Outline of Proposed Regulation of Share Margin Financing



In the last few years, there was a marked increase in retail participation in the market and a substantial rise in margin trading through largely unregulated finance companies. Many of these companies failed to undertake prudent risk management measures, leading to over-lending to margin clients and other non-securities related borrowers and over-exposure to specific stock collateral and individual borrowers.

Following the recommendation of the Securities and Futures Commission ("SFC"), an inter-agency working group ("Working Group") comprising representatives of the Financial Services Bureau ("FSB"), the Hong Kong Monetary Authority ("HKMA"), the SFC, the Stock Exchange of Hong Kong ("SEHK"), the Companies Registry and the Department of Justice was established in December 1997 to review the issue of regulating the share margin financing activities carried out by finance companies associated with securities dealers.

The Working Group considers that the current regulation over share margin financing activities insufficient and believes that there is an urgent need to bring them under the regulatory supervision by the SFC.

To this end, the FSB has issued a Consultation Paper outlining various proposals for the regulation of share margin financing activities. The FSB invites comments from the public on the draft proposals by 8 July 1998.

This booklet provides a simplified outline of the proposals and should therefore not be exclusively relied upon when considering the proposed regulatory framework. Persons interested in more detail should refer to the Consultation Paper.

Who will be affected?

Persons who provide share margin financing loans, generally those who are licensed under the Money Lenders Ordinance (Cap.163) or existing licensed securities dealers under the Securities Ordinance (Cap.333) would be brought within the purview of the proposed regulatory regime.

All authorised institutions licensed under the Banking Ordinance (Cap.155) except existing securities dealers licensed by the SFC would however be exempted .

What are the Proposals?

The Proposed changes in Financial Resources Rules ( " FRR " )

The changes outlined below have taken into account proposed amendments to the existing FRR as suggested in the SFC ' s March 1997 consultation paper on the review of the FRR.

Minimum paid-up capital

5% liabilities test

Margin loans receivable

[Haircut deduction]

It is proposed to apply a higher haircut of 25% to illiquid stocks which will be defined as shares not eligible for a derivative warrant issue.

The proposed haircuts for shares listed on the SEHK are as follows:

Haircut deduction

a) constituent stocks of the HSI10
b) other stocks listed on the SEHK which are eligible for a derivative warrant issue or HSI 10015
c) all other stocks listed on the SEHK25

[Concentrated risk adjustment]

It is proposed to apply concentrated risk adjustments to margin clients ' collateral stocks and margin loans as follows:

a) any excess of the value of any individual stock (or stocks of related companies) over 10% of the total value of stock collateral should be added to ranking liabilities; and

b) any excess of a single margin client receivable over 10% of total margin client receivables should be added to ranking liabilities.

Trade date or settlement date accounting

Reporting requirements

a) aggregate amounts drawn on bank loans, advances, etc. exceed total facility limits;

b) any concentration in exposures which attracts the concentrated risk adjustments as proposed above;

c) a Dealer has been unable to meet calls from a lender for three consecutive days or where a lender has exercised its right to liquidate stock collateral for reducing the outstanding loan;

d) aggregate margin shortfalls exceed shareholders ' funds.

Developing a Code of Business Standards

Given the importance of proper risk management control and investor protection, it is proposed that the Code of Conduct and the Management, Supervision and Internal Control Guidelines issued by the SFC and the Rules of the SEHK be revised to cover the following:

Fit and Proper Criteria

All applicants for a dealer ' s licence would, as at present, be subject to a Fit and Proper Test. Factors to be considered by the SFC in the Fit and Proper Test are:

Statutory requirements for a Dealer would include, inter alia, a sole business requirement which would confine it to share margin financing operation insofar as its money lending business is concerned, and securities dealing only.

Questions and Answers

1. How does share margin financing normally work in Hong Kong?

In Hong Kong, while some securities dealers do provide share margin financing for their clients without relying on external funding from unrelated institutions, the majority finance their margin loans out of a combination of facilities made available by third party banks, inter-group loans and credit balances maintained by margin clients. The facilities from those banks are themselves secured by the pooled stock of many clients. In many cases, it is conducted through the largely unregulated finance companies which, though usually associated with stockbrokers, are independent finance companies licensed under the Money Lenders Ordinance (Cap 163).

2. Will pooling of assets by margin finance companies still be permitted under the proposed regulations?

The Working Group believes that pooling of stock collateral may continue to be permitted provided that clients are fully informed of the risks involved which would be ensured by the disclosure requirements under the proposed regulatory regime.

3. The proposal envisages expanding the ambit of the Securities Ordinance by modifying the definition of "dealer" and "dealing in securities". Does this mean that share margin financing activities will be confined to SEHK members only?

The Working Group has recommended that share margin financing activities should continue to be allowed to be provided by member and non-member entities insofar as they are fit and proper to be registered with the SFC.

4. When will the Code of Business Standards come into effect?

It is intended that they would be introduced in tandem with the other new regulations under the proposed regulatory framework.

5. Would the SFC ' s Financial Resources Rules, especially those pertaining to margin financing, be revised?

Yes. The Working Group has proposed to impose, inter alia, a minimum paid-up capital requirement of HK$10 million on a Dealer providing margin financing and to introduce a 25% haircut deduction to less liquid stocks listed on the SEHK and a new concentrated risk adjustment on exposures to individual accounts or specific stock. The Working Group has taken into account proposed amendments to the existing FRR as suggested in SFC ' s March 1997 consultation paper on the review of the FRR. It has recommended to retain the 5% total liabilities test but to allow collection of collateral from margin clients on settlement day.

6. Why is it proposed that margin finance companies be regulated by the SFC, and not the HKMA or some other body?

Given the existing strong links between the finance companies and the associated brokers, that the customers of the former are also the customers of their associated brokers whom the SFC regulates and that the HKMA ' s supervisory framework is designed for depositor protection rather than investor protection, the Working Group considers it appropriate for the SFC to be the supervisory authority for these share margin financing companies.



Page last updated : 1 Aug 2012