Provisional Legislative Council

PLC Paper No. CB(1) 1375
(These minutes have been
seen by the Administration.)

Ref : CB1/PL/FA/1

Panel on Financial Affairs

Minutes of Meeting held on Monday, 2 March 1998, at 4:30 pm in Conference Room B of the Legislative Council Building

Members present :

Hon Paul CHENG Ming-fun, JP (Chairman)
Hon NGAN Kam-chuen (Deputy Chairman)
Hon NG Leung-sing
Hon Eric LI Ka-cheung, JP
Hon Henry WU
Hon Ronald ARCULLI, JP
Hon CHIM Pui-chung

Members absent :

Dr Hon David LI Kwok-po, JP
Hon CHAN Choi-hi
Dr Hon Philip WONG Yu-hong
Dr Hon LAW Cheung-kwok

Public officers attending :

Mrs Rebecca LAI, JP
Deputy Secretary for Financial Services

Mr Bryan P K CHAN
Principal Assistant Secretary for Financial Services

For Agenda item IV

Mr Anthony NEOH, SC, JP
Chairman, Securities and Futures Commission

Mrs Laura CHA
Deputy Chairman, Securities and Futures Commission

For Agenda item V

Mr Randy Gilmore
Chief Executive, Hong Kong Futures Exchange Ltd.

Mr William Grossman
Chief Counsel, Hong Kong Futures Exchange Ltd.

Mr Francis KWAN
Head of Electronic Trading Department, Hong Kong Futures Exchange Ltd.

Clerk in attendance :

Ms Estella CHAN
Chief Assistant Secretary (1)4

Staff in attendance :

Mr Andy LAU
Senior Assistant Secretary (1)6

I Confirmation of minutes and matters arising

(PLC Paper No. CB(1)987-Minutes of the meeting on 5 January 1998

PLC Paper No. CB(1)1033(01)-Report of the Panel on Financial Affairs)

The minutes of the meeting on 5 January 1998 were confirmed.

2. The Chairman advised that a draft report on the work of the Panel for the term of the Provisional Legislative Council had been circulated for members' consideration prior to the meeting. As the report was just circulated and that this was the last meeting for the term of the Provisional Legislative Council, he invited members to forward any comments to the Clerk after the meeting. Members also agreed to authorize the Chairman to endorse subsequent changes to the report as necessary before tabling in the Council on 1 April 1998.

II Information papers issued since last meeting

(PLC Paper No. CB(1)1021-The Challenge of Change - The Evolution of Smaller Stockbroking Firms issued by the Stock Exchange of Hong Kong

PLC Paper No. CB(1)1025-A letter from the Consul-General of Japan on emergency measures for the SouthEast Asian financial and currency crisis)

3. Members noted the information papers issued since the last meeting.

III Review of constituent stocks of the Hang Seng Index

(PLC Paper No. CB(1)1033(02) - Information paper prepared by the Administration)

4. Mr Ronald ARCULLI declared interest as a non-executive Director of the Securities and Futures Commission.

5. The Deputy Secretary for Financial Services, (DS/FS) advised that the Hang Seng Index (HSI) was compiled and managed by the Hang Seng Index Services Limited (HSIS), which was a wholly-owned subsidiary of the Hang Seng Bank. Although the Government had discussed the implications of recent financial turmoil with the company, it had no authority to direct its activities. As an index to measure the performance of the Hong Kong stock market, HSI was well received by the local and international markets. She also advised that HSI was regularly reviewed by HSIS and the latest review had been conducted in the last quarter of 1997 which had taken into account the views expressed in the light of the financial turmoil. With the co-operation of HSIS, an information paper summarizing the latest review on HSI had been prepared for members' information.

6. In response to a member's question, the Principal Assistant Secretary for Financial Services clarified that HSI had been first launched on 24 November 1969 but the base period for calculating the index had been back dated to April 1964.

7. Members expressed concern about the over-weighting of the HSBC Holdings (HSBC) in HSI and the alleged speculative activities on HSBC's shares. Given the financial strength of large fund houses/brokerage firms and taking into account the availability of a large number of derivative products in the market, some members disagreed with the view that it would be difficult for speculators to manipulate HSI through trading of HSBC's shares. A member pointed out that the weighting of HSBC in HSI was by far larger than the rest of the constituent stocks and this explained why HSBC was excluded by some other international corporations in measuring the performance of the Hong Kong stock market.

