Legislative Council

LC Paper No. CB(1)1236/98-99

Ref : CB1/SS/8/98

Purpose

This paper reports on the deliberations of the Subcommittee on Securities (Dealers, Investment Advisers, Partnerships and Representatives) (Amendment) Rules 1999 ("the Amendment Rules").

Background

2. Subsequent to the Government's operation in the securities and futures markets in August 1998, a 30-point programme was announced for strengthening the order and transparency of the markets. One of the measures was the strict enforcement of compulsory buy-in for outstanding stock positions which failed to settle by T+2 (i.e., two days after the date of the transaction). To implement this measure, the Hong Kong Securities Clearing Company Limited ("HKSCC") which operates the Central Clearing and Settlement System ("CCASS") proposes to launch a compulsory securities borrowing ("CSB") mechanism. Under this mechanism, HKSCC will borrow, as a principal, securities to deliver to buyers in cases where sellers default on their delivery obligations on T+2. Without this mechanism, buyers would have to wait until T+3 to T+5 for delivery of the securities following a default on the part of the sellers.

The Amendment Rules

3. Under rule 15 of the Principal Rules, a dealer is prohibited from being a party to securities borrowing unless he first enters into a written agreement with the other party to the securities borrowing. The written agreement must:

1. require the borrower to deposit with the lender collateral for the borrowed securities exceeding the market value of those securities;
   
   
2. require daily valuation by both parties of the borrowed securities and collateral deposited;
   
   
3. specify the circumstances in which each party is entitled to terminate the securities borrowing; and
   
   
4. specify the rights and liabilities of a party in the event of a default by either party.

4. The Amendment Rule amends rule 15 of the Principal Rules so that the above provisions will not apply to securities borrowing of Hong Kong stock by a recognized clearing house i.e., HKSCC. Hence, HKSCC as the borrower in CSB transactions and the broker lending the securities will not be required to enter into a written agreement and HKSCC will not be required to deposit collateral with lenders of securities.

The Subcommittee

5. At the meeting of the House Committee on 16 April 1999, Members decided to form a Subcommittee to study the subsidiary legislation. Hon SIN Chung-kai was elected as Chairman and the Subcommittee has held one meeting with the Administration to discuss the Amendment Rules. The membership list of the Subcommittee is at Appendix I.

Deliberations of the Subcommittee

6. Under CSB, HKSCC as the borrower in CSB transactions would not deposit collateral with lenders of securities because of the risk that lenders may not be able to return collateral to HKSCC upon the closing of CSB transactions. Members have pointed out that the risk originally borne by HKSCC as a clearing house would then be shared out with the lenders of securities to HKSCC. The risk would be passed on to the lenders of securities to HKSCC during the extreme situation where a defaulting seller could not deliver shares of substantial value to HKSCC which, if not backed by the Government, might also be forced to default. The Administration recognizes that the introduction of CSB would not add to nor reduce the overall market risk. However, members have been assured that lenders can rely on HKSCC's creditworthiness, and the risk management mechanisms that it applies to control its exposure to participants' defaults, to guarantee the return of securities to the lenders. The credibility of HKSCC is also demonstrated by its ability to withstand a variety of market conditions since its establishment in effecting orderly settlement of securities transactions, particularly in the financial turmoils in recent years. Besides, there are many options and market instruments available for market participants to reduce their exposure to risks, such as intra day margin calls.

7. The Administration has also clarified that lenders' participation in CSB is entirely voluntary and even after joining the scheme, lenders can choose to maintain any amount and type of securities in the lending account. Furthermore, lenders of securities can at any time demand return within five business days the securities borrowed. Hence the word "compulsory" within the term "compulsory securities borrowing" is only appropriate from the perspective of defaulting sellers.

8. On the part of HKSCC, members are concerned about whether there are any existing measures or regulations which can prevent the company from inappropriate accumulation of shares from CSB transactions, since HKSCC's holding of stock positions could impact on the availability of shares in the market. According to the Administration, under the CCASS Rules HKSCC is only allowed to effect a compulsory share borrowing transaction under two conditions:

1. to meet the aggregate of its delivery obligations to buyers of securities in cases where sellers default on their delivery obligations by day-end of T+2; or
   
   
2. to replace, in whole or in part, its stock borrowing under any other compulsory stock borrowing transaction.

HKSCC's objects as stated in its Memorandum also restrict any trading of shares except for clearing and settlement purposes. Although any transaction exceeding the scope of the company's capacity as set out in the Memorandum is not invalid, a member of the company may bring a legal action to restrain the company from acting in breach of its Memorandum. However, the Subcommittee also noted in section 5B(2) of the Companies Ordinance (Cap.32) that if rights or obligations were incurred by the company, members of the company could not restrain the company in fulfilling those obligations.

9. In addition, under section 50 of the Securities and Futures Commission Ordinance (Cap. 24), the Securities and Futures Commission (SFC) has the power to prohibit HKSCC from accumulating shares inappropriately in relation to, inter alia, the conduct or operation of its business as SFC may deem appropriate for the protection of investors or the proper regulation of the clearing house. The Administration has also pointed out that the computer system of CCASS is programmed in such a way that whenever HKSCC's stock account is credited with securities and there are no outstanding delivery obligations to meet, the system will automatically re-deliver the securities to terminate a stock loan. Furthermore, the Administration considers that HKSCC should have no incentive to hold securities borrowed for any unnecessarily long period as it is a non-profit making organization and the borrowed securities would incur a daily charge.

10. Noting the Administration's clarifications on the issues raised above, the Subcommittee has not raised any objection to the Amendment Rules.

Advice Sought

11. Members are invited to note the deliberations of the Subcommittee as described in paragraphs 6 to 10 above.


Legislative Council Secretariat
28 April 1999

附錄 I
Appendix I