The correct answer is that the licensed corporation must promptly notify the client of the margin shortfall, specifying the required amount and the deadline to meet the call. This is a fundamental step in managing credit and counterparty risk. The client agreement, which is governed by principles in the SFC’s Code of Conduct, will stipulate the firm’s right to issue a margin call when a client’s equity falls below the maintenance margin level. The primary obligation is to communicate this requirement to the client clearly and give them a reasonable opportunity to remedy the situation by depositing additional funds or closing out positions. Only if the client fails to meet the margin call by the specified deadline does the firm typically exercise its right to liquidate the client’s positions to cover the deficit. Immediately liquidating positions without notification is a subsequent step taken upon the client’s failure to act, not the initial obligation. Offering a credit line is a business decision that would increase the firm’s risk exposure, not a required risk management procedure. Suspending the account indefinitely, even if the margin call is met, is not a standard or appropriate response; the goal is to restore the account to a compliant margin level, after which trading can usually continue.

Operational risk management is a critical function for any licensed corporation, particularly in leveraged foreign exchange trading where transaction volumes are high and processing speed is essential. The SFC’s Code of Conduct and Management, Supervision and Internal Control Guidelines emphasize the need for robust internal controls. Statement I is correct because daily, independent reconciliation is a fundamental control to ensure that all executed trades are accurately captured, processed, and settled, helping to identify errors or unauthorized activities promptly. Statement II is correct as a mandatory block leave policy is a key control under people management. It ensures that another individual takes over the duties, which can help uncover any irregularities or fraudulent activities that the absent employee may have been concealing. Statement III is correct because the segregation of duties between the front office (dealing) and back office (confirmation, settlement) is a cornerstone of internal control. It prevents a single person from having end-to-end control over a transaction, which significantly reduces the risk of fraud and unauthorized trading. Statement IV is incorrect; granting front-office staff, even senior ones, access to amend back-office records directly contradicts the principle of segregation of duties. This would create a significant control weakness, enabling potential fraud or concealment of errors. Proper procedure requires back-office personnel to handle any amendments after appropriate verification. Therefore, statements I, II and III are correct.

Statement I is correct. A fundamental principle of credit risk management in leveraged trading is the prompt and clear communication of a margin call. The firm has a duty to inform the client of the shortfall, the amount needed to rectify it (the ‘top-up’ amount), and a clear deadline. This ensures transparency and gives the client a reasonable opportunity to act, which is consistent with the principles of treating clients fairly under the SFC’s Code of Conduct.

Statement II is correct. The client agreement for a leveraged FX account will invariably contain a clause granting the licensed corporation the right to liquidate (or ‘close out’) a client’s positions if they fail to meet a margin call. This is the primary mechanism by which the firm protects itself from incurring losses that exceed the client’s deposited margin, thereby managing its counterparty risk.

Statement III is incorrect. While a firm may have some discretion, relying solely on a client’s verbal assurance without any collateral or formal arrangement is considered imprudent risk management. The firm’s primary responsibility is to manage its own financial exposure. Extending credit based on a promise, especially during volatile market conditions, would be a significant deviation from a robust internal control framework.

Statement IV is incorrect. Client agreements typically give the firm the sole discretion to decide which positions to liquidate and in what order to bring the account’s margin level back above the required minimum. Requiring the client’s specific approval for each liquidation would be operationally impractical during a fast-moving market and would hinder the firm’s ability to mitigate risk effectively. Therefore, statements I and II are correct.

A robust operational risk management framework is critical for a licensed corporation engaged in leveraged foreign exchange trading. Statement I is correct because the segregation of duties between front-office (dealing) and back-office (settlement) functions is a fundamental internal control principle. This separation prevents unauthorized trading, conceals errors, and reduces the risk of fraud. Statement II is correct as modern trading environments rely heavily on information systems. Automated pre-trade limit checks and real-time position monitoring are essential for preventing breaches of risk limits and identifying errors promptly. Statement III is also correct; according to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, all client orders, regardless of how they are received, must be immediately recorded and confirmed with the client to ensure accuracy and provide a clear audit trail. Statement IV describes a poor practice that significantly increases operational risk. Allowing dealers discretionary authority to override system-generated risk warnings undermines the entire control framework. Such overrides should be exceptional, require approval from senior management or a dedicated risk function, and be thoroughly documented. Therefore, statements I, II and III are correct.

