Risk Management Best Practice Principles for FCM

8/9/2019 Risk Management Best Practice Principles for FCM

1/30

8/20/2014

http://eng.selaw.com.tw/FLAWDAT0202.asp

Article Content

TitleRisk Management Best-Practice Principles For Futures Commission Merchants(

Amended 2010 . 01 . 27)

1 General Provisions

1. These Principles are adopted to assist Futures Commission Merchants (FCMs) establish a

sound and integrated risk management system, and to strengthen the development of the

futures market. These Principles are also to be used as a reference for guidance by the

FCMs.

2. An FCM often encounters uncertainties in the course of its business operations. In general,

an uncertain event may be called a risk if it can cause an adverse impact that affects the

achievement of the FCM's strategic business objectives.

3. An FCM shall establish business strategies and organizational culture that emphasize riskmanagement, and shall keep a firm grasp on the results of qualitative and quantitative

management, which shall serve as a reference for the formulation of business strategies.

4. To manage risks, it is advisable that an FCM establish an integrated risk management

system, with the joint participation of and implementation by everyone from the board of

directors and managerial personnel of all levels to employees. Being a procedure to be

observed by all levels in the FCM, the system, through an overall perspective from the FCM,

identifies, measures, monitors, responds to, and reports on potential risks, and, with

qualitative and quantitative management methods, limits within a sustainable level all types

of risks that might be encountered during business operations, with the hope to reasonably

ensure the achievement of the FCM's strategic objectives, and to assist in the planning and

formulation of the system.

5. An FCM shall establish its risk management system in compliance with all applicable laws

and regulations. In addition, it is advisable that the FCM's organizational structure and

division of powers and responsibilities for risk management, the identification, measurement,

monitoring, responding, and reporting of risks, risk management information system, and

information disclosure be carried out pursuant to these Principles.

6. An FCM shall value the importance of its risk management unit and personnel, and authorize

them to perform their duties independently, to ensure that such risk management system

may be effectively implemented on a sustainable basis, and shall provide assistance to the

board of directors and the management level in the faithful performance of their duties so that

risk management will be effectively realized.

2 Organizational Structure and Division of Duties for Risk Management

1. Organizational Structure for Risk Management

A. An FCMs Organizational Structure for Risk Management

It is advisable that an FCM establish a risk management committee ("RMC") under

its board of directors. In addition, it shall designate personnel or establish an

appropriate unit for risk management, so that matters in connection with risk

management can be effectively planned and implemented.

Description:

1.The main factors to be considered for the designing of a risk management
http://www.selaw.com.tw/scripts/NewsDetail.asp?no=G0101542http://eng.selaw.com.tw/FLAWDOC01.asp?lsid=FL034939&lno=2http://eng.selaw.com.tw/FLAWDOC01.asp?lsid=FL034939&lno=1http://www.selaw.com.tw/scripts/NewsDetail.asp?no=G0101542http://eng.selaw.com.tw/FLAWDAT01.asp?lsid=FL034939


2/30

8/20/2014

http://eng.selaw.com.tw/FLAWDAT0202.asp 2

organizational structure for an FCM include the type of each organization, the

corporate culture, and the composition of risks. However, the general principle for risk

management is that the unit or the personnel implementing risk management shall

remain independent.

2.Responsibility for risk management does not lie exclusively with the risk

management unit. Effective risk management requires the cooperation of all related

departments within the FCM, including human resources, legal affairs, information

technology, internal control, auditing, and planning; otherwise it is difficult to carry out

risk management for overall business.3.The success of risk management depends on the joint promotion and

implementation efforts from all levels of the FCM; therefore, it is extremely important

to have effective communication, coordination, and connection between the board of

directors, the risk management personnel or unit, and related departments.

4.Successful implementation of risk management relies upon a clear authority

structure and well-planned reporting process. Without them, risk management

information cannot be effectively aggregated, transmitted and analyzed, and the

corporation's business strategies and risk management policies cannot be

appropriately adjusted in response to changes in its subjective and objective

environments.

2. Risk Management Function

A. The Role of the Board of Directors

The board of directors shall recognize the risks confronted by an FCM in the course

of its business operation (such as market risk, credit risk, liquidity risk, operational

risk, legal risk, model risk, reputation risk, and other risks in connection with its

business operation), ensure effective risk management, and bear the ultimate

responsibility for risk management.

Description:

1. The board of directors shall be held ultimately responsible for financial loss or

decrease of shareholders' equity value, and thus it shall establish an appropriate risk

management system, operating procedures, and a risk management culture, as well

as allocate the resources necessary to implement its risk management system.

2. The board of directors shall pay attention not only to the risks borne by each

department, but also to the aggregate risks to the FCM as a whole. At the same

time, the statutory capital adequacy requirements prescribed by the competent

authority, as well as other financial and business regulations that may affect the

allocation of capital, shall all be taken into consideration.

B. Role of the Risk Management Committee

It is advisable that an FCM establish a RMC under the board of directors to assist the

board of directors with its planning and supervising of matters related to risk

management; if no RMC is established, the board of directors shall take charge of

these functions.Description:

1. In light of the professionalism, regularity and timeliness required in risk

management, it is advisable that an RMC be established under the board of directors

to ensure effective monitoring of daily risk management, but the committee should

report to the board of directors on a regular basis.

2. The Committee shall draft risk management policies and establish qualitative and

quantitative management standards to facilitate the monitoring of daily risk

management. It shall also make timely reports on the implementation of risk

management to the board, along with recommendations for improvement.

C. Functions of the Risk Management Personnel or Unit


3/30

8/20/2014


The risk management personnel or unit shall be responsible for the monitoring,

measurement and evaluation of routine risks confronted by the FCM. It shall exercise

its authority independently of the FCM's business departments and trading activities.

In terms of organizational structure, the risk management personnel or unit may

report directly to the board of directors.

Description:

1. Subject to the types of business conducted by the FCM, the duties of the risk

management personnel or unit shall be:

(1) Help draft risk management policies;(2) Help draft risk l imits for each department and the method of allocation;

(3) Implement the risk management policies approved by the board of directors;

(4) Submit complete risk management reports in a timely manner;

(5) Make sure that business units understand the content of transactions prior to

undertaking them, and continue monitoring positions held after transaction are

completed;

(6) Improve as much as possible the skills used to measure the quantifiable risks of

financial instruments;

(7) Understand risk limits and their usage status in each business unit;

(8) Evaluate risk exposure and risk concentration;

(9) Develop and implement stress tests and back-testing procedures;

(10) Inspect the difference between the actual loss of the investment portfolio and loss

forecasted by the risk management personnel or unit;

(11) Review the pricing model and evaluation system for financial instruments used by

the FCM; and

(12) Deal with other matters in connection with risk management.

2. The risk management personnel or unit shall have proper authority to deal with

matters in connection with risk limit violations made by other departments, and shall

have proper authority to require that positions held by other departments be kept

under established limits.

D. Role of the Head of the Risk Management Unit

The appointment and removal of the head of the risk management unit shall be

subject to the approval of the board of directors. The head of the risk management

unit shall be responsible for measuring, monitoring, and evaluating the risk status of

the futures firm on a daily basis:

Description:

1. The primary duties of the head of the risk management personnel or unit are as

follows:

(1) To monitor and keep track of the implementation status of risk management

policies;

(2) To establish an integrated structure for measuring, monitoring, and evaluating

quantifiable financial risks;(3) To lead the implementation of measuring, monitoring, and evaluating risks;

(4) To monitor the risk limits of business units, and urge that corrective measures be

taken whenever any violation is discovered;

(5) To proceed with risk adjusted performance measurement (RAPM) or provide risk

information required by RAPM;

(6) To undertake evaluation and back-testing of the effectiveness of the model to

ensure the accuracy of evaluation results;

(7) To ensure that risk management skills being updated in a timely fashion; and

(8) To deal with other matters concerning risk management.

