FUTURES TRADING (AMENDMENT) BILL

Order for Second Reading read.

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

The Futures Trading Act was introduced in 1986 to foster the sound development of the financial futures industry. In 1984, the Singapore International Monetary Exchange, or SIMEX, was inaugurated to provide international investors with facilities to transact in financial futures. A tie-up with the Chicago Mercantile Exchange, or CME, in the form of a mutual offset linkage was established. The linkage would enable the futures positions entered on one exchange to be transferred to the other. SIMEX was able to establish the mutual offset linkage with CME because of the confidence the CME and its regulator, the US Commodities Futures Trading Commission, had of Singapore's commitment to establish and enforce a sound legislative framework to regulate futures trading.

In the past decade, the Futures Trading Act clearly served its purpose. The global stock market crash of October 1987 presented a major test. Prices of stock index futures fell sharply in tandem with the stock market, creating chaos in major futures exchanges, and led to the closure of a major futures exchange in Asia. SIMEX weathered the crisis unscathed, due in no small part to the presence of our futures trading legislation.

After a decade of operation, it has become necessary to review the Futures Trading Act to ensure its continued effectiveness. Global financial futures markets have grown very rapidly in the past 10 years. During the five years from 1990 to 1994, the volume of futures and options contracts traded on the top 10 exchanges in the world more than doubled from 450 million to 1.1 billion contracts.

It is also timely to review the Futures Trading Act because of the growth of leveraged foreign exchange trading in Singapore. Leveraged foreign exchange trading is the buying and selling of foreign exchange on a margin basis and hence it is similar to futures trading which is also conducted on a margin basis. The investor needs only put up a margin of 3% to 5% of the value of foreign exchange transacted. Such leverage means that the investor's potential for both profit and loss will be large relative to his initial investment. Leveraged foreign exchange trading is hence a risky business.

Currently, leveraged foreign exchange trading is not subject to any regulation. Any person can incorporate a company to offer such facilities to members of the public. The result has been a proliferation of such firms which use aggressive marketing and promises of high investment returns to entice unwary members of the public to trade in the foreign exchange market. MAS has received many complaints from customers on losses incurred in trading through such firms. One common complaint is that such firms do not explain the risks involved in foreign exchange trading or disclose that customers could not only lose their entire margins, but also be liable for further unspecified losses. Another complaint is that such firms had deliberately churned customers' accounts, by trading unnecessarily to generate commission income. Since leveraged foreign exchange trading and futures trading are similar in nature, leveraged foreign exchange trading can and should be regulated under the Futures Trading Act.

With the foregoing in mind, I will now deal with the main provisions of the Bill. The Bill may be broadly divided into six segments and I will now elaborate on each of these segments.

Extending the Scope of the Futures Trading Act to Regulate Leveraged Foreign Exchange Trading

Under the proposed amendments to this Bill, persons who offer to the public leveraged foreign exchange trading facilities, investment advice to customers for trading in foreign exchange, or manage customer's funds on a discretionary or non-discretionary basis for investment in foreign exchange markets, would need to be licensed by the MAS. Upon licensing, persons offering such facilities would be subject to capital adequacy standards, business conduct rules and prudential requirements. It should be noted that the Bill only seeks to regulate the trading of foreign exchange on a margin or leveraged basis. It does not regulate outright foreign exchange transactions involving the exchange of one currency for another, which does not give rise to prudential concerns. Similar legislation has also been introduced by Hong Kong to stamp out trading malpractices in its leveraged foreign exchange trading industry.

As the main purpose of regulating leveraged foreign exchange trading is to protect unsophisticated members of the public, the Bill will exempt the licensing requirements for persons who offer such facilities to certain classes of investors. These are as follows:

(a) A person who engages in leveraged foreign exchange trading only with accredited investors. Accredited investors are individuals with personal net worth of at least $5 million and corporations with net assets of at least $10 million, or their equivalent in foreign currencies;

(b) A person who engages in futures trading or leveraged foreign exchange trading with a related corporation or a related person, and

(c) A dealer or investment adviser licensed under the Securities Industry Act or any person exempt from holding such licence who engages in futures trading or leveraged foreign exchange trading for the purpose of hedging a portfolio of securities.

