clarifies that the rule does not apply to
a member that is registered with the Commission as an SBSD. See id.
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    In light of the Commission's October 6, 2021, registration
compliance date, FINRA proposed in April 2021 to amend FINRA Rules
0180, 4120, 4210, 4220, 4240 and 9610 to clarify the application of
FINRA rules to members' SBS activities after the Commission's
registration compliance date. These proposed amendments would: (1)
Adopt a permanent FINRA Rule 0180 to replace the temporary rule set to
expire on February 6, 2022; (2) amend FINRA's financial responsibility
and operational rules to conform to the SEC's amendments to its
capital, margin and segregation requirements for SBSDs and broker-
dealers, and to otherwise take into account members' SBS activities;
(3) adopt a new margin rule specifically applicable to SBS, replacing
the expiring interim pilot program establishing margin requirements for
CDS; and (4) amend Rule 9610 to permit FINRA to exempt members from
Rule 0180 under the process set forth in FINRA's Rule 9600 series
(Procedures for Exemptions).

B. Proposed Rule 0180 (Application of FINRA Rules to Security-Based
Swaps)

    Proposed Rule 0180(a) would provide that FINRA rules generally
apply to members' SBS activities unless otherwise specifically
excepted. This would reverse the presumption of the applicability of
FINRA rules to members' SBS activities in the current, expiring
temporary Rule 0180, which generally does not apply FINRA rules unless
otherwise specified.
    Proposed Rule 0180 paragraphs (b) through (g) would then specify
the exceptions from the general presumption of applicability of FINRA
rules in proposed Rule 0180(a). These proposed exceptions fall into
three general categories: (1) General exceptions based on
impracticability or operational burdens; (2) exceptions for SBS
Entities already registered with the Commission and associated persons
of SBS Entities; and (3) exceptions in connection with the conditions
to the SEC's cross-border SBS counting exception. Proposed FINRA Rule
0180(i) would further authorize FINRA to exempt a person from the
application of specific FINRA rules to SBS on a case-by-case basis,
pursuant to the existing procedural framework set forth in the FINRA
Rule 9600 series and as FINRA deems appropriate consistent with the
protection of investors and the public interest.

C. Proposed Rule 0180(b) (General Exceptions From Applicability of
FINRA Rules)

    Proposed Rule 0180(b) would provide that the following FINRA rules
shall not apply to members' activities and positions with respect to
SBS: (1) The Rule 6000 Series (Quotation, Order, and Transaction
Reporting Facilities); (2) the Rule 7000 Series (Clearing, Transaction,
and Order Data Requirements, and Facility Charges); and (3) the Rule
11000 Series (the Uniform Practice Code or ``UPC''). The Rule 6000 and
7000 Series include rules relating to trading, quoting, clearing, and
reporting for securities other than SBS (e.g., NMS stocks and over-the-
counter equity securities), and therefore are not applicable to
members' SBS activities.
    According to FINRA, the UPC, contained in the Rule 11000 Series, is
a series of rules, interpretations and explanations designed to make
uniform, where practicable, custom, practice, usage, and trading
technique in the investment banking and securities business,
particularly with regard to operational and settlement issues.\20\ The
Rule 11000 Series contains, for example, rules addressing matters
relating to the delivery of securities, certificated security matters,
delivery of bonds, and close-out procedures.\21\ According to FINRA,
the UPC was created to simplify and facilitate cash securities
transactions.\22\
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    \20\ See Notice at 26088.
    \21\ Id.
    \22\ See id.
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    By its terms, the UPC applies to all OTC secondary market
transactions in securities between members, with enumerated
exceptions.\23\ FINRA believes that, as a result, the UPC could be
interpreted as applying to SBS transactions in a limited set of
circumstances--e.g., an SBS transaction between two FINRA members.\24\
FINRA further believes that because the UPC could only be invoked for a
small portion of the SBS market--particularly

given that FINRA expects only a small number of its members to register
as SBSDs or otherwise engage in SBS activities--applying the UPC to
members' SBS activities has the potential to create confusion and
uncertainty in the SBS market.\25\ Because SBS transactions involve
bilateral contractual negotiations, often utilizing industry-standard
SBS documentation, FINRA believes that the operational and settlement
risks of SBS transactions are more appropriately addressed through
other means, including standardized contractual provisions in that
industry documentation, as well as, where applicable, the Commission's
risk mitigation requirements.\26\
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    \23\ See FINRA Rule 11100(a). Under FINRA Rule 11100(a)(1),
transactions in securities between members which are compared,
cleared or settled through the facilities of a registered clearing
agency are not subject to the UPC, except to the extent that the
rules of the clearing agency provide that rules of other
organizations shall apply. Paragraphs (a)(2) through (a)(5) of FINRA
Rule 11100 also provide exceptions for specific types of securities,
including exempted securities, municipal securities, redeemable
securities issued by investment companies and Direct Participation
Program Securities.
    \24\ See Notice at 26088.
    \25\ Id.
    \26\ Id. at 26089.
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D. Proposed Rule 0180(c) and (d) (Exceptions for Registered SBS
Entities and Associated Persons)

    As discussed above, the Title VII rulemakings completed by the
Commission, including business conduct standards, trade acknowledgement
and verification requirements, risk mitigation techniques for uncleared
SBS, and recordkeeping rules for SBS Entities, are now in effect for
SBS Entities, which are now required to be registered with the
Commission unless their dealing activity is below the de minimis
registration threshold.\27\ As described below, certain of these new
SBS-specific Commission rules are analogous to existing, generally
applicable FINRA rules. Where the Commission has promulgated analogous
rules applicable to registered SBS Entities, FINRA has proposed to
provide exceptions from its rules for SBS Entities registered with the
Commission and, in certain circumstances, associated persons of those
SBS Entities.\28\
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    \27\ See Business Conduct Standards Release; Trade
Acknowledgment and Verification Release; Risk Mitigation Release;
Recordkeeping Release, supra note 13.
    \28\ Id. at 26089.
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    Proposed Rules 0180(c) and (d) would provide exceptions to
specified FINRA rules for FINRA members that are also registered as SBS
Entities with the Commission or the associated person of the member,
where two conditions are satisfied: (1) The SBS Entity or associated
person is acting in the capacity of an SBS Entity or associated person
of that SBS Entity; and (2) the activities or positions relate to the
business of the SBS Entity within the meaning of Exchange Act Rule
15Fh-3(h)(1) (addressing supervisory obligations of SBS Entities).\29\
The proposed exceptions are for FINRA rules that FINRA believes are
analogous to SEC business conduct requirements,\30\ and are limited to
the members' SBS business and conditioned upon the application of the
SEC's supervision rule for SBS Entities.\31\
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    \29\ See 17 CFR 240.15Fh-3(h)(1). The exceptions in Rule 0180(c)
would apply to both SBSDs and MSBSPs or their associated persons,
while the exceptions in Rule 0180(d) would apply only to SBSDs or
their associated persons (and not MSBSPs or their associated
persons).
    \30\ See Notice at 26089.
    \31\ 17 CFR 240.15Fh-3(h)(1).
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    Under proposed FINRA Rules 0180(c) and (d), these proposed
exceptions would be available for eight FINRA rules that FINRA believes
are analogous to SEC rules, subject to the conditions described above.
Specifically, proposed FINRA Rule 0180(c) would provide exceptions for
the following five FINRA rules, for registered SBS Entities and their
associated persons: \32\
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    \32\ See Notice at 26089.
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     FINRA Rule 2210(d) (Communications with the Public--
Content Standards). Among other things, FINRA Rule 2210(d) requires
that member communications be based on principles of fair dealing and
good faith, be fair and balanced, and not omit any material facts or
make false or exaggerated claims. FINRA believes that this rule is
analogous to Exchange Act Rule 15Fh-3(g), which requires SBS Entities
to, among other things, communicate with counterparties in a fair and
balanced manner.\33\
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    \33\ See Notice at 26089-90; see also 17 CFR 240.15Fh-3(g);
Business Conduct Standards Release at 30000-02.
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     FINRA Rule 2232 (Customer Confirmations) generally
requires members to provide customers with written confirmations in
conformity with Exchange Act Rule 10b-10,\34\ along with specified
additional disclosures for certain types of securities. FINRA believes
this is analogous to Exchange Act Rule 15Fi-2, which requires SBS
Entities to provide trade acknowledgements and to establish, maintain
and enforce written policies and procedures reasonably designed to
obtain prompt verification of the terms of such trade
acknowledgments.\35\
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    \34\ See 17 CFR 240.10b-10; see also Notice at 26089-90.
    \35\ See 17 CFR 240.15Fi-2; see generally Trade Acknowledgment
and Verification Release, supra note 13.
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     FINRA Rules 3110 (Supervision), 3120 (Supervisory Control
System) and 3130 (Annual Certification of Compliance and Supervisory
Processes) require, among other things, each member to establish and
maintain a supervisory system; establish, maintain and enforce written
supervisory procedures; designate principals to establish, maintain and
enforce a system of supervisory control policies and procedures;
designate a chief compliance officer; and submit annual certifications
to FINRA related to the member's compliance policies and written
supervisory procedures. FINRA believes this is analogous to the
supervision rule for SBS Entities in Exchange Act Rule 15h-3(h), which
requires, among other things, an SBS Entity to establish and maintain a
system to supervise, and to diligently supervise, its business and the
activities of its associated persons; designation of at least one
person with authority to carry out supervisory responsibilities; and
establishment, maintenance and enforcement of written policies and
procedures addressing supervision of the SBS Entity's SBS business.\36\
Additionally, Exchange Act Rule 15Fk-1 requires each SBS Entity to
designate a chief compliance officer and submit annual compliance
reports to the SEC.\37\
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    \36\ See Notice at 26089-90.
    \37\ See 17 CFR 240.15Fk-1.
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    In addition, proposed FINRA Rule 0180(d) would provide exceptions
for the following three FINRA Rules for registered SBSDs and their
associated persons, but not MSBSPs: \38\
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    \38\ See Notice at 26089.
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     FINRA Rule 2030 (Engaging in Distribution and Solicitation
Activities with Government Entities) is FINRA's ``pay-to-play'' rule,
which imposes restrictions on member firms engaging in distribution or
solicitation activities with government entities. FINRA believes that
Exchange Act Rule 15Fh-6 imposes analogous restrictions.\39\
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    \39\ See id. at 26089-90; see also 17 CFR 240.15Fh-6; Business
Conduct Standards Release at 30045-50.
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     FINRA Rule 2090 (Know Your Customer) generally requires
that each member use reasonable diligence to know and retain essential
facts concerning every customer and the authority of each person acting
on behalf of such customer. FINRA believes this rule is analogous to:
Exchange Act Rule 15Fh-3(a), which generally requires SBS Entities to
verify the status of their SBS counterparties, including verification
that the counterparty is an eligible contract participant and whether
the counterparty is a ``special entity;'' \40\ and to Exchange Act Rule
15Fh-3(e), which requires each SBSD to

establish, maintain and enforce written policies and procedures
reasonably designed to obtain and retain a record of the essential
facts concerning each counterparty whose identity is known to the SBSD
that are necessary for conducting business with such counterparty.\41\
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    \40\ See Notice at 26089-90. ``Special entity'' is defined in
Exchange Act Rule 15Fh-2(d) and includes certain government
entities, employee benefit plans and endowments. See 17 CFR
240.15Fh-2(d).
    \41\ See Notice at 26089-90; see 17 CFR 240.15Fh-3(e).
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     FINRA Rule 2111 (Suitability) generally requires a member
or associated person to have a reasonable basis that a recommended
transaction or investment strategy is suitable for at least some
investors as well as for the customer receiving the recommendation.
FINRA believes it is analogous to Exchange Act Rule 15Fh-3(f), which
imposes suitability obligations on SBSDs with respect to
recommendations of SBS or trading strategies involving SBS.\42\ In
addition, Exchange Act Rule 15Fh-5 applies special, enhanced
requirements when SBS Entities act as counterparties to special
entities.\43\
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    \42\ See Notice at 26090; see 17 CFR 240.15Fh-3(f).
    \43\ See Notice at 26091; see 17 CFR 240.15Fh-5.
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E. Proposed Rule 0180(e) (Exceptions in Connection With Arranging,
Negotiating, and Executing Activity)

