Functions

The Corporate Finance Division consists of the Listing Policy and Market Development Department, the Takeovers and Mergers Department and the Investment Products Division.

Among other regulatory functions, the Corporate Finance Division:

• administers the Takeovers and Mergers Code and Share Repurchases Code to ensure there is full and timely disclosure of relevant information affecting the value of securities of public companies;
• ensures there is fair and equal treatment of public shareholders;
• maintains and improves investor protection standards by developing fair, clear rules for listed companies, and promoting the development of good and sound business practices;
• oversees the performance of the Stock Exchange of Hong Kong (SEHK) of its listing-related functions and responsibilities;
• reviews and recommends changes to the Listing Rules;
• facilitates the development of effective and efficient capital markets in both equity and debt issues; and
• facilitates the development of Hong Kong as the preferred overseas market for the listing and trading of securities of PRC enterprises.

China Initiatives

Eight PRC state enterprises listed their H-shares in Hong Kong during the year, raising approximately HK$13.91 billion from the market. Twenty-nine of the first 38 companies authorised by the PRC State Council to list outside the PRC have done so to date; and 27 of these 29 have chosen to list in Hong Kong. The State Council authorised a further 38 companies in December 1996 for overseas listing and it is expected a majority of these companies will also choose to list in Hong Kong.

During the year, two Hong Kong-listed H-share companies have issued convertible bonds amounting to a total value of US$300 million.

During the year, the Division held ongoing discussions with the China Securities Regulatory Commission (CSRC) on the listing and regulation of companies controlled by PRC interests in Hong Kong. These discussions were in addition to the regular quarterly meetings under the Memorandum of Regulatory Cooperation.

In May 1996, the SFC, together with the SEHK, the Hong Kong Monetary Authority (HKMA), Hong Kong Futures Exchange (HKFE) and the China Securities Regulatory Commission (CSRC) jointly organised a seminar in Beijing to promote the financial markets of Hong Kong to PRC government officials and senior executives of PRC companies. The SFC also participated in a seminar organised by the CSRC to further their understanding of Hong Kong's role as an international financial centre.

Derivative Warrants

In July 1996, the SFC approved major changes to the SEHK Listing Rules governing the listing of derivative warrants. This was the result of the joint effort of the SFC and the SEHK, developed through an extensive review of the previous rules and a market consultation exercise, with a view to further developing the derivative warrant market in Hong Kong.

The new rules, together with other existing requirements, were consolidated into a new chapter 15A of the Listing Rules. The new rules impose stringent ongoing disclosure requirements on issuers covering information relating to their financial statements and risk management systems. Criteria governing the issue of basket warrants were relaxed to accommodate comments from the market that the former rules were too restrictive. The new rules also encourage the listing of derivative warrants based on regional stocks.

Since the introduction of the new rules, the derivative warrant market in Hong Kong has experienced substantial growth. There was a marked increase in the number of derivative warrant issuers approved by the SEHK, from 16 a year ago to 22 as at the end of March 1997. As at 31 March 1997, there was a total of 296 (1996: 109) outstanding issues of derivative warrants listed on the SEHK, representing HK$31,686 million (1996: HK$11,249 million) in market capitalisation and approximately 0.92% of the total market capitalisation on the SEHK. The product type of derivative warrants has also diversified. There were 247 derivative warrants based on a single underlying share, 47 derivative warrants based on a basket of shares, and 2 derivative warrants based on non-equity financial instruments, such as a stock index or gold prices. Whilst the vast majority of the derivative warrants are call warrants, 4 put warrants were issued during the year.

Financial Disclosure by Banks

As the result of the joint efforts with the HKMA and SEHK, the SFC approved further enhancements to financial disclosure rules under the Listing Rules for banks listed on the SEHK. These rules reflect the requirements contained in the HKMA's Best Practice Guide and require banks to include in their financial statements cash flow statements which were previously exempt by the Companies Ordinance, information relating to their market risk exposures and additional segmental information relating to their significant classes of business. Disclosure requirements for listed banks as set out in the Listing Rules have been increased each year since 1994 and are recognised as the most rigorous regime in South East Asia.

