HK SFC Financial Resources Rules (FRR)


What is FRR?

Section 4:  All SFC licensed corporation must maintain financial resources (paid-up share capital and liquid capital) at all times not less than the specified amounts according to FRR Rules

(a)Applies to all SFC licenses (Types 1 – 10)
(b)Paid-up Share Capital 
(c)Required Liquid Capital
(d)At all times (not intraday)
(e) Specified amounts according to Schedule 1


Paid-up Share Capital

•“Paid-up Share Capital” means “total amount ($) of capital provided by shareholders”
•In practice, it means ü $ registered with Companies Registry (e.g.  $ in Annual Return (NAR1)) 


How to Calculate Liquid Capital
Liquid Capital(LC) = Liquid Assets Ranking Liabilities [Definition: “Liquid Capital”]

Liquid Assets
•  Cash held by an authorized bank in Hong Kong [S. 20] 
•  Accounts receivable from clients if not outstanding for 2 weeks [S.23]  
•  Proprietary positions (blue-chip stocks) with reduced haircut amount [S. 27]
=>  Assets provided to others for security not included

Ranking Liabilities
•Accounts payable to clients (“AP”)         e.g. AP lingers for T+2/3 Settlement 
•Overdraft, Loans, Guarantee or other financial commitment 
#   Approved Subordinated Loans are not included    [S. 53 (2)(a)]

Important notes:
1. Accrued on a trade date basis [S. 8]
2. Back-to-Back Trades are considered separate [S.10]
3. Assets and Liabilities shall not be set-off with each other [S. 11]


What is Required Liquid Capital?

•Licensed Corp is required to maintain Liquid Capital more than the Required Liquid Capital  [S. 6]
•“Required Liquid Capital” means the higher amount of:
1. 5% of Basic Amount = Adjusted Liabilities (Variable Required Liquid Capital /“VRLC”) 
or
2.Minimum Required Liquid Capital (“MRLC”)

Variable Required Liquid Capital (VRLC) means:  

5 % of Adjusted Liabilities  [= “Basic Amount”]

Adjusted Liabilities” = •On-balance Sheet Liabilities (not Ranking Liabilities)  minus  (-) •Client Moneys minus (-)   •(Approved) Subordinated Loan

Conclusion: 
1.If $ of VRLC (= 5% of Adjusted Liabilities) is more than HK$3,000,000 (MRLC), then Liquid Capital needs to be more than VRLC. 
2.If not, then Liquid Capital needs to be more than HK$3,000,000. 

Subordinated Loans
•To manage financial resources, Licensed Corp may consider applying for Subordinated Loans.
=> Subordinated Loans are not included in the Ranking Liabilities
•Many lenders dislike as they are subordinate to other lenders in case of Licensed Corporation’s insolvency. 
•The Lender is the authorized bank in HK or parent company.
•The application needs to be approval by SFC
•Model Agreement provided by SFC

Monitoring and Reporting Requirement
• Daily monitoring (not intraday)
• Notification to the SFC [S. 53] 
1.LC falls below 120% of RLC
2.RLC deficit occurs, but Licensed Corp is regarded as complied with MRLC by virtue of section 6(3)
3.LC falls below 50% of the last reported LC
4.Any information in the previous returns become false or misleading
5.LC falls below the RLC if it did not have any approved subordinated loan
6.The Licensed Corp exceeds any borrowing limits, is unable to meet any repayment demands from lenders, or any lenders have liquidated or have notified an intention to liquidate any collateral security
7.The aggregate commitment etc or claims made against it, exceeds HK$5 million, or if deducted from its LC, would reduce it to below 120% of the RLC
8.If it has made any insurance claim under the professional indemnity insurance policy
9.Any commitment, including a guarantee, has been provided on its behalf by a group company to an exchange or clearing house.