Establishment of Fidelity Fund by SIMEX

Because of growing interest from retail investors to trade in SIMEX futures contracts, additional safeguards to protect their interests are needed. The Bill therefore requires SIMEX to establish a Fidelity Fund, similar in structure to the Stock Exchange of Singapore's fidelity fund, to compensate investors for losses arising from defalcation by SIMEX members. The Fund will have the following main features:

(a) the initial size of the Fund will be $5 million;

(b) SIMEX will contribute 10% of its annual profit to the Fund;

(c) the Fund will pay a maximum compensation of $100,000 or 75% of the actual loss to a retail investor; and

(d) the maximum payout on defalcation claims will be $500,000.

Extending Scope of Futures Trading Act to Regulate Electronic Trading Systems

When the Futures Trading Act was enacted in 1986, trading was mainly in exchanges which used an open outcry system. In recent years, electronic systems utilizing terminals to trade futures contracts have been developed. A number of international futures exchanges have expressed interest in cooperating with SIMEX to install electronic trading systems to trade their products in Singapore. SIMEX is also developing its own electronic trading system in order to extend its trading hours. Since electronic dealing systems would effectively establish markets for the trading of financial futures, the conduct of futures trading via such electronic means will need to be properly regulated.

The next group of amendments sets out the provisions for requiring institutions licensed under the Futures Trading Act to assist in the investigation of drug money laundering offences. The Drug Trafficking (Confiscation of Benefits) Act allows the investigation, tracing, freezing and seizure of proceeds from drug trafficking and provides legal assistance to foreign enforcement agencies on fulfilment of certain conditions. To ensure that assistance is provided only for genuine drug trafficking investigations, a prima facie case of drug trafficking has to be established. Such assistance would be provided only if it is not contrary to our national interests. The amendment to the Futures Trading Act to facilitate drug trafficking investigations is similar to the recent amendments to the Banking Act and the Finance Companies Act for the same purpose.

Fine-tuning of Licensing Requirements

As the scope of activities of futures brokers and futures trading advisers has expanded, licensing requirements have to be reviewed to ensure effective protection of the interests of customers.

Currently, directors, officers and employees of a futures broker are not required to be licensed as futures broker's representatives. As the coverage of the Act has been expanded to include regulation of leveraged foreign exchange trading, it is necessary to require such persons to be licensed as futures broker's representatives. This will ensure that only individuals with the requisite experience, qualification and integrity are permitted to participate in the financial futures industry. Furthermore, as the scope of activities of a futures trading adviser has also been expanded to include the management of customers' funds, futures trading adviser's licence will only be granted to corporations. Individuals will have to incorporate a company to conduct such business and not as a sole proprietor. Companies have to meet stricter prudential requirements on internal controls and external audit. Any person affected by the change in the licensing framework will have a grace period of six months to apply to the MAS for a licence upon the coming into force of the Act.

The Act currently allows MAS to refuse a licence if an applicant is found to have committed a criminal offence or is a bankrupt. To ensure high standards of professionalism and integrity, the Bill proposes to spell out other qualitative criteria required for licensing. This will include the applicant's character and integrity, as well as his experience and expertise in such activities. Licences can be refused in Australia and Hong Kong on similar grounds.

Liberalisation of Certain Provisions

While the Bill seeks to update prudential requirements to enhance the integrity of the financial futures industry, it also proposes amendments to reduce the regulatory burden in areas which do not affect the soundness of the industry. In response to feedback from the industry, the MAS has hence proposed that certain provisions of the Futures Trading Act be liberalised.

Firstly, the Bill will exempt banks and merchant banks from the licensing requirements for leveraged foreign exchange trading activities since they are already subject to such regulation under the Banking Act.

Secondly, as the main purpose of regulating leveraged foreign exchange trading is to protect unsophisticated investors, the Bill will expressly exempt the licensing requirements for persons and their employees who offer leveraged foreign exchange trading facilities only to accredited investors.

