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)!