SFC finds 11 traders of Standard Chartered Securities (HK) violated regulations 61 times in 20 months

Standard Chartered Securities (Hong Kong) Limited (SCSHK), the securities brokerage arm of the Standard Chartered Bank Group, has gotten a fine of $2.6 million and has been reprimanded by the Hong Kong Securities and Futures Commission (SFC) over failures to:

• put in place adequate system and control procedures to ensure compliance with the disclosure requirements in relation to short selling orders under sections 171 and 172 of the SFO (Short Selling Provisions);
• comply with the Securities and Futures (Financial Resources) Rules (FRR).

In today’s announcement, the Hong Kong regulator explains that before October 2015, the Equity Derivatives & Convertible Bonds (ED/CB) businesses of SCSHK operated through a number of trading desks. Each desk maintained separate trading books. For the purpose of the short selling requirements, SCSHK adopted the individual trading desk approach. Internal stock borrowing and lending were allowed among these trading desks.

In September 2015, SCSHK informed the SFC that a trader of its ED/CB businesses had placed at least 33 sell orders to the market as long sells, when the positions should have been flagged as covered short sells during the period from January 2014 to January 2015. For some of the orders, there were inadequate written records of the stock borrowing arrangements between different trading desks within SCSHK. As a result, the SFC conducted an investigation into SCSHK’s internal controls in relation to short selling.

The SFC investigation showed that there were at least 61 instances of breaches of regulatory requirements by 11 traders of different trading desks from January 2014 to August 2015. These breaches were not detected or identified by SCSHK until months after the event.

During their compliance training which covered short selling requirements in Hong Kong, traders were reminded that the individual trading desk approach would be adopted. They were expected to check their positions to ascertain whether the sale was long or short. If it was a short sell order, they should ensure a valid stock borrowing arrangement was entered into, so that the sale would be covered. They were also responsible for ensuring accuracy in their inventory position in order to indicate the correct long or short marking and to have the required covered short documentation in place.

The numerous instances of SCSHK’s failure to flag a short sell order and/or obtain documentary assurance for a short sell order as required by the Short Selling Provisions between January 2014 and August 2015 revealed that SCSHK was heavily reliant on individual traders to identify and flag a short sell order and to maintain an accurate inventory position.

SCSHK’s systems were ineffective with regard to identifying short positions for which stock borrowing arrangements were required to be made and which should have been flagged, and with regard to providing its traders with readily accessible real time data on its inventory position to enable them to identify short positions in the first place. Such systems failed to ensure that the relevant regulatory requirements would be adhered to by its traders or to cross check their positions.

SCSHK implemented remedial measures in order to guard against either failure to flag short sale orders or erroneous flagging of the same. However, the Hong Kong regulator notes that these measures should have been in place at the outset.

With regard to breaches of the FRR, the SFC explains that in January 2015, SCSHK appointed Standard Chartered Bank (Hong Kong) Limited (SCBHK) as a Third Party Clearing Participant to perform clearing and settlement functions under the Central Clearing and Settlement System in relation to its transactions executed on the Stock Exchange of Hong Kong Limited. Under the FRR, the amounts receivable from SCBHK, as general clearing participant (GCP), could not be treated as liquid assets, and the amounts receivable from and payable to the GCP could not be set off.

The Hong Kong regulator found out that on September 24, 2015 that SCSHK appeared to have included amounts receivable from the GCP in the calculation of its liquid assets since January 2015.

SCSHK claimed that it had included the amounts receivable from SCBHK on trade receivables as liquid assets because it had mis-interpreted section 23 of the FRR regarding accounts receivable from counterparties in respect of dealings in securities, and only realized that its interpretation was incorrect when it discussed the matter with the SFC on September 24, 2015.

The regulator stresses that under rule 11 of the FRR, the assets and liabilities of a licensed corporation must be treated separately on a gross basis and shall not be set-off against each other. As SCBHK was not a clearing house, the amounts receivable from it would not be qualified and could not be included as liquid assets.

In the financial returns submitted by SCSHK for the months from January to September 2015, SCSHK had breached the FRR by wrongly including the amounts receivable from SCBHK as liquid assets. As at the end of August 2015, SCSHK had a required liquid capital deficit of $2 billion when such receivables from SCBHK were excluded from liquid assets. SCSHK therefore failed to maintain the required amount of liquid capital in breach of rule 6(1) of the FRR for almost 9 months since January 2015 when it appointed SCBHK as the GCP.

In deciding its disciplinary action against SCSHK, the SFC has taken into account all the circumstances of this case, including (inter alia) the duration and extent of SCSHK’s failures, SCSHK’s cooperation with the SFC, and the measures taken to rectify the violations.