SFC's Lip Service

Recently Financial Times reported that SFC "has privately advised financial institutions they can implement US sanctions without automatically violating a tough national security law (NSL) imposed on the city by Beijing".  Financial institutions include banks and institutional investors.

But where is HKMA?  Has HKMA also privately advise banks under its supervision as such?  Interestingly, HKMA's standpoint on US sanctions is subtly different from SFC's.

Can financial institutions rely on SFC's lip service?  If financial institutions implement US sanctions and then their employees are charged with breach of NSL, could they tell the court that they were misled by the securities regulator?  The answer is obvious.

The latest challenge is that 4 more China-Hong Kong officials have been added to OFAC's SDN list.  Let's see if those financial institutions bravely implement the new round of US sanctions.

Expired Standing Authority

As required by the Client Securities Rules ("CSR") under the SFO, a broker firm is only allowed to repledge its clients' securities collateral to banks if it has obtained their valid standing authority (but exemption is applicable to professional investors).  The CSR also requires annual renewal of the standing authority, where the broker firm must send a renewal notice to clients 14 days prior to the expiry date.  Negative consent is allowed (i.e. if a client doesn't object, the standing authority is automatically renewed for another 12 months).

Yesterday SFC reprimanded China Everbright Securities (HK) Limited ("CESHK") and fined it $2.5 million for pledging its clients’ securities with banks for financial accommodation without valid authorization.

Between 1 April 2018 and 19 August 2018, CESHK relied on expired standing authority given by around 6,841 clients to pledge their securities as collateral in obtaining credit line from three banks in Hong Kong.  The standing authority in question had expired on 31 March 2018.

Details of the incident leading to the breach:

• Starting from late 2017, China Everbright Securities International Group (of which CESHK is a member) and Everbright Sun Hung Kai Group (EBSHK Group) were going through an amalgamation.
• In late February 2018, the Compliance Department of the EBSHK Group (EBSHK Compliance) was instructed to take over CESHK’s compliance function.
• At CESHK, the standing authority renewal exercise was handled by its compliance team in or around March every year.  At EBSHK, the same process was handled by its operations team in or around August every year.
• It was not highlighted to EBSHK Compliance that the standing authority of CESHK’s clients should be handled by the compliance team.
• In mid-August 2018, when EBSHK Group began the process of renewing the standing authority of its clients, it discovered that CESHK had not delivered standing authority renewal notices to its clients at least 14 days before 31 March 2018 in respect of standing authority that had expired on 31 March 2018 pursuant to section 4(3) of the CSR.
• On 20 August 2018, CESHK made a self-report to SFC regarding its failure to renew its clients’ standing authority which expired on 31 March 2018.

It appears that this incident was caused by internal miscommunication, i.e. CESHK wrongly believed that the standing authority renewal exercise would be handled by EBSHK Compliance.  But in my opinion, it is not appropriate for the compliance team to take over such operational duties.  I reproduce below the following paragraph from SFC's Internal Control Guidelines:

Management ensures that, where practicable, policy formulation, supervisory and other internal review or advisory functions, including where applicable compliance and internal audit, are effectively segregated from line operational duties. Such segregation serves to ensure the effectiveness of supervisory and other internal controls established by Management.

Basic Mistake, Silly Belief

Yesterday SFC publicly reprimanded The Bank of East Asia, Limited (BEA) and fined it HK$4.2 million due to BEA’s failure to segregate its client securities from proprietary securities into separate accounts maintained at two external custodians as required by the Client Securities Rules ("CSR").

Section 5(1) of the CSR requires an intermediary (or its associated entity) to ensure client securities it receives are deposited in safe custody in a segregated account which is designated as a trust account or client account established or maintained in Hong Kong with an authorized financial institution, an approved custodian or other intermediaries licensed for dealing in securities, asap.

Between Nov 2015 and Jan 2016, HKMA conducted an on-site examination on BEA and expressed concerns regarding BEA’s non-compliance with the CSR.  In Dec 2016, following further enquiries from the HKMA, BEA made a report to SFC and HKMA regarding its failure to deposit client securities in a designated segregated account in accordance with the CSR.

SFC conducted an investigation and found that BEA failed to segregate its client securities and proprietary securities in accounts maintained at two external custodians, CCASS and Sumitomo Mitsui Banking Corporation ("SMBC"), from Apr 2003 to Dec 2016.

According to BEA, its failure to segregate client securities and proprietary securities was caused by its belief that the identification and segregation of client securities and proprietary securities in its internal electronic accounting records was sufficient to comply with section 5(1) of the CSR.

BEA had made a basic mistake, which was caused by a silly belief.  Who in BEA made the non-segregation decision?  Did they consult their lawyers or compliance team in advance?  Why such problem had not been detected by BEA's auditors (internal and external) over 13 years?

Listed Brokerage Houses Halted to Disclose Operating Data

Disclosure-based approach is a key regulatory philosophy.  Listed companies are usually required by regulatory authorities to publicly and regularly disclose their financial and operating information to enhance market transparency.

However, this week I read a shocking news from the PRC media  第一财经, where the key points are reproduced below:

• 券商8月单月经营数据目前尚未发布。按照惯例，证券公司在每月10号前会披露上一个月的经营数据简报。但目前已进入9月中旬，全部上市券商的8月月报却都迟迟未至。
• 记者以投资者身份电话询问了部分上市券商，有中小型券商投资者关系部人士表示，于上周接到相关通知要求暂不披露8月经营数据。
• 上市券商按月公布经营数据的规定于2010年出台，当年7月，上市券商首次公布月度经营数据。
• 据证监会官网，证监会2010年6月发布了《关于修改〈关于加强上市证券公司监管的规定〉的决定》，其中规定，上市证券公司在向监管部门报送综合监管报表的同时，应当以临时公告的形式在交易所网站公开披露公司月度经营情况主要财务信息，包括当期营业收入、当期净利润、期末净资产等数据，以及公司认为应当披露的其他财务信息。

We may have a reasonable belief that last week PRC listed brokerage houses were requested by CSRC to halt the monthly disclosure of their operating data.  But why did CSRC make such seemingly "anti-regulatory" request?  Would the disclosure create a chaotic market?

