FUTURES TRADING BILL

Order for Second Reading read.

The Minister for Finance (Dr Hu Tsu Tau): Mr Speaker, Sir, I beg to move, "That the Bill be read a Second time."

Before I proceed to describe the contents of the Bill, let me first brief Members on the nature of futures trading and the reasons why futures legislation is necessary.

In futures trading, a person enters into a futures contract which is a commitment to buy or to sell, at an agreed price, a standard quality of a particular commodity or financial instrument for delivery at a future date. Futures contracts enable a person to predetermine the price he has to pay or will receive for a commodity which he is liable to purchase or sell at a later date. This permits him to protect himself against potential price fluctuations. In addition to this hedging function, futures contracts perform another economic function, that of price dissemination. As trading in futures contracts is carried out in a centralized location, this leads to a wider dissemination of price information, which results in more efficient markets.

Futures trading in commodities, for example, wheat and corn, has a long history. It was said that the basic principles in futures trading, that is, trade now and settle later, was evident as early as 2000 BC. In recent years, trading in futures contracts based on financial instruments have become very popular. The free float of currencies in the foreign exchange markets have led to greater volatility in exchange rates. Consequently, currency futures became an important instrument to hedge against movements in exchange rates for importers, exporters, bankers and other institutions.

The popularity of financial futures as an instrument for managing risks in the financial market increased further when the Federal Reserve Board of the United States embarked in October, 1979, on a new monetary policy of targetting money supply growth rather than interest rates, resulting in US Dollar interest rates fluctuating widely.

Trading volumes in interest rate futures contracts soared, as banks, other financial institutions and corporate treasurers sought to hedge their interest rate exposures. Today, financial futures have assumed a prominent position in the financial markets of the world.

With the opening of the Singapore International Monetary Exchange (SIMEX) in September, 1984, Singapore became the first country in Asia to have a financial futures exchange. Although SIMEX was organized as a self-regulatory body, it became clear in our review of the countries with major futures markets and our discussion with foreign regulatory agencies that there should still be some basic form of legislation to provide the framework for an orderly market and an appropriate environment whereby self-regulation can work. Without such a legislation, the economic functions of the futures market might be hindered through attempts to manipulate the prices of futures contracts. In addition, users of the futures market could be exploited by unscrupulous operators.

Some Members may still remember that in the early 1980s the presence of gold futures firms which operated as "bucket shops" led to the investigation in 1982 of 24 gold futures trading companies for possible malpractices. Examination of the accounts of these companies showed that they had access to more than $14 million in customer funds. Some of these companies were found to have misappropriated customer funds. Others had operated their customer accounts to the detriment of the customers by over-trading in order to generate commission for themselves. 21 of these companies were subsequently wound up by the courts and a director of one of these firms was sentenced to imprisonment for criminal breach of trust. Further action could not be taken against the directors of the other firms, despite the findings of gross malpractices as our existing laws made prosecution difficult. In the absence of any legislation regulating futures trading, there would be no strong deterrent to prevent other companies from being set up to repeat the activities of the early 1980's.

It is against this background that the Futures Trading Bill is proposed to ensure that our futures market is operated properly and that public interest is preserved. Furthermore, the Bill will provide investors, especially international investors, with the confidence that our futures market is operated fairly. In this context, most Members will be aware that to benefit from the US experience in futures markets, SIMEX has established a link with the Chicago Mercantile Exchange. As a result of this arrangement, participation from US investors in SIMEX has been relatively heavy. There was a general understanding between the Commodity Futures Trading Commission, the US regulatory authority for futures trading and MAS that we would introduce legislation in due course.

At present, the scope of the Bill is limited to the regulation of trading in gold and financial futures contracts. Trading in futures contracts based on commodities not listed on SIMEX, such as coffee, red beans, etc, is not regulated under this Bill. It is not considered as yet appropriate for the MAS to regulate these other activities since they do not involve the financial sector. Broking firms that offer facilities solely in commodities futures are thus not subject to the regulations of this Bill and members of the public who trade with them will have to accept the risks involved in dealing with these firms. Investors who wish to trade in commodities are advised to place their orders through members of SIMEX as their activities in commodities markets are also closely monitored by the Exchange.

