In the face of the potential market risks of margin business, the Hong Kong Securities Regulatory Commission finally stepped in to regulate.

On April 4, the Hong Kong Securities Regulatory Board issued a consultation summary on the guidelines on Securities margin financing activities, setting seven monitoring benchmarks. The main three provisions include: the maximum margin loan that can be used by a brokerage firm is no more than 5 times the multiple of capital; the total margin loan of a single or affiliated client shall not exceed 40% of the shareholders' funds of the brokerage firm; and to control the centralized management of individual or related securities as collateral.

It is understood that the total amount of margin loans increased from 21 billion yuan at the end of 2006 to 206 billion yuan at the end of 2017, an increase of as much as nine times. In addition, the amount of short margin loans accounted for 7% of the shareholders' funds of brokerage firms increased to 19%, and the percentage of total margin loans increased from 11% to 16%.

Since then, the SFC believes that there are some deficiencies in the absence of a margin loan ceiling and stock concentration risk limit, and the Hang Seng Index has risen nearly 50% in the past two years but has since fallen, and market risk has emerged in 2018. Therefore, it is necessary to regulate margin financing.

Risk points of margin financing

Margin financing is equivalent to margin trading. Hong Kong, also known as "margin", is a leveraged financing tool on the market. Since the implementation of the relevant regulatory system in 2000, the scale of financing broke out from the end of 2006 to the end of 2017, during which the total amount of margin loans increased from 21 billion yuan to 206 billion yuan, an increase of nine times.

The Hong Kong Securities Regulatory Board is aware that the lending practices of a number of securities margin financing brokers seem to be too aggressive and inadequate risk monitoring.

The relevant macro analysis reveals that, first of all, the quality of margin loans has deteriorated, which is equivalent to an increase in the rate of bad debts.

The percentage of margin loan shortfalls in the shareholders' funds of brokerage firms under the Financial Resources rules has increased from 7% to 19%, while the percentage of margin loans in total margin loans has increased from 11% to 16%. The securities financing collateral ratio, that is, the ratio of the total market value of securities collateral deposited by margin customers with securities margin brokers to the total margin loans, has also decreased from five times to four times.

Second, the proportion of margin loans backed by a single collateral has nearly tripled. At the end of 2017, 30% of the main margin loans were backed by single mortgage stocks, compared with 12% at the end of 2006.

The third is the increase in the number of non-index stocks as collateral. At the end of 2017, 89% of the top three mortgage stocks (main collateral) of main margin loans were non-index stocks, compared with 73% at the end of 2006.

Fourth, the proportion of heavily pledged stocks in margin loan collateral has doubled. At the end of 2017, HPS accounted for 50% of the main collateral, more than double the level at the end of 2006.

The fifth is the doubling of the number of immobile collateral. At the end of 2017, about 600 stocks of the main collateral were reported as illiquid collateral, nearly double the level at the end of 2006. At the end of 2017, one-third of brokerage firms held at least three stocks that were illiquid collateral.

Make up for the lack of supervision

For this reason, the Hong Kong Securities and Futures Commission also noticed the following lack of monitoring during the review of securities margin financing:

1. Failure to establish or properly comply with the internal margin loan limit, stock concentration risk limit and customer concentration risk limit

Second, grant margin loans to customers purely or mainly based on the value of the collateral, with little consideration of the customer's financial ability.

Third, the percentage of deduction adopted by brokerage firms for collateral is looser than that adopted by lending banks, and a lower percentage deduction is adopted for collateral deposited by some "special" customers.

(4) insufficient monitoring of the collection of margin calls and relief for margin calls and forced realization, and granting additional margin loans to clients who fail to perform margin calls.

5. No (or no regular) stress tests are conducted to assess the financial impact on the brokerage firm when the market is under pressure, or when the price of collateral with significant risks falls sharply or when trading is suspended.

The SFC believes that market sentiment has improved over the past two years, with the Hang Seng index rising nearly 50 per cent to an all-time high of 33484 on January 29, 2018, but then adjusting down 14 per cent to 28955 at the end of June 2018. At the same time, a number of potential negative factors are emerging, such as higher interest rates, the widening interest rate gap between the Hong Kong dollar and the US dollar, geopolitical tensions and the threat of trade war.

For example, due to the sharp fall in the US stock market in February 2018, the Hang Seng Index plummeted by more than 1600 points in a single day, and the volatility of the stock market intensified, especially for non-index stocks which are the main components of collateral. Recently, the share prices of some stocks have plummeted by 80% or more in a single day for different reasons, or even suspended.

The SFC is therefore of the view that it is time to communicate with the industry the SFC's expectations for a prudent risk management system and to provide more guidance on the risk management practices that securities margin brokers should achieve.

New guidelines set seven monitoring benchmarks

The guidelines provide qualitative guidance and (where appropriate) quantitative benchmarks for seven major risk control areas, namely:

Monitoring of the total amount of margin loans

Monitoring of margin customer credit limit

Monitoring and Control of centralized risk of Securities collateral

Monitoring of centralized risk of margin clients

Deduction rate of securities collateral

Notice of margin call, suspension of further loans and forced encashment, and stress tests.

Among them, the most important provisions are: first, the maximum margin loan that can be used by a brokerage firm is no more than 5 times the multiple of capital; second, the total margin loan of a single or affiliated client shall not exceed 40% of the shareholders' funds of the brokerage firm; third, and control the centralized management of individual or related securities as collateral.

According to the guidelines, generally speaking, securities margin financing brokers should control the total amount of margin loans to margin clients within their capital.[Two / three / four / five times]Within (that is, the multiple of the total margin loan to the capital), that is, the maximum shall not exceed 5 times.

There is also a strict implementation of the risk limit for the concentration of securities collateral, especially in two cases: for securities collateral that are constituent stocks of the Hang Seng Index or the Hang Seng China Enterprise Index (index stocks), the impact of hypothetical pressure on the liquidity surplus of brokerage firms (as a percentage of the decline in liquidity surplus) exceeds that of brokers.[30%／40%／50%]In other cases, the impact of hypothetical stress on the liquidity surplus of brokers (as a percentage of the decline in liquidity surplus) exceeds that of brokers.[20%／25%]。

With regard to the limit for a single client, the guidelines stipulate that if the aggregate margin loans to individual margin clients or a group of related margin clients exceed the shareholders' funds of the brokerage firm[20%／30%／40%]The margin loan will be regarded as too large, that is, a maximum of 40%

And in any case, the deduction rate allocated by the repledge broker for securities collateral should not be lower than the deduction rate prescribed under the Financial Resources rules to apply to the collateral, or 80% in the case of non-quick collateral.