Thirdly, the Bill will also exempt persons and their employees from the licensing requirement for trading in financial futures and leveraged foreign exchange for their related corporation or family members. There are no investor protection considerations in such transactions as the customer and the intermediary are related parties.

Fourthly, in order to allow greater flexibility for stockbroking companies and fund managers to use the futures market and the foreign exchange market to hedge their customers' portfolio of securities, the Bill will waive the licensing requirements for such persons provided that their trading in such instruments is for the purpose of hedging the investment risk of a portfolio of securities.

Fifthly, under the Act, a futures trading adviser is currently only allowed to advise customers and publish reports and analyses concerning futures trading and futures markets. However, in recent years, there has been growing interest by fund managers to invest customers' funds in financial futures contracts and foreign currencies in addition to equities and debt securities. To cater to this development, the Bill will extend the scope of activities of a futures trading adviser to include the management of customers' funds, whether on a discretionary or non-discretionary basis, for investment in financial futures or foreign exchange transactions.

Administrative Amendments

The Bill also proposes to put into legal effect certain administrative requirements to strengthen the regulation of the financial futures industry. These are as follows:

(a) The Act currently requires futures brokers to meet minimum capital adequacy requirements. However, the Act does not require them to notify MAS of any failure to meet such statutory requirements or to rectify non-compliance. The Bill will require futures brokers to notify MAS of any failure to meet statutory financial obligations. This will allow MAS to impose prudential requirements to protect the interests of customers.

(b) A futures exchange is required to obtain approval from the Authority before listing any new futures contract.

(c) The Act currently requires auditors of futures brokers to report to MAS any findings of non-compliance of the provisions of the Act. The Bill proposes that MAS be granted powers to remove any external auditor who fails to carry out this duty.

(d) The Act currently requires futures brokers to place customer's funds in a trust account. This requirement to segregate customers' monies, however, only applies to monies received in connection with futures transactions. Since futures brokers may also receive customer funds for trading in other financial instruments, the Bill proposes to extend the segregation requirement to include such customer funds.

(e) Currently, the Act does not stipulate any business conduct rules governing futures brokers dealings with their customers. To enhance protection of the interests of customers and in line with the requirement imposed by SIMEX on its members, the Bill proposes to introduce business conduct rules such as giving priority to customers' transactions over the firm's own transactions, and obtaining customers' consent for transactions where there is potential for conflict of interest.

The Bill also proposes a technical amendment to the Finance Companies Act which was last amended in 1994. Under the last set of amendments, the definition of "director" in the Finance Companies Act was extended to include the immediate family members of a director under the provision where the directors of a finance company are responsible for losses arising from unsecured loans granted by the finance company to any of its directors and firms and corporations in which any of the directors has an interest, and any related firms and corporations of the finance company. However, this extension also had the unintended effect of making the family members of a director of the finance company liable for any losses incurred by the finance company in respect of such unsecured loans. As it is not the intention to impose such a liability on the family members of a director, the Bill proposes to exempt family members of a director from any liability in respect of losses arising from such unsecured loans.

The other proposed amendments to the Futures Trading Act are house-keeping in nature, and pertain mainly to the definition of terms and the imposition of penalties for breaches of regulations. They do not warrant any special mention in addition to what has been stated in reference to them in the Explanatory Statement.

Sir, I beg to move.

Question proposed.

Dr Ow Chin Hock (Leng Kee): Mr Speaker, Sir, I support the Futures Trading (Amendment) Bill. Like the Banking (Amendment) Act and the Finance Companies (Amendment) Act, this Amendment Bill is another step to safeguard the integrity of our financial system. This Bill also seeks to protect the small or non-accredited investors. To safeguard the integrity of our financial system, we must insist that operators in the financial sector have a high standard in terms of financial resources, track record, experience and qualified personnel. MAS' efforts in safeguarding the integrity of our financial system should be commended.

