Supervisory Policy Manual SB-2: Leveraged Foreign Exchange Trading

This module should be read in conjunction with the Introduction and the Glossary, which contains an explanation of abbreviations and other terms used in this Manual. If reading on-line, click on blue underlined headings to activate hyperlinks to the relevant module. ————————— Purpose To set out the HKMA’s approach to supervising AIs’ conduct in leveraged foreign exchange trading, including the making of unsolicited calls in connection with leveraged foreign exchange trading as well as the appraisal of customers in this regard Classification A statutory guideline issued by the MA under the Banking Ordinance, §7(3) Previous guidelines superseded Guideline 7.2 “Leveraged foreign exchange trading rules” dated 19.12.94; 7.4.1 "Guideline on Leveraged Foreign Exchange Trading Issued under Section 7(3) of the Banking Ordinance (Cap155)" dated 16.11.95; Guideline 7.5 "Leveraged Foreign Exchange Trading Conduct for Unsolicited Calls and Appraisal of Customers" dated 22.03.96; and SB-2 “Leveraged Foreign Exchange Trading – Conduct of Unsolicited Calls” (V.1) dated 28.03.03 Application To all AIs Structure

1. Introduction
   1.1 Terminology

1.2 Statutory exemption from the Securities and Futures
Ordinance
2. Conduct of leveraged foreign exchange trading activities
2.1 General principles
2.2 Unsolicited calls
2.3 Distribution of standard promotional materials
3. Conduct of unsolicited calls and appraisal of customers
3.1 Selection of customers
3.2 Marketing of leveraged foreign exchange contracts
through unsolicited calls
3.3 Staff suitability to make unsolicited calls
3.4 Standards of conduct for unsolicited calls
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1. Introduction
   1.1 Terminology
   1.1.1 In this module:

• “call” means a visit in person, or a communication
  by any means, whether mechanically, electronically, magnetically, optically, manually or by any other medium, or by way of production or transmission of light, image or sound or any other medium;
• “corporation”, “licensed corporation”, “related
  corporation” and “specified stock exchange” have the meanings as set out in Schedule 1 to the Securities and Futures Ordinance (SFO);
• “leveraged foreign exchange contract” has the
  meaning as set out in Schedule 5 to the SFO;
• “LFET” refers to leveraged foreign exchange
  trading, which has the meaning assigned to it by

Part 2 of Schedule 5 of the SFO. In broad terms,
it means: (i) the act of entering into or offering to enter into, or inducing or attempting to induce a person to enter into or to offer to enter into, a leveraged foreign exchange contract; (ii) the act of providing any financial accommodation to facilitate foreign exchange trading or to facilitate an act referred to in (i); or (iii) the act of entering into or offering to enter into, or inducing or attempting to induce a person to enter into, an arrangement with another person, on a discretionary basis or otherwise, to enter into a contract to facilitate an act referred to in (i) or (ii). It includes, but is not confined to, margin trading;

• “margin trading” means any transaction between
  an AI and a counterparty for the purchase or sale of foreign currencies, where the counterparty is required to put up only a small proportion of the value of the contract with the AI and top up such “margin” throughout the life of the contract if the exchange rate between the subject currencies moves against him, and with final settlement being made by reference to differences in rates rather than actual delivery;
• “RI” means an AI that is a registered institution
  under the SFO;
• “SFC” means the Securities and Futures
  Commission; and
• “unsolicited call” means any call made otherwise
  than at the express invitation of the person called upon. For the purposes of this definition, the provision by a person of his contact details, including an address, telephone or facsimile number, or electronic mail address, does not by itself constitute an express invitation to call that person.
  1.1.2 The explanations of legal terms given above are for
  general reference only. For a complete and definitive statement of the legal terms, direct reference should be

