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FINRA Issues Regulatory Notice on Liquidity Risk Management Practices
Practical Law Legal Update w-000-5950 (Approx. 3 pages)
FINRA Issues Regulatory Notice on Liquidity Risk Management Practices
by Practical Law Corporate & Securities
| Published on 17 Sep 2015 • USA (National/Federal) |
FINRA issued a regulatory notice that provides guidance to broker-dealers on effective liquidity risk management practices that senior management and risk managers should consider and implement.
On September 15, 2015, the Financial Industry Regulatory Authority (FINRA) issued a regulatory notice that provides guidance to broker-dealers on effective liquidity risk management practices that senior management and risk managers should consider and implement. The guidance is intended for firms that hold inventory positions or that clear and carry customer transactions, but states that other types of broker-dealers may find the guidance useful when assessing their owning liquidity risks.
The guidance comes as a result of a year-long review of the policies and practices at 43 broker-dealers related to managing liquidity needs in a stressed environment. The purpose of the review was to:
- Get a better understanding of the liquidity risk management practices of broker-dealers.
- Raise awareness of the need for liquidity stress planning.
The review consisted of two phases:
- In the first phase, broker-dealers were required to calculate the impact on liquidity when five stresses were applied concurrently to the broker-dealer's business. The stresses related to:
- funding inventory positions;
- financing for mismatched financing transactions;
- operational drains;
- funding customer withdrawals; and
- losses from forced deleveraging
- In the second phase, broker-dealers were able to:
- challenge the severity of the assumptions used in the test;
- describe mitigating actions the firm would take; and
- demonstrate the resources available to offset the stressed outflows of cash.
Based on the results of its review, FINRA concluded that a broker-dealer should:
- Rigorously evaluate its liquidity needs related to both market-wide stress and idiosyncratic stresses.
- Devote sufficient resources to measuring risks that apply to its business, and report those results to senior management. The risks to be measured would include:
- Risks based on historical events that have affected the firm or other firms; and
- Stresses that could occur but have not yet been observed.
- Develop contingency plans for addressing the risks so that the firm will have sufficient liquidity to operate after a stress occurs while continuing to protect all customer assets.
- Evaluate the effectiveness of the contingency plans by conducting stress tests and other reviews.
- Have a training plan for its staff and tested processes on which it will rely if a stress occurs.
FINRA plans to review firm liquidity risk planning and to use stress tests from time to time in the future, either with a group of firms or as part of the examination of individual firms. FINRA strongly encourages all firms to conduct a self-assessment of their businesses and to incorporate firm-wide liquidity stress testing into their risk and business planning.
To learn more about FINRA's rules governing the supervision of broker-dealers, see Practice Note, FINRA Supervision Rules.