I wish such black-box operation won't be adopted by regulatory bodies in Hong Kong.

Retail Investor Convicted of False Trading

Last week Hong Kong Police arrested 15 people on suspicion of conspiracy to defraud and money laundering by manipulating shares of Next Digital (282.hk), inducing a lot of criticisms. 

This week SFC demonstrated how it professionally sanctioned a retail investor who manipulated the market.

Yesterday SFC announced that the Eastern Magistrates’ Court has convicted Mr Ke Wen Hua of false trading in the shares of Carry Wealth (643.hk) following a prosecution by SFC.

Let's have a look at SFC's investigation findings:

• Ke began accumulating Carry Wealth shares in May 2011 and acquired most of his holdings in Carry Wealth shares at a price between $0.48 and $1.30 until Sep 2011.
• On 4 Sep 2012, Ke conducted trading in Carry Wealth shares through 6 securities accounts under his control.  In doing so, the share price of Carry Wealth was pushed to reach as high as $0.6 which was 50% higher than the preceding day’s closing price of $0.4.  On the same day, Ke’s trading generated a trading volume of 58.6 million Carry Wealth shares, approximately 3,000 times the average daily trading volume of Carry Wealth shares during the previous 10 trading days.
• Consequently, Ke was able to dispose of Carry Wealth shares at artificially inflated prices through his false trading and reduce the total of his trading losses by approximately $887,220.

Ke's trading had created extreme results (soaring price and turnover), otherwise SFC's prosecution would be an uphill battle.  He pleaded guilty to the offence and was fined only $30,000 (and also ordered to pay SFC’s investigation cost), not very punitive.  More importantly, Ke's market misconduct happened 8 years ago but SFC commenced criminal proceedings against him in July 2020.  This case seems like a delayed justice.

SFC Bypassed by Hong Kong Police

Yesterday Hong Kong Police ("HKP") arrested 15 people on suspicion of conspiracy to defraud and money laundering by manipulating shares of Next Digital (282.hk).  There have been lots of online discussions with some misconceptions.

Some laymen criticized HKP for accusing stock market speculators or prohibiting "buy low sell high" (profit making).  Stock market speculation is of course not illegal, but manipulation is another matter.  Stock market manipulation refers to fraudulent activities aiming at distorting the actual demand and supply  in order to create a false or misleading appearance of the price or turnover of a stock.  It is indeed a financial crime specified under the Securities and Futures Ordinance ("SFO").

If a securities firm has identified such fraudulent activities from its clients, it is obliged to report them to Securities and Futures Commission ("SFC").  A suspicious transaction report ("STR") would also be filed to Joint Financial Intelligence Unit ("JFIU") under HKP's Narcotics Division because the use of proceeds from a financial crime has the implication of money laundering.  Usually HKPF would not take any action until SFC has concluded that a serious offence was committed.

Whether or not the share trading constitutes market manipulation should be the professional judgement exercised by SFC at the outset.  Typically SFC spends a long period of time on the investigation process by collecting tons of records from securities firms and questioning the suspects.  According to SFO's relevant provisions, SFC is able to mandate any person to answer questions (but their answers may not be admitted as evidences in criminal proceedings to avoid self-incrimination).

SFC can refer a potential market manipulation case to Department of Justice ("DoJ") to assess whether the case should be criminally prosecuted and, if so, whether the case should be prosecuted on indictment by the DoJ in the higher courts or summarily by SFC in the Magistrates’ Courts.  SFC seldom requests HKP to make an arrest unless the suspect has a high chance to flee.

Unfortunately, it appears that in Next Digital's case SFC has been bypassed by HKP.  The public is hardly convinced that HKP is more professional than SFC to conduct an investigation into a market manipulation case, not to mention it hastily completed the process within one month.  Moreover, HKP bypassed SFC only for Next Digital's case but not for numerous other suspected cases, why?

If Hong Kong still has separation of powers (already denied by the HKSAR Government), SFC should challenge HKP's reckless action.   But now SFC has chosen to keep silent.

Latest update:

Today's evening SFC eventually made a statement on HKPF's action.  Apart from those wishy-washy words (implying HKP is not professional), SFC left only such remark: As investigations are continuing, the SFC is not in a position to comment any further.

I am afraid Hong Kong would soon be transformed from an IFC into a NFC.into a NFC.

Licensing of Family Offices

Over the past 2 decades, family offices have become more influential in the wealth management industry. Ultra HNWIs are no longer satisfied with the services of traditional private banks. They need an in-house professional team.

But shall family offices in Hong Kong, which make investment decisions on behalf of one or more families, be licensed by SFC?

On 7 January 2020, SFC issued a circular on the licensing obligations of family offices. It provides general guidance for family offices intending to carry out asset management or other services in Hong Kong. On 8 September 2020, SFC published a FAQ to provide additional guidance on the implications of the licensing regime to single family offices and multi-family offices. I reproduce the questions (Q) and answers (A) and give my comments (C) below:

Q1:
Is there a definition for “family” or “family office” under the licensing regime?
A2:
No, the Ordinance does not define “family” or “family office”. It is noteworthy that the licensing regime does not hinge on whether an entity is called a family office or whether its clients are families. A family office operator will have more flexibility to determine its legal form and operational structure with respect to its services to be provided.
C1:
A family office ("FO") is most likely deemed as an asset management firm because it usually conducts discretionary trading for the client (family). Thus licensing for RA9 is required. But if the client occasionally places dealing orders to the FO, then licensing for RA1 or RA2 may also be required.

