LC Paper No. CB(1)815/98-99
(These minutes have been
seen by the Administration)

Ref : CB1/PL/FA/1

Members present :

Hon Ambrose LAU Hon-chuen, JP (Chairman)
Hon Kenneth TING Woo-shou, JP
Hon James TIEN Pei-chun, JP
Hon David CHU Yu-lin
Hon Cyd HO Sau-lan
Hon Albert HO Chun-yan
Hon NG Leung-sing
Hon Margaret NG
Hon Ronald ARCULLI, JP
Hon James TO Kun-sun
Hon CHEUNG Man-kwong
Hon Ambrose CHEUNG Wing-sum, JP
Dr Hon Philip WONG Yu-hong
Hon Jasper TSANG Yok-sing, JP

Members attending:

Hon Martin LEE Chu-ming, SC, JP
Hon Fred LI Wah-ming
Hon CHAN Yuen-han
Hon LAU Kong-wah
Hon Emily LAU Wai-hing, JP

Members absent :

Hon Eric LI Ka-cheung, JP (Deputy Chairman)
Dr Hon David LI Kwok-po, JP
Hon HUI Cheung-ching
Hon Bernard CHAN
Hon SIN Chung-kai
Hon Timothy FOK Tsun-ting, JP

Public officers attending :

Mrs Rebecca LAI, JP

Secretary for Financial Services (Acting)

Mr Bryan CHAN

Principal Assistant Secretary for Financial Services

Mrs Laura CHA, JP

Acting Chairman, Securities and Futures Commission

Mr David WHITE, JP

Executive Director (Supervision of Markets),

Securities and Futures Commission

Attendance by invitation:

Stock Exchange of Hong Kong

Mr H C LEE, JP

Chairman

Mr Alec TSUI

Chief Executive

Hong Kong Futures Exchange

Dr Geoffrey YEH

Chairman

Mr William GROSSMAN

General Counsel

Hong Kong Securities Clearing Company Ltd.

Mr John CHAN

Chairman

Mr Stewart SHING

Chief Executive

Clerk in attendance :

Ms Estella CHAN,

Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG,

Assistant Secretary General 1

Mr Andy LAU,

Senior Assistant Secretary (1) 6

I Actions taken by Government in the foreign exchange, stock and futures markets


Due to the time constraint at the last meeting on 8 September 1998, members agreed to invite representatives of the Administration and relevant regulatory bodies again to this meeting to continue the discussion on actions taken by Government in the foreign exchange, stock and futures markets.

Hong Kong Securities Clearing
T+2 settlement rule

2. Mr Philip WONG Yu-hong said that as far as he was aware, the settlement rule of T+2 was adopted by the then Financial Secretary in April 1990 after extensive consultation with the industry. He queried why the rule was not properly reflected in the General Rules and the Operational Procedures of the Central Clearing and Settlement System (CCASS). He opined that the flexible arrangement whereby a compulsory buy-in could only be effected by Hong Kong Securities Clearing Company Limited (HKSCC) for brokers if their outstanding positions were still not settled by 11:00 am on T+5 had deviated from the original spirit of ensuring trades to be settled by T+2. Furthermore, he doubted whether members of the Stock Exchange of Hong Kong (SEHK) Council were fully apprised of the overdue settlement procedures presently in force.

3. The Chief Executive, Hong Kong Securities Clearing Company Limited (CE/HKSCC) explained that under the General Rules, the settlement due day was T+2, with overdue settlement procedures stipulated for T+3 to T+5. The T+2 settlement due day was therefore simply an objective and other procedural arrangements were in place to handle cases where selling brokers failed to deliver stocks by T+2. In this regard, he advised that if broker participants did not have sufficient stocks in their CCASS stock accounts to settle their Continuous Net Settlement (CNS) stock positions by the end of T+3, HKSCC, acting as the settlement counterparty, would issue buy-in instructions to such participants, requesting them to purchase from the market to settle their open positions. In case the outstanding positions could not be settled by 11:00 am on T+5, compulsory buy-in would be effected by HKSCC accordingly.

