The Securities and Futures Commission (SFC) has published a circular directed at commodity futures brokers (brokers) requiring them to take precautionary measures to manage the risks of trading crude oil futures contracts amid unprecedented volatility seen in the crude oil futures markets. The SFC has cautioned brokers not to open new positions for clients who do not fully understand these contracts or do not have the financial capability to bear the potential losses.  A separate circular on futures-based ETFs was also issued in parallel (read our blog on this here).

The SFC has recently found that two brokers committed significant (albeit short-term) breaches of the liquid capital requirements under the Securities and Futures (Financial Resources) Rules (the FRR) following failures to collect large amounts in margin calls prompted by the recent plunge in the price of crude oil. The SFC has urged brokers to adopt more prudent risk management measures to control exposures and to ensure that firms remain compliant at all times with regulatory requirements.

Controlling exposures to clients

The SFC has recommended brokers to take the following steps to control exposures to clients:

  • monitor and address individual clients’ concentration risks in a timely fashion;
  • act prudently in setting clients’ trading limits and position limits, taking into account both the client’s financial strength and settlement history, and the firm’s financial resources;
  • act prudently in setting margin requirements for clients and consider:

(i) increasing margin requirements to levels above those required by the clearing house or clearing agent to appropriately reflect prevailing market conditions, the client’s financial strength and settlement history, and the firm’s ability to meet margin calls (including intraday calls) on client positions from the clearing house or clearing agent; and

(ii) adding a margin cushion to cover the risk of being unable to collect additional margin from clients during public holidays and weekends;

  • ensure sufficient margins are collected before opening any new positions for clients; and
  • promptly collect outstanding margin calls from clients.

Other risk management measures

The SFC has also highlighted other (non-exhaustive) risk management measures which brokers are expected to continually implement to prudently manage risks, although the ultimate responsibility for the proper management of risks rests with senior management.

Key measures are outlined below:

  • changes in market conditions and margin requirements set by clearing houses or clearing agents should be closely monitored, and any corresponding impact on the firm’s risk exposures, cash flow and liquid capital should be rigorously assessed;
  • during periods of high market volatility, stress tests and liquid capital computations should be carried out regularly;
  • contingent funding and capital support from group companies or shareholders should be pre-arranged to ensure that brokers can cope with emergencies;
  • firm operations should be diligently supervised to mitigate operational risks and to ensure client assets are safeguarded e.g. proper controls should be in place to ensure that transfers of client money to overseas clearing houses or clearing agents comply with the requirements of the Securities and Futures (Client Money) Rules.  In addition, client margin deposits held with overseas clearing houses or clearing agents should be properly safeguarded and accounted for;
  • brokers dealing through overseas counterparties must establish and maintain appropriate policies and procedures (the SFC has previously issued a circular on conducting transactions through overseas counterparties here); and
  • in light of recent extreme price movements of crude oil futures, clients’ financial capabilities to bear potential losses arising from trading should be reassessed and new positions should not be opened for clients who are unable to bear potential losses as required under paragraph 5.3 of the Code of Conduct for Persons Licensed by or Registered with the SFC.