Report of the Securities and Futures Commission Working Group on Automated Trading Systems - Public Consultation

Appendix 1Appendix 2
Appendix 3Appendix 4


The Securities & Futures Commission (SFC) is publishing a Report of the SFC's Working Group on Automated Trading Systems. The consultation period for members of the public and the industry to provide comments on the Report to the SFC closed on 15 March 1997.


In mid 1996, the SFC formed a Working Group to consider "Automated Trading Systems" (or ATSs). These were defined broadly to include any automated system that provides a trading mechanism for securities or futures contracts, but excluding the operations of the Stock Exchange of Hong Kong Ltd. and the Hong Kong Futures Exchange Ltd.. The Working Group is chaired by a non-executive director of the SFC and includes representatives of the Hong Kong exchanges and other professionals involved in the securities and futures markets (see Appendix 1 to the Report).

The Working Group was formed in response to the emergence and use globally of ATSs. Driving forces in this regard include technological advances and the increasingly international character of markets, investors and market intermediaries. Also relevant is the SFC's proposed draft for a composite securities and futures bill, which includes proposed new legislation to address ATS operations in Hong Kong. The draft bill was the subject of SFC consultation papers in April and December 1996.

The Working Group provided its Report to the SFC in January 1997. The Report describes the operations of ATSs internationally and in Hong Kong. It then summarizes the regulatory approaches that apply to ATS operations and developing regulatory trends. Finally, the Report summarizes the Working Group's views on ATS operations and the regulatory approach that should apply to them in Hong Kong.

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There are many types of ATS operations internationally and in Hong Kong. They include: so-called electronic bulletin boards; other automated trade matching systems; ATSs operated by overseas exchanges; broker-to-client automated linkages; and ATSs operated on the Internet.

New regulatory requirements have been or are being developed internationally to address ATS operations. The most developed are found in the United States, United Kingdom, and Australia. The International Organization of Securities Commissions is also developing standards to apply to ATS operations. These are described in the Report.

The Working Group believes ATS operations will continue to grow internationally and in Hong Kong. It will be difficult if not impossible for regulatory authorities to stop these developments. However, the Working Group does not believe that ATS operations will replace traditional exchanges. Increased automation is likely to increase overall turnover and thereby create a bigger "pie".

ATS operations may provide benefits to the marketplace. Depending on the system involved, some of the potential benefits include lower costs, specialized services, ease of access, and expanded product ranges.

ATS operations may also raise concerns. Depending on the system involved, some of the potential concerns include the fitness and properness of the system operator, lack of transparency, adequacy of surveillance arrangements, and the maintenance of security and control procedures and back-up arrangements.

The Working Group believes a pragmatic and flexible approach should be taken to ATS operations in Hong Kong. The Report provides a set of general principles to be considered in relation to ATS operations (see section VI of the Report). Some of the main principles are:-

The Working Group believes these general principles will need to be applied flexibly and on a case-by-case basis in the light of the diversity of ATS operations. It will also be important for regulatory authorities to cooperate and share information in relation to ATS operations, because most ATSs operate across borders. Where ATSs operate from unregulated off-shore jurisdictions, it will be important to educate investors about the risks inherent in using such systems.

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The SFC has reviewed the Working Group's Report and believes the regulatory principles set out in the Report are necessary and appropriate in the context of ATS operations. The SFC's proposed draft for a composite securities and futures bill would address ATS operations by including a new category of "authorised trading facility" (see clause 4.12 of the draft bill). This would be in addition to the regulatory arrangements for brokers and exchanges. An ATS operating in Hong Kong would thereby be classified as either an authorised trading facility, a broker, or an exchange depending on the nature of its operation in Hong Kong. The existing law provides regulatory arrangements only for brokers and exchanges and which either exclude some ATS operations or are not specifically designed to address ATSs. As already stated in the SFC's consultation papers on the composite securities and futures bill, the Stock Exchange of Hong Kong Ltd. will continue, as is the case in current legislation, to be the only recognised securities exchange in Hong Kong.


