Introduction

1. An assessment of the HKSAR securities market was conducted August 26 to September 13, 2013 as part of the FSAP by Ana Carvajal, Monetary and Capital Markets Department and Malcolm Rodgers, External Expert. The assessment was conducted based on the IOSCO Principles and Objectives of Securities Regulation approved in 2010 and its Methodology adopted in 2011. Principle 38 was not assessed since this principle is now covered under the Principles for Financial Market Infrastructures (PFMI). As a result issues related to the central counterparties as self-regulatory organizations (SROs) are not covered in this assessment.

2. The recent global financial crisis has reinforced the need for assessments to be more critical, both in terms of the robustness of regulation as well as the intensity of supervision. On the regulatory side, assessors are required to look more closely at the extent to which the regulations in place adequately capture the risks undertaken by different participants. On the supervisory side, assessors are required to look more deeply into the licensing process, the off-site monitoring and on-site inspection programs as well as how the supervisor follows-up on findings, including the use of enforcement actions, to make an informed judgment on the overall quality of supervision. In jurisdictions that rely extensively on SROs such critical analysis also must be applied to them. In many jurisdictions, this enhanced approach has had an impact on grades. In addition, experience has been gained in connection with Principles 6 and 7 which allows assessors to delve deeper into the analysis of the processes in place to identify emerging and systemic risk. Furthermore through the Assessment Committee, IOSCO itself is developing further guidance for the assessment of these Principles.

3. The assessors relied on (i) a self-assessment and a report on market data, which were prepared by the SFC, with the collaboration from the HKMA and the Financial Services and the Treasury Bureau (FSTB) for the relevant principles; (ii) the review of relevant laws, regulations, codes, guidelines and other documents provided by the regulatory agencies including licensing, inspection and enforcement files; (iii) meetings with the CEO of the SFC, and senior staff from both the SFC and the HKMA, and other public authorities, in particular representatives of the FSTB, the Financial Reporting Council (FRC); as well as the HKICPA, (iv) meetings with the HKEx, banks and securities intermediaries, auditing firms, a credit rating agency (CRA) and a law firm.

4. The assessors want to thank staff of the SFC and the HKMA for their full cooperation as well as their willingness to engage in very candid conversations regarding the regulatory and supervisory framework of HKSAR. The assessors also want to extend their appreciation to all other public authorities and market participants with whom they met.

Institutional Structure

5. Under the current legal framework the SFC is the main authority responsible for the regulation and supervision of securities markets. The mandate from the SFC stems from the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (SFO) which charges it with the development and the regulation of the securities and futures markets, and the reduction in systemic risk in such markets. The SFC is a statutory body, with a board of directors of 14 appointed by the Chief Executive of Hong Kong (CEHK) or by the Financial Secretary (FS) under delegated authority. It is funded from levies on market participants, but its budget must be approved by the FS.

6. The HKMA is the responsible authority for the supervision of banks in the provision of securities business. Overall the HKSAR follows a model of universal banking whereby banks can provide most securities services within the banking entity—except that they cannot be members of the exchange. Under the Banking Ordinance (BO) and the SFO, their supervision in the provision of such services is the responsibility of the HKMA, both from a prudential as well as a business conduct perspective. For the latter, the Banking Conduct Department and the Enforcement Department were created within the HKMA in 2010, after the Lehman minibond incident. The HKMA has a Superintendent structure, and the Monetary Authority (MA) is appointed by the FS. It is funded through the Exchange Fund. The enforcement of breaches by bank entities of securities laws is conducted by the SFC, while there are shared responsibilities in connection with breaches by banks’ executive officers (EOs) and relevant individuals (ReIs).

7. The HKEx has important regulatory responsibilities, mainly in connection with the authorization of prospectuses. The HKEx has a unique position as it holds a legal monopoly in operating a securities exchange in the jurisdiction and also operates the only futures exchange. Two memoranda of understanding (MoUs) provide a framework for the discharge of regulatory functions by the HKEx and for its oversight by the SFC. Under The MoU on Listing, the HKEx approves offering documents for equity and debt issuers that want to make a public offering, as well as for structured products, with the SFC having power to object to HKEx’s decision. This approval is done jointly with the review by the HKEx of the listing requirements. For all other products offered to the public (mainly collective investment schemes (CIS) and non listed structured products) the SFC approves offering documents. In addition to this function, the HKEx conducts market surveillance for purposes of ensuring fair and orderly trading, while the SFC conducts surveillance for purposes of detecting market abuse and other unfair trading practices.

8. Responsibility for accounting standards, auditing standards and auditors’ oversight is outside of the purview of the SFC. The HKICPA is in charge of accounting and auditing standards, as well as for establishing admission criteria for auditors registered in HKSAR, their ethical standards, and their oversight, including the imposition of disciplinary actions. The governance structure of the HKICPA has evolved over time, and it is currently governed by a Council composed of its members, lay persons, and two Government representatives. The enforcement function is conducted by separate panels made up of both lay persons and accounting practitioners. The HKICPA is funded primarily from member subscriptions, student fees, firm registration fees and fees for practicing certificates. In 2006, the power to investigate irregularities in accounting and auditing of listed issuers was transferred to the FRC. The FRC is an independent statutory body established by the FRC Ordinance (Cap. 588). Its governing body comprises members appointed by the Government, a majority of whom (including the Chairman) are lay members. Besides being entrusted with comprehensive statutory powers for conducting independent investigations into reporting and auditing irregularities in relation to listed issuers, the FRC also has the statutory responsibility to enquire into possible non-compliances with accounting requirements on the part of listed entities. It is currently funded in equal parts by the HKSAR Government, the HKICPA, the HKEx, and the SFC. The Government has expressed its intention to continue strengthening the independence and oversight of the regulation of auditors of listed entities.

9. Several mechanisms are in place to foster coordination and cooperation. At a formal level several committees exist to bring together governmental and regulatory authorities. Of particular importance are the (i) Financial Stability Committee (FSC), which is in charge of monitoring the functioning of financial markets, assessing events that might have systemic implications and reporting to the FS on such events; (ii) the Council of Financial Regulators (CFR), which focuses on cross sector regulatory matters with a view to minimizing regulatory gaps or duplications; (iii) the Securities and Futures Liaison Committee (SFLC), where major policy initiatives are discussed; (iv) the FS meetings which is used by the SFC to report any major issue to the FS and the Secretary for Financial Services and the Treasury (SFST); and (v) the tripartite meetings between FSTB, SFC, and HKEx, which facilitate coordination and understanding on HKEx issues. In addition, there are MoUs in place between the SFC and the HKMA, and between the SFC and the HKEx, as explained above. These provide the basis for cooperation among the parties, as well as oversight for the HKEx. Finally regular contact takes place at a technical level between the SFC, HKMA and HKEx.

Market Structure

Issuers

10. As of April 2013 there were 1,558 companies listed on The Stock Exchange of Hong Kong Limited (SEHK), of which 1378 were listed on the Main Board and 180 on the Growth Enterprise Market (GEM). Market capitalization of the GEM remains small in relation to the main board and accounts for only 0.39 percent of the total market capitalization.

Listed Companies and Market Activity

Source: Stock Exchange of Hong Kong.

¹Figures include the number of transfers of listing from GEM to Main Board.

Listed Companies and Market Activity

Year	Units	2009	2010	2011	2012	At April 2013
Listed companies	Number	1,319	1,413	1,496	1,547	1,558
Market capitalization	US$m	2,297,469	2,709,121	2,254,146	2,821,353	2,875,895
Market capitalization	As % GDP	1077	1186	906	1076	N/A1
Market capitalization of top 10 companies	US$m	925,395	1,000,458	839,785	1,026,936	1,032,019
Market capitalization of top 10 companies	As % of GDP	434	438	337	392	N/A
Annual turnover	HK$m	15,515,249	17,210,078	17,154,074	13,301,050	5,555,559
Average daily turnover	HK$m	62,310	69,117	69,732	53,850	70,324
New companies listed1	Number	73	113	101	64	12

Source: Stock Exchange of Hong Kong.

¹Figures include the number of transfers of listing from GEM to Main Board.

View Table

Listed Companies and Market Activity

Year	Units	2009	2010	2011	2012	At April 2013
Listed companies	Number	1,319	1,413	1,496	1,547	1,558
Market capitalization	US$m	2,297,469	2,709,121	2,254,146	2,821,353	2,875,895
Market capitalization	As % GDP	1077	1186	906	1076	N/A1
Market capitalization of top 10 companies	US$m	925,395	1,000,458	839,785	1,026,936	1,032,019
Market capitalization of top 10 companies	As % of GDP	434	438	337	392	N/A
Annual turnover	HK$m	15,515,249	17,210,078	17,154,074	13,301,050	5,555,559
Average daily turnover	HK$m	62,310	69,117	69,732	53,850	70,324
New companies listed1	Number	73	113	101	64	12

Source: Stock Exchange of Hong Kong.

¹Figures include the number of transfers of listing from GEM to Main Board.

11. SEHK’s stock market is dominated by issuers based in the Mainland and the Mainland companies account for 47 percent of listings and 56 percent of total market capitalization.

Issuers by Country/Region of Origin, as at April 30, 2013

Issuers by Country/Region of Origin, as at April 30, 2013

Region	Number	Percent
Mainland Enterprises	737	47.3
Of which:
H shares	175	11.2
Red Chip	120	7.7
Mainland Private Enterprises	442	28.4
Hong Kong	722	46.3
Others	99	6.4
Total	1,558	100

View Table

Issuers by Country/Region of Origin, as at April 30, 2013

Region	Number	Percent
Mainland Enterprises	737	47.3
Of which:
H shares	175	11.2
Red Chip	120	7.7
Mainland Private Enterprises	442	28.4
Hong Kong	722	46.3
Others	99	6.4
Total	1,558	100

Classification Criteria:

• (1) H Shares and Red Chips classified as Mainland enterprises;

• (2) Spin-offs classified same as Mother Company;

• (3) Origin of establishment, if not in (1) and (2) above, is to be classified; and

• (4) Place of headquarters of companies to support criteria (3) if necessary or if (1), (2) & (3) above are not applicable.

12. The bond market is largely an institutional market, both for primary issuance and for secondary trading. The market has grown in recent years but still remains small compared to the equity market.

All Debt Securities

Source: Stock Exchange of Hong Kong.

All Debt Securities

Year	Units	2009	2010	2011	2012	At Apr 2013
Companies with outstanding issues	Number	157	169	192	269	319
Outstanding volume	US$m	50,374	62,779	75,691	113,597	134,163
Outstanding volume	As % of GDP	24	27	30	43	N/A
Annual turnover	HK$m	4	2	843	2,771	670
New issuing companies	Number	23	38	50	109	61

Source: Stock Exchange of Hong Kong.

View Table

All Debt Securities

Year	Units	2009	2010	2011	2012	At Apr 2013
Companies with outstanding issues	Number	157	169	192	269	319
Outstanding volume	US$m	50,374	62,779	75,691	113,597	134,163
Outstanding volume	As % of GDP	24	27	30	43	N/A
Annual turnover	HK$m	4	2	843	2,771	670
New issuing companies	Number	23	38	50	109	61

Source: Stock Exchange of Hong Kong.

Corporate Bonds¹

Source: Stock Exchange of Hong Kong.

¹Excludes debt securities issued by a bank, state, state corporation and supranational

Corporate Bonds¹

Year	Units	2009	2010	2011	2012	At Apr 2013
Companies with outstanding issue	Number	48	58	78	134	179
Outstanding volume	US$m	18,685	27,793	36,728	65,500	85,675
Outstanding volume	As % of GDP	9	12	15	25	N/A
Annual turnover	HK$mil	0.00	0.00	0.98	0.02	0.40
Number of new companies	Number	7	16	27	65	49

Source: Stock Exchange of Hong Kong.

¹Excludes debt securities issued by a bank, state, state corporation and supranational

View Table

Corporate Bonds¹

Year	Units	2009	2010	2011	2012	At Apr 2013
Companies with outstanding issue	Number	48	58	78	134	179
Outstanding volume	US$m	18,685	27,793	36,728	65,500	85,675
Outstanding volume	As % of GDP	9	12	15	25	N/A
Annual turnover	HK$mil	0.00	0.00	0.98	0.02	0.40
Number of new companies	Number	7	16	27	65	49

Source: Stock Exchange of Hong Kong.

¹Excludes debt securities issued by a bank, state, state corporation and supranational

Intermediaries

14. As of March 2013, 1,905 firms were licensed to carry out regulated securities market activities, including asset management. A further 117 banks were registered to conduct securities business. Of the licensed corporations, many are smaller Hong Kong firms but the market is dominated by a few large Hong Kong entities and global firms. As of December 2012, the top 10 firms accounted for 48 percent of the total value of transactions in securities, and 59 percent of transactions in futures and options. Many of the top firms have affiliations with other financial institutions.

Breakdown of Ownership (Domestic vs. Foreign) of Licensed Corporations

Source: Securities and Futures Commission.

Breakdown of Ownership (Domestic vs. Foreign) of Licensed Corporations

	March 31, 2013	March 31, 2012	March 31 2011
Total number of licensed corporations	1,905	1,840	1,752
Domestic ownership (In percent)	60	62	62
Foreign ownership (In percent)	40	38	38

Source: Securities and Futures Commission.

View Table

Breakdown of Ownership (Domestic vs. Foreign) of Licensed Corporations

	March 31, 2013	March 31, 2012	March 31 2011
Total number of licensed corporations	1,905	1,840	1,752
Domestic ownership (In percent)	60	62	62
Foreign ownership (In percent)	40	38	38

Source: Securities and Futures Commission.

Ownership (by Business Type) of Licensed Corporations

Source: Securities and Futures Commission.

Ownership (by Business Type) of Licensed Corporations

	March 31, 2013	March 31, 2012	March 31, 2011
Total number of licensed corporations	1,905	1,840	1,752
Affiliates of banks (in percent)	10	11	12
Affiliates of insurance companies (in percent)	2	3	3
Affiliates of other financial institutions (in percent)	36	35	35
Others (in percent)	52	51	50

Source: Securities and Futures Commission.

View Table

Ownership (by Business Type) of Licensed Corporations

	March 31, 2013	March 31, 2012	March 31, 2011
Total number of licensed corporations	1,905	1,840	1,752
Affiliates of banks (in percent)	10	11	12
Affiliates of insurance companies (in percent)	2	3	3
Affiliates of other financial institutions (in percent)	36	35	35
Others (in percent)	52	51	50

Source: Securities and Futures Commission.

15. As of March 2013, there were 316 firms managing SFC authorized funds, of which 80 were firms licensed by SFC and 236 were based in other jurisdictions. Banks dominate the distribution process for funds but funds management is shared between bank and non-bank entities. In fact, at December 2012, the top 10 fund managers managing SFC-authorized funds accounted for 50.1 percent of total AUM of SFC-authorized funds.

Collective Investment Schemes

16. As of March 2013, there were 1,847 funds authorized by the SFC for public offering in the Hong Kong market, of which 305 (17 percent) were Hong Kong domiciled funds. Of the remainder, 1,045 (57 percent) were Luxembourg-domiciled funds; 277 (15 percent) were domiciled in Ireland; 151 (8 percent) were domiciled in the Cayman Islands; and 53 (3 percent) were domiciled in the UK. Bond and equity funds are the predominant fund types.

AUM of SFC Authorized Funds by Type of Funds

AUM of SFC Authorized Funds by Type of Funds

AUM In US$ m	Dec. 31, 2012	% of total	Dec. 31, 2011	% of total	Dec. 31, 2010	% of total
Bond	467,175	37.75	324,078	31.96	360,944	30.38
Equity	498,959	40.32	436,280	43.03	571,859	48.13
Diversified	45,726	3.69	32,345	3.19	43,005	3.62
Money market	83,609	6.76	100,535	9.92	86,854	7.31
Fund of funds	9,332	0.75	7,817	0.77	7,898	0.66
Index	126,127	10.19	105,118	10.37	106,192	8.94
Guaranteed	515	0.04	712	0.07	1,287	0.11
Hedge	630	0.05	704	0.07	920	0.08
Other specialized	5,551	0.45	6,284	0.62	9,106	0.77
Total AUM	1,237,624	100	1,013,873	100	1,188,065	100

View Table

AUM of SFC Authorized Funds by Type of Funds

AUM In US$ m	Dec. 31, 2012	% of total	Dec. 31, 2011	% of total	Dec. 31, 2010	% of total
Bond	467,175	37.75	324,078	31.96	360,944	30.38
Equity	498,959	40.32	436,280	43.03	571,859	48.13
Diversified	45,726	3.69	32,345	3.19	43,005	3.62
Money market	83,609	6.76	100,535	9.92	86,854	7.31
Fund of funds	9,332	0.75	7,817	0.77	7,898	0.66
Index	126,127	10.19	105,118	10.37	106,192	8.94
Guaranteed	515	0.04	712	0.07	1,287	0.11
Hedge	630	0.05	704	0.07	920	0.08
Other specialized	5,551	0.45	6,284	0.62	9,106	0.77
Total AUM	1,237,624	100	1,013,873	100	1,188,065	100

Preconditions

17. Many of the preconditions for effective securities markets regulation appear to be in place in HKSAR.

• Barriers to entry: Foreign investors can invest in the securities markets on the same conditions as domestic investors; and licensing requirements for all categories of intermediaries are based on fit and proper criteria. However by law competition in the provision of trading platforms in domestic securities is limited by a monopoly granted to the SEHK.

• Taxation: Overall taxation of firms and individuals is low. A stamp duty applies to securities transactions, although certain type of products (mainly options) and transactions (mainly hedging) are exempted.

• Contract Law: Contract law in HKSAR is largely based on common law and there is no general statutory code for contract law. Binding precedents from courts is the basis of contract law in HKSAR. The general themes underlying the common law on contracts include the ideas of freedom of contract and sanctity of contracts.

• Company Law: The Companies Ordinance, CO (Cap. 32) is modeled on the English Companies Act. A significant overhaul took place recently, which provided for a modernized legal framework for incorporation and operation of companies in HKSAR. The new CO has come into effect in March 2014. Overall the CO remains a high level framework and thus needs to be complemented in important respects through the Listing Rules (for example the principle of one share one vote is not imbedded in the CO but in the Listing Rules) and/or the SFO. On the other hand a unique feature of the HKSAR securities markets is the fact that a significant proportion of the companies listed on it are not incorporated in HKSAR, but in offshore jurisdictions such as the Mainland, Bermuda, British Virgin Islands, and Cayman Islands. As a result, the Listing Rules and the SFO have greater importance than the CO in providing for shareholders rights, as they apply to all listed companies regardless of their place of incorporation.

• Insolvency Law: the CO does not contain a framework to allow for out of the court restructuring.

• Competition Law: A Competition law was enacted in 2012. The Ordinance provides for a judicial enforcement model through the establishment of the Competition Commission and the Competition Tribunal. The legislation will be implemented in phases.

• Accounting and auditing standards: Accounting and auditing standards are of high international quality as HKSAR has converged to IFRS and IAAS.

• Protection of investors’ rights: The judiciary is acknowledged to be independent from political influence. Class actions suits are not provided for in the legislation; and the assessors were told it is not common for investors to pursue remedies through the courts. The Consumer Legal Action Fund (CLAF) was set up to give greater consumer access to legal remedies by providing financial support and legal assistance. In practice, however, the CLAF (and the actions available with the framework that created the CLAF such as a “representative” action) may not afford investors’ similar protections to a class action suit. A Financial Dispute Resolution Center Limited (FDRC) came into operation in June 2012 to provide an independent and affordable avenue for resolving monetary disputes between individuals and financial institutions by way of “mediation first, arbitration next”. The FDRC administers a financial dispute resolution scheme (FDRS); the licensing conditions for HKMAs authorized institutions (AIs) and the Code of Conduct for Persons Licensed by or Registered with the SFC were amended to require them to become members of FDRS.

Main Findings

18. Principles for the regulator: The mandates of the SFC and the HKMA are clearly stated in the law. Both the SFC and the HKMA enjoy sufficient independence in their day to day operations; however, specific features in their legislative frameworks potentially threaten such independence. In addition, the SFC’s (and HKMA) role in the HKEx Risk Management Committee (RMC) could create potential conflicts vis-à-vis its supervision role. Both regulators are subject to strong mechanisms of accountability vis-a-vis the government and the public, including judicial review of their decisions. Both agencies work under a high degree of transparency, including in connection with the development of policy, which is subject to consultation. Strong ethical requirements apply to both institutions, including in connection with securities transactions. The Risk and Strategy Unit (R&S) that was created in 2012 has added centralization and focus to processes in place at the SFC to identify and monitor risks through R&S conducting of risk-focused industry meetings, its participation in the IOSCO Committee on Emerging Risks and the implementation of an internal risk register. Conflicts of interest are adequately addressed by the regulatory framework.

19. Principles for SROs: The governance of the HKEx and the composition of its RMC could create potential conflicts of interest for oversight. The SFC has established a strong supervisory program in connection with the listing functions of the HKEx, which include separation of the listing function, approval of rules by the SFC, the four eye principle in connection with individual decisions on listing, and on-site inspections. Supervision of market functions is discussed under Principle 34.