    Proposed Rule 0180(e) would provide that the following FINRA rules
shall not apply to members' activities and positions with respect to
SBS, to the extent that the member or the associated person of the
member, as applicable, is arranging, negotiating or executing SBS on
behalf of a non-U.S. affiliate pursuant to, and in compliance with, the
conditions of, Exchange Act Rule 3a71-3(d)(1): \44\ (1) FINRA Rule 2111
(Suitability); (2) FINRA Rule 2210(d) (Communications with the Public--
Content Standards); and (3) FINRA Rule 2232 (Customer
Confirmations).\45\ The availability of the exceptions under proposed
FINRA Rule 0180(e) would require the member's compliance with the
conditions specified in Exchange Act Rule 3a71-3(d)(1)(ii)(B) as if the
member were the counterparty to the SBS transactions (as opposed the
non-U.S. affiliate).\46\
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    \44\ See 17 CFR 240.3a71-3(d)(1). Rule 3a71-3(d)(1) provides an
exception from counting certain SBS transactions against the
thresholds associated with the de minimis exception to the SBSD
definition. See id.
    \45\ FINRA believes these proposed exceptions are appropriate
for similar reasons as the proposed exceptions for SBS Entities in
proposed FINRA Rules 0180(c) and (d). See Notice at 26093, n.64.
    \46\ A member acting as the U.S. Registered Affiliate under
Exchange Act Rule 3a71-3(d) would remain subject to all other FINRA
rules applicable to such SBS brokerage activity. See supra note 44.
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    In connection with finalizing certain Title VII rulemakings, the
SEC also adopted a number of rules and provided guidance to address the
cross-border application of various SBS requirements. One of these
rules, Exchange Act Rule 3a71-3(d), provides a conditional exception to
the provisions of Exchange Act Rule 3a71-3 that otherwise would require
non-U.S. persons to count--against the thresholds associated with the
de minimis exception to the SBSD definition--SBS dealing transactions
between non-U.S. counterparties when U.S. personnel arrange, negotiate
or execute those transactions.\47\ To qualify for this exception, all
such arranging, negotiating or executing activity must, among other
things, be conducted by U.S. personnel in their capacity as persons
associated with a registered broker that meets certain capital
requirements, or a registered SBSD, in each case so long as such entity
is a majority-owned affiliate of the non-U.S. person relying on the
exception (the ``U.S. Registered Affiliate'').\48\ The U.S. Registered
Affiliate also must comply with certain rules applicable to SBSDs with
respect to such SBS transactions as if the counterparties to the non-
U.S. person relying on the exception also were counterparties to the
U.S. Registered Affiliate and as if the U.S. Registered Affiliate were
registered as an SBSD, if not so registered.\49\
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    \47\ See 17 CFR 240.3a71-3(d); Cross-Border Release at 6276-92.
    \48\ See 17 CFR 240.3a71-3(d)(1)(i).
    \49\ See 17 CFR 240.3a71-3(d)(1)(ii)(A).
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    Specifically, Exchange Act Rule 3a71-3(d)(1)(ii)(B) requires the
U.S. Registered Affiliate to comply with, as a condition of the
exception: (1) Section 15F(h)(3)(B)(i) and (ii) of the Exchange Act and
Rule 15Fh-3(b) thereunder (disclosures of material risks and
characteristics and material incentives or conflicts of interest), (2)
Exchange Act Rule 15Fh-3(f)(1) (recommendations and suitability),\50\
(3) Section 15F(h)(3)(C) of the Exchange Act and Rule 15Fh-3(g)
thereunder (fair and balanced communications); and (4) Exchange Act
Rule 15Fi-2 (acknowledgement and verification of SBS transactions) and
the underlying definitions in Exchange Act Rule 15Fi-1.\51\ FINRA
believes it is appropriate to provide exceptions from the parallel
FINRA rules to provide clarity and avoid unnecessary regulatory
duplication, but only where the member is in fact complying with the
rules specified in Exchange Act Rule 3a71-3(d)(1)(ii)(B).\52\
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    \50\ Rule 3a71-3(d)(1)(ii)(B)(2) does contain a limited
exception from the requirement to comply with Exchange Act Rule
15Fh-3(f)(1). Specifically, if the U.S. Registered Entity reasonably
determines that the counterparty to whom it recommends an SBS or
trading strategy involving an SBS is an ``institutional
counterparty'' as defined in Exchange Act Rule 15Fh-3(f)(4), the
registered entity instead may fulfill its obligations under Rule
15Fh-3(f)(1)(ii) if it discloses to the counterparty that it is not
undertaking to assess the suitability of the SBS or trading strategy
involving an SBS for the counterparty.
    \51\ See 17 CFR 240.3a71-3(d)(1)(ii)(B).
    \52\ See Notice at 26093.
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F. Proposed Rule 0180(f) (Exceptions From Rules 2231, Customer Account
Statements, and 4512, Customer Account Information)

    Proposed FINRA Rule 0180(f) would provide that FINRA Rules 2231
(Customer Account Statements) and 4512 (Customer Account Information)
shall not apply to members' activities and positions with respect to
SBS, to the extent that the member is acting in its capacity as an SBS
Entity and the customer's account solely holds SBS and collateral
posted as margin in connection with such SBS, provided that the member
complies with the portfolio reconciliation requirements of Exchange Act
Rule 15Fi-3 with respect to such account and that such portfolio
reconciliations include collateral posted as margin in connection with
SBS in the account. FINRA Rule 2231 generally requires each member to
provide, on at least a quarterly basis, an account statement to each
customer containing a description of any securities positions, money
balances or account activity during the period since the last customer
account statement. FINRA Rule 4512 generally requires each member to
maintain specified information for each customer account, including
specified identifying information about the customer.
    FINRA believes that the customer account statements required under
FINRA Rule 2231 generally should reflect a holistic view of a member's
relationship with its customer, including SBS transactions, positions
and related collateral, if applicable.\53\ Therefore, to the extent
that a customer's account includes SBS along with other securities
positions or activity, or related money balances, then FINRA believes
that the account statement under FINRA Rule 2231 should include
SBS.\54\ However, FINRA understands that members that are also
registered as SBS Entities may have customer accounts that hold solely
SBS and related collateral, and do not hold any other securities
positions or have

any other securities activity.\55\ While SBS Entities are not subject
to a customer account statement requirement with respect to SBS,
Exchange Act Rule 15Fi-3 includes requirements applicable to SBS
Entities with respect to engaging in portfolio reconciliation with
applicable counterparties on a periodic basis, which the Commission
adopted as part of a broader set of risk mitigation requirements for
SBS Entities.\56\
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    \53\ Id. at 26091.
    \54\ Id.
    \55\ Id.
    \56\ See 17 CFR 240.15Fi-3; Risk Mitigation Release at 6362-70.
For purposes of Exchange Act Rule 15Fi-3, ``portfolio
reconciliation'' is defined as ``any process by which counterparties
to one or more SBS'' (1) exchange the material terms of all SBS in
the SBS portfolio between the counterparties, (2) exchange each
counterparty's valuation of each SBS in the SBS portfolio between
the counterparties as of the close of business on the immediately
preceding day and (3) resolve any discrepancy in valuations or
material terms. See 17 CFR 240.15Fi-1(l).
---------------------------------------------------------------------------

    Exchange Act Rule 15Fi-3(a) generally requires SBS Entities to
engage in portfolio reconciliation for all SBS with their SBS Entity
counterparties, with the frequency of such portfolio reconciliations
based on the size of the SBS portfolio with the applicable
counterparty, ranging from once each business day (for SBS portfolios
that include 500 or more SBS), to once each week (for SBS portfolios
that include more than 50 but fewer than 500 SBS on any business day
during the week), to once each calendar quarter (for SBS portfolios
that include no more than 50 SBS at any time during the calendar
quarter).\57\ Exchange Act Rule 15Fi-3(b) requires each SBS Entity to
establish, maintain, and follow written policies and procedures
reasonably designed to ensure that it engages in portfolio
reconciliation for all SBS with non-SBS Entity counterparties, with the
frequency of such portfolio reconciliations ranging from once each
calendar quarter (for SBS portfolios that include more than 100 SBS at
any time during the calendar quarter) to once annually (for SBS
portfolios that include no more than 100 SBS at any time during the
calendar year).\58\
---------------------------------------------------------------------------

    \57\ See 17 CFR 240.15Fi-3(a).
    \58\ See 17 CFR 240.15Fi-3(b).
---------------------------------------------------------------------------

    FINRA acknowledges that the portfolio reconciliation requirements
in Exchange Act Rule 15Fi-3 differ in some respects from the customer
account statement requirements under FINRA Rule 2231.\59\ For example,
the frequency of portfolio reconciliations varies as described above,
while customer account statements must be delivered at least quarterly.
In addition, as described above, an SBS Entity must have policies and
procedures in place to ensure that it engages in portfolio
reconciliation with non-SBS Entity counterparties, while a member must
provide a customer account statement to each customer unless a specific
exception under FINRA Rule 2231(b) applies. However, FINRA believes
that, while not identical, Exchange Act Rule 15Fi-3 serves analogous
purposes to FINRA Rule 2231, such that requiring members that are SBS
Entities to also provide customer account statements for accounts
holding solely SBS and related collateral would be unnecessarily
duplicative.\60\ Accordingly, FINRA believes to promote regulatory
clarity and avoid unnecessary duplication, proposed FINRA Rule 0180(f)
would provide an exception from FINRA Rule 2231 in the limited
circumstances where the member is acting in its capacity as an SBS
Entity and the account holds solely SBS and collateral posted as margin
in connection with such SBS.\61\ FINRA states that collateral in a
customer's account would be included in account statements provided
under FINRA Rule 2231.\62\ Therefore, in FINRA's view, the proposed
rule change includes as a condition to the proposed exception that the
member comply with Exchange Act Rule 15Fi-3 with respect to an account
qualifying for the exception and include collateral in the portfolio
reconciliation and dispute resolutions requirements as applied to such
an account.\63\
---------------------------------------------------------------------------

    \59\ See Notice at 26091.
    \60\ Id.
    \61\ Id.
    \62\ Id.
    \63\ Id.
---------------------------------------------------------------------------

    SBS Entities also are subject to Exchange Act Rule 15Fi-5, which
requires them to establish, maintain, and follow written policies and
procedures reasonably designed to ensure that it executes written SBS
trading relationship documentation with each of its counterparties
prior to, or contemporaneously with, executing an SBS with any
counterparty.\64\ In addition, SBS Entities that are also registered
broker-dealers are subject to the SEC's recordkeeping requirements
under Exchange Act Rule 17a-3, which require, among other things,
certain records to be kept for each SBS account.\65\ These SEC rules
generally require SBS Entities to obtain and keep records of certain
information in connection with their SBS accounts, including SBS-
specific identifying information. FINRA believes that, while not
identical to FINRA Rule 4512, these SEC rules serve analogous purposes,
and that also applying FINRA Rule 4512 to SBS-only accounts would be
duplicative.\66\ Accordingly, in order to promote regulatory clarity
and avoid unnecessary duplication, FINRA believes it is appropriate to
provide an exception from FINRA Rule 4512 in the limited circumstances
where the member is acting in its capacity as an SBS Entity and the
account solely holds SBS and collateral posted as margin in connection
with such SBS.\67\ Both exceptions under proposed FINRA Rule 0180(f)
would not apply to accounts holding SBS together with other securities
or to members that are not also registered SBS Entities.
---------------------------------------------------------------------------

