II. Counterparties
Non-professional counterparties are defined as non-banks and other companies that are not in the primary business of the products mentioned above. Personnel tasked in distributing should be cognizant of the following principles with regard to their counterparties.
  1. Know Your Customer

    1. Understand the customers' investment and risk management policy/ philosophy.
      1. Level of risk tolerance - financially and reputationally, how much can they afford to lose?
      2. Appropriateness of product to customer

    2. Understand the relationship between the customer and its employee - the person the sales officer deals with.
      1. Establish the authority of your counterparty to bind his institution to the transaction, by:
        1. Referring to client's legal constitutional documents.
        2. Referring to Corporate authorization or resolution on authorized signatory list.
        3. Referring to client's internal investment guidelines (for reference only)
        4. Ensuring that the transaction meets the Counterparty Risk limits set for the client.
        5. In case you are dealing with a fund manager or other agents acting in behalf of third party accounts, establishing their authority to commit their principal.
      2. Determine the customer's approval process.
      3. Know the limitations of the individual with whom the sales officer deals.
        1. Evaluate the client's capability to understand the risks of and make independent decisions about a potential transaction. Be aware that some clients are sophisticated in some markets but not in others.
        2. Evaluate the different level of sophistication of the client's representatives.

    3. In determining products to be sold, the sales person should follow these general guidelines to determine the appropriate level of concern to be exercised:

      HIGHER LEVEL OF CONCERN LOWER LEVEL OF CONCERN
      Unsophisticated client Sophisticated client
      Unusually complex product Simple, plain vanilla product
      Leveraged transaction Fully funded transaction
      Peak and average exposure is a high percentage of client's capital Peak and average exposure is a low percentage of client's capital
      Client contact at junior level with no senior management awareness Client contact at senior level or senior management fully aware
      Speculative, non-hedging transaction Hedging transaction
      Purely tax or accounting motivated transaction No tax or accounting motivation
      Unusually large transaction in relation to client's earnings or other measures of financial performance No unusual activity
      Transaction unusual in client's industry Transaction common in client's industry

    4. Regularly update information on the customer and its representatives. Customers change and the sales officer must understand the total situation.

  2. Account Opening

    1. The client must complete the following account opening requirements before doing any transactions with the financial intermediary:
      1. For Corporations:
        1. SEC Registration
        2. Articles of Incorporation
        3. By Laws
        4. List of authorized signatories
        5. Board Resolution specifically authorizing specific transactions with the financial intermediary
        6. Acknowledgement sheets of the financial intermediary's terms and conditions for opening and maintaining the account
      2. For Individuals:
        1. Signature cards
        2. Valid Identification cards (e.g. passport)
        3. Acknowledgement sheets of our General Business Conditions

      The above documents are the basic requirements needed to establish the authenticity of an account. Legal counsels may however, prescribe other documents and/or equivalent documents.

    2. Account openings should be approved only by duly designated officers.

  3. Counterparty Limits and Risks

    1. Counterparty Limits

      It is the responsibility of sales personnel, under the supervision of their department head, to cooperate with the Risk Management group in determining the inherent risks and the setting of appropriate limits to the risks that are acceptable to the financial intermediary.

      Limits for Counterparty Risk have to be approved by the Credit Department responsible for a given counterparty before a deal takes place.

      The sales personnel should ensure that a proper evaluation of the inherent risks has been carried out before dealing in a new product or portfolio with a counterparty and that appropriate limits have been established in conjunction with an independent Credit Department. It is not permitted to deal before this has been carried out.

    2. Types of Counterparty Risk
      1. Pre-settlement risk (PSR)
        - Counterparty defaults on a transaction before settlement and the financial intermediary has to go back to the market and replace the contract at a probably unfavorable market rate
        - PSR = Notional Amount x Credit Risk Factor whereby Credit Risk Factor is the estimated movement in price prior to replacement

      2. Settlement risk
        - The corresponding exchange of value or receipt of funds has not yet been verified but the financial intermediary has already paid or delivered

    3. Limit Control & Limit Excesses

      The information necessary to monitor and to control each type of risk against the approved limit must be available to the sales personnel on an ongoing basis. The same information must be made available to the appropriate department whose function is to monitor and control the risks independently of the sales personnel.

      Sales personnel should strive to obtain limit information that is screen based and real time, though operational and technological constraints may require that some information is available only in hard copy report format resulting from an end-of-day process. A clearly defined procedure for the notification to management of outstanding transactions in excess of limits must be established including an escalation procedure for the required credit approvals.

      Detailed, timely and accurate reports of outstanding transactions with counterparties in each product or portfolio must be available regularly to Credit Risk Administration indicating the names of the counterparties, limits established, the respective outstandings and the status of failed deals, if any.

    4. Review of Limits

      Limits represent a quantifiable indication of risk that the financial intermediary is prepared to expose itself to, whether in products or portfolios or towards counterparties, and as such the limits must be kept under constant review to reflect either changes in external circumstances or internal changes in the financial intermediary's desired exposure profile.

      Limits for counterparties should be reviewed and approved at least annually or whenever there is a material change in either their financial status or their market standing that could negatively influence the financial intermediary's position.
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