Sir, regulation is only one side of the coin. The Act and the Amendment Bill only set out the ground rules to ensure fair play and an orderly market. The other side of the coin is that potential investors themselves must fully understand the nature of the market, the derivatives and the risks involved before entering these markets. This is particularly important in the futures trading as futures markets are highly volatile and trading in futures is done on a margin basis. Even experienced traders can get their fingers burnt. The latest financial crisis of Baring Futures is a lesson for investors and potential investors to learn. May I take this opportunity to ask the Minister to inform the House what is the current position of the Barings crisis and what is its impact on the local financial sector? What measures have been taken or will be taken to prevent such a crisis from happening again?

Sir, the major provisions in the Amendment Bill are the expansion of the scope of the Futures Trading Act to include the regulation of leveraged foreign exchange trading. This implies that these are firms which have engaged in leveraged Forex trading without being subjected to any regulation. The Minister was reported to have said that "the recent proliferation of unregulated companies offering such services is an 'area of concern' and it was time to introduce measures to protect the public." [Business Times on 10th January 1995.] The Minister just now mentioned that MAS has received complaints. May I ask the Minister what is the estimated number of such unregulated operators of leveraged Forex firms in Singapore?

In tightening the regulations, clause 10 seeks to widen the grounds for refusal of an application for a licence. These criteria spell out the type of quality required of the operators by MAS. I welcome the inclusion of criteria such as the education and qualification and experience of the applicant or his shareholders, directors and employees. However, some criteria appear to be subjective. May I ask the Minister whether MAS will give the reasons of rejection to an applicant so that he can make up for his shortcomings?

Clause 14 seeks to amend section 24 of the principal Act to enable the MAS to prescribe minimum financial requirements for a futures adviser. However, clause 24 only stipulates that minimum financial requirements are to be prescribed by the MAS, and no specific sums are stipulated. If I heard the Minister correctly, he has already mentioned the sums. So I would not pursue this matter.

Other major provisions of the Amendment Bill are in clauses 20 and 26. Both clauses seek to protect the interests of investors. It is common practice for unregulated foreign exchange trading firms to take opposite positions against their customers. By taking the opposite side of the transactions without hedging their risks, the firms are effectively betting against their customers with respect to the movement of foreign currencies. Clause 20 prohibits such practices and other activities which run against the interest of the investors, such as front-running and cross-trading.

Clause 26 seeks to establish and maintain a fidelity fund for compensating small investors, or non-accredited investors, because of a defalcation committed by a member of the Exchange. One significant fact is that the fund, initially set at a minimum of $5 million, is paid by the Exchange itself. The fund will be increased by a sum equal to 10% or more of the net income of the Exchange per year. I would like to ask the Minister how is the $5 million arrived at, and whether the sum is too small in relation to the value and the volume of Forex and leveraged Forex trading by SIMEX members.

The proposed sections 49(I) and 49(J) also set two limits on the payments out of the fund: (i) the total amount to be paid by a member of the Exchange shall not exceed $500,000; and (ii) any claim shall be 75% of the actual loss subject to a maximum of $100,000. I wonder how these limits are set. I am amused by the name "fidelity fund" but I support and welcome the setting up of such a fund.

Sir, a final issue, in 1987, two officers of a commodities trading firm, Futurelink, were jailed for cheating more than 1,500 clients of $19 million over two years. In 1993, the Commercial Affairs Department was reported to have investigated a director of Credit Consultants Asia Pte Ltd, another commodities futures firm. May I ask the Minister whether he has plans to bring non-SIMEX firms that offer facilities in commodities futures under the regulation of the Futures Trading Act or any other statute? 4.00 pm

Mr Chay Wai Chuen: Mr Speaker, Sir, I speak in support of the Futures Trading (Amendment) Bill in the name of the Minister for Finance.

Sir, this Bill comprises a series of amendments to the 1985 Futures Trading Act. Over a period of 10 years, a decade of almost exploding dimension in terms of growth in the value of trade in futures and derivatives in commodities, currencies and exchanges epitomised in the financial markets global big banks, these amendments are needed to rein in on some of the many esoteric practices that are done in the world of the futures market. With the benefit of experience from other countries and our own, the time is appropriate, and I believe it is not too late, to draw the line for many people who trade in the futures market.

