Type 8 regulated activity, namely securities margin financing; and
Type 1 regulated activity, namely dealing in securities, that provide financial accommodation to any of their clients in order to facilitate acquisitions or holdings of listed securities by the persons for their clients,
(hereinafter together referred to as “Securities Margin Financing providers”),
are required to establish and enforce prudent margin lending policies and exercise robust controls over their securities margin financing activities to ensure compliance with the relevant requirements in the Code of Conduct1 and Internal Control Guidelines2, in particular -
Schedule 5 to the Code of Conduct, which, among other things, sets out additional requirements on margin lending policy and internal controls for Securities Margin Financing providers; and
Part VIII of Internal Control Guidelines, which requires licensed person to establish appropriate and effective risk management policies and procedures.
Securities Margin Financing providers who repledge securities collateral deposited by margin clients are further required to observe a 140% repledging limit pursuant to section 8A of the Securities and Futures (Client Securities) Rules.
The following questions and answers on regulatory requirements related to margin lending activities have been added to the FAQ issued by the SFC to provide further guidance to Securities Margin Financing providers. The SFC will be guided by the FAQ in assessing a licensed person’s compliance with the Code of Conduct and Internal Control Guidelines.
1 Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission 2 Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission
Can a Securities Margin Financing provider adopt a fixed loan-to-collateral ratio as the triggering level for making margin calls for all clients?
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.
What kind of information should be recorded for margin call follow-up actions?
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.
Should a Securities Margin Financing provider refrain from taking further purchase orders for a margin client who has failed to meet a margin call?
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.
What controls should be exercised in granting approval for deviations from the margin lending policy?
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.
What controls should Securities Margin Financing providers exercise to manage client / collateral concentration risk?
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.
Should Securities Margin Financing providers only perform stress testing in relation to their margin loan portfolio in times of significant market movements?
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.
What controls are expected of Securities Margin Financing providers in monitoring compliance with the repledging limit?
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.
Last update: 24 Aug 2009