1. OVERVIEW OF HONG KONG MARKETOverview of HK
market
Hong Kong’s financial market has had a dramatic
year with the outbreak of SARS that was compounded by the general economic
slowdown since the technology bubble burst in 2000. SARS caused regrettable loss of life and many aspects of social
and economic activities in Hong Kong were disrupted. However, as the SARS epidemic receded, confidence returned and
Hong Kong’s markets made a significant rebound as the local economy began to
recover in the latter part of 2003. The
economy received a further boost after the signing of the Closer Economic
Partnership Arrangement (CEPA) between the Mainland of China and Hong Kong.
As a whole, Hong Kong’s securities industry is
thriving and market participants generally have strong financial positions.
The financial services industry
is one of the key sectors of Hong Kong’s economy. It contributes 13% of Hong Kong’s GDP (in value-added terms) and
employs about 6% of its workforce.[1]
As at the end of March 2004,
there were 448 securities brokers (who are participants of the Stock Exchange
of Hong Kong Limited)
and 127 futures brokers (who are participants of the Hong Kong Futures Exchange Limited).
Table 1 below shows the key statistics:
|
Table 1 - Key Statistics (Mainboard + GEM combined) |
|
||
|
Demographics |
end 2003 |
end Apr 2004 |
|
|
Number of listed companies |
1,037 |
1,057 |
|
|
Number of trading
exchange participants on SEHK* |
452 |
449 (end Mar 04) |
|
|
Market cap and ranking |
end 2003 |
end Apr 2004 |
|
|
Market cap (US$ bn) |
711.3 |
680.5 |
|
|
Worldwide |
10 |
10 |
|
|
Asia |
2 |
2 |
|
|
Primary & secondary market |
during 2003 |
during Jan-Apr 2004 |
|
|
Number of new listings |
73 |
25 |
|
|
Funds raised (US$ bn) |
27.4 |
7.5 |
|
|
- of which from IPO |
7.6 |
3.4 |
|
|
Average |
1,335.8 |
2,396.8 |
|
|
Source: Hong Kong Exchange and Clearing Limited (HKEx) |
|||
*Stock Exchange of Hong Kong Limited
Big and small players – Ddemographics of brokers
Hong Kong’s securities market has developed on
what is essentially a two-sector structure.
One sector is composed of international
brokers of world repute serving primarily an institutional network and
accounting for roughly half the market share and trading mostly Hang Seng Index
stocks. The other sector is composed of
a large number of small and medium
sized local brokerages. The majority of these serve the retail
market, trading both Hang Seng and non-Hang Seng Index stocks. While the international brokers have helped
anchor Hong Kong’s position as an international financial centre, local brokers
play the important role of serving smaller investors and providing liquidity to
the market. Table 2 gives a break--down of market
share of different categories of brokers.
|
Table 2 - Distribution of trading by size group (Oct 02
|
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|
Type of trade |
Large-sized brokers |
Medium-sized brokers |
Small-sized brokers |
Total |
|
Principal trading |
79.3% |
0.7% |
19.9% |
100.0% |
|
Overseas agency trading |
45.7% |
38.9% |
15.4% |
100.0% |
|
-Retail |
7.0% |
24.6% |
68.5% |
100.0% |
|
-Institutional |
50.3% |
40.6% |
9.2% |
100.0% |
|
Local agency trading |
21.1% |
31.3% |
47.7% |
100.0% |
|
-Retail |
3.2% |
24.9% |
71.8% |
100.0% |
|
-Institutional |
40.0% |
37.9% |
22.1% |
100.0% |
|
Overall |
32.7% |
33.1% |
34.2% |
100.0% |
|
Source:
HKEx Cash Market Transaction Survey 2002/03 (CMTS) |
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(1)
Based on CMTS 2002/03, small-sized brokers handled 72% of the local
retail trades and 68% of overseas retail trades. They only contributed 22% and 9.2% respectively to local and
overseas institutional trades.
