Circular to Licensed Corporations providing securities margin financing

Call for prudent risk management

10 Oct 2017

In view of recent volatility in small cap stocks, the Securities and Futures Commission (SFC) is increasingly concerned that licensed corporations have failed to put in place appropriate risk management policies and internal controls for securities margin financing, creating undue risks and in some cases resulting in financial losses.

In particular, some licensed corporations were found to have excessive exposure to securities collateral which was highly concentrated, correlated (e.g. stocks with significant cross shareholdings), volatile or illiquid (i.e. holding a large portion of a stock in terms of its turnover or market capitalisation, making it difficult to liquidate).

Code of Conduct requirements

The Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) requires that a licensed corporation establishes a clear margin lending policy to provide a basis for protecting its capital and ensure that a consistent risk management policy and adequate procedures are in place to identify risks, carry out effective monitoring and take corrective action.

Licensed corporations are expected to, among other things:

The SFC has noticed that some firms have fallen short of the standards expected of them under the Code of Conduct. The SFC has informed these firms of its concerns and requested that they take immediate rectification measures to comply with the relevant regulatory requirements. In response, the firms agreed to improve their internal control systems and commission independent reviews of their margin lending policies and procedures. They have also undertaken to put in place appropriate interim measures (such as to stop providing new credit to clients and refrain from repledging client securities collateral) in advance of adopting appropriate controls.

Other regulatory requirements

Licensed corporations are required to comply with all regulatory requirements applicable to securities margin financing. In more serious cases, even in the absence of an immediate breach of the minimum capital requirements, the SFC may take regulatory action against licensed corporations for failing to comply with any of these requirements.

The comprehensive regulatory framework for securities margin financing is mainly made up of:

Prepare for the unexpected

Market conditions may reverse and share prices may plunge abruptly. In the past, a number of securities margin financing providers suffered significant financial losses and in some cases encountered financial difficulties due to unforeseeable market shocks, share price volatility, trading suspensions or client defaults. Licensed corporations should vigilantly identify, monitor and manage the potential risks of their margin lending business. They should also adopt a prudent margin lending and risk management policy which includes pre-emptive measures to protect their capital from different types of risk, for example by performing regular stress tests and avoiding over-concentration in specific stocks being used as collateral.

Senior management’s responsibility

The SFC also reminds senior management of licensed corporations that they bear the primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures by their firms. They should diligently supervise their margin lending business by instituting and enforcing prudent policies and rigorous controls to safeguard their business operations and clients’ interests.

Should you have any queries regarding the contents of this circular, please contact Ms Perla Yau on 2231 2115.

Intermediaries Supervision Department
Intermediaries Division
Securities and Futures Commission



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Page last updated : 10 Oct 2017