Brought to light by the default of Archegos in March 2021, resulting in reported market-wide USD 10 billion losses, global primary brokerage businesses are under increased scrutiny. The FCA and the PRA co-published a Dear CEO letter on 10 December 2021, outlining a supervisory review of these firms.
The joint PRA-FCA letter sets out their expectations, targeting all prime brokerage services to complete systemic reviews. These expectations consist of:
Business strategy and organisation
Firms need to establish consistency of controls, monitoring, and risk measurement across all relevant business units. Where a bank is offering prime brokerage services from more than one business unit, they must establish detailed mandates for each.
Onboarding and reputational risk
Firms must make continuous client re-assessment processes that require senior management decision making and sign-off. Firms are expected to dynamically combine new reputational risk due diligence, independent credit checks and variation in risk profiles across different business units.
Financial risk management controls and governance
Firms need to have in place standard contractual terms appropriate for different types of client accounts, including flexible clauses that allow for post-trade margin changes. That is expected to be achieved with consistent contract negotiation policies and procedures across different business units.
Further, in-house risk management teams also need to support all prime brokerage units in a holistic way. Thirdly, data quality and stress limit frameworks must combine to reflect each firm’s risk appetite across all types of client portfolio exposure.
Liquidation and close-out
Firms should ensure they are calibrating and scaling risk exposures to the firm’s own ability to exit positions in the event of default and liquidation. If not already in place, firms are more likely to manage these events by producing default and liquidation playbooks that provide detail on responsibilities, roles and scenarios.
The PRA and FCA expect firms to provide detailed plans for remediation and ensure that any necessary improvements are identified. A tight deadline, end of Q1 of 2022, has been set to complete reviews and plans.
The Dear CEO letter states that although Archegos did not have financial stability consequences, consequent events provide strong evidence of the effects of leverage in the non-bank sector on other counterparties. Additionally, the FCA and PRA highlight the pitfalls of poor risk management, and that firms should ensure that equity financing businesses strengthen their risk practices to ensure financial stability in the future.
Providing accurate data and a timely response will require one or more senior managers to be responsible for oversight of the remediation plan and confirm it is reported correctly to meet best practice. The supervisory review of equity finance businesses should ensure, where relevant, the highlighted themes cover all major brokerage activities including fixed income and derivatives. All reviews should also address broader observations on risk culture across the firm and the infrastructure in place.
For more information, contact Paul Young .