(2)
Large-sized brokers handled 40% of the local institutional trades,
50% of overseas institutional trades and 79% of the principal trades.
The big players practice international standards
and wish to be seen to be respecting local sensitivities and not interfering in
local politics.
The small players are quite vocal when defending
their turf and often use the media to polarise public opinion and sway
public sentiment in their favour. However, the small players do not
represent a majority of market participants (in turnover and employment), and their, intentions may not always align
with the overall intent of the Hong Kong market.et. even if it is to the detriment of
the market as a whole. An example of
this was the situation in Hong Kong before the demutualization of the Stock
Exchange whereby there was no correlation between the number of members of the
Exchange with trading licenses to their actual market share.
[The number
of SEHK participants registered under Securities Ordinance (before the
implementation of the SFO) was 509 as of the end of Mar 2000 and Mar 2001.]
Hong
Kong investors
of varying sophistication
The SFC carried out a number of investor surveys
which outlined the differences between retail investors and institutional
investors. As Table 3 below shows,
retail investors are not as well informed compared to the significantly more
sophisticated institutional investors.
(1) Investor
Survey on Investment Research Activities
s
Table 3 - Summary Findings
of Investor Survey on Investment Research Activities conducted by SFC
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|
|
|
Retail Investors |
Institutional Investors |
|
(1) |
% of survey
respondents who occasionally or frequently use research reports |
76% |
93% |
|
(2) |
Major channels for
obtaining research reports |
|
|
|
-First |
Print media |
Directly from
brokerage firms |
|
|
|
-Second |
Broadcast media |
Brokerage firms'
websites |
|
(3) |
% of survey
respondents who opine that analysts and their firms: |
|
|
|
-make sufficient disclosure |
10% |
14% |
|
|
-make insufficient disclosure |
47% |
27% |
|
|
Source: Investor Survey on Investment Research Activities |
|
||
(2) SFC
Retail Investor Survey 2003
The results of the
retail investor survey showed that that, in general, stock investors
in Hong Kong took proper measures to protect their interests in dealing with
their intermediaries. Prior to dealing, 78% of brokerage clients had checked the
licence status of the brokerage, the account executive, or both. 83% of stock investors understood fees and
charges of stock trading services well.
On monitoring their investments, 91% checked both contract notes and
account statements. Stock
investors were generally concerned about a listed company’s fundamentals before
buying its shares and did make efforts to conduct their own basic
analysis. Interestingly, over 42% of
stock investors surveyed referred to celebrity analysts' comments and analyses
of newspapers and televisions. 56.5%
of fund investors followed recommendations by sales people of fund houses or
distribution agents.
The survey also showed that if money were no
object, the main reason of non-investing seemed to be the lack of investment
knowledge. Hence, the SFC strongly
believes that better investor education is key to investor protection. We are convinced that better investor
education on the risks associated with investing in securities and funds will
help investors make informed decisions.
The SFC will also conduct similar surveys in the future to keep itself
abreast of investors’ education needs.
No one-size-fits-all approach to regulation
Given the diversity and size of market
participants and the unique characteristics of Hong Kong’s market, a
one-size-fits all approach to regulation would not work. Thus,
a feasible alternative is to build consensus on implementing changes that seek
to protect investors, benefit the industry and impact as few firms/persons as
possible.
Issues
in the Hong Kong market becoming increasingly politicised
The Hong Kong Legislative Council (LegCo)
elections are scheduled in September 2004.
As in any jurisdiction, different sectors of the economy have different
intentions
and objectives. As such, there is a
tendency for LegCo members to take up newsworthy financial issues from
different sectors to champion in the hope of gaining publicity and more
votes. This adds another facet for the
market regulator to consider when proposing reforms.
