Financial Industry Regulatory Authority, Inc. (FINRA) announced a proposed rule, FINRA Rule 4240, which would impose margin requirements for all credit default swap (CDS) transactions executed by FINRA members. The proposed rule will operate during an interim pilot period, beginning with the SEC’s approval of the rule and expiring on September 25, 2009. FINRA will request comments on the proposed rule during this pilot period.

Margin requirements under the proposed rule would apply to all CDS transactions, regardless of where they are booked. Margin for a CDS offset by a trade cleared through the Chicago Mercantile Exchange’s (CME) central clearing services must be at least equal to the margin required by the CME for the offsetting trade. However, if a member determines that the CME margin requirements are inadequate with respect to a particular customer or broker-dealer, the member should require additional margin.

The proposed rule includes criteria for determining minimum margin for CDS which are offset by a trade cleared through a central counterparty other than the CME. The minimum margin depends upon whether the member has bought or sold protection, among other factors. The member must require additional margin if it determines that the minimum under the rule is not sufficient based on its analysis of the customer or broker-dealer risk.

Members are required to monitor the risk of their customer or broker-dealer accounts and maintain a comprehensive written risk analysis methodology for assessing the risk posed by CDS to their capital. The rule sets out procedures and guidelines for monitoring the risk. Members would also have to review their credit extension activities for consistency with the risk monitoring procedures and guidelines.

The proposed rule also includes protection against excessive concentration of risk with respect to any reference entity under CDS transactions.