Margin Financing Disguised as Investments

On 3 Aug 2018, SFC issued the circular "Margin Financing Activities Disguised as Investments". SFC said it had observed that some LCs carrying on asset management activities may have aided and abetted unlicensed affiliates or third parties to provide securities margin financing in the guise of investments.

SFC warns that the provision of margin financing in the guise of investments under such an arrangement is illegal. Parties involved in the illicit activities may have avoided certain capital, conduct or disclosure requirements aimed at protecting investors and market integrity.

These suspected margin financing arrangements are set up or operated in different forms. For example, they may operate through discretionary accounts or private funds with the following features:

• jointly with a LC's clients (note), the unlicensed affiliates or third parties appear to fund the acquisition and holding of sizeable, concentrated positions in one or more securities;
• the clients are required to provide additional capital or collateral when the value of these investments falls below a pre-determined level, similar to a margin call;
• the unlicensed affiliates or third parties are entitled to receive a guaranteed or predetermined yield from these investments, similar to margin interest; and
• the LC does not have actual investment discretion as the listed securities to be acquired were previously agreed between its clients and the unlicensed affiliates or third parties.

Note: In the context of a private fund, these refer to a particular class of investor of the fund whereas the unlicensed affiliate or third party belongs to another class of investor of the fund.

Arrangements which involve the provision of financial accommodations to facilitate the acquisition and holding of listed securities may constitute "securities margin financing" (i.e. RA8). The unlicensed affiliates and third parties in the examples above are not licensed by the SFC in any capacity and they may be in breach of S.114 of the SFO.

Persons conducting business activities which constitute securities margin financing are also subject to other regulatory requirements, including the capital requirements under the FRR and the risk management requirements governing margin lending under the Code of Conduct. Obviously such kind of dubious arrangement aims at evading all of these requirements.