Harvard Case - Haitong: Accounting in Securities Margin Financing
"Haitong: Accounting in Securities Margin Financing" Harvard business case study is written by Xu Li, Tsun-kan Wan. It deals with the challenges in the field of Accounting. The case study is 12 page(s) long and it was first published on : Mar 23, 2021
At Fern Fort University, we recommend that Haitong Securities implement a comprehensive overhaul of its accounting procedures and policies for securities margin financing. This includes adopting a more robust activity-based costing (ABC) system, enhancing internal controls, and implementing a clear and transparent pricing strategy. This will improve profitability, mitigate risk, and ensure compliance with relevant accounting standards and regulations.
2. Background
Haitong Securities, a leading Chinese investment bank, is facing challenges in its securities margin financing business. The company's current accounting system, based on a simple allocation of costs, is inadequate for accurately capturing the true costs associated with different customer segments and margin financing activities. This leads to inaccurate pricing, potential profitability issues, and increased risk exposure.
The case study highlights the following key protagonists:
- Haitong Securities Management: Concerned about profitability and risk in their securities margin financing business.
- Accounting Department: Struggling to accurately capture costs and allocate them appropriately.
- Risk Management Department: Concerned about the potential for losses due to inadequate accounting practices.
- Customers: Seeking competitive pricing and transparent terms.
3. Analysis of the Case Study
This case study can be analyzed through the lens of cost accounting and risk management.
Cost Accounting:
- Inadequate Cost Allocation: Haitong's current cost allocation system fails to capture the true costs associated with different customer segments and margin financing activities. This leads to inaccurate pricing and potential profitability issues.
- Lack of Activity-Based Costing: The absence of an ABC system hinders the ability to accurately allocate costs based on specific activities, leading to distorted cost information.
- Limited Cost Analysis: The lack of detailed cost analysis prevents Haitong from identifying cost drivers and areas for potential cost reduction.
Risk Management:
- Increased Risk Exposure: Inadequate accounting practices can lead to increased risk exposure, including credit risk, operational risk, and regulatory risk.
- Lack of Internal Controls: Weak internal controls create opportunities for fraud and errors, further increasing risk.
- Compliance Concerns: The current accounting system may not comply with relevant accounting standards and regulations, leading to potential fines and penalties.
4. Recommendations
To address these challenges, Haitong Securities should implement the following recommendations:
1. Implement Activity-Based Costing (ABC):
- Develop a comprehensive ABC system to accurately capture and allocate costs based on specific activities associated with margin financing.
- Identify cost drivers for each activity, such as customer onboarding, trade execution, collateral management, and risk monitoring.
- Allocate costs based on the actual consumption of resources by each activity.
2. Enhance Internal Controls:
- Implement robust internal controls to mitigate risk and ensure compliance with accounting standards and regulations.
- Establish clear segregation of duties, including separate roles for transaction processing, reconciliation, and authorization.
- Implement regular audits and internal controls assessments to identify and address weaknesses.
3. Develop a Transparent Pricing Strategy:
- Develop a transparent pricing strategy based on the accurate cost information generated by the ABC system.
- Consider different pricing models, such as cost-plus pricing, value-based pricing, or competitive pricing, depending on the specific customer segment and margin financing activity.
- Communicate the pricing strategy clearly to customers to ensure transparency and fairness.
4. Strengthen Accounting Procedures and Policies:
- Review and update existing accounting procedures and policies to align with the new ABC system and internal control framework.
- Ensure that all accounting practices comply with relevant accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
- Implement a robust system for tracking and reporting margin financing activities, including customer balances, collateral positions, and transaction history.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: Implementing a robust accounting system aligns with Haitong's core competencies in financial services and its mission to provide high-quality financial products and services to its clients.
- External Customers and Internal Clients: The recommendations will benefit both external customers by providing them with transparent pricing and internal clients by providing them with accurate cost information for decision-making.
- Competitors: By adopting best practices in cost accounting and risk management, Haitong can gain a competitive advantage in the securities margin financing market.
- Attractiveness: The implementation of ABC and enhanced internal controls will improve profitability by accurately capturing costs and mitigating risk.
- Assumptions: The recommendations assume that Haitong Securities has the resources and commitment to implement the necessary changes and that the Chinese regulatory environment will continue to support the development of the securities margin financing market.
6. Conclusion
By implementing a comprehensive overhaul of its accounting procedures and policies, Haitong Securities can improve its profitability, mitigate risk, and enhance its competitive position in the securities margin financing market. The adoption of activity-based costing, enhanced internal controls, and a transparent pricing strategy will ensure that the company operates efficiently, effectively, and in compliance with relevant regulations.
7. Discussion
Other alternatives not selected include:
- Maintaining the status quo: This would continue to expose Haitong to risks and potentially hinder its profitability.
- Outsourcing accounting functions: This could be a viable option, but it would require careful selection of a reputable and experienced accounting firm.
Key risks and assumptions associated with the recommendations include:
- Implementation challenges: Implementing a new accounting system and enhancing internal controls can be challenging and require significant resources and commitment.
- Resistance to change: Some employees may resist changes to the existing accounting practices.
- Regulatory changes: Changes in accounting standards or regulations could impact the effectiveness of the new system.
8. Next Steps
To implement the recommendations, Haitong Securities should take the following steps:
- Form a project team: Assemble a cross-functional team to oversee the implementation of the changes.
- Develop a detailed implementation plan: Outline the specific steps, timelines, and resources required for each phase of the project.
- Communicate with stakeholders: Inform all relevant stakeholders, including management, employees, and customers, about the changes and their benefits.
- Monitor progress and make adjustments: Regularly monitor the implementation process and make necessary adjustments to ensure success.
By taking these steps, Haitong Securities can transform its accounting practices and achieve its strategic objectives in the securities margin financing market.
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Case Description
This case explores how Haitong International Securities Group Limited (Haitong, the Group, or SEHK: 665) had been accounting for margin loans under the Hong Kong Financial Reporting Standard 9 Financial Instruments (HKFRS 9) since the mandatory adoption date on 1 January 2018. Haitong belonged to one of the largest financial groups listed on the Hong Kong Stock Exchange in terms of market capitalization. Because of the fame and size of the Group, the protagonist Nancy (regional CFO) made reference to this company in finding out the accounting issues that could potentially occur in starting margin financing business in Hong Kong. Haitong incurred 'impairment charges, net of reversal' (net impairment charges) of HKD238.8mn and HKD634.5mn respectively in the year ended 31 December 2018 (FY2018) and 31 December 2019 (FY2019). The portion attributable to advances to customers in margin financing (margin loans or margin loan receivables etc.) constituted HKD353.7mn (148.1%) and HKD532.3mn (83.9%) of the aforesaid net impairment charges in the respective years. The case seeks to highlight the advantages and disadvantages of entering the securities margin financing business when IFRS 9 is in place. Students will learn the classification of margin loans under IFRS 9 and the measurement of expected credit loss (ECL) of these assets by three "stages" as prescribed by IFRS 9. Students will also grapple with questions on formulating the internal controls in credit risk management under the context of securities margin financing.
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