Inter-dealer Brokers

SFC recently issued a circular to clarify the licensing obligations of inter-dealer brokers. Typically, inter-dealer brokers carry on the business of facilitating transactions between institutional clients and financial institutions in relation to a wide range of financial instruments, including listed securities and futures contracts, listed structured products, unlisted fixed income products and OTC derivatives. Transactions in listed instruments may be effected by inter-dealer brokers OTC or through an exchange.

SFC's concern is that some inter-dealer brokers might be carrying on a business in a regulated activity in Hong Kong, without having been appropriately licensed under SFO. The licensing obligation is largely dictated by the nature of the financial instruments that they trade, their clients and the booking structures which they employ. However, it is likely in most cases that inter-dealer brokers are carrying on a business in Type 1 / 2 / 3 regulated activity. Accordingly, it must be appropriately licensed unless it can rely upon any of the exemptions stipulated in SFO.

Some inter-dealer brokers might take the view that they are not required to be licensed because they are able to rely upon the "as principal" exemptions provided for in the definitions of "dealing in securities" and "dealing in futures contracts". However, SFC points out that these "as principal" exemptions are quite narrow in their scope and that some of their business activities might well fall within the above definitions.

In particular, SFC does not interpret the "as principal" exemptions as being applicable to transactions such as back-to-back arrangements which involve the temporary interposition of a third party (such as an inter-dealer broker) between the parties who are, in the real sense, the buyer and the seller. Where a broker routinely facilitates or effects such transactions by entering into back-to-back contracts with the buyer and with the seller, it is not able to rely on the "as principal" exemptions. There is no "as principal" exemption provided for in the definition of "leveraged foreign exchange trading".

Some inter-dealer brokers which are approved money brokers under Banking Ordinance might take the view that they are not required to be licensed under SFO because they are able to rely upon the "money broker" exemptions provided for in the definitions of "dealing in securities" and "leveraged foreign exchange trading". Again, SFC states that these "money broker" exemptions are quite narrow in their scope. There is no "money broker" exemption provided for in the definition of "dealing in futures contracts".

In determining whether an inter-dealer broker is able to rely upon the licensing exemptions stipulated in SFO, SFC takes into account all of the relevant facts and circumstances and, in particular, whether the business model of the broker primarily involves agency brokerage.

SFC's clarification in this circular may be coming late because I've heard many inter-dealer brokers in Hong Kong are not aware of their licensing obligations.