The Securities and Futures Commission has prepared a draft of a composite Securities and Futures Bill to consult the market on the consolidation of the existing laws governing the securities and futures markets currently administered by it.
At present, the applicable laws are spread over some 11 Ordinances and parts of the Companies Ordinance. This is unsatisfactory because the laws governing certain issues, for example the regulation of the Exchanges, are spread over several Ordinances, with duplication and inconsistencies of wording between the Ordinances. This creates uncertainty and even traps for the unwary. As well, many provisions cannot be properly understood without reference to other pieces of legislation, for example in the definitions, and some of the provisions and even entire Ordinances have been overtaken by events.
Pursuant to a recommendation of the Securities Review Committee, the SFC commenced a review of the legislation in 1990 with a view to rationalising them into a composite Bill. In the course of this work, a degree of "updating" of the laws was inevitable to take account of developments in the markets, technological advances and changes in regulatory philosophy/emphasis since the main body of the laws was enacted in the 1970's. Other changes have been indicated from our experience in implementing the Ordinances.
The market was publicly consulted on some of the key areas of the proposed updating beforehand, for example changes to the licensing regime, the system of exemptions and the disclosure of interest regime. In other cases, the changes were developed following a series of informal consultations with industry bodies and practitioners.
Structure of the Draft Bill
The resultant draft Bill, published with this document to seek the markets' views, consists of 15 Parts and eight Schedules. It repeals and replaces eight of the existing eleven Ordinances. These are:
- The Securities and Futures Commission Ordinance;
- The Securities Ordinance;
- The Commodities Trading Ordinance;
- The Protection of Investors Ordinance;
- The Stock Exchanges Unification Ordinance;
- The Securities and Futures (Clearing Houses) Ordinance;
- The Securities (Insider Trading) Ordinance; and
- The Leveraged Foreign Exchange Trading Ordinance.
Three Ordinances have not been rationalised into the composite Bill because:
- The Commodity Exchanges (Prohibition) Ordinance, which regulates wholesale markets in soft commodities, has no real bearing on the financial markets.
- The Securities (Disclosure of Interests) Ordinance was the subject of public consultation in 1995 and the updating work is still being drafted.
- The Exchanges (Special Levy) Ordinance is now defunct.
Content of the Draft Bill
A brief description of the various parts and the main areas of change are:
Part I - Preliminary
This part deals with definitions. However, due to the volume involved, these have been set out in a schedule with no implications for their legal status. The main change in this area is to the definitions of "securities" and "futures" to avoid regulatory gaps arising from growing product innovation.
Part II - Securities and Futures Commission
This part deals with the functions and powers of the Commission. The main changes are the addition of an explicit SFC function to safeguard the interests of investors; a statement of objective to achieve fair, efficient, competitive and informed markets and a power to make rules to exclude classes of transactions from the transaction levy.
Part III - Securities and Futures Appeals Panel
This part re-enacts the existing legislation on the SFC Appeals Panel. Most of the procedural provisions affecting the conduct of proceedings have been removed to a schedule. In addition, a new provision has been included to enable the SFC to give effect to decisions to revoke or suspend a licence prior to the completion of the appeals process in the interest of the investing public.
Part IV - Exchanges
This part largely re-enacts the existing provisions governing the stock and futures markets. While it effectively retains the statutory monopoly of the Stock Exchange, to enable the SFC to regulate trading facilities outside the monopoly, such as cross-border electronic screen-based trading systems, the SFC is given the power to impose rules to govern their operations by authorising them. The details of regulation of such systems, when worked out, will be the subject of market consultation.
Part V - Clearing Houses
This part re-enacts the Securities and Futures (Clearing Houses) Ordinance without changes of substance.
Part VI - Licensing of Intermediaries
This parts sets out the regime for licensing of intermediaries. As agreed during the public consultation exercise undertaken in 1990, the definition of advisers will be amended to require persons who hold client assets to be licensed as dealers. Also pursuant to a public consultation exercise undertaken in 1990, the exemption provision will be narrowed to restrict exempt dealer status to persons whose securities dealings are directly incidental to their principal business activities, which must be non-securities dealing related. Finally, a provision has been added to empower the SFC to impose limited financial penalties for technical offences.
Part VII - Supervision and Investigations
This part re-enacts the existing supervisory and investigative powers of the SFC. In so doing, the power to investigate compliance with guidelines and codes of conduct has been specifically spelt out to avoid misunderstanding. To enhance the protection of assets held by intermediaries on behalf of clients, powers to order a licensed person to transfer such assets to a trustee are provided if a risk of their being dissipated exists.
Part VIII - Financial Regulation of Intermediaries
This part re-enacts the existing legislation governing the financial regulation of intermediaries. The only substantive change is to give the SFC a monitoring role over licensed or exempt person controlled nominee companies which hold client securities to improve the safeguards over these assets.
Part IX- Business Conduct
This part restates in more direct terms the SFC's power to issue codes of conduct and makes it clear that disciplinary inquiries may be undertaken in case of breaches of such codes.
Part X - Investor Compensation
This part covers the compensation arrangements for investors in the event of a default. To streamline the current system in relation to members of the two Exchanges, the operation and management of the Compensation Funds will be delegated to the Exchanges through rules made by the SFC. At the same time, the current inadequate compensation arrangements for dealers who are not Exchange members will be replaced by their taking out fidelity insurance satisfactory to the SFC.
Part XI - Insider Dealing
This part re-enacts the present Securities (Insider Dealing) Ordinance. The only change is to enable the Insider Dealing Tribunal to include expenses incurred by the SFC in the costs of the investigation.
Part XII - Market Manipulation
This part sets out the law against market manipulation. Clarifications regarding transborder manipulation activities and price stabilisation schemes have been included as well as some new provisions on misleading statements and "bucketing" offences.
Part XIII - Offers of Investments
This part sets out the law governing offers of investments. The existing arrangements are largely retained although the definitions of units trusts and mutual fund corporation have been amended to accommodate developments in the market.
Part XIV - Miscellaneous
This part consolidates and rationalizes the miscellaneous provisions in the various Ordinances. It includes provisions governing the SFC's powers to make rules, its powers to prosecute offences, time limits for prosecuting, its duties of confidentiality etc. It also sets out the penalties for offences. As requested by the Legislative Council on a number of occasions, all penalties in the existing legislation have been reviewed and updated.
Part XV - Repeals, Transitional Provisions and Consequential Amendments
This part provides the transitional arrangements and the repeal of the existing Ordinances for the smooth implementation of the draft Bill.
The Consultation Period
Members of the public and the industry are invited to give their views on the draft Bill to the SFC by July 15, 1996.
- A draft Securities and Futures Bill has been published by the Securities and Futures Commission in order to invite comments from the public and the financial services industry on this substantial piece of proposed legislation.
- This paper outlines the background to the draft Bill, its content, and the main areas where it would change or, as is the case in many instances, re-enact the substance of the existing law.
The Current Legislation
- The regulatory body for Hong Kong's securities and futures industry is the Securities and Futures Commission. It was established in 1989 by the Securities and Futures Commission Ordinance (Cap. 24). Under the definition of the term "the relevant Ordinances", the Securities and Futures Commission Ordinance lists the legislation which the SFC is currently responsible for enforcing -
- the Securities and Futures Commission Ordinance itself;
- certain provisions of the Companies Ordinance (Cap. 32) (relating principally to prospectuses and share repurchases);
- the Securities Ordinance (Cap. 333);
- the Commodity Exchanges (Prohibition) Ordinance (Cap. 82);
- the Commodities Trading Ordinance (Cap. 250);
- the Protection of Investors Ordinance (Cap. 335);
- the Stock Exchanges Unification Ordinance (Cap. 361);
- the Securities and Futures (Clearing Houses) Ordinance (Cap. 420);
- the Securities (Disclosure of Interests) Ordinance (Cap. 396); and
- the Securities (Insider Dealing) Ordinance (Cap. 395).
- This list is not exhaustive; the SFC also enforces the Leveraged Foreign Exchange Trading Ordinance (Cap. 451) and the subsidiary legislation under all of the relevant Ordinances. The SFC has also had to monitor the implementation of the Exchanges (Special Levy) Ordinance (Cap. 351).
- This profusion of Ordinances is unsatisfactory for several reasons.
- Many of the Ordinances can only be properly understood by reference to the others, because of cross-references between them. For example, many of the definitions in section 2 of the Securities and Futures Commission Ordinance refer the reader to definitions in the Securities Ordinance, the Commodities Trading Ordinance and the Stock Exchanges Unification Ordinance. These Ordinances themselves contain definitions that in turn refer the reader to other relevant Ordinances.
- The legislation on some topics is split between several Ordinances. For example, the law on exchanges is found partly in the Stock Exchanges Unification Ordinance, partly in the Securities Ordinance, partly in the Commodities Trading Ordinance and partly in the Securities and Futures Commission Ordinance; Hong Kong also has a Commodity Exchanges (Prohibition) Ordinance.
