Management of Risks Associated with Proprietary Business of Securities Companies

Construction of Risk-Management Systems for Proprietary Business of Securities Companies The unique characteristics of proprietary business, as compared to other types of securities company business, require a risk-management system that fits the business. Proprietary securities holdings, profit and loss, risks, and transactions are effectively monitored mainly through dynamic tracking of business operation information and data. Focus is on the prevention of such risks as unchecked expansion of proprietary business, decision-making mistakes, unauthorized operation, disguised proprietary operation, and insider trade.

An independent risk-management division or team may be set up for securities proprietary business. With the support of IT staff, a risk-control system can be developed. The planning and finance division is responsible for the management of equity-type proprietary funds, trading seats, and accounts, as well as routine capital clearing and accounting. The risk-management division or team helps calculate the maximum risk amount that the proprietary business can sustain, the formulation risk warning indexes, and the monitoring of risks associated with proprietary business. The monitoring results and a risk-assessment report are presented to the risk-management division of the company on a daily basis. After categorizing and analyzing the information, the risk-management division assesses the overall risk of the proprietary business of the company and comes up with suggestions or comments before sending the assessment results to each member of the risk-management committee. The risk-management committee evaluates the risk-management policies for securities proprietary business on a regular basis, and provides the board chairman and general manager with strategic advice.

The proprietary business unit should compile a securities proprietary report, which includes the following contents:

- Information about the accounts and trading seats of proprietary business

- Major decisions on the sale of proprietary business, risk limits, asset allocation, business authorization, and so forth

- Proprietary business risk monitoring report

- Other issues that should be reported

The responsible division, responsible persons, and process of proprietary business reporting should be specified clearly.

Risk-Control System for Proprietary Business of Securities Companies The success of risk control for the proprietary business of securities companies hinges on establishing a series of proprietary business systems. The behavior of decision makers and operators of securities proprietary business is shaped and governed through these systems. In designing risk control systems for proprietary business, the authorization system is the prerequisite and foundation. The investment decision-making process for proprietary business is improved based on clear authorization rules. The incentive and constraint systems are important means for ensuring the effective implementation of risk management for proprietary business. And the communication system is the key factor for the dynamic circulation of proprietary business risk control.

Risk-Management System for Proprietary Business

Sound Internal Control Management System and Effective Risk Oversight Internal control systems include proprietary trading management rules, proprietary investment decision making and risk control measures, operator management measures, proprietary account use management rules, and proprietary fund allocation mechanisms. These should be formulated and earnestly implemented to prevent and solve irrational actions and improper operation caused by human mistakes, as well as to increase return from proprietary business and lower trading risks.

Once internal systems are implemented, strictly abiding by laws and regulations is imperative. Risks that might be caused by holding too much of the same type of securities in the event of price fluctuation should be prevented. An even greater effort should be made to avoid various law- or regulation-breaching behaviors such as market manipulation.

Following this, in cooperation with other business divisions such as the investment bank division, the proprietary business division, and the brokerage business division, the trade division should stick to a rigorous internal insulation wall mechanism. This will maintain the separation of staff, finance, business management, and information. It effectively prevents connected transactions and insider trading from happening. Based on the characteristics of securities trading, the proprietary business may adopt an operation model with cascaded decision making, cascaded management, and cascaded control. An internal control process should be established for the proprietary business of securities companies.

Construction of Risk Warning and Real-Time Monitoring System Risk warning and monitoring is a fundamental and critical part of risk management for the proprietary business of securities companies. Risks can be controlled and protected against only if they can be identified. Risk warning and monitoring is a comprehensive and complex system. Securities companies need to accumulate empirical data and then construct and build up a risk warning and real-time monitoring system based on their own risk-control frameworks and systems. The following five steps should be followed:

1. Select warning indexes in a scientific and sensible way: A comprehensive analysis of securities proprietary should be conducted to provide a basis on which to forecast risks facing the business. The indices selected must be able to sensitively reflect the change of risks in securities proprietary business. The criteria should include the ability to categorize risks by their importance and nature and to characterize the risks.

2. Gather and process risk signals: Signals gathered as warning signals should be those of significance to the decision making in securities proprietary business. Interference from other factors should be avoided to prevent skewed or incomplete information gathering.

3. Identify and measure risks: Make judgments about risks in securities proprietary business based on existing knowledge and experience. Identify risks through effective risk-identification methods, such as the system decomposition method and the scenario analysis method. Based on risk identification, determine the weight and threshold value of each risk index and verify these in practice.

4. Assess and deal with risks: In the overall risk judgment and decision-making process, the risk is rated using the identification methods noted above. If the risk is rated at or above the warning level, the risk warning division must immediately issue risk warning signals, so that the risk-addressing division can enact remedies in a timely manner. Based on the risk warning signal level, the risk-control division identifies major risk factors, comes up with timely solutions, and implements them to bring the risks under control.

5. Receive risk control feedback: The securities propriety business risk control division feeds the status of risk control back to the risk warning, forecast, information gathering, and processing divisions. Risk-management organizations for the proprietary business of securities companies should also be notified.

Real-Time Monitoring System for Risks Associated with Securities Proprietary Business Risk management usually needs a series of quantitative techniques. The use of risk-management techniques should follow the principles of easy operation, flexibility, and convenience.

A risk-management information database should first be constructed. It should contain the amount of information needed to support the risk-control process for securities proprietary business. The database should include various types of dynamic data such as transaction volume, current market prices, model-supporting data, and major measurement results, such as risk exposure level and VaR. The database should also include various types of static information. Such information includes the scale of the proprietary business, the make-up of the portfolio, restrictive rules on the operation of proprietary business set by the securities company, and the system risk of the securities market. It also includes pre-stored information such as raw data, risk measurement standards, risk measurement model, and relevant parameters.

The next step is fast, reliable, and error-free processing of information. This is a core link for realizing real-time monitoring in securities proprietary business risk control.

At the core of risk information processing is a risk information integration program. The integration program provides standard interfaces, intersystem communication, and transmits the source data to the database system in a complete and safe manner.

Proprietary Business Risk-Monitoring Report After calculating, analyzing, and summarizing risk information, the proprietary business risk control staff proceeds to provide the latest risk-control advice in the form of a risk-monitoring information report for various tiers and levels. Risk reports for higher levels are sent to higher senior management of the securities companies through certain channels to serve as a basis for decision making. Risk-monitoring reports for other levels can be accessed by other employees through their respective user interface with a password, and serve as important guidance for proprietary business transactions or operation monitoring.

Implementation of Risk Transfer and Risk Disposition There are some effective means for securities companies to transfer the risks of securities proprietary business; for example, entrust specialized institutions with securities investment with higher risks, transfer the risks to others through covenants, or laterally transfer the risks through various forms of economic cooperation.

Two securities proprietary business risk disposition methods are corrective risk disposition and emergency risk disposition. When there is regulation-breaching operation or potential risks in the proprietary business of a securities company, the decision makers of the business use the corrective risk disposition method to correct their own behavior and prevent the risks from deteriorating. Emergency risk disposition measures are used in the case of a sudden deterioration of or a temporary payment risk in the proprietary business of a securities company. Remedial measures should be taken promptly to prevent the risks from further spreading.

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