Hong Kong: The Securities Market

The Securities Market

Hong Kong has the world's 10th largest securities market and the second largest in Asia after Tokyo. As of March 2000 the Hong Kong Stock Exchange and the Futures Exchange were merged into Hong Kong Exchanges and Clearing (HKEx). The launch of the Growth Enterprise Market (GEM) in November 1999 for smaller and high growth companies has broadened Hong Kong's stock market, although the timing of GEM's launch was unfortunate, and the 'dotcom' shakeout in 2000 weakened its initial impact.

The influx of Mainland China issuers into Hong Kong, boosted by economic reforms, has accelerated the growth of the Hong Kong market.

Being the most liquid overseas market for mainland enterprises, Hong Kong's capital market will play a key role in funding China's state-owned enterprises reform, as well as its massive infrastructure development program.

2010 was a good year for HKEx when a number of trading records were set. Listings were up 55% on the previous year and two of the three largest IPOs in the world, AIA Group Ltd and Agricultural Bank of China Ltd, took place on the exchange, which raised USD20bn and USD12bn, respectively, in Hong Kong. Total equity funds raised reached HKD850.1bn by December 31, beating the previous annual record of HKD642.1bn set in 2009. Funds raised by Chinese mainland enterprises (IPO and post-IPO) reached HKD466bn by year's end, well above the previous record of HKD384.9bn set in 2006.

The total number of shares traded in 2010 reached just under 35 trillion by the end of the year, surpassing 2008's record of 27.1 trillion. New records were also set in trading turnover for several instruments, including exchange-traded funds, futures and options, index futures and options, and stock options. The number of listed companies on the exchange rose by 8.65% to 1,244 during 2010, and market capitalisation was just under HKD30 trillion as at December 31, 2010, 17.86% higher than the end of 2009.

At the end of the first quarter of 2011 there were 1,258 companies and a total of 8,200 securities listed on the Main Board. Total turnover in the first quarter in terms of value was HKD4.69 trillion (up from HKD3.9 trillion in Q1, 2010).

On the GEM there were 168 listed companies at the end of Q1, 2011. Total turnover was HKD22.6bn (down from HKD31.5bn in Q1, 2010) and total market capitalisation stood at HKD137.8bn (down from HKD134.7bn at the end of Q1 2010).

Exchange traded funds (ETFs) have been a strong growth area for HKEx since the first one was listed in 2000. As of mid 2011, there were 76 ETFs listed on the exchange, accounting for about 3.5% of market turnover.

HKEx Strategic Plan 2010-2012

In January 2011, HKEx launched the second year of its Strategic Plan 2010-2012, focusing on three key components: accelerating its platform infrastructure upgrade and necessary market structure reforms, reinforcing its position as a global listing venue by promoting international listings, and developing its renminbi (RMB) capability and Mainland compatibility.

HKEx said that it anticipates "significant challenges" in pursuing these strategic initiatives in 2011 while at the same time maintaining its operational excellence and system reliability. "With inherent conflict between those objectives, the key is to determine when HKEx might be moving too fast or not fast enough," the exchange informed as part of its announcement on January 11. "Development pace cannot be at the expense of system stability and market readiness; but an overly conservative approach could result in loss of critical strategic opportunities, especially in today’s highly competitive environment and rapidly changing industry landscape. While HKEx will strive with full effort to achieve the most optimal outcome, it should also recognise that there is no magic formula for striking the perfect balance and that no option is risk free or cost free."

Below are HKEx’s major plans for the coming year and beyond:

• Extension of trading hours in two phases: HKEx is preparing internally for the implementation of the first phase which is scheduled to begin on 7 March, 2011. The second phase is scheduled to be implemented on 5 March, 2012. HKEx believes the proposed changes will improve the price discovery function for Mainland-related securities by increasing the overlap of trading hours with Mainland exchanges. This will also strengthen HKEx’s competitiveness by narrowing the gap between its trading hour duration and those of regional and global competitors.
• After-hours trading of futures and options: HKEx has been conducting a study and soft consultation with market participants on the trading of futures and options after their current market close to help improve execution efficiency and trading arrangements. HKEx plans to publish a consultation paper to seek market views on the proposal in the middle of this year.
• Review of risk management regime: One of HKEx’s strategic initiatives is to develop proposals to enhance clearing house capital adequacy and improve the securities market’s risk management and access to liquidity to meet its current and future needs, particularly in light of HKEx’s growing business and experience with market volatility. HKEx also aims to more closely align its clearing houses with international standards and best practices.
• OTC clearing: HKEx decided last month to establish a clearing house by the end of 2012 for derivatives traded in Hong Kong’s over-the-counter (OTC) market to support global regulatory initiatives and take advantage of business opportunities in OTC derivatives clearing. HKEx believes the business has tremendous potential for growth, particularly with the wider use of RMB in international transactions. HKEx plans to make an initial investment of $180 million in the new clearing house using internal resources.
• Securities and derivatives market system capacity and technology upgrades: The upgrade to the securities market trading system (known as AMS/3.8) aims for a 10-fold improvement over the existing securities trading system capacity to achieve an initial capacity of 30,000 orders per second (scalable to 150,000 orders per second if necessary), as well as an average order processing latency of nine milliseconds. HKEx expects the upgrades to be completed by the end of this year.
• Next Generation Data Centre and hosting services: In 2010, HKEx started preparatory work to build its Next Generation Data Centre (NGDC) in Hong Kong’s Tseung Kwan O Industrial Estate. The NGDC will consolidate the primary data centres for all of HKEx's markets and clearing houses’ systems, as well as certain IT development and support staff. HKEx currently has primary data centres in two separate locations in Hong Kong and backup centres in three other locations in the city. The NGDC will be built to meet the highest level of resilience, targeting top-level Tier 4 data centre requirements, and the LEED Gold standard, which is part of an internationally recognised green building certification system.
• Implementation of the scripless market model: The consultation conclusions were published on 21 September of last year. The Securities and Futures Commission (SFC) will consult the public this year on new subsidiary legislation that will set out in more detail how the scripless environment and those that play a key role in that environment will be regulated. A scripless regime will be implemented in phases following the necessary legislative changes and when the market infrastructure, key operators and market participants are ready. The first phase of the scripless regime is expected to be implemented in late 2013.
• Execution at market close: HKEx will explore possible options to enable execution at market close in view of market needs and based on its experience. Any future proposals will be put forward for public consultation before implementation. There is no timetable for this initiative.
• Narrowing of trading spreads: HKEx continues to review its trading environment from time to time and endeavours to enhance the efficiency and liquidity of its markets. It does not have a timetable for this initiative.
• Trading anonymity: While Hong Kong has a long tradition of showing broker identity on securities trading screens, HKEx is aware of some market participants’ suggestions about providing broker anonymity in its securities market’s electronic trading system, which processes all transactions. HKEx will closely monitor developments in other international markets and will carefully consider whether any changes are necessary. It does not have a timetable for this initiative.
• Direct market access: Some brokers provide designated connections for specific clients and these clients can send orders directly to HKEx's trading systems. In order to understand the market practice and development trend as well as the possible impact on our marketplace, HKEx will study direct market access related activities in its market and will work with the SFC to ensure best practices have been adopted by sponsoring brokers.
• Unification of clearing houses: HKEx is analysing the cost and benefits of unifying its clearing houses. This is a complex project which will require careful, in depth consideration. HKEx needs to be sure consolidation would be in the best interest of the markets and Participants before proceeding. A consultation on these proposals will be announced in due course.