- There is duplication on some topics. For example, compensation is the subject of extensive (and mostly identical) provisions in Part X of the Securities Ordinance and Part VIII of the Commodities Trading Ordinance. A further example of duplication is found in the way in which the Leveraged Foreign Exchange Trading Ordinance reproduces, for the purpose of regulating leveraged foreign exchange trading, many provisions which are also, for the purposes of the securities and futures industry, contained in the Securities and Futures Commission Ordinance, the Securities Ordinance and the Commodities Trading Ordinance.
- There are differences of wording between the Ordinances, where consistency would be expected, and this creates uncertainty, or even traps for the unwary. For example, the manner in which the two principal exchanges are required to process claims for compensation is provided for in section 113 of the Securities Ordinance (in the case of the stock exchange) and of section 90 of the Commodities Trading Ordinance (in the case of the futures exchange). Whilst the two sections follow the same wording for the most part, section 90(6) of the Commodities Trading Ordinance alone contemplates appeals to a disciplinary committee; yet that committee, and the legislation that provided for it, have long ceased to exist.
- Some of the legislation was framed in a way that was historically appropriate, but has been overtaken by developments since it was drafted. For example, the Stock Exchanges Unification Ordinance was designed to bring about the amalgamation of four stock exchanges that formerly existed in Hong Kong (into the "Unified Exchange"). The amalgamation was achieved in 1986, but the Ordinance still retains what are now spent provisions. This is considered further in the discussion of Part IV of the draft Bill, later in this paper.
Review of the Current Legislation
- In 1990 the SFC began a review of the legislation that existed at that time. This had been recommended in 1988, before the SFC was established, in the Report of the Securities Review Committee on the Operation and Regulation of the Hong Kong Securities Industry. At various stages prior to the publication of the draft Bill, and in the course of considering what changes might be required to the existing legislation, the SFC has consulted bodies with an interest in the different facets of the legislation in order to seek preliminary views. The draft Bill is now published for more comprehensive consultation.
Structure of the Draft Bill
- The published draft consists of 15 Parts and 8 Schedules. It would repeal and replace all but three of the "relevant Ordinances" listed at the beginning of this paper and also the Leveraged Foreign Exchange Trading Ordinance. The re-enactment of existing law in the Bill alongside reforms will have the advantage of reducing the number of Ordinances that contain Hong Kong's securities and futures legislation, and so creating a more convenient framework for future legislative developments.
- The "relevant Ordinances" that the Bill would not replace are, for reasons given in the following paragraphs-
- Parts II & XII of the Companies Ordinance;
- the Commodity Exchanges (Prohibition) Ordinance; and
- the Securities (Disclosure of Interests) Ordinance.
The Companies Ordinance
- Parts II & XII of the Companies Ordinance will remain separate from the securities legislation, at least until after the completion of a separate review of the Companies Ordinance that the Government has commissioned. Depending on the outcome of that review, it may be appropriate to make amendments to the law on the offering of securities and other investments, which is the subject of Part XIII of the draft Bill. Part XIII is considered later in this paper.
Commodity Exchanges (Prohibition) Ordinance
- The Commodity Exchanges (Prohibition) Ordinance would not be repealed by the draft Bill, but would cease to be treated as a "relevant Ordinance". That is because, despite its title, the Ordinance is not administered by the SFC and in practice has no direct bearing on the securities and futures industry. Its provisions are more appropriate to the regulation of markets in soft commodities than to the financial markets.
Securities (Disclosure of Interests) Ordinance
- A review of this Ordinance is being separately carried out. During 1995, there was consultation on proposals to shorten the period for disclosure, lower the disclosure threshold to 5%, bring unissued shares within the duty of disclosure, and make other changes to the Ordinance. Work is continuing on preparing the legislative text to implement those changes which will be published separately.
- The following table illustrates in broad terms the content of the draft Bill, and the relationship between each of its Parts and the eight Ordinances that the Bill would replace. (Several of the Parts are amplified by Schedules to the Bill, as described later in this paper.)
|PART NO & HEADING||SCOPE||CURRENT ORDINANCES|
|Short title, commencement and interpretation.||Definitions in the current Ordinances, but with extensive amendments.|
(Securities & Futures Commission)
|Constitution, finances and main functions of the SFC.||Parts II & VII of S.F.C.O.|
(Securities & Futures Appeals Panel)
|Constitution and functions of the Panel.||Part III of S.F.C.O.|
|Recognition and supervision of exchange companies; powers and duties of exchange companies.||
|Recognition and supervision of clearing houses.||S. & F. (C. H.) O.|
(Licensing of Dealers, Traders, Advisers and Representatives)
|Licensing of dealers, advisers and representatives; exemptions from licensing.||
(Supervision and Investigations)
|Powers of investigation and supervision.||
(Books, Records, Capital Requirements, Accounts and Audit)
|Accounting and auditing and record-keeping requirements for licensees; responsibilities of auditors; financial resources rules.||
|Power of S.F.C. to issue Codes and make rules. Restrictions on conduct.||
|Compensation arrangements to be made by exchanges.||
|Prohibitions on insider dealing in securities; Insider Dealing Tribunal; sanctions.||S.(I.D.)O.|
(Market manipulation and Deceptive Practices)
|Market rigging and other illegal activities.||
(Offers of investments)
|Regulation of offers of securities and other investments, and of advertisements; authorization of unit trusts and mutual fund corporations.||
|Subsidiary legislation; restriction notices; liability of principals; obstruction; prosecutions; limitation period; immunity; secrecy; forms, etc.||All the relevant Ordinances.|
Repeals, Transitional Provisions & Consequential Amendments
Content of the Draft Bill
- The following paragraphs of this paper discuss the main changes to the present law that would appear in each Part of the draft Bill.
Part I - Preliminary
- Part I of the draft Bill refers to definitions that are set out in a schedule at the end. Definitions usually appear at the beginning of an Ordinance, but because of the size of the draft Bill it may be more convenient to have them collected in a schedule. This approach would have no implications for the legal status of the definitions, and would not affect the procedure required for amending them in future - that is, a further Bill would be required. Views are invited on the use of a schedule of definitions in this way.
- The terms used in the draft Bill include some that have been adopted in preference to current statutory terms. For example, to describe the process of authorizing a person to conduct business it is intended to use the word "licensing" (as in the Leveraged Foreign Exchange Trading Ordinance) rather than "registration" (as in the Securities Ordinance and Commodities Trading Ordinance).
- And the word "commodity" (including its use in terms such as "commodity dealer" and "commodity trading adviser") will be replaced by references to "futures", consistently with modern market usage. The term "registered commodity trading adviser" will hence become, under the Bill, licensed futures adviser.
- The definition of "securities" would be amended, and a new definition of "futures contract" would be introduced, to facilitate market development in the manner discussed later in this paper, when Part IV of the Bill is considered (in relation to the exchanges). The definitions of "unit trust" and "mutual fund corporation" would also be amended to accommodate developments in collective investment schemes, as discussed later in this paper in the context of Part XIII of the Bill.
- The promotion of investment arrangements is at present regulated under the Protection of Investors Ordinance, which will be replaced by Part XIII of the Bill. Under the present definition of "investment arrangements", which appears to be directed at collective investments, it is sometimes difficult to determine what falls outside the definition. In the Bill there is a revised definition which still mainly applies to schemes or arrangements which are collective in nature, but it also provides that the Financial Secretary may, by subsidiary legislation, prescribe certain non-collective schemes or arrangements as "investment arrangements". The new definition also contains a list of particular types of arrangement or investment scheme that will be excluded from the definition, and therefore will not be subject to the provisions in Part XIII. This change, which is derived from the Financial Services Act in the U.K., seeks to reduce uncertainty in the present law.
Part II - Securities & Futures Commission
- The Securities and Futures Commission Ordinance established the SFC. Part II of the draft Bill, and a schedule of detailed provisions (Schedule 2), would re-enact the existing constitutional provisions without major changes of substance. However, the functions of the SFC currently listed in section 4 of the Ordinance would be restated in certain respects.
- Firstly, clause 2.2 (d) would for the first time explicitly state that it was a function of the SFC to safeguard the interests of investors. Secondly, clause 2.2 (e) would introduce a statement of four characteristics that the SFC should be seeking to achieve in the markets in which the securities and futures industry operates (including the conduct of takeovers and mergers); the four characteristics are that the market should be fair, efficient, competitive and informed. Thirdly the functions of the SFC would expressly include (also in clause 2.2 (e)) a reference to the regulation of takeovers and mergers; this merely recognizes in the appropriate Part of the Bill that it is a function of the SFC to regulate the conduct of takeovers and mergers (an existing function, acknowledged in section 54 of the SFC Ordinance).
