LC Paper No. LS140/98-99

Objects of the Bill

To amend the Securities Ordinance (Cap. 333) ("the Ordinance") to provide for :-

1. the registration of securities margin financiers; and
   
   
2. the regulation of the business of securities margin financing carried on in Hong Kong relating to listed securities;

and to provide for related matters.

LegCo Brief Reference

2. SU B49/99 issued by the Financial Services Bureau.

Date of First Reading

3. 31 March 1999.

Background

4. Securities margin financing activities operated other than by securities dealers are not subject to regulation. The Asian financial turmoil caused several companies carrying on securities margin financing business to collapse. The problems arising from the absence of regulation were made apparent. As a policy response, an inter-agency working group comprising representatives from the Financial Services Bureau, the Hong Kong Monetary Authority, the Securities and Futures Commission, the Stock Exchange of Hong Kong, the Companies Registry and Department of Justice was established in December 1997 to study the issue of regulating the securities margin financing activities carried on by financial companies associated with stockbrokers.

5. The working group completed its study and published its recommendations in the form of a consultation paper in early May 1998. The public consultation ended on 8 July 1998. The working group took into account the comments received and revised its recommendations. It proposed a new regulatory regime which has the following key features :-

1. registration under the Ordinance;
   
   
2. prudential rules on financial resources;
   
   
3. enhanced protection for clients' assets; and
   
   
4. standards for business practices.

Members may refer to the LegCo Brief for further information.

Comments

6. The Bill seeks to establish the legal framework for the new regulatory regime governing the business of securities margin financing. The more significant provisions are summarised below.

Registration under the Ordinance

7. The Ordinance is added a new Part XA which consists of 9 divisions covering the registration of securities margin financiers, conduct of securities margin financing businesses, contracts with unregistered financiers, accounting records, trust accounts and auditing of accounting and other records of the financiers.

8. After the coming into operation of the proposed amendments, a person must not carry on a business of securities margin financing or hold himself out as carrying on such a business unless registered as a securities margin financier (proposed section 121C). The registration is with the Securities and Futures Commission ("SFC"). Only a company that carries on only the business of securities margin financing may be registered as securities margin financier ("registered financier") and only a natural person who has reached 18 years of age is eligible to be registered as securities margin financier's representative ("registered representative") (proposed section 121E).

9. A registered financier cannot lawfully carry on a business of securities margin financing unless at least one of its directors is approved by the SFC (proposed section 121I).

10. One of the grounds upon which the SFC must refuse an application for registration is that it is not satisfied that the applicant is a fit and proper person to be registered (proposed sections 121G and 121H).

11. A certificate of registration will be issued to each successful applicant (proposed section 121M) subject to such conditions and restrictions as may be prescribed by Commission rules or imposed by the SFC at any time during the currency of the registration (proposed section 121J). The names of the registered financiers and the registered representatives will be published in the Gazette annually (proposed section 121P).

12. The SFC has power to revoke or suspend the registration of a registered financier or a registered representative (proposed sections 121R and 121T). It also has wide powers of inquiry into any misconduct and related matters of a registered financier and its officers or a registered representative (proposed sections 121S and 121U).

Conduct of Securities Margin Financing Business

13. A registered financier must provide a statement of account to each of its clients not later than the end of the next business day after entering into any of the following transactions :-

1. a deposit or withdrawal of securities collateral or money by or on behalf of the client;
   
   
2. a disposal of any of the client's securities collateral;
   
   
3. an adjustment of the terms on which financial accommodation is provided to the client;
   
   
4. any credit or debit of the client's account (proposed section 121Y).

The statement of account must include the particulars specified in the proposed section 121Y(3) and be kept for 2 years.

14. A registered financier must also provide a monthly statement of account to each of its clients within 7 business days after the end of each calendar month (proposed section 121Y(4)). Such statement of account should include the particulars specified in the proposed section 121Y(5) and be kept for 6 years. These statements have to be provided upon request by a client or made available for inspecting if the SFC so directs (proposed section 121Z).

Accounting Records

15. The registered financier must keep accounting records in compliance with the requirements under the proposed section 121AI and lodge annual financial statements and its auditor's report with the SFC within 4 months after the end of each financial year in compliance with the proposed section 121AK.

Trust Accounts

16. A registered financier must pay within 4 business days after receipt all client's money into a trust account expressly so designated and opened with a licensed bank (proposed sections 121AM and 121AO).

