FIS Blog

Trading in Asia: The one-two punch of the five percent rule

Chris Rojek | Monday, February 15, 2016

The five percent rule was published in response to the penny stock crash of 2013 when numerous penny stocks lost significant value. Because the Singapore market allows retail investors to fund their stock purchases at any time before the transaction closes – not upfront as in most other markets around the world – many investors simply walked away from their deals when these share prices plummeted.

The Monetary Authority of Singapore (MAS) responded with the five percent rule. It has three objectives: “(i) mitigate the risk of substantial loss of investors from excessive trading on unsecured credit; (ii) strengthen credit risk practices in the industry by reducing reliance on remisiers to bear the credit risk of investors; and (iii) promote orderly trading and prudent investing among investors.”

The references to risk are key. Initially, many brokers assumed they wouldn’t have to change their day-to-day practices. After all, customers are still allowed to fund transactions after making their purchases. So the logic runs like this: If the customer needs to top up at the end of the day, then we don’t need to do anything until the market closes. We then run the back-office reports and see who needs to top up collateral – it’s that simple.

But wait. Singapore’s equity brokers have huge retail businesses, ranging from 200,000 to 500,000 customers per firm. On a busy day, 50,000 customers might trade. It’s physically impossible to review the raw account status report within two hours at the end of the day.

Even if it was possible, collateral needs to be topped up on the same day, not the next day. So brokers can’t wait until the end of the day.

MAS has actually made it very clear that intraday risk management now becomes a top priority. Brokers must know what their clients are doing during the day. This is not designed to stop clients from trading, but to stop them from increasing their positions if they are short of collateral to cover them. Otherwise, MAS will impose higher collateral requirements.

Brokers will have to adapt their business practices to comply. Today, firms generally run an end of the day report and disclose any limit breaches to management the following morning. Now they will have to be proactive. In the event of a five percent breach, the account managers and risk managers will have to work together to increase the client’s collateral, have the client immediately reduce their positions or decide to stop the client’s trading altogether.

These changes won’t be possible without technology that can deal with exceptions in real time. With half a million customers, it’s impossible to check a spreadsheet application every five minutes and see which customers are close to the margin shortfall. And even though it’s a very simple calculation and a straightforward market, you need to know about any exceptions before they happen, not after.

Given the sheer number of trading accounts brokers have, the task of switching to a proactive risk management mode, from one of reactive back-office driven reporting, requires a major overhaul of the existing IT infrastructure at most brokerage houses.

However, real-time risk aggregation has several additional benefits beyond regulatory compliance. For example, along with managing client collateral levels, brokers would be able to consolidate open orders, revalue collateral in real time and run pre-trade checks.

So Singapore’s brokers need to consider both their business practices and their technology – a true one-two punch. But with preparation and robust, intelligent technology, brokers can avoid a knockout.


Tagged in: Institutional and Wholesale

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