- A minor change introduced by the draft Bill would be expressly to authorise the Commission to conduct its business by the circulation of papers, where those of its directors who are present in Hong Kong are in unanimous agreement. This is provided for in para 19 of Schedule 2 to the draft Bill.
- Part II of the draft Bill would also re-enact provisions (currently found in Part VII of the Securities & Futures Commission Ordinance) concerned with the finances and accounts of the SFC. There would be a change to the provisions governing the fixing and collection of transaction levies from the Stock and Futures Exchanges. The SFC has in the past recommended that certain new products on the exchanges (new futures contracts on the Futures Exchange and equity options introduced by the Stock Exchange) should not attract the prescribed levy. Whilst the Government has accepted such recommendations, there have sometimes been difficulties in implementing them because of doubts about whether a "nil" levy is consistent with the wording of the current statutory provisions. In the draft Bill, therefore, clause 2.14(8) would clarify the point for the future by enabling the SFC to make rules excluding classes of transactions from the transaction levy.
- The proposed Bill includes a change to the circumstances in which the legislation obliges the SFC to consult the Financial Secretary with a view to reducing a levy (or a fee). At present this obligation is triggered where the SFC's reserves exceed twice its estimated operating expenses (SFC Ord., section 52). Under the Bill, the trigger for consulting the Financial Secretary would essentially be where liquid assets (rather than "reserves") exceed twice the estimated operating expenses. This would enable the SFC to operate from premises which it owned (and which would fall to be treated as part of its "reserves") and still accumulate sufficient liquid assets equivalent to two years' operating expenses, before being obliged to consider reducing its income from levies and fees.
Part III - Securities and Futures Appeals Panel
- The Securities & Futures Appeals Panel was established by the Securities and Futures Commission Ordinance in 1989 (at the same time as the SFC). Tribunals are appointed from the Panel to hear appeals against decisions of the SFC, particularly where a decision has been made to refuse to register or license a dealer, adviser or representative or to attach conditions to registration. Under the original terms of the legislation, a non-executive director of the SFC was required to sit on each tribunal, but the law has been amended to remove non-executive directors from the Panel and thus to affirm the independence of tribunals from the Commission. In 1994 the jurisdiction of the Panel was expanded to include appeals from decisions of the SFC under the Leveraged Foreign Exchange Trading Ordinance.
- Part III of the draft Bill would re-enact the substance of this legislation, whilst locating most procedural provisions, affecting the conduct of proceedings, in a schedule (Schedule 3). The separation of the procedural provisions into a schedule in this way would be a matter of form and convenience only, and would not affect the legal status of those provisions or the method for amending them in future. Any such amendments would require a Bill.
- The following changes to the current law would be made by Part III.
Effective date of decisions to revoke or suspend a licence
- A decision of the SFC to revoke or suspend a licence or registration cannot at present take effect for at least 30 days (the time limit for appealing) or longer if an appeal to the Panel is pending. That is the effect of section 21(4) and 21(3)(a) of the SFC Ordinance; its purpose is to enable a member of the industry to continue in business until any appeal is resolved. But the "freezing" of regulatory decisions in this way is not always in the interest of investors and may be open to abuse. Where, for example, a client's investments are demonstrably at risk from continued mismanagement (or worse) by a licensed person, there may be a strong case for a suspension of the licensed person to take effect before an appeal is determined. The draft Bill therefore includes a provision (in clause 3.2(3)(c)) to enable the Commission to specify a date when a decision should take effect before any appeal, if that is in the interest of the investing public or the public interest.
- As the two exchanges and their clearing houses currently have such powers, this would also enable the SFC, when considering the case of an intermediary who was a member of an exchange and was being disciplined by the exchange, to co-ordinate the exercise of its powers with those of the exchange in appropriate circumstances.
- Views are invited on the proposal to enable the SFC to bring its decisions to suspend an intermediary in the interests of the investing public or the public interest into effect more immediately than is currently possible.
Decisions against which appeals may be brought
- The decisions of the Securities and Futures Commission against which appeals may be brought are currently listed in sections 19 and 44 of the Securities and Futures Commission Ordinance and sections 56 and 57 of the Leveraged Foreign Exchange Trading Ordinance. They include decisions to refuse registration or a licence; to attach conditions to the registration or licence; to revoke or suspend the registration or licence; or to impose a restriction notice on a registrant or licensee. Under the draft Bill, other decisions that will also be appealable are-
- decisions to refuse, revoke or suspend exempt status for securities dealers and securities advisers; and
- decisions of an exchange relating to compensation under Part X of the Bill.
Part IV - Exchanges
- Current legislation relating to stock and futures markets is spread between the Stock Exchanges Unification Ordinance, the Securities Ordinance, the Commodities Trading Ordinance and the Securities & Futures Commission Ordinance. Part IV of the draft Bill would bring together the relevant legislation, reflecting amendments described below.
- The main areas where the draft Bill contains changes to the present law are in relation to (1) definitions of securities and futures trading markets, (2) definitions of securities and futures contracts, (3) recognition of Exchange Companies, (4) duties of Exchange Companies, (5) rules of Exchange Companies, and (6) some miscellaneous provisions. These are summarized below. Views are invited on the proposals.
(1) Definitions of "stock market" and "futures market"
- These appear in the schedule of definitions, Schedule 1.
- The definitions of these terms would not require a market to be a physical "place" as is the case under existing legislation. The new terms would thus encompass markets with electronic screen-based trading systems in addition to those with physical trading floors to bring them within the scope of the Bill.
- On the other hand, the definitions will allow for facilities to be authorised for particular trading purposes by the SFC, whilst falling outside the scope of what constitutes a "stock market" or "futures market" under the legislation.
(2) Definitions of "securities" and "futures contracts"
- These definitions too appear in Schedule 1. The draft Bill would make several changes to the definitions of "securities" and "futures contracts". In the case of securities, a new provision would include within the definition any financial arrangement approved by the Commission for trading through the facilities of a stock market. This is to ensure that the definition of securities is flexible and does not inhibit the market from trading new and innovative products. It is envisaged that ordinarily new products would be brought to the attention of the SFC by the exchange, which would invite the SFC to give the necessary approval for trading, though the Bill does not exclude the possibility of approval being granted on the initiative of, for example, issuers of new products.
- The definition of "securities" would also be amended to include options, excluding futures contracts, in respect of stock indexes. This would be a logical extension of the present definition which already covers options in respect of stocks and bonds.
- The definition of "futures contract" would be correspondingly expanded to include any financial arrangement approved by the Commission for trading through the facilities of a futures market. As with the definition of "securities", this is to ensure that the definition of futures contract is flexible and can accommodate new products. The draft Bill would also eliminate existing provisions that require certain commodities and futures contracts to be listed in a statutory schedule. A futures market would therefore be able to trade any product approved by the Commission.
(3) Recognition of Exchange Companies
- The draft Bill continues to provide that no person may operate a stock or futures market unless recognized as an exchange company (clause 4.1). The Commission's authority to grant recognition in this regard would only be exercisable under the draft Bill if the Commission considered it appropriate in the interests of the investing public or in the public interest, or for the proper regulation of the markets.
- While clause 4.3 of the draft Bill effectively retains the current statutory monopoly of the Stock Exchange of Hong Kong Limited, the Commission is given the ability (by clause 4.12) to regulate other trading facilities outside the monopoly by authorizing it for trading purposes. The Commission is aware that the proposal to retain the monopoly for the stock market is potentially controversial.
- The arguments in favour of a monopoly include:
- the importance attributed to maintaining Hong Kong's existing systems at a time when there is particular sensitivity to changes;
- the apparent reversal of policy that would occur if the unification of the previous stock exchanges, which was achieved after much effort in 1986 under the Stock Exchanges Unification Ordinance, were now to become vulnerable to fragmentation; and
- the lack of any evidence that the existence of a monopoly has been abused by the Stock Exchange.
- The arguments against retaining a monopoly include-
- the contention that an exclusive statutory right to operate a market of any kind is inconsistent with the principles of economic competition that have made Hong Kong successful;
- the belief that a monopoly creates vested interests that inevitably involve conflicts of interest with investors and with listed companies;
- doubts that the current membership of the Stock Exchange has the capacity to provide a market for all the types of securities needed in Hong Kong (for example, a debt market) whilst others are precluded by virtue of the monopoly from doing so;
- the concern that a monopoly creates artificial constraints on the development of new markets; for example, even the current beneficiary of the statutory monopoly (the SEHK Ltd) was precluded from creating a subsidiary company for the introduction of the Traded Options Market since such a company would itself have breached the SEHK Ltd.'s own monopoly;
- the fact that the monopoly is to some extent illusory, in that technological developments have resulted in the development of unregulated electronic trading systems outside the statutory monopoly that cannot be brought within the scope of regulation because of the ostensible monopoly;
- the lack of a statutory monopoly for the Futures Exchange has not led to the need to create one for futures trading.
