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Financial & Operations Compliance



One of the main roles of IIROC’s Financial and Operations Compliance department (FinOps) is to assess whether firms have enough capital for the type and scope of their business activities. FinOps monitors firms for compliance with IIROC financial rules to reduce the possibility of financial failure due to excessive leverage or risky business practices.



 

 FinOps Information

 

FinOps monitors the financial status of IIROC-regulated firms and enforces compliance with IIROC rules. The main elements of the department’s work are:
  • Review of financial regulatory filings – FinOps staff review monthly financial reports and year-end audited joint regulatory financial questionnaires and reports to identify changes in trends, financial status and profitability. When necessary, IIROC can take preventive measures to preserve the capital position of a firm and protect client money and securities. Any investment dealer that does not meet minimum capital requirements is referred to as capital-deficient. The firm must immediately rectify its capital position or face possible suspension or termination of membership.
  • Annual and biennial "surprise" field examinations – FinOps staff conduct "surprise" examinations of each investment dealer’s books and records to ensure the reliability of their unaudited regulatory filings.
  • Review of audit working papers – Each IIROC-regulated firm is subject to a year-end audit by an approved panel auditor to validate the information filed by the firm with IIROC. To ensure the quality of the audit, FinOps staff review the panel auditor’s working paper files within three months of the filing date of the firm’s joint regulatory financial questionnaire and report.
IIROC rules require firms to protect client assets by keeping them separate, or segregated, from their own assets. This minimizes the risk of client assets being lost if the firm suffers failure or insolvency.

If problems arise and a regulated firm becomes capital deficient, IIROC immediately intervenes. IIROC allows the firm 24 to 48 hours to remedy the situation generally by injecting new capital into the firm or facing immediate suspension if it is determined there is a risk of an imminent financial loss to the investing public. Membership suspensions are promptly communicated to the public, and all capital deficiencies are reported to Enforcement for possible disciplinary action.
 

 Early Warning System

 

The Early Warning (EW) system measures the capital, profitability and liquidity position of IIROC-regulated firms to monitor their financial health.

Data from a firm’s monthly and yearly reports are used to calculate its Risk Adjusted Capital (RAC). The EW system measures a dealer’s RAC against certain arithmetical benchmark tests designed to detect the risk of insolvency. For example, staff determine the ratio of capital erosion, measured in months, by looking at the trend in reported operating losses relative to the remaining available capital of a firm.

If an IIROC-regulated firm fails any of the EW tests, or if IIROC determines its condition is unsatisfactory, the firm may be designated Early Warning Level 1 or Level 2, depending on the degree of risk. Rule 30 imposes standard restrictions on Dealer Members designated at each level.

To place a firm in Early Warning does not indicate that the public is currently at risk. The restrictions allow IIROC to require the firm to pause and re-assess its business model, implement changes such as cost rationalization measures or recapitalize. IIROC will closely monitor the firm's ongoing financial results and determine whether the measures have a positive effect or there is need for additional regulatory intervention to prevent the firm from incurring a capital deficiency.

In the event that a firm actually becomes capital deficient, meaning its RAC drops below an acceptable level, it is given no more than 24-48 hours to remedy its RAC or face immediate suspension if there is any likelihood of financial loss to the public.

Membership suspension notices are public information. Material breaches in capital requirements are referred to Enforcement for possible disciplinary action. All clients of IIROC-regulated firms are covered by the Canadian Investor Protection Fund (CIPF), which protects clients in the event that a Dealer Member firm becomes insolvent.
 

 Risk Assessment Model (FinOps)

 

The Financial & Operations Compliance Risk Assessment Model is a risk management tool to help identify, define, assess and weigh risks in respect to IIROC Dealer Member firms and determine priority focus in IIROC’s examination cycle of Dealer Member firms.

Essentially, the model gives an indication of the comparable risk assessed for each IIROC-regulated firm relative to its peers and all other firms under IIROC’s jurisdiction.

The objective of the FinOps Risk Assessment Model is to identify regulated firms having a higher than average probability of incurring a capital deficiency. With this information, IIROC ensures that regulatory focus is placed on higher-risk firms.

The model identifies three risk types, seven risk categories and twenty-one specific risks. Each specific risk is assessed and weighted to determine an individual firm business risk score. See Components.

The model then calculates the risk control score by identifying two risk control categories and six specific risk controls. Each specific risk control is assessed and weighted. Risk control is the method the firm uses to mitigate or reduce its business risk. The higher the risk control score the higher the quality of overall risk control.

The resulting risk control score is discounted and 40% of the score is subtracted from the business risk score to achieve a residual risk score for each firm. The discount factor is applied consistently to all Dealer Member firm risk control scores to better differentiate residual risk scores.
 