The problem with regulatory control in the futures trading is that these transactions take place by the hundreds of millions of dollars every minute of the day across many borders instantaneously in an electronically-generated environment. The market is truly one everywhere in the world. Sometimes it is hard to pinpoint which regulatory body is responsible for which aspect of the transaction. Any financial regulatory body has to balance between the stunting rigidity of too much regulation and supervision within its borders and the market forces of globalised perfectly mobile short-term capital moving in search of higher values. However, one cannot afford not to be too careful in this area and if one should err in controlling too much, it is better to err on the side of caution. Thus, I welcome the Futures Trading (Amendment) Bill.

For the purposes of this Bill, it excludes from the definition of foreign exchange trading and leveraged foreign exchange trading any contracts or arrangements by banks or merchant banks. The Minister has just explained the rationale for it. So I will not pursue this matter, because these institutions are covered by the Banking Act. This Amendment Bill should serve a signal to all those participants of the futures market, including the derivatives, that the authority is concerned with some of the practices so far and bucket shop operators should take heed of the operations and streamline their operations in accordance with the rules.

Section 14 of the principal Act is amended to enable the authority to be satisfied over a host of conditions such as qualifications, experience and the overall general suitability of the officials in charge in applying for these licences. The amendments also prohibit practices such as front-running, trading against customers and cross-trading in futures contract.

The amendments also provide for a fidelity fund of not less than $5 million from the fund of the Futures Exchange to be established for compensating the investors in case of defalcations. I share the view of the Member who spoke just before me and I would like to ask for the rationale for this $5 million to be set and whether it is not too low. As in all regulatory control in this area, it is ultimately the directors and the management within the trading corporation that must exercise the internal control. It is hard to expect the central regulatory body to do more than setting the off-limit markers. The directors and management ultimately hold fiduciary responsibility over these funds. Participants in this globalised free market should be prepared to be disciplined by the market regulating itself. In the Amendment Bill, the failure to comply shall make one liable for conviction to a fine not exceeding $50,000 or to imprisonment for a term not exceeding seven years. Does the Minister not consider the above penalties too lenient or the fine too small? After all, the cost of such non-compliance may involve hundreds of millions of dollars.

Assoc. Prof. Walter Woon: Sir, I support the Futures Trading (Amendment) Bill as far as it goes. My fear is that it does not go far enough. I have just one short point, if I may.

The recent problems with Barings reminds us forcefully of the great sums of money that are involved in this kind of trading. If there is fraud, the losses are numbered in tens and hundreds of millions of dollars and the profit of fraudsters is similarly mind-boggling. The problem is that the Futures Trading Act does not provide for adequate penalties in respect of multi-million dollar frauds. This is the failing that it shares with the Securities Industry Act. You look at the new sections 37A to 37D, for example. This kind of behaviour has now been criminalised. But what is the penalty for contravention? The penalty for contravention, you will find in section 40 of the existing Act, which reads:

`Any person who contravenes or fails to comply with any provisions of this Part shall be guilty of an offence and shall be liable on conviction to a fine not exceeding $30,000, or to imprisonment for a term not exceeding 3 years or to both.'

Since these offences apply to futures brokers and futures brokers by definition are corporations, you cannot send a corporation to jail. It means the punishment for contravention is a $30,000 fine. If you look again at Part VII of the Act which prohibits other offences, like creating a false market, false trading, manipulation, the penalties are found in section 56 which provides a maximum fine of $100,000 or imprisonment for a term not exceeding seven years or both. Would Members of this House consider that justice is done if a fraudster having made, say, $10 million, is fined the maximum of $100,000? No doubt he could go to jail for seven years. But when he gets out, he can still spend his ill-gotten gains. No doubt the court can order him to pay prosecution cost, but prosecution cost would not come up to $10 million. Theoretically, the victims of the fraud should sue for compensation under section 57(1). This is similar to section 105 of the Securities Industry Act. In the 20 years that the Securities Industry Act has been in the statute books, I know of no case reported, or unreported, where compensation has ever been awarded. This Futures Trading Act is a shorter pedigree, but I think the situation is not much better. I wonder if the Minister knows of any case where compensation has in fact been ordered.