Q2:
What constitutes a single family office for the purposes of the Circular?
A2:
It typically refers to an arrangement (often structured through a corporate vehicle owned or controlled by the family) under which the assets, investments and long-term interests of members of a single family are managed. The SFC has not sought to define what relationships of blood or of law would constitute family membership because the licensing obligations under the Ordinance do not hinge on whether the clients of a family office are family members or not.
C2:
SFC reiterated that members of a single family don't need to be strict "family members". In the Circular, SFC stated that "the family office will not need a licence because it will not be providing asset management services to a third party". I wonder if such licensing exemption could be abused, e.g. a so-called FO attempts to group a number of actually unrelated clients into a "single family".

Q3:
Is a single family office required to be licensed under the Ordinance?
A3:
The issue of whether a single family office is required to be licensed under the Ordinance is determined by reference to three key factors, all of which must be present in order to give rise to a licensing obligation: firstly, the services provided by the family office constitute one or more regulated activity as defined under the Ordinance; secondly, the family office is carrying on a business in the provision of such services; and thirdly, the business is carried on in Hong Kong.
In determining whether certain asset management activities amount to a regulated activity, the definition of Type 9 regulated activity contains an intra-group carve-out for a single family office where it provides such services solely to its related entities, which are defined as its wholly owned subsidiaries, its holding company which holds all its issued shares or that holding company’s other wholly owned subsidiaries.
What amounts to “carrying on a business in Hong Kong” is not defined in the Ordinance and will need to be determined by reference to the facts of each case, including whether the person is performing an occupation or a duty which requires attention; the activity involves continuity; the activity is capable of making profit; and the activity was carried out for the purpose of making profit. A genuine single family office arrangement, established to serve the investment needs of members of a single family, which is not being run as a business (i.e. not receiving any income, other than reimbursement of operating expenses from the family) or have the pursuit of profit as its business objective, should not in the ordinary course be considered as carrying on a business from a licensing perspective. It is also not the SFC’s intent to extend its regulatory oversight to this type of single family office setup.
C3:
A single FO is typically low key, not being run like a business. I think not many single FOs would be licensed by SFC in foreseeable future.

Q4:
If two or more single family offices co-operate together for the purposes of sharing a common administrative infrastructure in order to reduce operating overheads, would such arrangements trigger a licensing obligation?
A4:
The discussion in the response to Q3 above on the types of factors required to be present in order to give rise to a licensing obligation under the Ordinance would apply equally in these circumstances.
The sharing of office premises and administrative infrastructure by two or more family offices would not of itself automatically trigger a licensing obligation for such single family offices. However, where two or more single family offices make arrangements for the sharing of human resources involved in investment related matters, research or the investment process, this may be regarded as a multi-family office structure (see also the response to Q5 below) and, where the provision of services is carried on as a business, increases the likelihood of a licensing obligation arising.
C4:
If the different single FOs share not only administrative team but also investment team and they are required to be licensed, there is a potential conflict of interest problem - a licensed person (investment staff) is generally disallowed by SFC to carry out a regulated activity for 2 or more licensed corporations if they are not within the same group.

Q5:
What constitutes a multi-family office for the purposes of the Circular and is a multi-family office required to be licensed?
A5:
As mentioned in the Circular, “a multi-family office by definition serves more than one high net worth family” and such arrangements are likely to be evident.
Multi-family offices are typically established and run as commercial ventures. The issue of whether a multi-family office is required to be licensed under the Ordinance will be primarily determined by the three key factors set out in the response to Q3.
C5:
I envisage multi-FOs are more likely to be licensed by SFC. When the number of family clients increases, a multi-FO is akin to a private bank.

Buy High Sell Low

As we all know, “buy low sell high” is the invincible law of investing. If someone is deliberately breaching this principle, he would be in trouble.

From time to time I observe some clients trading with the following red flags:

• They focus on stocks with thin turnover;
• Their trading volume corners the market turnover;
• They conduct day trading, where the time interval between the buy order and the sell order is quite short; and
• The buy order price is often the same as, or even lower than, the sell order price.

Securities regulators would probably regard the above trading pattern as potential market misconduct (namely false trading) because it appears to have no economic substance. If the market is normal (all demands and supplies are genuine), nobody can always buy low sell high (otherwise he is the God). Market manipulators just intend to create artificial turnover. If they persistently buy low sell high, arbitragers would be attracted. So they would only persistently buy and sell at the same price, or buy high sell low.

Compliance professionals should endeavor to detect such suspicious transactions, block these fraudsters and file suspicious transaction reports to regulatory authorities. Of course, occasional “buy high sell low” may not be suspicious (it may be caused by a wrong judgement), but persistent behavior is another matter. That’s why detection of suspicious transactions requires holistic consideration of various red flags.

Responses to US Sanctions: SFC vs HKMA

Yesterday the US government added 11 China and Hong Kong officials to OFAC’s SDN List. Compliance professionals are of course eager to know the regulators’ responses to the sanctions imposed. Today SFC and HKMA provided their respective views on this issue.

The key message of SFC’s statement is here:

In considering the implications of the sanctions, intermediaries are expected to carefully assess any legal, business and commercial risks that they may be exposed to. We would expect any response to the sanctions to be necessary, fair, and have regard to the best interests of their clients and the integrity of the market.

SFC’s standpoint is obscure, but I pay attention to the words “necessary” and “fair”. It appears that SFC does not urge intermediaries to enforce the US sanctions if doing so is unnecessary or unfair.

On the other hand, HKMA’s standpoint is clearer. In its circular to authorized institutions, HKMA states that:

Hong Kong fully implements targeted financial sanctions in compliance with United Nations Security Council Resolutions…

…unilateral sanctions imposed by foreign governments are not part of the international targeted financial sanctions regime and have no legal status in Hong Kong.