2. In addition to the foregoing matters, as for unquantifiable risks, the head of the risk


4/30

8/20/2014


management unit shall also assist the board of directors to assign an appropriate

unit(s) to proceed with joint management of such risks, including emergency

response planning.

E. Roles of Risk Management Personnel at Business Units

In order to effectively link the communication of risk management information, and

implementation of risk management matters between the risk management personnel

or unit and each business unit, an FCM may place risk management personnel within

each of its business units where they shall implement effectively and independently

the risk management operations of each business unit.Description:

1. Whether to install risk management personnel shall depend on the FCMs type of

organization, scale and the importance and complexities of different units.

2. Major duties of risk management personnel at a business unit are as follows:

(1) To report the risk exposure of the business units in a prescribed and systematic

way, in compliance with the risk management reporting process;

(2) To ensure the timely and correct communication of risk information;

(3) To ensure the effective execution of rules on risk limits within business

departments;

(4) To monitor the status of risk exposure and report on instances where limits are

exceeded, including corrective measures adopted by the business unit in question;

(5) To ensure that business unit risk measurement, model use, and assumptions are

undertaken consistently; and

(6) To ensure effective implementation of internal controls within business units, so as

to comply with laws, regulations and risk management policies.

F. Role of Heads of Business Units

The head of a business unit shall be responsible for daily risk management and

reporting in his/her unit.

Description:

1. The head of a business unit shall bear the duties for all risk management matters

in the unit under management, and be responsible for analyzing and monitoring

relevant financial risk (such as market risk and credit risk) in the unit, and for taking

all types of corresponding measures.

2. The head of a business unit shall convey relevant risk management information to

risk management personnel or unit on a daily basis.

G. Establishment of Risk Limits

It is advisable that an FCM allocate the capital required by the FCM and each

business unit based on the strategic objectives of its business operations, to the

extent where the risks are bearable. It is also advisable that the power to make such

allocation be vested in the board of directors, or the Risk Management Committee

(RMC) may propose the allocation, and the proposed allocation shall be subject to

the approval of the board of directors. Monitoring and controlling the risk limits isextremely important for ensuring that the FCMs business activities do not exceed

tolerable risk levels.

Description:

1. A risk capital limit refers to the capital that must be allocated to respond to the

maximum risk of loss that is bearable by the company as a whole, or by individual

business units, for a certain period of time and degree of confidence. Together with

risk bearing, risk limits are part and parcel of the company's business activities.

2. The procedure for establishing risk limits involves a bottom-up collection of

requirements and suggestions from each department followed by a top-down

implementation of the approved limits as approved and allocated to each department,


5/30

8/20/2014


and the implementation status shall be effectively monitored through the risk

management system.

3. In the course of planning and calculating the risk limits, the capital that can be

allocated to each business unit shall be taken into consideration along with the

contributions that the capital can make to performance, and the risks that may be

sustained. During this process, the risk management personnel or unit shall play an

important evaluation role.

H. Management of Risk Limits

An FCM shall have a complete procedure for the management of risk limits. Theprocedure shall include the calculation method, allocation method, and

implementation of monitoring processes.

Description:

1. The risk limits can be calculated by qualitative and quantitative methods.

Quantitative methods shall be used as much as possible to express quantifiable risks

where necessary. Currently, technologies are available for calculating market risk and

credit risk, and useful tools for operational risk are gradually being developed.

2. In calculating limits, the correlation between different risks shall be taken into

account.

3. The establishment and allocation of limits may reflect different perspectives or

needs. For example, it may be done on the basis of business units, or on the basis of

the type of product, length of period, the level of concentration in a position, or

differences in risk factors.

4. After limits are established, ongoing assessment of their reasonableness is

required in order to make necessary adjustments, which shall be subject to approval

by the board of directors.

I. Risk Management Policies

An FCM shall establish risk management policies to serve as the basis of routine risk

management procedures. The content of these policies shall accurately reflect the

objectives of the FCMs operational strategies, its risk preferences, and the

characteristics of the risks it confronts. In addition, the policies shall be conveyed to

and implemented by all departments of the FCM through a prescribed process. The

risk management policies may be proposed by the RMC, and shall be implemented

after approval by the board of directors.

Description:

1. During the drafting of risk management policies, the following factors should be

taken into account:

(1) The overall operational strategies and product categories;

(2) The scale, nature, and complexity of transactions;

(3) Risk tolerance;

(4) The quality of internal control procedures;

(5) The capability to monitor risks and the completeness of the risk managementsystem and related procedures;

(6) The degree of professionalism with respect to risk management;

(7) Past experience and performance;

(8) Compensation (or bonus) policy (where special attention has to be paid to the

correlation between performance and compensation);

(9) Tax and accounting issues;

(10) Related laws, regulations and restrict ions; and

(11) Other matters concerning risk management.

2. An FCM shall review on a regular basis the appropriateness of risk management

policies, and make timely revisions to reflect changes of the subjective and objective


6/30

8/20/2014


environment.

J. Evaluation of Risk Management Effectiveness

An FCM shall evaluate, on a regular and irregular basis, the effectiveness of its risk

management, including whether the expectations of the board of directors are met,

whether risk management is conducted independently, whether the risk management

system is faithfully implemented, and whether the overall risk management

infrastructure is complete.

Description:

1. Evaluation of the risk management effectiveness:(1) The influence and impact risks have on the business are often affected by

changes in the objective environment. It is therefore necessary to periodically evaluate

risk management priorities, the choice of tools, and the cost and applicability of risk

management measures.

(2) The evaluation referred to in the preceding paragraph may be performed internally

by the risk management personnel or unit or other appropriate unit or personnel. It is

also feasible to engage professionals from external institutions to conduct the

evaluation.

2. Evaluation of the faithful implementation of risk management:

(1) Whereas the faithful implementation of risk management may be independently

evaluated by internal auditors, their reporting procedures must be independent of

transactions, back-office operations and the risk management system. It is also

feasible to rely on external auditors to assist in the evaluation.

(2) Auditing and testing of this type shall concentrate on risk management

procedures and internal controls. Upon discovery of any irregularity, or when there are

any significant changes in product types, model usage or internal controls, it is

necessary to enhance the depth, extent and frequency of the auditing.

(3) The scope of the above-mentioned model testing must include quantitative testing

and model management system operation. The internal or external personnel

performing model testing must have the professional qualifications and related

educational background to ensure its effectiveness.

3 Risk Management Process

Figure 1: Risk Management Process

1. General Principles

A. The risk management process for an FCM shall include: risk identification, risk

measurement, risk monitoring, risk reporting, and risk response.

B. An FCM shall establish a risk management information system so as to ensure

smooth implementation of the risk management process.

2. Risk Identification

For the purpose of risk management, an FCM shall first identify the risks it may face in the

course of its business operation. Generally speaking, risks may be affected by internal and

external factors, which are called risk factors. To effectively control risk, it is advisable to

adopt various feasible analytical tools and methods, and through bottom-up or top-down

discussion and analysis, to aggregate past experience and predict conditions that will give

rise to possible risks in the future. These shall be identified and categorized to serve as a

reference for further risk measurement and monitoring.