20. Principles for Enforcement: The SFC and the HKMA have broad licensing, supervisory and investigation powers in line with their respective mandates. Different avenues can be used by the SFC to seek enforcement actions. In practice, however, two domestic challenges limit enforcement efforts. First, for misconduct that does not constitute a crime, the current framework does not easily allow the SFC to seek both remedial and punitive actions. In practice the SFC then finds itself having to make difficult trade-offs. Second, challenges in the coordination with the DPP could limit the effectiveness of criminal enforcement. The SFC and the DoJ agree that an efficient and unreserved cooperation between the SFC and DoJ is both conducive of the proper administration of justice and in the interest of the public. High level discussions and meetings are being held between the DoJ and the SFC with the view to enhancing co-operation. In addition, the cross-border nature of the market, whereby many participants, including issuers and their auditors are located off-shore, is a challenge that the SFC manages through international cooperation.

21. Principles for Cooperation: The SFO contains a robust framework that obliges the SFC to cooperate and exchange information both domestically and with foreign regulators. Domestically, the SFC has MoUs in place with the HKMA and the HKEx, and cooperation takes place at all levels of the organizations on a regular basis. Internationally, the SFC is the body responsible for cooperation in securities markets matters. The SFC is signatory of the IOSCO Multilateral Memorandum of Understanding (MMoU), as well as a significant number of bilateral MoUs, and evidence was provided that in practice it cooperates effectively with other foreign regulators.

22. Principles for Issuers: Issuers of public offering are required to submit an offering document the content of which is in line with the requirements set out in the IOSCO Principles. There are arrangements in place for the review of offering documents whereby for all listed products (other than listed CIS) the HKEx acts as the front line regulator, with the SFC having the power to object. For CIS and unlisted securities the SFC is responsible for the authorization of the offering documents. Listed securities are subject to periodic and ongoing obligations, including annual and semiannual reporting as well as a strong framework for the dissemination of price sensitive information. Review of compliance with these reporting obligations lies mainly with the HKEx, while the review of compliance with price sensitive information is now undertaken both by the SFC and the HKEx. A separate regime of periodic reporting obligations exists for structured products, whereby for both listed and unlisted products annual and semi-annual reporting applies, as well as the obligation to disseminate inside information (for listed products) or material adverse changes (for unlisted products) compliance with which is monitored by the SFC. Financial statements to be included both in the prospectus and periodic reports must be prepared according to International Financial Reporting Standards (IFRS), Hong Kong Financial Reporting Standards (HKFRS) which are fully aligned with IFRS, or the Chinese accounting principles which appear to be consistent with IFRS. Other accounting principles have been considered acceptable, but in such cases a reconciliation must be submitted. Review of financial statements is carried out by three authorities, HKICPA, FRC, and HKEx. Overall there is effective monitoring of issuers’ compliance with their obligations, though enforcement is challenged by the cross border nature of the market.

23. Principles for auditors, Credit Rating Agencies (CRAs) and other information service providers: Auditors domiciled in HKSAR are subject to competence requirements set by the HKICPA. The HKICPA has established a review program for the oversight of auditors domiciled in HKSAR. However, its current governance structure does not ensure its independence from the accounting profession, and its enforcement framework is weak. Auditing standards applicable to domestic companies are of high international quality as HKSAR has converged with the International Auditing and Assuring Standards Board (IAASB) standards. The HKICPA has established robust independence requirements for auditors. Mainland companies with dual listing can use auditors registered in the Mainland who are approved for the purpose under a special arrangement between the authorities. Mainland auditors must use the Chinese Auditing Standards which have also converged to International Accounting Standards (IAS). For non-overseas companies the Exchange accepts non-Hong Kong audit firms on a case-by-case basis based on a set of predefined criteria. Non-Hong Kong auditors must be independent in the same way as is required for local auditors; the HKICPA does not have any oversight jurisdiction over them but the exchange expects non-Hong Kong reporting accountants and auditors to be subject to independent oversight by a regulatory body of a jurisdiction that is signatory to the IOSCO MMoU. The provision of credit rating services and the issuance of analysis or reports on securities and futures contracts are regulated activities (as defined under the SFO) that are subject to the licensing requirements. Firms that carry any of these activities are subject to the same requirements as any other intermediaries, as well as specific requirements established by the SFC for each category. Ongoing supervision of both types of intermediaries is conducted within the overall program for securities intermediaries, and involves both off-site monitoring (based on regular interactions such as periodic reporting and meetings), and on-site prudential visits and inspections.

24. Principles for Collective Investment Schemes: The operation and distribution of CIS in HKSAR are regulated activities that are required to be licensed or registered. CIS managers operating in HKSAR and licensed/registered by the SFC are subject to the same requirements as all other intermediaries, and to additional requirements established in the Fund Managers Code of Conduct and the Unit Trust Code. The offering of CIS to the public in HKSAR requires authorization of the fund by the SFC, even if the fund has been authorized by a foreign regulator. The authorization of a CIS requires the submission of a prospectus the content of which must comply with the requirements set forth in the Principles. CIS are subject to ongoing obligations including annual reports with audited financial statements, and semiannual reports, and the disclosure of material events. Material changes must be approved by investors and/or the SFC depending on the circumstances, and all material changes must be notified to investors. CIS must be valued on a fair value basis, and there are clear guidelines in connection with pricing errors. The winding up of CIS must be carried out as provided for in its constituent documents or with the approval of a general meeting of holders. Hedge fund (HF) managers are subject to the same licensing requirements as any other manager of CIS. HFs that are offered to the public must comply with the same requirements as other CIS, and a set of additional requirements set by the SFC. Ongoing supervision of CIS managers, including HF managers, is conducted within the overall program for securities intermediaries, and involves off-site monitoring (based on regular interactions with licensed firms such as periodic reporting and meetings), on-site prudential visits, and on-site inspections.

25. Principles for Intermediaries: The SFO defines a series of regulated activities, including dealing and advising on securities and futures that are subject to the licensing requirements. The SFC has established a common framework for the licensing of all regulated activities that is based on fit and proper criteria. The review of applications is robust. Banks conducting securities business are subject to a separate registration process, but the regulatory framework that applies to them is the same as for SFC licensed entities. Ongoing supervision for all intermediaries including banks involves both off site monitoring (based on regular interactions with licensed firms such as periodic reporting and meetings as appropriate) as well as on-site prudential visits and inspections, which are planned using a risk-based approach. This monitoring gives particular attention to conduct obligations including selling practices. The SFC makes significant use of thematic inspections to complement its inspections of individual firms. Licensed intermediaries are subject to capital requirements based on a net capital rule which has embedded charges for market, credit risk and concentration risk, while the minimum buffer required subsumes other risks that have not been specified (mainly operational risk). Licensed intermediaries are subject to an early warning system. The SFC has in place a contingency plan which covers the failure of an intermediary and market wide simulation exercises are conducted on a biannual basis.

26. Principles for Secondary Markets: There are provisions in the law concerning exchanges and ATS and the SFC has issued Guidelines in connection with ATS. However, the current framework does not provide sufficient guidance to potential applicants in connection with the differences in nature nor in the requirements applicable to different types of trading platforms–although as part of the application process the SFC has been open in its discussions with actual applicants. The HKEx has in place strong arrangements for real time supervision of the markets it operates. The SFC has established a program of oversight of the HKEx on both its listing and market function that comprises approval of rules, meetings, and periodic and ad-hoc reporting. On-site inspections have only been a regular part of the oversight arrangements for the listing function, but an inspection of the market function is planned for 2014. Resources devoted to the supervision of ATS are in line with their current importance. There is strong pre- and post-trade transparency, which is fostered by the current market structure as ATS trading volumes are not significant. The supervisory program in place to detect market abuse and other unfair trading practices is robust, though cross border challenges remain, as well as domestic challenges in connection with effective criminal enforcement. The HKEx has in place arrangements for the management of large exposures, including robust reporting obligations and position limits. More generally there are risk management mechanisms in place that include margining, and default procedures are transparent. A robust framework for both short selling and settlement leads to a minimal rate of settlement failures.

Summary Table of Implementation

Table 1.

Summary of Implementation—ROSC

Fully Implemented (FI) – 26; Broadly Implemented (BI) – 8; Partly Implemented (PI) – 3; Not Implemented (NI) – 0; Not Applicable (NA) – 1.

Table 1.

Summary of Implementation—ROSC

Principle	Grade	Findings
Principle 1. The responsibilities of the Regulator should be clear and objectively stated.	BI	The responsibilities of the SFC and the HKMA are established by law. There are robust arrangements for cooperation which are anchored in MoUs and include regular meetings at different levels of the organizations and sharing of information. There do not appear to be major gaps in regulation. However there currently is a disparity in the regulatory requirements in connection with the distribution of investment-linked insurance products.
Principle 2. The Regulator should be operationally independent and accountable in the exercise of its functions and powers.	PI	Both the SFC and HKMA operate under a high degree of operational independence. However current features of their governance frameworks, pose a threat to independence, including the power of the CEHK to provide direction to both agencies, the power of the CEHK to remove the members of the SFC without a clear framework that constrains such power, the role of the FS in connection with decisions related to exchanges and the participation of part time members on the board of the SFC which can be members of regulated entities. The SFC (and HKMA) role in the HKEx’s RMC could create potential conflicts vis-à-vis its supervision role. Both the SFC and HKMA have a stable source of funding. Both regulators are subject to a strong framework of accountability vis-à-vis the Government and the public, including judicial review of their decisions.
Principle 3. The Regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.	FI	Both the SFC and the HKMA have broad licensing, supervisory and investigation powers. Enforcement powers are in line with the Principles, though in practice SFC powers in disciplinary proceedings present important challenges as discussed in Principle 12. Both regulators have sufficient resources and steps have been taken in recent years to strengthen resources for conduct supervision.
Principle 4. The Regulator should adopt clear and consistent regulatory processes.	FI	The development of regulations and more generally policy (in the form of codes and guidelines) is subject to consultation—the former by legal requirement, the latter by market practice. Overall requirements to carry out regulated activities and to issue securities are clear, transparent, and sufficiently detailed, except in the case of the recognition of exchanges and the authorization or licensing of ATS, where internal policies need to be made more transparent to the market. This issue has been taken into consideration for the grade of Principle 33. Both regulators must provide reasons for their decisions, affected parties must be afforded due process, and decisions of the regulators are subject to review, including judicial review.
Principle 5. The staff of the Regulator should observe the highest professional standards, including appropriate standards of confidentiality.	FI	Both regulators have strong codes of ethics that impose obligations on board members (SFC) and staff. Specific obligations exist in connection with securities markets transactions. The SFC and the HKMA are subject to strong rules of confidentiality.
Principle 6. The Regulator should have or contribute to a process to monitor, mitigate and manage systemic risk, appropriate to its mandate.	BI	Current arrangements to identify and monitor systemic risk mainly rely on a bottom up approach. The recently created R&S has added centralization and focus to these arrangements through participation in the IOSCO Committee on Emerging Risk, risk-focused industry meetings and a risk register.
Principle 7. The Regulator should have or contribute to a process to review the perimeter of regulation regularly.	BI	The SFC has relied on a bottom up approach explained in Principle 6 to identify emerging risks stemming from regulated and unregulated activities, and to review past decisions on the perimeter of regulation. That is, through their day to day work, the operational divisions identify risks and issues of concern. Internal input is complemented by external sources, including information from the HKMA and risk meetings with market participants. Since inception in 2012, R&S has added centralization and focus to these arrangements through participation in the IOSCO Committee on Emerging Risk, risk-focused industry meetings and a risk register, each of which includes an assessment of the perimeter of regulation if new risks are identified.
Principle 8. The Regulator should seek to ensure that conflicts of interest and misalignment of incentives are avoided, eliminated, disclosed or otherwise managed.	FI	The regulatory framework for different categories of intermediaries requires them to put in place processes to identify and address conflicts of interest. The SFC and HKMA supervise compliance with these requirements via the licensing process and ongoing supervisory program. Overall, issuers are required to disclose conflicts of interest, and a strong framework for connected transactions is in place.
Principle 9. Where the regulatory system makes use of SROs that exercise some direct oversight responsibility for their respective areas of competence, such SROs should be subject to the oversight of the Regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.	BI	The governance of the HKEx and the composition of the RMC could create potential conflicts of interest for oversight. The SFC has established a strong supervisory program in connection with the listing functions of the HKEx, which include separation of the listing function, approval of rules by the SFC, the four eye principles in connection with individual decisions on listing and on-site inspections. Supervision of market functions is discussed under Principle 34.
Principle 10. The Regulator should have comprehensive inspection, investigation and surveillance powers.	FI	Both regulators have comprehensive powers to supervise and inspect regulated entities.
Principle 11. The Regulator should have comprehensive enforcement powers.	FI	The SFC, as the main body responsible for enforcement, has broad powers to investigate breaches of the securities laws, including requesting information from third parties. Different avenues can be used by the SFC in conducting enforcement actions for breaches of securities laws, including criminal and proceedings in front of the Market Misconduct Tribunal (MMT), civil proceedings and administrative/disciplinary proceedings. Formal powers afforded to the SFC are in line with the IOSCO Principles. However, the SFC faces challenges with their practical use which are discussed in Principle 12.
Principle 12. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.	BI	The SFC and the HKMA have put in place robust supervisory regimes. The SFC, as the main body responsible for enforcement of breaches to securities laws, has been active in using all avenues available to it to take enforcement action. However, two domestic challenges affect its enforcement efforts. First, for licensed or registered intermediaries who are in breach of the Code of Conduct in circumstances where the conduct does not also involve a contravention of the law enabling the SFC to seek remedial orders from the civil courts, the SFC cannot easily secure both remedial and disciplinary outcomes, and in practice has been confronted with difficult trade-offs. Second, coordination arrangements with the DPP have faced challenges, but the current DPP (who assumed office in September 2013) and the SFC are working to strengthen coordination. In addition, the cross border nature of the market poses challenges for effective enforcement which the SFC manages through international cooperation.
Principle 13. The Regulator should have authority to share both public and non-public information with domestic and foreign counterparts.	FI	The SFC and the HKMA have the power (and obligation) to cooperate both domestically and internationally. Cooperation at the international level does not require the existence of an independent interest.
Principle 14. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.	FI	Domestically, the SFC has MoUs in place with the HKMA and the HKEx that provide the foundation for effective coordination and sharing of information. Internationally, the SFC is signatory to the IOSCO MMoU, as well as a significant number of bilateral MoUs, and evidence was provided that in practice it cooperates effectively with other foreign regulators. The SFC is responsible for responding to all requests for information from foreign regulators, including by seeking information from HKMA if required.
Principle 15. The regulatory system should allow for assistance to be provided to foreign Regulators who need to make inquiries in the discharge of their functions and exercise of their powers.	FI	The SFC has the authority to cooperate with foreign authorities and collect information for them that is not currently in its files. HKMA can also supply information of this kind to the SFC for transmission to, or directly to, foreign regulators in accordance with the Banking Ordinance.
Principle 16. There should be full, accurate and timely disclosure of financial results, risk and other information that is material to investors’ decisions.	FI	Issuers of securities in a public offering must submit a listing document that is subject to review and authorization. Issuers of listed securities (other than structured products) are subject to ongoing obligations including annual and semiannual reports, and the dissemination of price sensitive information. Deadlines for submission of annual reports are long, but in line with other major jurisdictions. Issuers of structured products are subject to a separate reporting regime whereby both listed and unlisted products are subject to annual and half yearly reporting and disclosure of price sensitive information (for listed products) and material adverse changes (for unlisted products).
Principle 17. Holders of securities in a company should be treated in a fair and equitable manner.	FI	The CO and the Listing Rules provide for shareholders to be treated fairly. The Takeovers Code provides a framework for changes of control transactions to be conducted fairly and with full disclosure. Prompt notification of holdings by substantial shareholders and insiders is required.
Principle 18. Accounting standards used by issuers to prepare financial statements should be of a high and internationally acceptable quality.	FI	Financial statements to be included in the prospectus and in the annual and semiannual reports must be prepared according to (i) HKFRS which are fully aligned with IFRS, (ii) IFRS, or (iii) China Accounting Standards for Business Enterprises (CASBE). Other accounting standards are permitted but a reconciliation to HKFRS is required. Current mechanisms to supervise compliance with accounting standards include review of financial statements by the HKEx, the HKICPA, and the FRC.
Principle 19. Auditors should be subject to adequate levels of oversight.	PI	Oversight of domestic auditors is a responsibility of the HKICPA. The current governance structure of the HKICPA does not ensure its independence from the accounting profession. Further, the enforcement framework is weak: (i) the governance of the disciplinary committee does not ensure sufficient independence, nor foster the development of expertise, and precedents, and (ii) the range of sanctions is limited. Companies from Mainland with dual listing can choose an auditor domiciled in Mainland under a special arrangement signed in 2010. The relevant authorities have set up cooperation mechanisms for conducting post-approval regulation/investigation of the endorsed audit firms. For overseas companies the Exchange may accept a non-Hong Kong audit firm on a case by case basis. A firm would be considered acceptable if it (i) has an international name and reputation, (ii) is a member of a recognized body of accountants, and (iii) is subject to independent oversight by a regulatory body of a jurisdiction that is signatory of the IOSCO MMoU.
Principle 20. Auditors should be independent of the issuing entity that they audit.	BI	The Code of Ethics of the HKICPA establishes robust independence requirements for domestic auditors. Supervision of compliance with such requirements involves monitoring by the firm itself; the audit committees of listed issuers; and the review program of the HKICPA. Overseas auditors must be independent in the same terms as domestic auditors. In their case oversight is performed by the domestic oversight body as indicated in Principle 19.
Principle 21. Audit standards should be of a high and internationally acceptable quality.	BI	HKSAR has converged to International Standards on Auditing (ISA). Supervision of compliance with such standards involves monitoring by the firm itself; the HKICPA—mainly through its practice review program, but also through its program of review of financial statements—and the FRC, through its program of review of financial statements. Auditing standards apply by non-Hong Kong audit firms must be comparable to those used in HKSAR. Oversight of compliance with such standards is a responsibility of the home oversight body as indicated in Principle 19.
Principle 22. Credit rating agencies should be subject to adequate levels of oversight. The regulatory system should ensure that credit rating agencies whose ratings are used for regulatory purposes are subject to registration and ongoing supervision.	FI	The provision of credit rating services is a regulated activity subject to the licensing requirements irrespective of whether the ratings are used for regulatory purposes or not. CRAs are subject to the general regulatory framework applicable to all intermediaries, and to specific requirements set out in the Code of Conduct for CRAs which is modeled on the IOSCO’s Code of Conduct for CRAs. Ongoing supervision of CRAs includes off-site monitoring as well as on-site inspections.
Principle 23. Other entities that offer investors analytical or evaluative services should be subject to oversight and regulation appropriate to the impact their activities have on the market or the degree to which the regulatory system relies on them.	FI	The issue of analyses or reports on securities and futures contracts falls under the definition of regulated activities subject to the licensing requirements. Firms that provide analysis and the analysts themselves are subject to the general regulatory framework applicable to all intermediaries, and to additional requirements that deal more specifically with the threats to independence arising from these activities. Ongoing supervision of firms that provide analysis is conducted as part of the supervisory program for intermediaries and includes both off-site monitoring as well as on-site inspections.
Principle 24. The regulatory system should set standards for the eligibility, governance, organization and operational conduct of those who wish to market or operate a CIS.	FI	The operation and distribution of CIS fall under the definition of regulated activities subject to the licensing requirements. CIS operators licensed by or registered with the SFC are subject to the same requirements as that of any other intermediaries, and to additional specific requirements set forth in the Fund Manager Code of Conduct (FMCC). Ongoing supervision of fund managers is conducted as part of the supervisory program for intermediaries and includes both off-site monitoring as well as on-site inspections.
Principle 25. The regulatory system should provide for rules governing the legal form and structure of CIS and the segregation and protection of client assets.	FI	Currently, CIS established in HKSAR can only be constituted as unit trusts. Segregation requirements apply. Further, all CIS must appoint a custodian/trustee. Custodians/trustees can be entities affiliated with the CIS operator; however, additional safeguards apply including the requirement that custodians/trustees must be regulated entities themselves, they cannot be subsidiaries of nor share directors with the fund manager.
Principle 26. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a CIS for a particular investor and the value of the investor’s interest in the scheme.	FI	CIS that are publicly offered must submit a prospectus for authorization by the SFC. In addition, they are subject to ongoing obligations which include annual and semiannual reporting and disclosure of material events. Certain changes as specified in the SFO and the Code on Unit Trusts and Mutual Funds (UTC) require approval by investors or the SFC, and material changes must be notified to investors prior to their implementation.
Principle 27. Regulation should ensure that there is a proper and disclosed basis for asset valuation and the pricing and the redemption of units in a CIS.	FI	The constitutive documents of CIS must set out the rules for valuation of scheme assets. These rules, including rules for valuing illiquid assets, are consistent with IFRS. Independent auditors are required to assess compliance of the valuations with accounting standards.
Principle 28. Regulation should ensure that HFs and/or HFs managers/advisers are subject to appropriate oversight.	FI	HF managers/advisers are subject to the same licensing requirements as any other CIS operators. Thus they are subject to the same requirements applicable to all intermediaries. Only the HFs that are offered to the public are subject to authorization by the SFC; in such cases the SFC has established additional requirements for both the manager and the fund itself. HF managers are subject to off-site monitoring as well as on-site inspections, as part of the general program of supervision of intermediaries.
Principle 29. Regulation should provide for minimum entry standards for market intermediaries.	FI	The SFO defines regulated activities that are subject to the licensing requirements. Such requirements apply to both firms and individuals. Licensing requirements are based on fit and proper criteria, and this assessment applies to all directors, managers and substantial shareholders of the firms. License applications are reviewed thoroughly. Investment advisers are subject to the full licensing regime.
Principle 30. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.	FI	Licensed intermediaries are subject to minimum and ongoing capital requirements. Ongoing capital requirements of licensed intermediaries are based on a net capital rule that has embedded charges for market risk, credit risk and concentration risk, while a minimum buffer is used to address other risks (mainly operational risk). Licensed intermediaries must submit regular financial returns.
Principle 31. Market intermediaries should be required to establish an internal function that delivers compliance with standards for internal organization and operational conduct, with the aim of protecting the interests of clients and their assets and ensuring proper management of risk, through which management of the intermediary accepts primary responsibility for these matters.	FI	Licensed or registered persons are required to maintain appropriate internal controls including risk management and compliance systems. Codes of conduct require intermediaries to act in the interests of clients and provide requirements for the handling of conflicts of interest. Client asset protection rules, know-your customer and suitability rules, record-keeping requirements and key conduct of business requirements apply. Ongoing supervision programs that include both off-site monitoring and on-site inspections are carried out by the regulators.
Principle 32. There should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.	FI	The SFC has established contingency plans that include plans for dealing with the failure of a licensed intermediary and a market wide exercise is conducted on a biannual basis. Licensed intermediaries are subject to an early warning system whereby they must notify the SFC when their capital falls below a specified threshold.
Principle 33. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.	PI	The HKEx has been granted a monopoly for the operation of a stock exchange in HKSAR. Other exchanges can be established and are subject to recognition by the SFC. ATS can also be established and, depending on their nature, are subject to either authorization or licensing by the SFC. The SFC has been open in its discussions with applicants; however, there is a need for a more formal and transparent policy to guide potential applicants when choosing between a recognition as a recognized exchange company (REC) or an authorization as a Type III ATS. The same consideration applies in connection with Type V ATS, for which requirements have evolved overtime via licensing conditions but have not yet been incorporated into the ATS Guidelines.
Principle 34. There should be ongoing regulatory supervision of exchanges and trading systems which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.	BI	The HKEx conducts real time supervision of the markets it operates for purpose of ensuring fair and orderly trading, while the SFC conducts market surveillance for the purpose of detecting misconduct. The SFC has established arrangements for the supervision of the HKEx, which include meetings at different levels of the organization, reporting obligations, and on-site inspections for the listing function. The SFC has planned an onsite inspection for the market function for 2014. Currently, market supervision focuses on the markets operated by the HKEx, which is reasonable in light of the size of ATS.
Principle 35. Regulation should promote transparency of trading.	FI	The trading rules of the HKEx require both pre and post trade transparency. In addition exchange participants are required to report to the HKEx off exchange trades within 15 minutes. Iceberg orders are not allowed and block trades are only allowed in the futures exchange, but they must be communicated to the exchange immediately. ATS that manage dark pools do not provide pre-trade transparency but they must report all trades to the HKEx within 1 minute of their execution. In any event they are not significant in size. Of the remaining ATS, only a couple involve SEHK listed shares (one lit and one odd lot trading operator) and their trading volumes are not significant.
Principle 36. Regulation should be designed to detect and deter manipulation and other unfair trading practices.	FI	Market manipulation, insider trading, and unfair trading practices are prohibited misconduct under the SFO and front running is a misconduct under the Code of Conduct. Appropriate remedies are available, which include criminal prosecution, except for front running. The SFC has in place robust mechanisms for market surveillance that are based on automated systems that generate alerts. There is a dedicated team to investigate these alerts. However, enforcement actions face challenges resulting from the cross border nature of the market which requires significant cooperation from foreign regulators, and domestically from challenges in coordination between the SFC and the DPP. On the latter, the SFC and the current DPP are working to address these challenges. Challenges in enforcement have been taken into consideration for the grade of Principle 12.
Principle 37. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption.	FI	Exchange participants are subject to position reporting and position limits. The exchanges have a wide range of powers to deal with large exposures, including the power to require participants to reduce their positions, and in the event of non-compliance, they have the power to close out or transfer positions. Additional risk management mechanisms are in place including additional capital requirements for clearing participants, day and intraday margin, and a default fund. Default rules are transparent and provide the HKEx with a wide range of powers to close out, settle or transfer positions. There are robust rules for short selling which prohibit naked short selling and require reporting of short positions. A mandatory buy in is required for a failed settlement and the intermediary must also pay a fine. The result is a minimal rate of settlement failures..
Principle 38. Securities settlement systems and central counterparties should be subject to regulatory and supervisory requirements that are designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.	NA	Not assessed.

