The U.S. Financial Industry Regulatory Authority (FINRA) announced on Tuesday the release of new guidance setting out best practices in liquidity management at brokerage firms, in a bid to help firms guard against liquidity-driven collapses.
Liquidity risk — which arises when firms employ leverage and short-term borrowing to fund longer-term, less-liquid assets — was a significant factor in the failure of brokers, such as Lehman Brothers and MF Global, FINRA notes.
The self-regulatory organization (SRO) launched the review in order to better understand firms’ liquidity risk controls, and to boost awareness of the need for firms to have plans to deal with potential liquidity stress.
“Understanding how firms plan for and manage liquidity risk has been a priority for FINRA and other regulators since the financial crisis in 2008. The ability for a broker-dealer to navigate stressed liquidity conditions is an effective way to protect against failure when extreme events occur,” said Bill Wollman, FINRA executive vice president, member regulation, risk oversight and operational regulation, in a statement.
The guidance aims to highlight some of the more effective controls and practices FINRA found at the firms it reviewed, including: designating a group to ensure that systems and reports are available for management to understand and deal with a firm’s funding and liquidity process; having a governance process around stress test results and use of contingency funding plans; and establishing clear criteria for when a firm should shift from “business as usual” to contingent funding mode.
“The practices described in in this notice are intended to inform senior management and risk managers at firms of steps that they should consider and implement to combat stressed liquidity conditions,” said Wollman. “If firms do not contemplate a sufficiently severe stress environment, they may face problems during the next crisis.”