made to the SFO. Legal advice should be sought where precise interpretation is required.
1.2 Statutory exemption from the Securities and Futures
Ordinance
1.2.1 AIs are not subject to the registration regime set out in
the SFO for Type 3 regulated activity (LFET) and the rules in respect of such activity made by the SFC under that Ordinance. This acknowledges that AIs are subject to their own supervisory regime set out in the Banking Ordinance.
1.2.2 Nevertheless, some of the provisions of the SFO, e.g.
§§300 1 and 301 2 , are of general application to all persons. AIs, particularly those which are already involved in LFET, should therefore familiarise themselves with these provisions of the Ordinance.
2. Conduct of LFET activities
2.1 General principles
2.1.1 The HKMA expects that LFET activities of AIs are
conducted in a responsible, honest and business-like manner. AIs should have adequate systems of internal control for LFET activities.
2.1.2 AIs must treat their customers fairly and take into
account customers' interests in offering their advice and financial products. Where advice is provided, the advice should be objective and should be based on the customer's profile, considering the complexity of the product, the risks associated with it as well as the customer's financial objectives, knowledge, capabilities and experience.
2.1.3 AIs should make adequate disclosure of risks associated
with LFET, and ensure that the customer is willing and 1 §300 of the SFO relates to an offence of employing fraudulent or deceptive devices, etc. in transactions involving securities, futures contracts or LFET. 2 §301 of the SFO relates to the offence of disclosure of false or misleading information inducing others to enter into a leveraged foreign exchange contract.

has sufficient net worth to assume the risks and bear the potential losses of margin trading.
2.2 Unsolicited calls
2.2.1 Notwithstanding the general exemption that applies to
AIs, §174 of the SFO, with limited exceptions, prohibits the making of certain agreements in relation to leveraged foreign exchange contracts by a RI during unsolicited calls3 .
2.2.2 According to the Securities and Futures (Unsolicited
Calls – Exclusion) Rules, §174 of the SFO does not apply to any unsolicited call that is either:

• a permissible communication (as defined in the
  Rules); or
• made by a RI in relation to a leveraged foreign
  exchange contract in compliance with applicable requirements under the “Monetary Authority guideline”.
  2.2.3 This statutory guideline is the “Monetary Authority
  guideline” referred to in the Securities and Futures (Unsolicited Calls – Exclusion) Rules.
  2.2.4 Although §174 of the SFO and the Securities and
  Futures (Unsolicited Calls – Exclusion) Rules do not apply to an AI that is not a RI, the HKMA expects all AIs that make unsolicited calls in relation to leveraged foreign exchange contracts to observe the specific requirements set out in section 3 of this guideline.
  2.3 Distribution of standard promotional materials
  2.3.1 Where standard promotional materials are distributed to
  the general public not in the course of a visit in person or any other interactive dialogue, the act in itself can be interpreted as a permissible communication. This interpretation is derived from the definition of permissible communication under the Securities and Futures 3 Apart from leveraged foreign exchange contracts, §174 of the SFO also prohibits the making of certain agreements relating to securities, futures contracts and securities margin financing through unsolicited calls.

(Unsolicited Calls – Exclusion) Rules, and the fact that such communication does not require the recipient to respond immediately to it4 .
2.3.2 By the same token, §174 of the SFO does not apply to
the sending of standard promotional materials together with statements of account to general banking customers.
3. Conduct of unsolicited calls and appraisal of customers
3.1 Selection of customers
3.1.1 The marketing and promotion of leveraged foreign
exchange contracts by AIs through unsolicited calls should, among other things, be targeted at customers considered to be capable of understanding and bearing the potential financial risks that may arise from such contracts. AIs should take account of the fact that certain customers may not be able to fully understand the risks and obligations involved in such contracts or that these may otherwise be inappropriate for certain customers.
3.1.2 For such customers, there is a risk that unsolicited calls
may lead them into transactions for which they are unprepared and which they would not otherwise have undertaken. AIs should therefore have policies and procedures for identifying customers whom they consider are unsuitable for unsolicited calls.
3.1.3 Where such customers take the initiative to approach the
AI to enter into leveraged foreign exchange contracts, the AI may decide to engage in the transaction but should ensure in the normal way that adequate credit assessment of the customer is made and that there is proper explanation to the customer of the risks involved.
3.2 Marketing of leveraged foreign exchange contracts through
unsolicited calls
4 According to the Securities and Futures (Unsolicited Calls – Exclusion) Rules, the fact that the communication does not require the recipient to respond immediately to it is one of the factors indicating a permissible communication.