Fully Implemented (FI) – 26; Broadly Implemented (BI) – 8; Partly Implemented (PI) – 3; Not Implemented (NI) – 0; Not Applicable (NA) – 1.

View Table

Table 1.

Summary of Implementation—ROSC

Principle	Grade	Findings
Principle 1. The responsibilities of the Regulator should be clear and objectively stated.	BI	The responsibilities of the SFC and the HKMA are established by law. There are robust arrangements for cooperation which are anchored in MoUs and include regular meetings at different levels of the organizations and sharing of information. There do not appear to be major gaps in regulation. However there currently is a disparity in the regulatory requirements in connection with the distribution of investment-linked insurance products.
Principle 2. The Regulator should be operationally independent and accountable in the exercise of its functions and powers.	PI	Both the SFC and HKMA operate under a high degree of operational independence. However current features of their governance frameworks, pose a threat to independence, including the power of the CEHK to provide direction to both agencies, the power of the CEHK to remove the members of the SFC without a clear framework that constrains such power, the role of the FS in connection with decisions related to exchanges and the participation of part time members on the board of the SFC which can be members of regulated entities. The SFC (and HKMA) role in the HKEx’s RMC could create potential conflicts vis-à-vis its supervision role. Both the SFC and HKMA have a stable source of funding. Both regulators are subject to a strong framework of accountability vis-à-vis the Government and the public, including judicial review of their decisions.
Principle 3. The Regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.	FI	Both the SFC and the HKMA have broad licensing, supervisory and investigation powers. Enforcement powers are in line with the Principles, though in practice SFC powers in disciplinary proceedings present important challenges as discussed in Principle 12. Both regulators have sufficient resources and steps have been taken in recent years to strengthen resources for conduct supervision.
Principle 4. The Regulator should adopt clear and consistent regulatory processes.	FI	The development of regulations and more generally policy (in the form of codes and guidelines) is subject to consultation—the former by legal requirement, the latter by market practice. Overall requirements to carry out regulated activities and to issue securities are clear, transparent, and sufficiently detailed, except in the case of the recognition of exchanges and the authorization or licensing of ATS, where internal policies need to be made more transparent to the market. This issue has been taken into consideration for the grade of Principle 33. Both regulators must provide reasons for their decisions, affected parties must be afforded due process, and decisions of the regulators are subject to review, including judicial review.
Principle 5. The staff of the Regulator should observe the highest professional standards, including appropriate standards of confidentiality.	FI	Both regulators have strong codes of ethics that impose obligations on board members (SFC) and staff. Specific obligations exist in connection with securities markets transactions. The SFC and the HKMA are subject to strong rules of confidentiality.
Principle 6. The Regulator should have or contribute to a process to monitor, mitigate and manage systemic risk, appropriate to its mandate.	BI	Current arrangements to identify and monitor systemic risk mainly rely on a bottom up approach. The recently created R&S has added centralization and focus to these arrangements through participation in the IOSCO Committee on Emerging Risk, risk-focused industry meetings and a risk register.
Principle 7. The Regulator should have or contribute to a process to review the perimeter of regulation regularly.	BI	The SFC has relied on a bottom up approach explained in Principle 6 to identify emerging risks stemming from regulated and unregulated activities, and to review past decisions on the perimeter of regulation. That is, through their day to day work, the operational divisions identify risks and issues of concern. Internal input is complemented by external sources, including information from the HKMA and risk meetings with market participants. Since inception in 2012, R&S has added centralization and focus to these arrangements through participation in the IOSCO Committee on Emerging Risk, risk-focused industry meetings and a risk register, each of which includes an assessment of the perimeter of regulation if new risks are identified.
Principle 8. The Regulator should seek to ensure that conflicts of interest and misalignment of incentives are avoided, eliminated, disclosed or otherwise managed.	FI	The regulatory framework for different categories of intermediaries requires them to put in place processes to identify and address conflicts of interest. The SFC and HKMA supervise compliance with these requirements via the licensing process and ongoing supervisory program. Overall, issuers are required to disclose conflicts of interest, and a strong framework for connected transactions is in place.
Principle 9. Where the regulatory system makes use of SROs that exercise some direct oversight responsibility for their respective areas of competence, such SROs should be subject to the oversight of the Regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.	BI	The governance of the HKEx and the composition of the RMC could create potential conflicts of interest for oversight. The SFC has established a strong supervisory program in connection with the listing functions of the HKEx, which include separation of the listing function, approval of rules by the SFC, the four eye principles in connection with individual decisions on listing and on-site inspections. Supervision of market functions is discussed under Principle 34.
Principle 10. The Regulator should have comprehensive inspection, investigation and surveillance powers.	FI	Both regulators have comprehensive powers to supervise and inspect regulated entities.
Principle 11. The Regulator should have comprehensive enforcement powers.	FI	The SFC, as the main body responsible for enforcement, has broad powers to investigate breaches of the securities laws, including requesting information from third parties. Different avenues can be used by the SFC in conducting enforcement actions for breaches of securities laws, including criminal and proceedings in front of the Market Misconduct Tribunal (MMT), civil proceedings and administrative/disciplinary proceedings. Formal powers afforded to the SFC are in line with the IOSCO Principles. However, the SFC faces challenges with their practical use which are discussed in Principle 12.
Principle 12. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.	BI	The SFC and the HKMA have put in place robust supervisory regimes. The SFC, as the main body responsible for enforcement of breaches to securities laws, has been active in using all avenues available to it to take enforcement action. However, two domestic challenges affect its enforcement efforts. First, for licensed or registered intermediaries who are in breach of the Code of Conduct in circumstances where the conduct does not also involve a contravention of the law enabling the SFC to seek remedial orders from the civil courts, the SFC cannot easily secure both remedial and disciplinary outcomes, and in practice has been confronted with difficult trade-offs. Second, coordination arrangements with the DPP have faced challenges, but the current DPP (who assumed office in September 2013) and the SFC are working to strengthen coordination. In addition, the cross border nature of the market poses challenges for effective enforcement which the SFC manages through international cooperation.
Principle 13. The Regulator should have authority to share both public and non-public information with domestic and foreign counterparts.	FI	The SFC and the HKMA have the power (and obligation) to cooperate both domestically and internationally. Cooperation at the international level does not require the existence of an independent interest.
Principle 14. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.	FI	Domestically, the SFC has MoUs in place with the HKMA and the HKEx that provide the foundation for effective coordination and sharing of information. Internationally, the SFC is signatory to the IOSCO MMoU, as well as a significant number of bilateral MoUs, and evidence was provided that in practice it cooperates effectively with other foreign regulators. The SFC is responsible for responding to all requests for information from foreign regulators, including by seeking information from HKMA if required.
Principle 15. The regulatory system should allow for assistance to be provided to foreign Regulators who need to make inquiries in the discharge of their functions and exercise of their powers.	FI	The SFC has the authority to cooperate with foreign authorities and collect information for them that is not currently in its files. HKMA can also supply information of this kind to the SFC for transmission to, or directly to, foreign regulators in accordance with the Banking Ordinance.
Principle 16. There should be full, accurate and timely disclosure of financial results, risk and other information that is material to investors’ decisions.	FI	Issuers of securities in a public offering must submit a listing document that is subject to review and authorization. Issuers of listed securities (other than structured products) are subject to ongoing obligations including annual and semiannual reports, and the dissemination of price sensitive information. Deadlines for submission of annual reports are long, but in line with other major jurisdictions. Issuers of structured products are subject to a separate reporting regime whereby both listed and unlisted products are subject to annual and half yearly reporting and disclosure of price sensitive information (for listed products) and material adverse changes (for unlisted products).
Principle 17. Holders of securities in a company should be treated in a fair and equitable manner.	FI	The CO and the Listing Rules provide for shareholders to be treated fairly. The Takeovers Code provides a framework for changes of control transactions to be conducted fairly and with full disclosure. Prompt notification of holdings by substantial shareholders and insiders is required.
Principle 18. Accounting standards used by issuers to prepare financial statements should be of a high and internationally acceptable quality.	FI	Financial statements to be included in the prospectus and in the annual and semiannual reports must be prepared according to (i) HKFRS which are fully aligned with IFRS, (ii) IFRS, or (iii) China Accounting Standards for Business Enterprises (CASBE). Other accounting standards are permitted but a reconciliation to HKFRS is required. Current mechanisms to supervise compliance with accounting standards include review of financial statements by the HKEx, the HKICPA, and the FRC.
Principle 19. Auditors should be subject to adequate levels of oversight.	PI	Oversight of domestic auditors is a responsibility of the HKICPA. The current governance structure of the HKICPA does not ensure its independence from the accounting profession. Further, the enforcement framework is weak: (i) the governance of the disciplinary committee does not ensure sufficient independence, nor foster the development of expertise, and precedents, and (ii) the range of sanctions is limited. Companies from Mainland with dual listing can choose an auditor domiciled in Mainland under a special arrangement signed in 2010. The relevant authorities have set up cooperation mechanisms for conducting post-approval regulation/investigation of the endorsed audit firms. For overseas companies the Exchange may accept a non-Hong Kong audit firm on a case by case basis. A firm would be considered acceptable if it (i) has an international name and reputation, (ii) is a member of a recognized body of accountants, and (iii) is subject to independent oversight by a regulatory body of a jurisdiction that is signatory of the IOSCO MMoU.
Principle 20. Auditors should be independent of the issuing entity that they audit.	BI	The Code of Ethics of the HKICPA establishes robust independence requirements for domestic auditors. Supervision of compliance with such requirements involves monitoring by the firm itself; the audit committees of listed issuers; and the review program of the HKICPA. Overseas auditors must be independent in the same terms as domestic auditors. In their case oversight is performed by the domestic oversight body as indicated in Principle 19.
Principle 21. Audit standards should be of a high and internationally acceptable quality.	BI	HKSAR has converged to International Standards on Auditing (ISA). Supervision of compliance with such standards involves monitoring by the firm itself; the HKICPA—mainly through its practice review program, but also through its program of review of financial statements—and the FRC, through its program of review of financial statements. Auditing standards apply by non-Hong Kong audit firms must be comparable to those used in HKSAR. Oversight of compliance with such standards is a responsibility of the home oversight body as indicated in Principle 19.
Principle 22. Credit rating agencies should be subject to adequate levels of oversight. The regulatory system should ensure that credit rating agencies whose ratings are used for regulatory purposes are subject to registration and ongoing supervision.	FI	The provision of credit rating services is a regulated activity subject to the licensing requirements irrespective of whether the ratings are used for regulatory purposes or not. CRAs are subject to the general regulatory framework applicable to all intermediaries, and to specific requirements set out in the Code of Conduct for CRAs which is modeled on the IOSCO’s Code of Conduct for CRAs. Ongoing supervision of CRAs includes off-site monitoring as well as on-site inspections.
Principle 23. Other entities that offer investors analytical or evaluative services should be subject to oversight and regulation appropriate to the impact their activities have on the market or the degree to which the regulatory system relies on them.	FI	The issue of analyses or reports on securities and futures contracts falls under the definition of regulated activities subject to the licensing requirements. Firms that provide analysis and the analysts themselves are subject to the general regulatory framework applicable to all intermediaries, and to additional requirements that deal more specifically with the threats to independence arising from these activities. Ongoing supervision of firms that provide analysis is conducted as part of the supervisory program for intermediaries and includes both off-site monitoring as well as on-site inspections.
Principle 24. The regulatory system should set standards for the eligibility, governance, organization and operational conduct of those who wish to market or operate a CIS.	FI	The operation and distribution of CIS fall under the definition of regulated activities subject to the licensing requirements. CIS operators licensed by or registered with the SFC are subject to the same requirements as that of any other intermediaries, and to additional specific requirements set forth in the Fund Manager Code of Conduct (FMCC). Ongoing supervision of fund managers is conducted as part of the supervisory program for intermediaries and includes both off-site monitoring as well as on-site inspections.
Principle 25. The regulatory system should provide for rules governing the legal form and structure of CIS and the segregation and protection of client assets.	FI	Currently, CIS established in HKSAR can only be constituted as unit trusts. Segregation requirements apply. Further, all CIS must appoint a custodian/trustee. Custodians/trustees can be entities affiliated with the CIS operator; however, additional safeguards apply including the requirement that custodians/trustees must be regulated entities themselves, they cannot be subsidiaries of nor share directors with the fund manager.
Principle 26. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a CIS for a particular investor and the value of the investor’s interest in the scheme.	FI	CIS that are publicly offered must submit a prospectus for authorization by the SFC. In addition, they are subject to ongoing obligations which include annual and semiannual reporting and disclosure of material events. Certain changes as specified in the SFO and the Code on Unit Trusts and Mutual Funds (UTC) require approval by investors or the SFC, and material changes must be notified to investors prior to their implementation.
Principle 27. Regulation should ensure that there is a proper and disclosed basis for asset valuation and the pricing and the redemption of units in a CIS.	FI	The constitutive documents of CIS must set out the rules for valuation of scheme assets. These rules, including rules for valuing illiquid assets, are consistent with IFRS. Independent auditors are required to assess compliance of the valuations with accounting standards.
Principle 28. Regulation should ensure that HFs and/or HFs managers/advisers are subject to appropriate oversight.	FI	HF managers/advisers are subject to the same licensing requirements as any other CIS operators. Thus they are subject to the same requirements applicable to all intermediaries. Only the HFs that are offered to the public are subject to authorization by the SFC; in such cases the SFC has established additional requirements for both the manager and the fund itself. HF managers are subject to off-site monitoring as well as on-site inspections, as part of the general program of supervision of intermediaries.
Principle 29. Regulation should provide for minimum entry standards for market intermediaries.	FI	The SFO defines regulated activities that are subject to the licensing requirements. Such requirements apply to both firms and individuals. Licensing requirements are based on fit and proper criteria, and this assessment applies to all directors, managers and substantial shareholders of the firms. License applications are reviewed thoroughly. Investment advisers are subject to the full licensing regime.
Principle 30. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.	FI	Licensed intermediaries are subject to minimum and ongoing capital requirements. Ongoing capital requirements of licensed intermediaries are based on a net capital rule that has embedded charges for market risk, credit risk and concentration risk, while a minimum buffer is used to address other risks (mainly operational risk). Licensed intermediaries must submit regular financial returns.
Principle 31. Market intermediaries should be required to establish an internal function that delivers compliance with standards for internal organization and operational conduct, with the aim of protecting the interests of clients and their assets and ensuring proper management of risk, through which management of the intermediary accepts primary responsibility for these matters.	FI	Licensed or registered persons are required to maintain appropriate internal controls including risk management and compliance systems. Codes of conduct require intermediaries to act in the interests of clients and provide requirements for the handling of conflicts of interest. Client asset protection rules, know-your customer and suitability rules, record-keeping requirements and key conduct of business requirements apply. Ongoing supervision programs that include both off-site monitoring and on-site inspections are carried out by the regulators.
Principle 32. There should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.	FI	The SFC has established contingency plans that include plans for dealing with the failure of a licensed intermediary and a market wide exercise is conducted on a biannual basis. Licensed intermediaries are subject to an early warning system whereby they must notify the SFC when their capital falls below a specified threshold.
Principle 33. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.	PI	The HKEx has been granted a monopoly for the operation of a stock exchange in HKSAR. Other exchanges can be established and are subject to recognition by the SFC. ATS can also be established and, depending on their nature, are subject to either authorization or licensing by the SFC. The SFC has been open in its discussions with applicants; however, there is a need for a more formal and transparent policy to guide potential applicants when choosing between a recognition as a recognized exchange company (REC) or an authorization as a Type III ATS. The same consideration applies in connection with Type V ATS, for which requirements have evolved overtime via licensing conditions but have not yet been incorporated into the ATS Guidelines.
Principle 34. There should be ongoing regulatory supervision of exchanges and trading systems which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.	BI	The HKEx conducts real time supervision of the markets it operates for purpose of ensuring fair and orderly trading, while the SFC conducts market surveillance for the purpose of detecting misconduct. The SFC has established arrangements for the supervision of the HKEx, which include meetings at different levels of the organization, reporting obligations, and on-site inspections for the listing function. The SFC has planned an onsite inspection for the market function for 2014. Currently, market supervision focuses on the markets operated by the HKEx, which is reasonable in light of the size of ATS.
Principle 35. Regulation should promote transparency of trading.	FI	The trading rules of the HKEx require both pre and post trade transparency. In addition exchange participants are required to report to the HKEx off exchange trades within 15 minutes. Iceberg orders are not allowed and block trades are only allowed in the futures exchange, but they must be communicated to the exchange immediately. ATS that manage dark pools do not provide pre-trade transparency but they must report all trades to the HKEx within 1 minute of their execution. In any event they are not significant in size. Of the remaining ATS, only a couple involve SEHK listed shares (one lit and one odd lot trading operator) and their trading volumes are not significant.
Principle 36. Regulation should be designed to detect and deter manipulation and other unfair trading practices.	FI	Market manipulation, insider trading, and unfair trading practices are prohibited misconduct under the SFO and front running is a misconduct under the Code of Conduct. Appropriate remedies are available, which include criminal prosecution, except for front running. The SFC has in place robust mechanisms for market surveillance that are based on automated systems that generate alerts. There is a dedicated team to investigate these alerts. However, enforcement actions face challenges resulting from the cross border nature of the market which requires significant cooperation from foreign regulators, and domestically from challenges in coordination between the SFC and the DPP. On the latter, the SFC and the current DPP are working to address these challenges. Challenges in enforcement have been taken into consideration for the grade of Principle 12.
Principle 37. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption.	FI	Exchange participants are subject to position reporting and position limits. The exchanges have a wide range of powers to deal with large exposures, including the power to require participants to reduce their positions, and in the event of non-compliance, they have the power to close out or transfer positions. Additional risk management mechanisms are in place including additional capital requirements for clearing participants, day and intraday margin, and a default fund. Default rules are transparent and provide the HKEx with a wide range of powers to close out, settle or transfer positions. There are robust rules for short selling which prohibit naked short selling and require reporting of short positions. A mandatory buy in is required for a failed settlement and the intermediary must also pay a fine. The result is a minimal rate of settlement failures..
Principle 38. Securities settlement systems and central counterparties should be subject to regulatory and supervisory requirements that are designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.	NA	Not assessed.