    \64\ See 17 CFR 240.15Fi-5; Risk Mitigation Release at 6372-
6377. Such documentation also must include all terms governing the
trading relationship between the SBS Entity and its counterparty,
including, without limitation, certain terms specified in the rule.
SBS Entities are also required to maintain records of SBS trading
relationship documentation. See 17 CFR 17a-4(e)(12)(ii).
    \65\ See 17 CFR 240.17a-3; see generally Recordkeeping Release,
supra note 13. FINRA states in particular Exchange Act Rule 17a-
3(a)(9)(iv), which requires an SBS Entity to keep a record, for each
SBS account, of the unique identification code of the counterparty,
the name and address of the counterparty, and a record of the
authorization of each person the counterparty has granted authority
to transact business in the SBS account. See 17 CFR 240.17a-
3(a)(9)(iv).
    \66\ See Notice at 26092.
    \67\ Id.
---------------------------------------------------------------------------

G. Proposed Rule 0180(g) (Exception From FINRA Registration for Certain
Associated Persons of Registered SBS Entities)

    Proposed FINRA Rule 0180(g) would provide that persons associated
with a member whose functions are related solely and exclusively to
SBS, and undertaken in such person's capacity as an associated person
of an SBS Entity, are not required to be registered with FINRA.\68\
Generally, FINRA Rule 1210 requires that each person engaged in the
investment banking or securities business of a member must be
registered with FINRA as a representative or principal in each category
of registration appropriate to his or her functions and
responsibilities as specified in FINRA Rule 1220. Individuals seeking
to become registered with FINRA generally must pass an appropriate
qualification examination, and registered individuals are subject to
continuing education (``CE'') requirements under FINRA Rule

1240.\69\ The exception from registration would apply only to
individuals engaged solely in SBS activities on behalf of the SBS
Entity (and potentially non-securities activities, such as swaps).\70\
Under FINRA's proposed exception, if an associated person of the SBS
Entity engaged in any other securities activities in addition to SBS,
that individual must register with FINRA in accordance with FINRA Rule
1210.\71\ Associated persons of members that are not registered SBS
Entities would also still be required to register with FINRA, even if
those individuals engage solely in SBS activities.\72\ Additionally,
although individuals qualifying for the proposed exception would not be
required to register with FINRA, they would remain associated persons
of the member subject to all FINRA and SEC rules applicable to such
associated persons, including fingerprinting requirements under
Exchange Act Rule 17f-2.\73\
---------------------------------------------------------------------------

    \68\ This proposed exception is structured similarly to existing
exceptions from registration for persons associated with a member
whose functions are related solely and exclusively to certain other
product types (such as municipal securities, commodities or security
futures), as found in FINRA Rule 1230.
    \69\ See Notice at 26092.
    \70\ Id.
    \71\ Id.
    \72\ FINRA states that associated persons of SBS Entities are
not independently subject to registration, licensing or CE
requirements. See id. at 26109, n.58. However, an SBS Entity is
prohibited from permitting an associated person that is subject to a
statutory disqualification to effect or be involved in effecting SBS
on behalf of the SBS Entity. See 15 U.S.C. 78o-10(b)(6). The SEC's
SBS Entity registration rules also require an SBS Entity to certify
that it neither knows, nor in the exercise of reasonable care should
have known, of any such statutory disqualification. Such
certifications must be supported by questionnaires or employment
applications serving as the basis for background checks. See 17 CFR
240.15Fb6-2; Registration Process Release at 48973-79.
    \73\ See 17 CFR 240.17F-2.
---------------------------------------------------------------------------

    FINRA stated that it structured this exception similarly to
existing exceptions from registration for persons associated with a
member whose functions are related solely and exclusively to certain
other product types (such as municipal securities, commodities or
security futures).\74\ FINRA also stated that it based the proposed
exception in Rule 0180(g) on its analysis of existing registration and
related requirements, and its understanding that the number of
associated persons that would qualify for the exception is limited.\75\
FINRA stated that it will monitor developments with respect to the SBS
activities of its members and will continue to consider whether it
would be appropriate to tailor the registration and related
requirements to SBS, for example through targeted SBS-related
registration categories or the addition of SBS-specific content to
qualification examinations or CE content.\76\ FINRA stated that it will
consider whether it would be appropriate to rescind the exception under
proposed FINRA Rule 0180(g) in such circumstances.\77\
---------------------------------------------------------------------------

    \74\ See Notice at 26092, n.57; see also FINRA Rule 1230.
    \75\ See Notice at 26092.
    \76\ Id.
    \77\ Id.
---------------------------------------------------------------------------

H. Proposed Rule 0180(i) (Authority To Grant Exemptions From the
Application of Rule 0180 Upon Member Application) and 9610 (Application
for Exemptive Relief)

    Proposed FINRA Rule 0180(i) would provide that, pursuant to the
FINRA Rule 9600 Series (Procedures for Exemptions), FINRA may, taking
into consideration all relevant factors, exempt a person
unconditionally or on specified terms from the application of FINRA
rules (other than an exemption from the general application of proposed
FINRA Rule 0180(a)) to the person's SBS activities or positions, as it
deems appropriate, consistent with the protection of investors and the
public interest.\78\ FINRA believes it is appropriate and in the public
interest to provide this exemptive authority so that FINRA can account
for specific situations that may arise with respect to SBS in the
future on a case-by-case basis.\79\ In formulating the proposed rule
change, FINRA stated that it consulted with its members and reviewed
its rulebook to determine whether continuing exceptions from any of its
rules are appropriate.\80\ FINRA stated that it is proposing FINRA Rule
0180(i) in recognition that the SBS market continues to evolve and that
particular circumstances may arise in which applying specific FINRA
rules not otherwise covered by the proposed exceptions to SBS
activities may not be appropriate or feasible.\81\
---------------------------------------------------------------------------

    \78\ See Notice at 26093.
    \79\ Id.
    \80\ Id.
    \81\ Id.
---------------------------------------------------------------------------

    As proposed, FINRA would consider written applications for
exemptive relief, on a rule-by-rule and member-by-member basis, under
the existing process set forth in FINRA Rule 9610.\82\ Rule 9610
requires a member seeking exemptive relief to file a written
application with the appropriate department or staff of FINRA
containing, among other things, a detailed statement of the grounds for
granting an exemption from the application of a specific FINRA
rule.\83\ Pursuant to FINRA Rule 9620, FINRA staff is then required to
issue a written decision setting forth its findings and conclusions,
which may be made publicly available.\84\ A member would have the
ability to appeal such a decision pursuant to FINRA Rule 9630.\85\
FINRA stated that it expects to apply heightened scrutiny to
applications for exemptive relief from members that are not also
registered with the SEC as SBS Entities, and therefore not subject to
the SEC's regulatory framework for SBS.\86\ FINRA believes it is
appropriate and in the public interest to provide this exemptive
authority so that FINRA can account for specific situations that may
arise with respect to SBS in the future on a case-by-case basis.\87\
---------------------------------------------------------------------------

    \82\ Id.
    \83\ See FINRA Rule 9610(a) and (b).
    \84\ See Notice at 26093. FINRA would consider any such
application based on the specific circumstances described in the
application and whether the requested exemptive relief would be
consistent with the protection of investors and the public interest.
Id. at 26093, n.66.
    \85\ Id. at 26093.
    \86\ Id.
    \87\ Id.
---------------------------------------------------------------------------

    Finally, FINRA proposed a conforming change to Rule 9610 to add
Rule 0180 to the list of over 30 rules pursuant to which FINRA already
has exemptive authority.\88\
---------------------------------------------------------------------------

    \88\ See FINRA Rule 9610(a); see also Notice at 26093.
---------------------------------------------------------------------------

I. Financial Responsibility and Operational Requirements

    In June 2019, the Commission adopted final capital, margin and
segregation requirements for SBS Entities, along with amendments to the
existing capital and segregation requirements for broker-dealers, in
the Capital, Margin, and Segregation Release.\89\ As with other Title
VII rulemakings, the SEC aligned the compliance date for the amendments
under the Capital, Margin, and Segregation Release with the SBS Entity
registration compliance date.\90\ Among other things, the Capital,
Margin, and Segregation Release amended the existing net capital rule
for broker-dealers, Exchange Act Rule 15c3-1,\91\ in two key respects
relevant to FINRA's rules:
---------------------------------------------------------------------------

    \89\ See Capital, Margin, and Segregation Release, supra note
13.
    \90\ See id. at 43954.
    \91\ See 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

     First, the SEC adopted new minimum net capital
requirements for broker-dealers that are also registered as SBSDs, but
that do not operate pursuant to the alternative net capital (``ANC'')
requirements of Exchange Act Rule 15c3-1 (``Non-ANC Firms'').\92\ Non-

ANC Firms that are also registered as SBSDs must comply with a new
minimum dollar net capital requirement and a new component for
determining their minimum capital requirement that is based on a
percentage of initial margin computed for SBS (in addition to other
minimum requirements applicable to the broker-dealer).\93\ These
changes do not apply to broker-dealers that operate pursuant to the ANC
requirements of the rule (``ANC Firms''). These new minimum net capital
requirements also do not impact Non-ANC Firms that are not also
registered as SBSDs, regardless of whether such Non-ANC Firms engage in
SBS activities.\94\
---------------------------------------------------------------------------

    \92\ Generally, a broker-dealer may apply to the SEC for
authorization to use the alternative method for computing net
capital contained in Appendix E to Exchange Act Rule 15c3-1. See 17
CFR 240.15c3-1(a)(7). Such broker-dealers are known as ``ANC broker-
dealers.'' There are currently five approved ANC broker-dealers. See
SEC, Broker-Dealers Using the Alternative Net Capital Computation
under Appendix E to Rule 15c3-1, available at https://www.sec.gov/tm/broker-dealers-alternative-net-capital-computation. Other broker-
dealers are known as non-ANC broker-dealers and must compute net
capital pursuant to the provisions of Exchange Act Rule 15c3-1. See
Notice at 26093.
    \93\ See 17 CFR 240.15c3-1(a)(10).
    \94\ For example, the new minimum net capital requirements do
not apply to a Non-ANC Firm engaged in SBS dealing activity below
the de minimis threshold for SBSD registration, or to a Non-ANC Firm
engaged in SBS brokerage activity or entering into non-dealing SBS
transactions (e.g., hedging). FINRA stated that the SEC also adopted
new minimum capital requirements for MSBSPs, including that such
entities must at all times have and maintain a tangible net worth.
See Capital, Margin, and Segregation Release at 43906-07. FINRA does
not believe any changes to FINRA rules are necessary with respect to
the new MSBSP capital requirements. See Notice at 26094, n.71.
---------------------------------------------------------------------------

     Second, the SEC changed the minimum net capital
requirements for ANC Firms, regardless of whether they transact in SBS.
For ANC Firms, the SEC increased the minimum dollar net capital
requirement, added a new component for determining the minimum capital
requirement that is based on a percentage of initial margin computed
for SBS (in addition to other minimum requirements applicable to the
broker-dealer), increased the minimum tentative net capital requirement
and amended the early warning notification requirement for tentative
net capital.\95\
---------------------------------------------------------------------------

    \95\ See 17 CFR 240.15c3-1(a)(7).
---------------------------------------------------------------------------

    FINRA Rule 4120 (Regulatory Notification and Business Curtailment)
sets forth certain early warning notification and business curtailment
requirements if a member's capital falls below certain thresholds.
Specifically, FINRA Rule 4120(a) requires each carrying or clearing
member to notify FINRA if its net capital falls below certain specified
levels.\96\ FINRA Rule 4120(b) allows FINRA to restrict a member from
expanding its business in certain circumstances and FINRA Rule 4120(c)
allows FINRA to require a member to reduce its business if its net
capital falls below certain specified levels (generally lower than
those required for notification under FINRA Rule 4120(a)). According to
FINRA, these requirements are based on the minimum capital requirements
applicable to a member broker-dealer under Exchange Act Rule 15c3-
1.\97\ FINRA believes it is necessary to amend FINRA Rule 4120 to
conform the rule to the new and increased minimum capital requirements
for Non-ANC Firms that are also registered as SBSDs and for ANC Firms,
as described above.\98\
---------------------------------------------------------------------------

