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Securities and Futures Commission – Regulatory Updates

  • Market Insight 18 March 2020 18 March 2020
  • Asia Pacific

  • Regulatory & Investigations

After 30 years into its role, Hong Kong's number one financial watchdog – the Securities and Futures Commission ("SFC") – continues adapting to the city's ever-evolving financial market and emerging regulatory challenges in a bid to tackle market irregularities and preserve Hong Kong's competitiveness as an international financial centre.

Securities and Futures Commission – Regulatory Updates

This article reviews the new strategies the Commission has adopted, and the key risks it seeks to address.

Shift in regulatory focus

In recent years, we have seen a change in the SFC's enforcement approach. Instead of covering a broad range of potential breaches, the regulator now prioritises investigations into "high impact" cases. This has been reflected in the decreasing number of the SFC's investigations and the soaring amount of fines imposed by it.

Number of investigations commenced by SFC

  • 2016/2017: 414 cases
  • 2017/2018: 280 cases 
  • 2018/2019: 238 cases

Total amount of fines imposed by SFC 

  • 2016/2017: HK$93 million
  • 2017/2018: HK$483 million
  • 2018/2019: HK$940 million  

The SFC watch list  

In 2019, the following types of cases were in the Commission's spotlight:

  • sponsor failures;
  • internal control failures;
  • insider dealing and market manipulation;
  • late disclosure of / failure to disclose inside information; and
  • client money mishandling.

Sponsor failures: last year, the SFC imposed some record-breaking fines on sponsors of initial public offerings ("IPOs") for their due diligence failures. In March 2019, the regulator fined UBS Securities Hong Kong Ltd HK$375 million for failing to make reasonable and adequate due diligence enquiries. In the same month, Morgan Stanley Asia Ltd was fined HK$224 million for not following some guidelines on due diligence interviews under the Code of Conduct for Persons Licensed by or Registered with the SFC.

Internal control failures: in November 2019, the SFC issued a substantial fine of HK$400 million on UBS AG for overcharging its clients and for its other related internal control failures, such as having inadequate policies and system controls in place and having inadequate training and supervision. Also, in January this year, RHB Securities Hong Kong Ltd was fined HK$6.4 million for its non-compliance with regulatory requirements on conflicts of interest and supervision of account executives, leading to its failure to detect discretionary trading activities of an account executive for 23 months.

Insider dealing and market manipulation: following prosecutions brought by the SFC, some senior management officers were jailed for insider dealing. In February 2019, the Magistrates' Court sent a former group finance manager of China CBM Group Company Ltd ("China CBM") to prison for 4 months after he procured others to sell and also sold China CBM's shares before two pieces of inside information became public. In another case, a former senior regulatory affairs manager of the Hong Kong Television Network Ltd ("HKTV") was sentenced to 2.5 months' imprisonment after he profited from the disposal of his HKTV shares by insider information.

Late disclosure of / failure to disclose inside information: the financial regulator imposed a fine of HK$3.2 million on Health and Happiness (H & H) International Holdings Ltd and a fine of HK$1.5 million on Fujikon Industrial Holdings Ltd respectively for late disclosure of inside information.

Client money mishandling: in July 2019, the SFC reprimanded and fined Celestial Commodities Ltd ("CCL") and Celestial Securities Ltd ("CSL") a total of HK$6.3 million for client money mishandling. In particular, each of them wrongly transferred monies away from their client accounts. CCL transferred its client monies to pay commission rebates to its account executives; whilst CSL transferred its client monies to CCL's client accounts, so as to enable CCL to meet margin calls from the Hong Kong Exchanges and Clearing Ltd on time.

Virtual asset market on the watchdog's radar

In view of the increasing popularity of trading virtual assets in the cyber community, the SFC issued a position paper to set out a new regulatory framework for virtual asset trading platforms on 6 November 2019. It is an elaboration of the conceptual framework introduced by the Commission in its earlier statement dated 1 November 2018.  