Protection of Clients' Assets

17. A registered financier may :-

1. deposit its client's securities with an authorised financial institution or a registered dealer as collateral for financial accommodation provided to the registered financier; or
   
   
2. dispose of these securities in settlement of (i) the client's obligation to maintain an agreed level of margin or (ii) any liability of the client to repay the financial accommodation provided by the financier,

only with the written authority of the client or as permitted by the Commission rules. Such authority is only effective if it specifies the period for which it is valid. It shall be valid for the shorter of such specified period or 12 months of the giving of the authority and may be renewed in writing for a period of not more than 12 months at any one time (proposed section 121AA).

18. A registered financier must notify the SFC when it becomes aware or ought to have become aware that it cannot comply with the financial resources rules made under the Securities and Futures Commission Ordinance (Cap. 24). It must also cease to provide further financial accommodation other than to honour the agreement made before it becomes aware of the aforesaid contingency (proposed section 121AB)

Auditing Requirement

19. Each registered financier has to appoint an auditor to audit its accounting and other records (proposed section 121AT). The auditor so appointed is under a statutory duty to report any matter that in his opinion adversely and materially affects the financier's financial position or constitutes a contravention of the proposed section 121AA or 121AI, Division 6 or the financial resources rules or any qualification on adverse statement that the auditor has included or intends to include in his report on the financier's annual financial statements (proposed section 121AW).

Contract with Unregistered Financier

20. A client who has entered into a contract with an unregistered securities margin financier ("unregistered financier") has the right either to give the unregistered financier notice to rescind the contract within 28 days after becoming aware of the facts entitling him to do so or to apply to the court within a reasonable time for an order varying the contract or placing the client in a position as nearly as possible as if he had effectively rescind the contract for misrepresentation by the unregistered financier (proposed sections 121AD & 121AF). Neither the notice nor the court order shall prejudice any right or property interest of a bone fide purchaser for valuable consideration without notice.

21. After a client has served the notice to rescind under the proposed section 121AD, if the notice is effective, the client or the unregistered financier may and, if the notice is not effective, the client may apply to the Court for an appropriate order under the respective proposed sections 121AE and 121AG. The provisions under the Division 4 shall not affect the statutory or common law rules of misrepresentation (proposed section 121AH).

Consequential Amendments

22. Consequential amendments to the Ordinance comprise of three categories :-

1. the additions to the definitions in section 2(1) of the Ordinance to accommodate the new provisions introduced by the Bill;
   
   
2. the addition of substantive provisions in respect of the registered dealers' duties to his clients and the empowering of the SFC to make Commission rules and the power of the Chief Executive to make regulations prescribing contravention against Commission rules as offences; and
   
   
3. purely technical amendments to achieve consistency in the usage of expressions and terms.

Substantive Provisions

23. The existing sections 77 and 81 of the Ordinance are to be repealed and substituted by new sections, which together with the new sections 75A, 81A and 81B, impose on the registered dealers the duty to provide statement of accounts to his clients; and restriction on disposition of securities and on disposition of securities collateral. These provisions are similar to those applicable to the registered financier.

24. The existing sections 146 and 146A of the Ordinance are to be repealed and substituted by a new section 146 whereby the SFC is empowered to make rules to provide for matters that are covered by the existing sections 146 and 146A. The rules to be made under the new section 146 are called the Commission rules and are not subsidiary legislation. They are not subject to scrutiny by the Legislative Council. The rules already made will continue to remain in force as Commission rules.

25. A new section 146A is to be introduced to give the Chief Executive in Council the power to make regulations prescribing contravention of any specific Commission rules to be an offence subject to the stated penalties. The existing regulation will continue to remain in force as a regulation made under section 146A.

Other Consequential Amendments

26. The consequential amendments to the Securities and Futures Commission Ordinance (Cap. 24), Money Lender Ordinance (Cap. 163), Commodities Trading Ordinance (Cap. 250), and Stock Exchange Unification Ordinance (Cap. 361) are mainly of technical nature.

Public Consultation

27. There was a two-month public consultation on the proposed regulatory regime for securities margin financing which ended on 8 July 1998. According to the LegCo Brief, the reaction of the respondents are generally supportive of the initiative to bring securities margin financing under the supervision of the SFC and their views on specific proposals have been taken into account in the finalised proposal.

Consultation with LegCo Panel

28. The members of the Financial Affairs Panel of the Legislative Council have been briefed at its meeting on 7 January 1999 on the proposed regulatory regime.

Recommendation

29. Since the Bill is to set the legal framework for the regulation of the business of securities margin financing in Hong Kong and will have significant impact on the future of Hong Kong as a financial services centre, it may be appropriate for Members to form a Bills Committee to study the policy and legal aspects of the Bill in detail. The Legal Service Division is seeking clarification from the Administration on certain legal and drafting points.


Prepared by


KAU Kin-wah
Assistant Legal Adviser
Legislative Council Secretariat
12 April 1999