HKEx plans to expand its international listing base further by accepting more overseas jurisdictions as places of incorporation for listed issuers, including India and South Africa. Last year, the Listing Committee approved the US State of California, Brazil, the Isle of Man, Japan and Italy as recognised jurisdictions, bringing the total number of recognised jurisdictions to 15. This is in addition to the four jurisdictions stipulated in the Listing Rules, namely Hong Kong, Mainland China, Bermuda and the Cayman Islands.

The exchange also plans to develop its renminbi-handling capabilities and it is exploring the feasibility of developing an RMB liquidity pool to assist investors who do not have RMB to invest in RMB-denominated securities. Such a mechanism would also facilitate the listing of RMB-denominated products in Hong Kong. HKEx is working with banks on foreign exchange and other treasury arrangements for a RMB liquidity pool. A timetable has not yet been determined but HKEx hopes a liquidity mechanism can be introduced in the second half of this year.

HKEx is also preparing its systems for RMB-related products, including RMB futures. At the time of the Strategic Plan's release, HKEx was in discussions with potential market makers for RMB futures to explore ways to connect their forex trading systems to its trading system.

Regulatory Structure

The principal regulator of Hong Kong’s securities and futures markets is the Securities and Futures Commission (SFC), which is an independent statutory body established in 1989 by the Securities and Futures Commission Ordinance (SFCO).

The SFCO and nine other securities and futures related ordinances were consolidated into the Securities and Futures Ordinance (SFO), which came into operation on 1 April 2003.

The SFC is responsible for administering the laws governing the securities and futures markets in Hong Kong and facilitating and encouraging the development of these markets. Its regulatory objectives as set out in the SFO are:

• To maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry;
• To promote understanding by the public of the operation and functioning of the securities and futures industry;
• To provide protection for members of the public investing in or holding financial products;
• To minimise crime and misconduct in the securities and futures industry;
• To reduce systemic risks in the securities and futures industry; and
• To assist the Financial Secretary in maintaining the financial stability of Hong Kong by taking appropriate steps in relation to the securities and futures industry.

The SFC is divided into four operational divisions:

• The Corporate Finance Division is responsible for the dual filing functions in relation to listing matters, administering the Takeovers and Mergers Code and Share Repurchases Code, overseeing the Stock Exchange's listing-related functions and responsibilities, and administering securities and company legislation relating to listed and unlisted companies.
• The Intermediaries and Investment Products Division is responsible for devising and administering licensing requirements for securities and futures, and leveraged foreign exchange trading intermediaries, supervising and monitoring intermediaries' conduct and financial resources, and regulating the public marketing of investment products.
• The Enforcement Division is responsible for conducting market surveillance to identify market misconduct for further investigation, undertaking inquiry into alleged breaches of relevant ordinances and codes, including insider dealing and market manipulation, and instituting disciplinary procedures for misconduct by licensed intermediaries.
• The Supervision of Markets Division is responsible for supervising and monitoring activities of the exchanges and clearing houses, encouraging development of the securities and futures markets, promoting and developing self-regulation by market bodies.

The Stock Exchange of Hong Kong (SEHK) operates as a private entity. Thus when the stock market crashed in 1987, the Securities Commission had no legal authority to intervene in the affairs of the SEHK. The regulatory infrastructure for the securities industry has since been revamped and, in 1989, the Securities and Futures Commission Ordinance was enacted. The Ordinance provides the legal basis for the SFC to supervise and regulate the securities industry. The SFC now has the authority to take actions necessary to protect the safety of the securities market and to prosecute individuals who breach securities market ordinances and codes.

Evolution of the Regulatory Structure

In 1991 the Securities (Insider Dealing) Ordinance was amended, resulting in higher penalties for insider trading. Fraud and misrepresentation are also punishable by the SFC. Another ordinance enacted in 1991 calls on a company’s directors and executives, as well as those who acquire more than 10 percent of a company’s voting shares, to publicly disclose their dealings. Firms seeking to list on the SEHK must make a prospectus publicly available. The SFC has the authority to determine which clearinghouses are permitted to settle accounts and their rules of operation in order to ensure a sound clearinghouse system.

In November 2000 the Hong Kong Government introduced the Composite Securities and Futures Bill which combines and replaced all ten existing pieces of securities and futures legislation. The new law gives the SFC the power to regulate Internet trading. In addition the SFC can also seize the working papers of market professionals during investigations. The Bill became law in 2001. An independent non-statutory body, known as the Process Review Panel, has been established to ensure that the SFC's internal operations, including its investigative and disciplinary procedures, are fair and consistent. Despite the Securities and Futures Ordinance, the Government was keen to see further integration of financial regulation, modelled on the UK's Financial Services Authority (FSA). The government had been anxious for some time to address the perceived conflict of interest created by the fact that the stock market regulator, Hong Kong Exchanges and Clearing (HKEx) is also itself a profit-making listed firm.

