NEW INITIATIVE ON SHARE FINANCING

Dr Lily Neo asked the Deputy Prime Minister whether the recent new initiative by financial institutions in relation to share financing will lead to excessive credit exposure by investors.

BG Lee Hsien Loong: Mr Speaker, Sir, share financing is an integral part of the securities market. Before 15th March this year, under the old T + 5 settlement system, investors often did not have to pay up until 12 days after their trades were executed. The contra buyer could sell on the fifth day after the initial purchase, and only pay the broker the difference between the purchase and sale prices after settlement of the contra sale, which was another six days later. In addition, brokers often extended informal credit, so that when the market entered a downswing, some customers would default, exacerbating the problem of contra losses.

Now that we have shortened the settlement cycle to T + 3, contra trading has become less attractive. This may dampen market turnover. Brokers have responded by introducing new forms of financing for their clients, and reviving older forms. For example, at least one broker is giving its preferred clients up to 14 days interest free credit.

Where securities firms are concerned, the Singapore Exchange (SGX) requires its members to impose an initial margin requirement of at least 50%. This means that if an investor buys $2,000 worth of securities, he must pay the first $1,000 upfront. SGX rules also require the broker to make a margin call when the value of the securities falls below $1,800. If the investor is unable to meet the call, the broker will sell the securities and liquidate the position.

These margin requirements have helped to keep our stockbroking firms healthy and not over exposed to risk. They should adequately protect the firms should the market turn down. From the macro perspective, the rules have also prevented excessive leverage in the stock market, much like MAS' rules on property financing.

However, these margin requirements do not currently apply to banks, or to other lenders that are not members of the SGX. Hence, UOB could recently offer customers 100% share financing up to six times their monthly salary, so that they can buy shares without putting up any money upfront.

Our banks are well capitalised. Margin loans form only a small percentage of their total loan portfolio. MAS is therefore not worried that the banks will become over exposed to the stock market. However, MAS is concerned that over generous margin loans may create froth in the stock market, and increase market volatility. They may also lead to an excessive expansion of consumer borrowing, and tempt individuals to speculate in shares beyond the limits of what they can afford.

The US Federal Reserve Board (FRB) imposes margin requirements on brokers, banks and non-bank intermediaries. All providers of share financing are required to impose an initial margin requirement of at least 50%. There is thus a level playing field, unlike in Singapore. The US Federal Reserve Board requires investors to pay $1,000 upfront for $2,000 worth of securities. The exchanges also require margin calls to be made when the value of the securities falls below $1,333. This is more liberal than our threshold of $1,800, but, in practice, many American broker-dealers maintain stricter internal policies on initial margin requirements as well as margin calls.

As the US stock market has risen, margin debt has grown sharply. There have been calls on the FRB to raise the margin requirement, especially after the recent volatility in US equity prices. The FRB has not agreed to do so. Its position is that the present requirements are adequate, but it is continuing to monitor the situation. Other commentators have observed that margin financing is only one form of leverage in the stock market, and is still only a small percentage of total market capitalisation in the US.

MAS is reviewing whether to extend limits on margin financing across the broad spectrum of margin providers, and whether our present requirements provide the proper balance in our markets.

Dr Lily Neo (Kreta Ayer-Tanglin): Sir, may I ask the Deputy Prime Minister whether the new financing by financial institutions has aggravated the stock market fluctuations in Singapore recently?

BG Lee Hsien Loong: Sir, I doubt it, because I do not think the volume is very large. It is only about 1% of the stock market. So it is unlikely to have a major impact.

Dr Lily Neo: Sir, may I ask the Deputy Prime Minister whether there is a need to have a control on margin requirements presently or in the near future in Singapore?

BG Lee Hsien Loong: Mr Speaker, Sir, it is standard to have margin requirements, because we want to make sure that individuals do not over borrow, and that if the share prices go down, they are actually able to pay for it and do not default. And we also want to make sure that the intermediaries, like the brokers and the banks, do not over lend. Because if there is a default, it is not just the individual customer's problem or the individual broker's problem, but it could become a systemic problem, as Members will remember from Pan Electric. When Pan Electric went bust, a lot of brokers found that they had over extended themselves and several went out of business. We had to organise a life boat fund to try and rescue the rest, which we succeeded in doing. So there is a need for margin requirements. The question is how strict they should be, and how they should be applied, and what we should do with brokers and non-brokers. These are things which we are studying now.

Mrs Lim Hwee Hua: Sir, may I ask the Deputy Prime Minister, regardless of whether the Government thinks that margin debt is the cause or the effect of a rising market, would the MAS use the percentage of margin debt to the stock market capitalisation as a benchmark when deciding on margin requirements?

BG Lee Hsien Loong: Sir, I think the two have different parameters. The percentage of margin debt to total capitalisation is very small. We do not have an exact number, but I said it is about 1%. Whereas the margin requirement relates not to the size of that debt but to the volatility of the debt. Because if you bought shares worth $2,000, and you have paid $1,000, you still owe $1,000 secured against the $2,000 piece of paper - shares. If the shares go down to $1,500, you still owe $1,000, but it is only secured against $1,500 of shares. If your broker is slow to sell and liquidate the position, he may find the market has moved further against him and then he has a loss on his hands. So it is the volatility which concerns us when we have to judge how tight to make that margin financing limit.