Letter from Nathanaël Benjamin and David Bailey – Fixed Income Financing Thematic Review

  • Source: bankofengland.co.uk


Following the default of Archegos Capital Management back in March 2021 which resulted in excess of $10 billion losses across multiple firms, PRA and other regulators carried out a review of the firms counterparty risk management and identified a number of weaknesses pertaining to the risk management controls and governance, client onboarding, liquidation and close out, etc., Subsequent to this review, PRA puts the spotlight on fixed-income financing/repo/secured-financing business alongside outlining the following expectations from the CRO’s.

The recommendations outlined below are to be presented to the firms Board Risk Committee and benchmarked against the industry’s best practice and PRA’s expectations outlined below. To address any shortcomings determined from the internal benchmarking exercise, the firms are expected to create a robust remediation plan detailing the scope and timeline of the remediation plans and share the same with the PRA by 8th December 2023.

Counterparty Risk Management Controls:

  1. Counterparty risk stress testing – Individual counterparty and portfolio-wide stress scenarios should be produced and reviewed by the second line of defense on a systematic, frequent, and timely basis. Stress scenarios should be linked formally to risk exposure monitoring and should be incorporated fully into the decision-making and governance processes of the second line of defense.
  2. Counterparty risk concentrations – Firms should consider the adequacy of their counterparty risk management controls and limit frameworks in capturing concentrated financing exposures that may become illiquid under certain market conditions. Steps should be taken to flag and escalate build-up of such concentration exposures.
  3. Margin Period of Risk (MPoR) – Firms should establish formal criteria, owned by the second line of defense, for considering and establishing any non-standard MPoR inputs to risk exposure calculations, taking account of concentrated client exposures and the effective, operational close out-period for individual client portfolios.
  4. Collateral haircuts – Firms should independently assess and calibrate haircut terms to cover potential collateral shortfalls based upon reasonable credit assumptions. Also, the firms should establish collateral haircut policy, owned by 2nd line of defense setting out the criteria for determining the collateral haircuts for all counterparties.
  5. Onboarding / client due-diligence – Risk appetite should be appropriately calibrated, considering the size and leverage profile of the fund, its available liquidity, and its investment strategy, together with other pertinent matters. Firms should produce timely and appropriate management information reports to differentiate the exposures to different underlying funds.
  6. Fund manager disclosures – Firms should explicitly implement exception policies to the formal counterparty due diligence standards complimented by the independent risk management functions assessment of the quality of client’s credit disclosures in order to set the internal credit risk appetite and haircut terms.

Operations and Settlement Processes:

  1. Operational constraints – PRA has noted significant deficiencies around the firm’s settlement and margining systems lacking STP (straight-through-processing) and automated information capabilities. Hence, firms are expected to prioritize enhancements to downstream systems and controls.
  2. Margining processes – Firms are to focus on the automation of margining processes to mitigate the risks of large volume and scale of margin calls during heightened periods of stress.
  3. Alternative collateral arrangements – Optionality in margin fall back arrangements such as top-up collateral postings in the form of cash payments prior to the gilt market stress events etc., should be considered in the new accounting onboarding processes. Any such alternative cash payment lines opened with clients should be tested on a periodic basis.
  4. Critical operational processes and client due diligence – PRA had questioned the custodian bank’s ability to keep pace with the volume and complexity of requests from their fund clients during heightened market stress. Hence PRA expects the custody banks to ensure there is a heightened awareness of critical operational factors and client servicing arrangements during the client due diligence phase.

Liquidity Risk Management Controls:

  1. Treasury liquidity pool collateral monetization controls – Firms should carry out liquidity risk analysis in relation to the overall maturity profile of the matched book assets and liabilities and composition of HQLA (high quality liquid assets) including assessing the constraints on the mobilization of collateral across legal entities.
  2. Cross currency exposure risk appetite – Firms internal risk appetite should consider the notional size of cross-currency wrong way risk positioning against market stress events.

How Treliant Can Help?

Treliant’s risk experts comprising of practitioners and former regulatory supervisors can assist firms with all aspects of the risk governance including the design, review, and implementation of risk identification, risk monitoring, risk controls, and risk appetite frameworks covering credit and market and operational risks.


Kishore Ramakrishnan

Kishore Ramakrishnan is Managing Director, Capital Markets Advisory at Treliant. He has over 24 years of global industry and consulting experience across the banking, capital markets, asset, and wealth management businesses.

Tom Ciulla

Tom Ciulla is a Managing Director in Treliant’s Capital Markets Solutions practice. Tom is a senior executive with extensive business, operations, and IT experience as a Big 4 partner serving sell-side, buy-side, and industry utility clients across global financial markets. He specializes in developing financial services solutions, while growing and…