FINRA issued a request for comment on security-based swap ("SBS") activities and how FINRA rules might apply to those activities. FINRA asked firms to comment (i) on current and expected SBS activities (including the nature of the products); (ii) whether the entity (or any affiliate) will register as a security-based swap dealer ("SBSD"); (iii) on agency activities concerning SBS; (iv) on the "arrange, negotiate or execute" activity of broker-dealers; and (v) whether the broker-dealer and/or its affiliates (and, if so, which affiliates) are engaged in SBS activity.
Further, FINRA requested open-ended comment from firms on how FINRA "should . . . think about the application of its rules to SBS activities" and whether the application should vary depending on (i) whether the broker-dealer acts as agent or principal and (ii) whether the broker-dealer registers as an SBSD.
Comments must be submitted by July 31, 2020.
Commentary Nihal Patel
As highlighted last week in connection with FOCUS report filing, the role of FINRA in SBS regulation is an open question. FINRA's request for comment may be to member firms, but its impact goes beyond that.
A broad application of the FINRA rules to SBS activities of broker-dealers acting as principal in SBS would provide an additional incentive to avoid booking SBS to a broker-dealer. Non-broker-dealers are not subject to the FINRA rules. This will be particularly burdensome for non-registered SBSDs (given that they won't be subject to the SEC SBSD rules), but may also be relevant for registered SBSDs, who would be subject to an additional set of rules applying to SBS that are not applicable to other SBSDs. This should also be contrasted with ordinary "securities" transactions. For most securities transactions there is a more limited competitive concern given that there is a relatively small amount of non-broker-dealer competitors for the services provided by broker-dealers (i.e., because of registration requirements).
In contrast, because the Exchange Act does not impose securities dealer registration requirements on dealers in SBS, and given that many expected SBSDs are not broker-dealers, broker-dealers will face a significant competitive disadvantage if FINRA rules impose additional obligations beyond those already imposed under SEC SBS rules. (When it adopted conduct rules for SBS, the SEC recognized these concerns and aligned many SBSD conduct requirements to existing FINRA requirements, which further suggests that a second application of similar rules to broker-dealers is unnecessary.)
The issues are different as to "broker" or "agency" activity in SBS. The definition of "broker" in the Exchange Act includes acting as a broker in SBS, and so it is reasonably likely that most of this activity must be conducted through FINRA member broker-dealers. But the possibility for competitive imbalance through application of the FINRA rules remains, particularly for non-US SBSDs, who commonly use a US broker-dealer to agent SBS (in a "15a-6"-like structure). Application of the FINRA rules could effectively subject non-US SBSDs to additional regulation that does not apply to many of their US-based SBSD competitors.
Originally published May 22, 2020.
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