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Client’s best interest rule: Difference between revisions
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Secondly, where a [[dealer]] ''has'' offered a product — flakey or otherwise — [[TCF]] is about ''then'' ensuring that the [[dealer]] exercises its rights against clients in that product (''ceteris paribus''<ref>If a client [[Failure to pay|fails to pay]], or can’t meet margin, different story, clearly.</ref>) fairly. So, if you have 100 clients long the same [[delta-one]] [[equity swap]] and there is a [[Market Disruption Event - Equity Derivatives Provision|market disruption]] affecting ''half'' your hedge, you close out ''all'' positions ''pro rata'', rather than closing out the small clients in full and keeping the juicy [[platinum client]] open and therefore happy, however much that is better to your long term revenue profile. | Secondly, where a [[dealer]] ''has'' offered a product — flakey or otherwise — [[TCF]] is about ''then'' ensuring that the [[dealer]] exercises its rights against clients in that product (''ceteris paribus''<ref>If a client [[Failure to pay|fails to pay]], or can’t meet margin, different story, clearly.</ref>) fairly. So, if you have 100 clients long the same [[delta-one]] [[equity swap]] and there is a [[Market Disruption Event - Equity Derivatives Provision|market disruption]] affecting ''half'' your hedge, you close out ''all'' positions ''pro rata'', rather than closing out the small clients in full and keeping the juicy [[platinum client]] open and therefore happy, however much that is better to your long term revenue profile. | ||
Thirdly, trading any products ''necessarily involves taking on risk''. [[Dealer]]s do not have an unlimited tolerance for this stuff. It is axiomatic that [[dealer]]s don’t, without good reason and comprehensive [[verbiage]] grant their clients committed trading facilities. It might attract a capital charge for one thing. Suggesting that, because you have traded with ''one'' client means you are obliged to trade with another, obliges you, effectively to write the whole world a committed trading facility. | Thirdly, trading any products ''necessarily involves taking on risk''. [[Dealer]]s do not have an unlimited tolerance for this stuff. It is axiomatic that [[dealer]]s don’t, without good reason and comprehensive [[verbiage]], grant their clients committed trading facilities. It might attract a [[Regulatory capital|capital charge]] for one thing. Suggesting that, because you have traded with ''one'' client means you are obliged to trade with another, obliges you, effectively to write the whole world a committed trading facility. | ||
So let’s say dealer A has put on a big trade with client X in the process maxing out its appetite for bitcoin denominated cannabis futures. If client Y comes along and says, “well you did 5 yards with ''him'', so you can do five yards with me too,” it puts our poor risk manager in a pickle. Must she ''double'' her exposure, in the name of treating customers fairly? Is even ''that'' the end of it? If clients P, Q, and R arrive with the same request the next day, must she quadruple her exposure? Clearly | So let’s say [[dealer]] A has put on a big trade with client X in the process maxing out its appetite for [[bitcoin]]-denominated cannabis [[futures]]. If client Y comes along and says, “well you did 5 yards with ''him'', so you can do five yards with me too,” it puts our poor risk manager in a pickle. Must she ''double'' her exposure, in the name of treating customers fairly? Is even ''that'' the end of it? If clients P, Q, and R arrive with the same request the next day, must she quadruple her exposure to suit ''them''? Clearly that would be ''madness''. To take our ''[[reductio ad absurdam]]'' to the other end, we wonder, must our hapless risk manager instead keep some risk headroom open when trading with X, thereby declining to fill the client’s whole order, just so she can keep enough room to accommodate Y, P, Q, and R ''[[pari passu]]'' in case they decide they want to transact? But what of clients A, B,C all the way to ''n''? Clearly this is madness also. | ||
So we start to put some parameters on it: a [[dealer]] must have ''legitimate'' grounds for not trading: [[credit]] appetite, [[market risk]], prevailing [[volatility]], reputational and so on, as legitimate grounds. No doubt imaginative risk managers could think of others. At some point, any old fool can contrive ''some'' plausible excuse for not trading, so in practice we are at the point the [[JC]] started with: ''you don’t have to offer the same product, on the same terms, to everyone''. But this is a bad intellectual ground for getting there. None of these putative grounds have anything to do with “fairness between clients” as such — they all speak to the [[dealer]]’s personal risk appetite. So if these reasons ''do'' trump an incoming client’s request to trade, then it stands to reason that the [[dealer]]’s own interest takes precedent over the (putative) client’s interest. If so, this is a either a transgression of the client’s best interest rule, or a situation in which the client’s interest doesn’t prevail. The [[JC]] says it is ''obviously'' the latter. | So we start to put some parameters on it: a [[dealer]] must have ''legitimate'' grounds for not trading: [[credit]] appetite, [[market risk]], prevailing [[volatility]], reputational and so on, as legitimate grounds. No doubt imaginative risk managers could think of others. At some point, any old fool can contrive ''some'' plausible excuse for not trading, so in practice we are at the point the [[JC]] started with: ''you don’t have to offer the same product, on the same terms, to everyone''. But this is a bad intellectual ground for getting there. None of these putative grounds have anything to do with “fairness between clients” as such — they all speak to the [[dealer]]’s personal risk appetite. So if these reasons ''do'' trump an incoming client’s request to trade, then it stands to reason that the [[dealer]]’s own interest takes precedent over the (putative) client’s interest. If so, this is a either a transgression of the client’s best interest rule, or a situation in which the client’s interest doesn’t prevail. The [[JC]] says it is ''obviously'' the latter. | ||