4. CE/HKSCC further took the opportunity to clarify the misunderstanding towards HKSCC's position in enforcing the T+2 settlement rule for trades executed on 27 and 28 August 1998. He explained that HKSCC could only act in accordance with the provisions under the General Rules and the Operational Procedures. These rules were drawn up after a public consultation exercise conducted in March 1991 to solicit views of market practitioners on the business operations and system design of CCASS and had been in force since CCASS started operation in June 1992 with the approval of the then HKSCC's Board and the Securities and Futures Commission (SFC). In this connection, he undertook to provide a copy of the consultative paper on the business operations and system design of CCASS for members' reference.

HKSCC

(Post-meeting note : Members were informed that a copy of the consultative paper was available for members' reference at the LegCo Secretariat vide LC Paper No. CB(1) 216/98-99 dated 18 September 1998.)

5. CE/HKSCC went on to explain that in response to the Government's request made on 29 August 1998 and after consultation with SFC, HKSCC issued a circular to all CCASS broker participants that new measures would be implemented on 1 September 1998 to tighten up the enforcement of the T+2 rule within the limits of the General Rules. HKSCC had since then closely monitored the settlement obligation of broker participants under the CNS system and once the selling broker failed to deliver by T+2, HKSCC might at its discretion exercise a buy-in on T+3. However, according to HKSCC's own legal advice, trades executed on or prior to 31 August 1998 were subject to the Rules then in force and the revised Rules could not be applied retrospectively. For the same reason, the provision under Rule 3501 (I) of HKSCC General Rule that a default fee would be imposed on broker participants if they failed to deliver eligible securities on time under the CNS system could not be enforced until a notification was issued to broker participants as provided for in the Operational Procedures. He undertook to provide the relevant extract of the Operational Procedures for members' reference.(Post-meeting note: Extracts of the CCASS Operational Procedure related to the buy-in arrangement was issued to members vide LC Paper No. CB(1)544/98-99 dated 30 November 1998.)

HKSCC

6. CE/HKSCC further advised that since CCASS came into operation, the settlement efficiency for CNS trades had been more than 95% on settlement due day (T+2), rising to 99.5% on T+3 and 100% on T+4. In view of the high efficiency of settlement, HKSCC had considered it unnecessary to impose a default fee or to effect a compulsory borrowing before T+5. However, HKSCC would furnish information on failure of delivery to SFC for follow-up on a monthly basis. Compared with the average settlement efficiency for CNS of 95% by T+2, the settlement efficiency for trades executed on 28 August 1998 was about 91%. Noting that the settlement efficiency was expressed in terms of percentages of stock positions, members requested statistics of settlement efficiency in terms of number of shares and values on T+2 and T+3 for stocks traded on 27 and 28 August 1998 respectively.

HKSCC

(Post-meeting note: Relevant statistics were provided vide LC Paper No. CB(1)544/98-99 dated 30 November 1998.)

7. In response to a member's question on the number of brokers involved in settlement failure for trades executed on 27 and 28 August 1998, Chief Executive, Stock Exchange of Hong Kong (CE/SEHK) advised that there were about 240 brokers who failed to deliver the stocks by the settlement day (T+2). SEHK in conjunction with SFC had been taking follow-up actions. In this connection, the Chairman, Securities and Futures Commission (Acting) (C/SFC(Ag)) added that SFC had already issued more than 400 notices in respect of failed trades executed on 27 and 28 August 1998. As to whether there was a particular group of brokers who had repeatedly failed to deliver by T+2, she advised that although no specific pattern was observed, she would seek further information in this respect. At members' request, she would also confirm the exact number of selling brokers who failed to deliver the stocks for trades executed on 27 and 28 August 1998.(Post-meeting note: Relevant statistics were provided vide LC Paper No. CB(1)544/98-99 dated 30 November 1998.)

SFC SFC

8. Given that the Government had set aside adequate funds for payment of the share purchases, a member asked if arrangements would be made to reimburse the Government for the interest foregone on funds placed with HKSCC. CE/HKSCC responded that as funds from the buying brokers would only be collected upon receipt of shares from the selling brokers, no Government funds had been held up by HKSCC. On the other hand, the settlement between individual clients and brokers was a separate matter and was outside the ambit of HKSCC.