Periodic Returns
•Monthly Returns 21st day of every following month  [s. 56 (1)]
•Quarterly Returns [s. 56 (1)]


Scenarios for Licensed Corporation with RA1 License – Financial Standings (Amount in HK$)

Scenario 1 [FRR Breach below MRLC]   

Assets
 Balance Sheet CalculationLiquid Assets
Client Assets2,000,000Nil
Licensed Corp’s Bank Balance2,400,0002,400,000
AR from Client (less than 2 weeks)3,000,0003,000,000
Total7,400,0005,400,000
Liabilities
 Balance Sheet CalculationRanking Liabilities
AP to Clients5,500,0005,500,000
Rent Payment500,000500,000
Approved Subordinated Loan00
Total6,000,0006,0000,000
Liquid Capital
 5,400,000 (Liquid Assets) – 6,000,000 (Ranking Liability)
= – 600,000 (Liquid Capital)
What is the RLC in this case?
Higher of  
VRLCAL= = 6,000,000 (On-Balance Sheet Liabilities) – 2,000,000 (Client Assets) – 0 (Subordinated Loans) = 4,000,000 AL (4,000,000) x 5% = 200,000 = VRLC
MRLC3,000,000
ConclusionRLC = MRLC because MRLC (3,000,000) is higher than VRLC (200,000) => Because Liquid Capital is deficit (-600,000), Licensed Corp is in breach of FRR

Scenario 2 [FRR compliance using MRLC]

Assets
 Balance Sheet CalculationLiquid Assets
Client Assets2,000,000Nil
Licensed Corp’s Bank Balance10,000,00010,000,000
AR from other Brokers (less than 2 weeks)1,000,0001,000,000
AR from other Brokers (due more than 6 weeks)500,000Nil
Total13,500,00011,000,000
Liabilities
 Balance Sheet CalculationRanking Liabilities
AP to Brokers2,000,0002,000,000
Loan500,000500,000
Approved Subordinated Loan00
Total2,5000,0002,500,000
Liquid Capital
 11,000,000 (Liquid Assets) – 2,500,000 (Ranking Liability)
= 8,500,000 (Liquid Capital)
What is the RLC in this case?
Higher of  
VRLCAL= 2,500,000 (On-Balance Sheet Liabilities) – 2,000,000 (Client Monies) – 0 (Subordinated Loans)
[- Rent payment] = 500,000 AL (500,000) x 5% = 25,000 = VRLC
MRLC3,000,000
ConclusionRLC = MRLC as MRLC (3,000,000) is higher than VRLC (25,000) => Because Liquid Capital (8,500,000) is above MRLC (3,000,000), Licensed Corp is in compliance with FRR => Because Liquid Capital (8,500,000) is above 3,600,000 (120% of MRLC), there is no reporting requirement under s 55(1)(a) of FRR.

Scenario 3 [FRR Compliance using VRLC]

Assets
 Balance Sheet CalculationLiquid Assets
Client Assets0Nil
Licensed Corp’s Bank Balance100,000,000100,000,000
Total100,000,000100,000,000
Liabilities
 Balance Sheet CalculationRanking Liabilities
AP to Brokers61,000,00061,000,000
Approved Subordinated Loan00
Total61,000,00061,000,000
Liquid Capital
 100,000,000 (Liquid Assets) – 61,000,000 (Ranking Liability)
= 39,000,000 (Liquid Capital)
What is the RLC in this case?
Higher of  
VRLCAL =
61,000,000 (On-Balance Sheet Liabilities) – 0 (Client Monies) – 0 (Subordinated Loans) = 61,000,000 AL (61,000,000) x 5% = 3,050,000 = VRLC
MRLC3,000,000
ConclusionRLC = VRLC as VRLC (3,050,000) is higher than MRLC (3,000,000) => Because Liquid Capital (39,000,000) is above RLC, Licensed Corp is in compliance with FRR => Because Liquid Capital (39,000,000) is above 3,660,000 (120% of VRLC), there is no reporting requirement under s. 55(1)(a) of FRR.

Scenario 4 [FRR Breach using VRLC]

Assets
 Balance Sheet CalculationLiquid Assets
Client Assets0Nil
Licensed Corp’s Bank Balance100,000,000100,000,000
Total100,000,000100,000,000
Liabilities
 Balance Sheet CalculationRanking Liabilities
AP to Brokers95,450,00095,450,000
Approved Subordinated Loan00
Total95,450,00095,450,000
Liquid Capital
 100,000,000 (Liquid Assets) – 95,450,000 (Ranking Liability)
= 4,550,000 (Liquid Capital)
What is the RLC in this case?
Higher of  
VRLCAL = 95,450,000 (On-Balance Sheet Liabilities) – 0 (Client Monies) – 0 (Subordinated Loans) = 95,450,000 AL (95,400,000) x 5% = 4,770,000 = VRLC
MRLC3,000,000
ConclusionRLC = VRLC as VRLC (4,772,500) is higher than MRLC (3,000,000) => Because Liquid Capital (4,550,000) is below VRLC (4,772,500), Licensed Corp is not in compliance with FRR

