SFC Risk Management for Futures Contracts – New Proposed Guidelines

In November, 2022, the SFC issued its Consultation Paper on Proposed Risk Management Guidelines for Licensed Persons Dealing in Futures Contracts. The consultation sets out new guidelines, which, if adopted, will govern all Type 2 (dealing in futures contracts) activities. The consultation closed on January 31, 2023. If you’d like more information about how the proposed guidelines may affect you, please contact one of our financial services regulatory lawyers.

In response to extreme market volatility, in November, 2022, the SFC proposed new Risk Management Guidelines for Licensed Persons Dealing in Futures Contracts. ("Futures Risk Management Guidelines"). Whilst still the subject of consultation, if adopted, the new guidelines are intended to set minimum standards applicable to all persons licensed for Type 2 (dealing in futures contracts).

Key Principles

The draft Futures Risk Management Guidelines set out 11 key principles. The draft then provides specific guidance for each of these principles.

• Proportionality of Risk - A futures broker should ensure its risk appetites and risk limits are consistent with its financial and management capabilities.

• Risk Management Framework – A futures broker should establish an effective risk governance framework to manage both house and client risk.

• Management of Proprietary Market Risk - A futures broker should ensure that all market risks arising from house trading are properly quantified, monitored and controlled.

• Sufficient Knowledge of Commodities Traded – A futures broker dealing in a futures contract on a commodity should maintain a list of commodity futures products in which they can deal.

• Management of Client Credit Risk – A futures broker should put in place prudent risk limits, including trading and position limits, for each client or each group of connected clients to mitigate client credit risk and to ensure compliance with statutory or regulatory position limits.

• Limitations on Concessionary Margining – A futures broker should only apply concessionary margining to a client in respect of trading in futures markets if the client is a good credit risk, the broker complies with concessionary margining requirements set by the relevant exchange or clearing house and the broker has sufficient financial resources to settle counterparty margin requirements of all clients to which it extends concessionary margining.

• Counterparty Risk Management – A futures broker should manage the risk of it having to bear losses caused by the default of counterparties.

• Funding Liquidity Risk Management – A futures broker should ensure that client money or collateral is sufficiently liquid to settle margin requirements for the trading of futures contacts on behalf of clients.

• Segregation of House and Client Assets – A futures broker should ensure that house and client positions in futures contracts and their related margins are booked separately in their accounts with counterparties and client assets are held in a segregated trust account.

• Limitation in Set-off of Pooled Client Assets – A futures broker should take reasonable steps to ensure that where client assets are pooled, assets belonging to one client account or not used to settle overlosses on another client account.

• Stress Testing – A futures broker should conduct stress tests regularly (daily if concessionary margining is applied and weekly otherwise) to project the amount of loss to client and house accounts under stress scenarios and the amount of margin calls.

Self-Reporting

A futures broker should report to the SFC in any of the following circumstances:

• the sum of uncovered client margin in all client accounts for which concessionary margining has been made available does not, at the close of any trading day, exceed 10% of the higher of its excess liquid capital and available funding;

• in any stress test, the projected overloss of any client or group of connected clients exceeds 30% of excess liquid capital or available funding

• in any stress test, the projected overloss of the two clients (or groups of connected clients) who have the largest projected overloss and the projected loss in its house trading account exceeds its excess liquid capital or available funding

• any failure or potential failure to meet margin calls from any counterparty.

Timetable

The consultation closed on January 31, 2023. As proposed, the consultation calls for a 3 month transition period for all requirements other than credit limits and counterparty due diligence, which are subject to a 9 month transition period.