9. Some members pointed out that it was the general understanding of brokers and local investors that the settlement rule of T+2 was in force, but the flexible arrangement that compulsory buy-in would only be effected on T+5 might have benefited some investors who were aware of such arrangement. They queried whether individual investors had ever been informed of the General Rules and the Operational Procedures and in particular the flexible arrangement of settlement up to T+5 with no default fee imposed. In response, CE/HKSCC advised that each broker participant would receive a copy of the General Rules and the Operational Procedures when they joined the system. The same set of Rules would apply to each and every broker participant. Prior to the introduction of the Investor Participation Scheme on 8 May 1998, access to CCASS was only open to market intermediaries including brokers and custodians who, in turn, acted as mini-clearing houses for their clients. Broker participants made their own arrangements with their individual clients to ensure that stocks would be delivered to HKSCC for settlement in accordance with the requirements of the General Rules. With the introduction of direct investor participation in CCASS, a separate set of rules was issued for individual participants in the CCASS.

Effect of the settlement rule on Government's operations in the markets

10. Some members opined that to tie in with its operations in the securities and futures markets, the Government should have put in place administrative measures to tighten the T+2 settlement rule earlier. The failure on the part of the Government to introduce timely measures in this respect was indeed one of the most serious flaws of the recent operations and reflected very poor planning. Furthermore, members commented that the Chief Executive of Hong Kong Monetary Authority (CE/HKMA) appeared to have a different interpretation of the settlement rules from that of HKSCC, which gave an indication that senior officials in the Government were not fully conversant with the operations and practices of the markets.

11. On the specific question of whether senior officials in the Government including CE/HKMA were aware of the settlement rules, Secretary for Financial Services (Ag) (SFS(Ag)) confirmed that Mr Joseph YAM and his colleagues in the HKMA were aware of the CCASS rules and the practice of allowing a grace period before compulsory buy-in could be triggered if a selling broker failed to deliver the shares by T+2. She further said that there was no sign of serious settlement failures in the earlier periods when the turnover in the securities market remained at a fairly normal position. It was on 27 and 28 August 1998 when the turnover was unusually high that CE/HKMA was becoming concerned about the possibility of settlement failure. With the benefit of hindsight, compulsory buy-in could have been effected for unsettled trades executed on 28 August 1998 if the T+2 settlement rule had then been strictly enforced.

12. Some members stressed that the view expressed by CE/HKMA in the media on HKSCC's failure to strictly enforce the T+2 settlement rule, thereby failing to "short-squeeze" the short-sellers, was a reflection of the deficiency on the part of the Government officials in understanding the operations and practices of the market. They asked if the Government was prepared to clarify the view expressed by CE/HKMA. SFS(Ag) referred to the letter tabled at the meeting explaining HKMA's view in this respect and advised that the letter had been seen personally by Mr Joseph YAM and should truly reflect Mr YAM's views. The letter provided the background to Mr YAM's remarks. She further said that given the high success rate of CCASS to complete settlement on T+2 in the past, it was perhaps natural that HKMA as the purchaser of stocks was disappointed about the relatively poor delivery of stocks on T+2 in respect of trades executed on 28 August. She however stressed that sellers conducting naked short sales in the last few weeks would be liable to prosecution under the Securities Ordinance (Cap. 333) and brokers failing to report their short sales could be subject to disciplinary action under SEHK Rules.

13. Noting members' concern about the need to improve the settlement rules, the Chairman, Hong Kong Securities Clearing Company Limited (C/HKSCC) advised that the Board had approved, in principle, the proposal to tighten the T+2 settlement rule as suggested by the Government. Nevertheless, some flexibility should be allowed in case where broker participants could not settle their positions due to unforeseen circumstances or technical reasons. The Risk Management Committee of HKSCC would work out a list of circumstances under which overdue settlement would be allowed and reflected them clearly in the Rules of CCASS.

The Stock Exchange of Hong Kong
Short selling

14. Noting that a series of measures had been proposed to strengthen the rules against illegal short selling, Mr Albert HO Chun-yan asked if the disclosure and reporting requirements for short open interests would also apply to trustees outside Hong Kong and overseas investors. He opined that in order to facilitate subsequent investigation of illegal short selling, written proof of appropriate arrangements for stock borrowing should be provided at the time when the sales order was placed to ensure that the short sold securities would be available upon settlement.