In March, 2004, it became clear that the SFC was to be the sole regulator for listing sponsors. SFC chairman, Andrew Sheng explained that: "In line with the wishes of the market, there will be a single regulatory regime for sponsors, and both the HKEx and Commission agree that we will enforce that regime."

He went on to add that although investment banks sponsoring companies hoping to list on the stock exchange would not be expected to assume issuer liability: "They have to be liable for their own standards of conduct and their role in due diligence."

"We are pleased to note that there is overwhelming support for giving statutory backing to certain fundamental listing requirements and expanding the dual filing system," announced the Secretary for Financial Services and the Treasury, Mr Frederick Ma.

He continued: "The proposed improvement measures set out in the Consultation Conclusions will contribute towards a quality market. They will further strengthen our position as the premier capital formation centre for the Mainland and a major international financial centre in the region."

"We will work closely with the Securities and Futures Commission (SFC), the Hong Kong Exchanges and Clearing Limited (HKEx) and all market users towards this common goal," Mr Ma said.

The Consultation Conclusions recommended codifying in the statute the more important listing requirements, i.e. financial reporting and other periodic disclosure, disclosure of price-sensitive information and shareholders' approval for notifiable transactions. This was to be achieved by subsidiary legislation to be made by the SFC under s.36 of the Securities and Futures Ordinance (SFO).

In parallel, the government proposed the introduction of a Securities and Futures (Amendment) Bill into the Legislative Council to the effect that breaches of statutory listing requirements will become a new type of market misconduct. Any persons who breach the statutory listing requirements can either be subject to civil sanctions imposed by the Market Misconduct Tribunal under Part XIII of the SFO, or criminal sanctions under Part XIV of the SFO following prosecution.

Mr Ma added: "Any breach of statutory listing requirements would not only hurt our investors, but also tarnish the reputation of our equity market. By bringing the regulatory regime for listing in line with that for other types of market misconduct, such as insider dealing and stock market manipulation, we hope to demonstrate to the local and international investors our commitment to enhancing market quality."

To address market calls for swift action to be taken by the SFC, the government also proposed to amend the SFO to allow the SFC to impose direct civil sanctions, namely reprimands and disqualification orders, on specific, well-defined "primary targets" for breaches of the statutory listing requirements. It is the consensual view among the regulators that these "primary targets" should be the issuers, directors and corporate officers, who are primarily accountable for corporate disclosure and other corporate activities under the listing regime.

"We shall continue to rely on the regulatory framework under the SFO, in particular the licensing regime, for the SFC to regulate IPO sponsors. We note the efforts being made by the SFC and HKEx to upgrade the regulation of sponsors," Mr Ma observed. "We recommend that they should expedite action on this front."

The Securities and Futures (Amendment) Bill was introduced in 2005.

In September, 2006, the SFC announced that investors suffering losses due to defaults by licensed or registered intermediaries, securities margin financiers and banks would be able to claim up to $150,000 through the Investor Compensation Fund Company.

The SFC described "default" as meaning any situation in which an intermediary, its employee or its associated person is in bankruptcy, wound up or insolvent or has committed breach of trust, defalcation, fraud or misfeasance.

The maximum claim was capped at $150,000 for both securities and futures products traded on the Stock Exchange of Hong Kong and the Hong Kong Futures Exchange. Both margin clients and cash clients are entitled to compensation if their intermediaries default.

The commission explained that investors lodging claims need documents such as the client agreement, their latest account statements, contract notes, proof of payment, and deposit receipts for securities. The more evidence a claimant can provide, the easier it will be to deal with the claim.

Hong Kong's Securities and Futures Commission and the Financial Reporting Council signed a memorandum of understanding, to enhance co-ordination and exchange of information between the two parties, in November, 2007.

According to a government statement, the pact outlines the working arrangements between the two bodies in areas of potential authority overlap and matters of common interest, so that they can discharge their functions effectively and enhance investor protection.

The agreement also outlines the framework for case referral, and establishes principal contact points to ensure efficient and effective communication.

The council's Chief Executive Officer MT Shum added that he is confident that the two parties will work together to enhance the financial reporting integrity of listed entities in Hong Kong.

The Financial Reporting Council is a statutory organisation which launched in July, 2007. Its main functions are to investigate - with respect to listed entities - auditing and reporting irregularities, enquire into non-compliance with financial reporting requirements, and to require listed entities to address any non-compliance identified.

Recent HKEx Developments

On December 17, 2010, HKEx published two consultation papers: one proposed changes to the requirements for debt securities for professional investors only (currently referred to in the Rules as listing by selective marketing); the other proposed changes to the Code on Corporate Governance Practices (the Code) and certain Listing Rules relating to corporate governance. The former paper proposes:

• Presenting the Rules in more accessible language.
• Unifying the definition of professional investor in the Rules with the definition in the Securities and Futures Ordinance.
• Removing provisions relevant only to retail investors from the eligibility requirements for applicants.
• Replacing the current detailed disclosure requirements in listing documents with an obligation to include information that is customary for offers of debt securities to professionals. Existing requirements to include responsibility and disclaimer statements in prescribed forms and a statement limiting distribution of the offering circular to professionals will be retained.
• Streamlining the application procedures for applicants and the vetting and approval procedures within the Listing Division.
• Removing provisions relevant only to retail investors from continuing obligations.

“These changes will bring us more into line with the requirements of other stock exchanges and allow us to offer processing times that are comparable to those exchanges,” said Mark Dickens, HKEx’s Head of Listing. “None of these proposals will apply to debt offered to retail investors in Hong Kong.”

The consultation paper can be downloaded from the HKEx website. Interested parties were encouraged to respond to the consultation paper by submitting the questionnaire. The deadline for replies to the consultation paper was 18 February 2011.