The fact is that civil compensation is impracticable. Victims of fraud may be indisposed to sue. Their losses may individually be inconsequential although in aggregate may amount to a lot, and they may decide to write off the loss. One cannot depend on private enterprise to deprive a fraudster of his ill-gotten gains. May I suggest to the Minister that he look into the possibility of confiscating the benefits that a fraudster acquires through market fraud, not only for contravention of the Futures Trading Act but also for the Securities Industry Act.

I have not suggested detailed amendments to this Act because I do not think it should be looked at just from the point of view of futures trading. I think this is going to be a problem that affects all facets of white collar crime. Perhaps something on the lines of the Drug Trafficking (Confiscation of Benefits) Act could be enacted for white collar crimes. It would be a shame, I think, if after all the time and effort expended to bring white collar criminals to book, they could, after serving their jail sentence, merrily fly off to the Caribbean and live off their loot for the rest of their lives.

Dr Richard Hu Tsu Tau: I thank Members for their contributions. I will deal with the individual questions first before commenting on the Barings crisis at the end.

Dr Ow Chin Hock has asked a number of questions. I will take them individually. He has asked how many unregulated forex traders have been in business. MAS estimates there are between 30 and 40 such firms in operation. He also asked, when licences are refused by the MAS, whether the person involved will have a hearing. He will. In fact, if he is dissatisfied with the rejection, he can apply for a hearing and he will be told what are the reasons for the rejection.

Dr Ow has also asked how the various sums on the fidelity fund are arrived at. They are basically proposed by SIMEX itself and they are initial sums which are subject to review. They look relatively small at this stage but, depending on actual market conditions, they could be increased in due course.

Finally, he has asked whether the Futures Trading Act could be extended to cover the regulation of soft commodities. I would like to point out that there is in existence already a Commodities Futures Act which regulates rubber futures and it is proposed that coffee futures be covered by the same Act. So presumably all other soft commodities futures could be regulated by the same Act.

Both Mr Chay Wai Chuen and Prof. Walter Woon have commented on the relatively low penalties under the Futures Trading Act, particularly in the light of the Barings debacle. We agree that these penalties require review and we will actively look at them. I would like to thank Prof. Woon particularly for his suggestion that the ill-gotten gains in these cases might be subject to confiscation. We have already done it for drug trafficking and for other crimes, but we will also now consider whether this might not be extended to this type of crime.

Finally, I would like to give the House a review of the Barings debacle.

Members of this House would have heard that the Baring group, which is a long established financial institution in the United Kingdom, recently became bankrupt because of massive losses, reported to be in the region of o500 million, arising from derivatives transactions by one of its traders in Singapore. The trader concerned had accumulated a huge portfolio of futures and options contracts on SIMEX and various Japanese exchanges for its affiliated companies in Tokyo and London. As the Baring group was insolvent and cannot continue trading, it has applied for administration in the United Kingdom.

The Baring group has three major business operations in Singapore, namely, a merchant bank, Baring Brothers & Company; a stockbroking company, Baring Securities (Singapore) Limited, which is an international member of the Stock Exchange of Singapore; and a futures broker, Baring Futures (Singapore) Pte Limited (BFS), which is a member of SIMEX. The merchant bank and the stockbroking company are financially solvent and have adequate financial resources to meet their obligations. The merchant bank has ceased entering into new business and will close down its operations. The stockbroking company is currently under the administration of the Stock Exchange of Singapore, which will oversee its operations to ensure the smooth winding down of its financial liabilities. BFS, which was one of the largest traders on SIMEX, has come under judicial management. The bankruptcy of the Baring group has had no impact on domestic financial institutions as they have no exposure to the Baring entities or companies.

