Client’s best interest rule: Difference between revisions

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Client’s best interest rule (view source)

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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 [[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.
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 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 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.
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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.


====And client means?====
The same goes for close-outs and disputes. when confronted with any practial means of sorting out a specific dispute on a settlement failure with a client,. [[compliance]] will be sore pressed not to caution ''against'' this, on grounds of treating customers fairly - the equity in question being the resolution of this specific issue, and any other settlement or trading issue that might arise in any market, with any client at any time, if putatively analogous. Again, this ought not be the purpose of the [[TCF]] rule, if for no other reason it will “chilling” effect on a [[dealer]]’s appetite for settling any dispute with any client in any circumstances short of a final judgment of a competent court. [[TCF]] does not introduce the obligation to operate some kind of internal [[stare decisis]] policy, obliging a [[dealer]] to apply a [[doctrine of precedent]] binding it for all times to any practical accommodation it might make with any of its clients at any time for any reason. The intention is surely more limited: if ''two'' clients grumble about the ''same'' valuation the dealer makes on the ''same'' product at the ''same'' time, then TCF obliges the dealer who fixes the problem for one client to offer corresponding resolution to the other. Be even handed. That is all.
So, then when this rule says “client” what does it mean? Any person whom the [[dealer]] has [[Onboarding|onboarded]] as a client who has at any time traded any product, ever, or a live [[client]] with an ''actual'' [[exposure]] to the specific product in question? If you take the wider view — and a [[chicken licken]] will be [[inclined]] to, since that’s the least likely to get him skewered — then any onboarded entity acquires some (conditional?) right to be offered a trading line in ''this'' product over any other participant in the market who hasn’t yet been onboarded — remember “''[[a stranger is just a client you haven’t onboarded yet]]''” — and that inequity seems just as arbitrary as one between a client who ''is'' in the product against one who is not.
 
====And “client” means?====
So, then when this rule says “[[client]]” what does it mean? At first blush you might say this means any person whom the [[dealer]] has [[Onboarding|onboarded]] as a [[client]] who has at any time traded any product, ever, but a better view is that is should be a ''live'' [[client]] with an ''actual'' [[exposure]] to the specific product in question. If you take the former, wider, view — and a [[chicken licken]] will be [[inclined]] to, since that’s the one least likely to get him skewered — then ''any'' onboarded entity acquires some (conditional?) right to be offered a trading line in ''this'' product over any other participant in the market who hasn’t yet been onboarded — remember “''[[a stranger is just a client you haven’t onboarded yet]]''” — and that inequity seems just as arbitrary qnd, really, greater, than one between an existing client who ''is'' in the product at the time of the event, and one who is not.


When you back out of that ''cul-de-sac'', there is only one conclusion left: the [[dealer]]’s decision to deal in a product ''must'' be its own sovereign right. [[TCF]] must be about fair treatment of customers the [[dealer]] ''has'' traded with, not with randoms (whether onboarded or not) with whom it ''hasn’t''.  
When you back out of that ''cul-de-sac'', there is only one conclusion left: the [[dealer]]’s decision to deal in a product ''must'' be its own sovereign right. [[TCF]] must be about fair treatment of customers the [[dealer]] ''has'' traded with, not with randoms (whether onboarded or not) with whom it ''hasn’t''.  
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