Annual Reports
Securities and Futures Commission Annual Report 97/98 Home | Content | < Previous | Next >
 
Chairman's Statement
...................................................
 
 
Anthony Neoh's photo

Anthony Neoh


"Meeting the Challenges of Change"
 
 
A YEAR OF RAPID CHANGE
..........................................................................l
 
The year under review saw unprecedented boom and decline in rapid succession. In the boom phase of the market, turnover was stood on its head when, contrary to its hitherto trend, the volume of trading in non Hang Seng Index stocks exceeded by far the trading volume in Hang Seng Index stocks. All this was accompanied by rapidly rising trading volumes and share price movements bearing no relationship to the assets, profitability or prospects of many companies outside of the Hang Seng Index. These were market conditions which would, and did, put our markets to their most severe test since 1987. What then is the score card?
 
 
THE MARKET HELD UNDER THE STRAIN
............................................................................................l
 
In the Commission's Review submitted to the Financial Secretary in January 1988, we were pleased to report that market systems, particularly our trading, clearing and settlement systems operated efficiently and effectively under the strain. Good risk management was in effect at all times. Despite the unusual share price movements observed, a fair and orderly market was generally maintained, margin lending levels had been massively reduced in brokerages and their unregulated finance company affiliates. However, we were not satisfied and recommended a whole raft of policy and rule changes most of which have now appeared in the Financial Secretary's Review published in May.
 
CONTAGION WAS PREVENTED
.....................................................................l
 
The markets in the year under review claimed two major victims: Peregrine Investment Holdings Limited and the CA Pacific Group companies. In both cases, their failure could be attributed to the rapidity with which market conditions changed and while this did cast a long, psychological shadow over the market as a whole, the Commission's quick action arrested any contagion to the rest of the market which these failures might have caused.
 
Peregrine Investments Holdings Limited was a publicly listed investment holding company which had 11 licensed entities providing a wide spectrum of financial services to the markets. As soon as a hoped for rescue by overseas investors fell through and it became clear that the Group would experience liquidity problems, the Commission issued restriction notices to protect the assets of the clients of all 11 licensed entities. As a result, all clients of those licensed entities have had all their investments or money returned.
 
CA Pacific Securities Limited and CA Pacific Finance Limited form part of a group of financial services companies under a listed holding company. CA Pacific Securities was a securities dealer licensed by the Commission. It was also a member of the Stock Exchange of Hong Kong. CA Pacific Finance was a registered money lender and as such did not require to be regulated by the Commission. The fact that it came to the attention of the Commission at all stemmed from activities started by the Commission in May 1997 consequent to an emerging and worrying trend then beginning to form in the market.
 
MEETING THE CHALLENGES OF CHANGE:
ACTIONS IN FOUR CONCURRENT DIRECTIONS
............................................................................................................l
 
As can be seen from the chart below, the level of trading in non-Hang Seng Index component stocks began to grow out of normal limits. Whereas, trading in Hang Seng Index stocks typically take up 70% of the daily overall turnover, these stocks began to lose ground to non-Hang Seng Index stocks from about May 1997, when they fell to about 40% of the daily overall trading volume. In July, trading volume in Hang Seng Index stocks fell to 22% of the turnover. While this was happening, turnover began to increase significantly. At the same time the prices of many non-Hang Seng Index stocks, particularly Red Chips, began to show irrational movements, indicating that there was a high level of speculation driven possibly by rumour, market manipulation or insider trading or all three. To meet this emerging situation, the Commission took action in four concurrent directions:
 
l Action against market malpractice.
l Investor education.
l Inspections of brokerages and affiliated finance companies.
l Development of policy response to increased margin financing.
 
 
FAIR AND ORDERLY MARKETS
.....................................................................l
 
The Commission's immediate priority was to ensure that the markets were fair and orderly. Thus on 21 May 1997, a joint announcement was made by the Commission and the Stock Exchange expressing concern over the fact that there were unusual price movements and volume in trading in certain shares which appeared to bear no relationship to the assets, profitability or prospects of the companies in question and warning the market that, if necessary, shares may be suspended from trading until the Commission and the Stock Exchange could be satisfied that there was a fair and orderly market in the shares. As a result, there were 69 cases of suspension due to unusual price movements; 56 of these were requested by the companies, 7 were directed by the Stock Exchange and 6 were directed by the Commission. Save in the most exceptional cases, where the directors have refused to make adequate disclosure to the market or where the company is in serious financial difficulties, trading would resume once the company makes adequate disclosure. In many cases, disclosures have been very detailed, indicating that there was indeed much information that the investing public would have been deprived of if no action had been taken. During the year, suspensions resulted in 9 investigations into possible market manipulation and 13 investigations into possible insider trading. These were on-going at the end of the year under review.
 
INFORMING INVESTORS
.......................................................l
 
In the area of investor education, we issued brochures through the media and the Consumer Council, the most pertinent of which were "Choosing your broker or financial adviser" and "Monitoring your Investments". Our website had a dedicated Investor Education Section with an electronic facility for complaints. During the year, the Commission's enquiry hotline received an unprecedented number of complaints. Two popular television series have earlier in the year been aired under the auspices of RTHK on the pitfalls of unwise investment and knowing your broker and financial adviser. As the markets continued to reflect high exuberance on the part of investors, these messages appeared to have fallen on quite a few deaf ears. This will not, however, deter us from continuing to do more in investor education.
 