Although BFS has a large position in futures and options contracts on SIMEX, our futures exchange is not at risk as a result of the massive losses of the Baring group. This is because SIMEX, operating under the framework of the existing Futures Trading Act, has a comprehensive set of checks and controls to safeguard the financial integrity of the exchange and those of its futures broking members even if a major investor defaults on his transactions on the exchange. These safeguards are as follows:

Firstly, any investor who transacts on SIMEX is required to place a margin deposit for every contract transacted. The margin deposit serves as a cushion of safety which SIMEX can use to offset any losses arising from the fluctuations in futures prices which the investor is unable to honour. SIMEX sets its margin deposits at levels which vary with the assessment of the volatility of the underlying market. Up to Friday, 24th February, 1995 the margin set was at 8%. This was raised to 15% on Monday, 27th February, 1995 and is currently lowered back down to 10% because of lower volatility. As futures prices are highly volatile, SIMEX computes the margin deposit requirements on a daily basis based on the market price of the contract at the end of the day.

Secondly, under the Futures Trading Act, SIMEX requires its futures broking members to increase their capital whenever they have increased volumes of customer transactions. This requirement also serves to protect SIMEX, as futures broking members become liable for their customers' obligations to the exchange should such customers default; and

Thirdly, under the Futures Trading Act, SIMEX requires its futures broking members to segregate monies belonging to customers from those belonging to the futures brokers. This serves as a safeguard against any abuse of customers' funds and thus ensures that customers' funds will be available to meet possible margin calls by SIMEX.

As a result of these safeguards, SIMEX has more than adequate margin deposits from Baring for its open positions, even allowing for fluctuations in the prices of the contracts which Baring has entered into. These margin deposits are more than sufficient to offset Baring's unrealised losses from its positions on SIMEX. SIMEX is therefore able to honour all contracts made and cleared with the exchange. All customers' margin deposits with the exchange will be used exclusively for margining such customers' positions, and will not be diverted to meet the exchange's own obligations.

As the Baring companies which had traded on SIMEX had become insolvent, SIMEX had, in the last two days, worked to wind down most of the open positions of the Baring companies and will continue to wind down the remaining positions so as not to cause disruption in the market. If the Japanese market remains orderly, the balance of BFS' open positions are more than adequately supported by existing margins and there should not be any need for SIMEX to call upon any funds to close off BFS' positions. However, in order to ensure the confidence of participants, SIMEX has arranged for a letter of credit of US$300 million from local financial institutions, but it is not likely to need to call upon this.

Concern has been raised as to how BFS had managed to build up such a large position in futures and options contracts on SIMEX and on other exchanges. A full picture of BFS' trading operations which led to the crisis will not be known until investigations are completed. SIMEX did not deem it necessary to curb the increase in the open positions of the Baring entities trading on SIMEX since, until last Friday, BFS had not shown any signs of financial difficulty in its futures trading activities on SIMEX as margin calls were promptly made in full. Over the period from 1st to 24th February 1995, SIMEX made margin calls on BFS for 14 out of the 18 trading days, amounting to a net payment to SIMEX of US$128 million. BFS' speculative positions were also concealed as SIMEX was given to understand that BFS' open positions were undertaken for arbitrage trading purposes which involve less risks. The Baring group was also known as an internationally reputable and well established investment bank with a long track record in sophisticated financial activities.

An incident of this nature inevitably raises questions concerning the effectiveness of the existing regulatory system for the financial futures industry in Singapore. I would like to assure this House that the regulatory framework is fundamentally sound, and that SIMEX's financial condition is not at risk. I should point out that the principal objective of our regulation of the futures market is to ensure that the futures exchange is financially sound and is able to meet its financial obligations so that investors will have confidence in participating in the market. No regulatory system can guarantee that there will not be any failure among investors who participate in the futures market nor can regulations protect investors from making losses. Investors, as profit making enterprises, are accountable to their shareholders and are responsible for ensuring that they conduct their operations prudently. Investors who trade in derivatives with the aim of making a profit are expected to exercise proper discipline in order to prevent possible losses from growing out of control. Sound regulation is necessary but not sufficient. There is also a need for proper internal controls and procedures on the part of the market participants to ensure that they conduct their futures trading activities prudently. Such internal controls should be adequate to detect any fraud or excessive risk taking by traders. This is because no law can be enacted to prevent fraud.

