November 9, 2015
Thank you for the opportunity to comment on the proposed amendments to FINRA Rule 4210. I believe the amendments should be scrapped in their entirety for three reasons: (1) the amendments are by their very nature anti-competitive, (2) much of the language contained in the amendments is a solution in search of a problem and (3) most importantly, the amendments represent an expansion of FINRA authority in direct contravention of the intent of the authors of the Securities Exchange Act.
The application by rule of margin practices established by the TMPG to voluntarily address systemic risk represented by the huge mortgage TBA market to the entire universe of mortgage transactions places an unnecessary procedural burden on firms whose clients in no way represent the systemic risk addressed by TMPG practices. Such a protocol unnecessarily interferes in a market that has operated smoothly without incident for decades. The expense created by the maintenance of a margin protocol for each client regardless of the potential application will drive some dealers from the mortgage market. This is not to mention the burden placed on investors that will be totally confounded by the requirements. This burden on smaller firms is disproportionate and anti-competitive since the larger firms most likely already have systems in place to manage the process. Additionally, larger clients may be unwilling to transact business with mid-size and smaller dealers if to do so requires daily mark to market even in cases of simple current month specified trades.
FINRA claims that non-TMPG firms that are not collecting margin are somehow at a competitive advantage over huge Wall Street firms that have managed to retain an implied government guarantee that no small dealer possesses. Disregarding for a moment the irony in FINRA's claim, even that possibility could easily be eliminated if TMPG members only collected margin on transactions that actually represent systemic risk: transactions and clients of such size where smaller firms are no factor whatsoever. However, the application of the proposed requirements to transactions in specified pools and CMOs will diminish the ability of smaller firms to compete with the wire houses for large clients in the specified pool and CMO markets for the reason I have noted above. Some might argue that this may be the primary reason specified pools and CMOs are included in the proposal.
I understand the desires of the wire houses whose balance sheets themselves represent systemic risk to manage contra-party risk in the huge dollar roll TBA market. This, however, does not justify upending the entire specified mortgage market which does not represent systemic risk as I detailed in my prior comment letter. The specified and CMO markets combined represent about 12 percent of the entire universe covered by the proposed amendments. Furthermore, participants in these markets are investors and not engaged in financing transactions. I cannot recall a time when a mortgage or CMO investor simply refused to pay for bonds. The risk represented by these transactions simply does not justify the creation of an entire protocol related to marking to market trades which were previously viewed as simple cash or DVP transactions. I do not believe that expanding the definition of extension of credit from that defined in Reg T (permitted cash account transactions in 12 CFR 220.8) to this extent represents FINRA taking Section 1(a) 2 action for its own protection. As a member, it is certainly not necessary for the protection of my firm.
Congress addressed the question of the extension of credit by broker-dealers in Section 7 of the Exchange Act. Since the extension of credit was considered to be a banking function, regulatory power was granted to the Federal Reserve Bank to establish rules related to the extension of credit by broker-dealers. Such rules were established and are referred to as Reg T, which grants national securities associations the power to adopt stricter credit rules than those contained in Reg T. Nowhere, however, does Reg T grant a national securities association the power to regulate transactions that the Fed itself was expressly prohibited from regulating (such as those related to exempt securities), nor does Reg T expressly grant national securities associations the power to redefine extension of credit. However, for years it has been presumed by many that FINRA possesses the authority to regulate credit extension where the Fed did not possess the power to do so. NASD Rule 2520 (the precursor to Rule 4210) prescribed maintenance margin requirements for the extension of credit on exempt securities. However, neither Rule 2520 nor Rule 4210 has re-defined extension of credit-until now. FINRA is now claiming the authority to re-define extension of credit in a manner never intended by Congress or publicly expressed by the Fed. Re-defining all transactions in exempt mortgage backed securities settling beyond T + 1 (T + 3 for CMOs) as an extension of credit represents a sea change in the regulatory regime related to transactions in those securities. In 1984, Congress amended the Exchange Act to provide that transactions in private label mortgage backed securities were not to be considered extensions of credit if the transaction resulted in a delayed delivery of up to 180 days. It would seem odd that Congress did not include exempt mortgage backed securities in the definition of mortgage related securities unless you consider the fact that Congress (like almost everyone else) presumed that it was not necessary to exclude exempt MBS transactions from the extension of credit exclusion, since Section 7 already exempted transactions in those securities from margin requirements. The language of