Risks Faced by Securities Trading Organizations

Risks Faced by Securities Trading Organizations/Stock Broker firms 

Risk refers to the uncertainty about the effects or implications of an activity, often focusing on negative, undesirable consequences. Risk management can be defined as the action of identifying and assessing potential risk and developing appropriate strategies to mitigate or minimize the risk to the best possible level. As we know, there is no business that does not possess risk. Though it is not possible to mitigate the risk completely, some risks can be identified, and thus they can be minimized. Like all other businesses, Securities Trading Organization and Stockbroker firms face various risks, which, if not identified, can create a hurdle for organizations. The risks either can be from inside the organization e.g. lower efficiency of management or from outside the organization e.g. risk of intense competition or macro-economic changes.

Various risks faced by stockbrokers:

  1. Internal Management Risks:

Internal Management Risk is the risk faced by the organization from within the organization and arises due to inaccuracy of operations. In the context of stockbrokers, it refers to the possibility that brokerage businesses suffer losses due to fault in management and operation processes caused by the uncertainty of some of the factors. Some of the actions of stockbroker firms that can lead to potential risks are as follows:

  • Engagement in business with violations of regulations
  • Engagement in foreign exchange transactions in breach of foreign exchange administration regulation of either or both the countries
  • Failure of gaining expected market due to company’s misjudgment or lower efficiency
  1. Compliance Risk:

Compliance risk involves the potential exposure to legal and financial penalties and material loss, caused by its failure to act in accordance with industry laws and regulations, internal policies, or prescribed practices. In the context of stockbroking business, incompliance with laws may lead to lower efficiency of work, high operation cost, loss in operations, loss in revenue, punishments, or fines.

Potential compliance risks for this business include the following:

  • Risk of securities margin trading for clients
  • Incomplete or untrue account opening or closing information.
  • Skipping of the authorization procedures
  1. Credit Risk:

In essence, credit risk means a risk of default on a debt that may arise from a borrower failing to make payments. The brokerage business of securities trading organizations includes the risk of losses from overdraft by clients and the risk of losses from the absence of client confirmation relating to agency transactions. The introduction of securities margin trading has increased credit risk for the business. Margin trading is like using borrowed funds from brokers to trade financial securities, which act as collateral for the loan.

  1. Competition Risk:

Competitive risk involves the chance that competitive forces can prevent the business from achieving its goal. It often leads to a decline in revenue due to the actions of competitors. Competition risk can be from inside the industry or outside the industry.

For Stockbrokers, the potential risk from inside the industry can be intensified competition within the securities industry.

The risk from outside industry mainly comes from other financial institutions such as Banks and Insurance Companies. It can be seen that the financial industry has shown a trend of mixed operations, which can lead to fierce competition from the banking industry to such stockbroking organizations.

Various ways to mitigate/minimize the Risks:

As mentioned, there exist various risks for stockbroking firms. For the smooth running of the business, it is important to manage the risk. There are some ways to mitigate or at least minimize these risks.

  1. Ways to Mitigate Internal Management Risk:

Various ways to minimize internal risks are as follows:

  • Management should take any action after proper research of the business, other rivals of the same industry and their actions, rules & regulations related to the business, etc.
  • They must keep the eye on happenings related to the business
  • They should update their operations and business policies time by time according to the situation
  1. Ways to Mitigate Compliance Risk:
  • To minimize/mitigate compliance risk, the management must ensure that they know all the requirements imposed by applicable laws and regulations.
  • The compliance efforts should change according to changes in business
  1. Ways to mitigate Credit Risk:

To minimize the credit risk,

  • The credit record of new clients should be checked thoroughly
  • Credit risk mitigation techniques like structured finance, asset securitization, collateral, and netting should be used frequently.
  1. Ways to mitigate Competition Risk:
  • Constant evaluation should be done to know whether the competitor’s actions are posing threat to the business.
  • Constant monitoring of industry happenings and related industry happenings.

Final Thoughts:

Management of risk is necessary, rather essential for any firm irrespective of their industry. As for all businesses, risk management is important for stock trading organizations/stockbroking organizations. By identifying the risk earlier, the firm can at least minimize the risk. Thus, it can prevent a potential loss of money and time.

Author: Hetvi Shah

About the Author: Hetvi is a BBA(Finance) graduate. She is currently pursuing an MBA with Finance specialization. She has a keen interest in Financial Market, Financial Management, and Financial Analysis.

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