As recommended by the Working Group, the SFC is now seeking additional views and comments on the Report of the Working Group. Comments on the Report of the SFC's Working Group on Automated Trading Systems should be provided by 15 March 1997 and addressed to-

The Secretary Securities & Futures Commission 12/F, Edinburgh Tower The Landmark 15 Queen's Road Central Hong Kong Tel: 28409222 Fax: 25247069

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1.1   In August 1996, the Securities and Futures Commission (SFC) formed a Working Group on Automated Trading Systems. Automated Trading Systems (ATSs), which also may be termed "proprietary trading systems", were defined broadly. They include any automated system that provides a trading mechanism for securities or futures contracts, but exclude the operations of Hong Kong's Stock Exchange and Futures Exchange.

1.2   Mr. Roderick Chalmers a non-executive director of the SFC chairs the Working Group, which includes 8 other members involved in the securities and futures markets. The members include industry professionals from the Stock Exchange and Futures Exchange, a major accounting firm, brokers and asset managers, an ATS operator, the SFC, and academia (see Appendix 1). This Report provides members' personal views with limited input from their respective organizations.

1.3   The Working Group has produced this Report for the SFC following the terms of reference in Appendix 2. The report describes the operations of ATSs internationally and in Hong Kong. It then summarizes the regulatory approaches that apply to ATS operations and developing regulatory trends. Finally, the Report summarizes the Working Group's views on ATS operations and the regulatory approach that should apply to them in Hong Kong.


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2.1   Rapid advances in information technology and telecommunications, and the internationalization of financial markets, have spurred the development of many new financial market services. The increasing size and global activity of institutional investors have led to new services specifically tailored to their needs. Separately, new investment and risk-transfer products appear regularly. Technology is also being used to provide new services to retail investors through personal computer networks and the Internet. The new services accompanying these trends include various ATS operations for trading in securities and futures contracts, some of which are described below.

Bulletin Boards and Trade Matching Systems

2.2   Technological advances have led to the development of many interactive global telecommunications networks. For example, the networks of the traditional "newswire" services are used by most of the world's financial market participants. These systems provide electronic "bulletin boards" that collect and display information from market participants interested in trading in a variety of financial instruments, such as debt and money market instruments that historically have traded in telephone-based OTC markets. These systems may also be used to display interest in illiquid small company stocks that may not be listed on a recognized exchange. A bulletin board system typically does not provide trade matching or settlement services, but some have been expanded to provide matching services and are termed "trade matching systems". Transactions effected through these systems may be settled through recognized settlement services such as those provided by Euroclear and Cedel or settled directly between trading counterparties.

Broker-run ATSs

2.3   A number of innovative brokerage firms have developed their own "proprietary" systems for trading in securities and futures contracts. Typically, these systems offer their services to other brokers, banks and institutional investors who meet the ATS operator's credit standards. Trading is usually done anonymously and settlement effected directly with the ATS operator. One large international ATS (Instinet) operates in 30 countries with 7500 trading terminals on a 24- hour basis. These ATS operations are regulated as brokers in the majority of jurisdictions.

2.4   Broker-run ATSs may or may not be interfaced with traditional exchanges. Some ATS operators are members of an exchange and report all completed transactions to the exchange who then publishes the transaction data. They are also subject to the rules and regulations of the exchange. Others do not belong to an exchange, but report transactions to a "consolidated tape" which displays transaction data from multiple markets. Still other ATSs operate independently and may or may not publish transaction data.

2.5   The driving forces behind these systems vary. Some were developed to avoid the price spread in traditional quote-driven markets or to lessen the market impact cost of institutional-size orders. For example, some systems provide "passive" pricing at average daily prices or a single auction price, which may be attractive to managers of indexed portfolios. Anonymity is also cited by fund managers as a feature that reduces market impact costs. Some systems allow direct access to institutional investors and thereby disintermediate brokers. Other systems provide an efficient trading environment and a creditworthy counterparty for trading in emerging market securities where the home market lacks integrity.

Exchange-run ATSs

2.6   In response to the internationalization of investor interest and participation, traditional exchanges are increasingly expanding from their home geographical bases by using technology to provide global access to their facilities. For many years, of course, cross-border trading has flourished, typically being effected via various forms of telecommunications and through arrangements with home market intermediaries and global custodians.

