Annual Report 1996 - 1997
International Regulatory Cooperation

During the year the SFC continued its commitment to international regulatory cooperation with other jurisdictions. Four regulatory authorities namely, Comisio? Nacional del Mercado de Valores of Spain (CNMV), the Securities Commission of New Zealand (NZSC), the Monetary Authority of Singapore and the Ontario Securities Commission signed Memoranda of Understanding (MOUs) with the SFC, bringing the total number of MOUs and similar cooperative arrangements to 24. The CNMV and NZSC possess powers to provide investigatory assistance, similar to section 59A of the Securities and Futures Commission Ordinance, which they are willing to exercise on behalf of the SFC. The SFC has also to date entered into 12 informal exchange of information arrangements with other overseas regulators.

Recent events have also highlighted the importance of international cooperation amongst regulators of investment management business. The SFC concluded a Declaration on Cooperation and Supervision of Cross-Border Investment Management Activity with the Institut Mone`taire Luxembourgeois (IML) on 9 December 1996. This Declaration provides for exchange of information to enhance each authority's ability to regulate activities of persons involved in investment management which are registered with both authorities. The IML Declaration is particularly important in view of the large number of Hong Kong authorised funds domiciled in Luxembourg. Other countries have expressed interest in cooperative agreements in respect of investment management activity, and these will be pursued in the coming year.

A Memorandum of Regulatory Cooperation and Technical Assistance was concluded between the Intermediaries Division of the SFC and the Administration and Supervision Department of the State Administration of Foreign Exchange of the People's Republic of China. This Memorandum provides for mutual assistance and exchange of information to enhance each party's ability to protect market users, and to maintain market integrity in relation to trading of leveraged foreign exchange, foreign currency stock and foreign exchange futures contracts.

IOSCO, which now has 134 regulatory authority members from 81 jurisdictions representing more than 85% of the world's capital markets, was formed to enable members:

• to cooperate to ensure better regulation of the markets, on the domestic as well as international level, in order to maintain just and efficient markets;
• to exchange information on their respective experience in order to promote the development of domestic markets;
• to unite their efforts to establish standards and an effective surveillance of international securities transactions; and
• to provide mutual assistance to ensure the integrity of the markets by a rigorous application of the standards and by effective enforcement against offences.

The SFC is an IOSCO member, and a member of its Technical Committee, which is made up of 16 IOSCO members which regulate some of the larger and more developed securities markets in the world. Its objective is to review major regulatory issues related to international securities transactions and to coordinate practical responses to these concerns. Anthony Neoh, QC, Chairman of the SFC, was appointed Chairman of the Technical Committee in 1996.

During 1996/97, the SFC continued to participate actively in the work of the Technical Committee, including the work of Working Party (WP) 1 on Multinational Disclosure and Accounting, WP2 on Regulation of Secondary Markets, WP3 on Regulation of Market Intermediaries, WP4 on Enforcement and Exchange of Information, and WP5 on Investment Management. The main issues dealt with by the Technical Committee and its Working Parties during the year are summarised below.

The work of WP1 on Multinational Disclosure and Accounting concentrates on accounting and auditing matters. The principal task of WP1 is to work with the International Accounting Standards Committee (IASC) to complete a core body of accounting standards that can provide a comprehensive financial reporting framework suitable for international equity offerings. The IASC has accelerated its work with the aim of completing the accounting standards in 1998. The Working Party is also discussing the status of international standards on auditing with the International Auditing Practices Committee and preparing a report on non-accounting disclosures.

WP2 on Regulation of Secondary Markets continued to work this year on the issues raised by the Windsor Declaration, including the monitoring and exchange of information in respect to large exposures and the establishment of a common default procedure. In addition, WP2 is involved in a number of post-Windsor initiatives.

First, WP2 has been mandated to develop "Event-Specific Guidance to Facilitate Information Sharing" amongst market authorities. Until recently, information-sharing was primarily concerned with fraudulent cross-border market activities and therefore focused on enforcement and market surveillance. However, the focus has now changed to identification of market participants and their trading activities. A tentative agreement has been reached amongst WP2 members on the form and content of the event-specific guidance, and a revised draft is now being prepared for further comments.

A second major initiative involves the examination of problems and opportunities associated with the use of Internet for securities and futures businesses. To assist this initiative, WP2 conducted an Internet survey and has held preliminary discussions on the issues identified in the survey. The SFC also distributed its consultation document, "Report of the SFC Working Group on Automated Trading Systems" to WP2 members during a recent meeting in Mexico City. The Working Party plans to explore further the potential benefits and implications of the Internet and other electronic networks for the regulation of secondary markets.

Third, WP2 is now preparing for the issuance to major financial regulatory bodies worldwide of a "Disclosure Framework for Securities Settlement Systems", which will take place following approval by the Technical Committee.

Amongst its other initiatives, WP2 has produced a survey questionnaire on Comparative Analysis of the Supervision Practices for Regulated Markets and Clearing Houses; is assessing the technical adaptability of members' financial market system components to the "Year 2000 Problem"; and is working with the International Standardisation Organisation on the issue of "Securities Messages Standardisation".

The mandates assigned to WP3 of defining acceptable methodologies for determining minimum capital standards as well as surveys on systems and controls present an excellent opportunity for securities regulators to formulate responses to the challenges of the globalisation and erosion of the functional and institutional segmentation of finance.