The correct answer is that the firm should issue a formal margin call and prepare for liquidation if the client fails to meet it. This is the standard and prudent procedure for managing credit and counterparty risk in leveraged foreign exchange trading. When a client’s account equity drops below the maintenance margin level, it signals that the collateral is no longer sufficient to cover potential losses. The first step is to formally notify the client via a margin call, requesting additional funds to bring the account back to the required level. The client agreement will specify a reasonable timeframe for this. If the client fails to deposit the required funds within this period, the firm has the right to liquidate the position to prevent further losses and protect itself from credit risk. This process is a core component of the internal control framework mandated by the SFC’s Code of Conduct, which requires licensed corporations to have adequate risk management systems. Immediately liquidating the position without a margin call may breach the client agreement, unless a specific, pre-agreed stop-out level has been triggered. Offering a credit facility to cover the shortfall is a fundamentally flawed risk management practice, as it increases the firm’s exposure to a high-risk client. Advising the client to increase their exposure by ‘averaging down’ while deferring the margin requirement is irresponsible, constitutes poor advice, and exacerbates the risk for both the client and the firm.

A core component of managing credit and counterparty risk in leveraged foreign exchange trading is the margining process. When a client’s account equity falls below the maintenance margin level due to adverse market movements, the licensed corporation’s primary exposure to loss increases. Statement I describes the standard first step in this situation: issuing a margin call. This formally notifies the client of the shortfall and provides them with an opportunity to deposit more funds or collateral to bring their account back into compliance. Statement IV outlines the appropriate subsequent action if the client fails to meet the margin call. Liquidating just enough positions to restore the required margin level is a prudent and common practice that mitigates the firm’s risk while minimizing the impact on the client’s remaining portfolio. Statement II is incorrect because while client agreements typically grant the firm the right to liquidate positions, doing so immediately and without any notification is an extreme measure and not the standard initial procedure. A margin call is typically issued first. Statement III is a clear violation of sound risk management principles. Extending unsecured credit to a client to cover a margin shortfall would increase the licensed corporation’s credit exposure, directly contradicting the goal of risk mitigation. Therefore, statements I and IV are correct.

The correct answer is that the firm must promptly issue a margin call to the client. When a client’s account equity falls below the maintenance margin requirement, the licensed corporation faces increased counterparty credit risk. The established procedure, as outlined in the client agreement and dictated by sound risk management principles, is to formally notify the client of the deficit and demand the deposit of additional funds or collateral to bring the account back to the required level. This notification is known as a margin call. The client is typically given a specific, often short, timeframe to meet this call. Failing to issue a prompt margin call exposes the firm to potentially larger losses if the market continues to move against the client’s position. While liquidating the client’s position is a potential consequence, it is the remedy for an unmet margin call, not the initial step. The client must first be given the opportunity to provide the necessary funds. Hedging the firm’s overall exposure is an internal risk management activity for the firm’s proprietary book and does not resolve the specific credit risk presented by the individual client’s under-margined account. Similarly, while suspending the account from further trading is a prudent concurrent action to prevent the risk from increasing, the most critical step is the margin call itself, as it is the formal demand that initiates the process of rectifying the financial shortfall.

