Staff of the Division of Swap Dealer and Intermediary Oversight of the Commodity Futures Trading Commission issued an advisory that provides guidance, in their view, regarding elements of an effective risk management program (RMP). Pursuant to applicable CFTC rule, future commission merchants are required to establish, maintain and enforce risk management policies and procedures designed to monitor and manage the risks associated with their business (click here to access CFTC Rule 1.11). Among the risks FCMs should address in their RMP are market, credit, liquidity, foreign currency, legal, operational, settlement, segregation, technological and capital risks. Each FCM’s RMP must be administered by a risk management unit (RMU) that is independent of the firm’s business unit (BU) and reports directly to the FCM’s senior management. In the advisory, staff makes specific recommendations or provides multiple observations regarding elements of what it appears to consider more effective RMPs. Among other items, staff suggests that FCMs may want to include in their RMPs a description of how independence of the RMU is maintained from the BU; how often an FCM considers the adequacy of resources of the RMU; and a description of risk tolerance limits, including, for each risk type, the methodology to determine the limits and the procedure to ensure quarterly review and approval by senior management and annual approval by the FCM’s governing body. Staff also made observations regarding the quarterly risk exposure reports that must be made to an FCM’s senior managers and governing body, and provided to the CFTC. Among other things, staff observed that some FCMs disclose actual risk exposures for each period for each risk metric rather than just discuss breaches. According to staff, “[f]or example, the maximum, minimum, median and standard deviation for risk exposures could be provided or shown graphically over the course of the quarter.” The staff's advisory is dated March 2, 2016.
Compliance Weeds: Although staff’s guidance is expressly limited to the application of its risk management program requirements to FCMs that handle customer funds, a similar requirement to maintain RMPs applies to swap dealers and major swap participants (click here to access the relevant CFTC Rule 23.600). Although staff indicated that similar guidance might be issued to SDs and MSPs later, this FCM guidance should be considered by SDs and MSPs, by analogy, to evaluate the adequacy of their own RMPs. Also, as staff commented in its guidance, an FCM must broadly evaluate its risks when designing its RMP. An FCM must consider risks posed by affiliates, all lines of the FCM’s business, all other FCM trading activity and “must describe in detail how the RMP has been integrated into risk management at the consolidated entity level.” (Click here for further CFTC guidance on RMPs in the Federal Register release adopting CFTC Rule 1.11 (pgs. 68517 – 68521).)