    \96\ As discussed below, FINRA also proposed to apply all
requirements in the FINRA Rule 4000 Series applicable to carrying or
clearing firms to members that act as principal counterparty to an
SBS, clear or carry an SBS, guarantee an SBS or otherwise have
financial exposure to an SBS. See Notice at 26094, n.73.
    \97\ See Notice at 26094.
    \98\ As noted above, the SEC did not amend Exchange Act Rule
15c3-1 to apply increased minimum capital requirements to Non-ANC
Firms that engage in SBS activities but that are not registered
SBSDs. FINRA is therefore not proposing to amend FINRA Rule 4120 to
impose any additional minimum thresholds on such members. However,
FINRA states that, as a general matter, FINRA Rule 4120 would apply
to all members that engage in SBS transactions (and any related
transactions) because net capital is a holistic calculation based on
a firm's liquid net worth, which includes all of a firm's
activities. See Notice at 26094, n.74.
---------------------------------------------------------------------------

    FINRA Rule 4120(a) requires each carrying or clearing firm to
promptly, but in any event within 24 hours, notify FINRA in writing if
its net capital falls below any of the percentages specified in
subparagraphs (A) through (F) of FINRA Rule 4120(a)(1). The proposed
rule change would modify subparagraph (D), which applies to ANC Firms,
and also add new subparagraph (E), applicable to Non-ANC Firm members
that are also registered as SBSDs.\99\
---------------------------------------------------------------------------

    \99\ The proposed rule change would also make non-substantive
and conforming changes to other subparagraphs of FINRA Rule 4120(a)
to reflect the insertion of new subparagraph (E), update cross-
references to SEC rules that have been amended and reflect FINRA
rulebook format conventions.
---------------------------------------------------------------------------

    Prior to the amendments in the Capital, Margin and Segregation
Release, Exchange Act Rule 15c3-1(a)(7)(i) required an ANC Firm to
maintain minimum tentative net capital of not less than $1 billion and
minimum net capital of not less than $500 million. In addition,
Exchange Act Rule 15c3-1(a)(7)(ii) required an ANC Firm to provide an
``early warning'' notice to the Commission when its tentative net
capital fell below $5 billion (or a lower threshold, if the Commission
has granted an ANC Firm's application to use such lower threshold).
Subparagraph (D) of FINRA Rule 4120(a) is based on these net capital
requirements, requiring notification to FINRA if the member is an ANC
Firm and (i) its tentative net capital under Exchange Act Rule 15c3-
1(c)(15) is less than 50 percent of the early warning notification
amount required by Exchange Act Rule 15c3-1(a)(7)(ii) or (ii) its net
capital is less than $1.25 billion. In other words, notification to
FINRA is required if an ANC Firm's tentative net capital falls below
$2.5 billion (or a lower amount, if the ANC Firm has been permitted to
use a lower early warning notice threshold), which is half of the SEC's
early warning notification amount, or its net capital falls below $1.25
billion, which is 2.5 times the SEC's net capital requirement for ANC
Firms.\100\
---------------------------------------------------------------------------

    \100\ See Notice at 26094.
---------------------------------------------------------------------------

    In the Capital, Margin, and Segregation Release, the Commission
amended the net capital requirements for ANC Firms in three ways.
First, the Commission raised the tentative net capital requirement for
ANC Firms from $1 billion to $5 billion. Second, the Commission raised
the minimum net capital requirement for ANC Firms from $500 million to
the greater of $1 billion or the sum of the applicable ratio
requirement under Exchange Act Rule 15c3-1(a)(1) \101\ and two percent
of the risk margin amount.\102\ Third, the Commission raised the
tentative net capital early warning notification threshold from $5
billion to $6 billion. In light of these increased capital requirements
under the Commission's net capital rule, FINRA believes it is
appropriate to also modify the thresholds for required notification to
FINRA for ANC Firms under FINRA Rule 4120(a)(1)(D).\103\ Specifically,
under the proposed rule change, an ANC Firm would be required to notify
FINRA if, in addition to the conditions currently prescribed under
FINRA Rule 4120(a)(1)(A), (E) and (F): \104\
---------------------------------------------------------------------------

    \101\ See 17 CFR 240.15c3-1(a)(7)(i)(A). Under Exchange Act Rule
15c3-1(a)(1)(i), a broker-dealer generally may not permit its
aggregate indebtedness to exceed 1500 percent of its net capital. A
broker-dealer may elect not to be subject to the aggregate
indebtedness standard if it complies with an alternative method of
computing net capital. See 17 CFR 240.15c3-1(a)(1)(ii).
    \102\ The ``risk margin amount'' means the total initial margin
for SBS. See 17 CFR 15c3-1(c)(17). Exchange Act Rule 15c3-
1(a)(7)(i)(A) provides that initially the requirement will be two
percent of the risk margin amount. However, the SEC may issue an
order raising the requirement to four percent on or after the third
anniversary of the amended rule's compliance date and to eight
percent on or after the fifth anniversary of the amended rule's
compliance date. See 17 CFR 15c3-1(a)(7)(i)(A)(2) and (3) and 15c3-
1(a)(7)(i)(B).
    \103\ See Notice at 26094.
    \104\ Id.

---------------------------------------------------------------------------

     Its tentative net capital is less than 150 percent of the
minimum tentative net capital amount required by Exchange Act Rule
15c3-1(a)(7)(i)(A) (i.e., $5 billion, such that the notification amount
would be $7.5 billion),
     the member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/10th of its aggregate indebtedness and 150
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of the level specified in
Exchange Act Rule 17a-11(b)(2) \105\ and 150 percent of the required
percentage of the risk margin amount.
---------------------------------------------------------------------------

    \105\ See 17 CFR 240.17a-11(b)(2). Exchange Act Rule 17a-11
requires broker-dealers to promptly notify the SEC after the
occurrence of certain events. Exchange Act Rule 17a-11(b)(2)
requires such notification for broker-dealers using the alternative
method of computing net capital pursuant to Exchange Act Rule 15c3-
1(a)(1)(ii) when net capital is less than five percent of aggregate
debit items under the Exchange Act Rule 15c3-3 reserve formula.
---------------------------------------------------------------------------

    FINRA believes these modified thresholds are appropriately
calibrated to provide FINRA with sufficient early warning that an ANC
Firm's capital levels may be deteriorating.\106\ By revising the early
warning levels as proposed, FINRA believes the proposed rule change
aligns the historical thresholds in FINRA Rule 4120(a) for early
warning notification for ANC Firms with the revised capital
requirements applicable to such firms under the Commission's amended
rules.\107\ Additionally, according to FINRA, ANC Firms historically
maintain capital far in excess of the proposed amounts, so FINRA does
not expect these levels to be problematic for firms to maintain.\108\
---------------------------------------------------------------------------

    \106\ See Notice at 26094.
    \107\ See Notice at 26094-95.
    \108\ Id. at 26095.
---------------------------------------------------------------------------

    In the Capital, Margin, and Segregation Release, the Commission
also adopted a new minimum net capital requirement for Non-ANC Firms
that are also registered as SBSDs.\109\ Specifically, a Non-ANC Firm
that is registered as an SBSD must maintain minimum net capital of not
less than the greater of $20 million or the sum of the ratio
requirements under Exchange Act Rule 15c3-1(a)(1) and two percent of
the risk margin amount.\110\ Accordingly, FINRA believes it is
necessary to add corresponding new thresholds for required notification
to FINRA for Non-ANC Firms that are also registered as SBSDs under new
FINRA Rule 4120(a)(1)(E).\111\ Specifically, under the proposed rule
change, a Non-ANC Firm that is also a registered SBSD would be required
to notify FINRA if, in addition to the conditions currently prescribed
under FINRA Rule 4120(a)(1)(A), (E) and (F):
---------------------------------------------------------------------------

    \109\ See 17 CFR 15c3-1(a)(10).
    \110\ See Notice at 26095.
    \111\ Id.
---------------------------------------------------------------------------

     The member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/10th of its aggregate indebtedness and 150
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of the level specified in
Exchange Act Rule 17a-11(b)(2) and 150 percent of the required
percentage of the risk margin amount.\112\
---------------------------------------------------------------------------

    \112\ Id.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for
early notification to FINRA based on the new minimum net capital
requirements for Non-ANC Firms that are registered SBSDs.\113\ FINRA
also believes that the thresholds described above are appropriately
calibrated to provide FINRA with sufficient early warning that such a
firm's capital levels may be deteriorating.\114\ By defining the early
warning levels as proposed, the proposed rule change, in FINRA's view,
aligns the historical thresholds in FINRA Rule 4120(a) for early
warning notification with the new capital requirements applicable to
Non-ANC Firms that are registered SBSDs under the SEC's amended
rules.\115\
---------------------------------------------------------------------------

    \113\ Id.
    \114\ Id.
    \115\ Id.
---------------------------------------------------------------------------

    FINRA Rule 4120(b) allows FINRA to require a member that carries
customer accounts or clears transactions to not expand its business
during any period in which any of the conditions described in paragraph
(a)(1) of FINRA Rule 4120 continue to exist for more than 15
consecutive business days, provided that such condition(s) has been
known to FINRA or the member for at least five consecutive business
days. Since the proposed rule change would modify the conditions
specified in FINRA Rule 4120(a)(1) as described above, the triggers for
the application of restrictions under FINRA Rule 4120(b) would be
similarly affected. However, FINRA does not believe that any conforming
changes are needed at this time to the restrictions on business
expansion requirements under FINRA Rule 4120(b).\116\ FINRA states that
FINRA Rule 4120(b)(3)(A)-(G) includes a non-exclusive list of
activities that may constitute an ``expansion of business'' for these
purposes, and FINRA Rule 4120(b)(3)(H) provides that the term
``expansion of business'' may include such other activities as FINRA
deems appropriate under the circumstances, in the public interest or
for the protection of investors. FINRA believes that a member firm's
SBS activities would be within the scope of ``other activities''
contemplated by FINRA Rule 4120(b)(3)(H).\117\
---------------------------------------------------------------------------

    \116\ Id.
    \117\ Id.
---------------------------------------------------------------------------

    FINRA Rule 4120(c) allows FINRA to require a member to reduce its
business if its net capital falls below any of the percentages
specified in subparagraphs (A) through (F) of FINRA Rule 4120(c)(1).
Similar to the proposed modifications to FINRA Rule 4120(a) described
above, the proposed rule change would modify subparagraph (D) of FINRA
Rule 4120(c)(1), which applies to ANC Firms, and also add new
subparagraph (E), applicable to Non-ANC Firm members that are also
registered as SBSDs.\118\
---------------------------------------------------------------------------

    \118\ The proposed rule change would also make non-substantive
and conforming changes to other subparagraphs of FINRA Rule
4120(c)(1) to reflect the insertion of new subparagraph (E), update
cross-references to SEC rules that have been amended and reflect
FINRA rulebook format conventions. Similar non-substantive changes
would be made to paragraph (b)(1) and Supplementary Material .01 to
FINRA Rule 4120 to reflect FINRA rulebook format conventions. See
id., n.87.
---------------------------------------------------------------------------

    Current subparagraph (D) of FINRA Rule 4120(c)(1) permits business
curtailment if the member is an ANC Firm and (i) its tentative net
capital under Exchange Act Rule 15c3-1(c)(15) is less than 40 percent
of the early warning notification amount required by Exchange Act Rule
15c3-1(a)(7)(ii) or (ii) its net capital is less than $1 billion. These
thresholds are based on the broker-dealer net capital rule prior to the
amendments in the Capital, Margin, and Segregation Release. As
described above, the Commission amended the net capital requirements
for broker-dealers in the Capital, Margin, and Segregation
Release.\119\ Accordingly, under the proposed rule change, a member
that is an ANC Firm would be subject to the business curtailment
provisions of FINRA Rule 4120(c)(1) if, in addition to the conditions
currently prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F):
---------------------------------------------------------------------------

    \119\ See Capital, Margin, and Segregation Release, supra note
13.