The correct answer is that the firm must promptly issue a margin call to the client. According to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission and standard risk management practices, when a client’s account equity falls below the maintenance margin level, the licensed corporation’s immediate and primary obligation is to notify the client. This notification, or margin call, demands that the client deposit additional funds or acceptable collateral to restore the margin to the required level within a specified timeframe. This action is critical for managing the firm’s counterparty credit risk. Liquidating the client’s positions is typically a subsequent step taken only if the client fails to meet the margin call. Acting without first giving the client a reasonable opportunity to remedy the shortfall could breach the client agreement. Placing a hedge in the firm’s proprietary account is inappropriate as it conflates the firm’s risk with the client’s; the firm’s duty is to manage the credit risk posed by the client, not to manage the client’s market position for them. While notifying senior management is part of a sound internal control process, it should not delay the time-sensitive action of issuing the margin call to the client, as any delay increases the firm’s exposure to further market risk.

A robust operational risk management framework requires a multi-faceted response to a critical system failure. Statement I is correct because activating the Business Continuity Plan (BCP) is the primary, pre-planned response to ensure operational resilience and continued service, even through alternative means. Statement II is correct as timely and transparent communication with affected clients is a fundamental duty under the SFC’s Code of Conduct to act in the best interests of clients. Furthermore, assessing the incident for its reportability to the SFC is a key regulatory obligation. Statement IV is correct because a critical part of the risk management cycle is learning from incidents. A post-mortem analysis is essential to identify weaknesses in systems or controls and implement measures to prevent future occurrences. Statement III is incorrect because unilaterally liquidating all client positions without specific instruction or pre-agreed contractual rights could breach client agreements and expose the firm to legal and reputational risk. The priority should be to manage existing positions according to the BCP, not to forcibly close them. Therefore, statements I, II and IV are correct.

The correct answer is that the HKMA provides a two-way Convertibility Undertaking to licensed banks, committing to sell USD at 7.85 and buy USD at 7.75, thereby anchoring the market exchange rate within this defined band. Hong Kong’s Linked Exchange Rate System (LERS) is a currency board arrangement. Under this system, the HKMA provides a clear and firm undertaking to licensed banks. When the HKD strengthens to the strong-side limit of 7.75 against the USD, the HKMA will buy USD from banks. Conversely, when the HKD weakens to the weak-side limit of 7.85, the HKMA will sell USD to banks. This mechanism ensures that the market exchange rate for the HKD against the USD remains stable and operates within this narrow, pre-defined corridor. The other statements are incorrect. The rate of 7.80 is the linked rate at which note-issuing banks must deliver USD to the HKMA in exchange for Certificates of Indebtedness to back their banknote issuance; it is not a rate at which they trade directly with the public to maintain the peg. The HKMA’s intervention is not a discretionary action around the 7.80 level but a formal, rule-based commitment at the 7.75 and 7.85 convertibility limits. Finally, the LERS does not operate on a daily fixing rate set by the HKMA; it is an automatic adjustment mechanism governed by the convertibility undertakings, which is fundamentally different from exchange rate systems that rely on daily official fixings.

The correct answer is that the failure is most directly related to People Management. According to the principles of operational risk management and the SFC’s Code of Conduct, People Management encompasses ensuring that staff possess the necessary skills, training, and competence to perform their duties. In this scenario, the junior dealer’s lack of training on advanced products was the direct cause of the error. A robust People Management framework would include proper training programs, competency assessments, and appropriate supervision, especially for new staff or those handling complex instruments, to prevent such human errors. The option concerning Deal Processing is incorrect because the issue was not with the transaction workflow, confirmation, or settlement process itself, but with the incorrect trade being initiated due to a misunderstanding. The option related to the Information System is also incorrect as the scenario provides no evidence of a system malfunction or technological failure; the error was human-centric. Finally, the option regarding Management Reporting is not the primary failure. Management Reporting is a control that communicates risk information and incidents to senior management, typically after they occur. While this incident would be reported, the preventative control that failed was the one responsible for ensuring the dealer’s competence in the first place.