2.7   More recently, some exchanges have made their trading "terminals" available to member affiliates overseas. In some cases, exchanges have admitted overseas members. Moreover, dedicated trading terminals are rapidly being replaced by computer linkages using common communications protocols and security measures. This makes remote access as nearly invisible as telephone access, not only to regulators but potentially to the exchanges themselves. It also improves dramatically cross-border trading by providing, among other things, on-line execution, trade confirmation, and last sale reporting.

New Exchanges

2.8   ATSs have taken the form of a new exchange in several markets. In the United Kingdom, Tradepoint Financial Networks plc is a Recognized Investment Exchange on the same footing and subject to regulatory requirements applicable also to those for the London Stock Exchange and the London International Financial Futures Exchange. In the United States, the Arizona Stock Exchange provides a single- price auction market for U.S. stocks. It is classified as an exchange rather than a broker, but is exempt from many of the regulatory requirements applicable to other United States exchanges under a "limited volume" exemption.

Broker-to-Client Automated Linkages

2.9   Many brokers now operate linkages between their own systems and their clients' computers, often via the Internet. These linkages may provide market data; account balances; and on-line order entry, trade execution, and trade confirmation services. Client orders may be routed directly to an exchange for execution and confirmed directly to the client without any personal contact between the broker and client.

Internet Systems

2.10   The Internet is increasingly being used in financial markets for data transmission purposes, such as receipt and delivery of price data, listed company information, and order routing. As mentioned, it is also used to provide automated connections between brokers and clients. The Working Group is aware of only limited use of the Internet as a trade execution platform.

2.11   One example is that of the Spring Street Brewing Co. in the United States. This small company raised US$1.6 million in an IPO through Wit Capital Corporation by posting its offering prospectus on the World Wide Web. Wit Capital also provides a bulletin board facility for secondary market trading in the company's shares. Similar ventures are now being organized.

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3.1   Using the same classifications as above, the Working Group understands that the following systems are being used currently in Hong Kong.

Bulletin Boards and Trade Matching Systems

3.2   The major wire services offer their terminals and trading services worldwide, including in Hong Kong. These are used primarily for trading in debt and money market instruments (including Hong Kong Government debt), deposits, foreign exchange, and interest rate derivatives. These systems may be merely bulletin boards, but some also offer trade confirmation services such as the TRAX system operated by the International Securities Market Association and others offer trade matching and confirmation services but not settlement services, such as Reuters Dealing 2000-2 System.

Broker-run ATSs

3.3   One major broker-run ATS (Instinet) maintains offices in Hong Kong whilst other ATSs without a physical presence in Hong Kong are easily accessible via various communications media. The broker-run ATS is a member of the Stock Exchange and reports transaction data to the Exchange. It also provides trading services for, among other things, emerging market securities. Although not typically classified as ATSs, many other brokers maintain in-house systems for agency or principal trading in many different products.

Exchange-run ATSs

3.4   An international screen-based trading system for futures contracts (Globex - a venture of the Chicago Mercantile Exchange, the French MATIF, and Reuters) has installed trading terminals in Hong Kong. Hong Kong intermediaries have also established computer linkages enabling them to access regional and international stock and futures markets, including those in North America, Europe, Bermuda, Singapore and Australia. There is also an initiative to place terminals from the mainland Chinese markets in Hong Kong for trading in "B" shares.

Broker-to-Client Automated Linkages

3.5   An affiliate of a North American brokerage firm (Greenline) has registered as a dealer in Hong Kong and offers its clients computer connections to its own systems. This enables on-line order entry, trade execution, and trade confirmation services in relation to United States and Canadian stock, option, and bond markets. Several other firms are now exploring the offering of similar services in Hong Kong.

Internet Systems

3.6   Geographical location is not generally a factor in relation to the Internet. Arrangements such as that provided by Wit Capital are accessible from Hong Kong regardless of the location of the persons operating the Internet facilities. There is also an Internet trading facility for foreign currency trading on a 24-hour basis with product specifications similar to those of the Hong Kong Futures Exchange's foreign currency product. The operator, Currency Management Corporation, acts as counterparty to all trades.

