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.