80-20 ratio on regulatory resource allocation
The SFC also faces the 80%-20% conundrum, whereby
roughly 80% of our resources are spent regulating firms who only contribute 20%
of market turnover. Table 4 below
illustrates that although Category C brokers contribute less than 20% of market
turnover; they amount to about 86% of the total number of market participants. These firms also take up around 80% of the SFC’s resources
to monitor, supervise and regulate.
Table 4 - Turnover by Categories
of Exchange Participants
|
||||
|
|
Turnover during May 2003 - Apr 2004 (US$ mn) |
% of
total |
Number of SEHK Participants as
of end Mar 2004 |
% of
total |
|
Category A |
217,834 |
47% |
14 |
3% |
|
Category B |
157,738 |
34% |
51 |
11% |
|
Category C |
83,775 |
18% |
384 |
86% |
|
Total |
459,346 |
100% |
449 |
100% |
|
Remark: Categorization follows
the definition of HKEx. Category A
participants refer to the top 14 ranked by turnover, Category B participants
refer to 15-65 and the rest are Category C participants. Sources: HKEx, SFC |
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The
majority of brokers operate prudently, responsibly and with integrity. They have adequate risk management systems
in place, and maintain sufficient capital.
However,
the smaller firms do not have the resources and financial capability to maintain sufficient capital as a buffer or to
implement sophisticated
risk management and
monitoring systems.
That
said, these smaller
firms play an important role in providing liquidity to the market and retail
investors do benefit from the greater flexibility and convenience offered by
these firms. We do not believe it is in
Hong Kong’s interest to see these small players disappear. They provide plurality and choice to small investors.
Given this diversity, tTo get around this problem, the
SFC is moving towards risk-based regulation, focusing its resources on
tackling misconduct and financial imprudence, and granting appropriate modifications to firms
that have proper internal controls and risk management to give them some
flexibility under certain regulations that may
otherwise be too restrictive for these firms and grants
exemptions or waivers in appropriate
cases to intermediaries that are unable to meet specific regulatory requirements, without
compromising investor protection.
That said, these smaller firms do play an
important role in providing liquidity to the market and retail investors do
benefit from the greater flexibility and convenience offered by these firms.
Ensuring Ffair and progressive
markets through consensuspartnership
Although widely recognised as an international
financial centre and the 10th largest market in the world, HKHong Kong is still a small
market in terms of number of investors and market participants. Thus, it is essential for HKHong Kong to maintain its critical mass of
investors and market participants in light of the fact that global markets are
becoming ever more competitive. We face
competition from the other major financial markets globally and from within the
region including the Mainland of China.
As the market regulator, we believe our role is both to protect investors and
market integrity, AND
to facilitate market innovation and development. We believe investor protection need not be the antithesis of
market development and that our responsibilityies
as regulator is to strike the right balance.
have realised that the best way to successfully
maintain Hong Kong’s competitiveness and international standards is to build
consensus.
Indeed, Hong Kong’s strength is that our markets
work and move forward by consensus. We
do not believe in a ‘top-down’ approach dictated from above. We place emphasis on working in
partnership with the market, the investors, issuers and intermediaries.
A good example of how consensus building works in
Hong Kong via public
consultation, opinion surveys and full disclosure of information to investors is
the process by which Hong Kong’s newly revamped Securities and Futures
Ordinance (“SFO”)
was introduced. The SFO consolidates
and modernises the 10 ordinances previously regulating the securities and
futures market in Hong Kong. It became
effective on 1 April 2003.
A number of public and soft consultations were
carried out before the SFO was introduced.
The SFO began with a concept consultation to gauge the views and
sentiments of the market regarding the new laws that would affect them, after
which a White Bill was prepared and consulted upon. The Blue Bill was then drafted and numerous working groups were
set up to examine specific issues in the draft legislation. A long process of fine-tuning and revision
followed, not least an element of compromise with extensive scrutiny by the
LegCo Bill’s Committee at every stage. We arranged for meetings with
respondents to further explore ways and alternatives of doing things better in
the least intrusive manner possible.