15. CE/SEHK responded that SEHK had reminded its members to discharge their responsibility seriously, including ascertaining that their clients did have the covering stocks for sales order and in the case of short sales did have appropriate arrangements in hand, for example, the availability of an appropriate stock lending and borrowing agreement. Whilst provisions for illegal short selling under the Securities Ordinance (Cap. 333) should be strictly enforced, some degree of flexibility was provided to allow brokers to fulfill their obligations by various means. In this respect, SEHK had issued guidelines to its members to remind them to take reasonable steps to ascertain the availability of securities, in particular in respect of short sales. SEHK members were also reminded to ascertain the identity of their beneficiary clients and disclose the information to SFC upon request, and SEHK would report any improper activities to SFC for follow-up.

16. SFS(Ag) briefed members on what a SEHK member selling short should do when placing a short sales order to ensure that arrangements had been made for the availability of the securities required upon settlement. It would however be a matter for the court to decide whether brokers had taken all reasonable steps to fulfill their obligations. The proposal to make unreported short selling a criminal offence should further encourage brokers to be vigilant when they handled short sales orders for their clients.

17. C/SFC(Ag) advised that as naked short selling was prohibited under the law, SFC would follow up suspected cases of violation and request the brokers concerned to forward relevant information to SFC for inspection. However, investigation of some cases might be difficult if the beneficiary owners of the nominee accounts were outside the jurisdiction of Hong Kong and declined to disclose the required information to SFC. Regarding the circumstances under which short selling would be construed as legally acceptable, the Executive Director (Supervision of Markets), Securities and Futures Commission advised that at the time of sale, the seller should have a presently exerciseable and unconditional right to sell the securities. One of the way to prove the right to sell was the availability of a stock lending and borrowing agreement.

Hong Kong Futures Exchange
Disclosure of large open interests

18. Mr CHEUNG Man-kwong said that the Democratic Party was of the view that if a futures market was considered necessary for the development of Hong Kong as an international financial centre, it should be competitive enough to allow a profitable operation. Given the nature of the futures market which was important for strategic management and would require the maintenance of confidential business information, the regulatory regime should not be too rigid to avoid unnecessary disclosure of the positions of market players. Rather, a proper regulatory framework with sufficient risk control mechanism should be put in place to facilitate stable development of the market. In this regard, the Democratic Party was prepared to solicit views from different parties on the practicality, appropriateness and worthiness of requiring the disclosure of large open interests at a broker level to the market before taking a stance on the matter.

19. The Chairman, Hong Kong Futures Exchange (C/HKFE) assured members that HKFE would not place its members' interests on top of public interests. The mere fact that HKFE had reservations on some of the proposals put forward by the Government did not mean that HKFE did not support the Government. HKFE should make every endeavour to minimize the adverse ramifications of each regulatory measure whilst maximizing the benefits for the overall interest of Hong Kong.

20. C/HKFE further said that HKFE had no difficulty in disclosing real-time information of holders of large open interests to SFC as provided for under the existing legislation. He had every confidence in SFC that such kind of information would be kept confidential and would only be used for regulatory purposes. However, as a number of market practitioners had expressed concern about the proposal to require disclosure of large open interests at a broker level to the market, HKFE had already initiated discussions with SFC and Financial Services Bureau. C/HKFE said that the implementation details of the proposal had to be worked out so that the overall objective to strengthen the regulatory framework could be satisfied on one hand, whilst a balance of market viability was struck on the other.

21. Regarding the justifications for requiring the disclosure of large open interests at the broker level to the market and the associated ramifications of the measure, SFS (Ag) advised that the intention of the measures was to enhance the transparency of the market and to provide a level playing field for individual investors by allowing them to have equal access to information. This could help investors to make their investment decision on the best possible informed basis. The proposal was also in line with the similar practice of the Osaka Futures Exchange. She further advised that the details of implementation such as the timing and frequency of disclosure would be subject to further discussion amongst the Government, SFC and HKFE. The requirement on HKFE of such disclosure would not be as frequent as the daily disclosure of real-time information of holders of large open interests to SFC. While the Government considered it necessary to maintain a reasonable level of order and transparency in the market, it would avoid over-regulation which would stifle market development.

