Legislative Council Panel on Financial Affairs
Meeting on 7 December 1998

Government's Response to Views of
Market Practitioners and Academics on the
Regulation of the Securities and Futures Markets


The Legislative Council Panel on Financial Affairs held special meetings on 7 and 14 November 1998 at which representatives of the financial services industry and relevant associations and local academics were invited to present their views on the mechanism for defending the Linked Exchange Rate System and on the regulation of the securities and futures markets. Representatives of the Administration were also invited to observe the meetings to take note of the views expressed. This document summarises the Administration's response to the comments concerning the regulation of the securities and futures markets.


2. The participants raised many different comments on the operation and regulatory systems of the securities and futures markets. In summary, these comments covered areas such as information disclosure, securities settlement system, short selling regime, operation of the derivatives (including futurues) market and the overall regulatory regime of the securities and futures markets. In fact, in the Report on Financial Market Review published by the Administration in April 1998 and the 30-point programme introduced in early September to strengthen the transparency and discipline of the securities and futures markets, most of the above issues have been examined and specific recommendations have been made (see Annex for reference). Some of these recommendations have already been implemented. In respect of the suggestions raised by participants, the Administration's response is summarised herein below.

Information Disclosure

3. There was a recommendation that all listed companies should be required to make quarterly report on their business performance. In accordance with the existing Rules Governing the Listing of Securities (the "Lising Rules") issued by the Stock Exchange of Hong Kong ("SEHK"), listed companies are already required to make half-yearly report in the course of their financial years to provide the investors with more timely information. Recently, SEHK introduced a Practice Note 19 to the Listing Rules which specifies the instances where general disclosure obligation under paragraph 2 of the Listing Agreement should be made. The Practice Note which has come into effect on 1 December 1998 would help ensure that investors are kept informed of the latest developments of the listed companies.

4. In addition, there was also suggestion that SEHK Members should disclose to the public their own transaction volume. However, as such information is business information and its disclosure may have adverse impact on the business operations of the companies, the disclosure requirement is therefore considered inappropriate and inconsistent with international practices.

5. There were views that one of the measures of the 30-point programme, i.e. requiring the SEHK to remind its Members to ascertain the identity of their beneficiary clients and disclose the information to the SEHK and the Securities and Futures Commission ("SFC") upon request, could be burdensome to the brokers and clearer guidelines and more flexibility should be introduced when enforcing the requirement. In fact, under the existing laws, the SFC is already authorised to request for trading and client information from brokers for market supervision and regulation purposes. For implementation of this measure, SEHK and SFC made the announcement on 23 October 1998 to require SEHK Members and registered intermediaries to provide the relevant information. The SFC also plans to issue a practical guideline to provide clear guidance for the intermediaries in the near future.

Securities Settlement System

6. There were views that the strict enforcement of the T+2 settlement rule will undermine long-term investors' interests in our market and hinder future market development and that instances of genuine practical difficulties should be dealt with flexibly. Since the strict enforcement of the T+2 rule by the Hong Kong Securities Clearing Company Limited ("HKSCC") from 24 September 1998, over 99% of the settlements have been successfully completed in time. During the same period, trading has been more active than the preceding months. There is no obvious evidence suggesting that trading activities have been dampened due to the strict enforcement of the T+2 rule. The HKSCC has also in place clear guidelines specifying certain circumstances where brokers could be exempted from the compliance with the rule. The operation of the guidelines has so far been satifactory.

Short Selling

7. As regards the regulation of short selling activities, the issue has been discussed in detail in the Report on Financial Market Review. The 30-point programme introduces further measures to enhance the regulation of short selling activities. In addition, in order to counter short selling activities that violate the rules and to increase the deterrent effect, the 30-point programme also proposes to "criminalise" unreported short selling. The Administration is meanwhile examining the relevant legislative proposals and will take into account of the reservation expressed by the industry on the proposal. Separately, the SFC and SEHK will continue consider ways to further improve the information dissemination and reporting mechanism for short selling.