8. DS/FS noted that in terms of market capitalization the size of HSBC being even larger than the Citicorp of the US and double the size of the second largest HSI constituent stock, it was inevitable that the weighting of HSBC in HSI would by far be larger than the rest of its constituent stocks. However, she pointed out that it was also a true reflection of the structure of the market itself. DS/FS stressed that it was difficult to manipulate the price of HSBC as it would require an enormous amount of capital given its heavy weighting and its market size. Referring to the large number of derivative products in respect of HSBC, DS/FS said that this was simply a reflection of the fact that HSBC stocks were extensively traded in the market, which generated the demand for derivative products for hedging and other purposes.

9. A member expressed support for the introduction of a wider-based index like Hang Seng 100 Index (HS100) in view of the changed circumstances. However, he commented that the co-existence of HSI and HS100 might give rise to confusion and suggested that HSI be replaced by HS100. DS/FS pointed out that the popularity of an index would be essentially determined by the market and different indices could co-exist to better reflect the performance of different sectors of the economy as in the case of US Dow Jones Industrial Average Index and the Standard & Poor's 500 Index. Nevertheless, she undertook to refer the member's suggestion to HSIS for consideration.

10. Given the wider base of HS100 which made it a more effective instrument for hedging than HSI, a member urged the Administration to liaise with Hong Kong Futures Exchange (HKFE) with a view to replacing HSI futures contracts with HS100 futures contracts.

11. DS/FS advised that the HKFE had already indicated that it would examine the feasibility of introducing HS100 futures contracts, taking into account market needs. As to whether HSI futures should be replaced by HS100 futures upon its introduction, she considered it more appropriate to let market force determine the role of these derivative products.

12. Noting that SCMP (Holdings) had a higher market value than some other constituent stocks of the HSI and had been the only company in HSI which belonged to the mass media sub-sector, a member queried the removal of the company from the constituent stocks. DS/FS pointed out that the eligibility criteria for HSI constituent stocks were set out in paragraph 5 of the information paper. Apart from market value, the turnover ranking of a company was also essential in determining whether the company was qualified for selection. In the present case, SCMP (Holdings) had been removed from HSI because it had not been extensively traded in the market.

13. A member enquired about the reason for including China Telecom (HK) and Shanghai Industrial Holdings Ltd. in HSI as their business in the Mainland seemed to have no direct relation with the economy of Hong Kong. DS/FS explained that in the light of the structural changes to the local stock market with more listings of H shares and China-affiliated corporations (or so-called "red chips"), HSIS had decided that the constituent stocks would no longer be required to have a substantial business presence in Hong Kong, to the extent that they should not be a foreign company as defined by the Stock Exchange of Hong Kong (SEHK). Furthermore, the rule of 24-month listing history would also be flexibly applied in order to permit companies meeting all other selection criteria to be included in the HSI.

14. A member expressed concern that the cash market seemed to have been transformed into an instrument for the futures market. In some cases, HSI futures were not traded for the purpose of hedging but for speculation in relation to the foreign exchange market volatilies. He urged the Administration to review the matter. DS/FS confirmed that the issue would be examined under the review on the financial market since it was the aim of the Administration to maintain the stability of the financial market.

15. Some members opined that as HSI was heavily weighted towards a few stocks, it was susceptible to market manipulation and speculation, hence making it difficult to reflect the real performance of the Hong Kong stock market. Given the unique situation in Hong Kong where the top ten stocks already constituted a market capitalization of over 50%, the members opined that the bias would remain despite the introduction of HS100. To address the problem, a member suggested compiling a new index by removing the top and bottom five stocks in terms of market capitalization and turnover from HSI so as to give investors a more balanced picture about the market. This was in line with the practice of other international markets where different indices were compiled to reflect the performance of the markets from different perspectives.

16. DS/FS responded that the representativeness of HSI could be reflected by its wide acceptance in the local and international markets and by the investing public. Nevertheless, she would relay the member's suggestion to HSIS for consideration. Whilst the present concern seemed to arise from the heavy-weighting of HSBC in HSI, which was argued by many to have compromised HSI's representativeness, she pointed out that there were indeed other indices which reflected the performance of other sectors of the economy, for example, the Hang Seng MidCap 50 Index, Red Chip Index, H-share Index and the All Ordinaries Index which included all listed stocks on SEHK.

