LegCo Paper No. CB(1) 1746/96-97
(These minutes have been seen by the Administration)
Ref : CB1/PL/FA/1

LegCo Panel on Financial Affairs

Minutes of Meeting held on Monday, 7 April 1997, at 8:30 a.m. in Conference Room A of the Legislative Council Building

Members present :

    Dr Hon HUANG Chen-ya, MBE (Chairman)
    Hon Eric LI Ka-cheung, OBE, JP (Deputy Chairman)
    Hon David K P LI, OBE, LLD (Cantab), JP
    Hon CHIM Pui-chung
    Hon Ambrose LAU Hon-chuen, JP
    Dr Hon LAW Cheung-kwok
    Hon NGAN Kam-chuen
    Hon SIN Chung-kai
    Hon Mrs Elizabeth WONG, CBE, ISO, JP

Members absent :

    Hon Martin LEE, QC, JP
    Hon Ronald ARCULLI, OBE, JP
    Hon James TO Kun-sun
    Dr Hon Philip WONG Yu-hong
    Hon Andrew CHENG Kar-foo
    Hon Paul CHENG Ming-fun

Public officers attending :

    Item III

    Mr Rafael S Y HUI, JP
    Secretary for Financial Services
    Mr Anthony NEOH, QC, JP
    Securities and Futures Commission
    Mr Alec TSUI
    Chief Executive
    Stock Exchange of Hong Kong

    Item IV

    Mr Rafael S Y HUI, JP
    Secretary for Financial Services
    Mr Anthony NEOH, QC, JP
    Securities and Futures Commission

    Item V

    Mr Rafael S Y HUI, JP
    Secretary for Financial Services
    Mr Anthony NEOH, QC, JP
    Securities and Futures Commission
    Mr David J White
    Executive Director
    Securities and Futures Commission

Clerk in attendance:

    Ms Estella CHAN
    Chief Assistant Secretary (1)4

Staff in attendance :

    Ms YUE Tin-po
    Senior Assistant Secretary (1)6 (Atg)

I. Confirmation of minutes

(LegCo Papers No. CB(1) 1174 and 1074/96-97)

1. The minutes of the meetings held on 27 January and 24 February 1997 were confirmed.

II. Items for discussion for the next meeting scheduled for 5 May 1997

2. The Chairman said that Dr LAW Cheung-kwok had recently referred the subject "the establishment of an Economic Development Council" to the Panel on Economic Services for discussion. Since the Financial Services Branch was the coordinating Branch for the subject, the matter was subsequently referred to the Panel. He suggested and members agreed that the item would be discussed at the next meeting. He added that members of the LegCo Panels on Economic Services and Trade and Industry would be invited to attend the meeting for this item.

(Post-meeting note: At the request of Dr LAW Cheung-kwok and with the concurrence of the Chairman on 2 May 1997, the item was withdrawn.)

3. Members also agreed that the subject "review of the operation of trading funds" would be discussed at the next meeting. The Chairman requested members to notify the Clerk of any further items they wished to discuss.

4. Regarding the visit to the office of Hong Kong Federation of Insurers, the Chairman advise members of the various dates and times suggested by the Federation for the visit as follows:

  1. Tuesday, 22 April 1997 at 9:00 am or 2:15 pm; or

  2. Thursday, 24 April 1997 at 9:00 am or 2:15 pm.

He said that a circular would be issued to find out members’ preference. Arrangements for the visit would be made on the date on which most members chose to participate.

(Post-meeting note: With the concurrence of the Chairman on 17 April 1997, the visit was postponed until further notice.)

III. Computer data failure in the trading system of the Stock Exchange of Hong Kong on 12 December 1996

(LegCo Paper No. CB(1)1200/96-97(01))

5. Mr Alec TSUI briefed members on the closing price incident of the Stock Exchange of Hong Kong on 12 December 1996 and highlighted follow-up actions undertaken by the Stock Exchange of Hong Kong (SEHK) as detailed in the information paper.

6. On remedial measures taken by SEHK after the incident, Mr TSUI advised that members, investors and market participants were informed of the inaccuracy in the previous closing prices by various means such as Teletext, announcements in the trading hall, circulars and telephone. Traders and members of SEHK were also urged to be cautious in advising clients and executing orders. In fact, the correct prices were published in most newspapers before the market opened that morning. However, he admitted that some media such as Cable Television Ltd. and some telecommunications companies were not informed in time.