22. C/SFC(Ag) advised that the disclosure of real-time information of holders of large open interests by HKFE to SFC was an existing legal requirement. She remarked that in order to maintain the competitiveness of the market, and having regard to the need to maintain the confidentiality of business information, the disclosure of large open interests at a broker level to the market should not be required on a daily basis. A time gap between the date of trading and the date of release of information should be allowed to preserve commercial secrecy. In the Osaka model, such kind of information was only released a week in arrears and only the aggregate large open positions of each broker were to be disclosed. From SFC's point of view, the Osaka model could be adopted by Hong Kong.

Cross-market early warning system

23. On the proposal of establishing a cross-market early warning system, the General Counsel, Hong Kong Futures Exchange (GC/HKFE) said that HKFE had worked with SFC in analysing relevant cross-market warning signals for Hong Kong. However, any system so devised should match or conform with international standards, otherwise it might convey a wrong message to investors. HKFE would convene a meeting shortly with the SFC to discuss the measure further.

Automated Trading System

24 On whether the existing automated trading system of SEHK could be adopted for HSI futures trading, thus speeding up the automation process, GC/HKFE advised that it would not be possible as the requirement specifications of HKFE to serve the industry were significantly different from those allowed by the SEHK system. C/HKFE added that they would try to advance the implementation of the Automated Trading System for HSI futures contracts as far as possible and it was very likely that the system could be operational in the third quarter of 1999.

25. Mr Ronald ARCULLI pointed out that the number of futures contracts traded in the over-the-counter (OTC) market seemed to be larger in volume than that in the HKFE. He enquired about the implications of moving those trades into HKFE. GC/HKFE said that HKFE did not have full details of the OTC trades in HSI derivatives. As far as listed futures products were concerned, HKFE had 100% market share. The systems in HKFE, including risk management, were able to handle a sudden surge in volume as demonstrated in October 1997, hence there should not be any concern about HKFE's ability to handle an unexpected influx of trade volume.

Securities and Futures Commission
Regulatory function and power

26. Given that SFC was the enforcing agency for securities-related legislation, Miss Cyd HO Sau-lan enquired whether the scope of the existing legislation was wide enough for SFC to carry out its statutory duty. She pointed out that the gray area in margin financing as reflected in the collapse of the CA Pacific Group and the "State immunity" in the recent Government's operations had revealed deficiencies in the existing legislation. She also asked whether SFC had drawn the Government's attention to these deficiencies.

27. C/SFC(Ag) said that the existing legislation covered almost every aspect of the markets. As for margin financing, SFC was aware of the problem and had discussed the issue with the Administration with a view to introducing legislation to plug the loophole. Apart from the regulation of share registrars and trustees, which were currently unregulated, and custodian banks which fell within the ambit of HKMA, all other market activities were covered by existing legislation. Whether SFC had been given adequate authority was a separate matter, which had to be considered on a case by case basis. As the Government's operations in the securities and futures market was unprecedented, the existing legislation was not intended to cover such Government activities.

28. Miss Cyd HO Sau-lan opined that SFC should have warned market players that the operations of the Government in the securities and futures markets might give rise to a false market. Failure to do so would imply a default on the part of SFC. C/SFC (Ag) responded that the need to give warning to the market would depend very much on whether market manipulation was identified with reference to section 135 of the Securities Ordinance in respect of the creation of a false market. At the time of Government's operations, SFC was not aware of any individual share being manipulated in the market.

29. Mr Martin LEE Chu-ming suggested that since Government had become a major player in the market with substantial stocks in hand, SFC should seek further legal opinion to see if section 135 of the Securities Ordinance in relation to the creation of a false market should be applicable to the Government.

30. C/SFC (Ag) advised that SFC had sought legal advice on whether the Securities (Disclosure of Interests) Ordinance (Cap. 396) and the Securities Ordinance should apply to Government but they had not sought separate opinion in respect of individual provisions. Section 66 of the Interpretation and General Clauses Ordinance (Cap. 1) stipulated that "no ordinance shall in any manner whatsoever affect the right of or be binding on the State unless it is therein expressly provided or unless it appears by necessary implication that the State is bound thereby". Since there was no expressed provision to bind the State in the relevant securities ordinances, the Government's operations were outside the jurisdiction of SFC.