MARGIN TRADING
................................................l
 
The third prong of the Commission's actions was focused on margin trading and directed at brokerages and their affiliated finance companies. While margin trading has always been a feature of the Hong Kong markets, such trading had until May 1997 been at a relatively low level because of the low market turnover and because the pattern of trading was preponderantly in Hang Seng Index stocks. As the market practice was to lend on no more than 50% of the value of the stock deposited as collateral, margin lending, prior to May 1997, was not a high risk activity.
 
As market conditions in May 1997 appeared to be trending towards significant change, the Commission undertook a survey of margin lending and together with the Stock Exchange inspected 103 stockbrokers and 56 affiliated finance companies. As the Commission had no regulatory powers over finance companies, much resistance was encountered in the course of these inspections. But by sheer perseverance, we did manage to persuade the brokerages most exposed to margin lending to reduce the level of credit extended to their clients and this tightening did help the broking industry as a whole to weather the sharp market decline in October 1997 and the poor credit environment that ensued. As the credit environment worsened, the Commission formed a task force in January 1998 to conduct further inspections and as a result total margin levels were reduced by a further $1.8 Billion. The Commission succeeded in persuading all but one of the inspected braking firms and their associated finance companies to increase capital by $1.6 Billion.
 
In the course of these inspections, some companies in the CA Pacific Group were discovered to be encountering severe liquidity problems, due in large part to a connected property related loan which has since become the subject of a criminal charge. These liquidity problems meant that the securities firm might at any time go into default with Hong Kong Securities Clearing and were creating a huge potential for certain clients to be preferred against the rest. The Group was called upon to inject capital. In the event CA Pacific failed to do so. To ensure that the interests of all investors are protected, the Commission presented a petition to wind-up CA Pacific Securities and the Group itself presented a petition to wind-up CA Pacific Finance, and provisional liquidators were appointed to preserve the assets and oversee their orderly disposition. It should be noted that the Commission's decisive action against CA Pacific not only served to ensure that the legal rights of their clients were protected, but it also served to demonstrate determination on the part of the Commission. That helped in preventing contagion to the rest of the market as other firms responded to Commission concerns and found ways to inject capital and reduce their margin lending.
 
A POLICY RESPONSE
.....................................................l
 
In November 1997, the Commission developed a policy response to the increased margin activities of unregulated finance companies and in early December we submitted a report on margin lending activities recommending that a working party be set up to consider the various policy options put forward in our report. We are pleased to note that the Financial Secretary acted with speed in forming the Working Party, chaired by the Deputy Secretary for Financial Services. By the end of the year under review, the work of the Working Party was well advanced and legislative amendments bringing margin lending under tighter regulation were under discussion.
 
REGULATION IS A CONTINUING PROCESS OF MEETING THE
CHALLENGES OF CHANGE
...................................................................................................................................l
 
Regulation is a continuing process of meeting the challenges of change. Thus, the four sets of actions that the Commission undertook represented the Commission's response to changing market conditions. Whether these actions were adequate must remain a matter for judgement by others but we are convinced that in the rapidly changing market conditions of the time, we could only make judgements and take action on the basis of what could be perceived and reasonably anticipated at the time. In the light of the imminent constitutional change that Hong Kong was facing in 1997, it was impossible to expect a quick legislative fix to the Commission's powers or a widening of the regulatory net for margin financing. Thus the Commission decided to respond to changing market conditions by taking these actions in the midst of the many activities recorded in this Annual Report.
 
Among our many activities, we continue to strengthen the regulatory system. We have kept our Global Offering Mechanism as well as our Takeover Code up to date, and are in the course of reviewing the Share Repurchase Code when the issue of treasury shares will be considered. We are now embarked on the use of plain language in all corporate finance activities, including initial public offerings. The Fund Manager Code of Conduct was issued and a third Edition of the Code on Unit Trust and Mutual Funds published. We have made substantial strides in tackling, both within the Commission and in the market, the Year 2000 computer problem. We helped establish the Hong Kong Securities Institute. Our international activities brought us important recognition among our colleagues world wide as an important, trusted and professional partner in the regulation of increasingly globalised markets.
 
An effective financial regulatory agency must continue to hone its skills and professionalism to meet the challenges of change in the markets. Thus, we hope it will be thought that we have lived up to the motto that we exist to serve the needs of the markets and the community, without fear or favour.
 
A VOTE OF THANKS
....................................................l
 
This year has been one of the most difficult years for the Commission. I would like to place on record my gratitude and admiration for the dedication which the entire staff of the Commission has brought to their work. I would like to think that their work made a real difference in steadying the markets in the face of the strong winds that buffeted our community. I hope the community would think the same.
 
 
Anthony Neoh, SC, JP
Chairman
 
Home | Content | < Previous | Next >