17. Given the relationship between HSI futures and the cash market, members opined that the Government, the Securities and Futures Commission (SFC) and SEHK should have a role to play in reviewing the composition of HSI rather than leaving it entirely to commercial decisions. DS/FS replied that whilst it was a commercial decision for any new products to be launched in the market, these products were also subject to the listing criteria set out in the Listing Rules of SEHK and HKFE, which in turn were subject to the continuing scrutiny and regular review by the exchanges and the SFC.

Admin 18. In order to facilitate members' understanding of the effectiveness of using HS100 as a means to measure the performance of the Hong Kong stock market, members requested the Administration to provide an analysis on the correlation between HSI and HS100 over the past year. DS/FS replied that she would request HSIS to provide the requested information to members.

19. A member expressed concern about the issue of cross-ownership among HSI constituent stocks and enquired how such cross-ownership was reflected in the indices of other financial markets. On the issue of maintaining continuity of the index if cross-ownership components were removed from HSI, the member opined that investors and fund managers should be able to adapt to the change as long as an adequate notice period was given, as evident in the case of the review of the HSI constituent stocks from time to time. Considering the effect of cross-ownership among HSI constituent stocks on the composition of HSI and, in turn, the investment strategy of fund managers, particularly those who would work on Mandatory Provident Fund schemes, the member urged the Administration to review the issue.

20. DS/FS advised that at present, 17 out of the 33 HSI constituent companies in SEHK were controlled by seven consortia through cross-ownership. The latest HSIS review had examined various proposals to address the problem but considered none would be viable without drastically upsetting the continuity of HSI as a reference point for stock market performance, particularly for those investors and fund managers who relied on HSI to formulate their investment portfolio. Notwithstanding the above, she would discuss further with HSIS to see whether it was feasible to compile a new index without double-counting the cross-ownership among HSI constituent stocks in parallel with the original HSI. She further advised that there would be a substantial impact on HSI if double-counting of market capitalization among HSI constituent stocks was taken out. As an example, HSBC currently held more than 50% share of Hang Seng Bank and a change of the counting method would entail significant adjustment on the part of fund managers to the new HSI.

21. As to the concern about the market volatility on the settlement day of HSI futures contracts, a member requested the Administration to provide further information on the trading pattern of the market on the settlement day of HSI futures contracts for the past 10 years. He also enquired whether a longer time period of settlement, say, 90-day as in the case of the New York market, could help reducing overall volatility in the market.

22. DS/FS said that the trading of HSI futures was quite heavy and was not necessarily concentrated on the settlement days. In fact, investors could choose to close their positions at any time during the trading period. Nevertheless, the Administration would review the general issue of market volatility in the context of the Financial Market Review.

Admin 23. A member commented that the recent drop in asset prices might have given rise to more acquisition and merger activities. In that case, the market capitalization of listed companies on SEHK and the composition of HSI, HS100 and Hang Seng MidCap 50 Index might be affected. He asked whether the Administration had ever considered the implication of such possible increase of acquisition and merger activities on HSI. DS/FS said that she would provide a written reply after the meeting.

Admin 24. In concluding the discussion, the Chairman requested the Administration to take note of members' views and address these issues in the financial market review being undertaken.

IV Securities and Futures Commission's Budget for 1998-99

(PLC Paper No. CB(1)1033(03)-Information paper prepared by the Administration)

25. Mr Henry WU declared interest as the Permanent Honorary President of the Hong Kong Stockbrokers Association.

26. Members noted that the authority for approval of SFC's budget had been delegated to the Financial Secretary and the approved budget would be tabled in the Provisional Legislative Council in accordance with established practice.

27. Some members queried the justifications for SFC's increase in headcount at this time of economic recession when it was anticipated that related market activities would slow down and that the workload with regard to the setting up and development of SFC should have been stabilized after several years of operation. They expressed concern that the repeated deficit budgets might lead to eventual depletion of SFC's reserves. A member also questioned the justification for creating an additional Executive Director in the Commission.

28. The Chairman, Securities and Futures Commission (C/SFC) responded that SFC would maintain prudent control over the use of public money and the deficit budget was the result of SFC adopting a conservative approach in assessing the projected revenue. As was the case in the past, he hoped that SFC would manage to achieve a balanced budget eventually. He advised that the present proposal was in line with the three-year forward planning programme of the SFC and was already very moderate in terms of manpower increase.

