This is my sixth and last time penning a message for the annual report of the Securities and Futures Commission (SFC). I do so with mixed feelings – sadness that I am leaving Hong Kong, and in particular, the staff, and satisfaction that looking back, I leave a strong organisation, well placed to support the development of Hong Kong’s financial market. I will use this statement, therefore, not just to recap the past year but to reflect on the events of the last six years.
Reform to revitalise
Another year has passed, but regulatory reform following the global financial crisis remains a challenge. Many of the policy issues for Hong Kong have been resolved and I am pleased with the progress of those changes, given that clear timelines were set for implementation. The global agenda, however, remains at a fluid stage, notwithstanding the passing of the Dodd-Frank Act in the United States and the many reforms in Europe.
In Hong Kong, we have completed some reforms, and are in the process of implementing others. As a major item on our agenda for the reporting year, we launched reforms to two of our key regulatory functions. For retail investment products, we revised the product codes to improve transparency and set enhanced disclosure standards; for intermediaries, we amended the Code of Conduct to raise standards of selling practices.
Our regulatory reform agenda also included other items not stemming directly from the financial fallout, where the key purpose is to better protect investors. For instance, we introduced enhanced disclosure requirements for synthetic exchange-traded funds (ETFs), as well as a new annotation requirement to make it easier for investors to differentiate between traditional and synthetic ETFs.
In terms of enforcement actions, for the first time, we successfully sought an injunction to pre-empt the misuse of initial public offering (IPO) proceeds. We are seeking court orders to restore the funds raised from the IPO to those who subscribed to shares and to others who purchased the shares since the IPO.
In line with global development to tighten supervision of credit rating agencies (CRAs), we decided to add a new type of regulatory activity to our existing licensing regime. Starting from 1 June 2011, CRAs and their analysts working in Hong Kong are required to be licensed.
On the international scene, uncertainty still hangs over a number of issues unearthed by the financial crisis. As the regulator of securities and futures markets in an international financial centre, we adopt best global practices. We continued to participate actively in discussions at the level of the Group of twenty (G-20) and the Financial Stability Board to drive regulatory developments in areas such as over-the-counter instruments, dark pools, centralised clearing houses and swap-based execution of trades. Some of these items are new to Hong Kong but need to be addressed as they take up a big part of the global agenda.
Living our values
Over the years, the SFC has progressively established itself as a globally respected regulator and an organisation of professionals responsive to market changes.
To sustain this positive reputation in the financial market, we recognise the need to build on our strengths and most importantly, to revitalise ourselves continuously. We embarked last year on a programme to drive and develop an open and more integrated working culture within the SFC: one that acts with integrity and foresight.
In an organisation-wide effort, we promoted the cause of being proactive, professional and the recognition that people are our greatest asset. A series of “culture workshops” were held to champion these core values as an integral part of working at the SFC. Even though I shall be leaving, I know that these core values will prevail to guide and inspire our staff in their day-to-day work and to prepare the SFC to face challenges ahead.
To sustain our long-term vision of being a globally respected regulator that acts with independence and integrity and is responsive to market changes, we shall implement strategic initiatives to meet identified regulatory risks and challenges.
Items on our near-term agenda include: sponsors’ work and quality of listing documents, the disclosure of price-sensitive information and a paperless securities market. Given the rapid emergence of renminbi products and Mainland entities, we also shall strive to grow our market whilst remaining firmly committed to investor protection.
The list goes on. Please see our new “Corporate Outlook” as I shall not dwell on details here.
In the aftermath of Lehman Brothers’ (LB) collapse and the near meltdown of the global financial system, lots of questions have been asked of regulators. “Why didn’t you see it coming? Why didn’t you intervene earlier? Are you competent enough to understand the complexities of modern finance?”
There were failures in every market. Some were failures of major financial institutions; some were product failures and some fell just short of total failure but resulted in huge losses. While no market in the world was immune from the effects of the crisis, some fared better than others. Asian markets generally did better – in part because of the structural reforms implemented after the Asian financial crisis.
Within Asia, Hong Kong was more robust than many. We did have some product failures. In particular, credit-linked notes where LB was either the swap counterparty or a defined credit risk saw losses, and a number of other complex products also failed. However, we did not suffer any institutional collapses of brokerages, banks, hedge funds, etc as in other markets.
But the question remains – if this regulatory system has failed us, what is a better system? Regulatory systems around the world vary but most fall into three general categories. The original model, which still prevails in the United States, Hong Kong and Mainland China, is the institutional model. With this model, separate regulators look after banking, securities, insurance, etc. Most other markets have moved beyond this, to variants of either the single integrated regulator largely pioneered by the United Kingdom, or a “twin peaks” model where one organisation takes responsibility for prudential regulation and the other for conduct regulation.