Description:

1. Given the special nature of the futures industry, the primary risks that the industry may
http://eng.selaw.com.tw/FLAWDOC01.asp?lsid=FL034939&lno=3


7/30

8/20/2014


face are market risk, credit risk, liquidity risk, operational risk, model risk, and other related

risks. Accordingly, these Principles shall explain the major risks generally acknowledged by

the industry, and the other risks shall be identified, analyzed and dealt with by individual

FCMs.

2. Market risk refers to the risk of on- or off-balance-sheet loss due to uncertain changes

during a certain period in the market prices of financial assets, such as changes in interest

rates, foreign exchange rates, equity security prices, and commodity prices.

3. Credit risk refers to the probability that counter-party of a transaction fails to perform their

duty, and the risk of loss such nonperformance would cause to the risk amount or thefinancial status of the FCM.

4. Liquidity risk refers to the risk of failure to meet obligations when they come due because

of inability to liquidate assets or to obtain adequate funding (referred to as "funding liquidity

risk") and the risk of significant movements of market price due to inadequate market depth

or market disruptions (referred to as "market liquidity risk") in the course of disposing or

offsetting positions held.

5. Operational risk refers to the risk of direct or indirect loss arising from failure or mistakes

in internal operations, personnel or systems, or from external events.

6. Other risks include legal risk, model risk, strategy risk or business risk, and reputation

risk.

7. In risk identification, attention shall be paid to the correlation between events giving rise to

those risks.

8. The Product/Risk Matrix can be used as a standard for reference in identifying product

risk factors.

3. Risk Measurement

After an FCM identifies the risk factors in different products, it shall establish appropriate

measuring methods to serve as the basis of risk management.

Description:

1. Risk measurement includes risk analysis and evaluation. The former is to understand the

influence of risks on the FCM by analyzing the probability of risky events and the extent of

their adverse impact. In the latter, the influence of risks is compared to the threshold set in

advance, so that it may serve as a reference in setting priorities for risk control and selecting

response measures.

2. For an FCMs risk management, the risks shall be measured by quantitative or other

feasible qualitative approaches based on the types of risks involved.

3. In terms of risk management structure, rigorous statistical analysis and related

techniques may be applied to analyze quantifiable risks such as market risk and credit risk.

For other risks that are harder to quantify, appropriate risk response measures shall be

adopted to achieve the objectives of risk management.

4. It is advisable that an FCM adopt a progressive approach towards risk management

quantification. For example, one may seek quantitative management of market risk, followed

by the quantitative management of credit risk, liquidity risk, operational risk and other risks.5. Qualitative risk measurement is the expression of the probability and influence of risks

through written description. It may be applied in the following situations:

(1) Where it is used for preliminary screening and as preparatory work for more precise risk

measurement;

(2) Where quantitative analysis is too resource-consuming to be cost-effective; and

(3) Where relevant data and quantitative methods are not adequate for appropriate

quantitative analysis.

6. In qualitative analysis , one may also concurrently adopt proper quantitative analysis.

However, users shall bear in mind that, because this method cannot accurately reflect actual

degrees of risks, nor effectively differentiate between their particular natures or connections,


8/30

8/20/2014


it might pose a risk of producing misled judgments.

4. Risk Monitoring

An FCM shall establish a complete set of monitoring procedures to monitor and

appropriately report risk limits usage and over-limit circumstances, the aim being to facilitate

the adoption of response measures. This procedure shall be undertaken continuously as part

of routine operational activities, and off-line observation and understanding shall be made ex

post facto. All deficiencies found in the monitoring process shall be reported to the

supervisors in accordance with the rules.

Description:1. Compared to ex post observation and understanding, ongoing risk monitoring as part of

business operations is more important to an FCM.

2. Deficiencies found in risk monitoring shall be reported to immediate supervisor through the

normal channels. In addition, for serious deficiencies, a special expedited reporting

procedure may be established.

3. Ex post, off-line monitoring, with the involvement of the risk management personnel or

unit, may be conducted by business units through self-inspection. The depth, extent or

frequency of the monitoring shall be based on the importance of risks, the impact of

response measures and the content of the control methods adopted by the FCM to manage

risk.

5. Risk Reporting

An FCM shall faithfully prepare transaction reports, and prepare risk management reports on

a regular basis or at times of irregularities, submit them to the appropriate management

level, and keep them on file for recordation.

Description:

1. The preparation of written reports is extremely important in order to fully record

assumptions, methods, information sources and implementation results at each phase of

the risk management process, thus serving as reference for management. Each report shall

be designed and prepared in consideration of the following functional requirements:

(1) To indicate whether the management process is properly implemented;

(2) To indicate whether systematic methods are applied to undertake risk identification and

analysis;

(3) To record the status of risks and develop such records into a knowledge base for

business management;

(4) To serve as a reference for decision making and the approval of risk management

measures;

(5) To serve as a reference for determining accountability;

(6) To facilitate the execution of risk monitoring and evaluation work; and

(7) To share and communicate risk management information.

2. The head of each business unit shall ensure the accuracy and validity of the transaction

reports prepared by it. All transactions must be properly recorded in line with the regulations

made by the company and the supervisory authority, and shall be submitted accordingly.3. The risk management personnel or unit shall, on a regular basis or at times of

irregularities, prepare risk management reports and submit them to the relevant management

level.

4. Before undertaking transactions in a new product, the nature of such transactions shall be

taken into account to devise a transaction report in an appropriate format for future

submission.

5. Management shall pay special attention to the relevant information contained in derivatives

reports.

6. Risk Response

After evaluating and summarizing its risks, an FCM shall adopt appropriate response


9/30


10/30


11/30

8/20/2014


can adopt stress testing for simulation to measure the impacts of irregular market

fluctuations on the value of an investment portfolio, and the results may serve as the

basis for the drafting of response measures.

Description:

1. Most risk measurement models are based on many assumptions and specific

parameters, including the choice of confidence level. However, they do not provide

predicted losses that fall outside the confidence level or distribution assumptions. It is

therefore necessary to adopt stress testing to evaluate an FCMs potential irregular

loss, and to implement risk control.2. Stress testing is not limited to the quantitative analysis of potential losses; it shall

include qualitative analysis under specific conditions.

3. An FCM shall perform stress testing on a regular basis to evaluate the potential

irregular loss arising from excessive market fluctuations.

2. Credit Risk

A. Credit Risk Management Principles

An FCM shall establish an appropriate control system for the credit risk of all of its

business and shall implement such system faithfully:

Description:

1. Credit Risk Management System shall include at least:

(1) The authorization structure, reporting process and operation descriptions at

various levels in connection with credit risk management;

(2) Credit evaluation prior to transactions: A cautious evaluation of the credit of a

counter-party shall be made prior to a transaction, and the legality of the transaction

shall be confirmed;

(3) Creditworthiness: It is advisable to establish a creditworthiness system. Different

counter-parties with different levels of creditworthiness shall be imposed with different

credit limits, and administered according to their credit limits. ;

(4) Credit monitoring: The credit conditions of different counter-parties and their

positions shall be inspected on a regular basis. In addition, regular evaluation and

monitoring shall be performed on credit enhancement measures (including collateral);

and

(5) Other effective measures for credit risk reduction, such as collaterals, guarantees,

and credit risk netting agreements.

2. To control credit risk effectively, an FCM may adopt appropriate quantitative risk

management technology.

B. Credit Rating Management

An FCM shall have an appropriate credit assessment unit to evaluate its counter-

partys creditworthiness. Further, it shall establish different credit limits for different

counter-parties with different levels of creditworthiness, which shall be administered

based on their credit limits.

