The Risk of Pooling in Margin Trading

The SFC today issues the following advice to alert investors of the risk of pooling in margin trading.

The SFC believes that while retail investors generally understand the risk of leverage in margin trading, they may not be fully aware that, depending on the terms of their authorisation to the brokerage, their securities collateral may be "pooled" with the securities collateral of other margin clients and re-pledged to banks to secure bank borrowings for the brokerage’s use. It is possible that investors’ securities collateral may be pooled even if they have not borrowed from the brokerage. If the brokerage becomes insolvent, the banks may liquidate the securities collateral to discharge the brokerage’s indebtedness. As a result, investors may not be able to recover all the securities in their margin accounts. The failure of C.A. Pacific Securities Limited (CAPS) in January 1998 is an example (Note 1).

When an investor opens a margin account, the brokerage will normally ask for a written authorisation to re-pledge the investor’s securities in the margin account. Depending on the terms of the authorisation, the brokerage may pool and re-pledge the investor’s securities collateral even if the investor has not borrowed from the brokerage.

Therefore, investors should carefully consider whether they intend to use a margin facility before they open a margin account and sign the authorisation. Even if it is necessary to open a margin account, investors are advised not to leave more securities than are required in their margin accounts to cover the margin requirements.

To help retail investors better understand pooling risk, the SFC has published a new leaflet "What is Pooling Risk?" to explain the pooling arrangement on margin accounts and the implication for investors.

This leaflet is supplemented by more extensive educational information on margin trading on the SFC-operated Electronic Investor Resources Centre (www.hkeirc.org). Titled Securities Margin Financing, a series of feature articles discusses the regulation of securities margin financing, general margin call procedures, conditions that can lead to forced liquidation of securities in margin accounts and other risks of margin trading.

As with all other SFC investor publications, the leaflet "What is Pooling Risk?" is available to the public for free at the SFC’s office and the Consumer Advice Centres of the Consumer Council.

Retail investors can call the SFC’s Investor Hotline at 2840 9333 if they have queries about pooling risk in margin trading.

Ends

Notes :

1. Over five thousand clients faced the prospect of loss upon CAPS’s failure. Total investor loss exceeded $900M. The firm’s liquidation process has taken five years and is still not complete. Starting from 30 June 2003, the liquidators have begun the process of distributing shares to clients. Clients can take the option to repay voluntarily the amount of compensation fund already paid to them. This would remove the SFC’s subrogated rights to allocated shares and the shares will be distributed to clients. If clients indicate that they will not repay the SFC or take no action by 28 October 2003, the SFC may exercise its subrogated rights to obtain the shares allocated to the SFC. The SFC will dispose of the shares and use the proceeds of sale to replenish the Unified Exchange Compensation Fund. For details, please refer to the press release issued on 2 September 2003.