Scenario 5 [Use of Subordinated Loan]

Assets
 Balance Sheet CalculationLiquid Assets
Client Assets0Nil
Licensed Corp’s Bank Balance110,000,000
(10,000,000 Cash from Subordinated Loan)
110,000,000
Total110,000,000110,000,000
Liabilities
 Balance Sheet CalculationRanking Liabilities
AP to Brokers95,450,00095,450,000
Approved Subordinated Loan10,000,000Nil
Total105,450,00095,450,000
Liquid Capital
 110,000,000 (Liquid Assets) – 95,450,000 (Ranking Liability)
= 14,550,000 (Liquid Capital)
What is the RLC in this case?
Higher of  
VRLCAL = 105,450,000 (On-Balance Sheet Liabilities) 0 (Client Monies) 10,000,0000 (Subordinated Loans) = 95,450,000 AL (95,450,000) x 5% = 4,772,500 = VRLC
MRLC3,000,000
ConclusionRLC = VRLC as VRLC (5,000,000) is higher than MRLC (3,000,000) => Because Liquid Capital (14,550,000) is above VRLC, Licensed Corp is in compliance with FRR => Because Liquid Capital (14,550,000) is above 5,727,000 (120% of VRLC), there is no reporting requirement under s. 55(1)(a) of FRR.

Key Highlights on Hong Kong SFC Amended AML/CFT Guidelines (took effect on September 2021)

Key Highlights on SFC Guideline on AML/CFT issued September 2021

  1. Institutional risk assessment
  2. Due Diligence on cross-border correspondent relationship
  3. Third-party deposits and payments


1.  Institutional Risk Assessment

Financial Institution (FI) should: – 
(a) Consider all relevant risk factors before determining the level of overall risk and the appropriate level and type of mitigating measures to be applied (“Considering relevant risk factors”)
(b) keep the risk assessment up-to-date
(c) document the risk assessment
(d) obtain the approval of senior management of the risk assessment result
(e) have appropriate mechanisms to provide risk assessment information to relevant regulators (e.g. SFC, JFIU, the police, etc.) upon request

Standard for Institutional Risk Assessment[Para 2.4] In considering the institutional risk assessment, an FI should consider quantitative and qualitative information obtained from relevant internal and external sources (e.g. government or FATF guidance) to identify, manage and mitigate the risk.  We find this provision not very helpful. 

[Para 2.5] Nature and extent of institutional risk assessment procedures should be commensurate with the nature, size and complexity of the business of the FI
– FI’s business smaller in size or less complex => simpler risk assessment
– FI’s products and services are more varied and complex => more sophisticated risk assessment. 

Considering relevant risk factors
[Para 2.6] FI should holistically take into account relevant risk factors including (a) country risk, (b) customer risk, (c) product/service/transaction risk, (d) delivery/distribution channel risk, and (e) other relevant risks exposed to FI
=> Too broad  => BUT  Appendix A explains in detail about these risks with examples!

[Para 2.7]  Examples of Risks (helpful)
(a) Country Risk – jurisdiction in which the FI is operating or exposed to, either through its own activities or the activities of the customers.  Greater vulnerability due to (i) crime, corruption or financing of terrorism, (ii) general level and quality of jurisdiction’s law enforcement efforts related to AML/CFT, (iii) regulatory and supervisory regime and controls, and (iv) transparency of beneficial ownership
(b) Customer Risk – proportion of customers identified as high risk
(c) Product/Service/Transaction Risk – characteristics of the products and services that it offers and transactions it executes, and the extent of which these are vulnerable to ML/TF abuse.
(d) Delivery/Distribution Channel Risk – extent of which FI deals with customer, the extent of which it relies on third parties to conduct CDD or AML/CFT regulations.
(e) Other Risk – the review results of compliance, internal and external audits as well as regulatory findings.

Keeping risk assessment up-to-date 

[Para 2.9]  FI should review the institutional risk assessment at least every 2 years or more frequently upon trigger events with material impact on the firm’s business and risk exposure. 

Documenting risk assessment
[Para 2.9]  An FI should maintain records and relevant documents of the institutional risk assessment…   => Wolfsberg Questionnaire is a good starting point.