On proposed changes to the Code on Corporate Governance Practices (the Code) and certain Listing Rules relating to corporate governance, HKEx said that the consultation paper is part of its ongoing initiative to promote the development of higher corporate governance standards. "Our proposed changes are also generally in line with international best practice,” said Mark Dickens, HKEx’s Head of Listing. “We also propose revising some Listing Rules that may be impractical or burdensome to the market or may not meet their intended corporate governance purpose.”

The Code was introduced in January 2005. Since then, market conditions locally and overseas have changed, and HKEx believes an update to the Code and the related Rules is warranted.

Under the proposals, some Code Provisions (CPs) have been promoted to Rules because of their importance and many Recommended Best Practices (RPBs) have been upgraded to CPs. While issuers are required to abide by the Rules, they continue to have the flexibility to comply with the CPs. If issuers decide not to adopt a CP, they must explain the reasons for the decision in their corporate governance report. For RBPs, issuers are encouraged, but not required, to state whether they have adopted them.

In summary, the review and proposed rule amendments include measures to:

• Improve transparency by bolstering requirements for disclosure and communication with stakeholders;
• Enhance the quality of directors and company secretaries by requiring training;
• Require greater involvement in issuers’ board committees by independent non-executive directors (INEDs);
• Recognise company secretaries’ contribution to corporate governance and define their role and function; and
• Place emphasis on the leadership role of the chairman of the board in corporate governance matters.

Some of the proposals are highlighted below:

• Directors’ duties and time commitments: To strengthen the accountability of directors, HKEx proposes to expand the Rules on directors’ duties, provide guidance to directors, and revise the Code to recommend greater disclosure of time commitments by directors, particularly INEDs. HKEx also seeks market views on whether HKEx should introduce a Rule or a CP to limit the number of INED positions an individual may hold and if so, determine the maximum number. If there is strong support for such an approach, HKEx will conduct a further consultation on this specific topic before making any Rule change.
• Independent non-executive directors: HKEx believes that increasing the number of INEDs will promote better corporate governance and proposes to introduce a Rule that INEDs should constitute one third of an issuer’s board. Since 21 per cent of issuers do not currently meet this proposed requirement, HKEx proposes a transitional period with full compliance mandatory by 31 December 2012.
• Board committees:
  • Remuneration committee: HKEx proposes a rule to require issuers to set up a remuneration committee. The committee’s chairman and a majority of the members must be INEDs. The board should either delegate to the committee authority to determine the remuneration of executive directors and senior management, or retain that authority, with the committee taking an advisory role.
  • Nomination committee: HKEx proposes to upgrade the current RBPs relating to the committee’s establishment, composition and terms of reference to CPs.
  • Corporate governance committee: HKEx proposes to introduce new CPs that set out the duties and composition of a corporate governance committee. The Exchange also believes the corporate governance committee should be an RBP because some issuers may have resource constraints and would prefer an existing board committee to carry out the functions of a corporate governance committee.
  • Audit committee: HKEx proposes to revise the relevant CP so that instead of once a year, the audit committee should meet at least twice a year with the issuer’s external auditor. HKEx also proposes a new RBP stating that the audit committee should establish a “whistleblowing” policy enabling employees and those who deal with the issuer to raise concerns.
• Chairman and CEO: HKEx proposes to revise the Code by upgrading existing RBPs to CPs to emphasize the chairman’s role and responsibility in leading the issuer’s corporate governance efforts. HKEx also proposes rules requiring that a chief executive officer (CEO) who is not a director must disclose his or her appointment, resignation, re-designation, retirement or removal. The remuneration of a CEO (if he or she is not a director) should also be disclosed.

Other proposed changes cover areas including, among others, directors’ training, communication with shareholders, company secretary and board evaluation.

The consultation paper can be downloaded from the HKEx website. Interested parties are encouraged to respond to the consultation paper by completing and submitting the questionnaire. The deadline for replies to the consultation paper is 18 March 2011.

In December 2010, the Exchange decided to amend the Listing Rules to remove the requirements for issuers to file printed documents with the Exchange. The Rule amendments became effective on 1 January 2011.

"The changes are part of our continuing efforts to streamline our document requirements and to reduce paper consumption” said Mark Dickens, the Head of Listing.

Under the amended Rules issuers will no longer be required to submit printed copies of various documents to the Exchange, including:

• Financial reports;
• Takeover documents;
• Circulars for repurchase mandates and the corresponding resolutions passed at general meetings; and
• With respect to collective investment schemes, other documents issued to holders of interests in the schemes.

The SFC, and The Stock Exchange of Hong Kong Limited (SEHK), a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Limited, jointly released Consultation Conclusions on November 26, 2011, to allow the issue of paper application forms for public offers of certain securities without paper listing documents, subject to conditions set out in a class exemption.

The exemption will allow companies seeking to list shares and debentures on SEHK by public offers to distribute paper application forms as long as the prospectus is available on the Internet, subject to certain conditions. Similar waivers will be granted to issuers of SFC-authorised collective investment schemes that will be listed on SEHK.

“The proposal represents a balanced approach that facilitates market efficiency without undermining investor protection, given that investors will still have access to printed prospectuses and that issuers must satisfy exemption conditions and requirements," said Brian Ho, the SFC's Executive Director, Corporate Finance. "We further hope that this initiative will reduce wastage of paper prospectuses, in line with environmental protection.”

“The Mixed Media Offer will give issuers greater flexibility on prospectus information dissemination as the popularity of Internet continues to grow," said HKEx's Head of Listing Mark Dickens. “While a truly electronic environment for prospectus information dissemination requires more careful consideration, we continue to encourage issuers to create shorter and more concise prospectuses.”

The SFC and SEHK received wide support for the proposal from professional associations, market practitioners, law firms, members of the public and an environmental group.

The Exemption Notice, subject to negative vetting, will become effective on 1 February 2011. The Listing Rules amendments will take effect when the Exemption Notice becomes effective.