Fully Implemented (FI) – 26; Broadly Implemented (BI) – 8; Partly Implemented (PI) – 3; Not Implemented (NI) – 0; Not Applicable (NA) – 1.

Recommended Actions

Principle	Recommended Action
Principle 1	Authorities should proceed with the current initiatives that will ensure consistent conduct regulation of selling/distribution relating to investment-linked insurance products and other investments. Authorities should consider having periodic reviews of the supervisory and enforcement outcomes of both SFC and HKMA to ensure that, regardless of which regulator is involved, poor conduct by intermediaries and their managers and representatives, is treated in a consistent fashion, especially in terms of remedial, disciplinary and enforcement responses.
Principle 2	Authorities should consider strengthening the independence of the regulators by explicitly limiting the circumstances in which the CEHK can give directions to them, for example by precluding directions relating to specific cases. The circumstances in which the CEHK can remove Commission members of the SFC should be articulated, preferably in legislation. Consideration should be given to moving away from government appointees on the board of the HKEx. SFC and HKMA should not be members of the HKEx’s RMC to ensure an arms’ length relationship. Authorities should consider the desirability of moving away from part time Commissioners, or at least adopt a policy of not appointing directors of regulated entities as Commissioners.
Principle 3	Authorities should give consideration to increasing the maximum fines that SFC can impose and providing a mechanism for compensating investors that can be used alongside the disciplinary process. Authorities should give consideration to providing the HKMA with fining powers over EOs and ReIs.
Principle 4	SFC should further develop and formalize internal policies for publication of a comprehensive policy on the recognition of exchange markets and the authorization/licensing of other trading platforms. HKMA circulars about policy (rather than compliance guidance) should continue to be subject to consultation.
Principle 6–7	SFC should continue to implement the mandate for the R&S to comply with Principle 6 and over time assess the level of resources required for such compliance.
Principle 9	Consideration should be given to moving away from government appointees on board of HKEx and RMC. SFC and HKMA should not be members of the HKEx’s RMC to ensure an arms’ length relationship. Consideration should be given to subjecting decisions on the admission of participants to an appeal process (for example by SFC). SFC should proceed with its plans to carry out regular on-site inspections of the HKEx’s market functions.
Principle 11	Authorities should give consideration to increasing the maximum fines that SFC can impose; and providing a mechanism for compensating investors that can be used as part of the disciplinary process. Authorities should give consideration to providing the HKMA with fining powers over EOs and ReIs.
Principle 12	The authorities should continue working to enhancing coordination on the criminal arena. Authorities should consider having periodic reviews of the supervisory and enforcement outcomes of both SFC and HKMA to ensure that, regardless of which regulator is involved, poor conduct by intermediaries and their managers and representatives is treated in a consistent fashion, especially in terms of remedial, disciplinary and enforcement responses.
Principle 16	The SFC and the Exchange should implement shorter deadlines for the submission of periodic information, in particular interim reports.
Principle 18	The authorities should consider centralizing the function of monitoring issuers’ compliance with accounting standards into one single authority.
Principles 19–21	The authorities should proceed with their proposals to establish a fully independent authority with responsibility for the oversight of the audit profession and with strong enforcement power. Such authority should have jurisdictions over all auditors that audit companies listed in HKSAR.
Principle 33	SFC should further develop and formalize internal policies for publication of a comprehensive policy on the recognition of exchange markets and the authorization/licensing of other trading platforms.
Principle 34	The SFC should proceed with its plan to conduct regular on-site inspections of the market function of the SEHK.
Principle 35	The criteria under which ATS that operate as dark pools are not required to provide pre-trade transparency should be kept under review, especially if trading volumes in off-market venues increase.

View Table

Principle	Recommended Action
Principle 1	Authorities should proceed with the current initiatives that will ensure consistent conduct regulation of selling/distribution relating to investment-linked insurance products and other investments. Authorities should consider having periodic reviews of the supervisory and enforcement outcomes of both SFC and HKMA to ensure that, regardless of which regulator is involved, poor conduct by intermediaries and their managers and representatives, is treated in a consistent fashion, especially in terms of remedial, disciplinary and enforcement responses.
Principle 2	Authorities should consider strengthening the independence of the regulators by explicitly limiting the circumstances in which the CEHK can give directions to them, for example by precluding directions relating to specific cases. The circumstances in which the CEHK can remove Commission members of the SFC should be articulated, preferably in legislation. Consideration should be given to moving away from government appointees on the board of the HKEx. SFC and HKMA should not be members of the HKEx’s RMC to ensure an arms’ length relationship. Authorities should consider the desirability of moving away from part time Commissioners, or at least adopt a policy of not appointing directors of regulated entities as Commissioners.
Principle 3	Authorities should give consideration to increasing the maximum fines that SFC can impose and providing a mechanism for compensating investors that can be used alongside the disciplinary process. Authorities should give consideration to providing the HKMA with fining powers over EOs and ReIs.
Principle 4	SFC should further develop and formalize internal policies for publication of a comprehensive policy on the recognition of exchange markets and the authorization/licensing of other trading platforms. HKMA circulars about policy (rather than compliance guidance) should continue to be subject to consultation.
Principle 6–7	SFC should continue to implement the mandate for the R&S to comply with Principle 6 and over time assess the level of resources required for such compliance.
Principle 9	Consideration should be given to moving away from government appointees on board of HKEx and RMC. SFC and HKMA should not be members of the HKEx’s RMC to ensure an arms’ length relationship. Consideration should be given to subjecting decisions on the admission of participants to an appeal process (for example by SFC). SFC should proceed with its plans to carry out regular on-site inspections of the HKEx’s market functions.
Principle 11	Authorities should give consideration to increasing the maximum fines that SFC can impose; and providing a mechanism for compensating investors that can be used as part of the disciplinary process. Authorities should give consideration to providing the HKMA with fining powers over EOs and ReIs.
Principle 12	The authorities should continue working to enhancing coordination on the criminal arena. Authorities should consider having periodic reviews of the supervisory and enforcement outcomes of both SFC and HKMA to ensure that, regardless of which regulator is involved, poor conduct by intermediaries and their managers and representatives is treated in a consistent fashion, especially in terms of remedial, disciplinary and enforcement responses.
Principle 16	The SFC and the Exchange should implement shorter deadlines for the submission of periodic information, in particular interim reports.
Principle 18	The authorities should consider centralizing the function of monitoring issuers’ compliance with accounting standards into one single authority.
Principles 19–21	The authorities should proceed with their proposals to establish a fully independent authority with responsibility for the oversight of the audit profession and with strong enforcement power. Such authority should have jurisdictions over all auditors that audit companies listed in HKSAR.
Principle 33	SFC should further develop and formalize internal policies for publication of a comprehensive policy on the recognition of exchange markets and the authorization/licensing of other trading platforms.
Principle 34	The SFC should proceed with its plan to conduct regular on-site inspections of the market function of the SEHK.
Principle 35	The criteria under which ATS that operate as dark pools are not required to provide pre-trade transparency should be kept under review, especially if trading volumes in off-market venues increase.

Authorities’ Response

27. The Hong Kong authorities appreciate the comprehensive and positive assessment of Hong Kong’s securities sector, and welcome the IMF’s view that Hong Kong has developed a sound framework for the regulation of securities markets and exhibited a high level of implementation of the IOSCO Principles. The assessment contains some useful observations and recommendations which could help further enhance regulation of securities markets in HKSAR. The authorities will review these recommendations, and give due consideration to their adoption where appropriate, as we remain committed to enhancing market quality and efficiency. Our responses to some specific recommendations are set out in the ensuing paragraphs.

Detailed Assessment Report

36. The purpose of the assessment is primarily to ascertain whether the legal and regulatory securities markets requirements of the country and the operations of the securities regulatory authorities in implementing and enforcing these requirements in practice meet the standards set out in the IOSCO Principles. The assessment is to be a means of identifying potential gaps, inconsistencies, weaknesses and areas where further powers and/or better implementation of the existing framework may be necessary and used as a basis for establishing priorities for improvements to the current regulatory scheme.

37. The assessment of the country’s observance of each individual Principle is made by assigning to it one of the following assessment categories: fully implemented, broadly implemented, partly implemented, not implemented and not applicable. The IOSCO assessment methodology provides a set of assessment criteria to be met in respect of each Principle to achieve the designated benchmarks. The methodology recognizes that the means of implementation may vary depending on the domestic context, structure, and stage of development of the country’s capital market and acknowledges that regulatory authorities may implement the Principles in many different ways.