I would like to stress at this juncture the need for investors to understand fully the risks involved in their investments and to be discriminating in their choice of the parties with whom they deal with. Firstly, the Bill does not indemnify investors against loss as a result of price risks to which they knowingly expose themselves. Secondly, although legislation can be enacted to deter fraud and other malpractices, it cannot totally prevent the occurrence of such events. The investor is thus obliged to protect his own interests. With the foregoing in mind, I will now deal with the main provisions in the Bill. The Bill may be broadly divided into six segments:

a) The approving of the establishment of futures exchanges;

b) The licensing of futures brokers;

c) Accounts and audits;

d) The conduct of business;

e) Prohibitions of fraudulent practices; and

f) Specific powers of the MAS to regulate the market. I will now elaborate on each of these segments.

Approving of the establishment of futures exchanges

Futures exchanges play a key role in the system of self-regulation, as they exercise wide control over the activities of their members. Therefore, to ensure that the exchanges carry out their self-regulatory role properly, the Bill would empower the MAS (a) to approve the establishment of an exchange and a clearing house and to revoke such approval given; (b) to amend the business rules of an exchange to ensure that the interests of the investing public are protected; and (c) to review the disciplinary action taken by the exchange against its members to ensure that the exchange would take appropriate disciplinary action against members who flout its rules to the detriment of the public.

In the Bill, SIMEX is not required to apply for approval as the MAS has overseen its development, including the review of all its rules and regulations, the screening of its members and having representatives on its board of directors.

Licensing of futures brokers

The next segment deals with the licensing of futures brokers and other agents. Futures brokers engage in the business of buying and selling futures contracts on behalf of customers. They collect good faith money, known as margin, from their customers. These brokers may also be given discretion by customers to trade on their behalf. Therefore, in the performance of their functions, these brokers can have access to substantial amounts of customers' funds and the disposal of these funds. The licensing provisions will regulate the entry and participation of futures brokers and other institutions acting as agents in the futures market and ensure that they carry out their business properly.

Futures brokers which are already members of SIMEX are unlikely to encounter any problems in obtaining licences from the MAS as these companies have already been reviewed by the MAS prior to their admission as members of SIMEX.

Accounts and Audits

The Bill also requires that these agents maintain adequate and proper accounts. In addition, external auditors are given an enlarged role to provide for further checks in the self-regulatory system.

The conduct of business

In the futures industry, the segregation of customers' funds plays a key role in the protection of their interests. The Bill provides that the funds placed by customers with their brokers for margin requirements must be separately accounted for and not be comingled with those of the brokers. This is to prevent brokers from making use of their clients' funds for any other pur- pose than for the benefit of the clients themselves.

Prohibitions of fraudulent practices

Certain unethical or fraudulent trading practices, such as trading against the client without first informing him (commonly known as bucketing) and the manipulation of prices of futures contracts are prohibited so as to preserve the integrity of the market and ensure that the interests of investors are not compromised.

Specific powers of the MAS to regulate the market

Finally, the Bill confers upon the MAS certain emergency powers. There may be occasions in which the market may be manipulated to the detriment of the general public. Under such circumstances, the MAS would be able to take rapid action to remedy the situation using its emergency powers. Other provisions provide the MAS with the necessary powers to conduct an effective surveillance of the market, including (a) conducting routine inspections of futures exchanges and brokers; (b) conducting investgations to determine whether any person has violated the Act; (c) calling for information from market participants; and (d) issuing regulations in the course of the discharge of its functions.

Finally, I should like to caution potential participants in the futures markets. Futures markets are, by nature, highly volatile and though offering potential for substantial gains also present real dangers for substantial losses. The Futures Trading Bill, while it aims to protect the interests of the investing public, cannot guarantee to investors that they will make profits or not suffer losses from participating in the market. The Bill only sets out the ground rules to ensure fair play and an orderly market. I would therefore strongly advise potential participants in the futures markets to fully understand the nature of futures markets and the risks involved before venturing into these markets. They will then appreciate that risk and futures trading are inseparable.

Sir, I beg to move.

Question proposed.

2.53 pm

Dr Augustine H.H. Tan (Whampoa): Mr Speaker, Sir, hon. Members will surely welcome this Bill as another step to safeguard the integrity of our financial system. As a small developing country, we have to build up confidence in our financial system if investors are going to put their money in Singapore and also if our own people are going to keep their profits and their savings in Singapore.