- On balance, the Commission believes that the current monopoly of the SEHK Ltd. should be retained but that the existence of markets outside the SEHK Ltd. should be recognized and that the Commission should be given the ability to regulate them, by authorizing them and bringing them within the scope of the regulatory framework. Before any such facility is authorised, the SFC will first formulate a policy of recognition and regulation of these trading facilities for market consultation.
- Views are sought on the proposals -
- to retain a statutory monopoly; and
- to allow other trading facilities to be authorised and regulated by the SFC.
(4) Duties of Exchange Companies
- Under existing legislation, the Stock Exchange Company is subject to a duty to ensure a fair and orderly market and to act in the interests of the public, particularly the investing public. The draft Bill would extend this duty so as to apply it to the Futures Exchange Company. The draft Bill would also require every recognized exchange company to enforce its rules and to maintain adequate personnel and systems with adequate capacity, security, and contingency plans. This latter requirement expands on existing law to take account of the fact that modern trading systems are highly automated.
(5) Rules of Exchange Companies
- The draft Bill would provide generally uniform definitions of "rules" of exchange companies and clearing houses, and procedures under which rule changes require approval from the Commission. The Bill also would require rule changes to be submitted with an accompanying explanation of the reasons for making the rules and the impact they are expected to have on the markets, including the investing public.
- Under the present legislation, the Commission's authority to approve rule changes is (under the SFC Ordinance) non-delegable. The Bill would not retain this restriction, but would instead permit delegation in order to enable the SFC to respond in an appropriate fashion to emergency situations and to deal expeditiously with rule changes that are entirely technical in nature. Such a relaxation is necessary in order to avoid delays in rule approvals that could prejudice or inconvenience the exchanges.
(6) Miscellaneous Provisions
- The draft Bill would reduce the amount of detail currently in the provisions dealing with membership in any exchange company. It would require shareholders in an exchange company to be licensed dealers, subject to authority for the Commission to grant exemptions. The Bill would also include provision for the orderly disposition of shares in an exchange company where the owner was no longer a licensed dealer. In addition, it would enable a person who was not a shareholder to use the facilities of a stock or futures market, and in that sense to be a "member", whilst leaving it to the rules and articles of association of the appropriate exchange company to stipulate who could use those facilities and under what conditions.
- Many provisions in the Stock Exchanges Unification Ordinance are obsolete in that their purposes have been achieved, and they would disappear under the draft Bill. For example, section 32 of the Ordinance makes provision for how to proceed with the winding up of the former exchanges; they have all now been wound up, and section 32 therefore need not be retained.
Part V - Clearing Houses
- Until last year Hong Kong's primary legislation on clearing houses was contained in the Securities (Clearing Houses) Ordinance which, as its title indicated, provided only for securities clearing houses. The Ordinance had been enacted to provide specifically for the introduction of central clearing of transactions on the Stock Exchange. In 1995 the scope of the Ordinance was extended to cover futures clearing houses, and its title was amended accordingly to the Securities and Futures (Clearing Houses) Ordinance.
- Part V of the draft Bill would re-enact the renamed Ordinance, without changes of substance. Having regard to the fact that the concept of recognition of a clearing house is very similar to that of recognition of an exchange company, and that both clearing houses and exchange companies make rules that require approval from the SFC, Part V of the Bill includes provisions that are similar to Part IV so far as practicable.
Part VI - Licensing of Intermediaries
- The legislation governing the authorization of dealers, advisers and representatives is spread through the Securities Ordinance (Part VI), the Commodities Trading Ordinance (Part IV), the Securities and Futures Commission Ordinance (Part IV) and the Leveraged Foreign Exchange Trading Ordinance (Part IV).
- Part VI of the draft Bill would bring the law together in one place. In doing so it would iron out some differences between existing Ordinances and also make some changes. The changes that will be made by the Bill reflect for the most part proposals that were adopted after the publication of a consultative document by the SFC at the end of 1990 (referred to below as the "1990 consultative document") and were announced at that time.
- One of the inconsistencies that the Bill would remove is in the different terminology that currently exists to describe the authorization that the SFC confers for participation in the provision of financial services. In the case of the securities and futures industries, the authorization is described as "registration"; in the leveraged foreign exchange trading industry it is referred to as "licensing", though the process whereby authorization is granted, or may be revoked or suspended, is virtually identical in all cases. Under the Bill the term "licence" (rather than registration) is used.
Ambit of licensing requirement
- The present structure of the securities and futures legislation is to define broadly the activities of those who deal in securities or trade in futures contracts, those who give advice on them, or those who trade in leveraged foreign exchange contracts, for the purpose of requiring them to seek authorization from the SFC; but to exclude from that broad requirement certain persons, such as investors who deal on their own account, and solicitors who deal in securities incidentally in the course of their practice. The current legislation also empowers the SFC to grant exemption from registration. The same approach is adopted in Part VI of the draft Bill, with broad descriptions of the activities that need to be licensed, subject to specified exceptions and a power of exemption.
Structure of Licensing regime - Securities/futures /forex industries
- Under the current legislation -
- the requirements for registration of dealers, advisers and representatives in the futures industry are governed by the Commodities Trading Ordinance and the Securities & Futures Commission Ordinance;
- the requirements for registration of those in the securities industry are governed by the Securities Ordinance and the Securities and Futures Commission Ordinance; and
- the licensing requirements for leveraged foreign exchange traders and their representatives (there is no separate category of licensed advisers) are governed by the Leveraged Foreign Exchange Trading Ordinance.
Although the industries are dealt with in different Ordinances, the legislation is administered by a single regulatory organization, the SFC. The draft Bill adopts a unified approach to licensing for all three industries, so far as practicable.
- A new feature (proposed in the 1990 consultative document, at paragraph 28) would be the introduction of a special "temporary" category of licence. This would allow those who were licensed outside Hong Kong to undertake in Hong Kong business incidental to their main business for periods not exceeding 3 months, without being subject to full scale vetting.
Classification of dealer/adviser
- The 1990 consultative document observed (at paragraphs 32-34) that the distinction between "dealers" and "advisers" for registration purposes was not entirely satisfactory. Under the present law, an "investment adviser" includes a person who manages a client's portfolio of securities (including arranging their sale and purchase i.e. dealing). In addition, such "advisers" may expose investors to more than the usual risks of taking advice because they handle their clients' funds. Under the draft Bill the distinction between dealers and advisers would therefore be rationalized so that the distinction would be made on the basis of whether or not the licensee handled clients' funds.
- Part VI would therefore require persons who managed investment portfolios to be licensed as dealers if they held clients' property, but permit them to be licensed as advisers if they did not hold clients' property.
- The current legislation contains specific registration requirements for directors of corporate intermediaries. Section 48(1A) of the Securities Ordinance, for example, requires registration of "dealing directors" (defined in section 2 of that Ordinance); and section 26(2) of the Commodities Trading Ordinance requires the registration, as dealers, of directors (and employees) who are "accredited" to corporate dealers (as defined in section 2(2) of that Ordinance).
- The 1990 consultative document recommended (at paragraph 40) the simplification of the current arrangements for persons acting on behalf of corporate businesses, by removing the requirements for the registration of the dealing and accredited directors. Under the draft Bill, only the corporate entity that carried on business would be licensed as a "dealer" or "adviser"; individuals representing the business would be licensed as "representatives" whether they were directors, employees or otherwise engaged to represent the business.
Representatives and accreditation
- The 1990 consultative document also suggested (at paragraph 37) that under the present legislation the definition of "representative" is too broad, because it is wide enough to oblige secretarial or administrative staff of a licensed intermediary to be registered. The draft Bill would require only people who dealt or advised on behalf of their principals to be licensed as representatives.
- The 1990 consultative document recommended (at paragraph 42) that all licensed businesses should have staff with the necessary experience and qualifications, and that there should at all times be at least one representative of a corporation who could demonstrate the level of experience and educational standards required of dealers or advisers. The draft Bill would require "responsible officers" to be nominated by licensees in order to fill this need. The Leveraged Foreign Exchange Trading Ordinance already requires traders to nominate responsible directors, and the Bill would extend that principle to the securities and futures industry, whilst permitting persons other than directors to be nominated.
- Under the Leveraged Foreign Exchange Trading Ordinance (section 6), a licensed representative is required to be "accredited" to the trader for whom that representative acts. Accreditation is required to be recorded in the representative's licence and in the register of licensed persons, and can only arise where both the representative and his principal have notified the SFC of the existence of that relationship. These principles would be retained in the Bill, and extended to securities and futures dealers and their representatives.
- A further change of substance made by the Bill would be the removal of a separate licensing requirement for partnerships in the securities industry. At present, both partnerships as well as all the general partners are required to be registered. It appears that this requirement was introduced at a time when the criteria for membership of stock exchanges in Hong Kong were being expanded to allow limited partnerships to conduct business on an exchange.