Futures and Derivatives Markets

8. The Report on Financial Market Review also provides a detail account of the role of derivatives in the market.

9. As set out in the Report, the SEHK had convened a working group earlier this year to review the operation of the derivatives market and amended the listing rules for derivative warrants following the recommendations of the working group. The revised listing rules has come into effect from 10 July 1998 and the SEHK has also undertaken to conduct periodic review on the rules. In fact, most of the comments made by the participants at the special meetings of the Financial Affairs Panel have already been considered in the review. We are confident that the SEHK will take into account the views expressed in the context of its future review on derivative warrants.

10. A number of recommendations were made in respect of the operation of the futures market. It was recommended that the margin requirement for futures products which are denominated in Hong Kong dollar (HK$) should only be satisfied with HK$ and the margin required of clients should increase with their open interests. There was also a recommendation that the contract unit of Hang Seng Index futures contracts should be reduced by half and at the same time, the margin level should be raised so as to increase the cost of the speculators. There was also a suggestion that the Hong Kong Futures Exchange ("HKFE") should extend the settlement period from one month to three months and the settlement price should be computed on the basis of the average price of the Hang Seng Index at every 1-minute interval on the settlement day instead of 5-minute interval as currently practiced, in order to increase the cost of the speculators and reduce the possible impact on the cash market. These recommendations involve commercial consideration and risk management of the HKFE and have been referred to it for consideration. It is however important to note that the stability and integrity of the market remain the primary concerns of the Administration and the relevant proposals must therefore be considered on that basis.

11. A number of measures have been proposed in the 30-point programme to increase the transparency of the futures market. The suggestion of the partipants that brokers holding large open interest should disclose their positions will be referred to SFC and HKFE for further consideration. The 30-point programme has also suggested that HKFE should advance the implementation of automated trading in HSI futures and HKFE has undertaken to do so by the third quarter of 1999. It must however be underlined that while the full automation of HSI futures trading should be pursued as quickly as possible, comprehensive and sufficient testing must be conducted to ensure the operating efficiency and stability of the new system.

Securities and Futures Commission

12. There was suggestion that a separate supervisory committee should be established to supervise the work of the SFC. In accordance with the recommendation of the 1988 Ian Hay Davidson Report, SFC was establised as a regulatory body independent within the government. As provided under the legislation, the SFC must comprise an equal number of excutive and non-executive directors. There are currently a total of 5 non-executive directors coming from the commercial, legal and accountancy sectors to ensure that a wide range of perspectives are taken into consideration in the policy making process of the SFC. In addition, the work of SFC is clearly governed by the law and persons under its regulation may appeal to the Appeals Panel and seek judicial review against the decisions made by SFC. We are therefore of the view that adequate checks and balances are in place and it is not necessary to establish a separate supervisory committee.

13. Furthermore, some participants also proposed that the liaison and cooperation of the SFC and the two exchanges should be strengthened to avoid duplication of regulation and that SFC should meet with the Council of SEHK once a month. This is in line with our policy to encourage close cooperation between the SFC and the exchanges and to our knowledge, the SFC has indeed maintained regular liaison meetings with the management of the exchanges. The issue of division of regulatory functions has been addressed in the Report on Financial Market Review and the SFC and SEHK are working on a memorandum of understanding with a view to developing a set of clear guideline in this regard.

Education for Investors and Market Particpants

14. There were views that the SFC should attach greater importance to the education for market participants to ensure that they are fully aware of their responsibilities under the regulations and the importance of compliance, as opposed to relying largely on penalties on misconducts. As the market regulator, SFC is responsible for ensuring compliance of the market regulations by the market intermediaries. To help the intermediaries better understand the application of the rules and regulations, SFC issues from time to time practical guidelines which set out the standards expected by the regulators. In addition, SEHK would also regularly remind its members to comply with the member rules and to establish proper internal control measures to reduce the risk of malpractice or negligence within member firms. Nonetheless, in order to ensure the discipline and fair operation of the market, misconducts should never be tolerated.

15. It was also recommended in the Report on Financial Market Review to strengthen investor education and the SFC and the two exchanges will continue its effort in this respect.

