26 May 1999

Dear the Honourable Legislative Councillors,

In the past year or so, the Asian financial turmoil swept through Hong Kong has caused local economy to come under tremendous strain. In order to restructure the local financial market with a view to restoring confidence, the Government proposed to amend the legislation concerning the regulation of the securities industry. As representatives of the trade, we would like to put forward the views of the securities industry on the proposed regulation on securities margin financing.

Our financial market experienced sharp escalation to excessive heights in the past. We agree that after the steep decline in the stock market, the regulatory framework should be reviewed and improvements should be made. We are also in support of bringing the securities margin financing companies within the scope of regulation so as to protect the interests of public investors and the market as a whole. In fact, as a result of the recent slump in the stock market, the downturn of our economy, the sharp fall in the turnover, coupled with the fact that banks tightened their policies on processing loans, there were fewer transactions done through margin trading.

During the bull run in 1997, the buoyancy in the stock market was largely supported by securities margin financing activities. It was estimated that out of the total turnover, about 50% of transactions were done through margin trading at that time. Obviously, margin trading was the driving force of market growth. Undoubtedly, the lack of proper regulation leads to over-exposure to clients by individual finance companies. Investors thus suffer losses and the reputation of Hong Kong as an international financial centre is badly damaged. When such regulation is legislated for in the future, the Government must also take into account that the transparency of the finance companies will be enhanced substantially after bringing them within the scope of regulation. Like the current practice of regulating the registered securities dealers conducting securities margin financing business, an early warning system of risks will then be established. As for other legislation relating to risk management, the Government has to take into account the acceptability of the market and avoid turning the securities margin financing business into a commercially non-viable operation which will directly stifle the development of the stock market.

Given that the securities margin financing activities should be brought within the scope of regulation and the importance of risk management control, we thereby recommend the passage of the Bill, supplemented with subsidiary legislation or guidelines. Once enacted, the law should be enforced by front line regulatory bodies such as SFC and SEHK which should make appropriate adjustments to the rules from time to time in light of the changes in the market. In this way, the securities margin financing operators can continue to conduct their business under the appropriate level of supervision by the regulatory bodies.

A summary of views on the Bill is attached (see Annex) for your thorough consideration. We hope that having undergone the difficulties following the financial turmoil and with our co-operative efforts, the local economy will soon recover.

Yours faithfully,


Hong Kong Stockbrokers
Association Ltd.

D4/S116.DOC/J

Newly Proposed Regulation of Share Margin Financing

1. We agree that non-members of SEHK should be allowed to provide share margin financing facilities.

2. The continual practice of pooling system is vital to the survival of share margin financing business. With the supplement of the following proposals and administrative measures, adequate regulation can be exercised over its operation. As banks provide share margin financing facilities on a wholesale level, they cannot afford the complicated procedures of dealing directly with retail customers once the pooling system is banned. The pooling system is therefore the only way to support the share margin financing market.

3. We agree to the proposed minimum paid-up capital of $10 million.

4. Risk Concentration

1. We propose that concentrated risk adjustment be exempted under the following circumstances:

• the aggregate value of collateral in respect of different stocks does not exceed the amount of capital.
  
  
• the aggregate value of collateral in respect of different clients does not exceed the amount of capital.

2. We are against the proposal for including the stocks of related companies in the ranking liabilities as mentioned in the consultation paper. It is very common for a listed company in Hong Kong to hold 30% or more of the shares of another listed company. Cross-ownership of shares can be found in companies such as HSBC and Heng Sang Bank, and Cheung Kong, Hutchison Whampoa, Hong Kong Electric and CKI Holdings. If stocks of related companies are regarded as an individual stock, not only will the intended purpose of risk management be defeated, the dealers will also be forced to diversify their portfolio by trading in second-rate securities that involve higher risk.
   
   
3. Regarding the proposal of "including in ranking liabilities any excess of the value of any individual stock over 10% of the total value of stock collateral", we request to raise this percentage to 20% in order to allow more flexibility in meeting the demand of the market. Meanwhile, the total ranking liabilities should not exceed the total value of the entire loan portfolio.

5. We propose that, with a view to providing the clients with flexible investment choices, they should be allowed to dispose the stock-secured loans offered by securities companies in activities apart from securities trading and making transaction settlements. For example, they can invest the money in the futures market for arbitrage purpose and in the subscription for new shares.

6. Finance companies will soon be brought within the regulatory ambit which requires them to report at any time upon specific request of the supervisory bodies. For the preservation of their clients' commercial secrets and right to privacy, these companies should not be obliged to disclose the information of their top 20 margin clients. As the clients' accounts vary widely, depending on the size of the finance companies, submitting regular returns to disclose information on the top clients cannot achieve the aim of supervision. In addition to increasing the daily workload of the finance companies, this requirement may also help promote unfair competition among these companies because the clients of small finance companies will turn to large finance companies in order to prevent their information from being disclosed without reason.

7. Regarding the proposals for the code of business standards, some of them are either business decisions or not enforceable both in practice and in operation. Instead of including these proposals in the code of business standards of the securities industry, they should only be used as guidelines. We would like to give our further opinions on the following proposals:

1. As real-time settlement is not adopted for securities transaction, even if the broker ensures that his client has the required financial capacity on the trade day, he cannot ensure that the settlement obligation can still be met two days later. We therefore propose to follow the practice of the short selling system by letting the clients prove by themselves their financial capacity for meeting obligations arising from their transaction instructions.
   
   
2. Securities dealers should only be required to inform the clients that the securities held as margin collateral can be deposited or pledged with licensed banks and authorized financial institutions or the Hong Kong Securities Clearing Company Limited, and to make an appropriate risk disclosure statement but the exact place where the securities are kept need not be specified.
   
   
3. We agree that information as to whether an authorization letter under section 81(3) of the Securities Ordinance has been signed and the expiry date thereof should be included in the statements of accounts but not necessarily every statement of account.

8. The transitional arrangements propose that finance companies be given 30 days from the taking effect of the relevant legislation to decide whether to continue their business. Although the finance companies which have applied for continuing their business may be issued with a licence at the same time, the relevant legislation will come into effect in six months cross the board to avoid confusion arising from the application of the existing and the new legislation during the transitional period. For those who decide not to apply for continuing their finance business, they must cease operations on the expiry of the 30 day period. Meanwhile, those who have their applications rejected should be allowed to lodge an appeal. If they lose on appeal, they must also cease operations within 30 days.

9. The consultation paper does not discuss the requirements for capital base and risk management under the circumstances where a broker subscribes for new shares and underwrites securities (including foreign securities) on behalf of his client. These activities constitute an important element of the share margin financing business and have considerable effect on securities brokers. We hope that the Administration will consult the industry once specific proposals are available.