As the entire online financial world zooms in on safety of client funds following a series of events this year of which the Cyprus bailout , and more recently the situation surrounding Liberty Reserve, have heightened regulatory and corporate attention to securing client assets correctly, the ever-cautious Japanese Financial Services Agency (JFSA) yesterday released full comprehensive details regarding the regulatory supervision of financial instruments.
An often-discussed and easily implemented means of ensuring the client is safe from a regulatory perspective is to maintain capital adequacy requirements and supervise them in accordance with a framework set out by the regulators themselves.
With due consideration given to what the JFSA considers a notable susceptibility of the financial instrument operators to changes in the market environment, the regulator has stipulated that regulation on the capital adequacy ratio aims to ensure the soundness of each regulated OTC derivatives and trading company’s financial condition and thereby protects of investors, even if the business operators face a decline in their income due to rapid changes in the market conditions or a decline in the value of their asset holdings.
Through efforts to maintain an adequate level of capital adequacy ratio, financial instruments business operators must identify and manage risks involved in their businesses in a comprehensive manner and keep liquid assets (non-fixed capital) in sufficient quantity and quality, to enable them to withstand losses that may be caused by the materialization of various risks.
The JFSA established in its dossier to companies that the regulator will need to encourage Financial Instruments Business Operators to make voluntary efforts to maintain the soundness of their financial conditions through offsite monitoring, which should complement the efforts the business operators make on their own responsibility to maintain an appropriate level of capital adequacy ratio, which is currently based on the Basel II framework.
Whether this will lead to a somewhat Orwellian approach of using software to conduct surveillance is not known, however with ASIC already having gained some results from the monitoring of firms’ behavior through use of its Delta Stream system, a predilection for this type of monitoring clearly exists.
Australia’s ASIC also went down the route of investigating rulings on operating capital in the latter part of last year, announcing that it intended to revise the criteria in order that all ASIC regulated OTC derivatives brokers would need to ensure they have net tangible assets of $500,000 or 5% of revenue. In 2014, the requirement could be increased to $1million and 10% of revenue.
The regulators are following Basel 3 as a base for revenue and capital as a measure of a firm’s financial stability.
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Inspection With A Fine Toothed Comb
Supervisors shall strive to identify and keep track of the status of a Financial Instruments Business Operator’s market risk and its risk management through monthly offsite monitoring reports and hearings based thereon and, when necessary, require it to submit a report based on Article 56-2(1) of the FIEA and urge it to make improvement efforts.
Proprietary Trading Poses Risk
In terms of risk management regarding proprietary trading, a number of rules have been set out in order to define a procedure for identifying and managing market risks regarding proprietary trading, a Financial Instruments Business Operator must pay attention to the following points, in addition to identifying the value of the market risk equivalent on a daily basis, based on Article 178(2) of Japan’s FIB Cabinet Office Ordinance.
A Financial Instruments Business Operator should set the maximum allowable value of market risks that may be allotted to proprietary stock trading or reasonable limits and risks equivalent thereto (hereinafter referred to as the “allowable market risk value, etc.”), based on an appropriate capital adequacy ratio target set with due consideration of its own financial condition and other factors.
As perhaps is to be expected, regulators worldwide are increasingly concerning themselves with such matters. Raising the capital adequacy requirement for brokers by ASIC, CySEC, the FCA, NFA and now Japan’s FSA has seen a number of participants experience extremely high operating costs. This, coupled with the double-edged sword that is the reducing of payment options and the Cyprus banking crisis, has led to a year of expense for brokers.
Forex Magnates intends to investigate the industry’s viewpoint on these matters at tomorrow’s IFXEXPO event in Limassol, Cyprus.