In assessing whether to continue to provide banking services to an individual or entity designated under a unilateral sanction which does not create an obligation under Hong Kong law, boards and senior management of AIs should have particular regard to the treat customers fairly principles.

HKMA seems to imply that enforcing the US sanctions by banks is not a fair treatment of those 11 individuals on the SDN List. Interestingly, in the past HKMA would not give such advice when the sanctioned individuals/entities are non-Chinese (say, from Iran).

Banks are not obliged by Hong Kong law to follow the US sanctions. But who can excuse them from being sanctioned by the US government if they continue to maintain business relationship with those 11 individuals? On the contrary, if banks enforce the US sanctions, would they (and their management) be charged under the Hong Kong national security law? It sounds like a Catch-22 situation.

I always think SFC is more "politically neutral" than HKMA. This is another evidence.

Abuse of Complaint Officer’s Contact

A financial institution (esp. if it is serving retail customers) should have a complaint handling policy and let the public know the complaint channel. For example, a Hong Kong licensed corporation should disclose the contact details of its complaint officer in SFC’s public register. This is of course a desirable practice. However, such transparency could be abused by spammers.

I recently received a couple of emails issued by AimHigh Compliance Solutions (“AHCS”) to the email addresses of my firm’s complaint officers, promoting its whatever services.

According to its LinkedIn page, AHCS is a corporate compliance and regulatory advisory firm. Regrettably such a professional firm is acting unprofessionally by abusing the complaint officer’s contact. If compliance consulting firms are also licensed in Hong Kong, AHCS should receive a complaint. What I can do now is only to ban it from my firm’s email server.

SFC's Policy Statement for National Security Law

It's rare for SFC to issue a press release on Sunday but it did it today by issuing a Policy Statement in relation to the new National Security Law (NSL).

This Statement was issued as a result of conversations between SFC and globally active financial institutions ("firms") operating in HK markets. These conversations have centred on concerns expressed by firms about the potential ambit and effect of the NSL on the way they currently do business in HK. SFC said it has communicated firms' observations to the HKSAR Government, and welcomes the views of the Financial Secretary as set out in his Blog today.

In this Statement, SFC expressed the following viewpoints:

• SFC is not aware of any aspect of the NSL which would affect or alter the existing ways in which firms and listed companies originate, access, disseminate and transmit financial market and related business information under the regulatory regime it administers. For example, the principles applicable to, and methodologies used by, analysts in terms of the sources of information and data they use and the manner in which their views and opinions are expressed in their reports should remain unaltered.
• Equally, the rules and accepted practices governing market trading activities, including in exchange traded and OTC derivative markets, the use of hedging strategies and activities under Hong Kong's short selling regime, also remain unaltered; all related regulations will be administered by SFC in the same manner as before the advent of the NSL.
• SFC will continue to regulate Hong Kong's markets as it has done so before the NSL was enacted and in line with this Statement.

Having read this Statement, I still cast doubt on whether it has alleviated the following concerns:

• If analysts fail to independently issue negative views on Chinese-related companies due to the NSL, would they be sanctioned by SFC?
• Could listed companies or intermediaries use the NSL as a shield to deter SFC's enforcement actions?
• Would SFC impose restrictions on short selling or use of derivatives when the Hong Kong financial markets have encountered a big crisis (like what happened during 1997-98)?
• If the US impose sanctions on persons who support the NSL (e.g. HKSAR government officials), would SFC allow or mandate licensed firms to follow suit?

I sincerely hope SFC, being led by Mr Ashley Alder, would continue to stand firm with Hong Kong's regulatory standards.

證監會為國安法維穩？

 老證好少星期日出文，但今日星期日就為咗港區國安法出咗篇政策聲明，可能想等大家聽日入市都安心啲啩。

政策聲明連結：

證券及期貨事務監察委員會的政策聲明

www.sfc.hk

老證話，同班活躍本地市場嘅國際金融機構進行對話後，收到佢地對國安法潛在適用範圍同埋對經營業務影響嘅關注。老證表示已經同香港特區政府溝通過，仲話歡迎陳茂波今日篇網誌嘅睇法。

廢話跳過，我主要引述老證呢幾點：

• 證監會謹此闡明，本會並未有察覺到《國安法》在任何層面上會影響或改變機構及上市公司現時在本會執行的監管機制下產生、存取、發放及傳達金融市場和相關商業資訊的方式。舉例來說，就分析師所使用的資料和數據的來源，以及他們在報告中發表見解及意見而言，所適用的原則及採用的方法都應維持不變。
• 同樣地，規管市場交易行為（包括在交易所買賣及場外衍生工具市場，使用對沖策略及根據香港賣空制度進行的活動）的規則及公認的做法亦會維持不變，而證監會將以與《國安法》頒布前的同一方式執行所有有關規則。
• 自《國安法》頒布以來，香港的股票及衍生品市場一直保持有秩序地運作，而香港股市的交投仍然非常活躍。在各類本地和國際投資者的參與下，以及內地投資者透過股票市場交易互聯互通機制進行交易下，7月上旬的平均每日成交額大幅上升，國際投資者經滬股通及深股通的交易更是翻倍，印證了香港作為環球資金進入中國內地資本市場的重要樞紐。

總而言之，有冇國安法都好，老證話佢嘅監管都係咁有效囉。你信唔信？我做合規呢行就有以下嘅港人問號：

1. 啲分析員評論中概股，因為擔心觸犯國安法而言不由衷(唔敢唱淡或建議沽出)，咁係咪失去中立性？老證罰唔罰佢地先？
2. 啲上市公司或中介人，用國安法做擋箭牌，唔配合老證嘅執法行動，老證可以點？
3. 如果啲外資金融機構隊冧香港個市(好似97至98年咁)，老證會唔會干預自由市場運作(例如唔畀沽空，限制使用衍生工具)？
4. 一旦美國推出制裁名單，制裁支持/執行國安法人士(包括特區政府高官)，老證會唔會容許或強制持牌公司跟美國機，拒絕向受制裁人士提供服務，甚至凍結佢地資產？(留意返，跟美國機可能觸犯國安法，唔跟又可能畀美國制裁埋，兩難。)

Ashley Alder繼續做老證CEO可能有助穩定外資信心，但監管力度係咪真係唔受國安法影響？大家拭目以待。

Counterparty Risks of Lousy Broker

In May 2016, Guotai Junan Securities (Hong Kong) Limited was fined $1.3 million by SFC for the Client Identity Rule Policy. In Jun 2016, there was another enforcement case against Guotai Junan, which was much more severe.