Principles Relating to the Regulator
Principle 1.	The responsibilities of the regulator should be clear and objectively stated.
Description	Structure of the securities regulation regime Regulation of the financial sector in Hong Kong is broadly along sectoral lines, with separate regulatory authorities for each of: a. the securities and futures industry (henceforth the securities industry)—SFC; b. banks—HKMA; c. the insurance industry—the Office of the Commissioner of Insurance (OCI, previously the Insurance Authority (IA); d. the mandatory provident fund, MPF (pension fund) industry—the Mandatory Provident Fund Schemes Authority (MPFA). SFC has primary responsibility for the regulation and supervision of the securities industry in Hong Kong. However, the securities industry activities of licensed banks and deposit taking institutions are supervised by the HKMA, although the legislative and rule framework that applies to them is supplied almost wholly by the SFO and related legislation and by codes of conduct issued by SFC. The SFC is in charge of taking enforcement actions against banks for breaches of securities laws, mainly through referrals of the HKMA; while enforcement actions on EOs and ReIs are a shared responsibility. Regulation and supervision of auditors is carried out by a combination of the FRC and the HKICPA. The FRC is responsible for investigating and reporting on auditing and reporting irregularities and potential non-compliance with relevant standards in relation to listed companies. The HKICPA’s responsibilities include ongoing supervision of audit firms domiciled in Hong Kong which provide services to listed and non-listed companies. The HKEx group plays a self-regulatory role in relation to listed companies, and supervises the orderly conduct of trading on its markets. A specialist tribunal, the MMT, conducts administrative proceedings relating to market misconduct (Part XIII of the SFO) and breaches of a company’s obligation to disclose material events (“inside information”) (Division 3 of Part XIVA). SFC responsibilities, powers and authority The SFC’s responsibilities, powers and authority are set out in legislation. Its powers and authority are enforceable. The most important piece of legislation is the SFO including its subsidiary instruments (Rules made under the SFO). SFC also has functions and powers under other laws, such as: a. Parts II and XII of the CO: b. the Anti-Money Laundering and Counter-Terrorist Financing, AML/CFT (Financial Institutions) Ordinance (AMLO); and c. the Mandatory Provident Fund Schemes Ordinance (MPFSO). Section 4 of the SFO sets out the regulatory objectives of the SFC (which includes the integrity of markets, investor protection, the prevention of financial crime and the reduction of systemic risk) and section 5 sets out its general functions (defined as powers and duties). Specific powers and duties of the SFC are set out throughout the relevant provisions. Section 6 of the SFO sets out a number of matters that the SFC must have regard to in performing its functions. HKMA responsibilities, powers and authority HKMA’s responsibilities, powers and authority are set out in the BO. Some powers are also conferred on it by the SFO. HKMA’s supervision functions are specified in section 7 of the BO. Entities authorized to carry on banking business or a business of taking deposits (called AIs in the BO) that wish to engage in securities industry activities (“regulated activities” as defined under SFO) must be registered with SFC to become Registered Institutions (RIs) before they can conduct those activities. RIs are subject to obligations imposed by the SFO and rules and codes made by the SFC while the HKMA is the frontline supervisor. HKMA also gives consent to the appointment of EOs and maintains a register containing particulars of ReIs of RIs in connection with their securities industry activities. The powers and authority of HKMA to supervise RIs’ regulated activities are set out by law and enforceable. HKMA’s responsibilities are also set out in a 2003 exchange of letters between the FS and the HKMA. This exchange is published on HKMA’s website. Discretion to interpret authority Both SFC and HKMA can interpret their authority but must do so according to established principles of statutory interpretation and in accordance with the provisions of the relevant legislation. Section 6 of the SFO sets out the general duties of SFC, and any exercise of discretion by it must be consistent with them. An exercise of regulatory discretion by SFC (and HKMA in relation to decisions it makes about EOs and ReIs) can be challenged by: a. appealing to the Securities and Futures Appeals Tribunal (the SFAT); b. in appropriate cases, applying to the court for judicial review; c. complaining to the Office of the Ombudsman, which has power to investigate complaints about maladministration by government departments/agencies and relevant public bodies, including against SFC and HKMA and its staff in respect of the discharge of their duties SFC and HKMA operations can also be reviewed by the anti-corruption agency (the Independent Commission Against Corruption, ICAC). Gaps or overlaps There do not appear to be any gaps in the overall scheme of regulation, subject to what is said below about the regulation of selling practices for investment- linked assurance schemes (ILAS) HKMA adopts the same regulatory standards as SFC in supervising RIs. For example, both SFC and HKMA make use of the same set of standards set out in the Fit and Proper Guidelines issued by SFC in September 2006 (Fit and Proper Guidelines) and the Guidelines on Competence published by SFC, in respect of licensing/registration of securities intermediaries. The MoU between HKMA and SFC delineates the respective regulatory and supervisory roles and responsibilities of both parties with a view to ensuring consistency in the supervisory approach and preventing regulatory overlap. Consistent regulation of like services and products The disclosure rules that apply to securities under the SFO also apply to the offer of other investment products such as ILAS and MPF products (including MPF schemes and approved pooled investment funds under the MPFs regime and pooled retirement funds under the occupational retirement schemes regime). SFC is responsible for the authorization of disclosure documents before these products can be offered to the public (sections 103 and 105 of the SFO). These products are, however, not “securities” under the SFO and the SFO licensing provisions do not apply to those who distribute them to the public. Investment-linked insurance products Insurers and insurance intermediaries who only promote, offer or sell insurance products to the public (i.e. products that are not “securities” under the SFO) are not required to be licensed under the SFO. For example, although ILAS is an insurance contract with investment features and the issue of documentation relating to ILAS requires SFC’s authorization, promoting, selling or giving advice about the sale of ILAS does not require an SFC licence. Insurance SROs provide some standards but there are not strong suitability rules in their codes. For sale of ILAS by AIs, the HKMA introduced further requirements in addition to those required by the insurance SROs as it treats ILAS products on par with other investment products offered by AIs. The Government and the financial regulators are working on options to address the disparity in the regulatory requirements in connection with the distribution of ILAS products. The authorities highlighted that the establishment of a statutory licensing regime under the independent IA will help to strengthen regulation of conduct of insurance intermediaries, including those selling ILAS. Further the IA is introducing other enhanced disclosure and consumer protection measures for ILAS in 2014. MPF products The situation is different for MPF products. Although these activities are not regulated activities under the SFO, the MPFSO (following its amendment in 2012) makes the SFC, HKMA and IA frontline regulators of these intermediaries and confers statutory powers on each of them to supervise and investigate the conduct of the intermediaries who are licensed or authorized by them when they are selling MPF products. Coordination and cooperation between regulatory authorities SFC has a duty under section 5(1)(h) of the SFO to co-operate with and provide assistance to regulatory authorities or organizations, whether formed or established in Hong Kong or elsewhere. Similar provisions apply to HKMA under section 7(2)(e) of the BO. Section 5(3) permits SFC to rely in performing any function in relation to an RI on supervision of the RI by HKMA. HKMA and SFC are required by legislation to consult each other on specified regulatory matters. A range of matters requires one authority to consult the other before taking action. These include, for example: a. SFC must consult HKMA before making rules, codes or guidelines that apply to RIs (sections 398(4) and 399(9) of the SFO); b. mutual consultation obligations in relation to disciplinary matters (see for example section 196 of the SFO; sections 58A(1) and 71C(4) of the BO); c. SFC must consult HKMA before directing an AI to produce books and records (section 179(10)(a) of the SFO), or commencing an investigation of an RI (section 182(1)(e)(i)). The SFC and HKMA have entered into an MoU which provides a framework for cooperation and coordination. The MoU sets out the regulatory and supervisory roles and responsibilities of the two regulators, and establishes the channels and mechanism for the exchange of information between them, including, for example, periodic meetings, and the sharing of particular types of information. In addition, if HKMA becomes aware of a material breach by an RI or its staff of any applicable provision of the SFO or any rules, codes or guidelines made or published by SFC under the SFO, the MoU provides that HKMA will refer the matter to SFC. SFC may (after consultation with HKMA) commence an investigation under section 182 of the SFO. In practice there seems to be regular engagement between the authorities beyond what is set out under the MoU, on issues of policy, as well as on findings from their off and on-site programs, and referrals do take place. Relations between SFC and the HKEx are dealt with under Principle 9 and Principles 32–36. MoUs between SFC and the HKEx set out the agreed arrangements on various topics, including SFC’s oversight, supervision of exchange participants and market surveillance, and the supervision of listed entities. Coordination with other authorities for purpose of ensuring coordination and level playing field across the financial sector, and financial stability The SFO also imposes obligations on SFC to consult with the IA in a number of circumstances. The IA and the MPFA are also under statutory obligations to co-operate with other financial sector regulators and to consult with them in specified circumstances. The MPFSO requires the MPFA to consult SFC before issuing guidelines that apply to licensed corporations (LCs) or their representatives that are also registered with the MPFA. A variety of MoUs have been entered into between the financial sector regulators. In addition to the MoU with the HKMA, the SFC has entered into MoU with the IA. It is also a party to an MoU between the MPFA, SFC, IA and HKMA on the regulation of MPF intermediaries, and a tripartite MoU with the HKMA and the FDRC. The CFR comprising the FS, the SFST, the Chief Executive Officer of SFC (CEO), the Chief Executive of HKMA, the Managing Director of the MPFA and the Commissioner of Insurance meets regularly to discuss cross-market regulatory and supervisory issues. In addition, various MoUs have been entered into between the domestic regulators to ensure that there are no regulatory gaps or inequities.
Assessment	Broadly Implemented
Comments	The reason for the grade relates to the distribution ILAS vis-à-vis Question 2 b) of the IOSCO Methodology. As explained in the description currently there is a disparity in the requirements in connection with distributors of ILAS, whereby the sale of ILAS by banks and non-bank insurance intermediaries respectively are not subject to the same standard of conduct obligations. The assessors acknowledge that the government and regulatory authorities are working on options to address this issue. Overall the assessors found that there is active cooperation and sharing information between the SFC and the HKMA. However, the assessors encourage the authorities to consider having periodic reviews of the supervisory and enforcement outcomes of both SFC and HKMA to ensure that, regardless of which regulator is involved, poor conduct by intermediaries and their managers and representatives is treated in a consistent fashion, especially in terms of remedial and enforcement responses. This issue has not been taken into consideration in reaching the grade.
Principle 2.	The regulator should be operationally independent and accountable in the exercise of its functions and powers.
Description	Independence – SFC SFC is a non-governmental statutory body. It was established by the SFC Ordinance (now repealed) and is continued in existence under the SFO as a statutory corporation. SFC is not part of the Government and its employees are not civil servants. The CEHK is empowered to give SFC written directions (see section 11 of the SFO), but has not done so since the establishment of SFC in 1989. Senior SFC staff indicated that, in the explanatory material prepared when the provision was enacted, it was explained that this power would only be used by the Government as a last resort, in extreme circumstances. Further as set out in the SFO Ordinance, such power is subject to the following restrictions: (i) the direction must be in the public interest, (ii) it must further SFC regulatory objectives or the performance of any of its functions and (iii) the CEHK must first consult the SFC Chair to afford the SFC a formal opportunity to be heard. The authorities emphasized that the CEHK would not give directions to the SFC unless necessary in the public interest and that in doing so would have sought appropriate advice and take into account all circumstance prevailing at the time. These may include whether there is a major malfunction on the part of the SFC, whether financial stability of Hong Kong is at risk or its reputation as an international financial centre is at stake, the urgency of remedial actions required of the SFC and whether other checks and balances are performed effectively in the circumstance. Under section 1 of Part 1 of Schedule 2 to the SFO the chairman, executive directors and non-executive directors of SFC are appointed by the CEHK. The Government plays no part in the appointment of other staff. Governance Section 1 of Part 1 of Schedule 2 to the SFO provides that the number of non-executive directors of the Commission must be more than the number of executive directors. In practice, the board of directors of SFC (Board) meets at least once a month. The non-executive directors are not involved in SFC’s day-to-day operations. All Board members are appointed for a fixed term by the CEHK or by the FS under delegated authority. There must be a minimum of 8 members of the Commission. Currently there are 8 non-executive directors, including the Chairman and 6 executive directors (EDs), including the CEO. The posts of Chairman and CEO have been separated since 2006 by legislation. The letter of appointment of the SFC Chairman stipulates that he or she must not be a director of a listed company. Further, the Government requires him/her not to have any material interest in any principal business activity or be involved in any material business dealing with a company listed in Hong Kong or any person or company engaged in activities regulated by the SFC. On the other hand, non-executive directors may have other occupations (for example, currently one is a director of a listed company and 3 are legal practitioners). Potential conflicts of interest involving board members are dealt with by a code of conduct.. The authorities stated that when appointing non-executive directors the Government will take into account the various considerations including the avoidance of conflict of interests. In this regard, due consideration has been given to background and experience of the candidates, so as to ensure that their experience gained from various senior positions in major corporations and bodies would enable them to make positive contributions, as well as keep an independent eye on the performance of functions by SFC. Section 13, Part 1 of Schedule 2 to the SFO gives CEHK power to remove any member of the Commission whose removal appears to him to be desirable for the effective performance by the Commission of its functions. SFC senior staff emphasized, however, that the exercise of this power may be constrained by procedural fairness rules at common law; further, to date the power has not been exercised. In addition, the authorities indicated that such a decision can be challenged under general administrative law on the grounds that the CEHK acted unreasonably in the exercise of his powers or his decision was not appropriate. EDs’ contracts also specify other circumstances in which they may be removed, for example for misconduct. The Chairman leads the Board in setting the overall direction, policies and strategies of SFC and monitoring the performance of the executive arm in fulfilling the objectives, policies and strategies set by the Board. The CEO has the executive responsibility for the day-to-day running of SFC, in accordance with objectives, policies and strategies agreed by the Board. Some functions of the board are not delegable to executives, including enforcement decisions such as the decision to seek court orders under section 213 or to refer a matter to the MMT, and the power to make rules. A long list of non-delegable decisions is set out in Part 2 of Schedule 2 of the SFO. SFC structure is as follows:Interaction with government SFC is required by law to consult with the Government on a number of matters. In particular, the SFO requires prior consultation with the FS on a range of matters. These include: a. a number of decisions relating to the recognition and regulation of exchanges and clearing houses, including for example requesting an exchange company or clearing house to make rules (sections 23(4) and 40(4); b. making rules regulating the listing of securities (section 36(1); c. a number of matters relating to the establishment and operation of an investor compensation company; d. making rules requiring LCs to maintain certain financial resources (section 145); e. making rules to prescribe the circumstances in which any conduct that would otherwise constitute market misconduct under Part XIII or Part XIV shall not be regarded as constituting market misconduct (sections 282(2) and 306); f. publishing guidelines for the exemption of a person from the provisions of Part XV (Disclosure of interests in shares) (section 309(1)); and g. intervening in proceedings (section 385(1)) The consent or approval of the FS is also required in a limited range of circumstances: a. the appointment of SFC’s auditors (section 16(1)); b. the investment of funds of SFC (section 17); c. recognizing a company as an exchange controller (section 59(2)); d. withdrawing recognition of a company as an exchange controller (section 72(1)); e. appointing a person other than an employee of SFC to conduct an investigation under section 182 (1); and f. borrowing from a bank for the purposes of the investor compensation fund (section 237(2)). The circumstances under which the SFC is required to consult the FS or seek its approval/consent are set out in the legislation. They generally involve cross-sector issues which may have system implications. The authorities stated that the step of consultation with or seeking approval/consent of the FS is part of the process which aims at ensuring accountability of the SFC. The consent of the Secretary for Justice is required before: a. publishing a report of an investigation prepared under section 183 (6); and b. commencing proceedings before the MMT (section 252A(1)). The Secretary of Justice can only withhold consent if criminal proceedings for market misconduct are contemplated in respect of the same conduct; or proceedings for other indictable offences are contemplated, or have been instituted, in respect of the same conduct and the institution of MMT proceedings would be likely to cause serious prejudice to the investigation or prosecution of that offence. The SFC’s power to make or amend rules that constitute subsidiary legislation is subject to procedural requirements under section 34 of the Interpretation and General Clauses Ordinance (IGCO). This requires that amendments must be: a. published in the Hong Kong Gazette (a weekly publication available to the general public and accessible from the Government’s website); and then b. tabled before the Legislative Council of Hong Kong (LegCo) which may then approve, amend or reject the proposed subsidiary legislation. Interaction with HKEx SFC and the HKMA are members of the RMC of the HKEx, a statutory committee established under the SFO to formulate policies on risk management matters relating to the HKEx. The RMC provides recommendations to the HKEx board on risk management issues, including matters which may result in the need for the SFC to make regulatory decision or take regulatory actions, including changes to HKEx rules. Funding SFC has a stable and adequate source of funding. The SFC’s budget is approved by the FS. Detailed budgets that include staffing levels for each operational area are prepared as part of this approval process. See the details under Principle 3. Legal protection Board members and staff of SFC and persons assisting SFC in the performance of its duties are accorded legal protection for the bona fide discharge of their governmental, regulatory or administrative functions by section 380 of the SFO. This precludes actions in contract, tort, defamation, equity or otherwise. Arrangements are in place to indemnify Board members and SFC staff which include cover for costs and expenses in obtaining legal advice and/or representation in relation to any potential criminal and/or civil proceedings against or involving employees, whether or not the proceedings ultimately take place, provided that the advice/representation is with a view to preventing the action. The relevant costs and expenses are settled directly from the litigation budget. Independence - HKMA The MA is the Chief Executive of the HKMA, and is appointed by the FS under section 5A(1) of the EFO on such terms and conditions as he thinks fit. The MA is a public officer. Section 5A(2)(b) and (c) of the EFO requires the MA to perform such functions as the FS may direct and perform functions imposed on or assigned to the MA by any other Ordinance. For example, the BO assigns various functions to the MA, including principally the promotion of the general stability and effective working of the banking system. The supervisory powers in the BO are exercisable by the MA independently although prior consultation with the FS is necessary for some major decisions such as revocation of authorization and intervention under sections 22 and 52 of the BO. Section 10 of the BO gives the CEHK the right to give to the FS and the MA such directions as the CEHK thinks fit with respect to the exercise of the MA’s function under the BO, either generally or in any particular case. Some powers exercised by the MA are delegated to him by the FS, but others are conferred on the MA by the BO. Governance The existing MA was appointed for a term of 5 years, which was determined after consultation with the Exchange Fund Advisory Committee (EFAC) Governance Sub-Committee. The FS has the power to revoke appointment of the MA in the exercise of his or her statutory discretion pursuant to section 42 of the IGCO. The MA’s letter of appointment provides that it is not the FS’s intention to terminate the MA’s employment except for cause, such as the MA’s inability to discharge, or not adequately carrying out, his functions or duties; serious misconduct; conviction of a criminal offence punishable by imprisonment; or bankruptcy. In common with all other members of the MA’s staff, his employment may be terminated for “gross misconduct”. HKMA does not have a board per se but the EFAC carries out many of the functions of a management board. The EFAC established under section 3(1) of the EFO advises the FS on matters related to the control of the Exchange Fund, a fund under the control of the FS which shall be used primarily for such purposes as the FS thinks fit affecting either directly or indirectly the exchange value of the currency of HK and for other purposes incidental thereto. In addition to using the Exchange Fund for its primary purpose, the FS may, with a view to maintaining HK as an international finance centre, use the Exchange Fund as he thinks fit to maintain the stability and integrity of HK’s monetary and financial systems. The FS is the ex officio chairman of the EFAC and the MA is a member of the Committee. Other members are appointed by the CEHK under section 3(1) of the EFO. The members of the EFAC are appointed ad personam for the expertise and experience such as knowledge of financial and economic affairs. Current members consist of representatives from the banking, legal, accounting, business and academic fields. EFAC has a number of subcommittees, including a governance subcommittee. Members from the banking sector, however, do not sit on the EFAC Governance Subcommittee which monitors HKMA’s performance, oversees governance matters and provides advice on annual administration budget and remuneration policies for the HKMA. EFAC does not provide advice on matters relating to the supervision functions of the HKMA. Interaction with government The supervisory powers in the BO are exercisable by the MA independently although prior consultation with the FS is necessary for some major decisions (e.g. revocation of authorization and intervention under sections 22 and 52 of the BO). Section 10 of the BO gives the CEHK a right to give to the FS and the MA such directions as he thinks fit with respect to the exercise of their respective functions under the BO and which are consistent with the objectives and specific powers and duties contained in the BO. Section 132A gives persons aggrieved by decisions specified in the section to appeal the decision to the Chief Executive in Council. Funding HKMA has a stable and adequate source of funding. See under Principle 3. Legal protection Section 127(1) of the BO provides that no liability shall be incurred by the MA and his staff as a result of anything done or omitted to be done by him or his staff bona fide in the exercise or purported exercise of any functions under the BO. In line with the Civil Service Regulations of the Government, the MA will provide legal representation for his staff members for claims made against them with respect to actions or omissions made in the course of conducting their duties provided they acted in good faith. Accountability - SFC SFC is accountable to LegCo, the FS and various other bodies on an ongoing basis. Accountability mechanisms include: a. Section 12 of the SFO that requires SFC to provide to the FS such information regarding the “principles, practices and policy” it is pursuing or proposes to pursue in the performance of any of its functions as he may specify. In practice, SFC also submits a quarterly report on its operations to the FS. It also appears before the LegCo Panel on Financial Affairs when the need arises. b. Section 13 that requires i. SFC to submit its estimates of income and expenditure for the next financial year to CEHK for approval. The CEHK delegated this power of approval to FS in 2004; and ii. the approved estimates to be placed before the legislature for discussion, but not approval. c. Section 15 that requires SFC to publish an annual report which is sent to the FS, who places it before the legislature. In addition, SFC has published quarterly reports since 2011. d. Section 16 that requires SFC to send audited financial statements to the FS, and empowers the Government auditor to examine SFC’s books and records. e. An independent, non-statutory Process Review Panel established by the CEHK that reviews and monitors SFC’s processes and internal procedures. Transparency Section 169 of the SFO empowers SFC to issue codes of business conduct for intermediaries and section 399 creates a general power to issue codes and guidelines. SFC has used these powers to create an extensive range of codes and guidelines that are available on its website. As a matter of practice, SFC consults the industry and public on changes to these guidelines/codes or proposed new guidelines and codes. SFC is also required by law to consult the public on any subsidiary legislation (and any changes to subsidiary legislation) it proposes to make. Accountability - HKMA Through section 5A of the EFO (which specifies that the MA shall perform such functions as the FS may direct or functions imposed on or assigned to the MA by any other Ordinance (including the BO)) and section 9 of the BO (which specifies the reporting matters that the MA shall prepare and furnish to the FS annually), the MA is directly accountable to the FS. The MA is a public officer and his office is regarded as a part of Government. Though not specifically required by law, HKMA periodically provides briefings to the Legislative Council Panel on Financial Affairs to explain the work of HKMA and to answer questions. Section 9(1) of the BO requires the MA to send a report to the FS on the working of the BO and the activities of his office yearly. The FS may, under section 9(5), publish the report as he thinks fit. HKMA’s receipt and use of funds is subject to review and audit (section 7 of the EFO). The Audit Sub-committee of EFAC is responsible for ensuring the proper and smooth running of the HKMA operation and management of the Exchange Fund. The Audit Commission of the HKSAR Government audits the financial statement of the Exchange Fund. Review of SFC and HKMA decisions SFC Natural or legal persons adversely affected by SFC’s decisions or exercise or administrative authority can normally apply for judicial review of the decision. However, if the decision is a “specified decision” (see below) the review is undertaken by the SFAT (whose decision is also subject to higher appeal to the Court of Appeal on a point of law) rather than the Court of First Instance. The SFAT, a full-time and independent tribunal established under Part XI of the SFO, hears appeals against “specified decisions” made by SFC. The SFAT consists of a chairman (who is a judge) and two other members (who cannot be public officers but are expected to be market practitioners with appropriate knowledge and experience of the industry). “Specified decisions” principally are decisions relating to the licensing, discipline and operations of intermediaries, objections to listing applications and other decisions relating to listing matters (See Part 2 of Schedule 8 for a list of specified decisions). Reviews by the SFAT are a review on the merits, meaning a full review of the case and the decision is conducted. Other means of challenging SFC’s decisions include making a complaint to the Ombudsman, Privacy Commissioner or the ICAC depending on the subject matter of the decision. An appeal to the Chief Executive in Council may be made in relation to a number of decisions relating to exchange bodies and clearing houses, such as withdrawal of recognition or an order to cease operating facilities (e.g. see section 33 of the SFO). Such an appeal is also available in relation to a decision to withdraw recognition of an investor compensation company (section 86). HKMA Decisions of HKMA are amenable to judicial review. Under section 132A of the BO, a person or an AI may appeal to the CEHK in Council against a decision made by the MA, for example, the refusal by the MA to give consent to a person to become the chief executive of an AI under section 71(1) of the BO, and the proposed revocation of an AI’s authorization under section 22(1). An EO or ReI aggrieved by a disciplinary decision of HKMA may apply to the SFAT for review of the decision. Confidentiality SFC Section 378(1) of the SFO requires SFC to protect the confidentiality of information coming to its knowledge in the performance of its functions. Exceptions to confidentiality are set out in section 378(3) Section 378(3) permits the disclosure of non-public information in summary form, and disclosure to a comprehensive list of domestic regulators and authorities specified in that section, and under section 378(3)(g) to overseas authorities. HKMA Except as may be necessary for the exercise of any function under the BO or for carrying into effect its provisions, the MA and HKMA staff are required by section 120(1) of the BO to preserve secrecy with regard to all matters relating to the affairs of any person that come to their knowledge in the exercise of any function under the BO. Sections 120(5)(f) and (fa) of the BO permit disclosure to domestic regulatory authorities such as SFC, IA and MPFA and the FRC. For disclosure under sections 120(5)(f), HKMA must be satisfied, among other things, that the disclosure will enable the recipient of the information to exercise its functions. Section 121 allows HKMA to disclose information to overseas supervisory authorities under the conditions that the authority exercises the functions of supervising banks or the securities and futures industry in its jurisdiction, and is subject to adequate secrecy provisions.
