When a broker dealer becomes a carrying firm subject to SEC Rule 15c3-3 (the Customer Protection Rule), FINRA expects the firm to manage liquidity effectively. This means prioritizing customer cash commitments — such as withdrawals and trade settlements — ahead of the firm’s own.
A recent event shows how quickly these liquidity commitments can escalate. On June 30th, carrying firms clearing through DTCC encountered a “Double Settlement Day”. Due to erroneous trades submitted by a participant firm, settlement activity for June 29th was rolled over to the 30th. As a result, firms had to wait an additional day for sales proceeds, while the extra day of unsettled activity also drove up the clearing fund requirement for the 30th. This means net sellers of securities were hit with two liquidity stresses at once: continuing to front customer cash while waiting on delayed proceeds, and covering a larger deposit at DTCC at the same time. Because this coincided with month-end, ACI observed multiple carrying firms forced to deposit additional cash into their customer and PAB reserve accounts on July 1st . While the timing and cause of an event like this can’t be predicted, its liquidity impact can — and should — be modeled in advance through stress testing. The Double Settlement Day is a clear example of why well-managed liquidity is essential to daily operations and the financial system at large. Carrying firms provide an additional layer of cash liquidity to the entire system that ensures customer funds are secure, and customer trades will settle regardless of market conditions. Given this responsibility, FINRA focuses on “stress testing” — the regular practice of modeling a broker-dealer’s daily cash flows (usually in a spreadsheet) to ensure it can meet its cash obligations during periods of market disruption or firm-specific shocks. FINRA’s focus on liquidity stress testing isn’t new. It dates back at least a decade, with the publication of FINRA Notice 15-33 in September 2015. The notice outlined the results of a 43-member-firm study on “liquidity needs in a stressed environment”. The study measured the liquidity impact on these firms when various stressors were introduced over a 30-day period. Results were generally positive, though mixed: smaller firms struggled the most, and three firms ended up subject to increased surveillance, per FINRA Notice 10-44 (Page 2, Item 8, “cash flow problems”). Built on these findings, FINRA proposed Rule 4610 in June 2023, drawing largely on the scenarios outlined in 15-33. The rule has yet to pass, but it has set the stage for how FINRA views liquidity during cycle audits and New/Continuing Member Applications.
A comprehensive stress test, in a format similar to the one outlined in proposed Rule 4610, has been a consistent requirement across every carrying-firm application (NMA or CMA) and SEC/FINRA exam ACI has supported. No two are alike – each one reflects the firm’s business model, product mix and financing sources.
Firms that intimately understand their day-to-day liquidity position themselves and their customers for stability, regardless of market conditions. Modeling liquidity not only satisfies regulators, but it also reveals opportunities firms might otherwise leave on the table, from reduced financing costs to additional interest income.
ACI has deep, firsthand experience with FINRA’s expectations in this area and builds stress tests tailored to each client’s business, whether on an ad-hoc basis or as part of a larger engagement. Reach out to learn how ACI can help your firm build a stress-testing program that meets regulators’ expectations and strengthens your bottom line.