Conflicts of interest have long been a recurring regulatory concern for the SFC. Over the years, it has spotted some problems to do with client facilitation and provided guidance to the industry to address them. It has recently published a list of the mistakes that it has caught firms making.
Typically, clients use facilitation services to obtain liquidity or achieve a guaranteed execution price. As the nature of the relationship between client and broker may change in a facilitation transaction because licensed corporations assume a risk-taking principal position rather than an agency position, conflicts of interest may arise.
Findings from inspections
The SFC's latest review of brokers' compliance with its 'expected standards' (see below) began in the middle of last year. It found the following.
- Some traders misrepresented a house or client facilitation trade as an agency trade.
- Some traders were silent or not transparent about whether facilitation was to be involved in a trade.
- Some traders failed to obtain explicit pre-trade consent from clients when effecting client facilitation trades.
- Some indications of interest were described as natural, although they were not based on a genuine intent among clients to trade.
- Some firms’ policies and procedures were not clear and could not ensure compliance with the 'expected standards,' although they reported that their client facilitation policies were reviewed and enhanced in the light of the previous results that the SFC published in February last year. For example, some of the prescribed in-house language and written notifications to clients described the nature of trades in an ambiguous manner. The rest were the same as the above, indicating that these are perennial problems.
The SFC takes the occasion to say that brokerage firms and their traders should obtain explicit consent from clients before each client facilitation trade. Such consent should never be 'unidirectional,' blanket, implied by the making of some kind of disclosure or obtained after the trade.
Expected standards
The standards of conduct and internal controls the SFC expects of licensed corporations providing client facilitation services include:
- Controls, monitoring and management supervision. Each firm should establish policies and procedures which cover vital points such as the consent of the client, the visibility of the order, access to a system, the accuracy of indications of interest and position limits.
- Segregation of agency and facilitation activities. For client facilitation orders, the firm should record and monitor communications between agency and client facilitation traders in a timely way.
- Consent and disclosure. As firms assume a risk-taking principal position against clients in client facilitation activities, they should divulge the nature of the trades to clients and obtain their consent beforehand, so that they are fully aware of the inherent conflicts of interest. The parties responsible for obtaining consent should be identified clearly.
- Indications of interest. IOIs should only be disseminated when they are based on a genuine client's intent (or proprietary intent) to trade and they should provide enough details.