Our financial futures regulation, which is modelled after that in the United States, is therefore aimed primarily at ensuring that the futures exchange will remain financially sound even if there is a failure of one or more of its participants. In this regard, the Futures Trading Act has proved to be effective in achieving its objective of protecting the integrity of the futures market in Singapore. This is so because although Baring had incurred large losses as a result of trading on SIMEX and other futures exchanges, SIMEX is not affected by the incident, and continues to be able to honour its obligations to futures brokers and investors. Furthermore, as BFS had placed adequate margin deposits for its positions on SIMEX as required under the Futures Trading Act and SIMEX's rules, the impact of the Barings crisis is isolated and will not result in other SIMEX futures brokers having to step in to meet BFS' obligations.

SIMEX has issued a press release yesterday to state that BFS has maintained sufficient margin funds with SIMEX to enable the exchange to manage its positions. Both MAS and SIMEX have also provided the assurance that margins deposited by other investors on the exchange would be used exclusively for the purpose of their positions maintained with the exchange, and would not be used for any other obligations of the exchange. This assurance has helped to restore investor confidence in the Singapore financial market as reflected in the relatively steady volume of trading on SIMEX. The Singapore stock market has also rebounded yesterday by more than 32 points compared with the initial fall on Monday.

The Baring incident has however highlighted to SIMEX a number of areas which it could improve upon. I would like to inform Members that the following steps will be taken to further strengthen the financial soundness of the exchange:

(a) MAS and SIMEX will jointly review SIMEX's rules on business conduct to enhance the monitoring of the risk exposure of member firms with the view to protecting the integrity of the exchange.

(b) SIMEX will appoint experts from the global futures industry to be members of an Advisory panel to review and advise the exchange on protecting the exchange against similar crisis in the future.

(c) SIMEX will institute measures to require the head office of member firms to take more precautionary measures and strengthen their oversight over the internal controls of their futures subsidiaries in Singapore.

(d) MAS will enhance cooperation with overseas futures regulators to provide for better coordination in the supervision of financial institutions participating in the futures markets.

(e) SIMEX will strengthen its supervision and compliance department to enhance floor supervision and compliance by SIMEX members.

(f) SIMEX will require member firms to ensure that the head of the dealing section should not take charge of the settlement section and that proprietary traders should not handle customer business.

The proposals to tighten futures regulations contained in the Bill before the House will help to ensure that SIMEX will continue to remain financially sound in the event a future broking member should collapse like Baring. These proposals are as follows:

Firstly, the Act currently exempts employees of futures brokers from the requirement to be licensed by MAS. The Bill will require employees of futures brokers to be licensed by MAS on an annual basis. This will allow for closer supervision of dealers who trade in futures contracts on behalf of customers. In licensing such employees, MAS will also be able to apply more stringent criteria as proposed in the Bill. The new criteria for licensing such employees will include the requirement that they have relevant experience, and that they are of good character and reputation.

Secondly, the Bill will require SIMEX to seek MAS' approval for the listing of any new contract or the establishment of any subsidiary company, such as the setting up of a subsidiary company to handle the clearing functions of SIMEX. This will allow MAS to vet the introduction of any new contract, so as to ensure that such new contracts will not be susceptible to manipulation by market participants. MAS will also be able to assess that SIMEX has established a sound clearing system with adequate safeguards to ensure the financial soundness of the exchange.

Thirdly, the Bill will require SIMEX to establish a compensation fund for the purpose of compensating retail investors in the event of defalcation by a futures broking member of the exchange.

Fourthly, the Bill will allow MAS to remove any external auditor of a futures broker who is found to have failed to exercise its responsibility of vetting the adequacy of the futures broker's financial accounting and control system. This will encourage external auditors to invest greater resources in their audit of futures brokers.

Fifthly, SIMEX currently has a number of business conduct rules which its futures broking members have to comply with. These business conduct rules generally aim at protecting the interests of customers, such as requiring the futures broker to give priority to customers' transactions, and to obtain customers' consent if the futures broker acts as a principal to the customers' transaction. The Bill will provide legal backing for such business conduct rules by introducing them in the Futures Trading Act. This will allow MAS to take more effective action against futures brokers who do not comply with the business conduct rules.

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 Richard Hu Tsu Tau].

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