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)!

SFC's Licensing Guidance for PE Firms and Family Offices

On 7 Jan 2020, SFC issued guidance on the licensing obligations of private equity (PE) firms and family offices which conduct business in Hong Kong.

In the circular for PE firms, SFC provides more information about the licensing requirements for PE firms’ general partners, investment committee members and fund marketing activities. It also clarifies how SFC assesses PE firms’ discretionary investment authority and investments in securities of private companies as well as the industry experience requirement for their responsible officers.

Key points of the circular for PE firms:

• It is common for a PE fund to be constituted in the form of a limited partnership, where the general partner (GP) assumes ultimate responsibility for the management and control of the fund in return for management fees, carried interest or other remuneration. Then the GP should be licensed for RA9 if it conducts fund management business in Hong Kong.However, GPs themselves would not need to be licensed for RA9 if they have fully delegated all of the asset management functions to another entity which is licensed for RA9.
• To differentiate RA9 from RA4 or RA5, SFC takes the view that licensed asset managers must be granted full discretionary investment authority in respect of the funds they manage.
• Some PE firms licensed for RA9 have established investment committees in Hong Kong for the funds they manage. Members of an investment committee who play a dominant role in making investment decisions for the funds should be licensed as representatives or approved as ROs.  But members who do not have any voting right or veto power for investment decisions and their primary role is to provide input from a legal, compliance or internal control perspective would not need to be licensed.
• Many PE funds set up SPVs, incorporated locally or overseas, for investment holding purposes. In determining whether an investment portfolio of a PE fund comprises securities or futures contracts for the purposes of RA9, SFC will consider the composition of the entire investment portfolio. If underlying investments held through SPVs fall within the definition of "securities" (even if the SPVs are carved out) or the SPVs themselves fall within the definition of "securities", SFC will regard the management of the portfolio as RA9.
• If a PE firm offers investment opportunities to other persons whereby they may enter into securities transactions alongside the PE fund, the firm should be licensed for RA1. Nonetheless, the PE firm may not need to be licensed for RA1 if it is licensed for RA9 to manage the PE fund and its act of offering the co-investment opportunities is conducted solely for the purposes of carrying on RA9.

You may still remember in Oct 2019 SFC fined SEAVI Advent Ocean Private Equity Limited (SAOPEL) $1 million because it had allowed its director and an investment manager, both unlicensed, to conduct regulated activities by introducing clients to invest in the fund managed by SAOPEL, answering clients' queries and arranging for execution of the subscription agreements for the fund.


In the circular for family offices intending to carry out asset management or other services in Hong Kong, SFC explains the potential implications for both single and multi-family offices. Licensing exemptions, or carve-outs, may be available depending on how a family office operates.

Key points of the circular for family offices:

• A family office set up as a business to manage assets which include securities or futures contracts may be required to hold a licence for RA9. The licensing implications of providing asset management services in Hong Kong do not hinge on whether clients are families. The relationships amongst the beneficiaries of a family trust or between family members are not relevant in determining whether a licence is required.
• The way in which a single family office operates can lead to different consequences under the licensing regime.
• In cases where a family appoints a trustee to hold its assets of a family trust, and the trustee operates a family office as an internal unit to manage the trust assets, the family office will not need a licence because it will not be providing asset management services to a third party.
• If the family office is established as a separate legal entity which is wholly owned by a trustee or a company that holds the assets of the family, it will not need a licence if it provides asset management services solely to related entities (i.e. intra-group carve-out).
• A multi-family office serves more than one high net worth family. If it provides services to clients who are not related entities, it will not be able to make use of the intra-group carve-out.

Licensing is only the first step. I look forward to seeing more specific regulations (like Code of Conduct) formulated by SFC for PE firms and family offices.

RHB Securities and Inadequate Compliance Monitoring

On 2 Jan 2020, SFC reprimanded and fined RHB Securities Hong Kong Limited (RHBSHK) $6.4 million for its failures to comply with regulatory requirements on conflicts of interest and supervision of account executives.

SFC found that RHBSHK failed to:

• effectively implement its policy for avoiding actual and potential conflicts of interest between its research reports and investment banking relationships;
• adequately disclose its investment banking relationship with the listed company covered in a research report; and
• effectively monitor the trading activities of its research analysts.

SFC further found that RHBSHK did not have adequate controls to supervise its account executives (AEs).  In particular, the frequency and extent of its sample checking procedures for ensuring that client orders received by AEs through telephone are tape-recorded are not commensurate with the size of RHBSHK's business.  As a result, the discretionary trading activities without written authorization of an account executive went undetected for 23 months.

The Statement of Disciplinary Action of this case revealed that:

• RHBSHK explained that the discretionary trading went undetected because the client account and the account executive were not selected in its sample telephone recording checking. The sample checking only involved checking the order records of 10 trades each month.
• At the material time, RHBSHK had over 70 AEs, its sample checking of 10 orders each month is inadequate to offer any meaningful control for the detection and prevention of irregularities stemming from missing telephone recordings of order instructions.

I am not sure to what extent the penalty imposed on RBHSHK was attributable to the inadequate compliance monitoring to detect trading irregularity.  This case may shed some light on SFC's benchmark of effective sample checking.  Would SFC sanction RHBSHK's MIC of Compliance later?


