News & Insights

Compliance and control issues for futures brokers

On 22 June 2017, the Securities and Futures Commission (SFC) issued a circular on (i) key regulatory concerns about retail futures brokers following the Report on the fact-finding exercise of retail brokers of 28 April 2017; and (ii) expected standards of conduct and internal controls for futures brokers. 

Whilst the circular is focused on retail futures brokers, certain of its contents are also relevant to securities brokers that provide margin financing and to entities who will in future need to be licensed for the planned Type 12 regulated activity of providing clearing services for OTC derivative transactions. 

The SFC’s key concerns, and related expectations, are listed out below. 

  • Allowing unqualified clients to trade without sufficient margin

    The SFC expects futures brokers to consider the following criteria when assessing whether a client is an “established client” under Rule 617(b) of the Rules of Hong Kong Futures Exchange Limited (HKFE): 
    • demonstrating a record of consistently meeting margin obligations;
    • maintaining a sound financial position; and
    • ongoing review of the eligibility of established clients.

  For detailed guidance on the assessment criteria for established clients, please refer to the HKFE’s circular of 22 June 2017.

  • Collection of insufficient margin 

    Futures brokers should not allow unqualified clients to open new positions before receiving sufficient initial margin. The SFC expects futures brokers to maintain sufficient records of all margin calls made to every client, including information of initiation of each margin call, particulars of margin calls made, client’s response to a margin call, and follow-up actions taken, if any, such as forced liquidation.

  •  No disclosure to clients before setting-off

    The SFC expects futures brokers to disclose to clients all relevant information, either in the client’s original authorisation documents or by other means, and keep a proper trail of communications with clients before transferring funds to set-off a debit balance in a client’s futures trading account against the credit balance in the client’s other trading accounts. Examples of relevant information include:  
    • whether the client’s consent will be obtained before each fund transfer;
    • how clients will be contacted, and action taken if the client is uncontactable;
    • whether only excess funds in other accounts would be transferred to the client’s futures trading account;  
    • whether sales of collateral in the client’s other accounts might be used to fund a shortfall in the futures trading account;  
    • whether the transfer would cover the margin shortfall only or be a higher amount to establish or replenish any buffer; and
    • the market risks involved in holding open positions and any additional charges that may be borne by the clients.
  •  Failure to maintain segregated accounts and ledger accounts

    The SFC expects futures brokers which are HKFE exchange participants and transact HKFE trades and non-HKFE trades to maintain at least two segregated bank accounts and ensure that all client money relating to HKFE trades is paid into a segregated bank account designated as an “HKFE Trade” account. Client money relating to non-HKFE trades must be paid into a different segregated bank account designated as a “Non-HKFE Trade” account. In addition, futures brokers should maintain separate ledger accounts for every client in respect of all HKFE trades, all non-HKFE trades and all other trades which are unrelated to the business of dealing in futures contracts.
  • Client assets provided as margin for overseas transactions

    The SFC expects futures brokers to establish and maintain policies and procedures to ensure proper management of risks to which they and their clients are exposed when conducting overseas transactions. Future brokers are expected to evaluate and monitor the risks of transacting through overseas brokers, and avoid placing excessive client money with overseas brokers. Futures brokers should also explain to clients the risks associated with such trading activities, including the risk that client assets held overseas may not be subject to the protections given to client assets held in Hong Kong. 

Key Contacts

Scott Carnachan

Consultant | Financial Services

Email or call +852 2825 9265

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