---------------------------------------------------------------------------

     Its tentative net capital is less than the amount
specified under Exchange Act Rule 15c3-1(a)(7)(ii) (i.e., the early
warning amount, $6 billion),
     The member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/12th of its aggregate indebtedness and 125
percent of the required percentage of the risk margin amount, or
     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of one percentage point below
the level specified in Exchange Act Rule 17a-11(b)(2) and 125 percent
of the required percentage of the risk margin amount.\120\
---------------------------------------------------------------------------

    \120\ See Notice at 26095.
---------------------------------------------------------------------------

    FINRA believes these modified thresholds are appropriately
calibrated to provide FINRA with the ability to require ANC Firms to
reduce their business when their capital levels have deteriorated to a
level that may jeopardize their ability to continue to comply with
their capital requirements.\121\
---------------------------------------------------------------------------

    \121\ Id.
---------------------------------------------------------------------------

    As described above, in the Capital, Margin, and Segregation
Release, the Commission also added a new minimum net capital
requirement for Non-ANC Firms that are also registered as SBSDs.
Accordingly, the proposed rule change would add corresponding new
thresholds for business curtailment for Non-ANC Firms that are also
registered as SBSDs under new FINRA Rule 4120(c)(1)(E). Specifically,
under the proposed rule change, a Non-ANC Firm that is also a
registered SBSD would be subject to the business curtailment provisions
of FINRA Rule 4120(c)(1) if, in addition to the conditions currently
prescribed under FINRA Rule 4120(c)(1)(A), (E) and (F):
     The member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/12th of its aggregate indebtedness and 125
percent of the required percentage of the risk margin amount,\122\ or
---------------------------------------------------------------------------

    \122\ See supra note 101.
---------------------------------------------------------------------------

     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of one percentage point below
the level specified in Exchange Act Rule 17a-11(b)(2) \123\ and 125
percent of the required percentage of the risk margin amount.\124\
---------------------------------------------------------------------------

    \123\ See supra note 105.
    \124\ See Notice at 26095.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for
business curtailment based on the new minimum net capital requirements
for Non-ANC Firms that are registered as SBSDs.\125\ FINRA also
believes that the thresholds described above are appropriately
calibrated to provide FINRA with the ability to require such firms to
reduce their business when their capital levels have deteriorated to a
level that may jeopardize their ability to continue to comply with
their capital requirements.\126\
---------------------------------------------------------------------------

    \125\ Id.
    \126\ Id. at 26096.
---------------------------------------------------------------------------

    Lastly, FINRA states that FINRA Rule 4120(c)(3)(A)-(J) includes a
non-exclusive list of activities that may constitute a ``business
reduction'' for these purposes, and FINRA Rule 4120(c)(3)(K) provides
that the term ``business reduction'' may include such other activities
as FINRA deems appropriate under the circumstances, in the public
interest or for the protection of investors.\127\ FINRA believes that a
member firm's SBS activities would be within the scope of ``other
activities'' contemplated by FINRA Rule 4120(c)(3)(K).\128\
---------------------------------------------------------------------------

    \127\ Id.
    \128\ Id.
---------------------------------------------------------------------------

    In addition to these conforming changes to FINRA Rule 4120, the
proposed rule change would apply FINRA's financial and operational
rules more broadly to firms that enter into, or otherwise have exposure
to, SBS. Specifically, certain rules in the FINRA Rule 4000 Series
(Financial and Operational Rules) include provisions that impose higher
standards, or provide FINRA the authority to impose additional
requirements, on firms that carry or clear transactions or accounts
(generally referred to as ``carrying or clearing firms''). This
``tiering'' structure was built into certain rules so that firms that
only introduce their customer accounts and do not have exposure to the
settlement system are provided relief from the higher standards
required of firms that carry or clear transactions and accounts. Below
is a list of rules in the FINRA Rule 4000 Series where tiering has been
employed for carrying or clearing firms and a brief description of the
tiered requirements for such firms:
     FINRA Rule 4110 (Capital Compliance) includes requirements
for carrying or clearing firms to keep greater net capital, seek
permission for withdrawals of capital and seek approval for certain
add-backs to net capital.
     FINRA Rule 4120 (Regulatory Notification and Business
Curtailment) includes restrictions on expanding, or requirements to
reduce business, if sufficient capital levels are not maintained.
     FINRA Rule 4521 (Notifications, Questionnaires and
Reports) allows FINRA to collect additional data and require reporting
of a material decline in tentative net capital.
     FINRA Rule 4522 (Periodic Security Counts, Verification
and Comparison) requires more frequent security counts, verifications
and comparisons than would be required under Exchange Act Rule 17a-13.
     Rule 4523 (Assignment of Responsibility for General Ledger
Accounts and Identification of Suspense Accounts) requires a record of
primary and supervisory named individuals over general ledger
bookkeeping accounts.\129\
---------------------------------------------------------------------------

    \129\ Id.
---------------------------------------------------------------------------

    According to FINRA, the intent of the tiering employed in these
rules in the FINRA Rule 4000 Series is to impose higher capital,
recordkeeping and operational standards on firms that carry or clear
transactions and accounts, and therefore may have financial exposure to
customers, other broker-dealers, central counterparties or others.\130\
FINRA believes that similar considerations apply for members with
exposure to SBS.\131\ FINRA states that SBS are complex transactions
that will, by their nature, require detailed recordkeeping, margining,
legal agreements, collateral management, reconciliation and risk
management.\132\ FINRA therefore believes it is appropriate to also
employ tiering in the FINRA Rule 4000 Series for members that enter
into SBS on a principal basis or otherwise have financial exposure to
SBS.\133\ Specifically, under the proposed rule change, proposed FINRA
Rule 0180(h) would provide that, for purposes of the FINRA Rule 4000
Series, all requirements that apply to a member that clears or carries
customer accounts shall also apply to any member that acts as a
principal counterparty to an SBS, clears or carries an SBS, guarantees
an SBS or otherwise has financial exposure to an SBS.\134\ FINRA
believes that applying these higher

standards when a member enters into SBS or otherwise has exposure to
SBS is appropriate and consistent with the protection of investors and
the public interest.\135\
---------------------------------------------------------------------------

    \130\ Id.
    \131\ Id.
    \132\ Id.
    \133\ Id.
    \134\ Although this proposed tiering provision relates to the
financial responsibility and operational rules, FINRA believes it
should be included as a paragraph in proposed FINRA Rule 0180 so
that all provisions relating to the treatment of SBS under FINRA
rules are found in a single, consolidated rule. See id. at 26096,
n.95.
    \135\ See id. at 26096.
---------------------------------------------------------------------------

J. Margin Requirements

    As discussed above, in June 2019 the Commission adopted its final
Capital, Margin, and Segregation Release.\136\ Among other things, the
Capital, Margin, and Segregation Release adopted new Exchange Act Rule
18a-3, which prescribes margin requirements for uncleared SBS for SBSDs
for which there is not a prudential regulator (``nonbank SBSD'').\137\
Generally, Exchange Act Rule 18a-3 requires a nonbank SBSD to
calculate, for each account of an SBS counterparty as of the close of
business of each day: (i) The amount of current exposure in the account
(i.e., variation margin) and (ii) the initial margin amount for the
account.\138\ Under Exchange Act Rule 18a-3, variation margin is
calculated by marking the position to market, while initial margin must
generally be calculated using standardized haircuts, which are
prescribed in Exchange Act Rule 15c3-1 for nonbank SBSDs that are
registered broker-dealers.\139\ Nonbank SBSDs may apply to the SEC for
authorization to use models to calculate initial margin instead of the
standardized haircuts (including the option to use the more risk
sensitive methodology in Exchange Act Rule 15c3-1a), but nonbank SBSDs
that are registered broker-dealers must use standardized haircuts to
calculate initial margin for uncleared equity SBS.\140\ Based on these
calculations, Exchange Act Rule 18a-3 generally requires a nonbank SBSD
to collect and deliver variation margin, and to collect (but not
deliver) initial margin.\141\ Exchange Act Rule 18a-3 also provides
certain exceptions from the margin requirements, establishes thresholds
and minimum transfer amounts, specifies collateral requirements
(including collateral haircuts), establishes risk monitoring
requirements and includes other miscellaneous provisions, such as
definitions. All nonbank SBSDs, including nonbank SBSDs that are FINRA
members, are subject to the margin requirements set forth in Exchange
Act Rule 18a-3.
---------------------------------------------------------------------------

    \136\ See Capital, Margin, and Segregation Release at 43954.
    \137\ See 17 CFR 240.18a-3. Exchange Act Rule 18a-3 also
prescribes margin requirements for nonbank MSBSPs with respect to
uncleared SBS. As discussed above, Exchange Act Rule 18a-3 generally
requires SBSDs to collect or deliver variation margin, and also to
collect initial margin, with respect to its SBS counterparties.
However, Exchange Act Rule 18a-3 requires that a nonbank MSBSP only
collect and deliver variation margin, without prescribing any
initial margin requirement. See Capital, Margin, and Segregation
Release at 43877. As discussed below, FINRA believes it is
appropriate to apply variation margin and initial margin
requirements to all of its members that transact in uncleared SBS.
Therefore, proposed FINRA Rule 4240 would provide an exception for
members that are registered as SBSDs (and therefore subject to the
variation and initial margin requirements of Exchange Act Rule 18a-
3), but not for members that are registered as MSBSPs. See Notice at
26096, n.97.
    \138\ See 17 CFR 240.18a-3(c)(1)(i); Capital, Margin, and
Segregation Release at 43876.
    \139\ See 17 CFR 240.18a-3(d).
    \140\ See Capital, Margin, and Segregation Release at 43876.
    \141\ See 17 CFR 240.18a-3(c)(1)(ii).
---------------------------------------------------------------------------

    The FINRA Rule 4200 Series sets forth margin requirements
applicable to FINRA members. In particular, FINRA Rule 4210 describes
the margin requirements that determine the amount of equity or
``margin'' customers are expected to maintain in their securities
accounts, including margin requirements for equity and fixed income
securities as well as options, warrants and security futures. Current
FINRA Rule 4240 separately establishes an interim pilot program with
respect to margin requirements for any transactions in CDS held in an
account at a member (the ``Interim Pilot Program''). Under current
FINRA Rule 0180, FINRA Rule 4210 does not apply to members' activities
and positions with respect to SBS, but current FINRA Rule 4240 does
apply to activities and positions within its scope. Therefore, to the
extent that a FINRA member enters into SBS that are CDS, the margin
requirements under the Interim Pilot Program apply to such SBS.\142\
However, the Interim Pilot Program is a temporary rule, and SBS that
are not CDS are not currently subject to any margin requirements under
FINRA rules.\143\
---------------------------------------------------------------------------

    \142\ For purposes of current FINRA Rule 4240, the term ``credit
default swap'' includes any product that is commonly known to the
trade as a ``credit default swap'' and is an SBS as defined pursuant
to Section 3(a)(68) of the Exchange Act or the rules and guidance of
the SEC and its staff. See FINRA Rule 4240(a).
    \143\ See Notice at 26097.
---------------------------------------------------------------------------

