Liquidity Risk Management

Regulatory Obligations

Effective monitoring of liquidity and funding risks is an element of broker-dealers’ financial responsibility and is a longstanding focus for FINRA’s Risk Monitoring and Examination programs. FINRA routinely reviews and has shared observations on firms’ liquidity risk management practices, as discussed in Regulatory Notice 15-33 (Guidance on Liquidity Risk Management Practices), Regulatory Notice 21-12 (FINRA Reminds Member Firms of Their Obligations Regarding Customer Order Handling, Margin Requirements and Effective Liquidity Management Practices During Extreme Market Conditions) and Regulatory Notice 10-57 (Funding and Liquidity Risk Management Practices).

FINRA’s Supplemental Liquidity Schedule (SLS) was effective on March 1, 2022.¹ The SLS is a supplemental filing to the FOCUS Reports and generally is required of firms with the largest customer and counterparty exposures. The SLS is designed to improve FINRA’s ability to monitor for events that signal an adverse change in these firms’ liquidity risk.

Observations and Effective Practices

Observations

• Insufficient Stresses on Clearing Deposit Requirements: Incorrectly basing stresses on clearing deposit requirements on information that doesn’t necessarily represent the firm’s business operations (e.g., only using the amounts reflected on month-end FOCUS reports rather than reviewing for material fluctuations in deposit requirements that may have occurred intra-month) and insufficiently accounting for substantial regulatory or product changes (e.g., centralized clearing of Treasuries, the move to the T+1 settlement cycle).
• Unreasonable Stress Test Assumptions: Incorporating unreasonable assumptions into stress tests that materially misrepresent the firm’s liquidity position (e.g., inaccurately determining the amount of a firm’s inventory that would require financing in a stressed environment; relying on funding sources in a stress event that a firm does not engage with in a business-as-usual (BAU) environment).
• Inadequate Supervision: Firm departments responsible for liquidity risk oversight (e.g., second and third lines of defense) not identifying unreasonable assumptions or inaccurate calculations that existed in liquidity stress tests.
• Inadequate or No Contingency Funding Plans: Failing to develop contingency funding plans that would provide sources of liquidity for operating under market or idiosyncratic stress conditions, including identifying the firm staff responsible for enacting the plan and the process for accessing liquidity during a stress event, as well as setting standards to determine how funding would be used.
• Inaccurate SLS Reporting: Providing inaccurate or incomplete information in the firm’s SLS, including:
  • incorrectly reporting agent lenders rather than underlying principals as counterparties to repurchase agreements, reverse repurchase agreements and securities borrowed transactions;
  • providing incomplete information regarding noncash securities lending transactions (i.e., identifying either the received collateral or delivered collateral, but not both); and
  • not completing the line item for “Total Available Collateral in Broker-Dealer’s Custody” (or entering inaccurate information).

Effective Practices

• Liquidity Risk Management Updates: Updating liquidity risk management practices, policies and procedures to conform with the firm’s current business activities, including:
  • establishing governance around liquidity risk management, including determining who is responsible for monitoring the firm’s liquidity position, the frequency of monitoring, and the communication and coordination protocols; and
  • creating a liquidity management plan that considers:
    • liquidity use assumptions that are based on both idiosyncratic and market-wide conditions and stress scenarios; 
    • sources of funding in both business-as-usual and stressed conditions; 
    • stability and other characteristics of funding sources (e.g., restrictive covenants or material adverse change clauses within funding contracts that could affect the availability of the funding under certain conditions);
    • the type and quantity of available collateral needed to secure funding;
    • potential mismatches in duration between liquidity sources and uses; 
    • a contingency plan in the event of loss of funding sources; and
    • early warning indicators of liquidity loss and escalation procedures.
• Stress Tests: Conducting stress tests in a manner and frequency that consider the complexity and risk of the firm’s business model, including:
  • assumptions specific to the firm’s business (e.g., increased haircuts on collateral pledged by firm, availability of funding from a parent firm) and based on historical data;
  • the firm’s sources and uses of liquidity; 
  • changes to the stability and quality of liquidity sources relied upon for its funding needs in a stressed environment;
  • material swings in customer cash balances (e.g., redemptions, interest payments, sweeps);
  • the potential impact of off-balance sheet items (e.g., nonregular way settlement trades, forward contracts and related margin requirements) on the firm’s liquidity needs; and
  • periodic governance group review of stress test parameters based on current data.
• Contingency Funding: Considering any restrictive covenants and material adverse change clauses in contracts that could impact the availability of contingency funding.

Additional Resources

• FINRA
  • Funding and Liquidity Key Topics Page
  • Frequently Asked Questions: Supplemental Liquidity Schedule

1 See Regulatory Notice 21-31 (FINRA Establishes New Supplemental Liquidity Schedule (SLS)).