Finra considers increasing liquidity requirements for brokerages

Brokerages would have to maintain a financial cushion to survive market turmoil and other stressful periods under a Finra concept proposal.

The Financial Industry Regulatory Authority Inc. is contemplating a rule that would impose new liquidity requirements on its broker-dealer members. They would have to have available cash or liquid assets sufficient to meet funding obligations as they come due, Finra said in a regulatory notice Monday.

Under the proposal, firms would have to establish a liquidity risk management program and a contingency funding plan. They also would have to conduct stress testing. Finra could direct a firm to restrict or suspend business activities if its reserves run too low.

Brokerages currently must comply with the Securities and Exchange Commission’s net capital rule that requires minimum base capital and assets to meet customer and creditor obligations. Other SEC and Finra rules segregate customer funds and securities and prohibit brokerages from using them for proprietary activities. Another rule limits the amount of customer securities a brokerage can utilize in margin loans.

The existing rules limit risk when a brokerage fails, Finra said. But they may not go far enough to keep it upright during times of market stress, such as volatility in 2020 during the pandemic and in 2021 during the meme-stock trading frenzy.

“One risk that may not be sufficiently addressed by [existing] rules is liquidity risk, which is the risk that a broker-dealer will not have sufficient cash or liquid assets to meet its obligations as they come due,” Finra said. “Adopting additional liquidity standards would supplement these rules by creating greater safeguards to ensure that customer and creditor claims can be met in a timely manner and may prevent a broker-dealer failure.”

Finra floated the proposal as a concept release. The broker-dealer self-regulator is taking public comments until Aug. 11. After reviewing the feedback, it could draft a formal proposal, which likely also would be released for public comment. The SEC would have to approve a final rule.

Patrick Mahoney, a Los Angeles securities attorney, said the proposal adds additional safeguards for small brokerages that are more likely to face capital depletion.

“I think it’s really a great thing that Finra is starting to home in on the liquidity risks broker-dealers potentially have,” Mahoney said. “What I like about [the proposal] is it creates a set of liquidity standards that are applicable to smaller, non-retail-bank-affiliated broker-dealers.”

The proposal also is timely as many brokerages are turning to securities lending and margin loans to boost revenue. “It’s a move in the right direction … particularly in this environment, where we have rising interest rates,” Mahoney said.

Finra drafted the concept release in part to give it a way to crack down on poor liquidity risk management practices.

“Finra’s efforts to supervise our members’ liquidity risk have been limited by the absence of a dedicated rule that would facilitate our ability to take action when appropriate,” the organization said.

The concept proposal “has been informed by best practices” that Finra said it has observed among its member firms.

In the SEC’s semiannual rule-writing agenda, the agency said it was considering requiring large brokers to calculate their customer reserve deposit requirements on a daily, rather than on a weekly basis.