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United States

4.1   In the United States, almost all ATS operations are regulated as brokers. The Securities and Exchange Commission (SEC) staff have issued "no-action" letters to at least 22 ATS operators, meaning the SEC will not take action against them if they operate without being registered as an exchange. As a condition to the no-action letters, the SEC staff have imposed various conditions on ATS operators, such as requiring them to provide information on trading activity, system participants, and advance notice of changes to system operations. The SEC has also adopted Rule 17A-23, which imposes certain recordkeeping and reporting obligations on ATS operators.

4.2   The SEC follows a case-by-case approach and examines each ATS operation to determine if any specific conditions should be imposed. In some cases, such as that of the Arizona Stock Exchange (AZX), it determined that the AZX was an exchange, but exempted it from most regulations applicable to an exchange under a statutory "limited volume" exemption. In another case, it determined that a system for trading options on U.S. Treasury securities (Delta Government Options Corporation) was not an exchange and prevailed in a legal challenge against this determination (Board of Trade of the City of Chicago v. SEC 923 F.2d 1270).

4.3   The philosophy of the SEC is that the regulation of an ATS operation should be tailored to the functions it performs and the corollary need for regulation (SEC Release No. 34-33605). In the 1994 Report - Market 2000 An Examination of Current Equity Market Developments - it reaffirmed its flexible approach to ATSs and its view that competition and innovation should be encouraged.

United Kingdom

4.4   The United Kingdom considers ATSs variously as a recognized investment exchange, a broker, or a service company, with the level of regulation decreasing accordingly. For example, a service company which does not act as a trading counterparty is exempt from certain capital requirements. It also appears that an ATS operator may choose whether to be an exchange or a broker. In addition, where the terminals of an overseas exchange are used in the United Kingdom, the exchange may or may not need to register as a recognized overseas investment exchange, one criterion apparently being whether it maintains a place of business in the U.K. 4.5   In a 1994 Discussion Paper, the Securities and Investments Board (SIB) indicated that the current diversity of regulatory provisions applicable to trading services "is not conducive to the cost-effective achievement of regulatory coherence". In the absence of early legislative change, SIB suggested a number of guiding principles, summarized as follows :


4.6   In September 1995, the Australia Securities Commission (ASC) issued detailed guidelines on stock markets and the regulation of ATSs (Policy Statement 100). The Corporations Law defines and provides for approvals to operate as a "stock exchange", an "approved securities organization", a "stock market in prescribed interest schemes", and an "exempt stock market". There is also a "no enforcement" policy, available in circumstances where the ASC believes there would be little regulatory benefit in enforcing the general prohibition against conducting unauthorised stock markets.

4.7   The ASC explains the regulatory objectives as follows - The stock market provisions are designed to give stock market users confidence that they will be adequately protected in the markets on which they buy and sell securities, and confidence in the integrity of those markets. "Market integrity" means the processes that result in markets being transparent; users being treated fairly; the price formation process being reliable; and markets being free of misleading, manipulative or abusive conduct. The stock market provisions therefore reflect the major risks market users face, and the abuses potentially associated with stock market activity

4.8   A stock exchange or an approved securities organization is subject to a full panoply of regulation, including the requirement that it supervise its members (i.e. a self-regulatory organization).

4.9   A stock market in prescribed interest schemes contemplates a market for products not already traded on a securities exchange in Australia. Applicable regulations, among others, require an independent supervisor to monitor compliance with the market's rules.

4.10   Exempt stock market status is available only where regulatory objectives can be achieved by means other than the detailed requirements for a securities exchange. The ASC believes this will occur when the market provides less than full execution facilities, is limited to a narrow range of securities, or is restricted to a limited class of users. The ASC has set minimum conditions for an exempt stock market. These include ASC access to information, recordkeeping, reporting of unlawful or undesirable conduct, and production of an annual compliance report endorsed by a qualified independent person.

4.11   The "no enforcement" category applies, for example, to systems operated by exchange members. These systems must be used only for listed securities and must comply with applicable exchange rules.