7. As regards complaints arising from the incident, Mr TSUI advised that there were five complaints out of 67,000 transactions. SEHK had conducted investigations into these cases, but the complaints were not substantiated because members and traders of SEHK were aware of the data corruption in the Automatic Order Matching and Execution System (AMS) and were able to quote the correct prices before execution of orders.

8. Concerning the role of the Andersen Consulting (AC) in this incident, Mr TSUI advised that AC had been brought in to test the AMS in 1993 while SEHK’s support team was responsible for the maintenance and modification of the system. AC also provided advice on the advanced technology in the development of the AMS. Upon SEHK’s thorough investigation into the incident, AC was commissioned to conduct an independent inquiry to give a second opinion on the findings.

9. As to preventive measures which had been taken to avoid similar incidents in the future, Mr TSUI advised that SEHK had taken full responsibility to upkeep the AMS, particularly in the areas of software support, operations and contingency management. The support team of SEHK had undertaken steps to strengthen the automated cross-checking mechanism to safeguard the system. AC had also been commissioned to review the incident and to give recommendations on existing contingency procedures of SEHK. In addition, the Securities and Futures Commission (SFC) had undertaken to develop a comprehensive framework for contingency management of incidents involving all major financial institutions.

10. Mr Anthony NEOH supplemented that SFC had a regulatory mechanism in monitoring the contingency management of SEHK and other exchange bodies. It had also formulated standard requirements for computer system support teams of institutions concerned to perform and react appropriately when handling critical incidents. He also advised that independent trials by outside consultants were required to audit the contingency procedures of these bodies in case of incidents. As regards the development of a comprehensive framework for contingency management, SFC had organised an inter-market contingency working group comprising representatives from related institutions to work on the issue.

IV. The way forward following the issue of the consultation paper on the "Review of the Leveraged Foreign Exchange Trading Regulatory System"

(LegCo Paper No. CB(1)1189/96-97)

11. Mr NEOH briefed members on the salient points of the information paper on the way forward following the issue of the consultation paper on the Review of the Leveraged Foreign Exchange Trading Regulatory System.

12. Concerning the latest development of leveraged foreign exchange trading (LFET), Mr NEOH advised that there had been a significant contraction, both in terms of business volume and the number of active firms after enactment of the Leveraged Foreign Exchange Trading Ordinance. Since then, 52 LFET firms had applied for licences, of which 11 applications were withdrawn and 8 licences were surrendered, leaving 27 licensed traders (including one retail bank) in the market. The decline in the industry was also caused by the migration of the lower end of the business to Macau.

13. As regards public complaints, Mr NEOH advised that the number of complaints against traders had dropped from 88 in 1995 to 48 last year. These complaints included arbitrary closing of positions, fraud and unlicensed trading etc. In handling these complaints, SFC had conducted conciliation meetings for parties concerned to settle disputes. Besides referring some of the cases to the Securities and Futures Appeals Panel for follow-up, SFC had also taken disciplinary actions against traders who were found guilty of fraud or malfeasance.

14. Regarding some members’ request for further relaxation of the LFET regulatory framework in view of the contraction of LFET business, the Secretary for Financial Services (SFS) responded that the existing mechanism was necessary in disciplining traders in view of the misconduct, complaints of fraud and abusive trading practices within the industry in the last few years. LFETO aimed to enhance protection for investors in high-risk investment activities. He remarked that the less active market in the past two years as compared with that in the previous three years was due to the influence of interest rates and exchange rate fluctuations of major currencies rather than the introduction of the legislation. It was the responsibility of SFC and Government to ensure the orderly operation of the industry, and a relaxation of the regulatory framework would not be appropriate at that stage.

15. Mr SIN Chung-kai objected to SFC’s recommendation to reduce the minimum liquid capital requirement for LFET firms from $25 million to $15 million as this would undermine the protection for investors when disputes arose. Mr NEOH responded that the existing minimum liquid capital requirement was in excess of what was actually required to meet the risks involved, resulting in large chunks of capital being left idle and traders not being able to maximise the utilization of the financial resources committed to the business. It was therefore desirable to improve the minimum liquid capital requirement to enhance capital efficiency while maintaining the necessary regulatory control. This would help in a bid to revive the industry. He stressed that the liquid capital requirement was not a static figure. It rose as business volume increased beyond an initial cap for an aggregate gross position of 60 times liquid capital. The proposed reduction in liquid capital would not allow traders to run up additional risks which they could not have assumed under the existing rules.