Description:1. It is advisable that an FCM establish an independent credit evaluation procedure

whereby the counter-parties creditworthiness shall be evaluated.

2. It is advisable that an FCM establish an appropriate credit rating system, whereby

the credit limits shall be imposed upon different counter-parties with different level of

creditworthiness.

3. To identify a counter-party with high risks, an FCM may conduct appropriate credit

rating management based on each counter partys historical transaction

characteristics and the FCMs risk tolerance.

4. The risk management personnel or unit shall be responsible for measuring and

monitoring credit risk.


12/30

8/20/2014


C. Credit Monitoring:

An FCM shall review on a regular basis the counter-partys credit standing, and

establish credit monitoring procedures to ensure a constant control over credit risk. It

shall also review, monitor and manage on a regular basis each credit enhancement

measure (including collaterals and margins).

Description:

1. Credit monitoring procedures shall include:

(1) Regular review of the counter-partys credit conditions.

(2) Adopting appropriate measures for counter-party whose risk has been increased inorder to control the credit risk.

(3) Other measures that may improve risk monitoring and management effectively.

2. An FCM shall establish special monitoring and approval process for the trading

orders from high-risk customer, and shall establish a tracking and management

procedure for high-risk accounts for the following matters:

(1) Credit changes of the account;

(2) Legality of the account;

(3) Change, and profit and loss of the trading instruments of the account; and

(4) Collection and analysis of important relevant information.

D. Credit Enhancement and Credit Risk Mitigation

To further control credit risk, the company shall increase, depending on the nature of

the counter-party and goods contemplated by the transaction, the credit strength of

the transaction through collateral or guarantee. It is also advisable to adopt credit risk

mitigation method, such as entering into a netting agreement with a counter-party, to

offset mutual credit risks.

Description:

1. The company shall establish a certain process to decide which transaction

requires credit enhancement on the counter-party's part. Meanwhile, it shall establish

consistent standards to evaluate the effect of credit risk mitigation on the credit risk

reduction.

2. The company shall establish appropriate monitoring and evaluation process for the

counter-partys credit conditions and value of collaterals, so as to fully disclose its

risk;

3. To the extent authorized by laws, the company shall confirm the enforceability of

the netting agreement, and shall enforce such agreement in accordance with the

existing process.

4. The effect of credit enhancement and credit risk mitigation on the companys credit

risk shall be taken into account during the aggregation of credit risks.

5. The company shall implement faithfully the rules governing credit check for clients

at account opening.

E. Quantitative Measurement of Credit Risk

It is advisable that an FCM aggregate credit exposure, probability of default, andrecovery rate of the counter-party to calculate the expected and unexpected credit

loss and to quantify credit risk.

Description:

1. The expected loss for credit risk is estimated from:

(1) Credit exposure;

(2) The probability of default of a counter-party; and

(3) Recovery rate of a counter-party.

2. Unexpected loss for credit risk is the possible maximum loss under a certain

possible condition (within the confidence level), as evaluated by the FCM itself.

3. It is necessary to take into account the effect of credit enhancement of such


13/30

8/20/2014


transaction, and the offsetting effect of net credit risk exposure for the estimation on

expected and unexpected losses for credit risk.

F. Credit Risk Exposure

An FCM shall measure the credit risk exposure of the positions held and the counter-

party, and shall compare the results with the risk limits of counter-parties on a regular

basis.

Description:

1. Credit exposure shall be measured, monitored on a daily basis, and shall be

compared with the limits of individual counter-parties. If the scale of the portfolio issmall and the volatility of the transaction is slight, the measurement and monitoring

may be made on a weekly basis.

2. If it is difficult to measure the credit exposure, the FCM shall adopt other

appropriate methods for risk control.

3. The measurement on the credit risk exposure to each business unit shall comply

with the principles of accuracy, integrity, and consistency.

G. Current and Potential Exposure

An FCMs measurement of the amount of credit risk exposure for the positions held

by it shall be made on the basis of credit equivalent amount, and shall reflect the

change of market conditions. As there are different methods for measuring credit risk

exposure for different products, the FCM shall use the appropriate method to measure

the amount, such as the credit exposure for certain financial products, including the

current risk exposure and potential risk exposure.

Description:

1. Current Exposure: The replacement cost for the transaction, i.e., the current

market value, represents the amount of loss to be suffered by a counter-party if it

defaults on such given day, which equals to the closing price of the day.

2. Potential Exposure: The estimated value for future replacement cost of the

transaction, which represents the amount of loss to be suffered by a counter-party if it

defaults during the trading period in the future.

H. Probability of Default by a Counter-party

It is advisable that an FCM adopt appropriate methods to evaluate the probability of

default by a counter-party.

Description:

1. The probability of default by a counter-party may derive from the relevant

information issued by an external rating institution approved by the competent

authority, or estimated by the FCM itself.

2. If the FCM estimates the probability of default of a counter-party on its own, it shall

have a complete procedure, and the result shall be validated to ensure the

effectiveness of the model.

3. To estimate the probability of default by customers in the brokerage business, it is

advisable that an FCM conduct the estimation pursuant to the following principles:(1) For an corporate account that has external credit rating, the probability of default

shall be estimated according to the external rating information.

(2) If the client, including corporate account and individual account, does not have

external credit rating the probability of default for customers with different credit risk

characteristics shall be estimated according to the characteristics of past default

cases.

I. Counter-partys Recovery Rate for Defaults

It is advisable that an FCM adopt appropriate methods to reasonably evaluate a

counter-partys recovery rate for defaults.

Description:


14/30

8/20/2014


1. Loss Given Default Rate means 1 - recovery rate, and the recovery rate is the

percentage of the recoverable amount (such as claimable amount or the current value

of recovered principal and interest upon default) to the credit exposure amount or

outstanding amount (such as amount extended or current value of the debt upon

default) when there is a default.

2. The recovery rate of a counter-party shall be evaluated by the FCM itself, or

provided by an appropriate external institution.

3. Liquidity Risk

A. Liquidity Risk Management PrinciplesAn FCM shall establish appropriate measures to control liquidity risk (including

market liquidity risk and funding liquidity risk), and shall implement such measures

faithfully.

Description:

1. An FCM shall consider concentration and market trading volume of its positions,

so as to proceed with the quantitative management and non-quantitative management

on liquidity risk.

2. An FCM shall take into consideration the amount and schedule of the fund required

by each department; in addition, contingency plan shall be proposed to meet the

needs of funding arising from irregular or urgent conditions.

B. Market Liquidity Risk Management

An FCM may include the market liquidity risk into market risk model, or evaluate and

monitor such risk independently.

Description:

1. Market liquidity risk may be put into consideration for VaR model in order to

accurately reflect the risk of settled position, and for the risk management personnel

or unit to monitor such risk.

2. Block trading may have significant impact on the market price, so the FCM shall

carefully manage market liquidity risk in connection with large exposures.

C. Funding Liquidity Risk Management

An FCM shall evaluate and monitor the requirement of short-term cash flow in each

type of currencies by different characteristic of business, and shall adopt funding

liquidity risk management standards for future funding requirement.

Description:

Not only domestic short-term funding allocation, but also oversea and cross-market

funding allocation shall be considered for funding liquidity.

D. Funding Management

It is advisable that an FCM establish a funding management department independent

from all business units and responsible for supervising net cash flow of each business

units.

1. The funding management department shall report any significant or irregular use of

cash to the risk management personnel or unit.2. The funding management department shall keep close contact with business units

and relevant departments, and shall communicate with the sett lement-related

departments for the funds used by any individual transaction.