As announced on 22 Jun 2020, Guotai Junan was fined $25.2 million by SFC for for multiple internal control failures and regulatory breaches in connection with AML, handling of third party fund transfers and placing activities, as well as detection of wash trades and late reporting.

Third party fund transfers

• Between Mar 2014 and Mar 2015, Guotai Junan failed to take reasonable measures to ensure that proper safeguards were put in place to mitigate the risks of money laundering and terrorist financing in processing 15,584 third party deposits or withdrawals for its clients, totalling approximately $37.5 billion.
• Despite red flags suggesting some of the third party fund transfers were unusual or suspicious, Guotai Junan failed to adequately monitor the activities of its clients, conduct appropriate scrutiny of the fund transfers, identify transactions that were suspicious and report them to the JFIU in a timely manner.
• Guotai Junan processed 5,406 third party deposits from Jul 2015 to Jun 2016 without always documenting the identity of the depositors, their relationship with the account holders, and the reasons for these third party deposits.

Placing activities

• While acting as the placing agent for the global offering of a Hong Kong-listed company’s shares between Dec 2015 and Jan 2016, Guotai Junan failed to take reasonable steps to ascertain whether the clients’ subscription applications were consistent with its knowledge of their background and source of funds, and make appropriate enquiries when there were grounds for suspicion.
• In particular, the funds used by five clients to subscribe for $28.8 million worth of the listed company’s shares were deposited by the same third party into the respective client accounts in amounts far exceeding their self-declared net worth.
• Despite such red flags, Guotai Junan did not take reasonable steps to verify the ultimate beneficial owners of the clients’ accounts and their source of funds, nor make appropriate enquiries to ascertain whether the clients were independent of the listed company. In the end, 3 of the 5 placees, who were allotted 11% of the listed company’s shares of the total placing under the international tranche, turned out to be the listed company’s employees.

Detection of wash trades and reporting obligation

• Guotai Junan failed to detect 590 potential wash trades in a timely manner between Jan 2014 and Jul 2016 due to a lack of adequate written trade monitoring procedures or guidelines and technical failures of its transaction pattern monitoring system.
• However, despite becoming aware in Jul 2016 of 210 potential wash trades which could not be detected in a timely manner as a result of the system failure, Guotai Junan did not report these 210 trades to SFC until 7 months later in Feb 2017.

More details of this case can be found from the Statement of Disciplinary Action.

If your firm is a financial institution conducting business with such a lousy broker, how would you evaluate the counterparty risks (regulatory risk, reputation risk, operational risk, etc.) in light of this enforcement case?

Reliance on Individual Consultants to Conduct Product Due Diligence

As announced on 19 Mar 2020, SFC reprimanded and fined Convoy Asset Management Limited (CAML) $6.4 million for control failures in solicitation and recommendation of bonds to clients.

CAML referred clients to a third party platform between Mar 2015 and Jan 2017 (Relevant Period) to execute 30 transactions of Chapter 37 Bonds, some of which involved solicitation or recommendation made to clients.

In recommending Chapter 37 Bonds to clients, CAML failed to:

• conduct proper and adequate product due diligence on these bonds before making recommendation or solicitation;
• have an effective system in place to ensure that the recommendation or solicitation in relation to bonds was suitable for and reasonable in all the circumstances;
• maintain proper documentary records of the investment advice or recommendation given to its clients and provide each of them with a copy of the written advice; and
• have adequate and effective internal controls and system in place to diligently supervise and monitor the sale of bonds through the third party platform and to ensure its compliance with applicable regulatory requirements.

The SDA revealed further details:

• During the Relevant Period, CAML introduced its clients to a third party platform to execute 30 Chapter 37 Bonds transactions in the secondary market for 28 retail clients. Clients who purchased bonds via the third party platform had to open accounts at both CAML and the third party platform. They were clients of both firms.
• CAML did not have product approval and due diligence procedures on Chapter 37 Bonds. It relied solely on individual consultants to conduct product due diligence (PDD) and to assess the risks of the bonds.
• CAML engaged the bond dealing services of the third party platform to assist its consultants to understand each bond product before recommending such product to clients. The platform offered the services of a designated bond expert to CAML, and provided briefings, presentations and articles to CAML’s consultants on bond products, as well as responded to enquiries from CAML’s consultants. However, the third party platform did not assign a risk rating to the bonds, and did not identify which of the bonds on its platform were Chapter 37 Bonds.
• CAML provided limited guidance to its consultants on how they should conduct PDD on the bonds, including for instance, what features they had to review and the criteria to be adopted, what other factors they should take into account, and the weight to be attributable to those factors. Its consultants were also not required to record in writing what documents they had reviewed, in what respects the bonds were considered suitable for different risk categories of investors, and justification for such findings.

SFC does not disclose the identity of the third party platform, probably due to the fact that another disciplinary action is being taken against this firm.

SFC's Statement on HSBC's Cancellation & Suspension of Dividends

As we know, HSBC Holdings plc made an announcement made on 31 March 2020 relating to the cancellation of its fourth interim dividend for 2019 (Cancellation) and the suspension of payment of any further dividend until the end of 2020 (Suspension).

SFC said it has received a large number of enquiries and complaints from the investing public and professional bodies in Hong Kong in relation to the Cancellation and the Suspension.