Section 7(g) of the Securities Exchange Act, as amended, reads as follows: (g) Subject to such rules and regulations as the Board of Governors of the Federal Reserve System may adopt in the public interest and for the protection of investors, no member of a national securities exchange or broker or dealer shall be deemed to have extended or maintained credit or arranged for the extension or maintenance of credit for the purpose of purchasing a security, within the meaning of this section, by reason of a bona fide agreement for delayed delivery of a mortgage related security or a small business related security against full payment of the purchase price thereof upon such delivery within one hundred and eighty days after the purchase, or within such shorter period as the Board of Governors of the Federal Reserve System may prescribe by rule or regulation. FINRA claims that the new margin rules are a justified expansion of their authority and within the requirements of 15A (b) (6) of the Exchange Act. Section 7 (g) is very clear in its intent. Only the Fed has the authority to write rules that would alter this Congressional directive as to mortgage related securities. Does FINRA actually believe that Congress intended to provide this exclusion only for non-exempt securities? Or, is it more logical to believe that Congress intended the exemptions in Section 7 (a), (c) and (d) to apply to all attempts to regulate exempt securities as to the extension of credit, not just to rules adopted by the Fed, to whom Congress had granted the general authority. The proposal appears to avoid direct conflict with Section 7(g) since Covered Agency Securities do not include private label mortgage backed securities. Surely, however, FINRA cannot be claiming that exemptions in Section 7 do not have the effect of restricting an SROs regulatory power bestowed in Section 15A (b) (6), and somehow operate to exclude from the protection of Section 7(g) a transaction that Congress otherwise would have covered in an exempted security. If the proposed rules are adopted as written, the result will be a bizarro world wherein Government sponsored (exempt) mortgage backed securities transactions settling when accurate settlement figures are available will be considered extensions of credit, and transactions involving private label, considerably more volatile, mortgage backed securities will not.
While 15A (b) (6) does grant a national securities association broad powers, the Exchange Act makes repeated references to regulating in a manner not inconsistent with the provisions of the Exchange Act (this title). How can it be argued that the proposed amendments are consistent with the provisions of this title when the Rule claims as authority an ability to ignore Section 7 (a), (c) and (d) exemptions to do exactly what Section 7(g) was drafted to prevent? I cannot imagine that Congress believed it was abdicating its right to draft law when it bestowed national securities associations with 15A (b) (6) powers, and there is no way to approve the proposed amendments without concluding that very thing. Does FINRA believe that its 15A (b) (6) powers are so broad that it can regulate in a fashion that is diametrically opposed to the intent of Federal statute?
FINRA can address the issue of systemic risk created by TBA trading without re-constituting the entire mortgage market. In response to the growing number of institutions day trading the thirty year US Treasury bond, in 1983, the Fed opined that cash accounts were only to be used where there was a bona fide intent to pay for or deliver the securities involved. Customers could not utilize cash accounts to engage in financing transactions regardless of the exemption. The Fed was able to render such an opinion without challenge because: (1) they had express Congressional authority to regulate the extension of credit by broker-dealers and (2) no one would argue that Congress intended for customers to evade margin requirements by literally financing securities transactions in the cash account. The Fed made no attempt to circumvent the Congressional exemption by defining extension of credit for exempt securities as is in the proposed amendments: they simply stated that customers would not be permitted to utilize the exemption to evade Congressional intent. The TBA mortgage market is used as a financing vehicle and this use is what has created the systemic risk that this exercise was originally intended to address. Why can't FINRA use the existing regulatory structure to require those engaged in actual financing transactions (where there is no intent to pay for or deliver the securities involved in the transaction) to mark to market in margin accounts, and avoid disrupting the practices of actual investors? In the event that is not seen as an option, the net capital rules provide securities regulators with the requisite authority to address a broker-dealer over extension of credit to customers. If FINRA believes that broker-dealers truly are engaged in behavior that creates unacceptable risk to the financial system or their own capital structure, if rules have to be amended, the proper manner in which to address the situation is to amend the net capital rules.
I understand the risk represented by the TBA market and applaud the efforts of Wall Street to voluntarily address that risk. I also appreciate the effort of FINRA staff to craft the amendments to Rule 4210 in a manner that would have as little effect on small dealers as possible, but at the end of the day the burden imposed by the amended Rule is still large, unnecessary and in contravention of Congressional intent. The Commission should reject this proposal in its entirety.
Thank you again for the opportunity to comment.
Executive Vice President