- The separate registration requirement for partnerships has proved unsatisfactory, usually arising from the fact that a partnership has no legal existence distinct from its partners. The expanded vetting capacity of the SFC provided by section 23 of the SFC Ordinance removes the justification for a separate licensing requirement for partnerships. Section 23 now requires the SFC, when considering whether a partnership is a "fit and proper person" to be registered, to have regard to each of the partners' standing. With the removal of a separate requirement for licensing of partnerships, all general partners would be required to be licensed to carry on business.
- The SFC Ordinance and the Leveraged Foreign Exchange Trading Ordinance contain a "fit and proper" test to be met by persons seeking authorization. That test would be retained in the Bill.
- The present requirements that futures dealers must be members of a recognized exchange would be tightened up to the extent that a licence would no longer be available on the basis that the applicant was a subsidiary of a member of a recognized exchange. This again was foreshadowed in the 1990 consultation document [para. 46]. The change is, however, not expected to affect the industry in any material way as the law would be simultaneously amended to enable the Exchanges to allow non-shareholders to be members (as indicated above when discussing Part IV of the draft Bill - under the heading "(6) - Miscellaneous Provisions").
- Registered and licensed persons are at present subject to continuing requirements the object of which is to ensure that they remain fit and proper persons to conduct business and maintain sound financial health. Those requirements that are concerned with financial health (accounting, audit and capital requirements) are dealt with in Part VIII of the draft Bill. Other continuing obligations generally take the form of requirements to report or record various matters. For example, annual returns have to be submitted to the SFC; records have to be kept in approved locations; contract notes have to be prepared; and changes of address have to be reported.
- Reporting requirements are brought together in the draft Bill, which also contains a requirement for "responsible officers" to report attempts to interfere with the performance of their duties.
- Finally, and as suggested in the 1990 consultation document [paragraph 56], the requirements for the maintenance of registers of securities, presently contained in section 67 of the Securities Ordinance, would be repealed.
- Under the present law, the SFC may revoke or suspend a person's registration or licence in accordance with the procedures, and on the grounds, laid down in the legislation. In practice, this usually involves an inquiry by the SFC, which leads to preliminary findings and proposals being put in writing to the person concerned. That person may then make representations as to the facts, inferences or sanctions that have been indicated to him. After those representations have been received a decision is made. A person aggrieved by the decision may appeal to the Securities and Futures Appeals Panel.
- The present disciplinary powers do not include a sanction between a reprimand on the one hand, and revocation or suspension on the other. The draft Bill would (under clause 6.15(3)) enable the Commission to levy financial penalties in respect of certain technical offences, such as late lodgment of accounts and returns. This power was foreshadowed in the 1990 consultation document [paragraph 59].
- The Bill would also clarify the Commission's ability, when conducting inquiries leading to disciplinary sanctions, to require information to be provided to it by licensees (and by officers of corporate licensees.)
- The current appeals procedures, involving the appointment of tribunals from the Securities and Futures Appeals Panel, would continue, and would be extended to cover appeals against refusal by the SFC to approve the nomination of "responsible officers"; or to recognize a licensed representative's accreditation to a principal; and against revocation of exempt status.
- As indicated earlier in this paper, Part III of the draft Bill would enable the Commission to order that suspensions and revocations take immediate effect, despite the possibility of an appeal, where that would be in the public interest or in the interest of the investing public. In addition, automatic postponement of the effective date of non-controversial decisions (such as to revoke a licence at a licensee's own request) would be done away with.
Regulation of acquisition of substantial shareholdings in licencees
- Under the present law, the SFC may have regard to matters relating to substantial shareholders of companies when considering whether the company is "fit and proper" to be registered or licensed. A substantial shareholder is effectively one who controls 10% or more of the shares. (Section 23(6) and (8) of the Securities & Futures Commission Ordinance; section 9(2) and (3) of the Leveraged Foreign Exchange Trading Ordinance.)
- However, there is no effective mechanism to ensure that the SFC is able to vet the suitability of persons who become substantial shareholders after a licence has been granted and, in particular, to prevent persons whose licence applications had previously been rejected by the SFC from gaining a backdoor entry through acquisition. Separate legislation is being introduced to require Commission approval prior to the acquisition of such substantial shareholdings in licencees, and the draft Bill will need to be amended in due course to incorporate the legislation enacted on that subject.
Exemptions - exempt dealers
- Under the present law, exempt dealer status may be enjoyed (by virtue of section 60(2) of the Securities Ordinance) by persons whose main businesses are not securities dealing or, if their main businesses are securities dealings, that these consist of dealing activities broadly classifiable as professional or wholesale dealings. These activities include the issuing of prospectuses and the underwriting of offers of securities. In addition, licensed banks have a specific eligibility (under section 60(4) of the Ordinance) to apply for exempt status, and many have been granted it.
- Although the SRC Report recommended the total abolition of the exemption system, the SFC concluded, after a review of these provisions and following consultation with the industry in 1990, that there was a need for the exemption system to continue but that main-stream securities dealing activities of exempt persons, particularly banks, should no longer continue to enjoy exemption from regulation by the SFC.
- Under the Bill, exempt dealer status would be retained for businesses which only dealt in securities as an incident of some other (non-dealing) activity. While current exempt dealers would be "grandfathered" into the regime, pursuant to the recommendations of the consultative document issued in 1990, the SFC will undertake a review of these institutions following enactment of the Bill with a view to revoking the exempt status of those who fall outside the ambit of the new provision. Exempt dealers which have their status so revoked will be given a year to re-structure their activities or to obtain a licence from the SFC. Remaining exempt dealers would be required to make annual returns to the SFC and be liable to inspection by the SFC in the same way as licencees. In the case of institutions regulated both by the Monetary Authority and the SFC, the arrangements currently in place to avoid unnecessary regulatory duplication would continue when the draft Bill became law.
- The draft Bill provides that the criteria to be used in deciding whether to grant a securities dealer exempt status include that there should be no undue risk to the investing public.
- As far as exempt advisers are concerned, they are defined in the present law (section 2 of the Securities Ordinance) so as to expressly exclude licensed banks. This automatic exclusion would not exist in the Bill. Authorised financial institutions which apply for exempt status as advisers will have to demonstrate that their advisory activities are ancillary to their main business in Hong Kong. Other applicants will either (as at present) be limited to giving advice only to persons resident outside Hong Kong; or to giving advice only to persons whose business involves investing in securities (as opposed to the present requirement that advice be given mainly to such persons).
Revocation of exempt status
- The grounds on which exemption may in future be revoked are specified in the draft Bill. Revocation could be invoked for failure to meet the exemption criteria, for misconduct or for evidence of lack of fitness and properness, amongst other things. As foreshadowed in a review and public consultation conducted in 1990, exempt dealers who failed to meet the new exemption criteria would have their exempt status revoked and be given a year to apply for licences as securities dealers.
Leveraged foreign exchange trading by banks
- Under the Leveraged Foreign Exchange Trading Ordinance, leveraged foreign exchange trading does not require a licence if undertaken by an institution regulated under the Banking Ordinance (an "authorised institution"). The original intention behind this arrangement was that the Ordinance would not apply to authorised institutions at all. As worded, however, the Ordinance does not have that effect. It merely dispenses with the need for banks to have licences under the Leveraged Foreign Exchange Trading Ordinance. The draft Bill would exclude banks altogether from the scope of the law on leveraged foreign exchange trading. The Hong Kong Monetary Authority will continue to regulate conduct of banks pursuant to guidelines issued from time to time.
- Section 52 of the Securities Ordinance and section 31 of the Commodities Trading Ordinance require applicants for registration as dealers to pay a deposit, which can be used to satisfy creditors in certain circumstances. The level of deposit has been fixed at $50,000 for many years and is clearly inadequate as a source for payment of creditors. This would be repealed by the draft Bill in favour of compulsory fidelity insurance. The proposals relating to compensation reform are dealt with further in the comments on Part X of the draft Bill, later in this paper.
Part VII - Supervision and Investigations
- The principal legislation currently governing the SFC's power of investigation and supervision is contained in-
- Part VII of the Securities Ordinance;
- Part XI of the Securities Ordinance;
- Part V of the Securities & Futures Commission Ordinance; and
- Part VII of the Leveraged Foreign Exchange Trading Ordinance.
A brief description of the scope of these Parts and what would become of them under the draft Bill appears in the following paragraphs.
Part VII of the Securities Ordinance
- Part VII of the Securities Ordinance (entitled "Records") is expressed to apply to securities dealers and their representatives, and investment advisers and their representatives. It requires them to keep registers recording their interests in securities, with details of the acquisition and disposal of those interests. The provisions of Part VII may be applied by order of the Governor in Council to financial journalists.