Disposal of the Shares Acquired During the Augst Operation

16. The participants also raised suggestions as to how the Administration should dispose of the shares acquired during the August operation. The suggestions will be referred to the Board of the Exchange Fund Investment Limited for consideration.


17. As regards the regulation of massive fund flows, leaders of the member economies of the Asia Pacific Economic Co-operation agreed at its meeting held last month to establish a working group to study the relevant regulatory issue with a view to reducing the impact of such fund flows on small and medium economies. The HKSAR Government would actively participate in the exercise and continue its efforts to encourage international cooperation to ensure the stability of the international financial market. We will also work closely with the market regulators to keep improving the operation of our own market systems to reduce market risks, strengthen our market resilience to speculative attacks and enhance our strength in the face of increasing competition from other regional markets.


18. The Administration has always been committed to the further improvement of the operation and regulatory systems of the securities and futures markets of Hong Kong to ensure that the market systems are capable of coping with the market development and international regulatory standards. We are grateful to and will take careful consideration of the valuable comments made by the industry and the academics. With the further improvement of our market systems, we believe that the interest of investors would be better protected and the status of Hong Kong as an international financial centre would be further consolidated.

Financial Services Bureau
4 December 1998


Issues Addressed in the Report on
Financial Market Review and 30-Point Programme

18- The institutions should disclose outstanding and closed positions of short sales to increase transparency; short sellers should also disclose the source of shares, the amount of shares on loan and the maturity of the borrowed shares; the margin level for stock borrowing should be raised to 130%.

Paragraphs 4.14-4.32 of the Report on Financial Market Review
22- The amount of issued shares of a stock to be allowed for short sales by an individual or a group on any single day or a specified period of time should be capped at certain level; any short sales exceeding that level should be reported to SEHK and SFC immediately.

20- Funds, custodians and securities dealers should disclose their lending position on their stockholdings; they should also issue written confirmation regularly on shares on loan to others and the amount involved.

The 30-point programme proposes to study on regulation over stock lending and borrowing and regulation over custodians and other stock lenders.
21- Only shares which physically deposited in Hong Kong should be allowed to be sold or lent for purpose of short selling; the lenders should also maintain records of the stock loans for inspection by the regulators.

41- Custodians should comply with certain risk management requirements; for instance, when the amount of shares on loan exceeds a risk level with reference to the average transaction volume of that stock, stock lenders should report to the regulatory bodies and issue a risk warning to clients.

24- Issuers of derivative warrants should disclose the information of the total amount of warrants issued to demonstrate its capital adequancy and proper risk management.

Paragraphs 4.86-4.103 of the Report on Financial Market Review (note: the revised listing rules on derivative warrants have come into effect from 10 July 1998 and the SEHK has also undertaken to conduct periodic review on the rules as necessary.)
25- When issuing new derivative warrants, issuers should have in possession certain proportion of the underlying shares for delivery upon exercise of the warrants.

27- Issue of basket warrants should be banned.

28- Comments of listed companies should be taken into account in the context of reviewing the development of derivative products to minimize impacts on the general capital raising activities.

29- Issuers should have in possession at least 50% of the underlying shares for issuing call warrants; they should also have sufficient cash when issuing put warrants.

23- HKFE should disclose twice a day information of brokers and clients holding large open interests to the Financial Services Bureau for analysis and assessment if there are signs of manipulation. The 30-point programme proposes that HKFE should disclose real-time information of holders of large open interests to SFC on a daily basis and disclose large open interests at broker level to the market. It is also proposed that a cross-market surveillance committee be established to exchange market information and to take prompt and appropriate actions in response to anticipated market manipulation.

42- The share registrars should be obliged to provide the market with certain risk protection; properly transferred shareholdings should be adequately protected under the laws. The time required for share registration should be shortened and standardised to ensure fairness and effective safeguards against fake and stolen shares.

The 30-point programme proposes to study on the regulation over share registrars.

1. Same item numbers as recorded in the notes of meeting of the Financial Affairs Panel.