SFC issues risk management guidelines for futures brokers

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The SFC has introduced new Risk Management Guidelines that will significantly impact futures dealing activities. Set to take effect on 25 February 2024, the guidelines aim to enhance risk management practices in response to the challenges posed by extreme market volatility. They introduce several key changes and obligations for licensed futures dealers.

Risk management framework: Brokers must establish a robust risk governance framework covering material risk identification and assessment, determination of risk appetite and limits, ongoing risk monitoring and reporting, escalation and resolution procedures for breaches of risk limits, deviations from policies and procedures, and
stress testing and contingency planning.

Market risk management: When conducting proprietary trading in futures, brokers are responsible for quantifying, monitoring, and controlling all market risks that arise.

Commodity futures trading: Brokers must maintain a list of permissible commodity futures products and closely monitor associated risks.

Client credit risk management: Prudent risk limits, including position limits, should be implemented for each client or group of connected clients.

Concessionary margining: This is permitted only for clients with a history of meeting margin requirements, with strict conditions to be followed.

Risk management over agents: Brokers engaging executing or clearing agents must have written policies for managing exposure to these agents. For effective risk management over executing or clearing agents, futures brokers must regularly perform due diligence reviews of executing or clearing agents and put in place suitable contingency measures to reduce reliance on a single executing or clearing agent.

Funding liquidity risk management: Client funds or collateral must be sufficiently liquid for settling margin requirements.

Safeguarding client assets: Proper segregation of proprietary trading and client positions and assets is required.

Trading outside Hong Kong: Brokers must provide written disclosures on risks associated with transactions in overseas futures markets.

Stress testing: Brokers should conduct stress tests at least weekly and during volatile market conditions. The stress tests should project potential losses in client accounts and proprietary positions under assumed stress scenarios. They should also diligently review stress test results to identify threats to financial stability.

Notification requirements: Brokers must notify the SFC within one business day, in case of any failure to meet margin calls.

The SFC has identified some unsatisfactory risk management practices and highlighted various shortcomings in the ways future brokers handle their clients’ positions, risk exposure and financial safeguards. The SFC noted that in some cases, the futures brokers were affected significantly and required emergency funding or financial assistance to prevent defaults on their obligations to the clearing houses or to ensure compliance with the financial resources rules.

For futures brokers and potential licence applicants, it’s imperative to consider these changes and requirements. A good place to start is updating internal risk management policies and procedures to align with the new guidelines, and ensuring that your internal operations and systems are capable of meeting these regulatory demands.

While the guidelines are extensive, brokers should remember that they have an additional year to implement certain system developments related to incorporating client risk limits into their relevant risk management and order systems. It’s also worth using this time to carry out stress testing using an assumed stress scenario designed in accordance with the guidelines.

How we can help

We offer licensed corporations expert guidance on adopting the new requirements for future brokers. Our support ranges from drafting or reviewing your new risk management procedures and checking whether you have the appropriate internal controls in place, to providing advice or practical solutions on meeting the new regulatory requirements.