Segregating client funds from operational funds is not just one of the key risk management best practices for brokers: it’s essential to gain traders’ trust, grow their business in the long term and protect the reputation of the entire industry, according to Martin St-Hilaire, Chartered Professional Accountant (CPA, CA) and Managing Director at Titan FX.
“While that may be obvious to many, we still hear about firms who commingle their clients’ funds. This inevitably leads to disaster,” St-Hilaire noted.
“It’s not just the fly-by-night or unregulated brokers who get caught commingling. FTX had a big case last year. They were mixing billions of dollars like crazy with little oversight except for a notepad and an incomplete QuickBooks file!”
The issue also came up in the recent U.S. Securities Exchange Commission lawsuit against Binance. The biggest crypto exchange in the world was commingling client funds in its American bank accounts, among other alleged wrongdoings.
According to St-Hilaire, these are signs that the industry needs more risk management education. He should know: he started his career lecturing on financial auditing at a Canadian university before managing a string of businesses in the accounting, banking and insurance sectors.
“Unlike banks, FX and CFD brokers don’t have deposit protection from their government. There’s no one to protect our client’s assets except us. That’s why client funds must be segregated from every other business asset and left untouched. They shouldn’t be used to pay suppliers or loaned or reinvested. Period.”
“The entire industry must adhere to strict guidelines and implement effective internal controls to properly attenuate risk.”
Sound accounting is essential
The Titan FX chief believes that sound accounting is the most important skill he brings to the job, even more than his trading acumen.
“Some of my colleagues know more about trading and synthetic instruments than I do. My job, first and foremost, is to mitigate risk and keep a healthy balance sheet. Caring for our traders comes first, and that means caring for the funds they entrust us with. When management is reckless or incompetent, we fail to provide a controlled environment.”
Besides segregating client funds — which means they’re never used for operational purposes and are subject to daily reconciliation to determine settlement obligations between Titan FX and its clients — the firm has strict policies to further protect its traders, based on best practices in banking and accounting.
“Many brokers who went out of business did segregate client funds before their big fail. But that should be their last line of defense. Many other checks and balances should be in place to avoid a catastrophe. We need to be properly capitalized, and we need to monitor our capital adequacy and liquidity ratios in real time to make sure they’re within certain limits. We must conduct financial and compliance audits on a yearly basis. These are the tools that will help us build a reliable, trustworthy business.”
The Titan FX chief outlined some important rules to follow when entrusted with client funds:
Label the accounts appropriately, such as “Segregation account.” The more boring and obvious the better. Unallocated funds are still client funds and they should also be segregated.
Put more funds on top of client funds in the segregation accounts to add padding to the liability side of the balance sheet. A 20% buffer is healthy, but make sure it doesn’t fall below 10%.
Always watch for key metrics, such as capital adequacy (minimum 15%) and liquidity ratio (110%)
It’s nice to have risk reserves. They come in handy for disputes, complaints and chargebacks.
Always perform risk assessments, plus liquidity and stress tests. This includes keeping an eye on the potential failures of some partners. Again, top-tier banks are ideal.