4.12   An example of an ASC approved exempt stock market under the guidelines is that of ANZ McCaughan Securities as a market operator solely for trading in the unlisted securities of a single company. KPMG acts as the independent supervisor to ensure compliance with the rules and applicable laws and to report to the ASC.

International Organization of Securities Commissions (IOSCO)

4.13   IOSCO provides an active international forum for its member regulators from approximately 70 countries to discuss issues involving securities and derivatives markets. It routinely issues policy papers and guidelines that help to set international regulatory standards. A number of IOSCO working parties have considered the issues surrounding ATS operations.

4.14   In 1990, an IOSCO working party issued 10 suggested Principles for the Oversight of Screen-Based Trading Systems for Derivative Products. These are included in Appendix 3 to this Report.

4.15   Other IOSCO working parties have produced several policy papers analyzing the overall issues in the regulation of cross-border screen- based trading systems. This work has led to a draft suggested regulatory framework for such systems, which is now being discussed in the working group. Another group is now considering the use of the Internet as a communications medium and a trading platform for the securities and futures markets.


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5.1   This section provides the Working Group's views on how ATSs are likely to develop prospectively. It also provides members' views on the benefits of ATS operations as well as concerns raised by ATSs.

Likely Prospective Developments

5.2   ATS operations will continue to grow, certainly internationally and also in Hong Kong. Surprisingly, Hong Kong is behind other markets in using ATSs, given its relatively mature market and technological sophistication, but this will change in future. Ultimately, all markets may be accessible from a single location and a single automated connection.

5.3   It is difficult to define an ATS in the light of the vast array of telecommunications services and automated systems used in the financial markets. Within such a dynamic and technologically complex environment, it will be difficult for regulatory authorities to prohibit the use of ATSs. Even if this was practical in a particular jurisdiction, offshore ATSs will nevertheless be accessible and possibly in less regulated environments.

5.4   Although ATS operations will continue to grow, most Working Group members believe they are not likely to replace, nor to take substantial business away from, developed exchanges. Increased automation will tend to increase overall turnover, and thereby create a bigger "pie". Market participants inevitably seek liquidity, which will continue to be found in efficient exchange markets. In this regard, the Working Group notes that the largest ATS in the United States continues to grow, but its market share according to the United States SEC Market 2000 Report (1994) was only 1.4% of New York Stock Exchange turnover. 5.5   However, exchanges cannot satisfy the needs of all market participants, and ATSs will continue to fill niche markets. For example, ATSs may provide a broadening range of investment products, including efficient and transparent trading for otherwise low visibility over-the-counter products or for emerging market securities. Where a home market fails to provide products or services demanded by the investment community, ATSs may emerge to fill the gap.

5.6   In addition to providing niche markets, some Working Group members believe ATS operations will likely emerge where they can provide lower costs, reduced market impact, or increased efficiency. For example, ATS operations may provide a trading venue that avoids the costs of wide trading spreads or non-negotiable brokerage commissions.

5.7   In relation to the Internet, there will be increasing use of the Internet for communications and data processing purposes. Although the Internet is not used extensively as a trade execution platform, this could change in future. A likely use of the Internet is for routing orders to various locations for trade execution. Many uses of the Internet will be retail oriented, such as providing automated connections between brokers and their clients.

5.8   The Working Group has reservations about prospective use of the Internet as a trading mechanism. Depending on the Internet access provider, Internet response times can be either very fast or very slow, the latter being unsuitable for trading purposes. Overall reliability and security on the Internet are questionable, although this is likely to improve in future. Opaqueness in relation to Internet users also raises concerns over the fitness and properness of users and the ability to assess counterparty credit risks. These concerns are heightened in relation to the potential for Internet operations to locate in largely unregulated off-shore jurisdictions and to target primarily retail investors.

Benefits of ATS Operations

5.9   Depending on the system involved, most Working Group members believe ATSs can potentially provide the following benefits.

The table at Appendix 4 summarizes Working Group members' views on the potential benefits as well as their concerns in relation to the various types of ATS operations as categorized in sections II and III of this Report.