Review of the Listing Functions of the SEHK

Pursuant to the terms of the 1991 Memorandum of Understanding (MOU) between the SFC and the SEHK that devolved to the SEHK sole responsibility for the day-to-day administration of listing-related matters, the Division completed in February 1997 the third post-devolution review of the listing functions of the SEHK. The review covered the period from 1 January 1995 to 30 June 1996 and involved the examination of a number of operational areas of the Listing Division, including the prospectus vetting function, as well as the review of a number of selected cases.

The SFC will continue to perform reviews, at eighteen month intervals, on the operations of the SEHK in order to discharge its oversight functions on the SEHK under the MOU.

Mechanism for Global Offering of Securities

The SFC, together with the SEHK, conducted during the second half of 1996 interviews with market practitioners and listed issuers with regard to the offering mechanism used in the distribution of securities in global offerings. The purpose of the interviews was to review the implementation by the market of the Joint Policy Statements on offer mechanism made by the SFC and the SEHK in November 1994, with a view to refining the current practice and ensuring that the objectives of the policy statements were met. The SFC anticipates conducting a public consultation exercise with the SEHK before issuing further guidance in this area.

Statutory Protection for Auditors

The SFC assisted the Government in drafting a bill to protect auditors of listed companies from liabilities arising from reporting to the SFC and the SEHK reasonable suspicion of misfeasance by the companies and their officers. The SFC is of the view that such legislation would encourage auditors to report suspected misfeasance to the authorities in circumstances where they might be reluctant to do so for fear of possible legal proceedings by their clients alleging defamation or breach of duty to maintain client confidentiality. The bill has been presented to the Legislative Council and awaits consideration by a bills committee.

Securities (Disclosure of Interests) Ordinance (SDIO)

Whilst work is still continuing on the rationalisation of securities legislation, the proposed public consultation on the amendment of the SDIO and related legislation drafting work has been postponed. The Division intends to consult the public on proposed revisions to the SDIO as soon as work on the draft Composite Securities and Futures Bill is completed.

Corporate Governance

The subject of corporate governance has continued to attract public attention in Hong Kong. An SEHK Corporate Governance Working Party, which included an SFC representative, is expected to report to the Listing Committee in the second quarter of 1997 on possible changes to the SEHK's Code of Best Practice.

Mandarin Resources Corporation Limited

On 25 June 1996, following consultation with the Financial Secretary, the SFC filed with the Supreme Court of Hong Kong a petition against Mandarin Resources Corporation Limited (MRC) and the Honourable Mr Chim Pui Chung, its controlling shareholder. The petition seeks a number of remedies, including redress for the minority shareholders of MRC arising from the manner in which the affairs of MRC are alleged to have been conducted. The petition was based on an investigation conducted by the Division. It is anticipated that the case will be set down for hearing by the end of 1997.

Simplification of prospectuses and announcements by listed companies

In view of the increasingly complex language used in announcements, circulars and prospectuses issued by listed companies, in March 1997 the SFC formed a working group with market practitioners and the SEHK to consider and promote the use of plain and clear language in public documents issued by listed companies. The working group will also review the quality and format of information in a prospectus in order to make it easier for the investing public to discern the relevant information. It is anticipated that the working party will complete its review and issue recommendations by the end of 1997.

Administration of the Takeovers Code and Share Repurchases Code

During the year, there were 31 general offers under the Takeovers Code and 114 waivers of general offer requirements and confirmations of no offer requirement (e.g. placing and top-up), 6 privatisation proposals and 457 other waivers, consents and confirmations given by the Department. Statistics on cases handled by the Takeovers Panel and the Takeovers Executive are at Table 1, shown later. These show a very considerable increase in the number of cases handled by the Department. In addition, the year saw many large and complex transactions, some of which are discussed below.

TVE (Holdings) Limited

On 14 February 1996, South China Morning Post (Holdings) Limited announced a voluntary conditional share offer for all the shares of TVE (Holdings) Limited. Shortly after the offer document was dispatched, Shaw Brothers issued a counter-bid for TVE, offering to buy all the shares of TVE in cash. The SCMP offer was not considered to be fair and reasonable by the independent financial adviser of TVE. SCMP then increased its offer by adding a cash alternative, after which Shaw Brothers withdrew its offer with the consent of the Takeovers Executive. TVE was eventually privatised by SCMP under the compulsory acquisition provisions of the Companies Ordinance. This case is noteworthy as one of the very few hostile takeovers which have taken place in the Hong Kong market in recent years.

