Brokers at risk from margin trading services

Worldwide market volatility is prompting nervous flashbacks for those that suffered at the hands of the Asian financial crisis of 1997. With Peregrine Investment Holdings a prime example of business failure due to bad risk management becoming the focus of media attention again recently, financial institutions particularly are looking at their exposure.

That’s why providers of risk management solutions are finding this is a good time to evangelize and educate financial institutions on the potential for better risk management practices.

For brokers, especially those in the retail market, one of the key areas of potential risk is margin lending. But according to Joey Fan, chief technology officer at Quotepower International, the kind of systems commonly in use today aren’t up to the task of dealing with the highly competitive, high volume environment.

In the conventional approach to broker risk management, risk management functions are split between trading and back office system, meaning that a credit officer makes manual assessments using data that is often taken from the previous day. Collateral is the major factor used to determine customer’s credit limits and defaults are reported after the fact.

But most brokers, in Hong Kong at least, haven’t even gone that far, says Fan. “Maybe about half are at this basic level, but of the brokers that have embraced electronic trading, only a few have taken it any further.

“Some may have basic customer credit checking on an individual basis only, but they can’t get a real-time measure of enterprise-wide risk,” he adds.

A system that can plug in new data and events and generate new margin calls in real-time would be particularly useful in the event of dramatic market drops. This would support day trading and intraday margin calls. Having centralized credit control and risk management controlled by a mid-office credit officer would allow this, says Fan. It would also allow a broker to better assign credit limits according to customer’s likelihood of default, trading behaviour and risk profile.

The move towards multi-market trading for online retail customers is another consideration for managing margin trading. If an Asian brokerage trades in local and US stocks, will it offer US dollar margin lending? Should it require it to be offset against a US stock portfolio, or can Asian stocks be proffered as collateral?

Any new risk management system needs to take these cross-border questions into account. This would also require data feeds to evaluate overseas market conditions and foreign exchange rates.

Any new system that incorporates these changes could dramatically change not only risk exposure at a brokerage, but also the way it manages workflow. The role of the traditional credit officer will have to change, says Fan.
 
And it’s not just traditional or online brokers that are faced with a change in the way they will handle risk management in future, he adds. “A lot of banks want to offer real margin trading too. Now they have to do it with an overdraft on existing accounts. They want to do it with the customer’s portfolio, but just don’t have the set-up.”