Assessment	Partly Implemented
Comments	The grade stems from governance issues on both regulatory agencies in connection with questions 1a (HKMA) and 1a and b of the Methodology (SFC). The assessors acknowledge that de facto both regulatory authorities enjoy sufficient independence in their day to day operations. However there are features in the system that can become pressure points for political or commercial influence. Those relate to: The power of the Chief Executive to provide directions to both agencies. This power has the potential for interference in day to day operations as such directions can be about the handling of individual cases. The authorities have emphasized, however that to date these powers have not been used, and they will only be used as a last resort in extreme circumstances The power of the CEHK to remove SFC board members without the existence of a clear framework to constrain such dismissal. The authorities have emphasized, however, that some constraint would be imposed by common law and that a dismissal could be challenged under general administrative law. In the case of the SFC, the fact that key decisions concerning exchanges must be consulted with (and a few approved by) the FS. The assessors acknowledge that this is an area where many countries still keep some level of involvement in the hands of governmental authorities, anchored in a concept that exchanges have a key strategic role. That is particularly true in the case of Hong Kong where exchanges are considered a public utility. However in other countries there is a detailed policy framework for the recognition of exchanges that frames the participation of the Government in the recognition process. In addition, SFC (and HKMA) membership of the statutory committee on HKEx’s risk management could affect its ability to exercise independent oversight of critical aspects of HKEx’s operation. This is because, through the RMC, it contributes to the decision making process of the HKEx’s board. See further under Principle 9. The authorities have informed that they are currently reviewing this issue. In the case of the SFC, the potential for conflict arising from the participation of part-time members in the board, especially given that the current framework would allow them to be members of regulated entities and listed issuers. The assessors acknowledge that their participation can allow the SFC to bring to the table expertise that otherwise would be more difficult to obtain. At the same time this structure might be more open to conflict of interest, especially as a large number of decisions including enforcement decisions must be exercised directly by the board. While a recusal process exists to that effect, managing these conflicts in practice can become more challenging (if for example a member has to be recusing himself/herself too often). Other regulatory agencies address issues of expertise by establishing advisory committees (indeed SFC has an advisory committee established under section 7 of the SFO), which do not take part in formal decision making by the regulator. At the outset of the assessment, the current process of approval of the budget of the SFC raised concerns vis-à-vis independence, as it includes approval of the number of positions allocated to different departments. However conversations with the authorities left the assessors satisfied that in practice this issue has not affected the ability of the SFC to enjoy a stable source of funding, and to reallocate staff if necessary in light of emerging risks. Only if those risks lead to a major “overhaul” of resources then the SFC would require an authorization from the FSTB. This would be in line with an oversight role. In practice, a contingency of about 10 percent is included in the SFC’s annual budget, which provides some flexibility to meet unforeseen demands on resources.
Principle 3.	The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.
Description	Power and authorities The powers of the SFC and HKMA stem from the SFO, the BO and by other legislation administered by the authorities. Overall they both have broad licensing and supervision and investigations powers commensurate to their respective mandates. The SFC has different avenues available to conduct enforcement actions, including criminal and MMT proceedings, and civil and administrative/proceedings. Thus, from a formal perspective the enforcement powers afforded are in line with the Principles. Practical challenges are discussed in Principle 12. Enforcement powers of the HKMA are more limited; however as will be further discussed in Principle 10, enforcement of securities laws and regulations is mainly a responsibility of the SFC. Rules and codes SFC has power to make rules under section 398 of the SFO. Matters on which it may make rules are enumerated, and these include a very general provision permitting the SFC to make rules on “any other matters for the better carrying out of the objects and purposes of” the SFO (section 398(1)(p)). Rules are subsidiary legislation and have the force of law. Their making is subject to procedural safeguards including mandatory public consultation and a requirement to place rules before LegCo which can approve or amend them (see under Principle 2). SFC has a general power (section 399 of the SFO) to issue codes and guidelines to provide guidance for the furtherance of its regulatory objectives, in relation to any matters pertaining to any of its functions, and in relation to the operations of any provision of the SFO., It has issued a wide range of guidance to explain the regulatory requirements to regulated persons and the public. For intermediaries and their representatives, SFC also has specific powers to make rules (section 168 of the SFO) and codes (section 169). SFC makes extensive use of its rule making and code making powers. Codes do not of themselves have the force of law, but they set out what the SFC “expects” from regulated entities and persons, and non-compliance with them is generally relevant to SFC’s consideration of whether a person has complied with provisions of the legislation. More specifically, in relation to codes made under section 169, the legislation provides (section 169(4)) that a failure on the part of an intermediary, or a representative of an intermediary, to comply with the provisions of a code may be taken into account in considering whether the intermediary or representative is fit and proper and should remain licensed or registered. Codes made under both sections 169 and 398 are admissible in evidence in proceedings under the SFO before any court, and if any provision set out in the code appears to the court to be relevant to any question arising in the proceedings the court must take it into account in determining that question. However, according to recent jurisprudence, a violation of a Code does not create a third party right. That is, an investor cannot sue a licensed firm for violation of a code unless the obligation set out in that code is also an obligation contained in the contract between the investor and the firm. To address this gap, the SFC is proposing to require intermediaries to include a provision in all of their contracts with their clients to that effect. HKMA has power to make rules in a limited number of circumstances specified in the BO, for example the power to make rules about capital and liquidity requirements for AIs (sections 97C and 97H when it comes into operation). HKMA also uses Circulars to influence conduct by institutions it regulates, For example, it has required RIs to adopt measures additional to those required under the SFO in relation to AI’s selling of investment products, for example by requiring AIs engaging in retail securities business to audio record the sale process in branches, and to physically segregate their retail securities business from their general banking business in branches. Funding SFC is funded by the levies for transactions recorded on exchanges. It also receives its funding from fees or other charges in relation to share purchases, takeovers and mergers and applications for registration, authorization, approval, exemption, waiver or modification under the SFO. SFC also has investment income in the form of interest income derived from the investment of its reserves. SFC’s income for the 2012-3 year is budgeted at HK$1.170 billion and it now has accumulated surpluses in excess of HK$7 billion. Budgets have been sufficient to enable significant increases in staff levels, especially in supervision and enforcement. Section 395 of the SFO provides that fees prescribed by the rules may be fixed at levels sufficient to cover expenditure incurred, or likely to be incurred, by SFC in providing the services or performing the functions to which the fees relate. However, they are not limited to this criterion. The annual budget process is subject to scrutiny by the Administration and by LegCo. HKMA is funded from the Exchange Fund pursuant to sections 5A(3), 5A(4) and 6 of the EFO. Annual license fees paid by AIs under section 19 of the BO also form part of the annual revenue of HKMA. HKMA draws up its annual budget to ensure that sufficient resources are available for carrying out its functions. Budgeting takes into account both the continuing operations of HKMA and its strategic development set out in a three-year plan approved by the FS on the advice of the EFAC. Budgets have been sufficient to make the necessary increases in staff levels, especially in conduct supervision and enforcement. Both regulators control the operational allocation of their resources. Staff resources SFC’s remuneration levels are broadly competitive with those of the market. To maintain pay competitiveness to retain and recruit qualified employees, the Commission regularly reviews remuneration levels to calibrate the pay practices with that of a pre-determined peer group. SFC staffing levels are as follows: Division/Department Staffing level at end May 2013 CEO’s Office and Central Services 30 Corporate Finance 63 Enforcement 145 Investment Products 89 Intermediaries 207 Licensing   79 Supervision   128 Supervision of markets 33 Legal Services 32 Corporate Affairs 103 Total 702 Approximately 28 percent of SFC staff have professional qualifications in accountancy and 17 percent in law. HKMA has increased and centralized the supervisory resources dedicated to conduct supervision. A Banking Conduct Department with a current total of about 100 staff members (of which about 50 are specialized in the supervision of AIs’ conduct of securities, insurance and MPF intermediary activities) and an Enforcement Department with a current headcount of around 100 were established in April 2010. In general, staff members possess relevant working experience in the banking or financial industry with tertiary education. Training Both SFC and HKMA provide training for staff. SFC staff all have individual development plans in which training needs are set out. Policies and governance practices SFC has extensive policies and practice manuals and a rule book that govern the way regulatory work is carried out. These include “PRP Manuals” that set out procedures to be followed in performing SFC functions (see further under Principle 4). Non-executive directors of SFC sit on SFC’s audit, remuneration, budget and investment committees. Executive directors also sit on the budget committee (as non-voting members) and the investment committee. HKMA also has an extensive policy manual (Supervisory Policy Manual {SPM}), two parts of which set out its approach to supervising AIs’ securities and leveraged foreign exchange businesses. Staff members follow the Operations Manual for Banking Conduct Department Division 1 which spells out the approach and procedures adopted by HKMA in carrying out its supervisory functions. HKMA has also in place a set of enforcement procedural controls in governing the exercise of its investigation and disciplinary powers. Among other things, when a complaint is made to, or an event is identified by, HKMA that may indicate potential grounds for discipline, HKMA assesses the information available and submits the matter to an internal standing committee (Event Review Committee) to decide whether a case should be opened and the scope of any investigation. Investor education SFC conducts investor and public education by using multiple media, ranging from print materials, TV and radio programmes, to outreach programmes and a dedicated investor education website. The format of its investor education programmes also varies from conventional publications, talks and advertising campaigns to non-conventional game shows and story competitions. SFC’s statutory education mandate set out in the SFO was recently broadened following public consultation and legislative amendments. The Investor Education Centre (IEC) was established as a wholly-owned subsidiary of SFC in November 2012. It is a dedicated education organization to oversee the needs of investor education and delivery of related initiatives for the entire financial sector in Hong Kong with the aim of improving the financial literacy and capability of the general public. The IEC is governed by an independent Executive Committee (IEC ExCo), consisting of representatives of each of the four regulators (SFC, HKMA, OCI and MPFA), the Education Bureau, a representative of the financial services industry and the General Manager of the IEC. The Chair of the IEC ExCo is a non-executive director of SFC. The IEC has established working level arrangements with each of the financial regulators to facilitate communication and cooperation, and provide technical support and advice, for example on draft education materials. The IEC aims to be the focal point for financial education in Hong Kong. To promote consumers’ understanding of their rights and obligations, HKMA in December 2012, launched a “Consumer Corner” on its website providing information on local banking consumer issues and the HKMA’s role in banking conduct regulation. With the aim of better equipping the general public to be “smart and responsible” in the use of banking products and services, HKMA is also formulating a consumer education work plan involving the use of multiple channels to communicate effectively with the public on topics of interest.
Assessment	Fully implemented
Comments	Overall the assessors consider that the regulatory authorities have been given broad licensing, supervisory powers and investigative powers vis-à-vis their respective mandates. In addition, the assessors acknowledge that the SFC has access to different avenues to seek enforcement actions for breaches to securities laws, including criminal and MMT proceedings, civil and administrative/disciplinary proceedings. However, as further explained in Principle 12, for misconduct that does not constitute a crime the current framework does not easily allow the SFC to secure both remedial and punitive actions and in practice finds itself having to make difficult trade-offs. As this is an issue that affects effectiveness of enforcement it has been taken into consideration for the grade of Principle 12 only. An important question in a jurisdiction that relies heavily on codes is their enforceability. Based on conversations held, there appear to be sufficient precedents that establish that codes are enforceable for administrative and disciplinary proceedings.
Principle 4.	The regulator should adopt clear and consistent regulatory processes.
Description	Clear and equitable procedures Procedures rules and regulations Each operational division of SFC is required to have one or more procedures manuals that set out the procedures that must be followed in exercising its powers and discharging its functions in the vast majority of SFC’s work. The Process Review Panel (PRP), an independent, non-statutory, body comprising representatives from various community segments, the non-executive SFC Chairman and a representative from the Secretary for Justice (both in an ex-officio capacity). Its function is to review SFC’s internal operational procedures, including procedures for ensuring consistency and fairness, and to determine and report on the adequacy of SFC’s internal procedures and operational guidelines; and by conducting reviews of files, whether those procedures are followed in practice. PRP’s terms of reference cover procedures for complaint handling, licensing and inspection of intermediaries, corporate finance, disciplinary action etc. but not regulatory procedures and actions in relation to regulated markets. The Financial Services Branch of FSTB supports PRP members in carrying out these reviews. The PRP reports at least annually to the FS. These reports are made public on the FSTB website. SFC also has performance pledges which set out time frames for regulatory approvals. The BO is supplemented by HKMA’s SPM which sets out the best practice in risk management the HKMA expects AIs to follow, elaborates on its supervisory approach to monitoring compliance, and lays down the minimum standards which HKMA expects AIs to attain. The assessors’ review of files indicate that the regulators’ powers are exercised and the processes described above are applied consistently. Consultation and transparency SFC is obliged to consult publicly on any proposal to make or amend rules under any provision of the SFO (section 398 of the SFO). As a matter of practice, it also consults, both formally and informally, on proposals to adopt new policy or new non-statutory codes and guidelines. It does so in accordance with the Public Consultation Procedures published on its website. HKMA is required to conduct a public consultation before making rules. Its standard practice is also to consult the banking industry before any amendments to the SPM or guidelines are made, or any new SPM modules or guidelines are issued. HKMA senior staff indicated that, while not as formal as the consultation process for rules, where appropriate, they also consult the banking industry on circulars involving new regulatory measures related to securities activities. In fact, HKMA staff stated that the HKMA consulted the banking industry before each circular (about policy) was issued over the past two years. Transparency of requirements to conduct regulatory activities Overall the SFO, BO and the rules, codes, guidelines and circulars establish clear and sufficiently detailed criteria for the requirements and obligations of regulated activities. The only important exception is the recognition of exchanges and the authorization of ATS, where the current framework is very high level. (See the discussion under Principle 33.) SFC senior staff has indicated their plans to work on consultation papers that would allow them to develop a more detailed framework for these two areas. Procedural fairness SFC is required by the legislation to provide reasons for its regulatory decisions, and to provide an opportunity to be heard, in relation to: a. recognition of exchanges etc and their rules under Part III of the SFO; b. authorization of products under Part IV; c. licensing decisions under Part V; d. disciplinary decisions under Part IX; e. compensation decisions if it proposes to provide compensation less than the amount claimed (Part XII and section 8 of the Securities and Futures (Investor Compensation – Claims) Rules (Claims Rules); f. decisions to object to a proposed listing (section 6(7) of the Securities and Futures (Stock Market Listing) Rules (SMLR) (Cap. 571V)). It is the policy of the Takeovers Panel to publish its rulings (section 16.1 of the Introduction to the Takeovers Code). The HKMA is required under the BO to give reasons for any: a. refusal to give consent to a person to act as an EO (under section 71C(3)(b)); and b. suspension or revocation of registration or consent to act as an EO or a ReI (sections 58A and 71C). While there is no specific obligation to give reasons for conditions attached to a consent under section 71C(3)(a), the MA is required to specify such conditions. In practice, the HKMA issues “letters of mindedness” to the person before giving consent, specifying the proposed conditions and setting out the reasons for them. Cost of compliance SFC is not obliged to carry out detailed cost/benefit economic analysis, but uses both the formal and informal consultation processes to inform itself about cost of compliance issues. It takes these into account in finalizing rules, policy or codes and guidelines. HKMA has no obligation to carry out formal cost/benefit analysis of proposed rules or guidelines. Like the SFC, it takes account of comments it receives, including on the cost of compliance, in both formal and informal consultations. Review of decisions See under Principle 2. Confidentiality Investigations SFC and HKMA are subject to confidentiality/secrecy obligations (section 378 of the SFO; section 120 of the BO), the only exceptions to which are set out in the legislation. SFC may publish press releases concerning criminal actions and civil proceedings commenced by SFC or against SFC, once there has been a decision by the court in question and the information is public. In addition, under section 194(6A) and 196(6A) of the SFO, SFC has statutory authority to disclose to the public details of disciplinary action taken against a regulated person, the reasons for it and any material facts relating to the case. It typically does so when the time for appeal against the disciplinary action has expired. Section 120 of the BO aids in preserving secrecy with regard to all matters relating to the affairs of any person that may come to the HKMA’s knowledge in the exercise of any function under the BO, subject to specific gateways of disclosure provided in the general exception in section 120(1) and section 120(5), in particular section 120(5)(i) with regard to public information. Information on legal proceedings (if any) and judgments (if any) in relation to actions commenced by, or against, the HKMA may be published by the HKMA where such information is publicly available. Also, the HKMA has statutory authority under sections 58A(4A) and 71C(7A) of the BO to disclose to the public the details of any decision the HKMA has made under section 58A(1) and section 71C(4) against a ReI or an EO, the reasons for which the decision was made and any material facts relating to the case. In June 2013, the HKMA published a press release concerning the disciplinary action taken by the HKMA against a ReI for misconduct committed by such ReI in the selling of an investment linked assurance scheme.
Assessment	Fully implemented
Comments	Overall the current legal and regulatory framework and processes in place have provided a high level of transparency and consistency to day to day decisions. The only area that raises concerns relate to the recognition of exchanges and the authorization/licensing of ATS, where the current framework would benefit from additional detail and transparency. The authorities are aware of this challenge and plan to “formalize” existing internal policies–which have developed overtime—into the corresponding code for ATS and potentially guidelines for the recognition of exchanges. These issues have been discussed more in depth under Principle 33 and have been taken into consideration for the grade of such Principle. The assessors note the use that the HKMA makes of circulars as a way to impose additional conduct requirements on securities markets activities conducted by banks. In such context it is critical that such circulars be subject to consultation.
Principle 5.	The staff of the regulator should observe the highest professional standards, including appropriate standards of confidentiality.
Description	Staff of SFC are required to comply with any statutory provisions and with the provisions of: a. SFC Employee Handbook; and b. SFC Code of Conduct. Staff of HKMA are required to comply with HKMA Code of Conduct, Rules on Appointment and Discipline, and HKMA Administration Circular No. 2/2012 - Rules on Restrictions on Investments by HKMA Staff. Conflicts of interest Section 379 of the SFO makes it a criminal offence for staff of SFC (including directors) to enter (directly or indirectly) into transactions which would create a conflict of interest. A transaction will create a conflict of interest if it is the subject of any investigation or proceedings by SFC or if the staff member knows it is otherwise being considered by the Commission. The section also requires a staff member to inform SFC immediately if he is required to consider any matter relating to a transaction or corporation in which he has an interest, or in relation to person by whom he was employed, who is or was an associate, or of whom he is or was a client. Paragraph 2.1 of SFC Code of Conduct requires staff of SFC to take appropriate steps to avoid actual and potential conflicts of interest, including the appearance of loss of impartiality in the performance of his duties. SFC Code of Conduct obligations also extend beyond section 379 of the SFO to cover transactions that a staff member knows are the subject of an investigation by an overseas financial regulator. Other areas covered by SFC Code of Conduct include social contacts, loans, dealings with outside parties (including former SFC colleagues), accepting or offering gifts or benefits, accepting hospitality, relations with suppliers and contractors, gifts between colleagues, reporting of bribery, etc. HKMA Code of Conduct provides guidelines and advice on the main issues that may have a bearing on the integrity of HKMA and its staff, which includes acceptance of advantages, conflict of interest, investment restrictions and confidentiality of information. Staff of both SFC and HKMA are also subject to the provisions of the Prevention of Bribery Ordinance. Securities trading by SFC and HKMA staff SFC Code of Conduct contains restrictions on holding or trading listed Hong Kong securities and requirements to disclose financial affairs and interests in securities or futures contracts. These include: a. Initial Disclosure Obligation – on commencement of employment or, for EDs taking up an appointment, staff must declare all direct or indirect holdings of securities and futures contracts (page 13); b. Ongoing Disclosure Obligation - all transactions in securities or futures contracts, must be disclosed within 2 trading days of the transaction (page 14); c. Restrictions on dealing by EDs - i. No ED may deal in any securities except the Pilot Programme Securities [the Pilot Programme For Trading US Securities on SEHK] and securities held through the medium of CIS or investment companies (whether or not such CIS or investment companies are listed); and ii. No ED shall in any manner transact any trading in any securities (other than through a CIS and certain US securities) and any futures contract as (page 17); d. Restrictions on dealing by staff - i. Minimum Holding Period – staff must hold each investment for a minimum of 30 days after it has been purchased; ii. Index List – for securities, staff may invest only in securities included in the index list prescribed by SFC; iii. Derivatives – staff must not engage in derivatives transactions (some narrow exceptions apply); iv. IPOs – staff must not subscribe for shares of corporations or interests in real estate investment trusts (REITs) or exchange traded funds (ETFs) unless authorized by the Commission; and v. Margin Financing – staff must not use margin financing. The Rules on Restrictions on Investments by HKMA Staff and paragraph 4.6 of the HKMA Staff Handbook contain detailed instructions on how to handle private investment activity and sets out the relevant reporting requirements. All HKMA staff are required to report any purchase of shares or warrants and structured products, as well as purchases of foreign currency and funds involving HK$100,000 or more. Staff in the Banking Departments and designated staff having access to data on AIs are prohibited from purchasing shares or warrants of any AI. Use of information Paragraph 25 of the HKMA Code of Conduct states that staff of the HKMA who have access to or are in control of proprietary information should provide adequate safeguards to prevent its abuse or misuse. Staff should not use any such information made available to them in the course of their duties in return for monetary rewards or personal interest or to disclose such information which is not in the interest of the public or the HKMA. Disclosing proprietary information without authority may constitute a criminal offence or disciplinary case. Paragraph 26 of the HKMA Code of Conduct states that staff of the HKMA should also be mindful in handling information containing personal data. Unauthorised disclosure of such data may result in a breach of the provisions of the Personal Data (Privacy) Ordinance. Confidentiality and secrecy SFC and HKMA staff are both subject to confidentiality obligations under the SFO and the BO. HKMA staff are also subject to the Parts III and IV of the Official Secrets Ordinance. Paragraph 5.1 of the HKMA Staff Handbook deals with obligations relating to classified information. Procedural fairness SFC and HKMA staff are bound by the principles of procedural fairness under common law in the performance of their functions. See also under Principles 2 and 4. Processes for dealing with violations and sanctions Complaints about misconduct by SFC staff are examined by the Senior Director, Corporate Affairs, who is the most senior officer not responsible for an operational division. If misconduct is found, a staff member may be subject to disciplinary action, or to criminal sanctions such as those that apply to breaches of confidentiality obligations. The SFC staff informed that there has been only one case related to a violation of the ethics code. In such case the employee was issued a written warning. Consultation with the SFC Legal Services Department determined that no additional disciplinary action was needed. In HKMA, complaints about misconduct are examined by an appointed person at least one rank senior than the person in question. Staff guilty of misconduct are liable to disciplinary action, including criminal sanctions. The HKMA informed that no cases have been presented of violations to the ethical codes.
Assessment	Fully implemented
Comments
Principle 6.	The Regulator should have or contribute to a process to monitor, mitigate and manage systemic risk, appropriate to its mandate
