FINRA expects broker-dealers to develop and maintain robust funding and liquidity risk management practices to prepare for adverse circumstances - be it related to firm-specific events or systemic credit events.  FINRA also expects those firms affiliated with holding companies to undertake these efforts at the B/D level, in addition to their planning at the holding-company level. 

• Toward this end, FINRA offers guidance - which includes practices identified through FINRA exams and through a survey of 15 mid- and large-sized B/D's that hold inventory positions and carry customer accounts. 
• The guidance doesn't purport to provide a comprehensive description of all appropriate funding and liquidity risk management practices.
• Each firm is expected to determine which practices are best suited to its particular business. 
• B/D's that do not carry inventory positions may also find it to be a valuable resource.

    Specific Practice Areas.    FINRA highlights the following specific areas;  C-I encourage readers to click on and read the publication for themselves:  FINRA Regulatory Notice 10-57, November.

Risk Limits and Reporting.   The governing board and senior management of a B/D should be fully informed on the firm’s risk management policies and procedures, and should participate in setting and periodically re-evaluating the level of funding and liquidity risk the organization is willing to accept to meet its business goals.  Senior management should ensure that these determinations are communicated throughout the organization so that management in the various business lines can set appropriate funding and liquidity risk limits and evaluate existing risks presented by various markets and counterparties.

Escalation procedures are critical for reporting instances where pre-established funding and liquidity limits are exceeded to the appropriate level of management, including provisions for determining when such breaches should be immediately reported to senior management.  Among the key measures of funding and liquidity: 

• amount of excess liquidity currently available;
• future cash-flow projections based on multiple scenarios, including under stressed conditions;
• maturity profile of available funding sources;
• liquidation and mark-down assumptions for inventory positions, including those based on mark-to-model values;
• price volatility and correlation trends with respect to certain asset classes;
• inventory concentrations in related asset classes;
• the usage and limits of secured and unsecured lines of credit;
• how existing risk levels compare with pre-established risk limits;
• level of funding through particular markets and position concentrations for certain counterparties;
• ability to timely monetize assets that have been set aside in an excess liquidity pool.

Independent Risk Oversight.   B/D's are encouraged to use staff that's independent of business lines to ensure the firm doesn't exceed the levels of risk tolerance set by the governing board and senior mgmt. 

Maturity Profile of Funding Sources.   Over-reliance on shorter-term funding to finance longer-term assets was a significant factor in the severe difficulties faced by some financial firms during the credit crisis.  B/D's using shorter-term financing to fund longer-term positions should regularly assess their ability to continue operating under a variety of market conditions and firm-specific events.

Red Flags of Potential Funding and Liquidity Problems.  B/D's should be on the lookout for red flags that trigger management to take immediate action or perform additional monitoring.   FINRA identifies 22 red flags that serve these purposes

Inventory Valuation.   Strong practices for identifying the true liquidation value of inventory holdings are essential for an effective funding and liquidity management program.  The recent financial crisis highlighted the value of using staff that's technically competent and independent from the lines of business to evaluate pricing decisions, and empowering them to challenge pricing assumptions.

Stress Testing.   An effective stress-testing program can help a B/D identify and quantify sources of potential liquidity strains and analyze effects on its cash-flows, profitability and solvency.

Contingency Funding Plan.   In a credit crisis, management may have little time to react and few options available to access funding and generate liquidity.  A contingency funding plan can help a B/D prepare for such situations and assist in its efforts to prudently and efficiently manage extraordinary fluctuations in liquidity.

Use of Customer Assets.   Under Exchange Act Rule 15c3-3, a carrying B/D must calculate what amount, if any, it must deposit on behalf of customers in its reserve bank account for the exclusive benefit of customers (reserve bank account), according to the prescribed formula (reserve formula).

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