The regulations set out in this Bill are many and varied. I have one question in regard to the regulations and, that is, whether or not we have overdone it. For example, the licence is given only for one year at a time. Is it sufficient to induce people to set up the houses which are necessary to do the trading, especially if some fixed investments are required? On page 17, under clause 20, sub- clause (2) paragraph (a), the Authority can revoke a licence for a number of reasons but I take objection to sub-paragraphs (v) and (vi) and this also applies to sub-clause (2) (b), sub-paragraphs (vi) and (vii). They are analogous. One applies to a person and the other to a corporation. Clause 20 (2)(a)(v) says:

'if the Authority has reason to believe that the licensed person has not performed his duties efficiently, honestly or fairly;' It depends on interpretation, surely, what one means by "efficiently" or "fairly". "Honestly", I think, one can understand but this could lead to arbitrary exercise of powers by the MAS. Similarly sub-paragraph (vi) says that the licence can be revoked:

'if the licensed person contravenes or fails to comply with any condition or restriction applicable in respect of the licence;' I would have thought that if such a person had been convicted of an offence under the Act, then that should be grounds for revocation of a licence. But, as it appears, no conviction is necessary. All that is required is the judgment of an officer of the MAS.

Then in clause 23, there is provision for appeal to the Minister in case a licence is not granted or renewed or where a licence is revoked or suspended. There is no provision for appeal to a court. Normally, Ministers tend to listen to the civil servants who work under them. To safeguard the interests of those who set up futures trading houses, it might be desirable to have ultimate recourse to a court of appeal in addition to appealing to the Minister.

Another point has to do with whether the penalties which are specified in the Act are sufficient to deter wrongdoing. There are many penalties prescribed, most of them very small. But I would like to draw attention to page 39, clause 56, where a fine not exceeding $100,000 or imprisonment not exceeding seven years or both can be placed upon persons who violate offences under Part VII which include false trading, bucketing, dissemination of false information and the like. Sir, we are talking in terms of contracts which may be worth millions of dollars. So the fine of $100,000 appears to be rather small in relation to what unscrupulous operators can get away with.

Finally, Sir, the warning by the Minister on the dangers of engaging in the futures market by novices ought to be driven home. With the proliferation of financial instruments in Singapore, investment opportunities, particularly opportunities for speculation, not only in the futures market but also in stocks and shares and other markets as well, we should really have educational efforts to inform people about the merits and demerits of different types of investments and the dangers of speculation. What I am afraid of, Sir, is that with the availability of such a wide-range of instruments for speculation, a lot of time, energy and resources might be diverted from productive endeavours towards speculative endeavours to the detriment of Singapore's economy.

With the exception of these qualifications, Sir, I support the Bill.

Dr Hu Tsu Tau: Mr Speaker, Sir, I thank the Member for Whampoa for his comments on the Bill. I would take his points one by one.

As to whether we have overdone it, as he suggests, I would like to point out that, in fact, the contents and details of the Bill have been discussed extensively with the members of SIMEX themselves. They are familiar with the provisions and have no severe objections to the regulations.

Secondly, the Bill has been modelled on the United States' Commodities Trading Act so that we can follow as closely as possible within our laws trading practices as conducted in the United States because of the linkage between SIMEX and the Chicago Mercantile Exchange. We have to be able to assure American investors that the laws we apply here for futures trading are similar to the laws in which they are familiar with. So it is against this background that I am fairly confident that we have not overdone the provisions. In any case, the players in this market are generally professionals, people who I think are well aware of the risks involved and I take the point that the public at large should be cautioned again and again that this is not a casino they should indulge themselves in. Fortunately, the complexities of the market are such that I doubt very much that many non-professionals would indulge in it. However, given time this might change. So this point of educating the public will be kept in mind.

On the issue of appeal on the revocation of licences, this is a problem which has been levelled against the Government's other Bills in the past where it is considered rather unfortunate that there is no appeal past the Minister. The reason for this is, of course, that if we allow complete appeal on all licences to be taken to the courts, we would probably have to increase our courts many more times than there are now. I also believe that in the issue of a licence for a particular trading activity, it is not a constitutional right for anyone to have appeal to the courts. It is a privilege which the Government grants at its pleasure in order to ensure that the proper people are engaged in these activities.

As to the point about whether the penalties are adequate, these are set by the Attorney-General's Chambers, and the Attorney-General is satisfied that the provisions are sufficiently severe to deter anyone, except the most adventurous. Seven years in jail, I think, is not a minor sentence by any means. In any case the object of this Bill is to try and prevent the problems arising before they actually occur, and in this connection the provisions are quite strict. As you can see, in fact, some are over-strict in certain areas. Our objective is really to try and prevent a problem arising to the scale and size which requires life sentence, for example.

Question put, and agreed to.

Bill accordingly read a Second time and committed to a Committee of the whole House.

The House immediately resolved itself into a Committee on the Bill. - [Dr Hu Tsu Tau].

Bill considered in Committee; reported without amendment; read a Third time and passed.