E. Funding Strategies

An FCM shall establish various funding strategies against loss arising from liquidity,

or requirement for fund liquidity caused by incidents in the market.

Description:

1. The risk management personnel or unit shall understand through scenario analysis

the potential liquidity risk concerning the financial products possessed by the FCM ,

to further evaluate possible costs arising from fund raising in various circumstances.


15/30

8/20/2014


The risk management personnel or unit shall also establish emergent financing

policies and process for the FCM.

2. The FCM shall establish a proper structure for the management of funding liquidity

risk.

4. Operational Risk

A. Operational Risk Management Principles

An FCM shall, in addition to monitoring the risks pursuant to the operational

procedures and critical control points as required by its internal control systems,

establish and implement suitable monitoring and controlling mechanism againstoperational risks occurring in the course of business and trading process.

Description:

1. The management mechanism of operational risks as mentioned above shall include

at least the following:

(1) The trading department shall ensure that all transactions comply with the FCMs

policies. Critical control points such as the acquisition of information on the

authorization and support of transaction, counter-parties' experience, and preservation

of transaction records shall be regulated.

(2) Finance, settlement and other relevant departments shall adopt suitable

regulations governing critical control points such as evaluation, confirmation of price

information, compilation of income statements, handling and confirmation of

transactions, transaction and settlement operations, validation of accounts, and asset

control.

2. An FCM may adopt an appropriate quantitative risk management method to

effectively manage and control operational risks.

B. Authorization

An FCM shall establish clear authorization standards for different types of

transactions.

Description:

1. An FCM shall have a process for reviewing on a regular basis the appropriateness

of authorization so that relevant departments and persons clearly understand the

scope of authorization. There shall be appropriate handling measures in case of

violation of authorization process.

2. The authorization standards shall specify the authorized coverage and limits for

each type of transactions, and ensure that the trading personnel conduct transactions

within the authorized trading amount.

3. Before authorization, it is necessary to make sure that relevant personnel have

completely understood the FCMs risk management policies and guidelines, the

characteristics of the risk of specific products, and the operation control and process

for transaction.

C. Decision-making Support

Prior to t rading, the trading personnel shall acquire sufficient information from thecustomers and counter-parties, and other related and necessary information in order

to facilitate the FCMs pricing and trading decisions.

Description:

1. Before conducting a transaction, the trading personnel shall clearly understand the

counter-partys ability and needs, and understand their own duties and

responsibilities for the transaction. At the same time, the trading personnel shall also

obtain the counter-party's credit risk information and limits for trading reference.

2. Setting up an appropriate control procedure for a pricing model; an untested model

could expose an FCM to the risk of trading loss; therefore, the assumptions and

parameters of the pricing model shall be recorded clearly in the use and control


16/30

8/20/2014


procedure for the pricing model, and be reviewed and approved by the risk

management personnel or unit.

3. The personnel of the trading department shall understand the FCMs' risk

management and trading strategies.

D. Professional Knowledge and Experience of Trading Personnel and Counter-parties

Prior to conducting a transaction, trading personnel from an FCM shall possess to a

certain degree professional knowledge and experience, and take into consideration

the counter-party's professional knowledge and experiences

Description:1. The contractual s tipulations for some financial products, particularly derivatives, are

extremely complicated and highly technical. Trading personnel need to ensure both

their own and the counter-partys understanding of such products in order to avoid

possible huge losses (or trading disputes).

2. Relevant information regarding complex transactions of financial products shall be

obtained and preserved.

3. It will be helpful for improving a counter-party's understanding of the products by

sufficiently providing the counter-party with the sensitivity analysis of such transaction

in different market conditions.

E. Transact ion Records

An FCM shall establish a control system to ensure the completeness, accuracy, and

timeliness of the transaction records.

Description:

1. Trading personnel shall provide or preserve important transaction records to ensure

that the transactions have been accurately processed.

2. When a transaction has to be recorded in multiple information systems, these

systems shall be able to compare the transactions among themselves so as to

ensure information consistency, and the information shall be reviewed and confirmed

on a daily basis by the risk management personnel or unit, instead of the trading

department.

F. Valuation

An FCM shall re-evaluate the value of the positions by utilizing in a timely manner

reasonable fair price pursuant to the existing written documents or approved policies

and procedures.

Description:

1. An FCM shall establish appropriate policies and procedures for position valuation,

and review regularly their appropriateness. In addition, the FCM shall disclose the

valuation method and its reasoning, including whether the valuation is carried out

through mark-to-market or mark-to-model method.

2. An FCM shall adopt proper and consistent methods to valuate all positions.

3. An FCM shall adopt suitable valuation procedures for the products with extremely

low liquidity.4. The valuation time shall be consistent for all types of products.

G. Price Information Verification

Persons of the finance department and risk management related departments shall

acquire price information (including interest rates and exchange rates) from units

independent from the trading department so as to re-evaluate the FCMs positions. If

the evaluation is carried out with the internal evaluation model, the FCM shall

establish a reasonable and independent review procedure. There shall also be

appropriate control and authorization for any alteration of models.

Description:

1. It is advisable that the acquisition of price information not be carried out by the


17/30

8/20/2014


trading personnel so as to avoid any possible conflict of interests or price

manipulation.

2. An FCM shall fully understand the method for externally obtaining the price, and

establish operating procedures, which should preferably include the methods for

handling overestimate (underestimate) of price, unusual large trading volume, or other

irregular situations.

3. If it is not possible to obtain independent external prices, , the prices may be

calculated by estimation and model, but such model shall first be evaluated through

an independent review procedure for its suitability, and the FCM shall consider settingup a separate amount limit for these transactions.

H. Profit and Loss Report

An FCM shall compile profit and loss reports on investment portfolio on a daily basis

so that the management level may know the performance of business units.

Description:

1. The content of the profit and loss reports can be compiled and categorized by

business units, product types or geographic areas.

2. The finance or risk management department shall estimate on a regular basis the

capital demands and the costs, and compile relevant analysis reports.

I. Processing of Transactions

An FCM shall process all approved transactions in a timely manner, and preserve the

transaction records for the transactions conducted by the trading personnel so as to

control and manage the potential risks in a transaction process.

Description:

1. An appropriate transaction processing and control procedure shall be established

in order to control and manage the potential risks during the trading process.

2. The processing of transaction shall be completed immediately following the

execution of the trade, or at least within the same trading day, in order to ensure a

timely transaction record.

3. To ensure the integrity and accuracy of the transaction records (such as

independent transaction numbers, transaction details, counter-parties and transaction

time), t ransaction documents shall be preserved as required.

4. The verification procedure for transaction records shall be conducted by persons

who are independent of the business units, including validity check, supervision of

credit risks and market risk limits and the confirmation of the price information of off-

exchange trading, and other related matters.

5. Extra supervision and authorization shall be conducted for any alteration and

cancellation of transactions or any irregular transactions.

6. All doubtful or faulty accounts must be handled promptly; senior managers of

finance units shall review on a regular basis and analyze these unresolved

transactions.

J. Transact ion ConfirmationAfter a transaction is completed, confirmation of the transaction data between the

FCM and the counter-party shall be conducted by persons not from the trading

department.

Description:

1. The confirmation method for a transaction shall be decided based on the nature of

the transaction. The confirmation methods include written confirmation through

settlement institutions, settlement system, or directly with the counter-party. and

shall be independent from the trading personnel and cashier.

2. The sending and receiving, checking and verification of written transaction

confirmation shall be conducted by persons not from the trading department.


18/30

8/20/2014


3. Management reports shall include information of uncompleted transactions and

counter-parties with disputes.

