Introduction

The Securities and Futures Commission (the “SFC”) conducted a review of securities margin financing (“SMF”) activities in 2017, which comprised a macro analysis of trends in SMF activities and an in-depth study of the risk profiles and margin lending practices of the 20 largest SMF brokers. It revealed that a number of SMP brokers pursued aggressive margin lending practices which give rise to concerns that they are exposed to unacceptable financial and concentration risks.

On 17 August 2018, the SFC issued the Consultation Paper on the Proposed Guidelines for Securities Margin Financing Activities (the “Consultation”) and invited comments on the draft set of guidelines for SMF activities (the “Proposed Guidelines”) which the SFC proposes to issue to supplement the existing conduct requirements.

The existing conduct requirements

The existing conduct requirements for SMF activities are mainly high level principles-based guidelines on brokers’ margin lending policy under the code of conduct and related paragraphs of the internal risk controls.[1] Since these conduct requirements are high level or principles-based, brokers apply their own interpretations and some fail to consider the regulatory standards in designing their risk controls.

The Proposed Guidelines

The Proposed Guidelines provide qualitative guidance and, where appropriate, quantitative benchmarks on seven key risk control areas, to supplement the existing requirements.

• Total margin loans controls

SMF brokers shall establish a total margin loans limit taking into consideration all relevant factors including, amongst others, its liquidity profile and capital, the risk profiles of margin clients and prevailing market conditions. Further, the SFC proposes SMF brokers to set a quantitative benchmark “total margin loans-to-capital multiple” to gauge whether their total margin loans are excessive relative to their capital. The outstanding approved subordinated loans are allowed to be treated as “capital”.

• Margin client credit limit controls

SMF brokers should be prudent in setting the credit limits for individual margin clients or groups of related margin clients to ensure that margin clients have the financial capability to meet the obligations arising from the financing provided. The credit risks of related margin clients should be aggregated for the purposes of setting credit limits and monitoring their interconnectedness and aggregate risks. Besides, the SMF brokers should ensure strict enforcement of client credit limits and any waivers must be justified.

• Securities collateral concentration controls

SMF brokers should set prudent securities collateral concentration limits in light of their own circumstances by taking into consideration of a non-exhaustive list of factors. For higher-quality securities, more lenient benchmarks are allowed. Further, SMF brokers should perform an impact analysis on its excess liquid capital (“ELC”) and compare the ELC impact with the benchmarks so as to test the effectiveness of its concentration limits. The ELC impact analysis should be performed on a monthly basis or a more frequent basis if the concentration risk increases greatly during the month.

• Margin client concentration controls

SMF brokers should set prudent client concentration limits with reference to a number of factors such as their liquidity profiles and capital and their clients’ financial situations. It is also proposed that the aggregate margin loans advanced to any individual margin client or a group of related margin clients should not exceed a prescribed percentage of the broker’s shareholders’ funds. Under the Proposed Guidelines, an SMF broker would be required to estimate the ELC impact before granting a significant margin loan. A margin loan would be classified as significant if it is greater than 10% of the broker’s shareholders’ funds.

• Haircuts for securities collateral

SMF brokers should maintain a list of securities accepted for margin financing, document the basis and factors to be considered in setting haircut percentages for the margin lending policy, review the haircut percentages at least annually, strictly apply the haircut percentages, and document the risk assessment and risk mitigation measures to be adopted. For re-pledging brokers, the haircut percentage for collateral deposited by margin clients should not be lower than the average of the haircut percentages assigned by its top three lending banks to the same collateral minus a prescribed percentage point [X%] and in any event, not lower than the corresponding haircut percentage prescribed in the FRR.[2]

• Margin calls, stopping further advances and forced liquidation

Subject to the overarching principle of prudence, SMF brokers should tailor-make their policies and procedures according to their business needs. In general, SMF brokers should initiate a margin call when a margin loan exceeds the margin value of the underlying collateral or the client’s credit limit. They should stop granting waivers of margin calls to margin clients with poor settlement histories or whose outstanding margin loans exceeded the market value of the underlying collateral.

• Stress testing

SMF brokers shall regularly conduct stress tests on their ELC and liquidity (at least on a monthly basis) and whenever any material adverse event happens so as to quantify the impact of stress situations. They may apply their own stress testing models and stress scenarios provided that they are no less prudent than those suggested in the Proposed Guidelines.

Notification requirement

SMF brokers should observe the guidelines in designing their margin policies and managing SMF risks. Any deviation from the guidelines must be properly justified by equivalent or compensating controls which are no less prudent than those set out in the guidelines.

SMF brokers should report to the SFC immediately if it fails to comply with the quantitative benchmarks or pass the stress test on its ELC or liquidity performed so as to enable the SFC to follow-up with it on any risk issue underlying the non-compliance.

Conclusion

The Consultation will close on 18 October 2018. It remains to be seen how the public and the industry will respond to the Proposed Guidelines.

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: regcom@onc.hk

T: (852) 2810 1212

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.