The management of credit and counterparty risk in leveraged foreign exchange trading is critical. When a client’s account equity falls below the maintenance margin level, the licensed corporation must act decisively to mitigate its own risk exposure. Statement II is correct because the standard and required initial step is to issue a formal margin call. This communication must be clear, specifying the deficit amount and a firm deadline for remediation. Statement III is also correct as it describes the corporation’s right, established in the client agreement, to take protective action. If the client defaults on the margin call, the firm is entitled to liquidate positions to cover the shortfall and restore the margin to an acceptable level. Statement I is incorrect because the client provides prior authorization for such liquidations in the account opening agreement; seeking additional consent at the time of default would be impractical and expose the firm to further market risk. Statement IV describes a severe lapse in risk management. Indefinitely extending credit to a client in a losing position would be a breach of the firm’s responsibility to manage its financial resources prudently and could lead to significant losses. Therefore, statements II and III are correct.

The correct course of action is to liquidate sufficient positions to restore the required margin level. This is a critical risk management procedure for a licensed corporation engaged in leveraged foreign exchange trading. When a client’s account falls below the maintenance margin and they fail to meet a margin call within the agreed timeframe, the firm must act decisively to mitigate its exposure to further market risk and potential credit losses. This right to liquidate is a standard and essential clause in client agreements for leveraged products. It protects both the firm from financial ruin and the client from accumulating debt beyond their initial capital. Waiting for a market reversal is speculative and an abdication of risk management responsibility. While freezing the account is a step, it is insufficient as it does not close out the source of the ongoing risk. Using the firm’s own capital to cover a client’s margin shortfall is a severe breach of internal controls and prudent financial management, as it constitutes an unauthorized extension of credit and exposes the firm’s capital to the client’s market risk.

The correct answer is that the firm should promptly issue a margin call to the client. In leveraged foreign exchange trading, when a client’s account equity falls below the predetermined maintenance margin level due to adverse market movements, the licensed corporation faces increased counterparty credit risk. The standard and most critical first step in the risk management process is to issue a margin call. This is a formal demand for the client to deposit additional funds or collateral to restore their account equity to the required level. This action protects the firm from further losses and is a fundamental component of credit risk control as outlined in client agreements and expected under the SFC’s Code of Conduct, which requires firms to have adequate risk management policies. Liquidating the client’s position without first issuing a margin call and providing a reasonable time to meet it is typically a last resort. Such an action could be a breach of the client agreement unless specific pre-agreed conditions for automatic liquidation are met. Simply placing the account on a watch list is a passive measure that fails to actively mitigate the escalating credit risk. While monitoring is part of risk management, it is not a sufficient response to a margin breach. Contacting the client to discuss market outlook is secondary to the immediate need to rectify the margin deficiency; the firm’s primary responsibility in this scenario is to manage its own credit exposure, not to provide trading advice.

A licensed corporation (LC) must have robust procedures for managing credit and counterparty risk, particularly in leveraged FX trading. Statement I is correct because the client agreement explicitly grants the LC the right to liquidate a client’s open positions if they fail to meet a margin call within the stipulated timeframe. This is a critical mechanism to prevent the client’s deficit from growing and to protect the firm from credit loss. Statement II is also correct; while the LC has the right to liquidate, it must exercise this right in a commercially reasonable manner, aiming to achieve a fair market price and not acting in a way that unnecessarily disadvantages the client. This is consistent with the general duties of care and acting in the best interests of the client as outlined in the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. Statement III is incorrect because a verbal promise to transfer funds does not constitute meeting a margin call. The LC requires receipt of cleared funds to restore the margin to the required level. Relying on a promise would expose the firm to unacceptable credit risk. Statement IV is incorrect because the client provides prior authorization for the LC to liquidate positions under specific circumstances (like an unmet margin call) when they sign the client agreement. Seeking additional consent at the time of liquidation would be impractical and would undermine the entire purpose of the margin mechanism, which is to allow the firm to act swiftly to mitigate risk. Therefore, statements I and II are correct.

