Risk Management, Capital Adequacy and Client Asset Safeguards
Investment firms face market, credit, liquidity, operational and conduct risk. Capital adequacy under the Investment Firms Regulation and Directive (IFR/IFD) sets own-funds requirements based on minimum capital, fixed overheads, or K-factors reflecting risk to clients and markets. Candidates must know the three K-factor categories: risk-to-client (K-AUM, K-CMH, K-ASA), risk-to-market (K-NPR, K-CMG) and risk-to-firm (K-TCD, K-CON, K-DTF).
Client asset safeguards: client money and financial instruments must be segregated from the firm's own assets, held in appropriately titled accounts, reconciled regularly, and not used for the firm's account. Traps include assuming segregation eliminates all risk, confusing title transfer collateral arrangements with client money protection, and forgetting reconciliation and audit duties. Another trap: treating operational risk as irrelevant to capital.
Rule of thumb: segregate, title, reconcile, audit.
Worked example: a firm holds client shares at a custodian. If the firm becomes insolvent, those shares must be identifiable and returned to clients, not used to satisfy the firm's creditors; the firm must maintain records and reconciliations to prove ownership.
Reporting, Record-Keeping and Transaction Transparency
MiFID II and MiFIR impose transaction reporting to the FSC (as competent authority), with reference data, identification of the client, the instrument (ISIN), the venue, price, quantity and time. Firms must also report positions in commodity derivatives to the FSC. Record-keeping requires retention of communications and records relevant to services, generally for five years, extendable by the regulator. Candidates must know trade transparency: pre-trade (quotes) and post-trade (price, volume, time) reporting through approved publication arrangements and approved reporting mechanisms.
Traps include confusing transaction reporting with post-trade transparency (different purposes and channels), assuming records may be destroyed after a short period, and missing the clock-synchronisation requirement. Another trap: forgetting that telephone conversations relating to client orders must be recorded.
Rule of thumb: transaction reports go to the regulator; transparency goes to the market.
Worked example: a firm executes a client order on the BSE. It must report the transaction to the FSC with the required fields, publish post-trade details through an APA, and retain records for at least five years.