Time to fix flaws in Singapore’s contra trading system

Time to fix flaws in local contra trading system

Wednesday, Oct 16, 2013

Goh Eng Yeow

The Straits Times

Last week, the local stock market suffered its worst calamity since the global financial crisis when the Singapore Exchange (SGX) “designated” the trading of three counters – LionGold Corp, Blumont Group and Asiasons Capital. The SGX edict means investors must pay for these three stocks in cash, while contra trading and short selling are banned. It came after the trio’s share prices went into free fall the previous Friday. As the losses mount, there is the usual finger-pointing to find scapegoats, and soul-searching to determine if things could have been done better to prevent a similar incident in future. One important observation to make is the many flaws in the “contra trading system” that have been uncovered by the fiasco.This refers to the practice by brokers here to offer up to three days’ credit to their clients to settle outstanding purchases without having to put up any cash or collateral. And if a client were to sell the purchased shares before settlement date, he could offset the sale against the purchase as a contra profit or loss.

Tied to this trading arrangement is the remisier – the self-employed broker – who has to furnish a banker’s guarantee to his broking firm to account for any losses not paid by his clients.

Conventional wisdom dictates that such an outmoded and archaic system should have no place in a major financial market such as Singapore, given the outlandish risks brokers have to take, since they have no access to their clients’ finances and records of their Central Depository (CDP) accounts where their shares are kept.

This is considering that brokerage commissions for large trades can fall to as low as 0.15 per cent of the contract value. It also runs counter to the practice in other markets, such as Hong Kong and Australia, where investors have to pay for their stock purchases up front.

But what must surely take the cake is the ample opportunity contra trading affords to stock manipulators wanting to rig the market through a mechanism known as “wash sales” at minimal costs, since no upfront purchase payment is needed.

This typically involves a group of people buying and selling a stock in a way that does not involve a change in beneficial share ownership – to give a misleading impression that the stock was hotly pursued. The idea is to ramp up the share price.

Thus, it is not surprising that broking houses should resort to extraordinary measures to protect themselves from the huge contra losses their clients could incur whenever exuberant trading threatens to get out of hand.

Typically, this involves restricting a client’s exposure to a speculative counter by requiring them to make their stock purchases in cash. To enforce the rule, the brokerage also bans online trading of the stock.

So when stocks such as Blumont, LionGold and Asiasons went on a bull rampage in the past few months, big retail brokerages such as UOB Kay Hian – quite sensibly as it turned out – slapped trading curbs on them.

Now that the speculative bubble has burst on the trio, stories are circulating about the huge losses incurred by brokerages which failed to take similar steps.

This is not healthy. It leaves market pundits wondering if a similar curb imposed by one of the bigger broking houses in future will mean a mad scramble by others to follow suit.

Then there is the confusion over the trading restriction guidelines imposed on the three counters by the SGX – an anachronistic move which regulators in other stock markets would find alien.

It stipulates that an investor has to wait four days for the “designated” stock to be credited into his account if he wants to sell it, even though he has paid cash for the shares upfront.

Mr Jimmy Ho, the president of The Society of Remisiers, said that this runs counter to the SGX’s own trading rule book, which states that an investor who pays for a designated stock in cash would get his shares credited by 3pm the next day.

It leads others, such as former Morgan Stanley investment banker Michael Dee, to ask if there is another major bourse where an investor has to wait four days before he can sell a stock he has already paid for. It is a draconian move which may lead to much regret later on.

One final problem: Because remisiers have no access to their clients’ CDP accounts, they are now required to get clients to show evidence that they own the designated securities, before they are allowed to sell.

This is because the CDP does not provide for a link-up to stock trading accounts. This is unlike other markets such as Hong Kong, where stocks are kept with the broker so that there is no confusion when a client wants to off-load shares.

It is the pious hope of this column that the latest round of horrendous losses will spur the SGX and the broking houses to tackle all the issues which have been raised, and how they can be resolved to safeguard the interests of remisiers and their clients.

Already, there are too many horror tales of deeply traumatised traders and bankrupt remisiers circulating.

Time to act.

engyeow@sph.com.sg