자본 규정 / Capital requirements

Why capital requirements?
2.1 As discussed in the preceding section, the first step in regulating intermediaries is a satisfactory and sufficient licensing regime. In discussing the fitness and properness of licensed corporations, the first criterion is their financial status. The regulator must ensure that a licensed corporation has enough capital within the corporation (or available to it from external sources):
(a) to support the level of its business activities;

(b) to meet its liabilities as they fall due; and

(c) to provide a buffer in the event of sudden market changes, disruptions or loss of confidence.

Capital requirements for licensed corporations and registered institutions
2.2 The prescribed calculations for the minimum capital levels for licensed corporations and registered institutions are quite complicated in each case. For registered institutions, it is sufficient to meet the capital requirements set by the HKMA. There is no additional requirement to demonstrate that registered institutions meet the capital requirements set by the SFC as well. In view of their complexity, these requirements will not be discussed further here.

2.3 Licensed corporations (but not registered institutions) must meet the FRR set by the SFC.

Requirements of the SFO
2.4 Sections 145 to 147, SFO, specify the FRR requirements for licensed corporations (refer to sections 7.2 to 7.6 of Topic 3).

Securities and Futures (Financial Resources) Rules
2.5 The structure of the FRR is very detailed and quite complex and candidates are not required to know the full details for this paper. In this Topic, we provide a broad overview of the philosophy and approach of securities regulators in general and the SFC in particular to drafting capital rules. We also note the reporting and other practical requirements which have been included in the body of the FRR.

2.6 In simple terms, a licensed corporation must have an adequate amount of liquid assets to meet its liabilities, which are all likely to be short-term items except for the shares and debt securities or other longer-term loans.

2.7 The balance sheet provides the information used to check the financial health of a licensed corporation. For the purpose of the FRR, the regulator wants the balance sheet prepared or adjusted on specified bases:
(a) it must be prepared in accordance with generally accepted accounting principles;

(b) the bases used must recognize the substance of transactions;

(c) the individual items must be calculated on trade dates and not on settlement dates; and

(d) liabilities not stated on the balance sheet will normally have to be included in the calculations unless the SFC is satisfied that they can be excluded.

Liquid assets, ranking liabilities and liquid capital
2.8 In drafting the FRR, the SFC has considered how much the assets are worth in terms of having to be quickly realized to cover the liabilities. To be on the safe side, the regulators make specific rules to be applied to each and every asset of the licensee based on their analysis of how much these would be worth if they had to be realized urgently.

2.9 So cash and near-cash items which are readily available are given full value, 100%, in the calculation of liquid assets; or, looking at it the opposite way, any deduction to be made to work out their liquid value is 0%.

2.10 At the other end of the scale, the licensee may have fixed assets such as real estate and intangible assets such as goodwill and patents. These cannot be converted into cash quickly; they will normally take the longest time to convert. So they are given a deduction or “haircut” of 100%, i.e. they are marked down to nil value.

2.11 The many classes of assets between these two extremes are given various “haircut” percentages, as they are called, based on the experience of the regulators.

Ranking liabilities
2.12 Generally, the liabilities included in the calculation, called ranking liabilities, are the total liabilities of the licensee. On the other hand, there may be items which are allowed by the SFC as deductible from the total liabilities, for example, loans which the lenders have agreed to subordinate to the rights of other creditors and lenders, but these are few.

Liquid capital
2.13 After all these adjustments have been made, we end up with 2 items:
(a) liquid assets; and

(b) ranking liabilities.

Liquid capital = liquid assets . ranking liabilities.
Required liquid capital (“RLC”)
2.14 The regulator is not fully satisfied if there is merely a positive liquid capital, and will therefore require more. The collective experience of regulators has been that it is safer if the liquid capital is always greater than a buffer figure or RLC. The SFC specifies RLC at preset figures for different types of regulated activity. Approved introducing agents and licensed corporations for Type 4, Type 5, Type 6, Type 9 and Type 10 regulated activities which do not hold client assets have lower RLC requirements.

2.15 So the liquid capital must be greater than the RLC. A first point to note therefore is that the RLC or minimum capital level must be maintained at all times.

Paid-up share capital requirements
2.16 In addition to the RLC, licensed corporations are required to have and maintain at all times paid-up share capital ranging from HK$5 million to HK$30 million, depending on the regulated activity they conduct. (Refer to the figures given in Table 1, Schedule 1, FRR.) If a licensed corporation conducts more than one regulated activity, it must maintain the highest single requirement applicable to the individual activities. Some classes of licensed corporations, generally approved introducing agents, and securities advisers, corporate finance advisers, asset managers and credit rating agencies which do not hold client assets, do not have paid-up capital requirements.

Miscellaneous requirements
Notifications to the SFC
2.17 We have seen in section 7.3 of Topic 3 that a licensed corporation must notify the SFC if it fails to maintain the specified amounts of capital or is unable to comply with other capital requirements. A licensed corporation that cannot comply with the specified liquid or paid-up capital requirements will have to cease carrying on the regulated activity unless it is permitted to carry on by the SFC. Section 54, FRR requires the notification to state the reasons of and the steps being taken to rectify the breach.

2.18 A licensed corporation must also notify the SFC in writing in a number of circumstances, such as:
(a) if its liquid capital falls below 120% of the RLC, or falls below the RLC, or falls below 50% of the last liquid capital reported;

(b) if the information submitted in any earlier return has become materially false or misleading.

Returns to the SFC
2.19 Corporations licensed for any one or more of the regulated activities (other than pure advising activities, i.e. Type 4, Type 5, Type 6 and Type 9 regulated activities, not involving the holding of client assets) are required to make monthly returns to the SFC of liquid capital and RLC with supporting information. The 4 classes excluded above need only make a return half-yearly containing financial statements with less details specified than for the others.

2.20 The returns must contain declarations specified by the SFC.

Request and approvals by the SFC
2.21 The SFC may request information from the licensed corporation to assist it in reviewing the FRR position.

2.22 The SFC may on application approve the following for specified periods or until approval is withdrawn by the SFC:
(a) certain licensed corporations as “approved introducing agents” who are licensed corporations that only introduce business of specific types, do not hold client assets and can incur no legal liabilities except as a result of their own negligence, wilful default or fraud in respect of offers communicated or business introduced;

(b) redeemable shares as approved redeemable shares and subordinated loans as approved subordinated loans (see Note below);

(c) modification or waiver in the calculation of liquid capital;

(d) modification or waiver of the FRR provided that these will not prejudice the interests of any client or the investing public (these will be published by notice on the Internet for transparency and general awareness); and

(e) the adoption of an accounting principle other than one of those generally accepted accounting principles.

Note: The SFC may, on application by a licensed corporation, approve the exclusion of redeemable shares and subordinated loans from ranking liabilities in the calculation of its liquid capital (refer to section 2.12 above).
Revision questions:
Question 4: How often should a licensed corporation review its financial position, and why?
Answer 4: As a licensed corporation is required to maintain the RLC at all times, it should be aware of its financial position at all times. This means in practical terms that it should review the liquidity position whenever there is a material adverse movement in its approved assets and ranking liabilities.
Question 5: Name some points which must be considered by a licensed corporation in reviewing its balance sheet from the point of view of the FRR.
Answer 5: (a) transactions should be calculated on trade dates and not settlement dates;
(b) the balance sheet must be prepared using generally accepted accounting principles; and
(c) the substance of the transaction must be reflected in the balance sheet. Question 6: What is the RLC of a licensed corporation?
Answer 6: The RLC of a licensed corporation is the minimum excess of liquid assets over ranking liabilities which it is required to maintain.

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