Consolidated Electric Power Asia Limited

In October 1996, Hopewell Holdings Limited agreed to the takeover of Consolidated Electric Power Asia Limited (CEPA), its power generation subsidiary, by the Southern Group in the United States. This was the second largest takeover to date of a Hong Kong listed company in terms of the monetary value of the consideration received by shareholders. Under a Scheme of Arrangement, shareholders of CEPA were offered either cash or a combination of cash and new CEPA shares. This resulted in CEPA becoming an 80% subsidiary of the Southern Group and its withdrawal of listing from the SEHK. Upon completion of the Scheme of Arrangement in early 1997, control of CEPA was passed to Southern. Hopewell, the former controlling shareholder of CEPA, retained a substantial interest in CEPA. The Takeovers Code provisions regarding a privatisation by way of scheme of arrangement did not apply in this case as Hopewell effectively sold its control of CEPA to a third party purchaser on terms made equally available to other CEPA shareholders under the scheme.

Cheung Kong Group Reorganisation

The Cheung Kong Group announced in early January 1997 a proposed reorganisation involving a general offer by Hutchison Whampoa Ltd for Hong Kong Electric Holdings Ltd, followed by a realignment of two companies by way of intra-group transfers. The resulting group structure is a vertical one with Cheung Kong (Holdings) Ltd owning just below 50% of Hutchison Whampoa, and Hutchison Whampoa controlling Cheung Kong Infrastructure Holdings Ltd which in turn holds Hong Kong Electric. Hutchison Whampoa's takeover of Hong Kong Electric exceeded Southern's offer for CEPA in total monetary value. Of the various steps of the reorganisation which have implications under the Takeovers Code, the Takeovers Executive was satisfied

(i) that any general offer obligation resulting from the intra-group transfers of the interest in Cheung Kong Infrastructure from Cheung Kong to Hutchison and that in Hong Kong Electric from Hutchison to Cheung Kong Infrastructure could be waived on the basis that Cheung Kong remained in ultimate control over each of the group companies; and

(ii) that the consolidation of control by Cheung Kong over Hutchison Whampoa was effected within the creeper restriction applicable for the relevant 12-month period under the Takeovers Code.

Some Decisions by the Takeovers Panel

Privatisation of Asean Resources Holdings Limited

The Panel met on 3 May 1996 to review a ruling made by the Takeovers Executive in relation to a proposed privatisation of Asean Resources Holdings Ltd by Huey Tai International Ltd. The ruling related to the inclusion of a warrant-for-warrant alternative in the proposed offer structure.

Huey Tai owned 68.1% interest in Asean and proposed to privatise it by way of a scheme of arrangement through the offer of one cent or one new Huey Tai warrant for one Asean warrant. This offer (the warrant-for-warrant offer) was higher than the "see-through price" (i.e. the offer price for Asean shares less the exercise price of Asean warrants) of the Asean warrant. The issue for the Panel was whether the proposed offer was in compliance with the "equality of treatment" principle and Rule 13 of the Takeovers Code.

The Panel ruled that the "see-through price" formula provided under the Note to Rule 13 of the Code is only a minimum requirement for the protection of warrant holders. The Takeovers Executive or the Panel may permit an offer higher than the "see-through price". However, a higher offer would not be considered appropriate if it were to be considered part of a special deal to provide an incentive to persons who also hold shares or other securities of the offeree company to accept the offer. Regarding the interpretation of "equality of treatment" under Rule 13.1, the Panel takes the view that this should mean equality of treatment within a class of security holders as opposed to equality of treatment between different classes of securities.