This question assesses the understanding of standard procedures for managing credit and counterparty risk in a leveraged foreign exchange trading environment, specifically concerning margin calls and position liquidation. Statement I is correct because issuing a formal, clear, and timely margin call is the fundamental first step when a client’s account equity falls below the maintenance margin level. This communication must specify the amount needed and the deadline. Statement II is also correct. The client agreement, which is a legally binding contract, invariably grants the licensed corporation the right to liquidate a client’s open positions to cover a margin deficit if the client fails to meet the margin call by the specified deadline. This is a critical risk mitigation tool for the firm. Statement III is incorrect. There is no regulatory requirement or standard best practice that mandates a 24-hour extension. In fact, delaying liquidation, especially in volatile markets, would be considered poor risk management as it exposes the firm to potentially larger losses. While a firm may have its own policy, it is not a mandatory practice. Statement IV is incorrect. The client agreement typically gives the firm the discretion to decide which positions to liquidate and in what order to bring the account back into compliance. Requiring the client’s specific instructions before acting would be impractical, especially if the client is unresponsive, and could exacerbate the firm’s risk exposure. Therefore, statements I and II are correct.

This question assesses the understanding of proper procedures for managing credit and counterparty risk in a leveraged foreign exchange trading context, specifically when a client’s account falls below the maintenance margin level. Statement I is correct because the standard initial procedure is to issue a formal margin call to the client, specifying the required amount and the deadline. This is a fundamental step outlined in client agreements and aligns with fair treatment of clients. Statement II is also correct; the client agreement grants the licensed corporation the right to liquidate the client’s positions if they fail to meet the margin call within the stipulated time. This is a critical mechanism to protect the firm from incurring losses due to the client’s deficit. Statement III is incorrect because, while firms have the right to liquidate, doing so immediately without first issuing a margin call and allowing a reasonable time for the client to respond is generally not the standard first step, unless under specific pre-agreed conditions for extreme market events. The primary procedure is to call for margin first. Statement IV is incorrect as offering an unsecured credit line to cover a margin shortfall is a highly imprudent risk management practice. It exposes the firm to significant and uncollateralized credit risk, which is contrary to the principles of sound risk control and regulatory expectations for maintaining adequate financial resources. Therefore, statements I and II are correct.

Statement I is correct. A margin call is a formal request issued by a licensed corporation to a client when the equity in their leveraged account falls below the pre-determined maintenance margin level. Its purpose is to compel the client to deposit additional funds or collateral to bring the account equity back up to the required level, thereby reducing the firm’s credit risk.

Statement II is correct. The client agreement for a leveraged FX account grants the licensed corporation the right to liquidate a client’s open positions if they fail to meet a margin call within the specified time. This is a critical risk management tool that allows the firm to protect itself from further losses and limit its counterparty credit exposure.

Statement III is incorrect. If the liquidation of positions does not generate sufficient funds to cover the client’s entire debit balance (the amount owed to the firm), the client remains legally liable for the remaining shortfall. The firm can take further action to recover this debt.

Statement IV is incorrect. The client agreement, signed during the account opening process, typically contains a clause that pre-authorizes the licensed corporation to liquidate positions without further client consent if a margin call is not met. This is a standard and necessary provision for managing risk in fast-moving leveraged markets. Seeking separate authorization at the time of liquidation would be impractical and defeat the purpose of the margin mechanism. Therefore, statements I and II are correct.

The correct answer is that the firm has the right to liquidate any or all of the client’s open positions to restore the margin level. In leveraged foreign exchange trading, the client agreement grants the licensed corporation the authority to take protective measures when a client’s account equity falls below the maintenance margin level. A margin call is a formal request for the client to deposit additional funds to meet this requirement. If the client fails to do so within the stipulated time, the firm can, at its discretion and without further notice, close out the client’s positions to mitigate its own credit risk exposure. This is a critical risk management tool to prevent the client’s losses from exceeding their account balance, which would result in a debt to the firm. The firm is not obligated to seek the client’s specific instructions on which positions to close, as this would delay the risk mitigation process and is contrary to the pre-agreed terms. Similarly, the firm is not restricted to closing only the position that caused the margin call; it can liquidate any combination of positions deemed necessary to bring the account back into compliance. The firm is also not required to grant an additional grace period beyond the one specified in the margin call notice; the terms of the client agreement govern the liquidation process.