16. As regards the analysis of capital utilisation in LFET, Mr NEOH pointed out that according to statistics provided in paragraph 22 of the consultation paper on the Review of the LFET Regulatory System, the aggregate gross position had increased from $457,781 in December 1994 to $685,720 in June 1996. On average, the fluctuation in liquid capital due to a trader’s proprietary trading was about 6 %. At members’ request, he undertook to provide information on the latest statistics of the analysis of capital utilisation in LFET.

(Post-meeting note: The requisite information was circulated vide LegCo Paper No. CB(1) 1592/96-97 dated 14 May 1997.)

17. As regards Mr SIN Chung-kai’s enquiry on fidelity insurance, Mr NEOH remarked that it was an appropriate compensation arrangement to safeguard investors against fraud, malfeasance or negligence by an intermediary, thereby offering better protection. Taking SEHK’s existing policy on fidelity insurance for securities and futures trading as a reference, SFC proposed that all leveraged forex traders should be required to take out fidelity insurance with a cap liability at $8 million per member. However, SFC would keep the matter under review and make further adjustment if necessary. Mr SIN urged the setting up of a fidelity insurance scheme before the minimum liquid capital requirement was relaxed. Mr NEOH responded that the drafting of the Composite Securities and Futures Bill to implement the relevant proposals was still in progress and would be submitted to members for consideration once available.

18. Mr CHIM Pui-chung and Dr LAW Cheung-kwok were in support of SFC’s recommendations on the review of the LFET regulatory framework and requested early completion of the draft Bill.

V. The relationship between index futures, covered warrants and market volatility

(LegCo Paper No. CB(1)1200/96-97(02))

19. As to whether SFC would set up a regulatory mechanism to monitor index arbitrage activities of the futures market, Mr NEOH advised that the industry had adopted an autonomous environment where investors were free to buy or sell underlying index stocks at agreed prices in an orderly manner. He stressed that SFC would provide an appropriate regulatory framework to ensure fairness, efficiency, transparancy and prudential risk management in the market. In this connection, SFC had established a system to monitor the internal control of businesses of registered persons or companies. Regular audit inspections of books and records of individual traders would also be arranged. Ad-hoc analysis of AMS data arising from abnormal behaviour of particular companies would be conducted if necessary. He added that traders had their own code of practice and systems to monitor trading. The implementation of margin requirements for traders would also safeguard prudential risk management in the market.

20. Dr LAW Cheung-kwok was of the view that there was a link between derivatives trading and volatility in the underlying cash market on futures expiration days. He suggested that Government together with local universities should conduct a detailed study on the subject to facilitate policy formulation in the futures and securities markets of Hong Kong. Mr NEOH responded that no recent studies into the effects of derivatives trading were conducted due to insufficient manpower and limited resources of SFC. He agreed that local universities should be encouraged to conduct detailed research in this respect and SFC was willing to assist and provide relevant data.

21. As regards the higher price volatility on the expiration day of index futures market, Mr David J White advised that the market could be very volatile if large-volume buying or selling of the underlying stocks occurred over the past few days before the expiration day. Index arbitrage would occur arising from pricing differences between the index futures market and the underlying stocks market. Price volatility on the expiration day of each month depended on the characteristics of the market which in turn was dependent on individual volatilities of overseas markets, availability of liquidity and aspects of each individual close. As to whether it was desirable to adopt a 30-day cycle for expiration of index futures, he advised that the setting of the expiration day was coordinated between the Hong Kong Futures Exchange and SEHK and there was no plan to adopt a set 30-day cycle for such close. He stressed that the timing should be chosen for the availability of a clear run to ensure that there was sufficient liquidity in the process.

VI. Any other business

22. Due to insufficient time, members agreed to defer the last item "market manipulation" to the next meeting.

23. The meeting ended at 10:15 am.

Legislative Council Secretariat
31 May 1997

Last Updated on 18 August 1998