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.