Subsequent update on 29 Jan 2020:

• SFC announced the suspension of RHBSHK's AE Mr Shiu Yau Wah for 5 months, because he conducted trades involving over $1.62 billion worth of shares for a client account on a discretionary basis for almost two years between 2014 and 2016 without obtaining the client's written authorization.

Subsequent update on 6 Feb 2020:

• SFC announced that it has banned Mr Christopher Tse, a former research analyst at RHBSHK, from re-entering the industry for 12 months.
• Tse conducted trades through his father's securities trading account held at another brokerage between August 2013 and October 2015 without informing RHBSHK, and traded in a stock on RHBSHK's restricted list on two occasions. 
• Some of the trades conducted by Tse through his father's account between November 2013 and July 2015 were: (a) in a manner contrary to his recommendations; and (b) in the shares of companies covered in some of his research reports within 30 days prior to or three days after the issue of the reports.  
• Tse also failed to disclose his financial interests in his father's account in relation to four companies in a number of research reports between September 2013 and June 2015.

Accredited Investor Definition to be Amended

Recently US SEC voted to propose amendments to the definition of accredited investor, one of the principal tests for who is eligible to participate in our private capital markets. The proposal seeks to update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in our private capital markets.

SEC expressed that the current test for individual accredited investor status takes a binary approach to who does and does not qualify based only a person's income or net worth. Modernization of this approach is long overdue. The proposal would add additional means for individuals to qualify to participate in our private capital markets based on established, clear measures of financial sophistication.

The proposed amendments would allow more investors to participate in private offerings by adding new categories of natural persons that may qualify as accredited investors based on their professional knowledge, experience, or certifications. The proposal would also expand the list of entities that may qualify as accredited investors by, among other things, allowing any entity that meets an investments test to qualify.

"Professional investor" (PI) defined under the SFO is akin to accredited investor. In particular, Category-B PIs (corporate and individual) are subject only to the asset test, which is totally unrelated to "professionalism". I strongly recommend SFC to adopt SEC's proposal by amending the PI definition as well.

PWM Regulation Needs Improvement

In Oct 2019, PWMA and KPMG jointly published the Hong Kong Private Wealth Management Report 2019. I want to reproduce certain key contents about regulation from this report below:

• A key challenge faced by PWM institutions is the large number of circulars issued – some of which cover common areas between the HKMA and SFC – which have created complexity in the interpretation of regulations and difficulties in effectively updating processes and controls to remain compliant.
• Interviewed PWM executives have observed conflicting approaches between the 'principles-based' regulatory guidelines which infer greater flexibility in interpretation and implementation, and the findings from on-the-ground regulatory examinations which take a more prescriptive approach.
• Clients most commonly cited 'providing evidence for source of wealth', 'trade by trade disclosure requirements' and 'trade by trade investment suitability requirements' as the biggest pain points in their Hong Kong PWM experience in terms of time and administrative effort.

I share the view that the above issues would place Hong Kong at a disadvantage compared to other key PWM hubs.

Use of Cloud Services for Record Keeping

Under S.130 of the SFO, a licensed corporation shall not, without SFC’s prior written approval, use any premises for keeping records or documents relating to the carrying on of the regulated activity for which it is licensed. Basically SFC would not approve a premise outside Hong Kong because SFC can only conduct onsite inspection in Hong Kong.

But how about a LC makes use of cloud storage services to keep records?

On 31 Oct 2019, SFC issued the circular "Use of external electronic data storage", which states that when using external electronic data storage providers (EDSPs) for keeping Regulatory Records, LCs should remain in full compliance with the existing regulatory requirements. LCs should ensure that SFC’s access to Regulatory Records, in a legible form, pursuant to the exercise of its regulatory powers is not restricted or otherwise undermined, and that these Regulatory Records have not been deleted or tampered with. 

The authenticity, integrity and reliability of Regulatory Records, as well as the ability to access them promptly, are paramount if such records are required to be produced in legal proceedings initiated by SFC or DoJ.

Please refer to the circular for technical details. Simply speaking, if a LC wishes to keep any Regulatory Records exclusively with an EDSP, it should ensure compliance with the those requirements in the circular, including but not limited to the following:

• The EDSP (i) is either a company incorporated in HK or a non-HK company registered under the Companies Ordinance, in each case staffed by personnel operating in HK, and (ii) provides data storage to the LC at a data centre located in HK.
• As an alternative, if the EDSP is not a Hong Kong EDSP, the LC must obtain an undertaking by the EDSP to provide Regulatory Records and assistance as may be requested by SFC.
• The LC should seek approval for the premises used for keeping Regulatory Records under S.130 of the SFO.

However, the above requirements do not apply to:

• a LC which keeps Regulatory Records with an EDSP if the LC contemporaneously also keeps a full set of identical Regulatory Records at premises used by the LC in HK approved under section 130 of the SFO, for example when cloud storage is only used for the purposes of data backup or ensuring data availability; or
• a LC which uses computing services without keeping any Regulatory Records with an EDSP, for example where cloud computing services are only used for computations and analytics while Regulatory Records are kept at the premises of the LC.

Regulators are naturally prudent towards cloud-based systems due to security concerns, but in today's technology world they have to embrace fintech for maintaining financial market efficiency.