SFC does not usually comment on individual cases. However, in light of the significant public interest in this matter, SFC issued a statement on 15 May 2020 to inform the public about the actions that SFC has taken, including its communications with the Bank of England’s Prudential Regulation Authority (PRA) and HSBC.

Matters relating to the banking and prudential supervision of HSBC lie outside the SFC's regulatory ambit. SFC communicated with HSBC and PRA to establish the circumstances leading up to the Cancellation and the Suspension. SFC also conveyed to them the views of Hong Kong investing public, including:

• the overall impact on Hong Kong retail shareholders;
• reliance of many Hong Kong retail shareholders on dividend distributions by HSBC as a form of regular income; and
• that the Cancellation was made after the ex-dividend date in relation to the fourth interim dividend.

SFC understands that PRA's request for the Cancellation and the Suspension, and HSBC's agreement to such request, was made after carefully considering and balancing various factors, including the following:

• In line with regulators internationally, PRA has been monitoring the impact of COVID-19 on PRA-regulated firms and their groups and has put in place various measures to advance its general objective during this difficult time.
• As at 31 March 2020, there was a high level of uncertainty as to the duration and impact of the economic implications of COVID-19 on a global basis. PRA noted that there was a real risk of a very rapid reduction in economic activity globally in response to restrictions imposed by a number of governments and a particular need for additional lending to help real economies bridge the gap to the eventual removal of those restrictions.
• PRA considered the need for early action to preserve the capital position of firms in the face of continuing economic uncertainty. Further, PRA has the necessary statutory power to require HSBC to take capital preservation actions and it was clear that PRA stood ready to exercise such powers should HSBC not agree to take the requested action.
• The interests of HSBC's shareholders around the world balanced against the urgent need for capital preservation to finance the global economy during, and following, the COVID-19 pandemic. In particular, the PRA noted that a cessation of dividends to ensure adequate capital to support lending, in the case of HSBC, was likely to benefit the Hong Kong economy as well as the UK and the global economy.
• The announcement made by the European Central Bank on 27 March 2020 recommending banks not to pay dividends or engage in share buy-backs.

Further, according to the board of HSBC, HSBC's long-term interests were best served by acceding to PRA's requests, instead of requiring PRA to exercise its statutory power.

SFC also notes that HSBC received the PRA's direct request for the Cancellation at around 5:03p.m. (London time) on 31 March 2020 and HSBC published its announcement on the Cancellation prior to trading in Hong Kong on 1 April 2020.

SFC has conducted a careful examination of all information available to it to date (including, but not limited to, the matters mentioned above), and assessed it against the threshold criteria for investigating matters under the SFO such as insider dealing, failure to disclose inside information, disclosure of false or misleading information and unfair prejudice to shareholders, and has concluded that there is at present no ground on which regulatory action should be pursued under the SFO in respect of the Cancellation and the Suspension.

SFC's lengthy statement may reveal that it has been under a high political pressure to pursue this matter. Hong Kong, as of today, is still an international financial centre. SFC respects PRA's request and defends HSBC's action.

Checking of SFC licence records

When we check whether a firm or an individual is licensed by SFC, of course we visit SFC's public register. But today I accidentally find another website, which extracts data from SFC's public register but may be useful to a certain extent.

This homepage of SFC Licence Guru lists out licensed corporations with RO/rep most recently licensed. When inputting an individual's name into the search box, you can find out his licence history (no matter his licence is active or inactive) and the link to the official SFC record is also provided. However, you can't get any result by inputing a company name into the search box, which is a limitation.

Of course, David Webb's website can also provide similar licence checking function, where the data are more comprehensive.

Licensing Matters under COVID-19 Pandemic

On 31 Mar 2020, SFC issued the FAQs for "Licensing related matters in light of the COVID-19 pandemic". I would like to make comments on certain messages given by SFC to intermediaries.

All licensed individuals who are originally required, by way of licensing conditions or otherwise, to pass post-licensing regulatory examinations within a prescribed timeframe which falls due on or before 30 Sep 2020, will be allowed an extended period of 3 calendar months after the original due date to meet the requirement.

Comment: This is necessary as HKSI has suspended the regulatory exams (up to 11 Apr 2020, but may be extended due to the potential change of government policy). If the pandemic is not yet put under control, SFC would probably further extend the grace period.

SFC allows all licensed individuals who are unable to fulfil the annual CPT hours by 31 Dec 2020 to carry forward any unfulfilled CPT hours for the calendar year of 2020 to 2021.

Comment: Different from taking exams, fulfilling CPT hours at home (i.e. taking online courses) is perfectly acceptable under SFC's CPT Guidelines, given that it requires the submission of course assignment (e.g. quiz) upon completion.

An LC is required to notify SFC of significant changes in its business plan covering internal controls, organisational structure, contingency plans and related matters, including but not limited to:

• Confirmation of staff infection which may have an impact on the LC’s operations 

• Closing of office premises as a result of staff infection or government lockdown, including overseas office premises, if the closure has implications for the LC’s operations or the carrying on of its regulated activities (e.g. temporary closing of overseas office premises which handles back and middle office functions)

• Changes to its organisational resources (e.g. split team arrangements, staff relocation to overseas offices) 

• The triggering of the LC’s business continuity plan

Comment: It is desirable for SFC to design a questionnaire to facilitate LCs in making such kind of reporting.

While an LC has arranged for its staff to work from home or from its overseas offices which are not premises approved under s130 of the SFO, it should ensure that the staff will be able to remotely access the LC’s trading or other systems, and that the activities conducted by the staff will be captured in the records and documents generated by these systems. If certain records and documents need to be kept in unapproved premises on a temporary basis, the LC should send them back to the approved premises of the LC as soon as practicable.

Comment: During the current extraordinary circumstances, indeed SFC should adopt a lenient approach towards an LC's technical breach of operational rules.