The correct answer is that the Responsible Officer should instruct the risk management team to liquidate a sufficient portion of Mr. Chan’s open positions to restore the margin level to the required minimum. This action is a critical component of managing credit and counterparty risk. When a client fails to meet a margin call within the stipulated timeframe, the licensed corporation has the right, as per the client agreement, to close out positions to prevent further losses and protect the firm from the client’s potential default. This process mitigates the risk that the client’s losses could exceed their account equity, leaving the firm with a bad debt. Granting an unconditional extension based on a verbal promise exposes the firm to significant additional market risk, as the adverse price movement could worsen. While client relationships are important, they cannot override prudent risk management policies. Using the firm’s own capital to place a hedge against the client’s position is not the standard procedure; the primary recourse is to resolve the risk at its source, which is the client’s under-margined position. Waiting to negotiate a partial deposit after the deadline has passed similarly prolongs the firm’s exposure to risk and is contrary to established margin call procedures.

The correct answer is that the firm should proceed to liquidate Mr. Chan’s positions to cover the margin shortfall if he fails to deposit the required funds within the specified time. This is a fundamental principle of credit and counterparty risk management in leveraged foreign exchange trading. The client agreement and the firm’s risk management policies, which must align with the principles in the SFC’s Code of Conduct, will stipulate the firm’s right to close out a client’s positions to prevent losses from exceeding the client’s equity and to protect the firm from default. Allowing a client to continue holding a losing position without sufficient margin exposes the firm to significant credit risk. Converting the margin deficit into an unsecured loan is improper as it fundamentally changes the risk profile from a secured trading exposure to an unsecured credit exposure, which is not the business of a leveraged FX provider. Offering to restructure the position by opening new trades on the client’s behalf is also inappropriate; the firm’s right is to mitigate risk by closing existing positions, not to take on new market risk for the client. While a firm may have some discretion, granting an indefinite extension based on a client’s past profitability is a poor risk management practice and could be seen as a breach of the firm’s duty to manage its risks prudently.

The correct answer is that the firm must proceed with liquidating the client’s positions if the margin call is not met within the pre-agreed timeframe. According to the principles of sound risk management outlined in the SFC’s Code of Conduct, a licensed corporation must have robust procedures for managing credit and counterparty risk. When a client’s account falls below the maintenance margin level, a margin call is issued. If the client fails to deposit the required funds within the specified period (as stipulated in the client agreement), the firm is obligated to liquidate open positions to prevent the deficit from growing and to protect the firm’s own financial resources. This is a critical control to mitigate the risk of client default. Extending a credit line without proper assessment is a poor risk management practice that increases the firm’s exposure to the client’s potential losses. Relying solely on the client’s verbal promise to pay, without enforcing the liquidation deadline, constitutes a failure to follow established risk control procedures. Transferring the risk by hedging the position in the firm’s own book does not resolve the client’s deficit and inappropriately commingles client risk with the firm’s proprietary risk.

The correct answer is that the firm should promptly issue a margin call to the client, clearly stating the required amount and a deadline for payment, and if the client fails to meet this call, the firm must liquidate the positions. This procedure is a fundamental component of credit and counterparty risk management in leveraged foreign exchange trading. When a client’s account equity falls below the maintenance margin level, the licensed corporation is exposed to the risk that the client’s losses could exceed their deposited funds, leading to a debt owed to the firm. Issuing a formal margin call provides the client with an opportunity to restore their account to the required level. If they fail to do so within the stipulated time, the firm’s risk management policies, as expected under the SFC’s Code of Conduct, mandate the liquidation of positions to mitigate further potential losses and protect the firm from default. Waiting for a market reversal is a form of speculation and constitutes poor risk management, as it could exacerbate the firm’s exposure. Immediately liquidating the client’s positions without first issuing a margin call and allowing a reasonable time to respond may breach the terms of the client agreement. While discussing hedging strategies can be part of client service, it does not resolve the immediate and critical issue of the margin deficit, which must be addressed first to control the firm’s credit risk.

