Circular to licensed corporations on liquidity risk management

18 Dec 2017

The purpose of this circular is to provide additional guidance to licensed corporations (“LCs”) on establishing and maintaining prudential risk management practices for client money, liquidity and the concentration risks of funding sources within group-affiliated entities.

Hong Kong is an international financial center and Asia trading hub, and as such the securities market is vulnerable to large fluctuations in global market conditions. A sharp swing in market sentiment may cause a widespread liquidity crunch. To ensure financial stability, preventive measures should be implemented to address these risks as far as possible.

The Securities and Futures Commission (“SFC”) remains focused on whether LCs have rigorously evaluated their liquidity needs and developed contingency plans to weather market-wide or idiosyncratic stress. LCs are expected to proactively manage liquidity risks, including concentration limits for counterparties[1]. In addition, General Principle 8 and paragraph 11 of the Code of Conduct[2] require LCs to ensure that client assets are adequately safeguarded. Additional risk management should be considered with respect to the deposit locations of client money and sources of funding.

To better safeguard client assets, many regulators globally have tightened the requirements for client money protection. For example, some regulators require financial institutions to report the amount of client money deposited with different entities, and some require that the amount of client money deposited with an individual financial institution be less than a certain portion of total client money or that cash deposits held with any particular bank be limited to the net capital value of the firm’s normal day-to-day operating balances.

Results of fact-finding exercise

The SFC recently conducted a fact-finding exercise[3] on selected LCs with group-affiliated entities. Two major risk areas were: (i) protection of client money kept with affiliated banks, and (ii) reliance on funding from affiliated group entities.

This circular sets out the SFC’s regulatory concerns and the measures it expects of LCs. Examples of good practices are provided.

1.  Safeguard client money

LCs should keep client money in segregated accounts at all times. However, client money maintained at the LC’s affiliated financial institutions (“FIs”) may be subject to the discretion of the affiliated banking group when any one or more of the connected FIs encounter financial difficulties. Placing and segregating client money with non-affiliated FIs would better safeguard client money.   

In the fact-finding exercise, we noted cases where LCs predominantly deposited client money at affiliated FIs in Hong Kong.

To ensure client assets are adequately safeguarded, the SFC would like to remind LCs to establish, maintain and adhere to prudential risk management practices to safeguard client money, and in particular to set and enforce concentration limits for affiliated FIs.  

LCs should safeguard client money by:

Examples of good practice:

    • Deposit more than 50% of client money in non-affiliated FIs in Hong Kong.

    • Regularly review and diversify client money into FIs affiliated with different banking groups to reduce concentration risk.

    • Deposit client money with FIs or their affiliates which are in good financial standing and promptly respond to any change in market conditions.

    • Formulate a risk assessment framework and stress testing policy to regularly assess overall risks including the credit ratings of the FIs and their affiliates where client money is deposited.

To fulfill the expectations in this guidance, LCs may consider similar practices to ensure sufficient diversification of client money for liquidity risk management.

2.  Funding sources

Abrupt changes in market conditions may trigger a crisis which quickly soaks up liquidity and these conditions may last for an extended period of time. An LC would be adversely affected when it relies on a single or limited funding source.

Our fact-finding exercise found that although many of the LCs had at least one credit facility with multiple FIs, some LCs might obtain funding solely or predominantly from group-affiliated entities.

To properly manage the risks associated with the LCs’ businesses[4] and to ensure the contingent funds available to LCs are adequate to address liquidity shortfalls in a volatile market situation, LCs should not rely on a single source of funding from within their group. LCs should formulate a diversification strategy which provides for more than one source of funding, conduct regular reviews of existing funding sources including external sources and intragroup support and, where appropriate, obtain additional sources of contingent liquidity from non-affiliated FIs.

Examples of good practice:

    • Obtain multiple credit facilities from non-affiliated FIs to limit reliance on the parent group.

    • Secure committed lines of credit from more than one banking group to ensure the availability of stable contingency funds under adverse situations.

    • Review the reliability of existing funding sources and arrange credit lines with multiple sources to avoid the idiosyncratic risk of relying on a single source.

    • Regularly review independent funding available from non-affiliated FIs and formulate a liquidity contingency plan in the event of a credit rating downgrade or a material adverse event affecting the liquidity of the parent or an affiliate.

LCs may consider similar approaches to ensure independent funding sources are available to enhance liquidity under various market conditions.

Should you wish to clarify any aspects of this circular or in case of doubt, please contact the relevant case officers in charge.

Intermediaries Supervision Department
Intermediaries Division
Securities and Futures Commission



[1] Paragraphs 32-34 in the Appendix of the Management, Supervision and Internal Control Guidelines For Persons Licensed by or Registered with the Securities and Futures Commission.
[2] Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.
[3] The exercise was conducted on selected LCs with affiliated entities within a banking group to collect information about the deposit locations of client money and the availability of independent funding sources.
[4] Paragraph 14.1 of the Code of Conduct.

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Page last updated : 18 Dec 2017