Application of Rule 31.1(a)(i) of the Code

The Panel met on 1 March 1997 to consider a referral by the Takeovers Executive in connection with the application of Rule 31.1(a)(i) of the Code in relation to The Kwong Sang Hong International Ltd, a listed company which was owned more than 50% by Peregrine International Holdings Ltd. Peregrine announced in December 1996 a proposal to privatise Kwong Sang Hong by way of a scheme of arrangement. Implementation of the scheme is, therefore, subject to approval by a majority in number representing 90% in value of those shares that are voted at a duly convened general meeting by shareholders other than Peregrine and persons acting in concert with it (the "independent shareholders").

Peregrine was concerned that the scheme would not be approved by the necessary number of independent shareholders during the general meeting which was required to be held as a court meeting. Prior to the court meeting, Peregrine applied to the Takeovers Executive under Rule 31.1(a)(i) for consent to make a voluntary general offer for all the shares of Kwong Sang Hong if the privatisation proposal was not approved by the independent shareholders during the court meeting. The consideration offered to shareholders under the proposed voluntary offer would be the same as the consideration offered under the privatisation proposal. The voluntary general offer would be an unconditional offer. The Takeovers Executive did not consider it appropriate to give the requested consent and referred the matter to the Panel.

The Panel was asked to consider whether consent could be granted to Peregrine under Rule 31.1(a)(i) to make an unconditional voluntary general offer for all the shares of Kwong Sang Hong not already owned by Peregrine and its subsidiaries if the privatisation did not obtain the necessary approval by independent shareholders.

The Panel ruled that the proposed voluntary offer is contrary to the disciplines which the Code generally seeks to impose on offerors and, in particular, to the requirement of Rule 31 which does not permit an offeror to make a new offer for the same company within the twelve-month period following the date on which an offer has lapsed. Under Note 1 to Rule 31, the consent of the Takeovers Executive is not normally given when the offeror is a substantial shareholder of the offeree company, as is the case with Kwong Sang Hong and Peregrine. After considering the representations made by the Takeovers Executive, Peregrine, and its adviser, the Panel supported the Takeovers Executive's decision not to exercise its discretion to permit Peregrine to extend a voluntary offer for Kwong Sang Hong immediately following the failure of the privatisation proposal in respect of Kwong Sang Hong.

Suspension of trading

Under the Securities (Stock Exchange Listing) Rules the SFC may direct the SEHK to suspend all dealings in specified securities if it appears to the SFC that materially false, incomplete or misleading information has been included in a prospectus, circular, or equivalent document or in any written announcement, statement or circular issued by or on behalf of a listed company. The SFC may also direct suspension where it appears to be in the interest of maintaining an orderly and fair market, in the interest of the investing public or in the public interest. These powers were formally invoked only once during the year as the Division was able to encourage listed companies under certain circumstances to amend announcements, to provide further information in a public announcement, or to request voluntary suspension in the trading of shares until the relevant announcements could be made.

Functions

The Investment Products Division has regulatory responsibility for investment products, which include unit trusts, mutual funds, investment-linked assurance schemes, pooled retirement funds and immigration-linked investment schemes as well as other forms of investment arrangements. These products require authorisation by the SFC before they can be marketed to the public in Hong Kong. The Division vets applications for authorisation of investment products and related advertising material and monitors ongoing compliance with the requirements. In addition, it administers the prospectus-vetting provisions of the Companies Ordinance, vetting prospectuses for issues not listed on the SEHK.

To assist its work, the Division has developed and administers three Codes: the Code on Unit Trusts and Mutual Funds, the Code on Investment-linked Assurance and Pooled Retirement Funds, and the Code on Immigration-linked Investment Schemes. The Division also develops guidelines and policies on other types of investment products and matters affecting the investment management industry generally.

The Division administers the applicable provisions of the Protection of Investors Ordinance (PIO). It monitors the print media for offers to the public to invest, making enquiries into misleading advertising that falls within the remit of the PIO and working math the Enforcement Division in relation to enforcement action.

The Investment Products Division has also recently taken on responsibility for investor education, including the public enquiry and complaints function previously handled by the Enforcement Division.

Regulation of Investment Management

Following the Jardine Fleming (JF) disciplinary case in August 1996 (see paragraphs 3.14 3.16), and the temporary suspension of Morgan Grenfell's funds in the UK and Dublin in September 1996, many questions were raised by the media and the public about the regulation of investment management. Although no regulatory system can guarantee to prevent misconduct or malpractice, regulators are very aware of the ongoing need to take all reasonable steps to safeguard the interests of investors and to ensure that transactions take place in a fair market.