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. The scenario describes a classic operational failure stemming from human error (a junior dealer’s mistake) and system/process deficiencies (lack of real-time checks). A robust operational risk management framework, as expected by the Securities and Futures Commission (SFC), should incorporate preventative and detective controls.

Statement I is a key preventative control. Automated pre-trade checks within the information system are a critical part of the deal processing workflow to prevent the execution of trades at off-market rates, thereby mitigating human error.

Statement II addresses the ‘people’ element of operational risk. The ‘four-eyes’ principle is a standard internal control procedure that introduces a layer of human verification for high-risk or manual transactions, reducing the likelihood of a single individual’s error causing a significant loss.

Statement III focuses on improving the ‘system’ and management oversight. Real-time monitoring and reporting provide supervisors with the tools to detect anomalies and errors as they happen (intraday), rather than after the fact. This shifts the control from being purely detective (end-of-day) to being more proactive.

Statement IV is incorrect as it confuses operational risk control with market risk management. Increasing an open position limit (a market risk parameter) does not address the root cause of the operational failure. In fact, it could exacerbate the potential financial impact of a future error by allowing for larger erroneous positions to be established. The appropriate response to an operational failure is to tighten controls, not to loosen risk limits. Therefore, statements I, II and III are correct.

The correct answer is that the licensed corporation must formally issue a margin call, provide a clear deadline, and liquidate the position if the client fails to meet the call. This sequence is a fundamental component of credit and counterparty risk management in leveraged trading. When a client’s account equity drops below the maintenance margin, the firm is exposed to the risk that the client’s losses could exceed their deposited funds. The first step is to formally notify the client via a margin call, giving them a specified and reasonable timeframe to deposit additional funds or close positions to restore the margin level. If the client fails to act within this timeframe, the firm is contractually entitled, and from a risk management perspective, obligated, to liquidate the positions to prevent further losses and protect the firm from a potential deficit. This process ensures fair treatment of the client while upholding the firm’s financial integrity, a key principle under the SFC’s Code of Conduct. Immediately liquidating the position without a formal call and a chance to respond could breach the client agreement and regulatory expectations of fairness. Offering a credit facility would improperly increase the firm’s credit risk exposure, which is contrary to prudent risk management. Using the firm’s own capital to hedge the position is an unauthorized action that co-mingles firm and client risk and is not a permissible or standard procedure.

The management of counterparty credit risk in leveraged foreign exchange trading is governed by the client agreement and standard industry practices. When a client’s account equity falls below the maintenance margin level, the licensed corporation’s primary recourse is to issue a margin call. This formal request notifies the client of the deficiency and provides a specific timeframe to deposit additional funds or close positions to meet the margin requirement. This aligns with statement II. If the client fails to act within the stipulated time, the firm is contractually entitled to liquidate positions to cover the margin shortfall and protect itself from further losses, as described in statement III. Statement I is incorrect because, while firms have the right to liquidate, the standard procedure involves a margin call first, unless the client agreement specifies otherwise for extreme conditions. Immediate liquidation without any attempt at notification is typically a last resort. Statement IV is also incorrect; client agreements almost universally permit the firm to charge interest on any debit or deficit balance that remains after positions are liquidated, as this represents a loan from the firm to the client. Therefore, statements II and III are correct.