K. Customer Margins Management

An FCM shall manage customer margins in accordance with rules governing

management of customer margins as issued by the competent authority, Taiwan

Futures Exchange, and the Chinese National Futures Association, and as in the

companys internal control system.

Description:

1. An FCM shall manage customer margins in accordance with rules governingmanagement of customer margins as issued by the competent authority, Taiwan

Futures Exchange, and the Chinese National Futures Association.

2. An FCM shall establish customer margins management procedures in order to

faithfully implement the management of customer credit risks.

3. An FCMs management of customer margins shall include real-time monitoring

during trading session and management after the trading session.

4. An FCM shall handle the receipt/disbursement of customer margins, management

of incoming/outgoing funds, and collection operations pursuant to the management

and operation procedures for customer margins.

L. Clearing and Settlement

An FCM shall authorize the personnel independent from the trading, trading procedure

and account-checking units to execute the clearing and settlements of cash and

securities.

Description:

1. To effectively control the settlement of cash or assets, the cross-checking of

settlement details shall be authorized to personnel with sufficient experience and

knowledge, and the authorized personnel shall be divided into at least two levels or

more, and the responsibilities for each level shall be clearly dist inguished.

2. To maintain the security of electronic payment system or manual invoicing system,

phone calls for all transactions instructing on settlements shall be recorded.

3. Operations of non-standard settlement transactions shall be appropriately

authorized and crosschecked.

4. Settlement operations for cash and securities shall be separated and appropriately

authorized.

M. Account Validation

An FCM shall have the accounts validated by an independent unit, or appropriately

conduct the monitoring of internal accounts upon the establishment of internal

positions.

Description:

1. To maintain the consistency among the internal system and database and the

records in external organizations, the FCM shall validate the account, and the

application system in the trading department and the back-office database shall beintegrated.

2. The scope of account validation shall include trading personnel, back office

settlements, and records of accounting system.

3. The cash and custodial positions (including positions and cash) shall be validated

by an independent unit to ensure the truthfulness of the records.

N. Asset Control

An FCM shall establish an asset control system to maintain the security of assets

(including those of the FCM and clients).

Description:

1. All securities and other assets, including collaterals, shall be kept in a safe place


19/30

8/20/2014


and under control.

2. The securities shall be counted and checked at least on a regular basis.

3. Control procedures shall be set up to maintain the security of clients' assets,

including the confirmation of clients' assets and separate management of clients

assets.

4. Each clients transactions shall be accurately settled and recorded in details, and

the account balance shall also be disclosed.

O. Quantitative Measurement of Operational Risks

An FCM shall recognize the importance of operational risks, and collect and compiledata related to operation risks so as to facilitate appropriate quantitative

measurement and management.

Description:

1. Operational risks includes the risk of internal personnel, procedures and

information system as well as risks of loss directly or indirectly caused by external

affairs. An FCM shall collect and compile the relevant data on a regular basis

(including time of occurrence, type of event, documentation and description of loss),

and conduct appropriate quantitative measurement and management.

2. To effectively control operational risks, an FCM may adopt appropriate approaches

or models to measure operational risks.

3. For relevant information on risk quantification, please refer to the reports as issued

by the Bank of International Sett lement (BIS).

5. Other Risks

A. Control of Other Risks

An FCM shall, in addition to controlling the market risk, credit risk, operational risk

and liquidity risk suffered during business operations, establish appropriate risk

control procedures for other risks (including legal risk, model risk, reputation risk and

strategy risk) based on the characteristics of different risks and their impact on the

company.

Description:

1. Legal risk means the potential loss as a result of failure to comply with relevant

laws and regulations, and a voidance of the contract caused by illegality of the

contract, overstepping powers, neglect of clauses or incompletion of standards.

2. Model risk means that an FCM, when engaging in futures trading, shall reinforce

the control of internal model risk. For example, the pricing of index options involves

factors such as weighted index, exercise price, volatility, interest rate level, and

duration of the agreement so an accurate pricing and calculation of risk analysis shall

be based on the accurate financial models and programming. Therefore, when

controlling model risk, an FCM shall ensure the accuracy of the model and

programming used.

3. Reputation risk means any negative matter related to the operation of the FCM,

regardless whether it is true, that might lead to reduction of client base, decrease inrevenue, or even possible lawsuit expenses, or other possible losses.

4. Strategy risk means the risk of potential real-time or future loss in revenue or

capital suffered by the FCM as a result of unwise business decisions, inappropriate

execution of the decisions, lack of appropriate responses to competitions in the same

industry or lack of appropriate responses to industry changes.

5. In addition to market risk, credit risk, operational risk, and liquidity risk, an FCM

during business operations is also faced with legal risk, model risk, reputation risk

and strategy risk. It is advisable that the FCM establish, based on the characteristics

of each type of risks and their impact on the company, appropriate risk management

procedures to control other risk.


20/30

8/20/2014


B. Legal Compliance

An FCM shall establish a department especially designated for legal compliance to

be in charge of the compliance with relevant laws and regulations governing the overall

financial affairs and operating activities of the FCM, and to evaluate and manage the

FCMs legal risk.

Description:

1. The control of legal risk shall be jointly discussed, researched and drafted by the

risk management personnel or unit and the legal compliance department.

2. An FCMs internal rules shall be adopted pursuant to the relevant regulations of thecompetent authority.

3. An FCM shall review the appropriateness of the internal rules and ensure that they

are forward-looking and flexible, so that they can respond to the impacts of the

addition (amendment) of laws on its business operations.

C. Review of the Legality of Contractual Documents

Before undertaking any business operation, an FCM shall confirm the rights and

responsibilities between and with its counter-parties, and shall review the legality of

the deal and availability of legal documents.

Description:

1. An FCM shall establish a set of complete procedures to govern the review process

prior to engaging in transactions with the counter-parties, so as to ensure the legality

of the transactions. The aforementioned counter-parties include: financial inst itutions,

custodian institutions, brokers, traders and clients.

2. An FCM shall formulate written documents required for different transactions and

ensure the integrity of the details of the transaction documents.

3. Prior to a transaction, a business unit shall acquire the legal authorization for such

transaction, and comply with relevant regulations. In addition , all relevant documents

during the transaction process shall be completely preserved for the required time

period.

4. Considering the variety of characteristics of derivative financial products, such as

the complexity in their trading, high financial leverage multiple, different lengths of

transaction periods, huge number of counter-parties and transfer of risks, an FCM

shall pay special attention to the feasibility of executing the contracts, and counter-

parties' ability of performing the contracts, and shall formulate a complete set of

review procedures for the adequacy and legality of the contracts of derivatives

financial products.

6. Risk Limits (Note 1) and Risk Aggregation

A. Market Risk Limits

An FCM shall set up and monitor market risk l imits for the company as a whole, for

each business unit and for each trader, based on the regulations of the competent

authority and the TAIFEX and the companys own needs, and implement the

principles for handling the situation where the risk limits are exceeded.Description:

1. Market risk limits shall be adopted based on their position limits, sensitivity limits

and stop-loss limits, as well as the VaR limits or stress testing limits.

2. The risk diversification effect of investment portfolios shall be taken into

consideration for allocating market risk limits.

B. Credit Risk Limits

An FCM shall set up and monitor the credit risk limits of each counter-party based on

the regulations as issued by the competent authority, the TAIFEX and the Chinese

National Futures Association as well as the companys needs, and implement the

principles for handling the situation where the risk limits are exceeded.


21/30

8/20/2014


Description:

1. To establish credit risk limits, the following factors shall be taken into

consideration:

(1) The FCM shall set up credit risk limits for each counter-party or client.

