Breaches in Position LimitsA

The SFC today reminds market participants that they must observe the position limits for futures and options under the law.

In 2004, the SFC initiated six investigations into breaches in position limits under the Securities and Futures (Contracts Limits and Reportable Positions) Rules of the Securities and Futures Ordinance.  They involved underlying instruments including Hang Seng Index futures and options contracts, Hang Seng China Enterprises Index futures contracts (commonly known as H-shares Index futures), and stock options contracts.  Persons committing the breaches included an individual, fund managers, and exchange participants engaging in proprietary trading.

Position limits on futures contracts and stock options contracts were introduced in 1999 after the Asian financial turmoil in 1998. They serve to protect market integrity by discouraging excessive position building in the derivative markets that might be against the interests of the investing public. (Note 1)

Most of the known breaches only lasted for a short period of time. They were promptly identified by the Large Position Reporting requirements administered by the Hong Kong Exchanges and Clearing Limited.  Breaches were required to be rectified by restoring the positions to below the legal limit as soon as practicable.

At this stage, there is no evidence that the breaches were malicious.  

So far, three cases have been concluded. Warning letters were issued to the parties involved.  Investigations into the remaining three cases are continuing.

In one of the concluded cases, an overseas fund manager (referred to as a transaction originator under the Rules) claimed that he was not aware of the obligation to file Large Position Reports for the accounts under his management (Note 2).  While the SFC is not sympathetic to the pronounced ignorance, the SFC accepts that the problem could have been avoided if the exchange participant concerned had reminded the fund manager of the latter’s duty under the Rules (Note 3).  The SFC has referred the fund manager’s misconduct to the overseas regulator which has regulatory oversight of the fund manager.

The SFC would like to remind transaction originators of their duties to file Large Position Reports for all individual accounts managed by them.  The obligation arises when the aggregate position under their control exceeds the reporting threshold even though holdings for individual accounts do not attract any individual reporting requirement.  The SFC also expects exchange participants to pay attention to their general duty in ensuring clients’ compliance with the Rules.

Mr Alan Linning, SFC’s Executive Director of Enforcement, said: “The SFC considers that failure to trade within pre-determined position limits or to file Large Position Reports reflects badly on a firm’s internal control measures.  This might lead to disciplinary action. In serious cases, the rule breakers may be prosecuted.”

Ends

Notes:

1. The Rules apply to futures contracts and stock option contracts that are traded through the facilities of a recognised exchange company.  Different trading limits and reporting thresholds are applicable to different instruments and they are specified in Schedule 1 and Schedule 2 of the Rules. The maximum penalty for non-compliance to the requirement of the Rules is a fine of $100,000 and imprisonment for two years.

2. Large position reporting is widely adopted in all international futures and options exchanges.  Positions above a reporting threshold are required to be filed with the relevant exchanges.  Information requested usually includes details about contracts held, beneficial ownership, transaction originators, nature of positions, and brokers used.  Exchange officials will consolidate the various submissions for monitoring purpose.  For Hang Seng Index futures and option contracts, the current reporting threshold is the equivalent of 500 contracts.

3. Although the duty to report lies with the persons in control of the reportable positions, that is to say the transaction originators and the beneficial owners of the positions, the SFC believes the exchange participants who help to execute and clear the trades should at least remind the relevant persons of their duty to report.

4. Please refer to the Guidance Note on Position Limits and Large Open Position Reporting Requirement gazetted on 20 April 2004 for detail explanation of the operation of the Rules. The Guidance Note is available on the SFC website under “Legislation & Regulatory Handbook” – “Regulatory Handbook” - “Codes, Guidelines and Circulars”.