First, WP3 has recently published a paper on Client Asset Protection. The paper summarises the principal methods whereby client assets are protected in all major jurisdictions. To permit each jurisdiction to assess where it stands in utilising the standards and practices described in the paper, the Technical Committee has approved a request by WP3 to develop a self-assessment questionnaire.

Second, in cooperation with a Committee of the Basle Committee on Banking Supervision, WP3 has also prepared a follow-up survey of the disclosure practices of banks and securities firms as reflected in their 1995 Annual Accounts. This joint Basle/IOSCO survey was published in November 1996.

Third, a task force has been created to carry out a collaborative project with the relevant sub-group(s) of Basle. The terms of reference are: "A body of work aimed at defining acceptable methodologies for determining minimum capital standards and supervisory approaches to systems and controls as applied to internationally active securities firms. The capital standards would permit the use of models for the measurement of market risk under prescribed conditions. The standards would also address the appropriateness of the use of statistical techniques to assess credit risk and deal with the methodologies for taking account of funding and liquidity risks incurred by securities firms."

Fourth, WP3 has agreed to conduct surveys on supervisory priorities and techniques, capital regulation, and systems and controls. The three surveys are a first step in WP3's use of the Working Party structure to develop a common understanding of these methods and practices.

WP4 on Enforcement and Exchange of Information finalised its Report on "Measures Available on a Cross-Border Basis to Protect Interests and Assets of Defrauded Investors", which was presented to the Technical Committee in June. The Report, together with detailed information on the subject provided by most WP4 members and 12 other IOSCO members regarding their respective jurisdictions, was published during the IOSCO Annual Conference in September. The Report highlighted the problems confronting regulators in recovering assets of defrauded investors that have been moved to other jurisdictions. It also encouraged IOSCO members to examine the laws and procedures in their own jurisdictions and the need and scope for reform.

In accordance with the IOSCO Resolution on "Commitment to Basic IOSCO Principles of High Regulatory Standards and Mutual Cooperation", a Self-Evaluation Exercise of all IOSCO members was undertaken. A sub-group of WP4 conducted a preliminary review of members' responses to this Exercise and presented its findings at the Technical Committee meeting in September 1996. At the Task Force meeting in January 1997 in Hong Kong, it was resolved that a report on certain key aspects of the Exercise should be presented at the next IOSCO Annual Conference in November 1997.

Hong Kong continues to be an active participant in WP5 on Investment Management. In 1995, WP5 adopted a new work programme as a result of the Baring crisis. This resulted in the submission to the Technical Committee of papers addressing the issues of regulatory cooperation in emergencies, particularly with respect to suspension of dealing, and an examination of the custody issues affecting collective investment schemes. These papers were adopted by the Technical Committee at its meeting in Montreal in September 1996.

In 1996, WP5 also took on a new mandate, to review the issues relating to the supervision of fund managers. It is now developing a discussion paper on "Principles for the Supervision of Operators of Collective Investment Schemes", which is intended to be finalised in the coming year. It is hoped that the paper will assist IOSCO members in reaching a common understanding of the reasons why it is important to supervise operators of collective investment schemes, and those activities which are of prime importance in requiring effective supervision. It is also hoped that development of the Principles will enhance cooperation amongst IOSCO members in supervision of the increasingly global investment management industry.

During the year the SFC received and processed 43 enforcement-related requests for information of which 23 were for non-public information. The SFC also received 253 licensing related requests for non-public information from overseas regulatory bodies. The SFC itself made 910 requests to overseas regulatory bodies for non-public licensing-related information and 14 requests for enforcement-related information.

In addition, the SFC received 14 requests from overseas regulatory authorities for investigatory assistance. The SFC exercised its powers under section 59A of the Securities and Futures Commission Ordinance and section 63A of the Leveraged Foreign Exchange Trading Ordinance in response to four and three of these requests respectively: one to assist the Australian Securities Commission, three to assist the Securities and Exchange Commission of the United States (US SEC) and three to assist the US Commodity Futures Trading Commission, in accordance with the MOUs with these commissions. The assistance provided in these cases included obtaining non-public records and documents to assist overseas regulators.

The SFC also provided assistance to the British Columbia Securities Commission (BCSC) in the BCSC's investigation of Goldman Stanley Consultants Inc, Chinamax International Investment Ltd and Andy Chan Ying Leung. This assistance included arranging for an SFC staff member to give expert evidence concerning leveraged foreign exchange trading in Hong Kong to an administrative hearing by the BCSC. The BCSC announced on 27 March 1997 that on the basis of the findings of the administrative hearing it had banned Goldman Stanley and Chinamax from participating in the market in British Columbia and had fined Chan C$100,000 and banned him from participating in the securities market in British Columbia for thirty years.

The SFC obtained the assistance of the Ontario Securities Commission and the China Securities Regulatory Commission in serving notices to, and facilitating the attendance of, key witnesses for the purpose of Insider Dealing Tribunal hearings. Furthermore, the US SEC, in response to a request from the SFC, obtained certain securities trading records required for one of the SFC's investigations.

During the year, the SFC, through its Declaration on Cooperation and Supervision of Cross-Border Management Activity with the Investment Management Regulatory Organisation of the United Kingdom, exchanged non-public information and coordinated action during an investigation of Jardine Fleming Investment Management Limited. Details of this action can be found in paragraphs 3.14 - 3.16. The speed with which the investigation was concluded, the compensation paid to investors and the strong disciplinary action taken illustrate the extent to which such international cooperation can enhance the SFC's investigative and disciplinary efforts.