Two types of Questionnaires
Correspondent Banking Due Diligence Questionnaire (CBDDQ)
Financial Crimes Compliance Questionnaire (FCCQ)

  •  Due Diligence on cross-border correspondent relationship
[Para 4.20.1]  Correspondent Institution and Respondent Institution

“Cross-border correspondent relationships” refer to provision of services for dealing in securities…by an FI in HK (“Correspondent Institution”) to another financial located in a place outside of Hong Kong (“Respondent Institution”) where transactions effected on a principal (matched principal) or agency basis under the business relationships are initiated by the respondent institution.”

[Para 4.20.3] Vulnerability to AML/CFT risks

“ Where a Respondent Institution conducts business for or on behalf of customers through a cross-border correspondent relationship with an FI, the FI normally has limited information regarding underlying transactions and the nature or purpose of the  underlying transactions because it generally does not have direct relationships with the underlying customers of the Respondent Institution.”

“This will expose the FI to risks stemming from the lack or incompleteness of information about the underlying customers and transactions.” 

“FI must carry out CDD measures in relation to a customer including a Respondent Institution (special customer?).  Although an FI…(cannot) verify the identities of the beneficial owners (of the respondent institutions), FI should apply the following additional due diligence when it establishes a cross-border correspondent relationship (exception for existing Respondent Institution for 6 months grace period – end of March 2022)…”: 
(a) To understand the Respondent Institution’s business
(b) To determine the reputation of the Respondent Institution (based on public information)
(c) To determine the quality of the regulatory supervision over the Respondent Institution
(d) To assess AML/CFT controls of the Respondent Institution
(e) To obtain approval from senior management
(f) To understand FI’s AML/CFT responsibilities

[Para 4.20.6]  Risk Based Analysis (RBA) 

“FI should adopt an RBA in applying the additional due diligence measures stated above, taking into account relevant factors such as:

  • The purpose of the cross-border relationship, the nature and expected volume and value of transactions
  • How the Respondent Institution will provide services to its underlying customers through the account maintained by the FI for the Respondent Institution (“Correspondent Account”) 
  • The types of underlying customers whom the Respondent Institution intends to serve through the Correspondent Account and the extent of which any of these underlying customers and their transactions are assessed as high risk by the Respondent Institution
  • The quality and effectiveness of the AML/CFT regulation as well as supervision by authorities in the jurisdictions in which the Respondent Institution operates and/or is incorporated
[Para 4.20.7] Information to collect to understand the Respondent Institution includes the Respondent Institution’s: 

  • Management and Ownership
  • Financial Group
  • Major Business Activities
  • Target Markets
  • Customer Base
  • Location of Customers

Documenting risk assessment
[Para 2.18]  An FI should maintain records and relevant documents of the institutional risk assessment… 

 => Wolfsberg Questionnaire is a good starting point!

Two types of Questionnaires
Correspondent Banking Due Diligence Questionnaire (CBDDQ)
Financial Crimes Compliance Questionnaire (FCCQ)

  • Third-party deposits and payment (3/4)
[Para 11.3]
“Third-party deposits or payments should be accepted only under exceptional and legitimate circumstances and when they are reasonably in line with the customer’s profile and normal commercial circumstances”

Adequate policies and procedures (including risk management procedures) should be put in place, setting out;
(a) exceptional and legitimate circumstances under which third-party deposits or payments may be accepted and their evaluation criteria
(b) monitoring systems and controls for identifying transactions involving third—party deposits
(c) enhanced monitoring of client accounts involving third-party deposits or payments and the reporting of any ML/TF suspicions identified to the JFIU
(d) respective designated mangers or staff responsible for carrying out these policies and procedures

[Para 11.9] Delayed Due Diligence

“FI should perform due diligence on the source of the deposits before settling transactions with the deposited funds.

However, FI may, in exceptional situations, complete the third-party deposit due diligence after settling transactions with the deposited funds, provided that
(a) any risk of ML/TF arising from the delay in completing the third-party deposit due diligence can be effectively managed;
(b) it is necessary to avoid interruption of the normal conduct of business with the customer; andd
(c) the third-party deposit due diligence is completed as soon as possible after settling transactions with the deposited funds. 

[Para 11.11]  In case third-party deposit due diligence cannot be completed within the reasonable timeframe setout in the FI’s risk management policies and procedures, FI should refrain from carrying out further transactions for the customer.