31. Some members expressed grave concern that the Government, having become a major player in the market, was not subject to the same set of regulation as other market players. They asked whether it was necessary for SFC to bring the Government or the company to be formed under the Exchange Fund to manage the assets procured in the operations under its regulatory ambit so as to maintain a level playing field for all market players and to avoid possible conflict of interests.

32 C/SFC(Ag) responded that she was also very concerned about the mode of operation and the status of the company to be formed under the Exchange Fund. She pointed out that it was unclear yet as to whether the company would be construed as an organ of the "State". SFC would examine the issue further when more details were available. She said that SFC, like the Government, was committed to strengthening the order and transparency of the securities and futures markets and maintaining the status of Hong Kong as an international financial centre. They would make every effort to ensure an open and fair market such that no single player should enjoy any privilege.

Government's role
Coordination amongst regulatory bodies

33. Mr NG Leung-sing opined that the episode in August had reflected a lack of coordination amongst the regulatory bodies and asked if the Administration was prepared to review its coordination strategy. Mr Albert HO Chun-yan also questioned whether the failure to initiate timely measures to strengthen the order and transparency of the markets was due to a lack of coordination amongst different regulatory bodies. He opined that corresponding administrative measures such as strict enforcement of the T+2 settlement rule, reinstatement of the "uptick" rule for short selling and imposition of additional margin for futures trading could have been put in place earlier, hence saving the need for the market operations.

34. SFS(Ag) replied that given the nature of the operations, it was important and indeed essential to involve as few people as possible in the decision-making process. As such, the Exchanges and HKSCC were not informed prior to the operations. The Administration also deliberately kept the SFC at arm's length in the operations in order to preserve its neutrality in its market regulatory role. The Administration had reviewed from time to time the measures needed to be taken to respond to market development. Since the financial turmoil last year, the Administration had taken a thorough look at each facet of the currency defence mechanism and the securities and futures markets and had identified a number of areas where improvements could be made. However, given that every regulatory measure would have its cost, it was necessary to examine the full implications, the need for such measures and the latest market development before implementation. The proposed measures to strengthen the order and transparency of the securities and futures markets had indeed been made at the earliest possibility.

35. CE/SEHK added that there had not been any difficulty in the co-operation between SEHK and SFC. In fact, since April this year, both SFC and SEHK maintained good communication with each other over their work plan, including the necessary amendments to the legislation. C/SFC (Ag) also said that SFC had been working closely with SEHK, HKFE and HKSCC since the financial turmoil last year. Indeed, many of the measures announced by the Government recently had already been taken up by SFC upon the publication of the Report on Financial Market Review in April this year. However, in the light of the present circumstances, SFC would speed up the related work.

36. As to why SFC had remained silent over the Government's operations in the markets, C/SFC(Ag) said that SFC would only work within its own ambit. As the Financial Secretary had mentioned the Government's operations in the markets were strictly confidential and C/SFC was only informed personally of the operation hours in advance. On the reasons for not initiating timely measures in mid August, she said that the market operation and mechanism throughout the period from 14 to 27 August remained normal. Given that every measure would have a cost to bear, it might be counterproductive to introduce measures at an inappropriate time.

37. Referring to the allegation of cross-market manipulation, Miss Emily LAU Wai-hing enquired whether SEHK was aware of the problem and whether Government had ever consulted SEHK before taking actions in the securities and futures markets. CE/SEHK replied that in the past 10 months, SEHK had been providing necessary information on market operations to Government. Whilst the sentiment of cross-market manipulation did exist in the markets, there was no concrete information to substantiate such an allegation as SEHK was only responsible for the regulation of the securities market. As to whether SEHK had ever been consulted on the Government's actions in the securities and futures markets, he said that given the confidentiality of the Government's operations in August, it would not be appropriate for the Government to consult SEHK in advance, not to mention that SEHK was an active operator in the market.

Disclosure of information by Government

38. Some members were of the view that the holding of substantial amount of stocks by the Government was highly undesirable. The proposed measures to require HKFE to disclose real-time information of holders of large open interests to SFC on a daily basis and to empower the Chief Executive of HKSAR to give directions to the regulatory bodies in case of emergency would place the Government in an advantageous position compared with other market participants. If the company to be established to manage the Government stocks was exempted from provisions of the relevant legislation, it would be unfair to other market participants and would damage Hong Kong's reputation as an international financial centre. Therefore, the Government should disclose the information on assets procured in the operations as soon as practicable.