5.10   As mentioned, some Working Group members believe ATS operations may be able to provide a lower cost trading facility compared to traditional markets. ATSs that provide anonymous trading and passive pricing may also reduce market impact costs, which are particularly relevant to large-volume institutional investors. In these circumstances, some Working Group members believe an ATS may provide beneficial competition to traditional markets or specialized services targeted at specific segments of the market.

5.11   Ease of access refers to the ability to use an ATS via a simple computer connection, although credit assessment remains as an important consideration. An ATS may also provide 24 hour trading versus the fixed trading hours of most exchange markets. This also raises concerns as described below. It was also noted that exchange markets can potentially offer the same ease of access as ATSs.

5.12   Whilst most exchange markets focus on a particular range of stock or derivative products, ATS operations can offer an expanded range of products. Some individual ATS operations focus on a single product that might otherwise be ignored by exchange markets. Other ATSs, for example, offer trading in stocks from nearly all the major international markets plus those of emerging markets.

Concerns with ATS Operations

5.13   Depending on the system and the circumstances (see Appendix 4), ATS operations may raise concerns, such as those listed below. However, Working Group members generally believed it should be possible for the regulatory regime to address these concerns, as discussed below and in section VI of this Report.

5.14   The fragmentation concern is that trading interest might be split widely among multiple exchanges and ATS operations, resulting in a loss of the liquidity that would otherwise be provided by a central market. Similar concerns have arisen with multiple exchanges in a single jurisdiction (e.g. Hong Kong prior to 1986, Australia, and a number of European markets) where a consolidation has later been made or is being considered. However, a number of Working Group members did not see fragmentation as a concern.

5.15   Those Working Group members see a degree of fragmentation as beneficial in providing competition and new specialized services for particular market segments. It is also noted that ATS operations do not appear to have caused any material fragmentation in markets where they are active. The Working Group believes in general that the fragmentation concern is one that should be kept under observation.

5.16   Transparency in this context includes the timely display of orders, market depth, and last sale reporting. If minimum transparency standards are not required, an ATS may lack transparency and inhibit the pricing discovery process or create unfair informational advantages. The Working Group believes ATS operations should be subject to transparency standards appropriate to their operations, but keeping in mind that complete transparency in relation to, for example, institutional-size orders may be counterproductive.

5.17   The systemic risk concern arises where an ATS becomes of sufficient size and importance that its operational or financial failure could materially disrupt the market. Similar concerns exist with exchange markets, clearing houses, brokers, and banks. In all of these areas, the applicable regulatory regimes should impose minimum standards of operational and financial capabilities appropriate to the functions performed.

5.18   Many exchanges act as self-regulatory organizations, meaning they are responsible in the first instance for regulating their market and members. An ATS that is not an adequate self regulator or is not otherwise subject to adequate regulatory oversight may lack integrity.

5.19   This concern also raises an issue of fairness. The operation of a self- regulatory programme entails considerable expense. On the other hand, exchanges generate significant revenue from listing fees, sale of transaction data, and membership fees. In the view of some Working Group members, an exchange's self-regulatory obligations may be offset by these revenues. The Working Group believes the regulatory authority should be vigilant to ensure that ATS operations do not enjoy unfair or inappropriate advantages in relation to the functions they perform versus those of exchange markets.

5.20   The coordination concern, for example, relates to situations where an exchange temporarily suspends trading in a stock pending a company announcement, but an ATS continues trading. Similarly, 24-hour trading in an ATS environment may not be subject to the same information disclosure requirements as exchange trading.

5.21   In this regard, and depending on the circumstances, it may be desirable for ATS operators to disclose that the home market may be suspended or subject to a corporate announcement. Depending on the sophistication of users of the ATS, it also may be desirable for the ATS to suspend trading in line with the exchange market. This would likely be required by the exchange if the ATS operator is an exchange member. However, this would be difficult where the ATS provides trading services in foreign shares where the home market for the shares is not mature and the ATS operator is not a member of the exchange in that market.

5.22   As mentioned, the Working Group has particular concerns with the use of the Internet to provide ATS services. These include the potential for: inadequate response times for trading and trade reporting; inadequate security; unreliable software; the operation or use of the system by unqualified or inappropriate persons; and an inadequate level of information about the trading system and the investment products involved.