(2) Before conducting the transaction, a trader shall check the limits to verify the

validity of credit risk limits.

(3) After the transaction, the FCM shall review on a regular basis the changes of the

counter-partys credits and conduct proper handling.

2. The risk management personnel or unit shall review and subsequently monitor thecounter-party' credit based on the approved procedures, and evaluate whether the

credit risk is too concentrated in the following categories:

(1) The counter-party, including its affiliates.

(2) Enterprises with the same credit rating.

(3) Type of Industries.

(4) Origin of Country

3. An FCM shall measure credit risk through quantification model or method, and

design accordingly the risk limits for each counter-party and each business type.

C. Limit Review Procedure

When changes are made to the government's regulations, the FCMs policies, market

conditions or trading strategies, the FCM shall re-review its rules for risk limits.

Description:

1. An FCM shall review risk limits on a regular basis to reflect in a timely manner the

changes of external environment and internal business decisions.

2. An FCM shall set up different limits for each trader, and the head of the FCMs

business unit will review the limits on a regular basis.

D. Evaluation & Authorization for Product Limits

Before undertaking or developing new products, an FCM shall establish a formal

review procedure and a business operation plan for assessing the feasibility of such

undertaking or development, and shall evaluate the impact on the current limits for

existed products, so as to allocate appropriate risk limits.

Description:

1. An FCM shall, during the development of new products, confirm that the difference

between the new products and the existing product has been appropriately evaluated

and authorized. The FCM shall also take into consideration the changes of business

nature, structural difference, risk level, laws and regulations pursuant to operational

procedures.

2. For the approval procedure, the undertaking by an FCM of new products shall be

reviewed and signed by relevant departments (such as risk management, audit,

information, finance, and legal units), and then approved by the board of directors, or

the high-level management as authorized by the board of directors.

3. The content of the new product plan submitted for the review procedure shallinclude in details the reasons for the design of the new products, current regulations

governing documents modification, assessment procedures, potential trading counter-

parties, appropriate monitoring system and operation procedures, information system

operation and risk analysis methods.

4. The key contents of the business operation plan for new products shall include:

description of product type and business objectives, application for approval of

authorized limits, implementation procedures for risk measurement and risk control,

internal control and internal audit systems, operation procedures, accounting,

taxation, analysis of relevant regulations, and operations of information system.

5. For trading of new products, it is necessary to obtain approval for risk limits, and,


22/30

8/20/2014


in addition, the impact of such risk limits on the overall risk limits shall also be taken

into account.

6. The undertaking and development of the aforementioned new products shall be

approved by the competent authority pursuant to the Futures Trading Act.

E. Risk Aggregation

An FCM shall calculate and aggregate the companys overall risks and the risk of

each business unit, including market risk, credit risk and other quantifiable risks, and

compare them with authorized limits. It is advisable to take into account the

correlation between different risks in the process of risk aggregation.Description:

1. Daily aggregation of changes of the FCMs overall risks and any instance where

limits are exceeded shall be carried out, including:

(1) Exposure to market risk for every business unit and every financial instrument.

(2) Major exposure of credit risk.

(3) Concentration of credit risk.

2. The risk management personnel or unit shall aggregate and monitor on a daily

basis the different types of risks according to the existing procedures, and compare

them with risk limits, so as to understand the risk control conditions and response

measures of each business unit, and shall prepare on a regular basis the risk

management reports for the examination of the RMC or the board of directors.

5 Risk-Based Performance Management

1. Performance Measurement

A. Consistent Measurement Basis

An FCM shall measure the performance of each unit or business operation pursuant

to the principles of consistency; it is advisable to take into consideration the risks of

different business operations in the process of measurement, and such risks shall

serve as the basis for capital allocation.

Description:

1. Common quantitative indicators for performance include: profit and loss, and return

on shareholders equity. It is advisable for the company to consider the degree of

risks for different business operation pursuant to the risk management policy and the

performance target so as to effectively measure the performance of different business

units.

2. It is advisable to take into account the results of the risk-adjusted performancemeasurement in the decision-making for compensation schema, investment

opportunities assessment, product pricing, profit analysis, investment portfolio

management, risk limits and capital management in order to implement the risk-

adjusted performance management and to ensure the consistency between the

overall risk management policy and the business activities.

B. Quantitative and Qualitat ive Evaluation

It is advisable that both the quantitative and qualitative indicators be considered for

the measurement by an FCM of the performance of each unit.

Description:

1. Quantitative indicators for performance include: risk-adjusted performance


23/30

8/20/2014


measurement (RAPM) or return on shareholders equity; however,it is advisable to

select only one indicator for the comparison of the performance of each business unit.

2. Qualitative indicators for performance include:

(1) Business strategies of business units.

(2) Relationships with clients, other FCMs, and the society.

(3) The FCMs risk preference.

(4) Competitive position on the market.

C. Risk-adjusted Performance Measurement

It is advisable that an FCM should use risk-adjusted performance measurement toevaluate the performance of each business unit or each trader.

Description:

1. For the measurement of the performance of each department, business unit or

trading personnel, it is advisable to adopt a risk-adjusted performance measurement

indicator that takes into account both compensations and risks, such as risk-

adjusted return on risk-adjusted capital, (RARORAC, as shown in the figure below) or

other applicable indicators.

2. The risk-adjusted performance measurement can be used to assist the FCM to

effectively allocate the risk-adjusted capital of each unit, and to maximize profits

within the appropriate risk tolerance.

Figure. 2Risk-adjusted Return and Risk-adjusted Capital

Notes 1. Direct and indirect revenues shall mean the actual revenues from external

sources, and also include revenues from transfer of income between internal

departments and the imputed income of risk-adjusted capital benefit.

Note 2. Direct and indirect expenses shall mean the actual costs and expenses and

also include the costs and expenses for the transfer in internal operations, and the

costs for the transfer of internal capital.

D. Performance Target

It is advisable that an FCM set up an appropriate performance target for each

business unit.

Description:

1. It is advisable to take into account the risk limits or various risk parameters as

approved by the board of directors or the RMC prior to the establishment and

assessment of performance targets.

2. Each business unit shall establish a different performance target to be included in

the budget control. The following factors shall be taken into account for establishing

such target:

(1) Historic performances of each business unit.

(2) Whether a business unit undertakes new products or new business activities. (3)

The FCMs overall marketing or sales strategies.3. It is advisable to take into account the degree of risk assumption for the business

units performance targets or the trading personnels compensation scheme.

4. Performance targets can also serve as a reference for product pricing.

E. Assessment of Investment Opportunity

It is advisable that an FCM adopt the risk-adjusted performance measurement as the

assessment tool for future investment opportunities.

Description:

It is advisable that an FCMassess all risks and costs related to a new business or a

new product, measure the risk-adjusted return, compare it with the current target

benchmark, and use the result as a reference for investment decisions.


24/30

8/20/2014


2. Revenue & Cost Allocation

A. Revenue Recognition Policy

An FCM shall establish a revenue recognition policy to effectively reflect the actual

condition of business operation, and to comply with the current general accepted

accounting principles, so as to assist the board of directors and the RMC in obtaining

sufficient information for the management of risks.

Description:

1. The profit and loss for the FCM own positions shall be recognized with marked-to-

market method on a daily basis.2. The FCM shall establish a revenue recognition policy in order to govern the timing

and amount for revenue recognition as well as the strategies for the allocation of

revenue among business units.