    The Interim Pilot Program was originally proposed by FINRA and
approved by the Commission in 2009 specifically to address concerns
arising from systemic risk posed by CDS.\144\ Pending the SEC's final
implementation of the Title VII rulemakings, FINRA has extended the
expiration date of the Interim Pilot Program a number of times, most
recently in September 2021.\145\ The Interim Pilot Program under
current FINRA Rule 4240 is currently set to expire on April 6,
2022.\146\
---------------------------------------------------------------------------

    \144\ See Exchange Act Release No. 59955 (May 22, 2009), 74 FR
25586 (May 28, 2009) (Notice of Filing and Order Approving File No.
SR-FINRA-2009-012).
    \145\ See Extension Notice at 50392.
    \146\ See supra note 19.
---------------------------------------------------------------------------

    In light of the finalization of the Commission's margin
requirements for nonbank SBSDs under Exchange Act Rule 18a-3 and the
registration compliance date, FINRA believes it is appropriate and in
the public interest for the Interim Pilot Program to expire and for
FINRA to adopt a new margin rule specifically applicable to SBS.\147\
Accordingly, under the proposed rule change, current FINRA Rule 4240
would be replaced by a new FINRA Rule 4240 that would prescribe margin
requirements for SBS. Consistent with Exchange Act Rule 18a-3--and
unlike the Interim Pilot Program--proposed new Rule 4240 would apply
margin requirements to all SBS, not just CDS. However, proposed new
FINRA Rule 4240 would not apply to any member that is registered as an
SBSD, as such members are subject to the margin requirements of
Exchange Act Rule 18a-3. Additionally, proposed FINRA Rule 4240 would
defer to registered clearing agencies to set the margin requirements
for cleared SBS, and as such would only specify new variation margin
and initial margin requirements for uncleared SBS. Therefore, the
specific new margin requirements prescribed under proposed FINRA Rule
4240 would only apply to uncleared SBS transacted by FINRA members that
are not registered as SBSDs. FINRA believes that, by applying margin
requirements in these circumstances, the proposed rule change would
fill an important regulatory gap, protect FINRA members against
counterparty credit risk, maintain a level playing field for members
and prevent regulatory arbitrage.\148\ As described in further detail
below, the margin requirements under proposed FINRA Rule 4240 would be
structurally aligned with the margin requirements that will apply to
nonbank SBSDs under Exchange Act Rule 18a-3, with certain modifications
that FINRA believes are necessary given

that such members will not be subject to the SEC's comprehensive
regulatory framework for SBSDs.\149\ Thus, subject to certain
exceptions described in the proposed rule, proposed FINRA Rule 4240
would require members that are not SBSDs to collect and deliver
variation margin on a daily basis to cover the member's current
exposure to or from each uncleared SBS counterparty, and also to
collect (but not deliver) initial margin from each SBS counterparty.
---------------------------------------------------------------------------

    \147\ See Notice at 26097. FINRA states that, under the proposed
rule change, proposed FINRA Rule 0180 would no longer provide an
exception from current FINRA Rule 4210 applying to members'
activities and positions with respect to SBS. Absent additional
changes, therefore, the general margin requirements under FINRA Rule
4210 would apply to SBS. However, as described above, FINRA proposed
to specifically list SBS within the exceptions listed in FINRA Rule
4210, and adopt a separate, new FINRA Rule 4240 applicable to SBS.
See id., n.106.
    \148\ See id. at 26097.
    \149\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240 is divided into a header followed by
paragraphs (a) through (d). The header would specify the scope of the
margin requirements under proposed FINRA Rule 4240. Paragraph (a) would
describe the margin requirements for cleared SBS. Paragraph (b) would
describe the margin requirements for uncleared SBS. Specifically,
paragraph (b)(1) would set forth how variation margin must be
calculated, paragraph (b)(2) would set forth how initial margin must be
calculated, paragraph (b)(3) would prescribe the collection and
delivery requirements for variation and initial margin, paragraph
(b)(4) would specify the manner and time of collection or delivery of
variation and initial margin, and paragraph (b)(5) would list certain
exceptions from the margin requirements. Paragraph (c) would require
members to employ specified risk monitoring procedures and guidelines
for uncleared SBS. Finally, paragraph (d) would define certain terms
used in proposed FINRA Rule 4240. Each of these aspects of the proposed
rule change is described in further detail below.
    Proposed FINRA Rule 4240 would be entitled ``Security-Based Swap
Margin Requirements.'' \150\ The header text to the rule would state
that each member that is a party to an SBS with a customer, broker or
dealer, or other Counterparty,\151\ or who has guaranteed or otherwise
become responsible for any other person's SBS obligations, shall comply
with the requirements of proposed FINRA Rule 4240, except that a member
that is registered as an SBSD shall instead comply with Exchange Act
Rule 18a-3. This provision of the proposed rule is intended to clarify
that the margin requirements under proposed FINRA Rule 4240 apply in
all circumstances where a member is a party to an SBS, regardless of
the type of counterparty, and also where a member has financial
exposure to an SBS, whether through a guarantee or other arrangements
under which the member is responsible for another person's SBS
obligations. FINRA believes that this provision is necessary to ensure
that the proposed margin requirements adequately protect member firms
against counterparty credit risk, regardless of the specific manner
through which the member has become exposed to such risk.\152\
Additionally, as discussed above, this provision clarifies that members
that are registered as SBSDs are not subject to the proposed margin
requirements because they must comply with Exchange Act Rule 18a-3.
FINRA believes it should defer to the SEC's margin framework for
registered SBSDs rather than impose additional or different
requirements on such entities.\153\ Proposed FINRA Rule 4240(a),
entitled ``Cleared SBS Margin Requirements,'' would state that, except
as provided in paragraph (b)(5) (i.e., specified exceptions from
proposed FINRA Rule 4240, discussed below), the margin to be maintained
on any Cleared SBS is the margin on such Cleared SBS required by the
Clearing Agency through which such SBS is Cleared. As discussed above,
this provision clarifies that proposed FINRA Rule 4240 defers to
registered clearing agencies to set the margin requirements for cleared
SBS. FINRA believes that it is appropriate to defer to clearing
agencies to establish margin requirements for cleared SBS in light of
the SEC's comprehensive regulation of clearing agencies, including
their required margin levels, under the Exchange Act.\154\
---------------------------------------------------------------------------

    \150\ In addition to the new provisions under proposed FINRA
Rule 4240 discussed above, the implementation of new margin
requirements for SBS under proposed FINRA Rule 4240 would also
require a conforming change to FINRA Rule 4220 (Daily Record of
Required Margin). FINRA Rule 4220 requires each member carrying
securities margin accounts for customers to make a record each day
of every case in which initial or additional margin must be obtained
in a customer's account. To ensure that similar records are
maintained for SBS margin required under proposed new FINRA Rule
4240, the proposed rule change would update FINRA Rule 4220 to also
require such records for each member subject to proposed FINRA Rule
4240.
    In addition, the proposed rule change would add new
Supplementary Material .06 to FINRA Rule 4210 to clarify that a
Regulation T good faith account, other than a non-securities
account, is a margin account for purposes of FINRA Rule 4210. This
provision is intended merely to codify FINRA's existing
interpretation regarding the scope of FINRA Rule 4210. The proposed
rule change would also include a parallel provision in new
Supplementary Material .01 to proposed new Rule 4240.
    Finally, the proposed rule change would make two other
conforming changes to FINRA Rule 4210, including to add proposed new
FINRA Rule 4240(e)(9) and to make a technical adjustment to FINRA
Rule 4240(g)(2)(H). See id. at 26097-98, n.107.
    \151\ ``Counterparty'' would be defined under proposed FINRA
Rule 4240(d)(5) to mean a person with whom a member has entered into
an uncleared SBS. An ``SBS'' would be defined in proposed FINRA Rule
4240(d)(16) by reference to the definition of ``security-based
swap'' under Section 3(a)(68) of the Exchange Act and ``Uncleared''
would be defined in proposed FINRA Rule 4240(d)(18) as an SBS that
is not Cleared. Under proposed FINRA Rule 4240(d)(3), an SBS would
be considered Cleared if it is cleared through a Clearing Agency by
or on behalf of the member, and Clearing Agency would be defined
under proposed FINRA Rule 4240(d)(4) as a clearing agency registered
pursuant to Section 17A of the Exchange Act or exempted by the SEC
from such registration by a rule or order pursuant to Section 17A of
the Exchange Act.
    \152\ See id. at 26098.
    \153\ Id.
    \154\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b), entitled ``Uncleared SBS Margin
Requirements,'' would set forth the substantive margin requirements
applicable to members that are not SBSDs when such members transact in
uncleared SBS. Paragraph (b)(1), entitled ``Current Exposure
Calculation,'' would require that, as of the close of business of each
business day, the member calculate, with respect to each Uncleared SBS
Account,\155\ the Counterparty's Current Exposure to the member (if
positive) or the member's Current Exposure to the Counterparty (if
negative). Current Exposure would be calculated as an amount equal to
the net Value \156\ of all uncleared SBS in the Uncleared SBS Account
plus the Value of all Variation Margin collected from the Counterparty
minus the Value of all Variation margin delivered to the

Counterparty.\157\ This provision would define a member's Current
Exposure for purposes of collecting or delivering Variation Margin
under proposed FINRA Rule 4240(b)(3), discussed below, by taking into
account the net Value of SBS in the Counterparty's account together
with any Variation Margin that has already been collected or delivered.
FINRA believes this calculation is consistent with the variation margin
requirements under Exchange Act Rule 18a-3.\158\
---------------------------------------------------------------------------

    \155\ Under proposed FINRA Rule 4240(d)(19), an ``Uncleared SBS
Account'' would be defined to mean an account with respect to a
Counterparty consisting of all Uncleared SBS between the member and
the Counterparty, together with long or short positions for
Variation Margin in the form of securities collected or delivered,
respectively, credit or debit balances for Variation Margin in the
form of cash collected or delivered, respectively, and long
positions or credit balances for Initial Margin collected in the
form of securities or cash, respectively.
    \156\ ``Value'' would be defined in proposed FINRA Rule
4240(d)(20). Under this definition, the Value of one or more SBS
would be the mid-market replacement cost for such SBS. The Value of
a security position would be the current market value of such margin
securities, as defined in FINRA Rule 4210(a)(2) and determined in
accordance with FINRA Rule 4210(f)(1) (i.e., the provisions of
FINRA's general margin rule used to determine the current market
value of margin securities). Alternatively, a member could elect to
determine the Value of margin securities collected as Variation
Margin or Initial Margin by applying a haircut to the current market
value of such securities equal to the margin requirement that would
be applicable to them under FINRA Rule 4210 if they were held in the
Counterparty's margin account (in which case, however, such margin
securities would not be required to be themselves margined under
proposed FINRA Rule 4240(b)(2)(A)(iii)). The Value of cash in U.S.
dollars would be the amount of such cash, while the Value of freely
convertible foreign currency would be the amount of U.S. dollars
into which the currency could be converted, provided the currency is
marked-to-market daily. See id. at 26098, n.110.
    \157\ Under proposed FINRA Rule 4240(d)(21), ``Variation
Margin'' would be defined to mean the cash or margin securities
collected from, or delivered to, a Counterparty in accordance with
proposed FINRA Rule 4240(b)(3)(A), as discussed below. Under
proposed FINRA Rule 4240(b)(2)(A)(iii), all securities deposited as
Variation Margin for uncleared SBS would themselves be margined in
accordance with FINRA Rule 4210, unless the member has chosen to
haircut them for purposes of determining their Value.
    \158\ See id. at 26098.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(2), entitled ``Initial Margin
Computation,'' would require that, as of the close of business on each
business day, the member compute the Initial Margin Requirement for
each Uncleared SBS Account equal to the sum of the Initial Margin
Requirements on the Uncleared SBS and securities positions in that
Uncleared SBS Account. The remainder of proposed FINRA Rule 4240(b)(2)
would describe how a member must calculate the Initial Margin
Requirement, which is then used for purposes of collecting Initial
Margin under proposed FINRA Rule 4240(b)(3), discussed below.\159\
Under the proposed rule change, the Initial Margin Requirement would
depend on the type of uncleared SBS involved, with different
requirements depending on whether the uncleared SBS is (i) a ``plain
vanilla'' CDS; (ii) a ``plain vanilla'' SBS other than an CDS (i.e., an
SBS that is the economic equivalent of a margin account containing a
portfolio of long or short positions in securities or options, such as
a ``plain vanilla'' equity total return swap (``TRS'')); or (iii) any
other type of SBS (e.g., a complex CDS or equity TRS that would not be
considered ``plain vanilla'' under the proposed rule, including for
example a CDS swaption, or a dividend swap). FINRA believes that
differentiation as to initial margin requirements among these different
types of SBS is appropriate and necessary given the unique
characteristics and risks posed by different SBS products.\160\
---------------------------------------------------------------------------