If an LC or AE anticipates delays in preparing its audited accounts or other documents, it may apply for an extension of the submission period asap. SFC will consider these applications pragmatically.

Comment: This year LCs and AEs are required to submit the new version of Business and Risk Management Questionnaire (BRMQ), which is much more lengthy than the old one. Request for delayed submission of BRMQ may be necessary.

Nothing is certain but death and regulations.

Over-charging of Commission in Bond Transactions

As announced on 19 Mar 2020, SFC banned Ms Chan Tan Lo, a former relationship manager of BOCI Securities Limited (BOCIS), for 14 months.

Chan executed nine bond transactions for two clients in Mar 2016, she failed to disclose and/or provided them with inaccurate information about the final execution prices and/or the actual commission rates she charged them. She also overcharged them in these transactions.

Further details are disclosed in the SDA:

• During the regular sample checking of the telephone recordings of the trades executed by its RMs, BOCIS found that in 9 bond transactions Chan executed for the clients from 1 Mar 2016 to 23 Mar 2016, Chan charged them higher commission rates than had been previously agreed with them.
• According to the clients, they agreed with Chan that BOCIS could charge them a commission of 0.2% of the execution price in bond transactions executed on their behalf. The clients were not willing to pay any commission rate higher than 0.2% as had been agreed with BOCIS.
• Audio-recordings of the telephone conversations between Chan and the clients' representative show that during the price quotation stage:

• Chan quoted the best available prices to the clients' representative for the 9 bond transactions.

• Chan either expressly told the clients' representative that there would be a mark-up of 0.2%, or did not correct the clients' representative when he expressed his understanding that there would be a mark-up of 0.2%, or indicate to him that the mark-up might change.

• When the 9 bond transactions were executed at a better price, Chan unilaterally increased the mark-up without informing the clients' representative of the increase and seeking his consent to charge a higher mark-up for the transaction. Chan failed to disclose, and/or provided inaccurate, information to the clients about the actual execution prices and the actual commission rates charged by her, and overcharged the clients commission by 0.2% to 0.8% in the 9 bond transactions.

This is no doubt cheating. This case was revealed by sample checking of telephone recordings. For a better control, the trading system should record the agreed commission rate for the clients and automatically ban any over-charing of commission.

2020-21 Budget - Financial Services

The following points about financial services in the 2020-21 Budget Speech announced on 26 Feb 2019 are relating to the securities industry:

• In order to strengthen the competitiveness of Hong Kong as an ETF listing platform, the Government proposes to waive the stamp duty on stock transfers paid by ETF market makers in the course of creating and redeeming ETF units listed in Hong Kong.
• To attract more private equity funds to Hong Kong, the Government has been making full efforts to introduce new fund structures, including the preparation of new legislation on the establishment of a limited partnership regime that meets the operational needs of funds, so as to encourage the setting up of private equity funds in Hong Kong. The Government also plans to provide tax concession for carried interest issued by private equity funds operating in Hong Kong subject to the fulfilment of certain conditions.
• The Government will further enhance Hong Kong's AML/CTF regime having regard to the recommendations of FATF's evaluation report, and consider incorporating virtual asset service providers and dealers in precious metals, stones and jewellery into the AML/CTF regulatory framework.

Compliance professionals should pay more attention to the last point - further enhancement of the AML/CTF regime.

Challenge to SFC's Investigative Powers Failed

No doubt the SFO has given SFC very strong investigative powers. From time to time market players have attempted to challenge such powers, but this is an uphill battle.

SFC announced on 18 Feb 2020 that the Court of First Instance has dismissed judicial review applications against SFC in connection with a search operation it conducted for ongoing investigations into suspected breaches of the SFO.

The judicial review applications were brought separately and concurrently by Mr Cyril Cheung Ka Ho, Mr To Hang Ming, Mr To Lung Sang, Mr Jacky To Man Choy and Mr Wan Wai Lun. They sought to challenge search warrants issued by two Magistrates in July 2018 on the basis that they were unlawful or invalid for want of specificity.

They also alleged that seizures of the digital devices pursuant to the search warrants, SFC's continued retention of the devices and notices issued by SFC under the SFO for the production of emails or passwords for the devices or email accounts were unlawful, and interfered with their right to privacy under the Basic Law and the Hong Kong Bill of Rights.

The Hon Mr Justice Anderson Chow rejected their applications and held in his judgment that:

• the search warrants plainly authorised digital devices to be seized by SFC. The words "document" or "record" in the SFO should not be narrowly construed, having regard to the manner in which information and data are nowadays being created, transmitted and stored in digital devices;
• the right to privacy is not absolute. The seizures and retention of the digital devices were rationally connected to a legitimate aim. They were no more than reasonably necessary in the circumstances of the cases and they did not result in an unacceptably harsh burden on the five applicants on the facts of the present cases; and
• SFC is empowered, under the SFO, to require the applicants to provide means of access to email accounts and digital devices which contain, or are likely to contain, information relevant to its investigations even though the email accounts and digital devices would likely also contain other personal or private materials which are not relevant to SFC's investigations.

Let's see if those JR applicants would appeal.

Illegal Cross-Border Business Activities

In Jan 2014, SFC issued the circular "Regulatory Compliance regarding Cross-border Business Activities", which warned that before conducting any cross-border business activities, a licensed corporation should make proper enquiry as to how the law of the other jurisdiction applies to the particular activity. Activities which are likely to be regulated under the laws or regulations of other jurisdictions may include:

• solicitation of opening of client accounts
• signing of account agreements or mandates
• marketing or selling of investment products
• entering into transactions of investment products
• giving investment advice

Para 12.1 of the Code of Conduct provides that a licensed person should comply with, and implement and maintain measures appropriate to ensuring compliance with the law and relevant regulatory requirements (including those requirements in other jurisdictions).