All of these models existed around the world during the crisis and it is not clear that any single model performed particularly better than any other. Why? It is the quality of the implementation that is critical – not the model itself. In particular, the challenge lies in managing the interfaces – either between separate organisations, or between different parts of the same organisation.
In the original report to the Government following LB’s collapse and the subsequent product failures in Hong Kong, I proposed that the “twin peaks” model be considered as an alternative to today’s structure for Hong Kong. Inevitably, the question is whether the disruption and organisational upheaval of moving to a new structure is justified by the benefits that will accrue.
Two years on, we find ourselves with essentially the same model but some important tweaks to that structure. The SFC has successfully rolled out some improved disclosure requirements for products and Hong Kong is the first regime in the world to develop a regulatory structure specifically for structured products. We have spent some time fine-tuning the conduct requirements of intermediaries to ensure that the existing requirements are better implemented. We have also spent a lot of time improving the interfaces with other regulators.
Financial crises are unfortunately a recurring feature of financial markets. The important thing is to take lessons from this crisis – just as we did with the Asian financial crisis – to ensure that we are in a more robust position when the next crisis emerges.
Coming full circle
I joined the SFC at a time when the local market was on the rebound after the outbreak of the severe acute respiratory syndrome. At the time, Hong Kong was riding very much on the resurgence of the growing Mainland capital markets. Looking back, we have come almost full circle. We went from that to the meltdown of 2007 and 2008, which uncovered problems of product suitability. Since LB’s collapse, we have been spending much time rebuilding structures, addressing weaknesses that have become apparent, and rebuilding confidence in the market. The focus of investor protection has also become much clearer as a result of that experience.
Over the past six years, I have seen remarkable changes at the SFC in more aspects than one. As a regulator, we have been taking a firm and pragmatic approach and it paid off. Having in place an effective regime for short selling, for instance, we were able to weather the volatility of 2008 without following other major markets to take up ad hoc measures.
And if successful prosecutions are indicative of esteem, then I am glad to observe that we have been held in high regard by judges. Since March 2007, we managed more than 170 convictions for market manipulation, representing two-thirds of all such convictions since the SFC’s inception 22 years ago.
We also made a number of breakthroughs in the courts, by taking on successfully a number of complicated cases, including intervening in a major corporate action, obtaining
a court order to freeze assets of an overseas asset management house and those of its senior officers for suspected insider dealing, and obtaining the maximum jail sentence for insider dealing.
Above all, we took decisive steps to the problems of product-suitability and sales practices, securing from banks and brokers billions of dollars in payment for investors of LB-related products and some other structured products.
As the only regulator with a statutory mandate to educate investors, we have been using multiple channels to reach out to diverse target audiences. The collapse of LB highlighted the issue that investment products were becoming ever more complex and their distribution channels often cut across traditional boundaries of the banking, insurance and securities sectors. Recognising this, we have been working closely with the Government to establish the Investor education Council, which will take a holistic approach to investor education and address their multi-faceted wealth-management needs.
Traditions in evolution
As a corporate citizen, we formalised a policy to show care for the environment, the community and our staff while maintaining top vigilance in corporate governance. As a place to work, we have been promoting core values and the one-organisation concept to bring out the more productive, proactive and participative traits of colleagues.
By and large, these changes were made in the context of a changing culture. Culturally, Hong Kong is a diverse mix. While the heritage of the colonial system still lingers, the influence of Mainland China is increasingly evident. When I first came from the UK, I ran a couple of “white board (brainstorming) sessions” but nobody would speak up. In the latest “CEO Sharing Session,” however, I had to answer many well-thought-out questions raised by staff.
I take with me a range of experiences that will be invaluable to apply back in the UK. The whole of Europe is undergoing a fairly massive set of regulatory reforms. I am proud of the milestones and directions we managed to set here. Without the support of the Board and the dedication of my colleagues, I am afraid some of the milestones would not have been possible. So let me take this opportunity to thank the Board and all our staff for weathering through challenges and working through the storm.
I am also enormously appreciative of the support we received from the community. Our perception as an organisation has become higher in society than when I first joined. I am pleased that a clear majority of industry participants and industry-related parties polled in a survey last year expressed satisfaction with the work of the SFC. I also would like to thank the media and the legislators for their understanding and feedback.
While I do not underestimate the challenges and uncertainties ahead, I trust that the SFC, which has established itself as a respected regulator both locally and globally, will continue to strengthen and protect the integrity and soundness of Hong Kong’s securities and futures markets for the benefit of investors and the industry.
Chief Executive Officer