- No order has ever been made extending the application of Part VII. And the requirements that apply to registered persons have in effect been superseded by requirements that are now contained in the SFC Ordinance, for example section 30 (supervision) and section 31 (Information relating to transactions). Since the provisions of Part VII of the Securities Ordinance are in effect a dead letter, it is proposed that they be repealed without re-enactment. This was suggested in the 1990 consultation document.
Part XI of the Securities Ordinance
- Part XI of the Securities Ordinance (entitled "Inspections and Investigations") enables the SFC to appoint inspectors to investigate "any alleged breach of trust, defalcation, fraud or misfeasance"; or "any matter concerning dealing in securities or the giving of investment advice" (s.127(1)).
- The Financial Secretary also has power, under the Companies Ordinance, to appoint inspectors in relation to the affairs of companies. The powers of the Financial Secretary under the Companies Ordinance and those of the SFC were amended in 1994, and the SFC can now provide a swift response to complaints of such matters as breach of trust and fraud in a listed company, by carrying out an inspection of the books and records of the company; whilst the Financial Secretary has the ability to appoint inspectors to carry out a fully-fledged investigation where that is necessary.
- The SFC also has authority under section 33 of the SFC Ordinance to mount an investigation into (amongst other things) into "a defalcation or other breach of trust, fraud or misfeasance" in dealings in securities, trading in futures contracts and the giving of related financial advice.
- The powers that the SFC has under the SFC Ordinance (as amended in 1994) are such that Part XI of the Securities Ordinance is no longer essential and it would be repealed by the draft Bill without re-enactment.
Part V of the Securities and Futures Commission Ordinance
- Part V of the Securities and Futures Commission Ordinance is entitled "Regulation of registered persons' business, etc." It includes the SFC's powers to supervise the securities industry by carrying out an inspection of a listed company's books and records, to inspect the records of registered persons, to gather information about transactions, to investigate offences, to apply to magistrates for warrants, to apply to the High Court for orders relating to the affairs of listed companies and to issue intervention notices to registered persons.
- These supervisory powers would be reenacted in Part VII of the draft Bill. At present the powers of inspection that the SFC has under section 30 of the SFC Ordinance are confined to determining whether there has been compliance with legislation or the terms of registration. Under the Bill, the SFC would also be able to investigate compliance with guidelines and codes of conduct (clause 7.2(2)); and also be authorised, in addition to requiring production of documents, to seek information about them.
- The SFC is authorised under Part V of the Securities and Futures Commission Ordinance to issue notices to registered persons, and under Part VIII of the Leveraged Foreign Exchange Trading Ordinance to issue notices to persons licensed under that Ordinance, restricting the way that business may be done or assets may be dealt with, or requiring assets to be maintained as directed by the SFC. Those powers are very similar to provisions in Part VI of the Financial Services Act 1986, in the United Kingdom. They have been an invaluable tool to enable the SFC to protect investors. In one area, however, they have been found lacking. They do not include an equivalent to section 67 of the Financial Services Act, to enable the regulator to require a registered or licensed person to transfer assets to a trustee to safeguard client assets in the event of risks of their being dissipated. The draft Bill includes a provision (in clause 7.18) under which the SFC could require a licensed person to transfer assets to a trustee (which could be the Commission itself).
Part VII of the Leveraged Foreign Exchange Trading Ordinance
- The Leveraged Foreign Exchange Trading Ordinance was enacted in 1994. Its provisions for investigating and supervising the leveraged foreign exchange trading industry were derived extensively from legislation already available to the SFC to regulate the securities and futures industry.
- Part VII of the draft Bill would, for the most part, be a consolidation of Part V of the S.F.C.O. and Part VII of the Leveraged Foreign Exchange Trading Ordinance.
Part VIII - Financial Regulation of Intermediaries
- Statutory provisions for the financial regulation of registered and licensed persons are currently found principally in-
- Part V (Accounts and Audit) of the Commodities Trading Ordinance;
- Part VIA (Special Provisions relating to Dealers) and Part IX (Accounts and Audit) of the Securities Ordinance;
- sections 28 & 29 of the Securities & Futures Commission Ordinance (which provide for the making of Financial Resources Rules);
- Part V of the Leveraged Foreign Exchange Trading Ordinance (Books, Records, Capital Requirements, Accounts and Audit).
- The provisions of Part V of the Commodities Trading Ordinance and Part IX of the Securities Ordinance are broadly similar to each other. The draft Bill would produce, so far as practicable, a set of provisions in Part VIII with common requirements for the securities, futures and leveraged foreign exchange trading industries. It would, to some extent, re-enact the current provisions but it would also cure inconsistencies between them, and in some respects amend the current law relating to financial regulation of intermediaries. For example, the current legislation applies only to dealers; Part VIII of the Bill would apply also to securities and futures advisers.
Use of Chinese
- There are requirements at present (in section 83(2) of the Securities Ordinance and section 45(2) of the Commodities Trading Ordinance) that accounting and other records must be kept in writing in English or in a manner that enables them to be readily converted into written English. Having regard to the provisions of article 9 of the Basic Law, it is proposed to delete the present provisions which place primacy on the English language.
Financial Resources Rules
- Financial Resources Rules under section 28 of the SFC Ordinance were made for the first time in 1993. The process of drafting them and of implementing and enforcing them has revealed the need for some changes. In particular, there are difficulties with section 29, which provides a special procedure for modifying (though no power to waive) the application of Financial Resources Rules to specific registered persons. This procedure includes a requirement to publish the notification in the Gazette. Prior to the introduction of the rules, capital adequacy requirements were provided for under section 65B of the Securities Ordinance, and they could be waived under section 55A of the SFC Ordinance with minimum procedural formalities. That arrangement worked well. A similar waiver power is now contained in section 69 of the Leveraged Foreign Exchange Trading Ordinance. It is therefore proposed that such a provision be included in the Bill (see clause 6.20), and section 29 of the SFC Ordinance would not be re-enacted.
Securities held for clients
- Licensed and exempt persons are currently required by section 81 of the Securities Ordinance to hold securities for the safe custody of which they are accountable to other persons, in any of several ways. One of the prescribed ways is to hold them in the name of a nominee company which is controlled by the licensed or exempt person. Some nominee companies, however, carry out trading activities which are not supervised by the Commission. They may also hold assets for other persons for various reasons which are not envisaged in the legislation. The beneficial owners of the securities held by the nominee companies for the licensed or exempt persons may be at risk on account of these activities and because of commingling of their assets with those of others.
- Clause 8.6(4), (5) and (6) of the draft Bill would enable the Commission to exercise a minimum monitoring role over the nominee company. The provisions would introduce safeguards against the risks which beneficiaries face as a result of-
- the control which the licensed or exempt person exercises over the nominee;
- the lack of any current regulatory supervision over the manner in which the nominee holds the securities;
- the possibility of commingling of securities which the nominee might hold for different beneficial owners; and
- the susceptibility of securities to misappropriation.
Similar provisions are common in many other financial centres.
Segregated accounts for client money
- Registered and licensed persons are required by law, and will continue to be required by the Bill, to operate separate bank accounts (often called "trust accounts") for their clients' money. The purpose is to protect investors' money from the dangers of mixing their money with that of their financial intermediary and from the risk that their money might be taken by the creditors of the intermediary.
- The Bill replaces with a single provision (clause 8.9) the requirements currently contained in section 84 of the Securities Ordinance, section 46 of the Commodities Trading Ordinance and section 23 of the Leveraged Foreign Exchange Trading Ordinance. Because those provisions are not identical to each other, it is inevitable that clause 8.9 will introduce some changes for some cases. The model chosen for clause 8.9 is section 23 of the Leveraged Foreign Exchange Trading Ordinance, which is more in line with current practice in other leading financial centres. The main changes that this involves, therefore, are for the securities and futures industry; the time limit for placing clients' money in a trust account will be reduced from four days to one (as already is the case under the Leveraged Foreign Exchange Trading Ordinance). Also, there will be a requirement (as under the LFETO) for monthly reconciliations of payments into and from the trust accounts to be carried out.
Part IX - Business Conduct
- Requirements of business conduct for registered persons may take several forms. They may be imposed by primary legislation; they may be prescribed in subsidiary legislation; or they may be set out in non-statutory documents, such as recommended standards, guidelines, or codes of conduct. An advantage of statutory requirements is that they tend to be precise and breaches may attract criminal sanctions; their disadvantage is that, because they are framed as legislation, they tend to attract "legalistic" interpretation and argument in contexts where the enforcement of a criminal sanction is not necessarily the most appropriate way to resolve the problem that has arisen.
- The primary objective of rules of business conduct is to ensure that, by the enforcement of fit and proper conduct, investors are protected against misconduct in the management of their financial affairs. With that aim the SFC has promulgated non-statutory codes of conduct for observance by registered and licensed persons. These are issued either under section 4(2) of the SFC Ordinance, as guidelines indicating the manner in which the SFC ordinarily performs a regulatory function (such as determining whether an applicant for registration is a "fit and proper person", according to the "Fit and Proper Criteria" published by the SFC); or under section 76 of the Leveraged Foreign Exchange Trading Ordinance, as guidelines setting out "principles, procedures and standards" for trading (such as the SFC's "Conduct of Business Guidelines" under that Ordinance).