Corporate Finance Division

29. C/SFC advised that in view of the increased workload resulting from increased market activities and the increased workload in respect of H-shares and red chips companies, there was a need to strengthen the establishment of the Corporate Finance Division. Following the policy decision of the Central Government, it was envisaged that more and more PRC enterprises would choose to be listed in Hong Kong. In this regard, guidelines for listing of PRC enterprises in Hong Kong would need to be reviewed and beefed up to tie in with the market development. As for merger and acquisition activities, C/SFC said that despite a drop in the number of applications, the nature of cases were becoming more and more complex. Furthermore, with the globalization of financial markets, there was also a need to pay special attention to the development of the Hong Kong market in both the local and international contexts. Additional manpower was also required to cope with the increased workload with regard to investor education and translation service.

Intermediaries Supervision

30. C/SFC said that there was a shortage of manpower in the area of intermediaries supervision. The CA Pacific incident had highligted the need to put finance companies of securities firms under a regulatory framework of SFC. In this regard, he advised that there were more than 1,000 such finance companies in the market, in addition to the 1,900 companies and 20,000 intermediaries which were already subject to regulation by SFC, the manpower in this respect would need to be strengthened.


31. Members noted that the increase in manpower in the Enforcement Division was mainly to enable SFC to handle more cases and to deal with their increased complexity. The Deputy Chairman, Securities and Futures Commission advised that since the establishment of SFC in 1989, its headcount had only increased from 238 to 310 in 1998/99. During the same period, companies listed in SEHK had doubled and HSI had surged from 2,800 to over 10,000 with a twelve-fold increase in turnover. Given the increase in market size and number of market participants, there was a need to increase the manpower to cope with the increase in workload and the nature of the work that had become more complex.

32. Referring to the additional Executive Director proposed, C/SFC explained that the Chairman and Deputy Chairman of SFC were presently overloaded with responsibilities for the day-to-day operation of SFC and could not spare the time to focus more on forward planning, cross-divisional co-ordination and communication. The creation of this additional post was foreshadowed in discussions with consultants during their review of SFC's operational structure and would be dependent on Government's approval. Upon implementation, an additional non-executive director would need to be added in accordance with the statutory requirement in respect of the Commission's constitution.

33. C/SFC further said that given the annual wastage of around 16%, any redundant staff could be absorbed within the establishment of SFC. Whilst it was not envisaged that the workload of SFC would decrease, a restructuring exercise could be conducted to lay off redundant staff, if necessary.

34. Whilst agreeing that there should be additional manpower to cope with the increase in workload in respect of launching of new investment products, a member expressed concern about the growing authority of the SFC, in particular, when more than half of the new posts were created for intermediaries supervision and enforcement. He also queried whether the monitoring role played by SFC would duplicate that of professional bodies in respect of internal control and requested more information to justify the manpower increase.

35. C/SFC explained that this was a matter of maximizing the cost efficiency in allocation of resources to respective areas of work of these bodies. In order to maximize the utilization of resources, SFC was exploring means to assess how its efficiency could be measured. In fact, SFC had discussed with the Hong Kong Society of Accountants on how the demarcation of duties between the two bodies could be improved for optimal efficiency.

36. Mr Henry WU stated that in view of the high level of reserves accumulated by SFC, he would not support the proposal to increase the fees and charges of SFC's services from 1 April 1998.

Investor Protection

37. In response to a member's comment that investors did not get the appropriate protection from SFC after paying the levies, C/SFC acknowledged that it was SFC's responsibility to protect investors but it would be a matter for investors to judge whether SFC was able to protect their interests.

38. As regard the CA Pacific incident, a member expressed concern that the costs involved in the lengthy liquidation process could use up the remaining assets of the company and urged speeding up of the work. C/SFC responded that the liquidators had to act in accordance with statutory procedures. It was unfortunate that they encountered difficulties in collecting information from the management of CA Pacific Securities and a court order was required in this regard. Now that the problem had been resolved and SFC would continue to liaise with the liquidators with a view to speeding up the liquidation process.