In November 1996, the SFC issued a consultation paper on Management, Supervision and Internal Control Guidelines, which outlines detailed compliance procedures for all intermediaries, including fund managers. In addition, the Division has been working with the Hong Kong Investment Funds Association (HKIFA) on the development of "best practice" guidance to supplement the existing rules and codes. The HKIFA has prepared a detailed guideline on the restrictions for personal account dealing by fund managers, to supplement the existing requirements for client priority and avoidance of conflicts of interest. Fund management companies themselves, moreover, are demonstrating increasing compliance awareness, which will be reinforced by SFC inspections.

Statistics

Strong growth in the fund industry continued over the period. Despite the deauthorisation of 52 funds, 164 funds were authorised during the period, bringing the tot number of authorised funds to 1,356 as at 31 March 1997 (See Figure 1 below), compared to a total of 1219 as at 31 March 1996. This represents an increase of 11.2% and the highest level yet achieved for authorised funds in Hong Kong. Of the 1,356 authorised funds, 972 were sub funds of umbrella funds, representing a 12.8% increase over the last year (See Table 2 shown below).

Figure 1 Authorisation vs De-Authorisation Unit Trusts & Mutual Funds, April 1996 - March 1997	Figure 2 Authorised Unit Trusts & Mutual Funds by Jurisdiction

 

The number of applications continued to increase steadily. In particular, equity funds investing in the Asian region continued to be a market favourite (See Table 3).

Despite the entrance of a number of new management groups, mostly from overseas, restructuring and amalgamation of some existing fund management groups has caused the number of fund management groups to remain fairly steady. As at 31 March 1997, the number of fund management groups authorised to market their funds in Hong Kong totaled 90 compared to 87 at the end of March 1996. However, this does not include the total number of fund management companies in Hong Kong, which is estimated at 195. This number is a subset of the population of licensed Securities Investment Advisers, and a more detailed database will be established with the assistance of the licensing Department in the coming year.

Authorised funds in Hong Kong continue to be predominantly international in origin. (See Figure 2 above). Although Hong Kong authorised funds are domiciled in 20 jurisdictions, some 55% of authorised funds are managed or advised by Hong Kong domiciled fund managers, with the remaining majority being managed or advised in places such as the UK and the United States. (See Figure 3).

Figure 3 Domicile of fund managers

The average authorisation time for standard funds remained at about three weeks. Overall, the Division has continued to maintain its efficiency in processing new applications (see Performance Pledges).

Unlisted Company Prospectuses

Apart from the authorisation of 74 mutual fund prospectuses, the majority of the applications for authorisation for registration of unlisted company prospectuses were Eurobond issues, most of which were medium term note programmes. There was one public share offer and four B-share rights issues during the period.

Investment-linked Assurance and Pooled Retirement Funds

Two major initiatives came to fruition during the past year in relation to investment-linked assurance schemes. The first was the introduction of the cooling-off period which came into effect on 1 July 1996. Buyers of long-term life policies, including investment-linked assurance schemes, are now given a maximum of 21 days to demand a full refund (less a market value adjustment, where applicable) from the insurer. The second initiative was the requirement for insurers to provide details on surrender values to prospective investors in these schemes before they sign the application form, illustrating the penalties applicable to the early years of the policy. This requirement came into effect on 1 January 1997.

These initiatives stem from an increasing number of investor complaints about these products in recent years, in particular from investors who claimed to have been misinformed about the long-term nature of the products and the penalties for early encashment. Both initiatives received the invaluable assistance of the Life Insurance Council of Hong Kong and the Insurance Authority.

In the coming year, the SFC will revamp the Code on Investment-linked Assurance and Pooled Retirement Funds in the fight of recent developments in the market for both products. These include, among other things, the increasing localisation of the market for unit-linked policies, the increasing involvement of fund houses in the pooled retirement funds market and the potential impact of the Mandatory Provident Fund.