Historical Developments - Liberalization of the Renminbi

After Chinese Premier Wen Jiabao announced in Singapore, in November 2007, that he did not agree with the cash withdrawal limits placed on Shenzhen banks, they were hastily withdrawn, leaving the underground pipeline that has been sustaining Hong Kong's booming stockmarket in full flood.

"The Shenzhen banks' motives are good but they could employ better methods," said Wen. "We should have taken measures that were more effective and that were acceptable to the public."

The Chinese authorities are of course fully aware of the flow of illegitimate cash to Hong Kong, caused by Chinese exchange controls, and they are under heavy pressure to liberalize the renminbi (RMB). It was this that had led to the now-abandoned 'through-train' proposal to allow investment in Hong Kong stocks through defined channels.

Shenzhen banks had set a daily withdrawal limit of RMB30,000 on personal accounts. "If the illegal fund flow is not controlled, it will affect the financial stability in the country, including Hong Kong," Wen said, but it's not clear what action Beijing will now take.

It's not just the official banks that operate the pipeline: the local equivalent of hawali money-exchange networks are involved, and there are many parallel unofficial links between individuals. In fact the border is so porous that it's difficult to see how some form of liberalization can be avoided. Local estimates are that the daily flow of cash between Hong Kong and Shenzhen amounts to several billion renminbi.

Liberalization of renmimbi trading in Hong Kong is in fact now well under way. In April, 2004, the Bank of China Hong Kong announced that it would begin issuing credit cards and bank cards for use with the yuan. The first renminbi bond issue by a Mainland financial institution came in 2007. In August 2010, the People's Bank of China (PBoC) announced that eligible institutions outside the Mainland could take part in a pilot scheme to make use of their RMB funds to invest in the Mainland's interbank bond market.

In 2011, companies could be able to issue Chinese RMB-denominated shares through initial public offerings in Hong Kong, according to Charles Li, Chief Executive of HKEx. A move to allow stock issues in RMB, to be followed by equity derivatives and other products within another five years, would provide an additional outlet for offshore investors with funds deposited in the currency, in Hong Kong or elsewhere, following recent liberalization measures allowing interbank transfers, trade settlements in yuan, and yuan-based bonds and insurance policies.

Such investments might also provide the competitive returns that have been so far lacking in RMB-denominated products in other investment areas. Li disclosed that he is hoping that those equity products with more attractive yields would also encourage further trading in the RMB market, particularly through HKEx.

However, he was aware that the development of a yuan-denominated equity market would not happen overnight. There are various technical and regulatory barriers to overcome, and liquidity in the market would be a big problem. As in other markets, it would be the case of progressing on a gradual basis, continually demonstrating to the Chinese regulators that possible risks to the internal RMB market can be controlled.

Li was also bullish about Hong Kong’s future as an international centre for RMB-denominated products, in possible competition with Shanghai and other cities in China. He pointed out that Hong Kong is already an international financial centre, and one which allows China to test the market for new products in RMB, without any direct effect on its domestic financial market.

Concessions on Foreign Investment

In its bilateral agreement with the United States over WTO accession, China made concessions on foreign investment in the mainland's securities market. Foreign securities firms can establish joint ventures (with foreign ownership less than 1/3) to engage (without Chinese intermediary) in underwriting A-shares, and in underwriting and trading B- and H-shares, as well as government and corporate debt within three years of accession.

Moreover, as greater foreign ownership is allowed in telecommunications, banking, insurance and other sectors, more mainland firms will seek a listing in Hong Kong to tap overseas funds. Restructuring among China's enterprises (mergers and acquisitions) should increase in preparation for intensified foreign competition. Restructured mainland companies will rely more on equity finance for expansion as part of the regional trend, bringing more business to Hong Kong.

Notable Developments since 2004

Listing Rules Amended

A major element of HKEx’s mission depends on demonstrating the effective discharge of its regulatory responsibilities. The Listing Division has a keen and continuing interest in demonstrating that it is discharging its responsibilities effectively and making itself more effective. HKEx welcomes the steady improvement of corporate governance in Mainland companies listed in Hong Kong and intends to do all it can to ensure that this improvement continues.

Amendments to the Main Board and GEM Listing Rules designed to enhance corporate governance and market quality came into effect on March 31, 2004. They included new provisions on notifiable transactions and connected transactions, revised classifications of notifiable transactions and connected transactions, revised definitions of the terms “reverse takeover”, “connected person” and “associate” of a connected person, revised requirements for refreshment of general mandate and revised requirements on the disclosure of directors’ remuneration in annual reports.

In addition, there have been changes in the initial listing eligibility criteria, listed companies’ continuing obligations and the disclosure requirements at the time of listing.

Securities Law Consultation Conclusions Released

In September, 2006, the SFC released the Consultation Conclusions on the reform initiatives proposed under a drive to modernise the regime governing the public offering of shares and debentures in the Companies Ordinance.

In August, 2005, the SFC had consulted the public on 21 reform initiatives relating to the CO prospectus regime and received 26 submissions from market practitioners, issuers and professional bodies.

There was broad support for the majority of the initiatives, but certain of the proposals have been revised in light of public comments received.

Brian Ho, the SFC�s Executive Director of Corporate Finance, announced that: �Implementation of the initiatives proposed to be taken forward will more closely align Hong Kong's public offering regime with that of other leading jurisdictions and support Hong Kong's continuing role as an international financial centre."

