Facilitation Trading

Yesterday SFC issued a reprimand to Deutsche Securities Asia Ltd (DSAL) and fined it HK$6m. This case is definitely a serious one in terms of financial penalty (the maximum fine under SFO is HK$10m), involving the issues of "facilitation trading".

As explained by SFC, facilitation trading involves brokers and clients executing transactions on a principal to principal basis rather than on an agency basis, which can give advantages to clients by providing them with liquidity and more certain execution. As the nature of the relationship with client may change in a facilitation transaction (because the broker is no longer an agent but dealing with the client as principal), conflicts of interest may arise. Therefore, brokers offering facilitation services need systems in place to identify, manage and control any conflicts that may arise in the provision of facilitation services.

SFC's investigation into DSAL's services provided to institutional clients through its facilitation trading desk found that, from May 2001 to Sep 2005, DSAL failed to:

• put in place an adequate system to identify and resolve potential conflicts of interest arising from commingled proprietary and client trades executed by the facilitation trading desk;
• maintain an appropriate and effective compliance function to detect and manage the risks to clients involved in dealing with clients as principal; and
• keep adequate audit trails of client order instructions.

In issuing the reprimand and imposing a fine of HK$6m, SFC has taken into account all the circumstances of the case including:

• as a result of DSAL's report to SFC in Nov 2005, the control deficiencies were discovered; and
• DSAL has been co-operative with SFC and has agreed to accept the reprimand and fine.

While there were many overseas enforcement cases in respect of failures to monitor facilitation trading, DSAL's case was probably the first one in Hong Kong. I wish SFC could also disclose the following details:

• Did clients of DSAL suffer any losses from the mis-managed facilitation trading?
• How was the fine of HK$6m determined?
• Would any responsible officer or other regulated persons (e.g. compliance officer) be penalized?