39. SFS(Ag) reiterated that the Government would announce the details of the shares procured as soon as circumstances permitted even though they were not required to do so under the existing legislation, bearing in mind Government's responsibilities to safeguard the interests of the general public and to protect the economy of Hong Kong as a whole, and to upkeep the stability of our financial system. Having regard to the exceptional circumstances faced by Hong Kong, the Government should take all necessary actions to maintain the stability of our financial markets for the overall interests of the general public. She said that the Government policy was to strengthen market transparency as far as possible and the company to be formed under the Exchange Fund might not necessarily enjoy the same degree of immunity but this would be subject to further examination.

40. Members requested Government and the related regulatory bodies to provide further information on the regulatory mechanism and the disclosure requirement in respect of investment companies owned by overseas governments, if any.	Admin

(Post-meeting note: Relevant information was provided vide LC Paper No. CB(1)544/98-99 issued on 30 November 1998.)

Discretionary power of the Chief Executive of HKSAR

41. Referring to the implication of empowering the Chief Executive to give directions to regulatory bodies on their independence, SFS(Ag) explained that the existing legislation had already empowered the Chief Executive of HKSAR to give direction to SFC which, in turn, could give further direction to the Exchanges and HKSCC by means of restriction notices. However, such an indirect means might not allow the Government to react promptly when public interests were under threat. She said that it was envisaged that the Chief Executive would only exercise his power under very exceptional circumstances and noted that such kind of residual power also existed in other non-securities related legislation.

42. SFS(Ag) further explained that each regulatory body had its own role. But the Government needed to look after the overall interests of the general public and the financial system as a whole. Under normal circumstances, differences in opinion among them could be resolved through consultation. But in case of emergency, there was a need to provide the Chief Executive with residual power to determine in an efficient manner what was in the overall public interests of Hong Kong. Whilst there had been close cooperation amongst different regulatory bodies in carrying out the recommendations contained in the Report on Financial Market Review published in April 1998, the Government considered that there was room for further improvement in respect of enhancing the mechanism for exchange of market information on a regular basis for the benefit of the market as a whole.

43. Commenting on the Chief Executive's discretionary power, CE/SEHK remarked that given that such power would only be exercised in exceptional circumstances, it would bring more benefit than cost to the market.

44. C/SFC(Ag) pointed out that under section 11 of Securities and Futures Commission Ordinance (Cap. 24), the Chief Executive of HKSAR had already been empowered to give to SFC directions in writing as regards the performance of any of its functions as he considered appropriate. Section 50 of the Ordinance also empowered SFC to give notice to the Exchanges and HKSCC to act in accordance with its directions. Under such circumstances, they need to examine further with the Government to see how this residual power to be given to the Chief Executive of HKSAR in case of emergency could best be incorporated in the current legislation.

45. C/HKFE said that as far as HKFE was concerned, the Government did not have any privilege over other market participants. For example, the holdings of the Government were also subject to the same margin surcharge of 50% for open interests above 10,000 contracts and all brokers would be subject to the same requirements to disclose the information to SFC.

46. Regarding the stance of HKSCC on granting of power to the Chief Executive of HKSAR to give directions to HKSCC, C/HKSCC said that since HKSCC was under the supervision of SFC, it made no difference to HKSCC as to whether the instruction was given by SFC or the Government.

Governing structures of regulatory bodies

47. In the light of the episode in August, Mr Ambrose CHEUNG Wing-sum asked if the Government considered it necessary to reconstitute the Boards of HKFE, SEHK and HKSCC so as to bring in more independent directors to safeguard the interests of investors whilst maintaining viable operations in the markets. C/SFC(Ag) advised that the structures of the Boards of Directors of the respective bodies were approved by the Government after extensive consultation. As far as SFC was concerned, all directors were appointed by the Chief Executive of HKSAR. For SEHK and HKFE, apart from lay council members, other directors were elected by broker members amongst themselves.