"Consolidation of all securities laws in a single piece of legislation marks a significant step after the implementation of the Securities and Futures Ordinance in our drive to conform the regulatory philosophy and eliminate opportunities for regulatory arbitrage.�

Some of the key initiatives proposed and consulted upon were:

• To consolidate securities laws in a single piece of legislation, the provisions in the CO relating to the public offering of shares and debentures will be moved to the Securities and Futures Ordinance (SFO) as a discrete part separate from the investment advertisement regime in Part IV of the SFO.
• To harmonise the legal and regulatory treatment of investment arrangements and instruments with broadly similar risk and reward exposure, public offers of structured products will be subject to regulation under Part IV of the SFO, whilst plain vanilla share or debenture offers will be governed under the separate prospectus regime. This should reduce regulatory arbitrage.
• The focus of the prospectus regime will be changed from a �document-based� to a �transaction-based� approach by regulating the act of offering rather than any document containing the offer.
• Offerors will be regulated without regard to place of incorporation or their legal form. This will bring the prospectus regime into line with the investment advertisement regime in Part IV of the SFO, which regulates advertisements and invitations issued by any person, whether made in writing or otherwise.
• To attach liability unequivocally to specified persons responsible for the prospectus, prospectus liability will be imposed on (i) the issuer and/or the offeror of the shares or debentures; and (ii) each person who accepts, and is stated in the prospectus as accepting, responsibility for the prospectus. In view of the market response and the new Guidelines for Sponsors and Compliance Advisers issued by the SFC which were due to come into effect on 1 January 2007, imposition of prospectus liability on sponsors was viewed as premature.
• In order to provide investors with withdrawal rights where materially adverse new developments occur prior to the results of allocation being announced, the issuer of the prospectus will be required to publish a supplemental prospectus and provide successful applicants with a right to withdraw their allocations and be repaid in full. The offer period will not be required to be extended or re-opened � this will allow the scheduled date for refund of surplus application moneys and unsuccessful applications to remain unchanged.

According to the SFC, the following proposals would not be taken forward at that stage:

(i) Proposal 9 � to extend the classes of persons who may claim compensation for a misstatement in a prospectus to subsequent purchasers who buy in the secondary market;

(ii) Proposal 10 � to remove the requirement for claimants to prove that they have actually read and relied on the prospectus when making a claim for compensation;

(iii) Proposal 17 � to extend the 3-day waiting period before allotments of shares or debentures in the case of initial public offers of shares or debentures and the removal of the 3-day waiting period for allotments in the case of public offers of shares or debentures of a class already listed;

(iv) Proposal 18 � to provide that an application form or procedure for shares or debentures may not be distributed or implemented by any person unless it is accompanied by or contained in a prospectus which complies with the prospectus provisions or is exempted from them;

(v) Proposal 20 � to introduce a separate regulatory regime to regulate offers to employees and their dependants, including a requirement for a declaration of solvency and going concern by the directors and auditors of the company; and

(vi) Proposal 21 � to provide that an issue or sale of securities in contravention of the law should be void or voidable.

Chinese 'Red Chips' Threatened

In September, 2006, it seemed that Chinese 'red chip' listings were threatened by new rules which came into effect to control abuse of the restructuring process needed to transfer assets into offshore control.

A 'red chip' share is formed when a Chinese company transfers its assets into the ownership of an offshore holding company, typically in the Cayman Islands or the British Virgin Islands, prior to a listing in Hong Kong or New York. Historically there has been little control over the process, allowing Chinese owners to sell assets to the offshore companies at artificially low prices, encouraging capital flight.

The new regulations cover the valuation of assets to be transferred, and permission for each issue will have to be given by the Ministry of Commerce. Brokers and issuers feared that if the rules were applied retrospectively, whether to already listed stocks, or to those in the issuance pipeline, there would be delay and confusion in the markets.

The new rules also sought to control the use of the proceeds of a red chip issue by requiring listed companies to repatriate funds obtained through listing and to report on the process to the State Administration of Foreign Exchange.

Listing of Overseas Companies Encouraged

In March 2007, the Stock Exchange of HKEx and the SFC published a Joint Policy Statement Regarding the Listing of Overseas Companies. The joint policy statement was aimed at facilitating the listing of overseas companies by clarifying requirements in the Listing Rules and providing a clear roadmap for potential issuers and their advisers to refer to regarding key shareholder protection matters.

Applicants incorporated outside Hong Kong and other recognised jurisdictions seeking a primary listing on the Main Board and the Growth Enterprise Market are currently assessed on a case-by-case basis and have to demonstrate they are subject to appropriate standards of shareholder protection, which are at least equivalent to those required under Hong Kong law. The schedule of key shareholder protection measures set forth in the joint policy statement will help applicants in providing submissions on key requirements to demonstrate they are subject to appropriate measures.

SFC’s Chief Executive Officer, Martin Wheatley, said: “The policy statement provides clear guidance to companies seeking to list in Hong Kong which are incorporated outside Hong Kong, Bermuda, Cayman Islands and the PRC. It implements the Economic Summit Focus Group on Financial Services’ recommendation to facilitate listing of overseas companies which have substantial operations in the Mainland, and further develops Hong Kong as an international listing platform for quality companies from around the world.”

“This policy statement is intended to ensure listing in Hong Kong for overseas companies is not overly burdensome,” said Paul Chow, HKEx’s Chief Executive. “The roadmap is expected to facilitate and hopefully reduce the amount of work required for overseas companies seeking to list in Hong Kong. It will allow them to focus attention on fewer but more relevant issues, thereby streamlining the listing process for overseas issuers while maintaining the quality of our market for investors.”

“With the continuing growth of Hong Kong’s financial market, we believe more and more companies worldwide, especially those with business interests or other ties in Mainland and Hong Kong, will over time seek to raise funds and be traded here. HKEx is taking a long-term view and does not expect to receive a large number of applications from overseas companies in the near term,” Mr Chow added. “HKEx has explained the merits of listing in Hong Kong at events in several overseas markets over the last few years and those promotional efforts will continue.”

Measures to improve the registration system for non-Hong Kong companies were put in place from December 14, 2007, the Financial Services and the Treasury Bureau announced.

Under the Companies (Amendment) Ordinance 2004: the registration regime for overseas companies will be modernised; "overseas companies" will be renamed "non-Hong Kong companies" and will be obliged to file a full annual return; a new service of issuing certificates of registration in respect of non-Hong Kong companies will be introduced.

The Registrar of Companies has also appointed the same date to implement the Companies Ordinance (Amendment of Eighth Schedule) Order 2007, giving effect to the amended statutory fees for non-Hong Kong firms.

The Order replaces the existing filing fees concerning non-Hong Kong companies with a single filing fee, and introduces a new fee for the issue of registration certificates.