Given the increasing divergence of the two products, the SFC intends to split the Code into two and publish one code each for investment-linked assurance schemes and pooled retirement funds. This is expected to be achieved within the coming year and, when implemented, will facilitate promoters' of scheme documents as requirements will be more specific to the products under regulation.

Statistics

The number of investment-linked assurance and pooled retirement funds whose documentation had been authorised increased to 119, of which 67 were investment-linked assurance schemes and 52 were pooled retirement funds. The number of management groups or companies increased by 5 to 41.

Immigration-linked Investment Schemes

As in previous years, Canada continued to be the only country from which immigration-linked investment schemes originated. Activity in this area slowed considerably since the Canadian government halted the promotion of private sector managed schemes in July 1996 (except for Quebec-based schemes). At present, the market is dominated by government-administered or Quebec-based schemes. It is difficult to predict with accuracy how the market for this product will be in the coming year as, among other reasons, the Canadian government is again reviewing the situation and some changes to the Immigrant Investor Program are due to be made in June 1997. The SFC authorised the documentation of a further 6 immigration-linked investment schemes during the year, making a total of 57 authorised schemes since the introduction of the Code on Immigration-linked Investment Schemes in May 1990. As of 31 March 1997, only 12 authorisations remain current.

The Investor Education Unit was established in April 1996 to implement educational initiatives to explain to the investing public the operation of the regulatory framework, the protections available within it, and the role investors should play to safeguard their own interests when investing. It also handles investor enquiries and complaints.

Publications

New publications, in English and Chinese, designed for prospective and existing retail investors, were launched in August 1996. These booklets discuss some of the key issues people should consider when deciding to invest. Those issues include the risks and rewards of investing, the importance of "doing your homework" when selecting an investment or choosing a broker or financial adviser, and what the SFC can do to help investors who encounter market malpractice by intermediaries. The titles of these publications are

• Step 1: Your First Moves Towards Investing
• Step 2: Choosing Your Broker or Financial Adviser
• Step 3: The Importance of Monitoring Your Investments
• Step 4: When to Pursue a Complaint

All the publications are available to the public free of charge at the SFC and all 16 offices of the Consumer Conned. Some 35,000 brochures were distributed within three weeks of launch in August 1996.

The contents of these publications are available here. At the request of both Ta Kung Pao and the Oriental Daily News, the contents of the brochures have also been published in a series of articles.

Media Programme

In a joint project with Ming Pao, a series of eight investor education stories appeared in the newspaper's business pages in August and September 1996. The stories illustrate common problems experienced by investors and explain how investors can safeguard their interests in similar situations. These stories can also be found here.

The SFC sponsored two television series, produced by Radio Television Hong Kong (RTHK), which aim to guide the public through the steps of wise investment. The first series, "All About Investing", comprised eight episodes of five minutes each and was aired on the TVB Jade and ATV Home channels in October 1996. The second series, "Invest Wisely", consisting of six half-hour documentaries, was aired on TVB Jade from February to April 1997.

The next phase of the investor education programme will seek to enhance the existing publication programme by developing more booklets on topics of concern, as well as to explore other media to disseminate the SFC's educational messages. In addition, the Investor Education Unit will continue to coordinate educational activities with the Exchanges and other market bodies such as the Hong Kong Investment Funds Association.

Investor Enquiries and Complaints

All investor enquiries and complaints are handled by the Investor Education Unit. Investors can call the SFC Hotline at 2840-9333 if they believe there has been malpractice in relation to their investments or if they want to check whether their broker is licensed or if an investment product is authorised. The Hotline operates during normal working hours and has a tape recording system outside of working hours. Investors may also submit a written enquiry or complaint or request an appointment to discuss these matters in person.

During the year, the SFC received 1,088 enquiries and 565 complaints from the investing public. The subjects of enquiries were diverse, but it is clear that the investing public were increasingly concerned about the operation of the regulatory framework and their rights in dealing with intermediaries. The vast majority of complaints were resolved without further investigation being necessary. Legitimate complaints are passed on to relevant SFC departments for further assessment, and if necessary, to the Enforcement Division for investigation. In 19 of these cases, formal investigations were initiated.

Figure 4 Number of Investor Enquiries and Complaints April 1996 - March 1997

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