- The draft Bill restates (in clause 9.1) the authority for issuing codes and standards of conduct in more direct terms, and states their effect - or more particularly, the effect of not observing them (which is that an inquiry may be undertaken under clause 6.15 of the Bill).
Part X - Investor Compensation
- The need for changes to the present compensation arrangements has been recognized for some considerable time. The SFC reviewed the present legislation and consulted its Advisory Committee and the present Compensation Fund Committees in 1992 and 1993 about possible changes. What is now proposed in the draft Bill is based upon the work done at that stage.
- Compensation is presently available to investors who suffer loss as a result of a default on the part of, and in the course of business carried on by, registered securities or futures dealers. There are two distinct types of compensation arrangements.
- One type of arrangements, covering dealers who are members of one or other of the two Exchange Companies, is contained in the Securities Ordinance (Part X) and the Commodities Trading Ordinance (Part VIII). The other type covering dealers who are not Exchange members, is contained in sections 52 and 52A of the Securities Ordinance and the Securities (Miscellaneous) Rules (in relation to registered securities dealers) and in sections 31 and 33 of the Commodities Trading Ordinance and the Commodities Trading (Dealers, Commodity Trading Advisers and Representatives) Rules (in relation to registered futures dealers).
- It is proposed to repeal the compensation arrangements relating to registered dealers who are not members of an Exchange Company, as the present form of statutory compensation is not effective. It would be replaced by a requirement (in Part VI of the Bill) for such dealers to be covered by suitable fidelity insurance satisfactory to the SFC.
- The present legislation relating to compensation in respect of registered members of the two Exchanges has proved anomalous and inflexible and has created difficulties of interpretation and implementation. Part X of the draft Bill would replace it with more flexible and less complicated provisions. Part X consists essentially of a general obligation on recognized exchange companies to establish and maintain such compensation arrangements as may be prescribed in rules made by the Commission, together with provisions enabling the Commission to make rules covering specific matters relating to the compensation arrangements. Those specific matters would include specification of the basis for compensation claims and how and by whom such claims are to be made and determined and the maximum amount of compensation payable in each case.
- This approach would provide greater consistency in the operation of the legislation than at present and would eliminate much of the existing duplication of primary legislation. At the same time it would provide greater flexibility by enabling the rules to be amended to take account of changed circumstances.
- Placing the bulk of the compensation provisions in subsidiary legislation would not be a novel approach. For example, section 54 of the Financial Services Act 1986 of the UK enables the Secretary of State to make rules for the establishment of a compensation scheme for investors and sets out what such rules may cover. Rules have been made under this provision by the Securities and Investments Board, following the transfer of the powers of the Secretary of State in this regard to the Board under section 114 of the Act. A similar legislative approach is adopted by the Ontario Securities Act whereby, under Regulations made under that Act, certain dealers are required to participate in a compensation fund or contingency trust fund approved by the Ontario Securities Commission and established by a prescribed organization, which includes certain recognized Stock Exchanges.
Part XI - Insider Dealing
- The current legislation on insider dealing is contained in the Securities (Insider Dealing) Ordinance (Cap. 395). Since the commencement of that Ordinance in 1991, it has been amended in two principal respects -
- its prohibition of insider dealing in the securities of listed companies has been extended (since 1994) to dealings in derivative instruments based on such securities;
- the Ordinance was amended in 1995 for the purpose of enabling more than one insider dealing inquiry to be conducted at any one time by the Insider Dealing Tribunal.
- Part XI of the draft Bill would re-enact the substance of the present Securities (Insider Dealing) Ordinance. It would also enable the tribunal (under clause 11.19(1)(e)) to include in the costs that an insider dealer could be required to pay, those expenses incurred by the SFC in carrying out an investigation before the case was referred to the Tribunal.
Part XII - Market Manipulation
- Part XII of the Securities Ordinance (Prevention of Improper Trading Practices) and sections 62 to 65 of the Commodities Trading Ordinance contain the present legislation in Hong Kong on activities designed to deceive the markets in securities and futures contracts and to deceive those who invest through them. Section 40 of the Leveraged Foreign Exchange Trading ordinance prohibits fraud and deception in leveraged foreign exchange trading.
- Part XII of the draft Bill would contain the law on this subject, but with some changes to the present law. The Commodities Trading Ordinance does not include prohibitions corresponding with all the offences created by Part XII of the Securities Ordinance for securities markets. Under the Bill, that difference of treatment of the two types of market (securities and futures) would as far as practicable be eliminated by creating similar offences for both types of market.
- Since market manipulation activities (as in other areas of crime) may take place across jurisdictional boundaries, the Bill would make it clear that activities which manipulated the Hong Kong markets breached Hong Kong law even if they took place elsewhere; and that activities in Hong Kong which were directed at manipulating a market elsewhere also breached Hong Kong law.
- Section 137 of the Securities Ordinance makes price stabilization activities illegal, where those activities contravene regulations made for the purposes of the section. This provision may create the impression that price stabilization activities which are undertaken to interfere with the price-setting effect of a free market are necessarily lawful, in the absence of regulations forbidding them. The ambiguity that the language creates would be removed by the draft Bill. Instead, clause 12.16 would enable rules to be made prescribing what may be done without breaching the law. Arrangements designed to influence the price of securities would otherwise be prima facie unlawful (under clause 12.6).
- Section 138 of the Securities Ordinance prohibits misleading statements that induce the sale of securities. The provision inadvertently omits to refer to misleading statements that induce the purchase of securities. That would be corrected by clause 12.7.
- The activity of "bucketing" orders for futures contracts (not placing client orders to the floor of the Futures Exchange whilst maintaining a pretence of doing so) is not the subject of a specific offence under current Hong Kong law, though it is elsewhere. This gap in Hong Kong law makes prosecution of such activity very difficult even though deception may be involved. Clause 12.12 of the draft legislation would therefore introduce a "bucketing" offence.
Activities carried out in accordance with exchange rules
- Clause 12.16(2)(b) of the draft Bill is intended to make it clear that activities that comply with rules of any market where they are carried out are not to be regarded as a breach of the law; and that the Commission should be able to make rules prescribing permitted activities, so that compliance with such rules would avoid any risk of breaching Part XII.
Part XIII - Offers of Investments
- Hong Kong's legislation governing the content of offers of securities is found in the Companies Ordinance (Cap. 32), the Protection Of Investors Ordinance (Cap. 335 ) and, to a lesser extent, the Securities Ordinance (Cap. 333). There are also provisions in the Commodities Trading Ordinance (Cap. 250) relating to the offering of futures contracts, and in the Leveraged Foreign Exchange Trading Ordinance (Cap. 451) relating to foreign exchange contracts.
- Part XIII of the Bill is derived mainly from the Protection of Investors Ordinance, which regulates offers of securities and property investment arrangements, and some provisions in the Securities Ordinance. The draft Bill, however, would change the law in certain respects.
Authorization of unit trusts and mutual funds
- Unit trusts and mutual funds are authorised by the SFC for distribution in Hong Kong. Currently this is done under section 15 of the Securities Ordinance; in the Bill, the relevant provision is clause 13.3. Whilst the enabling power in the Bill would follow the form of the current law, the definitions of "unit trust" and "mutual fund corporation" would be amended to accommodate market developments.
- Firstly, "unit trust" is currently defined, as the name suggests, in terms appropriate to the law of trusts. Trusts are associated with common law jurisdictions. In other legal jurisdictions, comparable collective schemes are created using other legal structures and yet may be equally suitable for marketing (and regulating) in Hong Kong. In order to enable the SFC to authorise the distribution of such products, the Bill will enable the SFC to specify additional arrangements for participating in investment profits and income.
- Secondly, "mutual fund corporation" will be defined more broadly than under the current law. At present it is a company that (in effect) issues redeemable shares and is engaged primarily in investing in securities. The limitation of the company's primary investments to securities is out of step with current practice, under which investments may be in a whole range of products, including futures, foreign exchange, money market instruments and cash deposits. The definition of "mutual fund corporation" would therefore be expanded by the Bill to include companies that invest primarily in property other than securities.
- In addition, the draft Bill would (in clause 13.3) expressly provide for the publication of codes of practice for unit trusts and mutual funds.
- The Protection of Investors Ordinance regulates offers to the public of both securities and "investment arrangements". The definition of "investment arrangements" is very wide. It is probably intended to be confined to schemes involving collective investments by the participants, but the wording is ambiguous. The Bill would make the collective nature of an arrangement a clearer element of the definition, based on the provisions of section 75 of the Financial Services Act 1986 of the U.K.