 FAQs

 

 


Regulatory financial statement capital (otherwise known as regulatory capital)
Capital & Margin Rules
Insurance
Introducing Broker/Carrying Broker Arrangements
Bare Trustee Agreement

 

 

Regulatory financial statement capital (otherwise known as regulatory capital)

 

Purpose:
This FAQ document has been prepared to assist Dealer Members in understanding the approval process over regulatory capital 1, either by the Dealer Member issuing shares 2 or debt.

For clarity, we have supplemented the FAQ with decision trees – Exhibits 1 to 3. These decision trees illustrate the approval process for change requests from Dealer Members relating to the regulatory capital in the business. Exhibit 4 is a standard risk disclosure acknowledgement form that is required when a non-industry investor is involved.


    Where are the IIROC rule references for eligible sources of regulatory capital?
    Who are the source providers of eligible regulatory capital?
    What are the main sources of eligible regulatory capital?
    Are all classes of preferred shares considered eligible regulatory capital?
    How is the percentage ownership of a Dealer Member calculated for purposes of seeking IIROC approval for changes in capital structure?
    What is the threshold level of Dealer Member ownership for which District Council approval is required?
    Is IIROC approval required for any change (either increase or decrease) to the Dealer Member’s regulatory capital?
    Where are requests for changes in regulatory capital amount or structure sent? And how much lead time is needed in order to get approval?
    For share capital changes (increases and decreases), what supporting documents are required to be provided by a Dealer Member?
    What concerns does IIROC have in respect to subordinated loan investors that are not otherwise officers or employees of the Dealer Member?
    How can a commercial revolving loan facility between a Dealer Member and an approved industry investor be structured as a subordinated loan?

Footnotes:


1 Regulatory financial statement capital as reported on Statement B line 4 of Form 1

2 In the case of Dealer Members that are structured as partnerships, the equivalent source is partnership capital.

3 Refer to Note 2 of the General notes and definitions to Form 1 (the regulatory financial report).

4 IIROC Rule 17.12


Exhibit 1
Exhibit 2
Exhibit 3
Exhibit 4

 

 

Capital & Margin Rules

 

    Where can I locate IIROC’s financial rules?
    How can I determine if a security is eligible for margin?
    What if there are no capital and margin requirements set out in Rule 100 for the particular security that I am looking for?
    Is there any other information available on the application of Rule 100?
    Where can I get a copy of the lists that are used for determining counterparty credit risk classification?
    Can I treat an institution as an acceptable institution or an acceptable counterparty even though they are not listed in the acceptable institutions / acceptable counterparties database?
    Where can I get a copy of the lists that are used for determining whether a custodial location is acceptable for regulatory purposes?
    Where are the standard industry agreements located on your website?
    Can an employee of a Dealer Member guarantee the trading account of another employee of the same firm or a client's account?
    Can a family member of an investment advisor guarantee the investment advisor's account?
    Can a Dealer Member provide a financial guarantee to a third party?

 

Insurance

 

    Do insurance companies have to be registered in Canada in order to be able to issue an FIB policy to a Dealer Member?
    Do Dealer Members have to limit their insurance coverage to the maximum $25 million?
    Do Dealer Members have to report their client net equity on Schedule 10 even if they are providing the maximum required coverage of $25 million?
    Can a Dealer Member use an insurance policy other than Form 14, as long as the policy contains the required clauses?
    Does the maximum required coverage of $25 million apply to all clauses of the FIB Policy?
    Can temporary insurance coverage be arranged for the in-transit requirements should such requirement be infrequent?
    Can a Dealer Member use the courier’s insurance in lieu of the in-transit coverage?
    Should certified cheques be included in the calculation of the in-transit requirement if they are being transported to and from the Dealer Member’s offices?
    What is the logic of requiring a double aggregate limit for the FIB policy where such limit is stipulated?
    How should a double aggregate limit of $10 million coverage be reported on Schedule 10?
    Can a Dealer Member who has a required double aggregate coverage of $10 million use a single aggregate of $20 million?
    Do carriers have to include the client net equity of their introducers (type 1, 2, 3 &4) in their own calculation of their insurance coverage?
    Do introducing Dealer Members have to have their own insurance coverage or can they rely on the carrier’s coverage?
    If a carrier picks up securities from the introducer’s premises, whose insurance coverage would be used to cover the in-transit requirement?
     If the introducer ships securities to the carrier, whose in-transit coverage would be applicable?
    Is there a limit on how high the insurance deductible can be set at?
    What should a Dealer Member report as the actual insurance coverage on Schedule 10 if it is different for the various clauses (A through E) of the policy?
    For IIROC Dealer Members who are cross-guaranteed, do they require separate insurance coverages?
    Can individual or aggregate limits under the policy be affected by claims made by or on behalf of any of the Dealer Member’s subsidiaries?
    How would you deal with FIB policies that have other entities included in the policy?
    If a Dealer Member has a full reinstatement provision, should it be problematic to have other entities being included in the policy?
    How soon do insurance coverage violations have to be corrected?
    Does the insurance coverage requirement vary depending on the negotiability of securities?
    What is a primary insurance coverage and how is it different from secondary coverage?
    Can mail insurance be part of the FIB Coverage or does it have to be the subject of a separate coverage?
    Is there a minimum mail insurance requirement?
    Can mail insurance be part of a global coverage?
    Is mail insurance subject to the requirement to provide the IIROC with a 30-day cancellation notice?
    Can a Dealer Member be exempted from the registered mail insurance requirement?
    Are agents acting in a principal/agent relationship (IIROC Rule 39) covered for insurance purposes under the standard Form 14 FIB policy?
    Are Dealer Members required to have excess CIPF coverage?
    When the auditor confirms the financial institution bond at the time of the year-end audit, can the confirmation be with the insurance broker or should it be confirmed with the insurance underwriter?
    Does the requirement of a double aggregate limit (where an aggregate is stipulated) apply to registered mail insurance coverage?