48. Regarding the shareholders of HKSCC and the composition of HKSCC's Board, CE/HKSCC said that HKSCC was limited by guarantee, 50% of which was provided by SEHK and 10% each from its five member banks. On the composition of the Board, he said that HKSCC was governed by a 22-member Board, ten of whom were appointed by SEHK, five by the five member banks and another five by the Financial Secretary. The Chief Executives of HKSCC and SEHK were ex-officio directors.

49. Mr CHEUNG Man-kwong asked if there would be any room for discussion in respect of the 30 measures put forward by the Government for strengthening the operations of securities and futures markets and whether the Government would consider the proposal to reconstitute the Board of Directors of HKFE. He was also concerned that the directors of HKFE might be under pressure to accept the reform measures which might not necessarily be beneficial to the long term development of the market in Hong Kong.

50. In response, SFS(Ag) advised that the measures represented the initial consensus amongst the Government and the Chairmen of the respective regulatory bodies. The Government would welcome comments from the industry and refine the measures as appropriate. C/HKFE added that HKFE's directors would respond to market needs and reflect their views to SFC and Government. He did not believe that directors would sacrifice the interests of the public or those of members in exchange for their positions on the Board.

Impact of the improvement measures on market development

51. Mr Albert Ho Chun-yan stressed that whilst the Democratic Party was in support of the Government's move to initiate measures to combat cross-market manipulation, a balanced approach should be adopted so as to avoid over-regulation, which would stifle market development. Given that the Government had currently become a major player in the securities and futures markets, he opined that the measures to be introduced should be fair and consistent with international standards so as to provide a level playing field for all market participants. Furthermore, the Government should focus its attention to combating cross-market manipulation rather than introducing unnecessarily restrictive measures. SFS(Ag) responded that the Government would follow the above principles in addressing the problem of cross-market manipulation.

52. In response to Members' questions on quantitative analysis on the possible impact of the 30 measures, SFS(Ag) explained that it would be impossible to quantify the market impact of the 30 measures. The objective of these measures was to make our market less susceptible to cross-market manipulation and they might have certain negature impact on some business in short term. The Government would strike a balance between the need to maintain the competitiveness of our market and the need to make the market system less susceptible to cross-market manipulation. In the long term, the Government believed the measures would provide a better foundation for the future development of the securities and futures markets in Hong Kong.

53. The Chairman thanked representatives of the Administration and the regulatory bodies for attending the meeting.

II Any other business

Next meeting

54. Members agreed that questions addressed to the Administration at the meeting but were not answered due to the time constraint should be dealt with at another meeting to be held on 17 September 1998 at 4:30 pm. In this regard, the following questions put to the Administration would be deferred to the next meeting scheduled for 17 September 1998:

1. Mr Martin LEE Chu-ming enquired about the justification for maintaining the Hang Seng Index at 7,800 during the Government's operations in the second half of August 1998 and whether Government had ever assessed the market value of individual stock procured in terms of the assets of the stock issuers or the profits (including anticipated profits) as referred to in section 135 of the Securities Ordinance.
   
   
2. Mr Ambrose CHEUNG Wing-sum asked, in the light of the recent incidents, whether the Government considered it necessary to reconstitute the Boards of Directors of HKFE, SEHK and HKSCC so as to bring in more independent directors to safeguard the interests of investors whilst maintaining viable operations in the markets.
   
   
3. Mr CHEUNG Man-kwong asked if there would be room for discussion in respect of the 30 measures put forward by Government for strengthening the operation of securities and futures markets and how the Government would respond to the remarks made in the media by Hon Henry TANG, an Executive Council Member, on the reconstitution of the Board of Directors of HKFE.

55. In order to make the best use of the Council's time and to facilitate efficient conduct of meeting, members agreed to forward their other remaining questions in advance for the Administration.

56. Members also considered it necessary to invite Mr Donald TSANG, Financial Secretary, Mr Joseph YAM, Chief Executive of HKMA, and the Secretary for Financial Services to the meeting on 17 September 1998, to continue the discussion on actions taken by Government in the foreign exchange, stock and futures markets, and the proposed measures to improve the currency board arrangements and the order and transparency of the securities and futures markets.

57. There being no other business, the meeting ended at 12:55 pm.


Legislative Council Secretariat
28 January 1999