    \159\ Under proposed FINRA Rule 4240(d)(9), the term ``Initial
Margin'' would be defined to mean all cash or marginable securities,
excluding Variation Margin, received by the member for a
Counterparty's Uncleared SBS Account or transferred to the
Counterparty's Uncleared SBS Account from another account at the
member, including margin collected from a Counterparty in accordance
with proposed FINRA Rule 4240(b)(3)(B), as discussed below, that in
each case have not been returned to the Counterparty or applied to
an obligation of the Counterparty. Under proposed FINRA Rule
4240(b)(2)(A)(iii), all securities deposited as Initial Margin for
uncleared SBS would themselves be margined in accordance with FINRA
Rule 4210, unless the member has chosen to haircut them for purposes
of determining their Value.
    \160\ See id. at 26099.
---------------------------------------------------------------------------

    Proposed paragraphs (b)(2)(A)(i) and (ii) would define the Initial
Margin Requirements for uncleared plain vanilla CDS (referred to as
``Basic CDS'') \161\ and other uncleared ``plain vanilla'' SBS
(referred to as ``Basic SBS''),\162\ respectively. First, the Initial
Margin Requirement for an uncleared Basic CDS would generally be
computed based on the term and spread of the uncleared Basic CDS, using
the chart and offsets set out in Exchange Act Rule 15c3-
1(c)(2)(vi)(P).\163\ In FINRA's view, the proposed rule would therefore
follow Exchange Act Rule 18a-3(d)(1)(i) by determining the Initial
Margin Requirement for uncleared Basic CDS using the haircuts
applicable to such SBS under the SEC's net capital rule.\164\ FINRA
believes that determining initial margin for CDS in this manner would
promote regulatory consistency and reduce potential arbitrage.\165\
Additionally, in FINRA's view, the haircuts prescribed in Exchange Act
Rule 15c3-1(c)(2)(vi)(P) are analogous to existing FINRA Rule 4240
margin requirements, so in effect the proposed requirements have
already been used during the Interim Pilot Program.\166\ Second, the
Initial Margin Requirement for a Basic SBS would generally be computed
by applying FINRA Rule 4210 to the Equivalent Margin Account. Since an
uncleared Basic SBS would be the economic equivalent of a margin
account that would otherwise be governed by the margin provisions of
FINRA Rule 4210, FINRA believes it is appropriate to treat such SBS
similarly.\167\
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    \161\ Under proposed FINRA Rule 4240(d)(1), a ``Basic CDS''
would be defined to mean a Basic Single Name Credit Default Swap or
a Basic Narrow-Based Index Credit Default Swap. A Basic Single-Name
Credit Default Swap would mean an SBS in which one party pays either
a single fixed amount or periodic fixed amounts or floating amounts
determined by reference to a specified notional amount, and the
other party pays either a fixed amount or an amount determined by
reference to the value of one or more loans, debt securities or
other financial instruments issued, guaranteed or otherwise entered
into by a third party (i.e., the ``Reference Entity'') upon the
occurrence of one or more specified credit events with respect to
the Reference Entity (for example, bankruptcy or payment default).
The term ``Basic Single-Name Credit Default Swap'' would also
include a swap that, upon the occurrence of one or more specified
credit events with respect to the Reference Entity, is physically
settled by payment of a specified fixed amount by one party against
delivery by the other party of eligible obligations of the Reference
Entity. A Basic Narrow-Based Index Credit Default Swap would be
defined to mean an SBS consisting of multiple component Basic
Single-Name Credit Default Swaps. See id. at 26099, n.113.
    \162\ Under proposed FINRA Rule 4240(d)(2), a ``Basic SBS''
would be defined to mean an SBS, other than a CDS, under which each
party is contractually obligated to provide the other the economic
equivalent of a margin account containing a portfolio of long or
short positions in securities or options (i.e., an ``Equivalent
Margin Account''). See id. at 26099, n.114.
    \163\ See 17 CFR 240.15c3-1(c)(2)(vi)(P). This provision of the
SEC's broker-dealer net capital rule prescribes the haircuts
applicable to uncleared SBS.
    \164\ See Notice at 26099.
    \165\ Id.
    \166\ Id.
    \167\ Id.
---------------------------------------------------------------------------

    In addition, proposed FINRA Rule 4240(b)(2)(A) would permit the
Initial Margin Requirements for both uncleared Basic CDS and uncleared
Basic SBS to be computed based on a combination of multiple SBS and
securities or options positions, as applicable and subject to certain
conditions. Specifically, proposed FINRA Rule 4240(b)(2)(A)(i) would
provide that, if the member has a netting or collateral agreement that
is legally enforceable against the Counterparty and covers any
combination of uncleared Basic CDS or securities specified in clause
(iii), (iv) or (v) of Exchange Act Rule 15c3-1(c)(2)(vi)(P)(1) (i.e.,
specified offsetting debt securities), the member may compute the
Initial Margin Requirement on such combination of positions equal to
the ``haircut'' on that combination under Exchange Act Rule 15c3-
1(c)(2)(vi)(P)(1). Proposed FINRA Rule 4240(b)(2)(A)(ii) would
similarly provide that, if the member has a netting or collateral
agreement that is legally enforceable against the Counterparty and
covers any combination of uncleared Basic SBS, securities or options
positions, the member may compute the Initial Margin Requirement on the
combination of such positions equal to the margin that FINRA Rule 4210
would require to be maintained on the combination of Equivalent Margin
Accounts for such uncleared Basic SBS and securities or options
positions. Proposed FINRA Rule 4240(b)(2)(B) would impose conditions on
computing the Initial Margin Requirement using these combination
methods, including that (i) securities positions must be in the
Counterparty's uncleared SBS Account or margin account at the member;
(ii) securities may not be included if the member has chosen to haircut
them for purposes of determining their Value; (iii) options

positions must be in the Counterparty's margin account at the member;
(iv) no SBS, security or option positions may be included in more than
one combination; and (v) no combinations may include securities or
options positions for which reduced margin requirements are computed
under FINRA Rule 4210(e)(1) (i.e., reduced margin requirements for
offsetting long and short positions) or 4210(f)(2)(F)(ii) through
(f)(2)(l) (i.e., various reduced margin requirements for certain
options, including covered options and offsetting options
positions).\168\ FINRA believes these conditions would ensure that the
Initial Margin Requirement calculated using the combination method is
based on securities and options positions that the member actually has
in its possession and does not reflect reductions in value that would
inappropriately lower the margin requirement.\169\ In addition,
proposed FINRA Rule 4240(b)(2)(B) would provide that if the Initial
Margin Requirement is computed on a combination as described above, the
Initial Margin Requirement on the uncleared SBS included in the
combination shall be reduced (but not below zero) by the aggregate
maintenance margin requirements under FINRA Rule 4210 applicable to
such margin account positions. FINRA believes that this provision would
appropriately take into account margin already collected under FINRA
Rule 4210 with respect to such positions.\170\
---------------------------------------------------------------------------

    \168\ Id.
    \169\ Id.
    \170\ Id. In connection with this proposed provision of FINRA
Rule 4240(b)(2)(B), the proposed rule change would also add a new
paragraph (e)(9) to FINRA Rule 4210, entitled ``Security-Based
Swaps; SBS Offsets.'' Specifically, where the Initial Margin
Requirement on the combination of SBS and securities or options
position in the margin account would be less than the FINRA Rule
4210 maintenance requirement on the margin account positions,
proposed FINRA Rule 4210(e)(9) would reduce the FINRA Rule 4210
maintenance requirement on the margin account positions to equal the
computed Initial Margin Requirement.
     In addition, proposed FINRA Rule 4210(e)(9) would clarify that,
except for SBS carried by a member in a portfolio margin account
subject to the requirements of FINRA Rule 4210(g), as discussed
below, margin requirements on SBS and positions in Uncleared SBS
Accounts are determined by proposed FINRA Rule 4240, rather than
FINRA Rule 4210. See id. at 26099, n.117.
---------------------------------------------------------------------------

    The proposed rule change would not specify Initial Margin
Requirements for other uncleared SBS that do not qualify as Basic CDS
or Basic SBS. Instead, proposed FINRA Rule 4240(b)(2)(A)(iv) would
provide that the Initial Margin Requirement for any uncleared SBS other
than a Basic CDS or Basic SBS would be determined in a manner approved
by FINRA pursuant to proposed FINRA Rule 4240(b)(2)(C), which would
permit a member to apply to FINRA for the approval of an Initial Margin
Requirement for any other type of SBS. Under the proposed rule change,
any such application would be required to:
     Define the specific type of SBS covered by the
application;
     describe the purpose(s) that the member and its
Counterparties would have for entering that type of SBS;
     identify all variables that influence the value of that
type of SBS;
     explain all risks of that type of SBS;
     propose a specific Initial Margin Requirement (not a
margin model) for that type of SBS;
     explain how the proposed specific Initial Margin
Requirement would adequately protect a member and its capital against
each of those risks;
     attach copies of the member's SBS risk management
procedures and describe the application of those procedures to that
type of SBS; and
     provide the results of backtesting of the proposed
specific Initial Margin Requirement over periods of significant
volatility in the variables influencing the value of that type of
SBS.\171\
---------------------------------------------------------------------------

    \171\ See Notice at 26100.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(2)(C) would further provide that, if
FINRA approves any such application, the approval may be unconditional
or conditional, including in the form of a time-limited pilot program;
may approve the use of the specific Initial Margin Requirement only by
the applicant; or may take the form of a Regulatory Notice or other
communication approving the use of the specific margin requirements by
members generally. Under proposed FINRA Rule 4240(b)(2)(C), no member
would be permitted to become a party to an SBS other than a Basic CDS
or Basic SBS unless FINRA has approved an Initial Margin Requirement
for such member's use with respect to that type of SBS. As described
above, FINRA states that the Initial Margin Requirements for Basic CDS
are based on the Commission's treatment of such SBS under its net
capital rule, while the Initial Margin Requirements for Basic SBS are
based on the margin that would be required for a margin account that
would be the economic equivalent of such SBS.\172\ However, in FINRA's
view, other types of SBS--including CDS and equity TRS with complex
features--may not be easily accommodated under these frameworks, and
the specific risks that accompany such SBS may not be readily apparent
or quantifiable to FINRA without additional information.\173\ Moreover,
as noted above, SBS can be complex financial instruments that pose
substantial risks to members and margin serves as an important means of
protecting member firms, and thereby their customers and investors,
from such risks. FINRA therefore believes that members that are not
SBSDs (and therefore not subject to the SEC's comprehensive regulatory
framework for registrants under Title VII of Dodd-Frank) should not be
permitted to enter into other types of SBS unless and until FINRA has
evaluated the risks of such SBS and approved margin requirements that
adequately address such risks.\174\ If FINRA determines that a proposed
margin requirement does not adequately address the risks for a
particular type of SBS, FINRA would not approve the application under
proposed FINRA Rule 4240(b)(2)(C), and members would not be permitted
to enter into such SBS. To FINRA's knowledge, this SBS activity by
members that do not plan to register as SBSDs is relatively
limited.\175\
---------------------------------------------------------------------------