Escalating fees for the late filing of annual returns by non-Hong Kong firms are also being introduced, to encourage compliance with the filing requirements under the Companies Ordinance and the timely disclosure of corporate information.

As regards the new single filing fee, it is set on the basis of the "revenue neutral" principle. However, according to the announcement, non-Hong Kong companies, on average, would not pay more when compared with the fees payable at present as long as their annual returns are filed within the deadline prescribed in the Companies Ordinance, that is, within 42 days after the anniversary date of registration.

The Hong Kong Stock Exchange has adopted measures to enhance the stock trading suspension mechanism's transparency, Secretary for Financial Services and the Treasury Professor KC Chan announced in October, 2007.

The measures include publishing the conditions imposed for resumption, asking the suspended issuer to publish a regular update, and automatically invoking the delisting procedure if a security has been suspended for a prolonged period of time without the issuer taking steps to achieve resumption.

Development of the GEM

In May 2008, HKEx published its Growth Enterprise Market Consultation Conclusions. They include details on the proposed development of GEM as a second board and as a stepping stone to the Main Board.

Listing Rules amendments will be introduced to reflect the new role of the market but GEM will largely retain its existing structure. The key changes are:

• Under new quantitative admission requirements, applicants will need to have achieved positive cash flow of not less than $20 million in aggregate for two preceding financial years;
• The power to approve the admission of new issuers to GEM will be delegated from the GEM Listing Committee to the Listing Division, and the GEM Listing Committee will retain monitoring, appeal and policy responsibilities;
• Continuing obligations of GEM listed issuers will be brought closer to the requirements applicable to the Main Board requirements;
• Existing GEM issuers will be required to comply with the new rules from their effective date, except that in the case of the public float requirement they will be given a three-year grace period; and
• The process for transferring listing from GEM to the Main Board will be streamlined and there will be a 50% cut in the Main Board initial listing fee for all transfer applicants from GEM.

2009 Review of Listing Matters

The SFC's 2009 Annual Review of the Exchange’s Performance of its Regulation of Listing Matters concluded that the operational procedures and decision-making processes reviewed were appropriate to enable the Exchange to discharge its statutory obligation to maintain an orderly, informed and fair market, and to make rules for the proper regulation and efficient operation of the market in 2008.

Mr Brian Ho, SFC’s Executive Director of Corporate Finance, said: “We are satisfied that the Exchange has taken steps to address the recommendations in our 2008 report. The Exchange has also adopted new measures to canvass views from, and interact with, the market with a view to strengthening communication with the market to further enhance its performance in the formulation of new Listing Rules.”

“At the same time, we identified certain areas where we recommend that the Exchange should continue its efforts to enhance its performance,” Mr Ho added.

The SFC will continue to discharge its statutory responsibility to supervise, monitor and regulate the activities carried on by the Exchange.

Observing a deterioration in standard of listing application documents, the SFC said in its July 2010 edition of the Dual Filing Update that sponsors were under a duty to thoroughly understand their listing applicants and to critically assess whether the disclosures in the listing applications are sufficient in the circumstances.

The issue highlights a number of cases in which the sponsors failed to properly identify and explain in the draft prospectuses the relationships of significant stakeholders, such as distributors and suppliers, to the listing applicants. In one case, it was only after repeated requests by the regulators that the sponsor did additional due diligence work to clarify how the applicant’s distributors – its former employees – were able to finance their initial purchases requiring sizable upfront payments.

The issue further points out the need to provide investors with sufficient disclosure for an informed assessment of the listing applicants’ financial performance. In one case, the draft prospectuses and associated submissions were potentially materially inaccurate in explaining the applicant’s financial performance, but the application was withdrawn upon the resignation of the reporting accountants and the sponsors, before the SFC could pursue the matter further.

“It is the responsibility of the sponsors and other professional parties, and not the regulators, to ensure that proper due diligence is conducted for listing applications,” said Mr Martin Wheatley, the SFC’s Chief Executive Officer. “Undue reliance on regulators’ enquiries in making disclosures would create inefficiencies, unnecessary delays, and possible material non-disclosures that cannot be uncovered by the regulators in reviewing the draft listing documents.”

Also chronicled in the issue are other disclosure deficiencies among listing applicants, including some in the mining industry and others with a place of incorporation recognised as an acceptable jurisdiction only recently.

Channel Island Companies Approved for Listing

In October, 2009, Jersey companies were approved for listing on the Hong Kong Stock Exchange. The move is a significant development for Jersey’s finance industry, which is seeking to increase business flows from the Asia Pacific region.

The formal inclusion of Jersey companies on the Hong Kong Exchange’s approved list is the result of more than a year’s negotiation, research and document preparation involving government officials in Jersey, representatives from Jersey Finance, and the finance industry.

Robert Kirkby, Technical Director of Jersey Finance, commented: “Gaining access to a major capital market such as Hong Kong is further excellent news for Jersey and is a step forward in our ability to attract new business from the region. The move by the Exchange authorities adds weight to Jersey’s reputation as a rigorously supervised, highly regarded jurisdiction and also demonstrates how the market in Asia views the quality and robustness of Jersey company law. Moreover it gives further impetus to the formal opening of our second overseas office in Hong Kong later this month and is very welcome news.”

On May 18, 2011, it was officially confirmed that companies incorporated in Guernsey has received the green light from the Hong Kong Stock Exchange Listing Committee to list on HKEx.

The confirmation by the HKEx Listing Committee was described by Geoff Cook, Chief Executive of Guernsey Finance, as a "very positive development" for Guernsey's finance industry.

"Our service providers are seeing continued growth in terms of the numbers of clients from the Far East and there has been particular interest in being able to list Guernsey incorporated companies on the Hong Kong Stock Exchange," he said. “Receiving this approval is very much welcomed because it means that now we will be able to meet this demand and, indeed, there are opportunities already in the pipeline."

