MFA Challenges FINRA’s Expanded Securities Loan Reporting Rules

In a significant regulatory development, the Managed Funds Association (MFA) has raised substantial concerns regarding FINRA’s proposed securities loan reporting rules. In a detailed comment letter sent to the SEC on July 31, 2024, the MFA has urged FINRA to align its proposed securities loan reporting rules (Rule 6500 Series or SLATE rules) with the SEC’s Securities Lending Rule 10c-1a, which took effect on January 2, 2024. The SEC rule mandates that FINRA propose new regulations governing securities loan reporting, a task FINRA undertook four months following the rule’s implementation. In this article, Michelle McGurk examines FINRA’s proposed rules, the MFA’s arguments, and the potential implications for the investment management industry.

FINRA’s Proposed Rules

FINRA’s proposed rules introduce a comprehensive framework for the reporting and public dissemination of securities loan information, significantly expanding the scope and detail of data to be made public compared to existing SEC requirements. Under this proposal, financial firms must report detailed transaction data on securities loans to the Securities Lending and Transparency Engine (SLATE), which will then make this information available publicly. The rule specifies what constitutes a “covered securities loan” and identifies the parties required to report—termed “covered persons.”

This detailed reporting includes not just basic transaction details but also requires disseminating this information to the public in a way that could potentially expose sensitive trading strategies and positions, especially for thinly traded securities. The proposed rule also introduces unique identifiers and additional data points not specifically mandated by the SEC, such as daily aggregate transaction activity broken down by borrower types like brokers or banks, which could inadvertently reveal the market positions of these entities.

The broader implications of this rule for the investment management industry include increased operational burdens due to the need for enhanced data tracking and reporting systems, potential risks of exposure to proprietary trading strategies, and the need for firms to adjust their risk management and compliance frameworks to accommodate these new reporting requirements.

Summary of the MFA’s Letter

The MFA’s argument is a critical attempt to prevent the imposition of overly burdensome requirements on market participants that could dampen the efficacy and liquidity of the markets. MFA has also initiated legal action challenging the SEC’s Securities Lending Rule, asserting that the rule disregards the interconnected nature of securities lending and short-selling regulations, which could, in turn, detrimentally expose investor strategies and reduce market efficiencies.

The Securities Lending Rule already necessitates detailed reporting of each securities lending transaction at a granular level. This requirement could disadvantage investors with short positions by exposing sensitive trading information. Yet, the FINRA proposal takes these transparency measures further by demanding even more extensive data disclosure than the SEC has specified. This includes publishing detailed transaction data that could significantly increase the breadth of information required to be reported and published. Furthermore, FINRA has proposed an entirely new set of ‘modifiers and indicators’ that the SEC did not mandate. The MFA contends that the proposed FINRA rules exceed the SEC’s mandate and could negatively impact market stability and investor protection.

Additionally, the MFA highlights the significant operational and cost burdens these rules could impose on firms, especially smaller ones, which may struggle to meet the enhanced data tracking and reporting requirements. This could create a competitive disadvantage and further disrupt market functionality.

The MFA emphasizes that securities lending is crucial in market liquidity, price discovery, and efficiency. The association is particularly worried that FINRA’s proposed rules could undermine these functions by demanding overly detailed transaction data disclosures that could expose trading strategies and adversely impact investor behavior. The concern is that this could lead to reduced market participation and increased volatility, particularly by discouraging short selling.

Moreover, the MFA raises concerns about potential conflicts between FINRA’s proposal and the SEC’s existing framework, particularly regarding the timeliness and format of data disclosures. By requiring near real-time publication of loan data and granular breakdowns, FINRA’s proposal could contradict the SEC’s approach, which seeks to delay the dissemination of certain loan information by 20 business days to protect market participants from having their strategies reverse engineered.

The industry response suggests that aligning FINRA’s rules with the SEC’s more general guidelines could prevent potential disruptions in market operations and ensure a balanced approach to regulation that doesn’t stifle economic activity. This situation highlights the broader regulatory landscape, where there is a constant need for harmony between various regulatory bodies to ensure efficient and stable markets.

The Bottom Line

The timeline for responding to the MFA’s comments and the broader industry feedback is still uncertain. Still, the decisions will likely have significant implications for regulatory practices and investment strategies. This ongoing situation underscores the importance of regulatory clarity and the need for industry stakeholders to stay engaged with regulatory developments to adapt strategies and ensure compliance efficiently.

As the industry awaits FINRA’s response, the implications of these proposed rules could significantly reshape the regulatory landscape. Investment managers and stakeholders must stay vigilant, ensuring they are prepared to adapt to these changes, which could redefine market dynamics and compliance strategies. Staying engaged with these regulatory changes is essential for maintaining a competitive edge and ensuring that new requirements do not disrupt strategic operations. Our team of experts can help ensure your compliance. Take the first step and discover how Arootah’s Hedge Fund Advisory can support you.