Securities Margin Financing providers should refrain from adopting a mechanical monitoring practice because a fixed loan-to-collateral ratio may not enable the Securities Margin Financing provider to identify all key risk factors for follow-up actions, such as where the liquidity of securities collateral has dropped even though the price of securities remains unchanged.

When determining the triggering level for making margin calls, Securities Margin Financing providers should take into consideration all relevant factors, including the quality, volatility and liquidity of the securities collateral provided by the client, prevailing market conditions and the client’s credit worthiness etc.

To ensure that the case history of margin calls for each individual client can be readily established, information including the initiation of each margin call, details of the calls made on the client and responses received, and follow-up actions taken (such as forced liquidation of collateral) should be documented.

Executing further purchase orders for a client who has failed to meet a margin call may not be consistent with prudent risk management practices. A Securities Margin Financing provider’s margin lending policy should set out clearly when it should stop providing further advances to a client when he has failed to meet a margin call. Any permission to effect further purchases for such a client should be supported by a sound justification and approved by senior management in writing.

The margin lending policy should set out clearly the circumstances in which deviations from the policy may be allowed, with clear limits set for each level of management approval and guidance on practical considerations, for example, the Securities Margin Financing provider should, before granting such approval -

• diligently conduct appropriate assessment of the client’s creditworthiness; and
• prudently assess the quality, liquidity and volatility of the securities collateral provided by the client, with due regard to the prevailing market conditions.

Deviations from the margin lending policy should be supported by a sound justification and approved by senior management in writing.

Securities Margin Financing providers should -

• establish a formal policy which provides clear guidance on the practical considerations for setting concentration limits and following up breaches of concentration limits, with due regard to the quality, liquidity and volatility of securities collateral, credit worthiness of clients, and the Securities Margin Financing provider’s financial resources; and
• build a robust control framework to enable the Securities Margin Financing provider to promptly identify and mitigate concentration risks, such as by ceasing to provide further advances to the concentrated client or ceasing to accept further concentrated securities as collateral.

As an example, a Securities Margin Financing provider should consider setting a cap for the maximum loan amount to be advanced to a single margin client when the client’s outstanding margin loan exceeds 10% of total margin loan outstanding.

Stress testing can enable Securities Margin Financing providers to better assess the potential impact of changing market conditions on the firm’s capital. Securities Margin Financing providers are encouraged to conduct stress testing regularly and not only in times of significant market movements.

Stress testing scenarios should be designed to test, at a minimum, the impact of an abnormal and significant price drop of individual securities collateral and of significant market movements. Stress test results should be submitted to senior management for consideration of the need for additional measures, such as tightening the margin lending policy, or reducing exposures to individual clients or concentrations in individual securities collateral.

Securities Margin Financing providers should closely monitor compliance with the 140% repledging limit including by -

• establishing a written policy and procedures for monitoring and ensuring compliance with the repledging limit requirement under the Securities and Futures (Client Securities) Rules;
• maintaining proper audit trails (e.g. calculation of the aggregate market value of repledged securities collateral and aggregate margin loans outstanding on a settlement date basis etc.) and taking prompt follow-up action to prevent any breach of the repledging limit requirement; and
• senior management carrying out daily reviews of the repledging percentage.