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Trading and Capital-Markets Activities Manual

Examination Policy: Organizational Structure 
Source: Federal Reserve System 
(The complete Activities Manual (pdf format) can be downloaded from the Federal Reserve's web site)

Obtaining an overview of the organization, management structure, product universe, and control environment of a financial institution's capital markets and trading activities is a critical initial step in the examination process. This overview can be developed by applying the examination procedures listed in this manual, which enable the examination team to understand the institution's legal-entity and managerial structures and the scope and location of its activities, and to evaluate policies, procedures, and actual practices. An overview also helps the examiner to identify broad internal control processes and gain insight into how effectively they cover trading activities. Finally, the overview helps identify significant changes in operations and the rationale for those changes. 

Evaluating the capital-markets, trading, and marketing activities conducted by the financial institution can be a complicated task that may be compounded by the lack of a clear distinction between bank and non-bank powers granted to an institution. A number of institutions will shift positions among legal entities to facilitate risk management along product or geographic market lines. Therefore, the overview or organizational structure is central in evaluating whether the financial institution has separated activities as required by law and regulation. 

The examiner-in-charge is responsible for evaluating the organizational structure, activities, overall risk-management system, and controls of the global-trading and capital-markets operations at the highest organizational level. In a U.S. financial institution, this would generally be the bank holding company level. Examiners should be aware that organization and structure can differ significantly among financial institutions. 


The ownership structure includes the geographic locations and legal-entity divisions of an institution's relevant banking and non-banking operations, including holding companies, significant affiliated entities, and separately capitalized units such as section 20 or limited purpose ''venture'' entities. Other organizational structures include branches, agencies, subsidiaries, joint ventures, or portfolio investment partnerships. Some of these entities may be registered with regulatory agencies such as the Securities and Exchange Commission (SEC), National Association of Securities Dealers (NASD), and Commodity Futures Trading Commission (CFTC) and may have affiliations with, or membership in, stock and commodities exchanges worldwide. These organizations may impose constraints on the activities of an institution, and the examination team should be aware of the scope, conclusions, and timing of any examinations, inspections, and reviews conducted by other regulatory bodies. 

Depending on the powers granted to it by the country having jurisdiction, a diversified multinational banking organization may use a variety of functional management structures which cross legal-entity boundaries to invest, trade, underwrite, or deal in trading products. Functional management lines may be introduced to facilitate decision making. An institution may clear its own trading products, provide clearing services for customers, or maintain clearing and settlement relationships with correspondent financial institutions. The examiner should review these operations as well as the reasons and results of significant reorganizations, particularly if the entities have exceptional earnings profiles. 

To manage and control activities on a global basis, a financial institution should have programs established to identify where it conducts activities both by business entity and by legal entity. These programs should document how activities are monitored on an ongoing basis and reported to senior management. The examiner should review the adequacy of the management information system from a reporting and automation perspective. The most recent internal and external audit reports covering the banking institution's capital-markets and trading activities should be evaluated to identify any deficiencies related to organizational structure and separation of duties. For additional guidance, examiners should refer to the Bank Holding Company Examination Manual, specifically section 2185.0 on non-bank section 20 subsidiaries engaged in dealing and underwriting and the 3000 sections on non-bank activities, including securities brokerage, foreign-exchange advisory, futures commission merchant, primary dealer, and a wide range of other underwriting and dealing activities.

Risk-Management Organization 

Risk management is the process of monitoring, controlling, and communicating to senior management and the board of directors the nature and extent of risk from capital-markets and trading activities. The board of directors has a regulatory mandate to set and periodically approve an institution's limit levels, given its tolerance for risk. Senior management should regularly evaluate the risk-management procedures in place to ensure they are appropriate and sound. Senior management should also foster and participate in active discussions with the board of directors, staff of risk-management functions, and traders regarding procedures for measuring and managing risk. Management must also ensure that capital-markets and trading activities are allocated sufficient resources to manage and control risks. 

Personnel responsible for the risk-management function should be separate from trading-floor personnel. In contrast to the measurement and assessment of risk exposures, the day-to-day management of exposures by trading staff may follow a decentralized, product- or portfolio-specific approach. Therefore, an independent system for reporting exposures to both senior level management and the board of directors is an important element in the overall risk-management process. 

A review of the structure of managerial reporting lines is helpful in determining the financial institution's capacity to identify and manage risk. The reporting lines may be structured by legal entity, by functional lines of responsibility, or along business or profit-center lines. The examiner should request the organization chart to identify overlaps in the legal and operational structures and should cite possible violations of section 20 firewall provisions or other regulations which require strict separation of activities. Examiners should be aware of special conditions appearing in authorizations for the board of directors. Potential conflicts of interest of board members should also be evaluated. 

Risk management can be performed globally, concentrating on the institution's generic categories of risk, locations, and activities, or by functional department, specific product, or portfolio. Global risk-management reports should clearly describe the elements of risk; provide a quantifiable description of the amount of capital allocated to capital-markets and trading activities; and identify limits on market, credit, and operational risks. Examiners should be aware that a global approach to risk analysis can fail to identity specific risk levels in specific products, functions, or activities. Conversely, functional decentralized approaches can miss consolidated risks. Risk-analysis methods which incorporate aspects of both approaches are more effective. 

