Hong Kong’s SFC reminds prime brokers about their regulatory obligations

Hong Kong’s Securities and Futures Commission (SFC) has earlier today published a circular directed at prime brokers (Pbs) – financial institutions providing prime services and conducting related equity derivatives activities in Hong Kong, reminding them about the need to comply with Hong Kong regulations.

The SFC noted that the operating models for prime services are fragmented by nature with multiple legal entities of a financial institution involved in different aspects of a client relationship. Hence, PBs are reminded that if clients are serviced in Hong Kong or if PBs are carrying out their prime services in Hong Kong, PBs are expected to comply with the applicable rules and regulations in Hong Kong regardless of where the risk positions are booked.

While PBs usually adopt the risk management framework set out at the group level, they are expected to take reasonable steps to ensure that they operate within a robust risk management framework, with reporting and accountability processes clearly defined and suitably integrated across the different jurisdictions involved. PBs also have to overlay their risk management programs with relevant local regulatory requirements and operational needs to ensure the standards are not less stringent than the applicable local rules.

In case the risk positions are not booked into Hong Kong, PBs should still have adequate controls and procedures in place to follow the relevant compliance standards established by their group companies.

PBs are expected to:

• maintain effective policies and procedures for proper risk management and ensure adequate information is provided to allow management to take appropriate and timely action to contain or manage risks.
• establish appropriate risk limits for on-going monitoring and assess them periodically for appropriateness.
• conduct regular stress testing, which should also be tailored to special situations, for example, in cases of risk mismatches or when client portfolios hold illiquid positions or products with complex features and risk profiles. Stress testing methodologies should be properly defined and periodically reviewed.

If an intermediary is the contracting entity where the risk positions for prime services are booked, PBs are reminded to comply with the applicable regulatory requirements, including those related to over-the-counter (OTC) derivative transactions, securities margin financing and the Securities and Futures (Financial Resources) Rules.

PBs are also reminded that if PBs or their group companies are impacted by breaches or severe control failures arising from operations in Hong Kong, the SFC will assess the implications of such cases on the fitness and properness of the PBs in Hong Kong.

Also today, in a report, the SFC provided an overview of the prime services industry landscape in Hong Kong and shared observations and good industry practices noted from the SFC’s recent thematic review of the internal controls and risk management processes of selected Pbs.

The thematic review was conducted in two phases:

• A questionnaire was sent to 17 selected financial institutions operating in Hong Kong to collect information about whether they offered prime services, their practices in relation to the scope of services provided, their front-to-back business processes and risk management frameworks for prime services and their related equity derivatives activities. According to the responses, 13 out of the 17 institutions surveyed offered a full range of prime services in Hong Kong.
• In the second phase, PBs with different business models were selected for prudential visits to further verify their responses to the questionnaire or on-site inspections to assess their key risks and validate their controls for the provision of prime services activities.