- The Bill would, however, retain the existing provision (in section 2A of the Protection of Investors Ordinance) for specifying arrangements that are required to be treated as constituting "investment arrangements" or, as the case may be, as not constituting investment arrangements.
Offers of securities by dealers and hawking
- The draft Bill would re-enact (in clause 13.9) the requirements of section 72 of the Securities Ordinance, prescribing the content of offers by dealers to buy or sell securities.
- Provisions governing the hawking and cold calling of investments are found in the Securities Ordinance, the Commodities Trading Ordinance and the Leveraged Foreign Exchange Trading Ordinance. Clause 13.10 of the draft Bill would replace those provisions with a single provision, based on the existing section 39 of the Leveraged Foreign Exchange Trading Ordinance. It would thus be illegal, in the course of an uninvited visit on a person, to sell securities to that person or to seek to persuade that person to buy them. The same would go for futures contracts, investment arrangements and leveraged foreign exchange transactions.
Part XIV - Miscellaneous
- Since the present legislation that is administered by the SFC is spread across many Ordinances there is a substantial degree of duplication of the kinds of provisions that typically are grouped together in a part of an Ordinance headed "Miscellaneous". Such provisions include the power to make subsidiary legislation; the power to prosecute, and time limits for prosecuting; the liability of directors of companies for criminal offences committed by companies; duties of confidentiality, and so on. Part XIV of the draft Bill would consolidate such provisions, eliminating minor differences of wording where these have arisen in the past, and reducing the current volume of such miscellaneous provisions.
- Part XIV of the draft Bill is also a suitable location for the re-enactment of some provisions which are common to the regulation of both exchanges and clearing houses, and so have relevance to both Parts IV and V of the draft Bill. For example, clause 14.3 reproduces the substance of section 50 of the Securities and Futures Commission Ordinance, enabling the SFC to issue restriction notices to exchanges and clearing houses.
- The following paragraphs of this paper relating to Part XIV of the draft Bill refer to those provisions which make changes of substance to the present legislation.
Duties of directors and staff of the SFC
- Under section 59(2)(c) of the Securities & Futures Commission Ordinance and section 63(2) of the Leveraged Foreign Exchange Trading Ordinance, the Securities & Futures Commission is relieved of its duty of secrecy when it is a party to civil litigation. When information is required for litigation to which it is not a party, the current legislation provides no relief. The draft Bill will give the Commission (in clause 14.1(2)(c)) a discretion to accede to requests from litigants for information in such cases.
- Under section 59 (6) of the Securities & Futures Ordinance, a duty is imposed on directors and staff of the SFC to disclose (amongst other things) whether a matter that he is considering in the course of his duties is one relating to a bank or deposit-taking company of which he has been a customer; or to a customer of a bank or deposit-taking company by which he has been employed. This duty was introduced in the course of preparing the Securities & Futures Commission Ordinance in 1989, and was soon found to be far too wide to be practically enforceable. It was not reproduced in section 62 of the Leveraged Foreign Exchange Trading Ordinance, which is otherwise similar to section 59 of Securities & Futures Commission Ordinance, and the draft Bill will remove references to such financial institutions in this context.
Liability of directors for corporate offences
- The Leveraged Foreign Exchange Trading Ordinance introduced, for companies which contravened the Ordinance, a stricter test of responsibility for directors of corporate traders than had customarily been the case under the relevant Ordinances. Directors may be prosecuted under that Ordinance for offences committed by their company, but under section 66 of the Ordinance, a defence of "reasonable diligence" is provided for.
- The effect of section 66 of the Leveraged Foreign Exchange Trading Ordinance would be retained in Part XIV of the draft Bill, but be extended to embrace corresponding offences relating to activities in securities and futures.
Rules made by the Commission
- Many of the relevant Ordinances currently confer upon the SFC powers to make rules. Rules relating to the conduct of business by licensed persons would be made under Part IX of the draft Bill. Other rule-making powers, unless specifically identified elsewhere in the draft Bill, are set out in Part XIV. (See clause 14.13).
- The Bill would remove certain anomalies that currently exist in the terminology relating to rules made by the Commission, and in the penalties that may be imposed. For example, previous amendments to section 146 of the Securities Ordinance have given rise to the indiscriminate use of the words "rules" and "regulations" to describe the same thing. And whilst section 28(e) of the Interpretation and General Clauses Ordinance ordinarily enables a rule-making body to prescribe criminal sanctions (within limits) for breaches of its rules, the Governor in Council alone may prescribe them for breaches of rules made by the SFC. This has proved to be an unsatisfactory arrangement, because there is a need to coordinate the exercise of concurrent rule-making powers of the SFC and the Governor in Council, and yet it is not possible in practice to initiate the procedure for prescribing penalties until after the SFC has published its rules.
- The Bill would return to the principle on which section 28 of the Interpretation and General Clauses Ordinance was based, and permit the SFC, when making rules, to prescribe criminal penalties of up to a fine of $25,000 - "level 4" - and imprisonment for 3 months.
Rules made by Exchanges and Clearing Houses
- It has long been accepted that rules made by exchanges and clearing houses are not subsidiary legislation. They are more in the nature of domestic rules made and enforced by the relevant institution under its memorandum and articles of association. They are not published as part of the laws of Hong Kong.
- However, the power to make such rules is referred to in primary legislation relating to the exchanges and clearing houses (for example in section 34 of the Stock Exchanges Unification Ordinance and in section 4 of the Securities and Futures (Clearing Houses) Ordinance). It is important that there be no question as to the true status of their rules, which are at the heart of the responsibilities of exchanges and clearing houses as front line regulators. The draft Bill would put the matter beyond question (in clause 14.7) by expressly providing that such rules do not constitute subsidiary legislation.
- Some of the powers conferred by the relevant Ordinances are required to be exercised by notice published in the Gazette. It is not always clear whether or not such an instrument should be treated as subsidiary legislation. The publication of the names of licensed persons in the Gazette should plainly not be regarded as a power to make subsidiary legislation. On the other hand, a power to amend a statutory schedule (such as the Schedule to the Protection of Investors Ordinance) probably should be so regarded.
- If a particular instrument does constitute subsidiary legislation, it should as a matter of legal principle be published in the Gazette; the draft Bill would not seek to make any change to this principle which would be governed by the Interpretation and General Clauses Ordinance (Cap. 1). But the Bill would introduce a provision designed to ensure that there was no room for argument as to whether an express requirement in the Ordinance to publish something in the Gazette was to be construed as a power to make subsidiary legislation. The draft Bill would do this by providing that a publication in the Gazette made in compliance with express requirement or power in the Commission's legislation should not be treated as subsidiary legislation in the absence of an explicit statutory requirement for it to be so treated.
- All penalties in the existing legislation have been reviewed. Because they were introduced at various times over many years, there is inevitably inconsistency between penalties in the current legislation. The Bill would introduce greater consistency, having regard to the penalties introduced by the SFC Ordinance in 1989, and by the Leveraged Foreign Exchange Trading Ordinance in 1994.
Part XV - Repeals, Transitional Provisions and Consequential Amendments
- Changes introduced by the Bill include those to the terminology currently used for persons registered under the Securities Ordinance and the Commodities Trading Ordinance. For example, a "commodity trading adviser" will become a "futures adviser", and will be "licensed" rather than "registered"; and a registered "investment adviser" will become a licensed "securities adviser". The intention is that registrants will automatically be treated as authorised ("licensed") under the new legislation, albeit under their new descriptions, without any action having to be taken by them. The SFC would make appropriate administrative arrangements to replace their certificates of registration, over time, with licences bearing the new nomenclature.
- Similarly, the two existing exchange companies and three existing clearing houses would, under the Bill, be treated as exchange companies and clearing houses recognized under the new legislation. And unit trusts and mutual funds authorised under section 15 of the Securities Ordinance would continue to be treated as authorised under the new legislation, without any fresh application having to be made for that purpose.
- The principle, therefore, will be for there to be a smooth transition from the existing legislation to the new, with no unnecessary disruption to participants in the industry or to investors. There are, however, certain provisions where particular arrangements will have to be made for transitional provisions.
- For example, any investment adviser who wishes to have access to clients' assets will have to apply for a licence as a dealer. That is because, as has been noted earlier in the commentary on Part VI of the Bill, it is proposed that registered advisers will not be able to handle clients' funds. Their existing status (as registered advisers) will be treated as giving them the status of licensed advisers under the Bill, but without the right to have access to their client's funds. If they wish to have such access, they will need to apply for a licence as a dealer.
- By way of further example, Part X of the Bill includes revised arrangements for compensation of investors. As far as the two statutory compensation funds (contributed to by members of the two exchanges) are concerned, transitional provisions will be required (included in Schedule 8) to provide for the disposal of outstanding claims and the distribution of compensation money thereafter.
The Consultation Period
We regret to inform you that the consultation period is now over.
Last update: 7 Aug 2012