Financial institutions should have highly qualified personnel throughout their capital-markets and trading teams, including those in functions responsible for risk management and internal control. The personnel of independent risk-management functions should have a complete understanding of the risk associated with all on- and off-balance-sheet instruments that are transacted. Accordingly, compensation policies for these individuals should be adequate to attract and retain qualified personnel. As a matter of general policy, compensation policies, especially in the risk-management, control, and senior-management functions, should be structured to avoid potential incentives for excessive risk taking that can occur if, for example, salaries are tied too closely to the profitability of capital-markets and trading activities.


Financial institutions identify primary business lines in a variety of ways. In trading operations, the transaction activity of different instruments may be subdivided into financial engineering, sales and distribution, underwriting, market making, proprietary trading and advisory services, and others. The grouping of activities may provide insight into the market strategy or competitive advantage of an institution, its capital and risk-limit allocation, and its concentration of risk. Transaction-activity groupings may help to identify the managerial and operational synergy between business and product lines and between affiliated entities.

 Institutions may specialize in trading specific types of instruments and offer services tailored to their customers. The degree of diversity in the range of business lines and services is a measure of the banking organization's capacity to establish a presence in those markets. Diversity of business lines can be an early indicator of potential imbalances in an institution's resource allocation, such as too broad a range of unsupervised activities or dependence on too narrow a range of activities. 

Products and services that an institution has begun offering or discontinued since the previous examination should be identified. Business strategies which discuss any planned or recent changes to the business should be reviewed. A restrucEagle Tradersg in business lines and services might be used to camouflage problems such as recognizing illegal profits or incurring large losses or breaches of internal limits, controls, regulations, or banking and securities laws. The examiner should refer all exceptional or unusual findings to the examiner-in-charge. Initiation of new products or new business initiatives should be formally approved by the board of directors after thorough research into all relevant aspects of the product. 

Banking regulations provide for limitations and restrictions on permissible activities for banking organizations and their non-bank subsidiaries. A review of specific products and services is an additional check for identifying the banking organization's adherence to applicable legal or regulatory requirements. To ensure the adequacy of internal accounting, clearing, and settlement of transactions, banking institutions should document the methods used to collect and monitor information on all traded instruments. 


Capital-markets and trading management structures may be organized by legal entity, business line, profit center, or a combination thereof. Regulatory conditions as well as safe-and-sound banking practices often require the separation of managerial duties. Overlaps should be reviewed for compliance with regulations, ethical standards, and safety-and-soundness concerns. 

Background reviews include the evaluation of management expertise and character. Resumes should be reviewed to determine whether key managers in trading, sales, operations, and compliance have been or are currently registered with any non-bank securities regulators (for example, provisions such as NASD Series 7 or CFTC commodity or exchange requirements such as ''registered principal''). The reviews should indicate whether management or trading and sales personnel have been cited for violations of securities laws, mentioned in criminal referrals to state or federal officials and are currently or have been under statutory supervision or periods of disqualification under NASD, New York Stock Exchange (NYSE), or other self-regulatory organization (SRO) rules. 

The review should indicate whether management or trading and sales personnel are allowed to trade for their own accounts. Policies directed at the personal-investment activities of staff, as well as the areas responsible for monitoring and controlling them, should be identified. The compensation structure of key principals, including current and deferred salary, bonus, commission, equity participation, or other remuneration, should be described. Loans between the institution and key management should also be identified. Compensation practices should be reviewed to determine that the independence of those involved in risk-management oversight is not compromised by direct benefit from the profits of the risk-taking function. Finally, the profiles section should comment on the reasons for resignations or reassignments of key managers, traders, and salespeople. 

The growing level of sophistication of capital markets requires experienced management with appropriate credentials to understand complex trading instruments and their associated risk-management techniques. The level of experience required to understand quantitative analysis and advanced risk-based sensitivity analysis should be commensurate with the sophistication of the firm's activities. 

Any deficiencies in management's capacity to understand and control the instruments or the types of risk associated with them are cause for regulatory concern. However, the determination of deficiencies must be based on a fair and impartial assessment of the products traded and the institution's future business plans. 


The adequacy of policies and procedures for capital-markets and trading activities should be evaluated against the complexity and volume of financial transactions. Policies and procedures should be written and include, at a minimum, a mission statement, limits approved by the board of directors, procedures for reviewing limits, a list of traders and their assignments, the organization's structure and responsibilities, permissible activities, an approved list of brokers, counterparties, dealing guidelines, and an explicit dispute-resolution methodology. Furthermore, the institution should have a code of ethics for employees, a policy for personal trading, investment guidelines, a detailed description of transaction processing, and reconciliations and accounting procedures including a chart of accounts. 

Policies and procedures should require that capital-markets and trading activities are under senior management review and subject to periodic audit. An internal audit department should be organizationally and functionally separate from trading-management oversight and should report to the board of directors of the institution. In institutions that are more active in trading, other organizational units should provide an independent assessment of the profitability and risk inherent in these activities.

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