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06 December 2023

Time runs out for brokers to obey Esca rule

By Mohamad Al Kady




A regulation requiring the separation of clients’ accounts from brokerage firms’ accounts has led to confusion among stock brokers.
Regulation R66 issued by the Emirates Securities and Commodities Authority (Esca) led to a downturn in the volume of trading on UAE stock markets last week, after brokers refused to grant credit and margin trading facilities to their clients.The regulation originally stipulated firms should create separate bank accounts for itself and for each client to prevent the use of pool accounts by brokers.

But many brokerage firms contacted by Emirates Business said it was impossible to separate the accounts of more than 100 firms and millions of investors.A meeting between Esca officials and representatives of brokerage firms took place on February 25 to discuss the issue and last week the authority amended the regulation. Separate accounts are still required for firms, but pool accounts can be retained for clients.

Esca has issued strict instructions to all brokerage firms setting tomorrow as the deadline to submit reports on account separation for February.However, several brokerage firms were still unaware of the amendment. And there is confusion among brokers about the mechanism and technical aspects of the regulation’s implementation.

“It is much easier for every firm to create two separate accounts, one for the company and one for all their clients,” said Mostafa Saeed, compliance department manager at Makaseb Securities. “However, this situation will harm brokerage firms because they will not be able to use their earnings from commission on trading to grant credit for their clients and should separate these earnings in their accounts. This will limit our abilities in trading.”He said the amendment will benefit only the brokerage arms of banks, who will be able to offer credit to their clients.

“The banks will be able to cover credit, while Esca will prevent brokerage firms from using their accounts to cover credit for clients.
Brokerage firms will also lose clients, who will prefer to open accounts with firms related to banks.”Mohamad Al Beheiri, head of trading at Amana Capital, said the amendment to R66 was a positive move by Esca to ease the regulatory burden on brokers.

“Each brokerage firm has a large number of clients, but the majority are inactive and use their accounts only during initial public offerings. Active clients represent around 20 per cent of the total, so it would be difficult to open accounts for a large number of inactive clients.
However, the major issue is that the amendment came after the end of February, but it asks firms to submit reports on their accounts for February. This created widespread misunderstanding among brokerage firms.”

Brokerage firms warned the requirement to report the separation of firm and clients’ accounts on a monthly basis would create artificial patterns of movement in the stock markets, that might conflict with the natural pattern of supply and demand.

Waleed Al Khateeb, financial analyst at Daman Securities, said brokerage firms had a month-long period in which to offer high credit to their clients, but must liquidate the margin two days before the end of the month, creating unwanted movements in share prices.

“This regulation will have a limited impact on big brokerage firms and brokerage arms of banks because they have large cash assets and they can offer credit and margin for their clients,” he said. “Small and new brokerage firms with limited stake in the market, will be affected. They will offer credit for their clients throughout the month, but they will have to liquidate the margin before submitting the report and this will create pressure on stocks.

“The regulation is a positive move by Esca to control artificial liquidity in the stock markets, but we need to implement the rules on a weekly basis to avoid the expected unwanted price movements.”Al Khateeb said the markets faced a period of downturn due to uncertainty and caution among investors.

“There is a wide misunderstanding among brokerage firms on the methodology of implementation of the regulation. This is why they reduced credit for clients last week, but this will be a short-term measure until the implementation is clarified.”

Another financial analyst, who asked not to be named, said brokerage firms were using pool accounts for all their clients.“This is totally unethical because they were using the cash of one client to finance margin trading of another client without his permission.”

He added top brokerage firms and banks would have no problem with the new regulation because they have high credit and cash accounts and could finance their clients. “The duration for implementing the rule is an essential part because Esca asked for monthly reports, while the markets’ conditions require weekly report on clients’ accounts to avoid any artificial patterns in stocks.

“Sometimes the markets need to go up, while pressure on small firms by the end of each month will lead them to sell stocks to cover the positions of their clients.”He said large brokerage firms would use this pattern to hit small firms and buy stocks at lower prices before the end of each month and then push prices higher after submitting account separation reports.

“The market fluctuation last week was the result of expectations that Esca may postpone the implementation of R66, but it sent clear instructions to all firms that the deadline for submitting reports on account separation is tomorrow.”

However, Al Beheiri said reporting on a monthly basis would not be a problem because the regulation gave Esca the right to carry out surprise inspections of the accounts of brokerage firms and it can fine those violating the rules.Alaa Mostafa, head of trading at Hermes, said the procedures for account separation were not clear.

“The markets were going down because trading by institutional investors was very weak,” he added. “There are fears among investors about markets movements and also brokerage firms reducing margins due to the new regulation.”

The regulation

R66: the rule by Emirates Securities and Commodities Authority stipulates separate accounts for brokerage firms and pool accounts for clients

Rules on margin trading and financial adequacy

Two new regulations aimed at streamlining performance of the UAE’s stock markets have been prepared by the Emirates Securities and Commodities Authority (Esca).

They include rules on margin trading and the financial adequacy of brokerage firms. The move follows the announcement of the accounts separation regulation that will require all brokerage firms to create two accounts for each client – an investment account and a margin trading account.

“Esca has prepared drafts of the new regulations,” a well-informed source told Emirates Business. “The main purpose of the proposed margin trading regulation is to set limits on each client’s trading.“The margin account should not exceed a specific ratio of the investment account. This will prevent brokerage firms from going to extremes.”

The source added that running accounts at extreme levels had created massive artificial liquidity in the markets and imposed heavy pressure on stocks. “During the market crisis in in 2005 and 2006, stocks were over-priced because of high margin trading. We should learn from our mistakes and the mistakes of other stock markets.”

The financial adequacy regulation will require brokerage firms to maintain capital equal to not less than 10 per cent of their liabilities in addition to maintaining their capital at levels disclosed in the letters of guarantee they submitted to Esca. It will also require brokerage firms to maintain adequate financial resources to cover their obligations.

The rules hope to create integration in stock markets to achieve stability and reduce the operating risks of brokerage firms.

The source said there was close co-operation between Esca, the Abu Dhabi Securities Market and the Dubai Financial Market over the new regulations.“They are doing a very positive job for investors because these steps are very important to stabilise the markets and regulate trading.”