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6.1   Working Group members believe a pragmatic approach should be taken to ATS operations in Hong Kong. It should be flexible and as simple as is possible in the circumstances. It must also enable the regulatory authority to address important issues such as maintenance of audit trials, surveillance, transparency, system integrity, and fairness.

6.2   The Working Group's views on the regulation of ATS operations are set out separately below in relation to general principles to be considered in relation to ATS operations and in relation to each of the categories of ATS operations.

General Principles to be Considered in relation to ATS Operations


6.4   The Working Group notes that ATS operations are diverse, and that this diversity is likely to grow in future. The general principles are meant to be applied flexibly on a case-by-case basis. The level of regulation applied to an ATS should be commensurate with the functions it performs and the risks it poses. Some ATS operators may already be subject to regulation in Hong Kong or elsewhere, often as broker dealers and as exchange members, which should be taken into consideration by the regulatory authority.

6.5   Many ATSs operate across borders and it is therefore important for financial market regulators to cooperate and share information in relation to ATS operations. In addition, international organizations such as IOSCO may be best placed to steer international developments in this area as they have done with a number of other cross-border issues. Finally, where ATSs operate from unregulated off-shore jurisdictions, it will be important for regulators to help to educate investors about the risks inherent in using such systems.

Bulletin Boards and Trade Matching Systems

6.6   Bulletin boards and simple trade matching systems that do not provide settlement services and do not involve the ATS operator as a settlement counterparty may pose the least need for regulation. However, the need for regulation will likely increase as trading volume increases.

Broker-run ATSs

6.7   These systems will generally be regulated as broker dealers. However, the regulatory authority will also need to consider the general principles listed above, including transparency, surveillance, and security and control procedures.

Exchange-run ATSs

6.8   Most exchange-run ATSs are regulated as exchanges in their home markets, which vary in terms of maturity and the applicable regulatory framework. In addition, overseas exchanges have always been accessible to Hong Kong investors and intermediaries via telephone, telex, and fax communications. The Working Group does not believe the regulatory treatment should be fundamentally different due to the use of ATS technology, particularly when increased use of technology can improve cross-border trading efficiency.

6.9   Nevertheless, there is a concern that an overseas exchange-run ATS may not measure up to international regulatory standards. In these circumstances, an expansion of its accessibility via ATS facilities in Hong Kong may increase risk to Hong Kong persons. Cross-border trading may also give rise to cross-border disputes or cross-border misconduct. In this regard, it would be desirable for the regulator in Hong Kong to have an information sharing and cooperation arrangement with the regulator of the overseas exchange-run ATS. There is also a question of reciprocity. If an overseas exchange provides ATS services in Hong Kong, consideration should be given to whether the Hong Kong exchanges are able to provide ATS services on a similar footing in the overseas market.

6.10   For the reasons discussed above, the Working Group believes the regulatory authority should consider the following points in relation to overseas exchange-run ATS operations in Hong Kong.

Broker-to-Client Linkages

6.11   These automated linkages typically do not constitute a trading system. They should be examined by the regulatory authority in relation to the regulation of broker dealers and relevant matters such as internal controls, audit trails, and best execution.

Internet Systems

6.12   The use of the Internet as a communications and data transmission medium will typically not amount to the provision of a trading system. Where a trading system is provided via the Internet, regulatory authorities should cooperate in determining the "home" market for regulatory purposes.


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7.1   The Working Group has presented this Report to the Securities and Futures Commission and recommends that it should be provided to a wider audience of interested market participants for their views and comments. The Report and the additional comments received should be considered by the SFC, Government, and the Exchanges to assist them in articulating appropriate policies in respect of ATS operations in Hong Kong.

Appendix 1


Appendix 2



Bearing in mind that, automated trading systems (known by various names, for example, as proprietary trading systems) have for some time been operating in world financial markets, and that the SFC has proposed in the Securities and Futures Bill that it be given the power to recognize and regulate such trading systems, and in order to study the regulatory approach which may suit Hong Kong's market conditions, the SFC intends to form a Working Group, with the following terms of reference.