3. In response to the situation where the profit and loss for the positions are

recognized with marked-to-market method on a daily basis, the FCM shall consider

the provisions of expected credit loss, liquidity risk and operational risk when

conducting the measurement of risk-adjusted performance.

4. Each of the business units within the FCM shall adopt consistent valuation method

for similar products and similar transactions.

B. Cost Allocation

An FCM shall allocate direct and indirect costs to each business unit to serve as the

indicators for measuring the contributions of each business unit.

Description:

1. It is advisable to take into account the following principles so as to ensure the

fairness of the cost allocation:

(1) All direct costs shall be attributed to each business unit.

(2) The method used to allocate costs to each unit shall be consistent.

(3) The costs of supporting departments shall be allocated based on the predefined

costs of the services provided.

(4) The indirect costs of administrative departments shall be reasonably allocated to

each business unit, or be taken into account during the establishment of the risk-

adjusted benefit target of each business unit.

2. The cost allocation policy should also provide for appropriate handling of services

that are not negotiated in advance.

C. Funding Cost & Transfer Pricing

Each business units of an FCM shall assess its profit conditions based on transfer

prices through a consistent and objective method.

Description:

1. The finance department shall set up the price for the funds provided to each

business unit based on the transfer pricing method. Trading of financial instruments

between business units shall also be priced through the transfer pricing method.

2. It is advisable to take into account the following principles for the application oftransfer pricing:

(1) Transfer pricing can be applied to the transactions of all assets, liabilities, equities

and off-balance sheet items between different business units.

(2) Marginal costs shall be taken into account for the establishment of transfer

pricing.

(3) In case when there is no reasonable price of any internal transactions for

reference, an FCM shall establish the transfer pricing with mark-up marginal costs.

(4) The transfer pricing method shall be fair and assist the FCM in improving its

business standard. The pricing mechanism shall be as simple as possible.

3. Regulations on Capital and Other Relevant Issues


25/30

8/20/2014


A. Regulations on Capital

An FCM shall maintain a continuous, correct adjusted net capital that meets the

requirements of the competent authority.

Description

1. An FCM shall complete the calculation of adjusted net capital within the required

deadline and preserve the records for relevant calculations.

2. The risk management personnel or unit shall be familiar with the FCMs trading

strategies and their effects on the adjusted net capital.

3. An FCM shall establish an internal control system for the review of adjusted netcapital pursuant to the regulations by the competent authority.

B. Compensation Policies

An FCM shall ensure that its compensation policy corresponds with its corporate

culture, long-term operational goals and strategies, and control environment

Description

1. An FCM needs to offer sufficient incentives to ensure the appropriate proficiency

and experience of the hired risk management personnel. For the design of

compensation system, it is also necessary to take into account the independency of

the risk management personnel in carrying out business operations.

2. The performance evaluation and remuneration standards of managerial officers and

associated persons and the remuneration structure and system of the directors in an

FCM shall be adopted in accordance with the following principles:

(1) The FCM shall adopt the performance evaluation and remuneration standards or

remuneration structure and system based on future risk-adjusted performance and in

line with the company's long-term overall profitability and shareholders interests.

(2) The remuneration and reward system shall not entice any director, supervisor,

managerial officer, or associated person to engage in any act exceeding the

companys risk appetite in pursuit of remuneration. The FCM also shall regularly

review the remuneration and reward system and performance in order to ensure their

consistency with the companys risk appetite.

(3) The time for payment of remuneration by the FCM shall be set based on future

risk-adjusted profitability in order to avoid the inappropriate circumstance of sustaining

loss after the payment of remuneration. A significant percentage of the

remuneration/reward shall be paid by a deferred method or an equity-related method.

(4) When an FCM assesses the individual contribution of a director, supervisor,

managerial officer, or associated person to the companys profits, it shall conduct an

overall analysis of the futures industry to clarify whether such profits resulted from an

overall advantage such as the use of the lower capital cost of the company, in order

to effectively assess the contributions that come from individual persons.

(5) The stipulations on severance pay between the FCM and its directors,

supervisors, managerial officers, and associated persons shall be adopted based on

realized performance, in order to avoid improper circumstances such as receiving highseverance pay after a short term of employment.

(6) The FCM shall fully disclose to shareholders the adopted principles, methods, and

goals of the aforementioned performance evaluation and remuneration standards or

structure and system.

The associated persons governed by these Principles are those persons whose

remuneration or performance evaluation is based on the sale of various financial

products or services.

C. Internal Audit

The internal audit unit of an FCM shall review the implementation of the FCMs risk

management system and, truthfully disclose the findings in the audit report. Any


26/30

8/20/2014


deficiency or irregularity found in the review shall be tracked after such audit report is

submitted for approval, and a follow-up report shall be made on a regular basis, so as

to ensure that the relevant units have taken appropriate improvement measures in a

timely manner.

D. Taxation

An FCM shall review taxation issues on a regular basis in order to avoid such major

loss as caused by any taxation issues.

E. Soundness of Business Operations

An FCM shall establish a crisis management plan so as to ensure the continuity ofbusiness operations in the event of a major crisis .

Description

1. The plan shall clearly define and allocate responsibilities and accountability, and

provides appropriate authorization.

2. The plan shall include system backup and restoration, the procedures for quick

establishment and sell-off of current posit ions, and the procedures for settlement

default and temporary cash management requirement.

3. The FCM shall appoint a senior manager as the representative to deal with overall

crisis.

F. Risk Management of Affiliates

It is advisable that an FCM take into account its affiliates for risk management

operations, and establish overall risk management policies for the group.

Description:

1. An FCM shall establish an appropriate overall risk management mechanism based

on its ability to control affiliates.

2. If an FCM has the controlling ability or significant influence over its affiliates, it is

advisable to adjust the goal of risk management policies for the affiliates, when

necessary, to make them consistent with the goal of the FCMs overall risk

management policies. The risk profiles of individual affiliates shall be disclosed

separately so as to understand its impact on the risks of the entire group.

3. The results of the risk assessment by the FCM shall be reported to the parent

company in order to assess and aggregate the groups overall risks.

6 Risk Management Information System

Figure 3: Structure Chart of the Risk Management Information System

1. General Principles

A. Structure of the Risk Management Information System

It is advisable that an FCM establish a risk management information system. The

structure of the risk management information system includes three important

dimensions - application, data, and technology.

Description:

1. The application structure provides the FCM with functions related to the risk

management information system as required

2. The data structure defines the data and access interface required by the

application system, for which the establishment of database and the integrity of the

data shall be taken into account.

3. The technical structure defines the software and hardware environment where the

system operates. The system security shall be ensured during the establishment of

the information system.


27/30

8/20/2014


2. Functions of the Risk Management Information System

A. Definition of the Functions in the Risk Management Information System

It is necessary to take into account the possible demands of each level in the FCM

for risk management functions for the time being and in the future for the design of the

application structure for the FCMs risk management information system.

Description:

1. The functions of the application structure should preferably include: market and

credit risks management, capital allocation, assets and liabilities management,

performance assessment, and relevant management reports.2. Users shall participate in the function design and system testing for the risk

management information system, to ensure that the requirements for the risk

management are met.

3. In addition to the definition of system functions, it is also necessary to confirm the

feasibility of the solutions to the problems as adopted by the risk management

information system during establishment of the system.

B. Function Distribution

The risk management information system adopted by an FCM shall, based on the

internal control levels, clearly govern and allocate the types and levels for the

centralized risk control, and the decentralized risk control in individual business units.

Description:

1. It is advisable that the risk management information system match with the FCMs

organizational structure and control method for risk control management.

2. Risk management information system shall adopt a centralized information

management method (distr