FINRA Issues Liquidity Risk Management Guidance

FINRA believes that effective liquidity management is a critical control function at broker-dealers and across firms in the financial sector. Failure to manage liquidity has contributed to both individual firm failures and, when widespread, systemic crises.  To address this, FINRA has recently provided guidance on effective practices that senior management and risk managers at firms should consider and implement.

FINRA Regulatory Notice 15-33 is directed at firms that hold inventory positions or clear and carry customer transactions.  However, other types of broker dealers may find the Notice is of value to them when assessing their own liquidity risks.

By way of background, beginning in March 2014 and continuing into the first quarter of 2015, FINRA conducted a review of the policies and practices at 43 firms related to managing liquidity in a stressed environment. The review had two broad purposes: to understand better firms’ liquidity risk-management practices and to raise awareness of the need for liquidity stress planning.

The review included assessing a firm management’s knowledge and understanding of the liquidity risks that a firm faced, the firm’s ability to measure liquidity needs in stress situations, management’s preparedness and plans for addressing such a scenario should it arise, and the specific steps the firm would take to address its needs.  The firms reviewed comprised a wide range of clearing firms and large introducing firms with varying levels of capitalization. The business mix at these firms also varied, from firms that focused on one or two market sectors to firms that provide a full range of products and services.

The review consisted of two phases. The first phase required firms to calculate the impact on liquidity when five stresses were applied concurrently to the broker-dealer’s business.  The second phase allowed a firm to challenge the severity of the assumptions used in the test, describe mitigating action the firm would take, and demonstrate the resources available to offset the stressed outflows of cash.

The results of the review of the 43 firms for effective risk management are described in Regulatory Notice 15-33, click here to read the entire notice.