Next, we published the consultation summary conclusions after each
consultation and this was posted on the SFC website.
To highlight underscore the importance of public
consultation in forming policy, the the SFO now requires the SFC to
conduct a public consultation on all new rules or rule amendments. In practice, we also consult the market on
any new codes of practice and guidelines that we propose to introduce.
The SFO has now been in force for over a year and
is accepted by the market without having created any major problems or needing
revision. This is a good illustration of how
regulating by consensus has worked out well.
We strongly believe that regulators should not
dictate to the market. We would rather
strive to ensure that all relevant
parties,
including
the media, market participants, politicians, market commentators, key industry
associations and investors have a basic understanding of what are
the broad problems/issues affecting the market and move towards achieving
consensus on how to resolve these problems.
In summary, to achieve our regulatory objectives, Hong Kong regulators have
to:
·
aAnticipate
in advance possible obstacles arising from any proposed reform or policy change;.
·
bBuild
support for any proposed changes;.
·
mManage
the fallout (if any) from implementing those changes;.
·
nNavigate
around obstacles that arise;.
·
sStill
maintain international standards.
i) Conflicts
of interest among financial analysts market intermediaries
ii) Misselling
of products by investment advisers
iii) Market
manipulation – integrity of intermediaries
4. STEPS TAKEN TO ENSURE FAIR AND
COMPETITIVE MARKETSteps taken to ensure fair and competitive markets
The key
steps taken to ensure fair and competitive markets include:
i) Regular
updating of Codes of Conduct for licensed intermediaries
ii) Investor
education
iii) Effective
supervision of intermediaries
iv) Waivers
and modifications
vi) Disciplinary action
i) Regular updating of Codes of Conduct
and rules
The SFC regularly
updates its rules, codes and guidelines on the conduct of licensed
intermediaries to ensure that they are in-line with current best market
practices. These rules lay the foundation and set
the standards for the regulation of market intermediaries to enhance investor
protection and foster market development.
ii) Investor eEducation
Educating and empowering investors to protect
themselves is a top priority at the SFC. The SFC has launched investor
education programmes that include radio segments, documentary dramas on
television and websites (including the SFC corporate website and the Electronic
Investor Resources Centre).
iii) Effective monitoring and supervision
of intermediaries
The SFC
continuously monitors the financial positions of licensed intermediaries and
supervises their conduct. This includes inspecting intermediaries
to identify breaches in conduct regulation.
The SFO has standardised the regulatory capital
framework for all licensed intermediaries in the form of a liquid capital
requirement to strengthen prudential regulation over advisers and asset
managers. Advisers and asset managers
are now required to regularly submit their financial returns to the SFC. To obtain further information about their business operations and
risk management measures, all licensed corporations and associated entities are
required to submit annually a Business and Risk Management Questionnaire with
their audited accounts.
The SFC also continues to take pro-active action
to manage down risky intermediaries with weak internal controls and risk
management, including ring-fencing their business activities, in order to
protect investors’ assets and minimise systemic risk.
iv) Waivers and modifications
We recognise that no set of rules can
apply equally to all
parties. To ensure that our rules are
not too rigid and inflexible, the SFC has granted over 32 modifications and
waivers of regulatory requirements to intermediaries over the last financial
year in unique and appropriate cases without compromising investor protection.
vi) Disciplinary action
One of the
primary statutory objectives of the SFC is to minimise crime, misconduct and
the risk of systemic failure in the securities and futures industry. This means that the SFC has to send out a
strong message to the market that misconduct will not be tolerated. The primary burden of enforcing the laws falls on the SFC’s Enforcement
division.
To ensure that our markets are ethical and
transparent, our enforcement activities are targeted at fighting corporate
misgovernaance,
market misconduct and intermediaries who are dishonest and put clients at
risk. Our focus on corporate governance
resulted in a large number of listed company inspections. More market manipulators and dishonest
intermediaries were successfully prosecuted.
