Hong Kong’s Securities and Futures Commission (SFC) today issued a circular reminding licensed corporations (LCs) that the expected regulatory standards covering customer due diligence, handling of client orders, conflicts of interest and information for clients in respect of leveraged foreign exchange trading (LFET) activities will come into effect on January 1, 2021.

LCs are reminded to ensure that they have internal controls, systems and procedures in place to comply with the expected regulatory standards.

Forex brokers will have to:

• (a) take all reasonable steps to establish the financial situation, investment experience and investment objective of each client trading Forex using leverage; and
• (b) assure themselves that the client understands the nature and risks of the LFET products they offer and has sufficient net worth to assume the risks and bear the potential losses of trading in the products.

Adequate information should be provided so that client is reasonably able to understand the risks associated with LFET. This should include, amongst others:

• the risks associated with the underlying market;
• the risk of LFET and margin trading;
• the fact that the product is being sold over-the-counter (OTC) and its implications.

Forex brokers are expected to execute client orders on the best available terms and avoid any dishonest and unfair execution practices, such as asymmetrical treatment of positive and negative slippage which allow the broker to retain profits arising from positive slippage, whilst passing losses from negative slippage on to the client.

Also, FX brokers have to adopt a fair pricing methodology by:

• referencing the prices offered to clients to market data;
• using independent and externally verifiable price sources or liquidity providers to derive the prices; and
• ensuring that all charges, mark-ups or fees affecting clients are fair and reasonable and characterised by good faith.

The regulator notes that some FX brokers’ business models present inherent conflicts of interest, in particular where a broker takes opposite positions against client orders or hedges client orders with liquidity providers which are affiliated companies.

Regardless of the business model adopted, FX brokers should state in the client agreement whether they take opposite positions to client orders. They should take all reasonable steps to avoid any conflicts of interest, and when such conflicts cannot be avoided, ensure that their clients are fairly treated and disclose any actual or potential conflicts of interest before transacting with clients.

The SFC says that FX brokers should provide clear and effective disclosure to clients about how their orders are executed. This should include, amongst others:

• the order execution policy, explaining the methodology they use to deliver the best possible outcome when executing orders; and
• the methodology for determining the prices of different LFET products.