Regulatory Obligations and Related Considerations
Effective liquidity controls are critical elements in a broker-dealer’s risk management framework. Exchange Act Rule 17a-3(a)(23) requires firms that meet the thresholds specified under the rule to make and keep current records documenting the credit, market, and liquidity risk management controls established and maintained by the firm to assist it in analyzing and managing the risks associated with its business. FINRA routinely reviews firms’ practices in these areas, and in Regulatory Notice 15-33 (Guidance on Liquidity Risk Management Practices) shared observations on liquidity management practices.
- What departments at your firm are responsible for liquidity management?
- How often does your firm review and adjust its liquidity management plan and the stress test frameworks?
- Do your firm’s liquidity management practices include steps to address specific stress conditions and identify firm staff responsible for addressing those conditions? Does your firm have a process for accessing liquidity during a stress event and determining how the funding would be used?
- Does your firm’s contingency funding plan take into consideration the quality of collateral, term mismatches and potential counterparty losses of your firm’s financing desks (in particular, in repo and stock loan transactions)?
- What kind of stress tests (e.g., market or idiosyncratic) does your firm conduct? Does your firm conduct stress tests in a manner and frequency that is appropriate for your firm’s business model, for example tests limited to a single time horizon, or over multiple time horizons? Does your firm incorporate the results of those stress tests into your firm’s business model?
Exam Observations and Effective Practices
- Not Extending the Stress Test Period – Failing to expand stress tests from a single time horizon to multiple time horizons (such as 10 days to 30 days or longer).
- Not Modifying Business Models – Failing to incorporate the results of firms’ stress tests into their business model.
- No Liquidity Contingency Plans – Failing to develop contingency plans for operating in a stressed environment with specific steps to address certain stress conditions, including identifying the firm staff responsible for enacting the plan, the process for accessing liquidity during a stress event and setting standards to determine how liquidity funding would be used.
- Liquidity Risk Management Updates – Updating liquidity risk management practices to take into account a firm’s current business activities, including:
- establishing governance around liquidity management, determining who is responsible for monitoring the firm’s liquidity position, how often they monitor that position, and how frequently they meet as a group; and
- creating a liquidity management plan that considers:
- quality of funding sources;
- potential mismatches in duration between liquidity sources and uses;
- potential losses of counterparties;
- how the firm obtains funding in a business-as-usual (BAU) condition, and stressed conditions;
- assumptions based on idiosyncratic and market-wide conditions; and
- early warning indicators, and escalation procedures, if risk limits are breached.
- Stress Tests – Conducting stress tests in a manner and frequency that considered the firm’s business model, including:
- assumptions specific to the firm’s business, and based on historical data;
- the firm’s sources and uses of liquidity, and if sources could realistically fund its uses in a stressed environment;
- the potential impact of off-balance sheet items on liquidity;
- frequency of conducting stress tests, in accordance with the risk and complexity of the firm’s business; and
- periodic review of stress test results by appropriate governance groups.
- Regulatory Notice 15-33 (Guidance on Liquidity Risk Management Practices)
- Regulatory Notice 10-57 (Funding and Liquidity Risk Management Practices)
- Funding and Liquidity Topic Page