Description	Entity responsible for systemic risk in securities markets The SFC is responsible for the administration of the laws governing the securities and futures markets in Hong Kong. In what relates to this principle, the SFO gives the SFC the objective of reducing systemic risks in the securities and futures industry; and assisting the FS in maintaining the financial stability of Hong Kong by taking appropriate steps in relation to the securities and futures industry. The SFC has relied mainly on a bottom up approach to identify emerging and systemic risk, via its operational departments, with coordination achieved via periodic meetings at different levels of the organization. In 2012, the R&S was created, in order to bring a centralized approach to risk which would “help the SFC to more effectively coordinate its overall strategy to deal effectively with the range of risks affecting market participants and investors”. Internal inputs Supervision of markets: the daily market monitoring conducted by this division plays a key role in the identification of risk to the orderly functioning of markets It has access to several sources of information, including trading data, which it analyzes based on a series of indicators; settlement reports from the central counterparties (CCPs); large open position and short position reports; and flow of funds data. Exceptional market drop reports are provided to FS and SFC ExCo when there are significant market corrections. Corporate Finance and Investment Products: these divisions are key contributors to the identification of risks emerging from products available to HK retail investors. First, through the authorization function, the division collects information on new products authorized, which is also shared with the HKMA and the OCI; and its ongoing monitoring allows it to identify trends in products, as well as issuers of concern. For example, in view of the sovereign debt crisis in Europe, the Investment Products Division has been collecting information, on a regular basis, from major fund managers on their schemes’ exposure to, among others, European countries. It has held meetings with major fund managers to understand the crisis’ impact on them and their contingency plans. Intermediaries Supervision: through its off and on-site monitoring of licensees, this department assists the SFC in identifying risks particular to a specific intermediary. Its thematic reviews contribute to gaining an understanding of risks that cut across a sector of licensees. In addition, it conducts surveys from time to time to assist it to identify risk emerging in different sectors: for example, on the distribution of unlisted products, the activities of HF managers, etc. External inputs The HKMA: the HKMA provides inputs to the SFC on risks arising from the securities markets activities of banks. Of particular importance are the results of the quarterly survey on products distribution that the HKMA shares with the SFC. In addition, MoU meetings are used also to raise issues of concern and there are also informal mechanisms of communication. Meetings with industry participants: Starting in March 2013 the R&S conducted risk-focused industry meetings with ten global institutions to ascertain evolving business models, market structure, product innovation, emerging risks and risk governance trends, which resulted in the publication of a report entitled “Risk-focused Industry Meeting Series: G-SIFI Trends in Risk and Risk Mitigation” (http://www.sfc.hk/web/EN/files/ER/Reports/20140109_RIM(EN).pdf). In addition to the risk-focused meetings, the R&S also monitors industry trends through a variety of other approaches, including but not limited to: liaison meetings with other regulators, industry associations and industry representatives; subscription to real time market data and news sources; industry research; and market intelligence through the network of R&S members. The R&S produces a global regulatory and macro newsletter that incorporates topical global and regulatory risks developments. Internal Coordination Through meetings at different levels of the organization the inputs coming from all these sources are shared among the divisions to achieve a common view of risk. Weekly management meetings: these are the main vehicle for the divisions to share information on emerging issues that are of concern; these are relatively “unscripted” meetings. Biweekly meetings of the ExCo: these are more formal meetings that are used to prepare issues that need to be discussed at board level. Senior staff of the SFC indicated that a “spotlight on risk” is being added to these meetings. Quarterly Policy Meetings of the Board: These meetings were instituted recently to provide the Board more room to discuss policy and risk issues. These meetings are an at early stage (so far only six have taken place) thus senior management expect them to get more focused as the risks capabilities of the institution itself grow. Cross-department/functional working groups for specific policy projects. Increasingly R&S is taking a greater role in supporting the risk identification function of the SFC and allowing it to get a centralized/focused view of risk. As stated above, it currently supports risk identification through its meetings with external participants. An example of risk identified by the R&S relates to the implications of the tightening of US monetary policy. The R&S identified this as an emerging risk theme in mid-2012, on the basis of (i) large bond fund sales volumes in Hong Kong and globally, and (ii) a rapid rise in the volume of issuance of high yield bonds, especially by Chinese enterprises. The R&S raised this risk theme within the SFC, with the HKMA and others. As a member of the IOSCO Committee on Emerging Risks, the Head of R&S also raised this as an emerging risk theme at the IOSCO Emerging Risk Discussion in September 2012 and supplemented it with further market data and information in later IOSCO Emerging Risk Discussions. Based on a consensus with Intermediaries Supervision Department of the relevance of this topic from a sales practices and investor standpoint, on 19 November 2012 the SFC issued a circular to LCs and RIs entitled “Selling of Fixed Income Products.” The circular was based on joint inputs from the SFC and HKMA and set out the risks associated with fixed income products in the “search for yield” environment. The HKMA similarly issued a circular on the Selling of Fixed Income Products on the same date. In the first half of 2013, R&S actively discussed the search for yield and interest rate risk in meetings with a series of global financial institutions that are active in Hong Kong, in the context of a dialogue on emerging risk themes and risk governance. In December 2013, R&S has published a report on the outcome from its risk-focused industry meetings. The report is entitled “G-SIFI Trends in Risk and Risk Mitigation” (http://www.sfc.hk/web/EN/files/ER/Reports/20140109_RIM(EN).pdf). This report followed a series of meetings conducted by the R&S between March and August 2013 with senior executives of G-SIFIs on topics focused on the evolution of risk and on measures for risk mitigation, against the backdrop of changing business models and market structure as well as product innovation. The report highlights (1) aspects of best practices adopted by G-SIFIs for the purpose of risk identification and risk mitigation; and (2) forward-looking themes to achieve continuous improvement by G-SIFIs in risk governance and risk culture. In January 2014, R&S produced a report on Bitcoin that was shared with regulatory counterparties in Hong Kong and formed the basis for a regulatory dialogue on this topic. The takeaways from the report were also shared with members of the IOSCO Committee on Emerging Risk. Another key project of the R&S is the development of a risk register. The risk register has been implemented. Because it is a “living” document, it will require periodic liaising by R&S with the SFC operating divisions with a view to ensuring that the Risk Register is up to date, accurate and complete and that the Heat Map is properly calibrated. The Risk Register and associated Risk Heat Map will be used for strategic planning purposes and for periodic reporting to ExCo/ the Board and will be tabled for periodic emerging risk discussions at ExCo/ the Board. One target of these discussions will be to assess whether any additional steps should be taken that straddle operating divisions and may require more frequent sharing of data and information. The risk register is automated and accessible on the internal R&S portal. The R&S portal integrates all key aspects of the work of R&S, including the report published pursuant to the risk-focused industry meetings, the internal risk register, reports published as a result of collaboration on the IOSCO Committee on Emerging Risks, the R&S Global Regulatory and Macro newsletter and other ad hoc projects and research. Development of expertise With the establishment of the R&S qualified staff were hired. The unit comprises four professional staff with legal, front office derivatives trading, prudential and conduct risk governance experience. SFC staff participate in the IOSCO Emerging Risk Committee which helps gain a better understanding of initiatives of other regulators in the area of identification and measurement of risk. In this regard, three relevant products are: the IOSCO Risk dashboard; the annual IOSCO Securities Markets Risk Outlook (public report) and the guidance paper on methodologies for the identification, monitoring and assessment of risk by securities regulators. Coordination in connection with financial stability There are several committees that allow the sharing of information among regulators. FSC The key committee for purposes of systemic stability is the FSC, in which the SFST (chair), the SFC (CEO, ED, SOM), the HKMA (CE) and the OCI (Commissioner) participate. The FSC is responsible for monitoring the functioning of the financial system and any events or developments with cross-sector and systemic implications. Its responsibilities include: regular monitoring the functioning of the financial system of Hong Kong, including the banking, debt, equity, insurance and related markets; deliberating on events, issues and developments with possible cross market and systemic implications, and where appropriate, formulating and co-ordinating responses; and reporting regularly and as necessary to the FS regarding matters in (a) and (b) above. The FSC meets monthly. It is mainly used by the regulators to update the FS and each other on key developments that can affect systemic stability, and to coordinate any necessary actions. All regulators can influence/shape the agenda. The meetings work on a free flow discussion. For example, the FSC discussed the proposed tapering of quantitative easing by various central banks and the effect that it could have in HK. CFR The CFR is made up of the FS (Chair), SFC (CEO, ED/SOM), HKMA (CE), OCI (commissioner), MPFA (managing Director), and SFST. It focuses on cross-sector regulatory matters with a view to minimizing regulatory gaps or duplications. Its objectives are to: facilitate cooperation and coordination among its members; share information and views on regulatory and supervisory issues and important trends in the financial system, particularly those that may have a cross-sectoral impact; minimize duplication or gaps in the regulation and supervision of financial institutions, paying close attention to the need to keep regulatory costs to a minimum; review international developments in financial sector regulation and to draw lessons for Hong Kong; discuss regulatory and supervisory issues relating to individual financial institutions that may have a cross-sectoral impact; and oversee trends, issues and developments which may have implications for financial stability in Hong Kong. The CFR meets quarterly. The FS is the secretariat and is in charge of setting up the agenda. SFC senior management considers that the CFR has been very useful to discuss issues of concern to all the regulators, such as the ILAS. Another topic currently on its agenda is the development of a resolution framework. Securities and Futures Liaison Committee (SFLC) The SFLC is made up of the SFST and SFC (CEO, EDs of all divisions, Chief Counsel, Commission Secretary). The SFLC meets monthly. Major policy proposals (for example, those that would require legislative changes) are discussed. The agenda is proposed by the FSTB, but senior management of the SFC indicated that the SFC can add issues to the agenda if they see the need. FS Meetings Monthly meetings take place that are attended by the FS, SFST and SFC (Chairman, CEO). Similar topics to those discussed at the SFLC are discussed here Tripartite meetings Bi-monthly meetings take place among the SFST, SFC (Chairman, CEO, ED, Corporate Finance Division/ED, SOM) and the HKEx. The meetings focus on current topics of common interest. Examples include the new regulations concerning the sponsor regime, the regulation of overseas companies, the new business model of the exchange and how the SFC is responding to it. RMC This is a statutory committee, created after the merger of the exchanges. Under the SFO, it is composed of the HKEx Board Chairman and seven other members, 3-5 appointed by the FS while the HKEx appoints not more than two. It meets monthly and focuses on risk management issues at the HKEx. A current topic on the agenda relates to the enhancement of the risk management of the CCP in light of the PFMI.
Assessment	Broadly implemented
Comments	The initial assessments conducted under the new methodology focused on the analysis of three high level issues in connection with the existence of a process to identify systemic risk or to review the perimeter of regulation which is required pursuant to question 1 of the respective principles: (i) whether the arrangements in place allow for a holistic (across products, entities, and markets) view of risk, (ii) whether they allow for periodic reassessment of risk (iii) and whether they allow for proper follow up (actions). The experience gained over the last year allows assessors to delve deeper into these issues, for example, by looking at the type of data and analysis that is used by the authorities to identify such risks, and the degree to which the processes implemented allow for proper accountability. Such rigorous analysis is in line with the recommendations included in the report of the Assessment Committee of IOSCO. Accordingly and based on question 1 in the methodology this principle has been graded broadly implemented. The assessors acknowledge that the authorities are making significant progress in improving existing arrangements for the identification of both emerging and systemic risks. Operational divisions are indeed key players in the identification of risks; they have a foot in the ground and are able to see what is happening at the microlevel. However, the risk of a bottom up/decentralized approach is that the view of risk is more likely to be fragmented. Thus the assessors welcome SFC initiatives to complement this approach with a stronger top down component. In this regard, the examples provided indicate that the addition of the R&S is already bearing fruit, as it is bringing much needed centralization and focus to the existing framework. The risk register adds further “structure” to the process as it assists in the integration of the views on risks from different parts of the organization as well as in achieving a ExCo/ Board level discussion of risks. It should also help to conduct appropriate monitoring of actions taken and whether they are being effective in addressing the risks identified.
Principle 7.	The Regulator should have or contribute to a process to review the perimeter of regulation regularly
Description	Identification of risks The SFC has mainly relied on the bottom up approach explained in Principle 6 to identify emerging risks stemming from regulated and unregulated activities, and to review past decisions on the perimeter of regulation. That is, through their day to day work, the operational divisions identify risks and issues of concern. Internal input is complemented by external sources, including information from the HKMA and risk meetings with market participants. Issues of concern are discussed at different levels of the organization, through the weekly meetings, and the biweekly ExCo meetings. If issues are of sufficient concern they are brought to the consideration of the board and when appropriate, also to the HKMA and other public authorities through the relevant committees. As indicated in Principle 6, the Board has recently instituted quarterly policy meetings to provide an opportunity for more substantive discussions. External Committees The SFC operates a number of committees, comprised of SFC senior executives and market professionals, which play an important role in enabling the SFC to review its regulatory perimeter. The Advisory Committee was established under section 7 of the SFO, and meets quarterly to advise the SFC on a broad range of policy initiatives and market issues including consultation proposals by the Government and SFC, listing-related matters and Mainland and international regulatory developments. Non-official members are drawn from different sectors, including brokers, funds, listed companies, legal, and banking. There are several committees that specialise in particular regulatory areas such as market supervision, investment products and public shareholders’ rights and interests. Examples include: The Committee on REITs that advises the SFC on general policy matters or regulatory issues that are related to the Code on REITs, the overall market development of REITs, the property or securities market or investment management in Hong Kong or elsewhere, professional practices or guidelines that are involved in the operation of REITs, and fund investment or management in general. The Products Advisory Committee that may be consulted by the SFC on a wide range of matters relating to the Products Handbook, the SFC Code on MPF Products and the Code on Pooled Retirement Funds, overall market environment, industry practices and novel product features. The Public Shareholders Group that advises the SFC on aspects of the regulatory framework relating to shareholders’ interests and investor protection, in order to promote (i) a level playing field among all shareholders, (ii) increased accountability by directors and management of listed companies to shareholders, and (iii) proper functioning of the securities market. The Group is chaired by the ED of Corporate Finance Division, and met three times in 2012 to discuss issues including the SFC’s review of the IPO regime and a proposal on the new prospectus regime. The Takeovers and Mergers Panel one of the functions of which is to review the provisions of the Takeovers Code and the Rules of Procedure and to make recommendations to the SFC on any necessary or appropriate amendments. The R&S As indicated in Principle 6, a key addition to the SFC’s activities has been the creation of the R&S, which will strengthen the development of a centralized view on risks. The risk register is a tool that allows all divisions to provide input to the process of risk identification. It allows for prioritization, and proper follow up of decisions made in regard to actions to be taken, including when appropriate a review of the perimeter of regulation. The Risk Register includes an assessment of “Perimeter” and R&S will work further with other divisions, including the Legal Services Division, on items that require perimeter analysis and/ or extension. Revisions to the perimeter of regulation Through the arrangements described above the SFC identifies risks that require adjustments to the perimeter of regulation. In some cases the adjustments can be done directly by the SFC through changes to its codes, and/or supervisory programs; while others require coordination with other authorities and/or legislative changes. In the latter case, the SFC raises such issues in the SFLC and cross-regulatory meetings. Senior staff from all relevant authorities (SFC, FSTB) indicated that the FSTB is generally supportive of SFC initiatives, which it forwards to the LegCo. Further, the authorities use the period before the start of a new legislative term to map all changes that are needed to the legislative framework. Two examples of emerging risks that have led to adjustments in the perimeter of regulation relate to: ILAS: as this involves a case of disparity in the regulatory requirements across sectors in connection with the distribution of ILAS, actions are been taking in a coordinated manner by the Government along with the financial regulators, as explained in Principle 1. Enhancements to the initial public offering (“IPO”) sponsor regime: this case stems from concerns over the quality of disclosure in IPOs. The SFC considered it necessary to strengthen the obligations of sponsors. Further the SFC has requested that legislative amendments also be pursued to clarify the civil and criminal responsibility of sponsors for the due diligence that they are required to perform. In addition, the authorities highlighted the existence of several projects that will entail adjustments to the perimeter of regulation. Some of them have been triggered by the lessons from the crisis and the global regulatory reform agenda (such as, the OTC derivatives reform and the development of a resolution framework). Others respond to micro challenges that have arisen from the current structure of the HK securities markets, including (i) the increased interconnection of the HK market with the Mainland (initially via listings and more recently also through the entrance of intermediaries), and (ii) the new business strategy of the HKEx.
Assessment	Broadly implemented
Comments	The grade stems from the need to further strengthen the processes in place for the identification and monitoring of emerging risks and to address issues of the perimeter of regulation as already planned by the SFC. This issue has been explained in Principle 6. The assessors note that the SFC has been active in identifying risks arising both from the macro as well as from the microenvironment. On the latter, the assessors encourage the SFC to continue to take a proactive stance to identify and address challenges arisen from the increased interconnection with the Mainland, in particular in connection with the effectiveness of enforcement, as well as from the new business strategy of the HKEx, its implications vis-à-vis the supervision of the HKEx, but also vis-à-vis competition.
Principle 8.	The Regulator should seek to ensure that conflicts of interest and misalignment of incentives are avoided, eliminated, disclosed or otherwise managed.
Description	Regulated entities The existing regulatory framework requires regulated entities to put in place mechanisms to identify, monitor and mitigate conflicts of interest. Overall, the framework for intermediaries is principles based, and establishes three types of actions that intermediaries can take to address conflicts of interest: avoidance, control and disclosure (see Principle 31). Conflicts of interest obligations exist also for specific types of participants including auditors (see Principle 20), credit rating agencies (see Principle 22), sell side analyst (see principle 23), and SROs (see Principle 9). The SFC (and the HKMA) reviews compliance with the conflict of interest obligations through its licensing and ongoing supervisory program. At the licensing stage, an applicant’s policies and procedures to identify and manage conflicts of interest are reviewed and if necessary changes are requested. On an ongoing basis, if problems with compliance are identified the SFC can take different type of actions including issuing of guidelines if problems are common across many participants and taking enforcement actions against individual participants. To strengthen the regulatory regime, in 2010, the SFC introduced measures to enhance intermediary conduct, in particular, on practices relating to the sale of investment products. These required enhanced disclosure to clients of sales related information, such as the capacity (principal or agent) in which an intermediary is acting; the affiliation of the intermediary with the product issuer; and the monetary and non-monetary benefits received by the intermediary for the distribution of investment products. This disclosure must be made prior to or at the point of sale. Also in 2010 the HKMA established a separate Banking Conduct Department to respond to the need to strengthen its supervision of banks. The HKMA has also complemented SFC codes (and the obligations therein concerning distribution of products) with circulars that establish additional obligations on that banks, including, for example, requiring AIs engaging in retail securities business to audio record the sale process in branches and to physically segregate their retail securities business from their general banking business in branches. Investor education is also one of the SFC’s regulatory focuses and is an important complement to the regulation of intermediaries. It helps investors protect themselves, allowing them to acquire better knowledge of market operations, product features and associated risks and thereby make informed investment decisions. For example, the SFC has published articles, newsletters and booklets to illustrate the new regulatory requirements on the disclosure of sales related information, including information regarding the potential conflicts of interest between the product issuers and distributors, to assist investors to safeguard their interests. Issuers In the case of issuers, the main mechanism used to address misalignment of incentives is disclosure to the public. Through the discussions with authorities and market participants the assessors have identified family owned structure of the majority of listed companies as a key source of conflicts of interest in HKSAR. This risk is well known to the authorities. In fact a very strict framework for transactions between related parties is in place, as discussed under Principle 17. Another area of potential misalignment of incentives relates to structured products. In this regard the SFC has issued a Code for non listed structured products that requires manufacturers to design products fairly and appropriate for the markets for which they are intended.
Assessment	Fully implemented
Comments
Principles for Self-Regulation
Principle 9.	Where the regulatory system makes use of SROs that exercise some direct oversight responsibility for their respective areas of competence, such SROs should be subject to the oversight of the Regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.
Description	SROs The HKEx and the exchanges that are members of the HKEx group perform an SRO function in the Hong Kong market. Similarly, the clearing houses owned by the HKEx play a supervisory function in relation to the clearing and settlement of transactions on the exchanges. No other Hong Kong-based entities operate exchange markets in Hong Kong. The Hong Kong Mercantile Exchange operated a futures exchange as an ATS authorized under Part III (sections 95-101) of the SFO but its authorization was withdrawn in May 2013. The HKEx group HKEx is a recognised exchange controller under the SFO. It owns and operates the only stock exchange and a futures exchange in Hong Kong and their related clearing houses. Historically, the exchanges operated by HKEx pre-dated the legislation and their recognition under the SFO was grandfathered. These exchanges are: a. The SEHK operates a stock market in Hong Kong and under section 19(1)(a) of the SFO is the only exchange permitted to trade equity securities in Hong Kong. b. HKFE is a REC under the SFO. HKEx also wholly owns the London Metal Exchange. HKEx owns and operates 3 clearing houses that are recognised clearing houses under the SFO: a. Hong Kong Securities Clearing Company Limited (HKSCC) provides services for the clearing and settlement of securities; b. The SEHK Options Clearing House Limited (SEOCH) provides services for the clearing and settlement of stock options; and c. HKFE Clearing Corporation Limited (HKCC) provides services for the clearing and settlement of transactions on HKFE. Governance HKEx is a listed company, with the Government of Hong Kong retaining 5.8 percent of the shares. Under section 77 of the SFO, the FS has the power to appoint up to eight directors of HKEx where the FS is satisfied that it is appropriate to do so in the interest of the investing public or in the public interest. The authorities highlighted that apart from its commercial interests the HKEx also has important public functions of ensuring an orderly and fair trading in securities and futures trading as well as prudent risk management, noting that the HKEx has the right to operate the only stock market in HKSAR. The appointment of a number of directors by the FS is therefore necessary to ensure adequate reflection of public interest and interest of the investing public in the decision making body of HKEx. Directors are appointed by the FS from among, inter alia, market professionals and distinguished members of the community. No government officials have been appointed by the FS as members of the board of directors of HKEx. Of the current board of 13 directors, 6 (including the Chairman) were appointed by the FS. The Chief Executive is the only executive director. The boards of SEHK and HKFE are appointed by HKEx as the sole shareholder. Section 26 of the SFO provides that the approval of SFC is required for the appointment of the chief executive of a recognized exchange company (i.e. SEHK and HKFE). The RMC established by law advises and provides recommendations to the board of HKEx on risk management issues. The FS appoints the majority of the members, and a representative of each of SFC and HKMA are members. Changes the HKEx needs to make to meet the new PFMI is an example of the type of issue on which the RMC would provide recommendations. Division of responsibilities between SFC and HKEx The CEHK has power under section 25(1) of the SFO, at the request of SFC, to delegate to a recognized exchange some specified regulatory functions, including licensing of participants and approval of prospectuses. In practice, only the power to approve prospectuses is delegated. Under the legislation, SFC has direct responsibility for: a. licensing of all market participants; b. monitoring market participants’ compliance with the SFO and subsidiary legislation, and SFC codes, and acting on non-compliance; c. monitoring the market and acting on suspected market abuse and insider dealing; d. monitoring issuers’ compliance with the obligation to disclose inside information and acting on non-compliance; e. monitoring compliance with the disclosure of interests provisions in Part XV of the SRO (substantial shareholding and short positions) and acting on non-compliance; f. approving prospectuses and offer documents other than for listed equity and debt securities and listed structured products. (Offer documents for listed CIS products are approved by the SFC); g. approving new exchange products through the rule approval process; h. monitoring exchanges’ compliance with obligations under the SFO. HKEx and its exchanges are responsible for: a. deciding applications for admission as an exchange participant; b. monitoring compliance by market participants with exchange rules and acting on non-compliance; c. admitting issuers to listing; d. under delegated authority, approving prospectuses and offer documents for listed equity and debt securities, and for listed structured products; e. monitoring compliance by issuers with the Listing Rules and acting on non-compliance; f. monitoring the market to ensure that trading is orderly. In practice, HKEx and the exchanges in the group perform a self-regulatory function primarily in relation to the listing function performed by SEHK. Other regulatory functions are performed by SFC. Admission of participants An entity that wants to participate directly in the