3.2.1 The HKMA expects AIs to be selective in the marketing
and promotion of leveraged foreign exchange contracts. As a result, for the purpose of soliciting a person to enter into a LFET transaction, an AI may:

• call a person who has entered into a written
  agreement with the AI for it to provide, transact with or undertake on behalf of, that person, leveraged foreign exchange contracts;
• call any person who, at the date of such call, has
  deposits in excess of $750,000 with the AI or assets in excess of $750,000 under management, whether on a discretionary or non-discretionary basis, by the AI or a related corporation or one or more of them;
• call a corporation which is a related corporation of
  a corporate customer and meets the above deposit or asset tests;
• call a corporation which is listed on a specified
  stock exchange or a related corporation of such corporation;
• call a corporation with a paid-up share capital that
  is not less than the minimum expected market capitalisation of new applicants at the time of listing under the Listing Rules of the Stock Exchange of Hong Kong Limited, or a related corporation of such corporation;
• in relation to contracts other than margin trading
  contracts, call any corporation;
• call another AI or a related corporation of such AI;
• call a licensed corporation or a related corporation
  of such corporation; or
• call an insurer authorized under the Insurance
  Ordinance (Cap. 41) or a related corporation of such insurer.
  3.2.2 Where the call is made to a corporation, it should be
  made to a person who is authorized to trade on behalf of the corporation.

3.2.3 AIs should note the definition of “call” in para. 1.1.1 and
ensure that the above requirements on marketing are observed regardless of whether a person is being approached by a telephone call or at branch premises.
3.3 Staff suitability to make unsolicited calls
3.3.1 AIs should have adequate internal procedures to ensure
that only suitable staff are allowed to make unsolicited calls. These staff should possess the necessary knowledge of leveraged foreign exchange products and should be familiar with the AI’s policies and procedures relating to the conduct of unsolicited calls, as well as the requirements provided in this guideline. Appropriate training should be provided to such staff.
3.3.2 The HKMA expects AIs to be able to provide on request
evidence that they are capable of exercising adequate supervision of the making of unsolicited calls by the relevant staff. Such evidence should be maintained in such a way that it can be reviewed by the internal auditors or the HKMA and may include the following:

• written policies and procedures issued by the AIs
  on the making of unsolicited calls;

• information on the qualifications and experience of
  the relevant staff; and

• information on the contents of the relevant training
  programmes.
  3.4 Standards of conduct for unsolicited calls
  3.4.1 AIs should ensure that their staff observe the following
  standards when making unsolicited calls:

• unsolicited calls must not be made before 8:00
  a.m. or after 9:00 p.m., unless the customer has specifically agreed that calls may be made outside this period;

• the caller must terminate the telephone call
  immediately, or leave the premises immediately, if the customer makes it clear that he does not wish the call to continue;

• the caller must take reasonable steps to ensure
  that the customer understands the purpose of the call and the kind of investments or investment services which the caller wishes to discuss during the call;

• the caller must not attempt to disguise the
  purpose of the call or the nature of the investment agreement which the customer may enter into;

• the caller must not make an unsolicited call on a
  customer with the object of discussing a subject which the customer has recently made it clear that he does not wish to discuss;

• in relation to margin trading contracts, the caller
  must make a risk disclosure statement to the customer explicitly warning the customer of the risks of margin trading; and

• where the caller provides information to enable
  the customer to understand the nature and risks of a transaction, it should:

• ensure that the information is accurate;

• ensure that information in any economic
  forecast is reasonable, based on proper research and reasonable grounds; and

• present the downside and upside of the
  proposal in a fair and balanced fashion.
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