Hong Kong Securities Institute

39. Noting that a provision of $10 and $5 million had been made in 1997/98 and 1998/99 respectively to subsidize the establishment and operation of the Hong Kong Securities Institute (HKSI), a member queried the justification for establishing HKSI when various courses and programmes on financial services were offered by local institutions and SEHK.

40. C/SFC explained that similar organizations like HKSI existed elsewhere in the world. As the setting up of such an organization in Hong Kong had been dragged on for sometime, SFC decided to take the lead to inject an initial sum of $15 million with a view to facilitating its establishment for promoting the standard of market practitioners. Presently, only one member of HKSI's Board was from SFC, which would not be concerned with the day-to-day operation of HKSI. In order to promote the standard of market practitioners, HKSI would organize a series of seminars and examinations and co-ordinate training programmes amongst different institutions.

41. C/SFC further advised that training courses offered by HKSI would not duplicate those offered by local institutions and SEHK. Presently, there was a training vacuum in areas such as derivatives, internal control and management, corporate finance, acquisition and merger and investment banking etc. Whilst experienced personnel in these areas might be available in the market, their service could only be obtained at a very high market price. It was hoped that with the provision of more specific training, more qualified persons would be available to the market and hence, improve our competitiveness.

42. Regarding student admission to HKSI, a member opined that the HKSI should also consider accepting those persons who had previously been regarded as not meeting the "fit and proper" criteria of SFC, as the person would have had received the necessary disciplinary actions in the past. In respect of the fit and proper criteria for registration with SFC, C/SFC advised that SFC would accept persons holding diplomas issued by the examination bodies in the United Kingdom, United States of America, Australia and SEHK for registration. As to whether diplomas issued by HKSI would also be accepted by SFC, he said that this had yet to be determined pending further evaluation of the contents of its examinations and the standard of the training courses offered.

V Proposed Automatic Trading System for the Futures Exchange

(PLC Paper No. CB(1)1033(04) - Information paper prepared by the Administration)

43. Responding to the Chairman's question on the re-training programme for existing staff and their re-employment opportunity upon implementation of HKFE's Automated Trading System (ATS), the Chief Executive, HKFE (CE/HKFE) said that HKFE would provide the necessary facility for its members to train their employees on the operation of ATS, but as far as employment decision was concerned, it would be a matter for its members to decide. In view of limited job opportunities under the current economic situation, the Chairman urged the Administration to monitor the situation so that not too many people would encounter hardship as a result of the change.

44. A member pointed out that subsequent to defaults in the futures market in 1987, investors had to bear the amount of compensation in the order of $2 billion over the years in the form of transaction levies. Now that a surplus of $84 million had been accumulated in this respect, HKFE should take the initiative to contribute to the investor compensation fund to assist investors who recently suffered looses in the stock market.

45. CE/HKFE advised that in January 1989, the Government, Hong Kong Futures Guarantee Corporation and Lifeboat lenders had agreed that after the full repayment of the Lifeboat loan, the right to claim and receive recoveries from defaulters would thereupon be assigned to the Hong Kong Futures Exchange Clearing Corporation (HKCC). The surplus of around $80 million had been appropriated to the HKCC as provided for under the arrangement as re-structured in 1989 for the purpose of providing an overall backup to the market. As such, to return the money to investors was not something which the HKFE or the HKCC could decide on their own. However, he would relay member's view to HKFE's Board for consideration.

46. As regards whether HKFE would help out in the market crisis, CE/HKFE advised that the HKFE had agreed to make available to SEHK a loan of $100 million in early January but subsequently the SEHK had advised that they were not in need of the money as they believed that the compensation arrangement for the failure of the CA Pacific Group could be handled within their existing resources.

47. Whilst supporting the migration of trading of HSI futures and options contracts to ATS, a member considered the migration process too long and urged the HKFE to speed up the work. CE/HKFE explained that it was HKFE's goal to move fully to become an electronic market place as early as possible. However, given that HSI futures and options represented the backbone of the entire derivatives industry, it was HKFE's responsibility to ensure a smooth migration and a robust new system which was well received by its members. Furthermore, it also took time to train employees of members in the operation of ATS.

VI Any other business

48. As this was the last regular meeting of the Panel in the Provisional Legislative Council term, the Chairman thanked members and the Administration for their contributions towards the work of the Panel.

49. The meeting ended at 6:35 pm.

Provisional Legislative Council Secretariat
22 June 1998