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 Calculation | Liquid Assets | |
| Client Assets | 2,000,000 | Nil |
| Licensed Corp’s Bank Balance | 2,400,000 | 2,400,000 |
| AR from Client (less than 2 weeks) | 3,000,000 | 3,000,000 |
| Total | 7,400,000 | 5,400,000 |
| Liabilities | ||
| Balance Sheet Calculation | Ranking Liabilities | |
| AP to Clients | 5,500,000 | 5,500,000 |
| Rent Payment | 500,000 | 500,000 |
| Approved Subordinated Loan | 0 | 0 |
| Total | 6,000,000 | 6,0000,000 |
| 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 | ||
| VRLC | AL= = 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 | |
| MRLC | 3,000,000 | |
| Conclusion | RLC = 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 Calculation Liquid Assets Client Assets 2,000,000 Nil Licensed Corp’s Bank Balance 10,000,000 10,000,000 AR from other Brokers (less than 2 weeks) 1,000,000 1,000,000 AR from other Brokers (due more than 6 weeks) 500,000 Nil Total 13,500,000 11,000,000 Liabilities Balance Sheet Calculation Ranking Liabilities AP to Brokers 2,000,000 2,000,000 Loan 500,000 500,000 Approved Subordinated Loan 0 0 Total 2,5000,000 2,500,000 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 VRLC AL= 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 = VRLCMRLC 3,000,000 Conclusion RLC = 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 Calculation Liquid Assets Client Assets 0 Nil Licensed Corp’s Bank Balance 100,000,000 100,000,000 Total 100,000,000 100,000,000 Liabilities Balance Sheet Calculation Ranking Liabilities AP to Brokers 61,000,000 61,000,000 Approved Subordinated Loan 0 0 Total 61,000,000 61,000,000 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 VRLC AL =
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 = VRLCMRLC 3,000,000 Conclusion RLC = 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 Calculation Liquid Assets Client Assets 0 Nil Licensed Corp’s Bank Balance 100,000,000 100,000,000 Total 100,000,000 100,000,000 Liabilities Balance Sheet Calculation Ranking Liabilities AP to Brokers 95,450,000 95,450,000 Approved Subordinated Loan 0 0 Total 95,450,000 95,450,000 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 VRLC AL = 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 MRLC 3,000,000 Conclusion RLC = 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 Calculation Liquid Assets Client Assets 0 Nil Licensed Corp’s Bank Balance 110,000,000
(10,000,000 Cash from Subordinated Loan)110,000,000 Total 110,000,000 110,000,000 Liabilities Balance Sheet Calculation Ranking Liabilities AP to Brokers 95,450,000 95,450,000 Approved Subordinated Loan 10,000,000 Nil Total 105,450,000 95,450,000 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 VRLC AL = 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 MRLC 3,000,000 Conclusion RLC = 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.