This question assesses the understanding of credit and counterparty risk management procedures in a leveraged foreign exchange trading context, specifically focusing on margin calls and position liquidation. Statement I is correct because issuing a prompt and clear margin call is the standard first step when a client’s account equity falls below the required maintenance level. This action is crucial for notifying the client and initiating the process to restore the required margin. Statement II is also correct; the client agreement for leveraged products typically grants the licensed corporation the right to liquidate positions to cover a margin deficit if the client fails to meet the margin call within the stipulated time. This is a fundamental tool for the firm to control its credit exposure. Statement III is incorrect because providing an automatic extension is contrary to prudent risk management. While a firm may exercise discretion in exceptional cases, an automatic policy would expose the firm to unacceptable levels of market risk if the client’s position continues to deteriorate. Statement IV is incorrect because, while a firm might consult a client as a matter of good service if time permits, it is under no regulatory or contractual obligation to do so. In volatile markets, the firm must act swiftly to protect itself, and the client agreement grants it the discretion to liquidate positions as it sees fit to cover the shortfall. Therefore, statements I and II are correct.

The explanation teaches the concept of managing credit and counterparty risk in leveraged foreign exchange trading, specifically focusing on the procedure following a failed margin call. The correct course of action when a client fails to meet a margin call is for the licensed corporation to liquidate the client’s open positions. This is a critical risk management control designed to prevent further losses for both the client and the firm. The client agreement, which outlines the terms of trading, will almost invariably grant the firm the right to close out positions to restore the required margin level. This protects the firm from credit risk (the risk that the client will default on their losses) and protects the client from accumulating a debt that exceeds their deposited funds. Extending the deadline for the margin call, even for a client with a good history, is a poor risk management practice as it exposes the firm to potentially unlimited losses if the market continues to move against the position. Freezing the account to prevent new trades is a necessary but insufficient step; it does not address the risk of the existing under-margined positions. Seeking a partial deposit does not fully remedy the margin shortfall and leaves both parties exposed to ongoing market risk; the standard procedure requires the full margin requirement to be met or positions to be liquidated.

A robust operational risk management framework is crucial for a licensed corporation dealing in leveraged foreign exchange. Statement I is correct because a mandatory holiday policy for staff in sensitive positions is a key internal control. It ensures that another individual takes over the duties, which can help uncover fraudulent activities or irregularities that the regular staff member might be concealing. Statement II is correct as the segregation of duties between the front office (which initiates trades) and the back office (which confirms, settles, and reconciles trades) is a fundamental principle of internal control. This separation prevents a single individual from executing and concealing unauthorized or erroneous transactions. Statement IV is correct because a clear, documented escalation procedure for trade discrepancies and settlement failures is essential. It ensures that problems are identified, reported to the appropriate level of management, and resolved in a timely manner, preventing minor issues from becoming significant losses. Statement III is incorrect; while performance targets are common, making them a primary requirement can increase operational risk. Aggressive profit targets may incentivize traders to take excessive risks, breach trading limits, or engage in unauthorized activities to meet their goals, thereby undermining the control framework. Therefore, statements I, II and IV are correct.

The correct answer is that the firm should issue a formal margin call to the client, and if the client fails to deposit the required funds within the timeframe stipulated in the client agreement, the firm should then proceed to liquidate the client’s positions. This sequence of actions is a fundamental component of credit risk management for leveraged products as outlined in the Code of Conduct. The client agreement establishes the contractual right for the licensed corporation to take this action. First, a margin call provides the client with a formal notification and a reasonable opportunity to remedy the margin shortfall by either depositing additional funds or closing out positions themselves. If the client fails to act within the contractually agreed-upon time, the firm must then act decisively to protect itself from further credit risk by liquidating the positions. Liquidating the client’s portfolio immediately without issuing a margin call would typically be a breach of the client agreement, unless specific and explicit ‘no margin call’ terms were agreed upon, which is not the standard procedure. Waiting indefinitely for the client’s instructions after a margin breach is not a prudent risk management practice, as it exposes the firm to potentially unlimited losses if the market continues to move adversely. The firm has a right and an obligation to mitigate its own risk. Liquidating a portion of the position first and then issuing a margin call reverses the proper order of operations; the call should precede any forced liquidation by the firm.