  1. To examine and report on the present and prospective state in Hong Kong of automated or so-called "proprietary" trading systems for securities or futures contracts other than those operated by the Stock Exchange of Hong Kong Ltd (SEHK) or the Hong Kong Futures Exchange Ltd (HKFE).
  2. To examine and summarize the state internationally of automated trading systems for securities or futures contracts and the various regulatory regimes applicable to them and the developing trends in the regulation of such systems.
  3. To provide opinions and views to the Securities and Futures Commission (SFC) on the regulatory approach to be taken in relation to the operation of automated trading systems in Hong Kong under existing laws and in relation to relevant proposals in the Draft of a Composite Securities and Futures Bill.
  4. To liaise and consult with such persons and for such purposes as it may determine to be appropriate under these terms of reference.
  5. To do all things necessary to enable it to carry out these terms of reference.
  6. To invite any person to participate in Working Group meetings, to set its own meeting dates, to establish its own procedures, and to submit interim or progress reports to the SFC as it may determine.
  7. To submit a report to the SFC consistent with these terms of reference and with a view to the publication of such report.

The Working Group will be chaired by a Non-Executive Director of the SFC, and secretarial work will be undertaken by the Supervision of Markets Division of the Commission.


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Appendix 3


Principles for the Oversight of Screen-based Trading Systems for Derivative Products

  1. The system sponsor should be able to demonstrate to the relevant regulatory authorities that the system meets and continues to meet applicable legal standards, regulatory policies, and/or market custom or practice where relevant.
  2. The system should be designed to ensure the equitable availability of accurate and timely traded and quotation information to all system participants and the systems sponsor should be able to describe to the relevant regulatory authorities the processing, prioritization, and display of quotations within the system.
  3. The system sponsor should be able to describe to the relevant regulatory authorities the order execution algorithm used by the system i.e., the set of rules governing the processing, including prioritization, and execution of orders.
  4. From a technical perspective, the system should be designed to operate in a manner which is equitable to all market participants and any differences in treatment among classes of participants should be identified.
  5. Before implementation, and on a periodic basis thereafter, the system and system interfaces should be subject to an objective risk assessment to identify vulnerabilities (e.g., the risk of unauthorised access, internal failures, human errors, attacks, and natural catastrophes) which may exist in system design, development, or implementation.
  6. Procedures should be established to ensure the competence, integrity, and authority of system users, to ensure that system users are adequately supervised, and that access to the system is not arbitrarily or discriminatorily denied.
  7. The relevant regulatory authorities and the system sponsor should consider any additional risk management exposures pertinent to the system, including those arising from interaction with related financial systems.
  8. Mechanisms should be in place to ensure that the information necessary to conduct adequate surveillance of the system for supervisory and enforcement purposes is available to the system sponsor and the relevant regulatory authorities on a timely basis.
  9. The relevant regulatory authorities and/or the system sponsor should ensure that the system users and system customers are adequately informed of the significant risks particular to trading through the system. The liability of the system sponsor, and/or the system providers to system users and system customers should be described, especially any agreements that seek to vary the allocation of losses that otherwise would result by operation of law.
  10. Procedures should be developed to ensure that the system sponsor, system providers and system users are aware of and will be responsive to the directives and concerns of relevant regulatory authorities.

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Appendix 4

Relevance of the benefit/concern to each ATS type. The following table indicates the relevance of the benefits/concerns, as discussed in ' WORKING GROUP VIEWS ON ATS OPERATIONS ' of the report, to each ATS type. Where four or more working group members believe the factor is relevant, the box is marked with a '*'.

Bulletin BoardsBroker-run ATSExchange-run ATSBroker/Client LinkagesInternet Systems
Lower transaction costs****
Reduced market impact costs***
Passive pricing**
Competition / specialized services***
Ease of access****
Expanded product ranges****
Market fragmentation / reduced liquidity**
Lack of transparency**
Increased systemic risk**
Absence of self-regulatory programme/unfairness***
Lack of coordination with exchange markets**

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Page last updated : 1 Aug 2012