We also disciplined intermediaries for poor internal control in their
businesses and from failing to protect their clients’ assets.
Under the
previous regime, our sanctioning powers limited us to reprimands or an outright
revocation of an intermediary’s license.
Experience has shown that merely reprimanding an intermediary is
sometimes an inadequate deterrent.
However, revoking an intermediary’sies licencse may be too harsh a sanction
depending on the situation. The SFO
gives us wider sanctioning powers, such as the ability to fine and partially
suspend or revoke licences, which we will use to punish intermediaries more
proportionately. We are also imposing
tougher sanctions. For example, we have
imposed the first life ban of a licensed person and heavier fines. In future, in cases of internal control
supervision failings facilitating serious misconduct harming clients, the SFC
will consider imposing heavier sanctions.
In the most severe cases, we will consider suspending a brokerage’s
licence for a long period or even revoking it.
5. CLEARLY DEFINED PROCESS FOR APPEAL AND CLEAR
ACCOUNTABILITYlearly defined processes for appeal and clear
accountability
Internal ccontrols
(a) SFC
Non Executive Directors
The SFC’s Non Executive
Directors (“NEDs”)
oversee the work of the SFC on a regular basis. They
act as the first line of independent supervision of the Commission’s executive
functions and provide an important balance of independent objectivity.
(b) Process
Review Panel (PRP)
The SFC’s internal procedures for regulating the
markets, including procedures for ensuring consistency and fairness, are
reviewed on an ongoing basis by the Process Review Panel (PRP). The PRP is an independent, non-statutory
panel established by Hong Kong’s Chief Executive in November 2000.
The PRP is tasked to review and advise the SFC on
the adequacy of the SFC’s internal procedures and operational guidelines
governing the action taken and decisions made by SFC staff in the performance
of their regulatory functions. The PRP can review any completed or discontinued file, the results of any
prosecutions and subsequent appeals and any complaints made against us or our
staff. The PRP will check that our
internal decision-making processes have been consistently followed and
impartially applied in those cases.
All complaints received by the SFC have
to be tabled before the CCC. The CCC will then assess whether a complaint
justifies further action and if so, which division/department should follow up
the complaint or to which external organisation the complaint should be
referred to.
External cControls
There
are a number of external checks and balances against abuse of the SFC’s
powers.
These
include:
(a) Securities
and Futures Appeals Tribunal
Intermediaries
who are disciplined or are refused a license have the right of appeal to the
independent Securities and Futures Appeals Tribunal. This
Tribunal has the power to review most decisions.
(b) Judicial
review
Aggrieved
parties can seek judicial review of a SFC decision.
(c) Ombudsman and the Independent
Commission Against Corruption (ICAC)
The
SFC is subject to the scrutiny of the Ombudsman and the ICAC. At the
Commission’s request, the ICAC has carried out a full review of the SFC’s
activities.
The
SFC’s Information Technology (IT) Division has achieved ISO 9000 status. As
such, the IT Division is the first division within the SFC to be subject to
regular quality audits by the ISO governing body.
The SFC’s accounts are audited by independent
external auditors and may also be reviewed by the Government Auditor. The Director of Audit has access to the SFC’s financial records.
(f) Reporting
to the Legislative Council
The annual audited accounts and annual financial
estimates of the SFC are reviewed and approved by the Financial Secretary and
tabled before the Legislative Council (LegCo). SFC
officers regularly appear before the LegCo Panel on Financial Affairs to answer
questions on proposed rules and new policies.
The SFC
has limited resources. As such, we adopt a risk-based approach to regulation anddoes not intend
to create a draconian compliance regime or to make the lives of intermediaries
especially difficult, however the SFC will focus itsour resources on promoting:
(i)
efficient, fair and transparent markets; and
(ii)
public confidence and investor awareness.