 

Introducing Broker/Carrying Broker Arrangements

 

    What is an Introducing Broker/Carrying Broker Arrangement?
    Now that the MFDA has been recognized as a SRO, does this mean that MFDA Member firms can now enter into introducing broker/carrying broker arrangements with IIROC Dealer Members?
    What trading related functions in combination are considered to be an Introducing Broker/Carrying Broker Arrangement?
    IIROC Rule 35 details four types of permissable Introducing Broker/Carrying Broker Arrangements. Why were four types of arrangements developed and what are the unique characteristics of each type?
    Is a Dealer Member allowed to be a full service broker for one segment of their business while introducing another segment of their business to a carrying broker?
    Can a Dealer Member introduce customers to more than one carrying broker?
    Can an introducing broker execute a customer trade either through a different carrying broker or a jitney broker?
    Can an introducing broker execute principal trades either through a different carrying broker or a jitney broker?
    Can security-lending/financing activities be carried out by the introducing broker under any of the four types of arrangements?
    Is a Type 4 introducing broker required to carry out its own security-lending/financing activities?
    Whose name (the introducing broker, the carrying broker or both) should be on contracts, statements and correspondence that relate to introduced customer accounts?
    Is there a standard disclosure statement that should be used?
    Is the introducing broker or the carrying broker responsible for customer free credit segregation?
    Since both the introducing broker and the carrying broker must be SRO members, they are both considered regulated entities for account margin purposes. Does this mean that account balances resulting from introduced transactions that arise on the books of the introducing broker or the carrying broker must be margined on a “value for value” basis?
    Does the carrying broker have to segregate any comfort deposit it has received from the introducing broker?
    What is the margin requirement to be provided by the Type 1 and 2 introducing broker in the event the carrying broker liens on the comfort deposit?
    Is the introducing broker or the carrying broker responsible for ensuring that customer securities are properly segregated?
    What responsibilities do the auditors of introducing brokers have with respect to the segregation of customer securities?
    Can the contracting parties modify a standard introducing agreement?
    In the case of a Type 3 arrangement, the introducing broker is responsible for the reporting and margining of customer account balances and the carrying broker is responsible for any necessary segregation of customer free credit balances. How does the carrying broker calculate the free credit segregation requirement when it doesn’t report elsewhere in its regulatory filings the free credit balances of introduced customer accounts?
    Do carrying brokers have to provide introducing brokers with a security record and position listing securities held for their customers?
    Do auditors of Type 3 and 4 introducing brokers have to confirm their year-end security positions with their carrying broker?
    Do introducing brokers have to enter into a separate RRSP trust agreement with a trustee in order to provide RRSP accounts to their customers?
    Can an introducing broker/carrying broker arrangement be entered into with a foreign affiliate?
    What kind of Canadian Investor Protection Fund (“CIPF”) coverage would customers of a foreign affiliate have?
    What credit policies should an Introducing Broker have in place?
    What other reference sources are there on the IIROC web-site relating to Introducing Broker/Carrying Broker Arrangements?

 

Bare Trustee Agreement

 

     What is the purpose of the bare trustee agreement
    How often is the approved bare trustee list produced?
    What administrative role does IIROC play in approving the bare trustee agreement?
    What is the role of the Dealer Member?
    What is the role of a Fund Manager?
    What is the required documentation for including a Fund Manager on the monthly IIROC bare trustee custodial agreement listing?

To assess financial and compliance risk, IIROC staff weight various kinds of risk alongside the controls that firms use to manage that risk. Click here to view the formula.
 
How do FinOps staff assess risk? Click here to see a diagram of the assessment structure.
 
Residual Risk Rating: IIROC can assess a firm’s financial operations and compliance residual risk as low, moderate-low, moderate-high or high, compared to other dealer firms. Learn more.
 
Several factors are considered in an assessment of a dealer’s financial operations and compliance risk. To view all the components, click here.
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