Under the new framework (which has been in operation since 6 November 2019), the SFC implements a compulsory licensing regime on certain centralised virtual asset trading platforms in Hong Kong. So long as a trading platform offers trading of at least one virtual asset or token which falls within the definition of "securities" or "futures contracts" under the Securities and Futures Ordinance (Cap. 571) ("SFO"), the platform operator must then apply for a licence from the regulator for carrying out Type 1 (Dealing in Securities) and Type 7 (Providing Automated Trading Services) regulated activities.  

In other words, it remains that the SFC has no power to supervise a platform that only trades assets or tokens which are not "securities" or "futures contracts" under the SFO. However, where a platform trades both security tokens and non-security tokens, all aspects of the platform's operations will fall within the Commission's regulatory remit.

When granting licences, the regulator may impose the following key licencing conditions upon qualified platform operators:

  • the licencee must only provide services to professional investors;
  • the licencee must comply with the "Terms and Conditions for Virtual Asset Trading Platform Operators" (for example, safe custody of assets, know-your-client requirements, anti-money laundering and counter-financing of terrorism etc.);
  • the licencee must obtain the SFC's prior written approval for any plan to introduce any new service or activity, to make any material change to an existing service or activity, or to add any product to its trading platform;
  • the licencee must provide monthly reports to the SFC on its business activities; and
  • the licencee must engage an independent professional firm to conduct an annual review of its activities and operations and prepare a report of that.

Any breach of the licensing conditions would be considered as "misconduct" under Part IX of the SFO. The breaches may also have a negative impact on the fitness and properness of a platform operator for it to remain licensed, and may result in disciplinary action by the SFC. 

Upon becoming licensed, a virtual asset trading platform operator will also be placed in the SFC Regulatory Sandbox for a period of close and intensive supervision (i.e. more frequent reporting, monitoring and reviews). Depending on the performance of the platform operator in the Sandbox, the Commission may decide to, upon application, remove or vary any licensing condition it imposed, or to revoke the licence it granted.

What's next?

Proactive action

Since 2017, the SFC has adopted a front-loaded and risk-based supervisory approach by focusing its resources on the greatest legal threats and the systemic risks. This strategy will likely continue in 2020. The regulator places emphasis on more targeted intervention at an earlier stage to tackle market irregularities and protect the investing public. It seeks to identify and address market misbehaviour before it takes place, or while the misbehaviour is happening, rather than pursuing enforcement action for a specific breach or loss after its occurrence.

In particular, the regulator is keeping a close eye on "shell" related activities, unusually rapid exponential increases in market capitalisation, and networks of companies with complex patterns of crossholdings, as these indicate harmful speculative activities.

For IPO-related transactions, the Commission's pre-emptive regulatory approach means utilising its statutory powers under the Securities and Futures (Stock Market Listing) Rules and more generally under the SFO to proactively intervene in transactions which appear to be oppressive or unfairly prejudicial to shareholders or potential investors, or where fraud or other serious misconduct is suspected.

Enforcement priorities

In terms of enforcement, misconduct by listed companies, corporate fraud and IPO sponsor failures remain at the top of the Commission's watch list. With the SFC's continuing focus on "high impact" cases, we anticipate more hefty penalties on sponsors, banks, securities companies and directors and offices in 2020.  

Type 13 regulated activity

Also, it is worth noting that in September 2019, the SFC launched a consultation on a proposed Type 13 regulated activity i.e. acting as a depository (trustee or custodian) of an SFC-authorised collective investment scheme. This regime would regulate depositaries for SFC-authorised unit trusts, mutual funds, real estate investment trusts and pooled retirement funds and open-ended fund companies; however, mandatory provident fund products would be excluded from the regulatory net.

Virtual asset trading

Finally, on 24 October 2019, President Xi gave the green light to accelerate the development of blockchain technology in China. A global trend of trading virtual assets appears to be imminent, and the formulation of a comprehensive regulatory framework to govern these assets would soon be called for. Our financial watchdog has already taken its first step to put in place some relevant regulatory measures, and will continue to liaise with the Hong Kong Government to consider the need for legislative changes in the long run.


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