As announced in 14 Feb 2020, SFC reprimanded and fined Capital Global Management Limited (CGML) $1.5 million for its failures to ensure compliance with applicable laws and regulations in distributing investment funds and offering investment advice in Taiwan, and to adequately supervise the business activities of its representatives to ensure such compliance.

In August 2015, the Prosecution Office of the Taipei District Court fined the former owners of CGML for distribution of offshore investment funds and offer of investment advice in Taiwan from 2005 to 2014 without obtaining prior approval, in contravention of Taiwan’s Securities Investment Trust and Consulting Act.

Article 16 of the Act provides that "No person may, itself or as an agent, engage within the Republic of China in the public offer, sale, or investment consultancy of offshore funds without first obtaining approval from the Competent Authority or effective registration upon filing with the Competent Authority." The Competent Authority is the Financial Supervisory Commission R.O.C. (Taiwan).

SFC found that CGML's licensed representatives operated and performed sales functions and distributed investment products to clients in Taiwan between July 2014 and April 2015.

I don't understand why a LC would have the fantasy that its SFC licence is an "international driving permit" to let it conduct cross-border business in other jurisdictions. A compliance professional should always question why an overseas-based employee needs a SFC licence, unless she/he wants to be an itinerant professional or temporary licensed representative. 

Suspicious Transactions Arising from Placing

SFC reprimanded and fined BMI Securities Limited (BMISL) $3.7 million for failures in complying with AML/CFT regulatory requirements. It also suspended Ms Maggie Tang Wing Chi, BMISL’s RO, for five and a half months.    

In 2016, a number of BMISL’s clients subscribed for the placing shares of 2 Hong Kong-listed companies and subsequently transferred most or all of these shares to third parties using bought and sold notes in a series of off-exchange transactions.

The off-exchange transactions, whose consideration ranged from $4.4 million to $855.9 million apiece, displayed various suspicious features including:

• the subscription amount for the placing shares was incommensurate with the clients’ financial profile; and
• the clients did not conduct any other transactions in their BMISL accounts apart from acquiring and disposing of the placing shares.

SFC reported those suspicious activities to JFIU.

SFC alleged, during the period from 1 May 2016 to 30 Nov 2017, BMISL failed to:

• implement adequate internal controls to mitigate the ML/TF risk associated with suspicious transactions conducted through bought and sold notes;
• identify, and conduct proper enquiries and sufficient scrutiny on, suspicious transactions and consider reporting them to JFIU;
• perform appropriate CDD and keep customer information up-to-date and relevant; and
• put in place adequate and effective procedures for the identification of PEP and the screening of terrorist and sanction designations.

The SDA revealed 3 cases indicating BMISL's failure to identify and conduct proper enquiries and scrutiny on suspicious transactions. Those red flags were in fact too obvious to be ignored. BMISL as the placing agent should not turn a blind eye to the subsequent off-exchange transfers of those placed shares.

With reference to this case, compliance professionals should include those red flags highlighted by SFC in their AML monitoring program.

SFC's Arrangements under Coronavirus Outbreak

Many financial institutions in Hong Kong have allowed part of their staff to work from home to reduce the coronavirus infection risk. Today SFC also announced that it has allowed some staff to work from home or remotely.

SFC said its response times in some areas may be longer than normal. This may affect licensing applications, product applications, and public complaints and enquiry service.  

SFC still expects licensed corporations to make all reasonable efforts to maintain "business as usual" in relation to their regulatory obligations and all regulatory filing, reporting and other deadlines. However, if they encounter specific difficulties arising from the coronavirus situation, they are encouraged to communicate promptly with their usual contact points at SFC.

I have the following suggestions for SFC:

• To reduce the exchange of correspondences via physical copies. SFC should encourage licensed corporations to submit letters and documents by email or online portal.
• To provide a longer period for licensed corporations to respond to regulatory enquiries or surveillance/investigation notices.
• To take a more lenient approach towards licensed corporations' difficulties in complying with certain operational regulations (e.g. Contract Notes Rules).
• To extend the deadline (4 months after the financial year end) for licensed corporations to submit their annual audited accounts if the statutory audit can't be timely completed.

Subsequent update on 7 Feb 2020:

• I just received the following notice from SFC: Owing to the current situation relating to novel coronavirus, certain LCs may encounter operational difficulties in making the required submission of their audited accounts within the timeframe mentioned above. If a LC anticipates delay in preparing its audited accounts or other documents, it may apply for an extension of the submission period. SFC will take into account the impact of the coronavirus situation on the LC as well as its auditors when handling the application.

Compliance vs Coronavirus

With the outbreak of coronavirus, the Hongkong Post has suspended office counter service, mail delivery service and mail collection from posting boxes from 29 January to 2 February 2020.  As a result, securities firms are facing the difficulty of complying with the Securities and Futures (Contract Notes, Statements of Account and Receipts) Rules (CNR)...they have failed to deliver the contract notes and statements within the statutory deadline (T+2).

If contract notes / statements could be left at the counter of Hongkong Post (with delivery delayed), then there is no problem because those mails have already been "served" (i.e. out of the securities firm's hand).  Unfortunately, now Hongkong Post's mail collection service is also halted.

Though most of the investors should have chosen the receipt of contract notes and statements by email, there is a certain demand (esp. from senior citizens) for hard copies.

In principle, securities firms may take other means (e.g. courier service) to deliver the mails, but the cost is prohibitively high.

If a securities firm fails to send out contract notes / statements timely, it should report such technical breach to SFC under s18 of the CNR within 1 business day, even though the delayed delivery is not caused by internal operational matter (thanks CCP).

Probably SFC had received too many enquiries within this week, yesterday it issued an email to inform all licensed corporations that they are NOT expected to give the s18 report where the delay is caused by the suspension of postal service.

This is "Law in the Time of Cholera" (法在瘟疫蔓延時)!