    \172\ Id.
    \173\ Id.
    \174\ Id.
    \175\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(3), entitled ``Collection or Delivery
of Variation and Initial Margin,'' would set forth a member's
obligation to collect or deliver margin as calculated pursuant to
proposed FINRA Rule 4240(b)(1) and (2), as described above. Paragraph
(b)(3)(A) would require each member to deliver or return to each
Counterparty cash or margin securities with a Value equal to the
Counterparty's Current Exposure (if any) to the member, or collect or
retrieve from the Counterparty cash or margin securities with a Value
equal to the member's Current Exposure (if any) to the Counterparty.
Paragraph (b)(3)(B) would require each member to collect from each
Counterparty cash or margin securities with a Value at least equal to
any Initial Margin Deficit.\176\ Therefore, consistent with Exchange
Act Rule 18a-3, proposed FINRA Rule 4240(b)(3) would require members
that are not SBSDs to collect and deliver Variation Margin, and also to
collect (but not deliver) Initial Margin, in amounts determined
pursuant to the

provisions of FINRA Rule 4240(b)(1) and (2) as described above, for
their transactions in uncleared SBS.\177\
---------------------------------------------------------------------------

    \176\ Under proposed FINRA Rule 4240(d)(10), the term ``Initial
Margin Deficit'' would be defined as the amount, if any, by which
(A) the sum of the Value of the Initial Margin in an Uncleared SBS
Account and the Counterparty's Rule 4210 Excess is less than (B) the
Initial Margin Requirement for the Uncleared SBS Account. A person's
``Rule 4210 Excess'' would be defined in proposed FINRA Rule
4240(d)(15) to mean the amount, if any, by which the equity (as
defined in FINRA Rule 4210(a)(5)) in the Counterparty's margin
account at the member exceeds the amount required by FINRA Rule
4210. See id. at 26100, n.118.
    \177\ To account for situations where a member is not the actual
party to an SBS, but nonetheless has financial exposure for
uncleared SBS (e.g., through a guarantee), proposed FINRA Rule
4240(b)(3)(C) would also require a member to collect both Variation
Margin and Initial Margin from the party that has obligations under
the uncleared SBS for which the member has responsibility, to the
extent that such collection would be required if the member were a
party to the uncleared SBS, unless the member can establish that
such margin has been delivered to the other party. See id. at 26100,
n.119.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(4), entitled ``Manner and Time of
Collection or Delivery of Variation and Initial Margin; Prohibited
Returns and Withdrawals,'' would set forth additional detailed
requirements and clarifications regarding the manner and time of
collection or delivery of variation and initial margin, as calculated
pursuant to proposed FINRA Rules 4240(b)(1) and (2) and collected or
delivered in accordance with proposed FINRA Rule 4240(b)(3), as
described above. Specifically, proposed FINRA Rule 4240(b)(4) would
provide for the following: \178\
---------------------------------------------------------------------------

    \178\ See id. at 26100.
---------------------------------------------------------------------------

     Under proposed FINRA Rule 4240(b)(4)(A), margin would be
deemed collected or returned to the member when it is received in the
Counterparty's Uncleared SBS Account at the member (or transferred to
such account from another account at the member).
     Under proposed FINRA Rule 4240(b)(4)(B), margin would be
deemed collected or returned to the Counterparty when it is transferred
from the Counterparty's Uncleared SBS Account at the member in
accordance with the Counterparty's instructions or agreement with the
member, which could potentially include transfer to another account of
the Counterparty carried by the member.
     Under proposed FINRA Rule 4240(b)(4)(C), margin would be
required to be collected or delivered pursuant to proposed FINRA Rule
4240(b)(3) as promptly as possible, but in any case no later than the
close of business on the business day after the date on which the
Current Exposure or Initial Margin Requirement was required to be
computed in accordance with proposed FINRA Rule 4240(b)(1) or (2)
(i.e., margin would generally be required to be delivered or collected
on a T+1 basis). Further, unless FINRA has specifically granted the
member additional time, a member that has not collected margin as
required by the close of business on the third business day (i.e., by
T+3) would be required to take prompt steps to liquidate positions in
the Counterparty's Uncleared SBS Account to eliminate the margin
deficiency.
     Proposed FINRA Rule 4240(b)(4)(D) would require a member
to net the delivery or return of Variation Margin against the
collection of Initial Margin, if applicable, and would further permit a
member to net the return of Initial Margin against the collection or
retrieval of Variation Margin, if applicable.
     Proposed FINRA Rule 4240(b)(4)(E) would prohibit a member
from returning Initial Margin to a Counterparty, or permitting a
Counterparty to make a withdrawal from the Counterparty's margin
account, if doing so would create or increase an Initial Margin
Deficit.

FINRA believes it is appropriate and consistent with the protection of
member firms and investors to require margin for uncleared SBS to be
delivered or collected, as applicable, on a T+1 basis, and to further
require that uncleared SBS positions be liquidated if margin is not
collected within a T+3 timeframe.\179\ FINRA also believes the other
clarifications described above are necessary to ensure that members and
their uncleared SBS counterparties have a clear and consistent
understanding of when and how margin must be delivered or collected
under the proposed rule change.\180\
---------------------------------------------------------------------------

    \179\ See id. at 26101.
    \180\ Id.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(5), entitled ``Exceptions,'' would
provide eight specific exceptions from a member's general obligation to
collect or deliver margin, as applicable, under proposed FINRA Rule
4240(b)(3), as described above. FINRA believes the proposed exceptions
would further align the requirements of proposed FINRA Rule 4240 with
the margin requirements applicable to SBSDs under Exchange Act Rule
18a-3 and provide members with additional flexibility in managing their
risk exposures, while still ensuring that the risks to members with
respect to their uncleared SBS exposures are adequately addressed.\181\
The proposed exceptions under FINRA Rule 4240(b)(5) would include the
following:
---------------------------------------------------------------------------

    \181\ Id.
---------------------------------------------------------------------------

     Clearing Agencies. A member would not be required to
deliver Variation Margin to, or collect Initial Margin or Variation
Margin from, any Clearing Agency, and would also not be required to
deduct otherwise required Variation Margin or Initial Margin in the
computation of its net capital under Exchange Act Rule 15c3-1 or, if
applicable, FINRA Rule 4110(a). FINRA believes this exception is
consistent with its determination to defer to Clearing Agency margin
requirements with respect to Cleared SBS.\182\
---------------------------------------------------------------------------

    \182\ Id.
---------------------------------------------------------------------------

     Legacy SBS. A member would be permitted to omit all (but
not less than all) Legacy SBS with a Counterparty from the
Counterparty's Uncleared SBS Account when computing Current Exposure
and the Initial Margin Requirement, provided that the member collects
and delivers margin on Legacy SBS to the extent of its contractual
rights and obligations to do so.\183\ However, a member would be
required to take a capital deduction under Exchange Act Rule 15c3-1 or,
if applicable, FINRA Rule 4110(a), to reflect the amount of any margin
that it would have otherwise been required to collect if the Legacy SBS
had been included in the Counterparty's Uncleared SBS Account. FINRA
believes it is appropriate to provide a general exception for legacy
SBS, as members would not be in a position to require their
counterparties to legacy SBS to exchange margin under existing SBS
agreements as would otherwise be required under proposed FINRA Rule
4240.\184\ However, in such cases, FINRA believes it is appropriate to
require a member to take a corresponding capital charge to account for
the member's ongoing risk exposure under such SBS.\185\
---------------------------------------------------------------------------

    \183\ Under proposed FINRA Rule 4240(d)(12), a ``Legacy SBS''
would be defined as an uncleared SBS entered into before April 6,
2022. See Amendment No. 1. Proposed FINRA Rule 4240(b)(2)(A)(iv)
would also clarify that for any Legacy SBS for which proposed Rule
4240 does not specify an Initial Margin Requirement (i.e., an SBS
other than a Basic CDS, Basic SBS or other SBS for which FINRA has
approved specific margin requirements), the Initial Margin
Requirement must be calculated using the applicable method specified
in Exchange Act Rule 15c3-1(c)(2)(vi)(P). The Initial Margin
Requirement for Legacy SBS calculated under this provision would be
used for purposes of determining the appropriate corresponding
capital charge, as well as to determine the Initial Margin
Requirement for a Legacy SBS to the extent that a member elects not
to utilize the Legacy SBS exception under proposed FINRA Rule
4240(b)(5). See id. at 26101, n.120.
    \184\ See id. at 26101.
    \185\ Id.
---------------------------------------------------------------------------

     Multilateral Organizations. A member would not be required
to deliver Variation Margin to, or collect Initial Margin or Variation
Margin from, any Multilateral Organization.\186\

However, a member would be required to take a capital deduction to
reflect the amount of any margin that it would otherwise have been
required to collect from such a Multilateral Organization. FINRA
believes it is appropriate to follow Exchange Act Rule 18a-3 by
providing an exception for Multilateral Organizations and requiring the
risk posed by such SBS to be accounted for in a member's capital
computations.\187\
---------------------------------------------------------------------------

    \186\ Under proposed FINRA Rule 4240(d)(13), a ``Multilateral
Organization'' would be defined to mean the Bank for International
Settlements, the European Stability Mechanism, the International
Bank for Reconstruction and Development, the Multilateral Investment
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the European Bank for Reconstruction and
Development, the European Investment Bank, the European Investment
Fund, the Nordic Investment Bank, the Caribbean Development Bank,
the Islamic Development Bank, the Council of Europe Development
Bank, or any other multilateral development bank that provides
financing for national or regional development in which the U.S.
government is a shareholder or contributing member. See id. at
26101, n.121.
    \187\ See id. at 26101.
---------------------------------------------------------------------------

     Financial Market Intermediaries. A member would not be
required to collect Initial Margin from a Counterparty that is a
Financial Market Intermediary (but would still be required to collect
or deliver Variation Margin, as applicable).\188\ In such case, a
member would be required to take a capital deduction to reflect the
amount of any Initial Margin that it would have otherwise been required
to collect from such Financial Market Intermediary. A Counterparty that
is a Financial Market Intermediary generally would be subject to a
comprehensive regulatory framework, including capital requirements.
FINRA therefore believes it is appropriate to account for the reduced
counterparty credit risk posed by such Counterparties by permitting a
member to take a capital charge in lieu of requiring such
Counterparties to post Initial Margin.\189\ However, FINRA continues to
believe that Variation Margin should be exchanged with such
Counterparties to account for ongoing the market risk posed by such
uncleared SBS.\190\
---------------------------------------------------------------------------

    \188\ Under proposed FINRA Rule 4240(d)(8), a ``Financial Market
Intermediary'' would be defined to mean an SBSD, swap dealer, broker
or dealer, FCM, bank, foreign bank, or foreign broker or dealer. See
id. at 26101, n.122.
    \189\ See id. at 26101.
    \190\ Id.
---------------------------------------------------------------------------

     Sovereign Counterparties. A member would generally be
required to deliver Variation Margin to, and collect Initial Margin or
Variation Margin from, a Sovereign Counterparty.\191\ However, under
proposed FINRA Rule 4240(b)(5)(E), if the member has determined
pursuant to policies and procedures or credit risk models established
pursuant to Exchange Act Rule 15c3-1(c)(2)(vi)(l) that the Sovereign
Counterparty has only a minimal amount of credit risk, the member would
not be required to collect Initial Margin from such Sovereign
Counterparty (but would still be required to collect or deliver
Variation Margin, as applicable). In such case, a member would be
required to take a capital deduction to reflect the amount of any
Initial Margin that it would have otherwise been required to collect
from such Sovereign Counterparty. As for Financial Market
Intermediaries, FINRA believes it is appropriate to account for the
reduced counterparty credit risk posted by highly creditworthy