Local stock market operator Hong Kong Exchanges and Clearing Ltd (HKEx) said on Friday that it is launching a three-month consultation on its plans to beef up its risk management system and bring it in line with other global exchanges.

In light of the Lehman Brothers minibond scandal that hit the city in 2008, the measures include requiring brokerage houses to post up enough money to cover the margins of their clients' cash equities transactions.

Unlike their counterparts at derivatives clearing houses, local cash equity clearing participants currently are not required to cover margin payments.

But under the HKEx proposal, brokerage houses will be required to cover standardized daily margin payments for their cash transaction business for the first time, a move that brings cash clearing more in line with existing derivatives clearing practices.

HKEx also proposed that the required margin payment on cash equity transactions be based on the 5 percent volatility-based margin methodology. The margin payment would only be used in cases when the contributing brokerage firm defaults.

HKEx emphasized that the current capital adequacy capabilities of the local cash equity clearing system may not be sufficient to withstand any potential losses arising from the defaults of any brokerage firm.

HKEx estimated that the guaranteed fund of the Hong Kong Securities Clearing Company (HKSCC) - the local clearing house for local cash equity transactions - only amounts to HK$245 million. That has been deemed insufficient to cover potential losses.

"Our risk management system is at the Third World level, so it must be reformed," said HKEx Chief Executive Charles Li, adding that he expected the proposal will elicit opposition in the local brokerage industry. He promised he would listen to their views, however.

It is expected that the impending consultation will trigger intense debate within the city's broader brokerage industry. Unlike dealers in the derivatives market, brokerages are not used to the idea of paying an upfront margin or collateral before being allowed to put through clients' trading positions for trade confirmation, netting and settlement at the clearer.

HKEx also proposed that in addition to covering margins, local brokerage firms will also be required to contribute to a pooled fund called the Dynamic Guarantee Fund (GF) that will be used to cover losses arising from the defaults of other brokerage firms.

To help local brokerages better cope with the changes, HKEx proposed that each brokerage firm be credited with HK$5 million and HK$1 million respectively to cover their margins and contribute to the Dynamic GF. Brokerage firms will be required to pay margins or contribute to the Dynamic GF after their credit limits are used up.

"After these measures, nearly 80 percent of the brokerage firms will no longer be required to pay margins or into the Dynamic GF on a given day to minimize the impacts of the new requirements on the market," Li added.

"The proposal is fair as it is based on the "user pays" principle. Risk management contributions will be commensurate with the levels or risk created by individual brokerage firms," Li said.

If the margin payment and the Dynamic GF are still not adequate enough to cover potential losses arising from brokerage firms' defaults, the risk management capital (RMC) of HK$4 billion will be provided by HKEx to cover the losses, HKEx added.

FX Week contributed to this story.

oswald@chinadailyhk.com

China Daily

(HK Edition 07/09/2011 page2)