Technological Developments

Hong Kong Exchanges and Clearing (HKEx) introduced AMS/3, a third generation automatic order matching and execution system, in late 2000. In February 2001 it added an Order Routing System (ORS). ORS is an open system that enables investors to place stock market orders through the Internet, mobile phones and other electronic channels, which may be developed by HKEx or vendors. After an order is placed through an electronic channel connected to ORS, the system automatically sends the order to a Stock Exchange Participant for approval and submission to the market for matching and execution.

More than 100 Stock Exchange Participants have so far connected to ORS, and are able to offer their clients Internet trading. All Stock Exchange Participants, including those who have connected to the HKEx channel, will also be able to offer their clients electronic trading services, including Internet and mobile trading, through Proprietary Network System (PNS) channels provided by vendors.

CCASS provides settlement services under which securities are credited or debited to participants' CCASS stock accounts and funds are recorded in the participants' money ledgers on settlement day.

Details of all Exchange trades, including trade data and trade amendments, are electronically and automatically transmitted to CCASS by the Stock Exchange on each trading (T) day. There is no need for broker participants to input or further confirm their trade details in CCASS. Broker participants receive Provisional Clearing Statements of their stock and money positions through their CCASS terminals shortly after 1800 hours on each T day for reconciliation. Final Clearing Statements are available to broker participants shortly after 1400 hours on T+1 day for confirmation purposes.

Portware LLC, a leading independent provider of global, broker-neutral, multi-asset trading and strategy systems, announced in August 2007, the opening of its Hong Kong office to support its growing client base in the Asia-Pacific region.

Damian Bierman, formerly head of FIX Product Services at trading solutions provider NYFIX, in Hong Kong, has been appointed to head up the Portware Hong Kong office and oversee day-to-day operations. The office will focus on implementation management and support, and is staffed by regional specialists and experienced project managers from Portware’s US headquarters.

Portware has seen a rapid growth in demand from buy- and sell-side firms for its easily deployed multi-asset trading and strategy systems. Portware’s flexible framework offers a full range of components from ready-to-trade systems through to customizable enterprise solutions, enabling financial institutions to quickly integrate execution management tools and manage complex trading strategies and risk in one place. Through a combination of Portware’s open Application Programming Interface (API), plug-and-play architecture and regional development support, Portware’s Asia-Pacific customers are able to achieve a high degree of localization, tailored specifically to the varied needs of the Asia-Pacific markets.

Bank Negara Malaysia and the Hong Kong Monetary Authority (HKMA) announced, in October 2007, the implementation of a cross-border delivery-versus-payment (DvP) link between Hong Kong’s US dollar real time gross settlement (RTGS) system.

The DvP link will help eliminate settlement risk for US dollar bonds issued and traded in Malaysia, by ensuring simultaneous delivery of US dollars in Hong Kong and US dollar bonds in Malaysia.

The DvP settlement services provide the necessary settlement infrastructure to support potential issuance of US dollar bonds in Malaysia, as part of the initiatives to promote Malaysia as an Islamic financial centre and Hong Kong as an international financial centre.

The new link builds on the success of the payment-versus-payment (PvP) link between Hong Kong's US dollar RTGS system and Malaysia's Ringgit RTGS system that was established in November 2006.

The Hong Kong Monetary Authority (HKMA) has announced the launch of the electronic trading platform (ETP) for Exchange Fund Bills and Notes (EFBNs), which commenced operation on 11 December 2007.

The ETP is designed to enhance price transparency among the market players, and streamlines the trading process. With the launch of the ETP, market players can identify their trade counterparties and conclude deals more efficiently. The ETP is designed to be flexible enough to allow it to be set up according to the specific requirements of individual market players.

"The launch of the ETP is an endeavour by the HKMA and the Treasury Markets Association (TMA) to encourage electronic bond trading, a practice which has increasingly been adopted by more advanced bond markets in the world," commented Eddie Yue, Deputy Chief Executive of the HKMA, and Chairman of the Executive Board of the TMA.

The launch of the ETP is one of the recommendations arising from the Review of Debt Market Development completed by the HKMA in late 2006. The ETP provides the necessary infrastructure to support electronic trading of other bonds in addition to EFBNs, and can be extended to cover other financial instruments available in the market. Besides market players in Hong Kong, overseas market players are also encouraged to use this platform when trading bonds and other financial instruments issued in Hong Kong.

The ETP is developed and operated by Bloomberg LP, with advice on functional design and testing provided by a User Group established by the Treasury Markets Association (TMA).

HKEx has announced a three-year plan to revamp AMS/3 (end of 2009) and develop the next generation trading system with enhanced functionality and capacity.

In October 2010, HKEx published a paper to provide market participants with information about upgrades of AMS/3 and Market Data System (MDS). The upgrades, which are named AMS/3.8 and MDS/3.8 respectively, are scheduled for completion by the end of 2011. HKEx says they will increase the market's efficiency and transparency and pave the way for future growth.

"HKEx is committed to devoting its best effort and resources to the provision of high quality market infrastructure and services for the investing community," said HKEx Chief Executive Charles Li. “The AMS/3.8 and MDS/3.8 upgrades will play a crucial role in maintaining the competitive edge of Hong Kong’s securities market and helping us capture new growth opportunities.”

AMS/3.8 will essentially operate in the same way as the current version of the securities market trading system. However, the system upgrade will increase the processing capacity over the existing system by about 10-fold to 30,000 orders per second, and reduce average latency to 9 milliseconds, 16 times faster than present. Market transparency will also be improved as AMS/3.8 will display the 10 best price levels compared to the five best price levels in the current system. In addition, some legacy system functions will be streamlined to improve Exchange Participants’ operational efficiency.

Upon the rollout of MDS/3.8, throughput for market data dissemination will be increased to 2,000 stock page updates per second from 1,000 stock page updates per second, the message rate target that the existing system will use at the end of 2010. As a transitional arrangement, HKEx will disseminate market data at both message rates in the first year following the upgrade.

HKEx plans to introduce a new set of real-time market datafeed products about six to nine months after the rollout of MDS/3.8 to meet the increasing demand for deeper and faster market data. Market users will be provided with more data product choices and flexibility in choosing the market datafeed which best fits their needs and reception capability.

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