trading of the products listed on SEHK or HKFE must apply to become an exchange participant of the relevant market. The SEHK or HKFE has the right to admit or refuse to admit any person or company as an exchange participant. The eligibility requirements and ongoing obligations of exchange participants etc. are stipulated in the Rules and Regulations of HKFE and SEHK. The decisions are final and cannot be appealed against. One of the eligibility criteria established by the exchanges and clearing houses for their participants is that the persons should be corporations licensed by the SFC. Admission to listing The SEHK is the front line regulator of listed companies. It is responsible for admitting companies and products for listing, granting waivers associated with listing and monitoring and enforcing disclosure requirements under the listing rules. Rules The recognized exchange companies (SEHK and HKFE) establish and enforce binding rules of trading, business conduct and qualification for membership. All exchange participants must comply with the rules and regulations of the exchanges of which they are a participant. Any breaches of the rules and regulations are subject to the disciplinary actions of the exchange. Recognition of Exchange Companies Section 19 of the SFO provides for the recognition of exchange companies. The SFC must be satisfied that recognition is appropriate in the interest of the investing public or in the public interest; or for the proper regulation of markets in securities or futures contracts. Before it grants recognition, SFC must consult with the public and the FS. It can impose conditions as it considers appropriate. Under section 63(1) of the SFO, it is the duty of a recognized exchange controller which is a controller of a recognized exchange company or recognized clearing house to ensure so far as reasonably practicable: a. an orderly, informed and fair market in securities or futures contracts traded on the stock market or futures market operated by the recognized exchange company or through the facilities of the company; b. that there are orderly, fair and expeditious clearing and settlement arrangements for any transactions in securities or futures contracts cleared or settled through the facilities of the recognized clearing house; c. that risks associated with its business and operations are managed prudently; d. that the recognized exchange company or recognized clearing house (as the case may be) complies with any lawful requirement placed on it under any enactment or rule of law and with any other legal requirement placed on it. Section 21(1) of the SFO provides that it is the duty of a recognized exchange company to ensure: a. so far as reasonably practicable, an orderly, informed and fair market: (i) for a stock market, in securities that are traded on that stock market or through the facilities of that company; or (ii) for a futures market, in futures contracts that are traded on that futures market or through the facilities of that company; and b. that risks associated with its business and operations are managed prudently. Section 21(2) provides that, in discharging this duty, a recognized exchange company must: a. act in the interest of the public, having particular regard to the interest of the investing public; and b. ensure that the interest of the public prevails where it conflicts with the interest of the recognized exchange company. Market Rules Under section 23(1) of the SFO a recognized exchange company may make rules for such matters as are necessary or desirable:- a. for the proper regulation and efficient operation of the market which it operates; b. for the proper regulation of its exchange participants and holders of trading rights; c. for the establishment and maintenance of compensation arrangements for the investing public. Section 23 set out a detailed of list of what may be covered in such rules. Section 24 of the SFO provides that no rule of recognized exchange companies (whether or not made under section 23) or any rule amendment has effect unless it has the approval in writing of the SFC. In addition, section 36 gives SFC, after consulting the FS and the relevant exchange, the authority to make statutory rules on a variety of matters relating to market activity, for example the listing of securities and on persons who may be admitted as exchange participants. If exchange rules are inconsistent with these statutory rules, they are ineffective to the extent of the inconsistency. SEHK and HKFE have Trading Rules governing participation in its markets. Rules apply equally to all participants. Listing Rules The SEHK administers the Rules Governing the Listing of Securities on SEHK (Main Board Listing Rules) and the Rules Governing the Listing of Securities on the GEM (GEM Listing Rules) (collectively the Listing Rules). Under sections 23 and 24 of the SFO, the SEHK must submit any proposed rule or change of the Listing Rules to the SFC for prior approval before any rule change is implemented. Disciplinary powers SEHK and HKFE have disciplinary rules enabling them to impose sanctions for non-compliance with the trading rules. The disciplinary action includes censure, fines, suspension or withdrawal of trading rights. Co-operation with SFC By section 21(5) of the SFO, a recognized exchange company has a duty to immediately notify SFC if it becomes aware: a. that any of its exchange participants is unable to comply with any exchange rules or any financial resources rules; or b. of a financial irregularity or other matter which in the opinion of the exchange may indicate that the financial standing or integrity of an exchange participant is in question, or that an exchange participant may not be able to meet its legal obligations. SFC has MoUs with HKEx governing the relationship between the two organizations. A 2001 MoU deals with matters relating to SFC oversight, supervision of exchange participants and market surveillance. It sets out the terms of cooperation and obligations of both parties, including the responsibilities of HKEx and its exchanges and clearing houses, the review of HKEx’s operations by the SFC, data and information that should be provided to the SFC on a regular or ad hoc basis. It provides that if HKEx becomes aware of a serious matter as set out in Appendix I of the MoU, it will, to the extent permitted by law, notify the SFC as soon as practicable. A 2003 MoU deals with matters relating to listing. Avoiding anti-competitive situations and misuse of oversight role Potential misuse of power by HKEx as the sole operator of exchange markets in Hong Kong is dealt with by: a. SFC’s role in the approval of all exchange rules; b. Section 76 of the SFO, which requires that fees imposed by HKEx (as a recognized exchange controller) or SEHK and HKFE (as recognized exchange companies) must be specified in rules approved by SFC. In making its decision on fee rules, SFC must have regard to: i. the level of competition, if any, in Hong Kong for the matter for which the fee is to be imposed; and ii. the level of fee, if any, imposed by another recognized exchange controller, recognized exchange company or recognized clearing house or any similar body outside Hong Kong for the same or a similar matter to which the fee relates. Oversight Market functions SFC’s market supervision functions and activities are described under the Principles for Secondary Markets. In carrying out these functions, SFC has constant contact with the exchanges and is able to monitor their activities on an on-going basis. The 2001 MoU provides that SFC may carry out onsite reviews on the operations of HKEx, the exchange companies and clearing houses. The MoU sets out the cooperation and assistance that HKEx must provide and the procedures for conducting an onsite inspection. The SFC is planning to conduct its first such onsite review of HKEx and its exchanges and clearing houses in 2014. The purpose of the onsite review is to assess how well HKEx and its exchanges and clearing houses are discharging their respective statutory duties specified in the SFO including arrangements for monitoring compliance with and enforcing their trading and clearing rules, and handling conflicts of interest. In addition to the supervision functions described above, there is a schedule of regular meetings between SFC, HKEx and others that deal with matters relating to markets. This schedule includes: a. meetings between senior management of HKEx and SFC (monthly or bimonthly); b. RMC meetings (monthly includes other parties as well as SFC and HKEx) c. meetings between SFC, HKEx and FSTB (bimonthly); d. meetings between SFC market supervision team and HKEx IT team (quarterly). SEHK’s listing function The SEHK submits a monthly report to the SFC on the activities of the SEHK with respect to its listing responsibilities in relation to the Main Board and GEM. Pursuant to the 2003 MoU, the SFC and the SEHK hold monthly meetings to discuss matters arising from the monthly report, any matters or issues relating to the SEHK’s regulation of listed companies or the SFC’s oversight of the SEHK in listing related matters, and any policy or other matters relating to any of the SEHK’s functions and responsibilities. SFC conducts annual reviews of the SEHK’s listing related functions in accordance with the 2003 MoU (see further under Principle 34). The SFC’s annual review reports are published on the SFC website. The process focuses on the procedures and processes used by SEHK’s Listing Division as a whole. The SFC reviews sample cases to understand how the division’s policies work in practice and to verify whether the division’s practices follow its policies. As part of the review process, SFC interviews each of the Heads of Departments, including the Head of Listing, to obtain understanding of their assessment of the effectiveness and efficiency of their respective department’s decision-making processes and operational procedures. In 2012, the SFC performed thematic review on the Listing Division’s processes and procedures in respect of: a. processing listing applications in respect of Initial Public Offering (IPO) of equity securities; b. processing structured products listing applications; and c. dissemination of listed company information. Professional standards A recognized exchange controller, recognized exchange company and recognized clearing house must fulfill the statutory duties stipulated in the SFO. They are required to observe the secrecy provisions set out in Section 378 of the SFO. Under the rules of these entities, the disciplinary procedures include the right to appeal. In addition, laws of natural justice will apply and the right to judicial review is available. Conflicts of interest Potential conflicts of interest are dealt with by a number of mechanisms. The listing function SEHK admits issuers to listing and, under delegated authority, makes the formal decision on the adequacy of disclosure documents, including the prospectus. Potential conflicts associated with this role are dealt with as follows: a. the dual filing system means that the SFC also reviews prospectuses and has a power of veto; b. the Listing Committee makes the formal decision on listing applications. The Listing Committee comprises 28 individuals, including 8 investor representatives; 19 persons who provide a balance of representatives of listed companies and market practitioners; and the HKEx’s CEO. Rules for conflicts of interest are set out in paragraph 9 of the Guidance for Member of the Board and Committees of HKEx and require a member to declare any conflicting interest and not to take part in any matter where there is such a conflict. Individuals are nominated by a Nominating Committee comprised of three HKEx directors, and the SFC’s Chairman, CEO and Executive Director Corporate Finance; c. HKEx’s Listing Division is separated from the rest of HKEx by an information barrier (Chinese wall). The head of listing is not permitted to discuss listing applications with any other part of HKEx, except the CEO in his capacity as a member of the Listing Committee. HKEx board may from time to time make comment on the Listing Rules and proposals for changes to them; d. The Listing Division is the sole gateway for applicants for listing. If the SFC wants to inquire about a listing application, that request is channeled through the Listing Division. HKEx, as a company listed on its own stock market, is regulated by the SFC to avoid any conflict of interest and to ensure a level playing field between HKEx and other listed companies subject to the Listing Rules of the Main Board and GEM. Regulation by the SFC is imposed through two sets of provisions: a. Chapter 38 of the Main Board Listing Rules and Chapter 36 of the GEM Listing Rules contain provisions dealing specifically with the listing of HKEx. They set out the requirements that must be satisfied for the securities of HKEx to be listed on SEHK as well as the powers and functions of the SFC in the event of a conflict of interest; b. a 2001 MoU between the SFC, HKEx, and SEHK deals specifically with the self-listing of HKEx. It sets out the way the parties to it will relate to each other in relation to: i. HKEx’s and other applicants’ and issuers’ compliance with the Listing Rules; ii. the SEHK’s enforcement of its rules in relation to HKEx’s securities and those of other applicants and issuers; iii. the SFC’s supervision and regulation of HKEx as a listed issuer and, where a conflict of interest arises, other applicants and issuers; iv. conflicts of interest which may arise between the interests of HKEx as a listed company and companies of which it is the controller, and the interests of the proper performance of regulatory functions by such companies; and v. market integrity. Section 75 of the SFO provides that where the SFC is satisfied that a conflict of interest does or may exist, the SFC has the powers and functions with respect to the performance of regulatory powers and functions by HKEx or any company of which it is the controller. HKEx’s status as a listed entity is an example of where these powers apply.
Assessment	Broadly implemented
Comments	The view that the HKEx is a “public utility” and the monopoly granted by the SFO has triggered a level of involvement of the Government with the HKEx that is uncommon in developed jurisdictions. Such level of involvement manifests not only in the consultation and approval of certain measures concerning exchanges by the FS, but also on the appointment of a significant number of board members of HKEx by the FS. Such involvement in turn could pose conflict vis-a-vis the implementation of a strong framework of oversight of the HKEx. In such context, it is important that the process for appointment of directors be rigorous and transparent and that the persons selected are not government officials. The assessors note that no government officials have been appointed. Another manifestation of the close relations between authorities and the HKEx is the RMC. This has positive benefits in that it enables a coordinated approach to policy issues. On the other hand, it results in a situation where the SFC and the HKMA are involved in a decision making process on matters which at a later stage the SFC will be required to make regulatory decisions or take regulatory actions. Some matters, for example the PFMIs, will result in the need for rule changes. The involvement of the regulatory authorities in the RMC, with the functions it currently has, does not foster an appropriate arms’ length relationship between the regulators and the HKEx as a regulated entity. The review of the oversight framework led assessors to conclude that current arrangements in connection with the most direct SRO functions of the exchange, as well as requirements in place to handle conflict of interest in this function, are robust. In this regard such arrangements require separation of the listing function, approval of the HKEx rules by the SFC, the four eye principle for decisions on new listings (whereby the SFC can object to decisions made by the HKEx) and on-site inspections of the listing function. On the market function, the SFC should consider whether decisions on the admission of participants should be subject to an appeal process (for example by SFC), particularly in the light of the monopoly position of HKEx. Furthermore, as the HKEx implements its new business strategy, ensuring that robust arrangements are in place in connection with the market function become more relevant. Issues of concern remain in connection with the limitations to competition, but those do not arise from the rules of the exchange, rather from policies embedded in the SFO as it granted a monopoly to the SEHK. Thus these issues are not considered for purposes of the grade of principle 9.
Principles for the Enforcement of Securities Regulation
Principle 10.	The regulator should have comprehensive inspection, investigation and surveillance powers.
Description	Information gathering and inspection powers Both SFC and HKMA have broad powers to obtain books and records, seek information and carry out on-site inspections of regulated entities. A failure by a regulated entity to comply with SFC requests or directions made using these powers is a criminal offence. General powers Section 180 of the SFO creates a general power to obtain information from and inspect the business operations and the books and records of regulated institutions and their associated entities at any reasonable time. This power is available both to SFC and to HKMA. HKMA also has powers under the BO to require production of books and records and to conduct inspections of AIs, including AIs that are also RIs (sections 55 and 56). HKMA routinely uses both SFO and BO powers in its dealing with RIs. On-site inspections can be carried out without notice but the exercise of the power must be reasonable in the circumstances. Judicial action is not required and inspections may be carried out on a routine basis as well as in response to a particular inquiry. There is no requirement for the regulator to suspect misconduct before exercising these powers. Section 181 of the SFO gives SFC power to require a shareholder, a person who holds an interest in an investment product (securities, futures, CIS etc), a person who has conducted a transaction in an investment product, or an LC or RI to provide identity, transaction and holding details. LCs and RIs have extensive reporting obligations under the SFO, including both regular reports (such as annual reports and financial and capital requirements reports), as well notifications of specified events. See further under Principles 29–32. Stock exchange transactions Under section 71 of the SFO, SFC can require any exchange company or clearing house to provide trade and client information, including information in its possession or under its control that relates to the affairs of any of its members. MoUs between SFC and the HKEx set out the arrangements and procedures for facilitating the performance of their functions, including surveillance of trading activities. SFC conducts real-time surveillance of the trading activities of both the stock market and the futures market at the HKEx. Specialised systems are deployed to monitor the markets on a real-time basis every day. Record keeping requirements Securities and Futures (Keeping of Records) Rules (Record Keeping Rules) require all SFC intermediaries and RIs and their associated entities to keep records containing sufficient details to explain their business activities and operations and account of their client assets, and to keep these records for not less than 7 years. Customer identity SFC’s Code of Conduct requires LCs and RIs to obtain and keep information on the ownership and control of transaction accounts and prohibits them from executing transactions on behalf of clients unless they hold the required information (see paragraph 5.4 of the Code and further under Principle 31). SFC’s Client Identity Rule Policy sets out SFC’s approach to these requirements, in particular providing for a no action approach where it is not practicable to obtain details of an ultimate beneficiary before a transaction, for example where the client is an overseas financial institution’s omnibus client account. In that case, it is sufficient if the relevant information is provided to SFC or one of the Hong Kong exchanges within 2 days of a request. In addition to their general obligations under Record Keeping Rules, section 20 of Schedule 2 to the AMLO requires financial institutions (including LCs and RIs), in relation to each transaction carried out by them, to keep the original or a copy of the documents and a record of the data and information obtained in connection with the transaction. The Guideline on Anti-Money Laundering and Counter-Terrorist Financing requires that the records be sufficient to permit reconstruction of individual transactions and establish a financial profile of any suspect account or customer. These records must be kept for 6 years from transaction date, and SFC can require a longer period. SFC has access to this information using its information gathering powers. Issuers Section 179 of the SFO gives SFC the power to require production of records and documents concerning listed corporations (see further under Principle 12). Inspections outsourced to SROs and other third parties SFC does not outsource or grant inspection or enforcement authority to any third party. It may occasionally engage external consultants to assist in performing inspections on LCs in some specialised areas. Generally, in such cases, detailed scope of work and procedures to be followed for performing the inspection are set out in the letter of engagement between the SFC and the external consultants, and the SFC’s prior agreement is required for any material adjustments by the external consultants to the scope of work and procedures. Consultants are bound by the confidentiality obligations under section 180 of the SFO. HKMA also uses its own staff to carry out inspections.
Assessment	Fully Implemented
Comments
Principle 11.
Description	SFC Powers of investigation Issuers Section 179 of the SFO gives SFC the power to compel a corporation that was or is listed, its related companies, banks, auditors and any other person to produce records and documents specified by the SFC investigator. The SFC also has the power to require the person providing the records or documents to provide or make any explanation or statement in respect of the record or documents (section 179(3)). This power can be exercised in the circumstances listed in the section, including where it appears to the SFC that there are circumstances suggesting that: a. the business of the corporation (which is or was listed) has been conducted; i. with intent to defraud its creditors, or the creditors of any other person; ii. for any fraudulent or unlawful purpose; or iii. in a manner oppressive to its members or any part of its members; b. the corporation was formed for any fraudulent or unlawful purpose; c. persons concerned in the process by which the corporation became listed (including the public issue of securities) have engaged, in relation to such process, in defalcation, fraud, misfeasance or other misconduct; d. persons involved in the management of the affairs of the corporation have engaged, in relation to such management, in defalcation, fraud, misfeasance or other misconduct towards it or its members or any part of its members; e. members of the corporation or any part of its members have not been given all the information with respect to its affairs that they might reasonably expect. General investigation power Under section 182 of the SFO, the SFC has the power to direct one or more of its employees to conduct an investigation. This power can be exercised to investigate possible offences, when the SFC has reasonable cause to believe that: a. a person may have engaged in defalcation, fraud, misfeasance or other misconduct in connection with: i. dealing in any securities or futures contract or trading in any leveraged foreign exchange contract; ii. the management of investment in any securities, futures contract or leveraged foreign exchange contract; iii. offering or making any structured product, leveraged foreign exchange contract or CIS; iv. giving advice in relation to the allotment of securities, or the acquisition or disposal of, or investment in, any securities, structured product, futures contract, leveraged foreign exchange con-tract, or an interest in any securities, structured product, futures contract, leveraged foreign exchange contract or collective in-vestment scheme; or v. any transaction involving securities margin financing; b. market misconduct may have taken place; c. the manner in which a person has engaged or is engaging in any of the activities referred to in paragraph (a)(i) to (v) is not in the interest of the investing public or in the public interest. Once an investigation under section 182 of SFO has been started, the powers under section 183 of the SFO become available. Under section 183 of the SFO, the SFC has the power to compel both unregulated and regulated natural and non-natural persons to produce information and documents relevant to the investigation, including bank records, telephone and any electronic records. This power applies to both persons under investigation or whom the SFC has reasonable cause to believe has information relevant to the investigation. The SFC has the power to compel regulated and unregulated individuals to attend interviews and provide statements (section 183 of SFO) – see further below. The SFC also has power to apply to the court for search warrants to be executed at the premises of both supervised and unregulated natural and non-natural persons, including listed companies (section 191 of SFO). SFC Power to require information As described under Principle 10, SFC has broad powers to obtain records and information from regulated entities and other persons, including details about the owners and beneficiaries of transaction accounts, dealing instructions, transactions etc. Section 183 of the SFO allows the SFC when conducting an investigation to compel the production of information and documents relevant to its investigation, including contemporaneous records sufficient to reconstruct all securities and derivatives transactions, including records of all funds and assets transferred into and out of bank and brokerage accounts relating to those transactions. The information gathering power under section 183 of the SFO is wide and applies to both regulated and unregulated persons and entities. Telecommunications data Using its powers under section 183, the SFC has access information from telecommunications providers, such as information about whether telephone calls between parties under investigation and others have occurred. Bank records Under section 183(4) of the SFO, the SFC can require a bank to disclose any information or produce to the SFC any record or document relating to the affairs of a customer where the SFC is satisfied that: a. the customer is a person whom the SFC has reasonable cause to believe may be able to give information relevant to the investigation; and b. this disclosure or production is necessary for the purposes of the investigation and certifies in writing that this is the case. Power to compel a person to provide information Under section 183(1) of the SFO, the SFC has the power to require a person under investigation or any person whom the SFC believes has in possession or under his control the relevant information to attend an interview and answer truthfully and to the best of his ability such questions relating to the matters under investigation as the SFC investigator may put to him (regardless of whether the person is regulated and unregulated by the SFC, and regardless of whether he is a suspect or a witness). Individuals must answer questions but may claim privilege in respect of the information they provide so that answers they give may not be used in evidence against them in subsequent criminal proceedings. SFC can also require the interviewee to: a. verify the statements so made in the interview by statutory declaration; or b. verify by a statutory declaration that he was unable to provide information required because the information was not within his knowledge or was neither in his possession nor under his control (sections 183(2) and (3)). HKMA powers of investigation HKMA powers to investigate are contained in: Section 55, 63(2) and 72A(2) of the BO which empower the HKMA to conduct examination and investigation of the books, accounts and transactions of AIs and to require ReIs and EOs to submit information to the HKMA; and Section 180(1)(c) of the SFO which gives similar powers to the HKMA to make inquiries of (i) an intermediary or an associated entity, (2) a related corporation of the intermediary or the associated entity, (3) any other person, whether or not connected with the intermediary or the associated entity, whom it has reasonable cause to believe has information relating to, or is in the possession of, any record or document relevant to the investigation. These persons are required under section 180(4) to give access to such record or document and produce the record and document and answer any question raised by the HKMA. Under the BO or the SFO the HKMA does not have some of the investigation powers available to the SFC under section 183 of the SFO, such as the power to compel a regulated or unregulated person to give a written statement. Senior staff from the HKMA indicated that the absence of this power does not constitute a limitation in practice, given that under the current legal framework the enforcement function in connection with breaches arising from the securities markets activities of banks belongs to the SFC (as will be explained below).
	SFC enforcement powers As indicated above, the SFC is the main authority in charge with taking enforcement actions for breaches to the securities laws. The SFC has a range of enforcement powers to take criminal, MMT, civil, administrative and other actions. Criminal prosecutions The SFC has power to initiate criminal prosecutions at the Magistrates’ Court for offences which are to be tried summarily (section 388(1) of the SFO). For more serious offences triable on indictment, the SFC refers the cases to the DoJ. Article 63 of the Basic Law provides that the DoJ has overall control over criminal prosecutions, free from any interference. Many breaches of the SFO are criminal offences, including: a. market misconduct – there are six types of misconduct, including insider dealing, false trading, price rigging, disclosure of information about prohibited transactions, disclosure of false or misleading information inducing transaction, and stock market manipulation (Part XIII and Part XIV of the SFO); b. the conduct of unauthorized markets (e.g. section 19(1)); c. unauthorized offers of investment products (section 103(1)); and d. unlicensed conduct of regulated activities (section 114). Under the legislation, all market misconduct offenses are indictable offenses and thus can be tried either summarily or upon indictment. Offences tried as summary offences carry lighter penalties than those tried on indictment. For example, convictions for market abuse offences carry a maximum penalty of HK$1 million dollars and 3 years’ imprisonment if tried summarily, and HK$10 million and 10 years imprisonment if tried on indictment (section 303(1) of the SFO). The power to decide the venue of trial is vested in the DoJ. In addition to the penalties described above, in criminal proceedings the court may: a. ban a convicted person from being a director or manager of any listed corporation or from taking part in the management of any listed corporation for a maximum period of 5 years; b. ban a convicted person from dealing in securities in Hong Kong for a maximum period of 5 years; and c. issue an order recommending that any professional body of which the convicted person is a member to discipline him (section 303 of the SFO). MMT proceedings For breaches of market misconduct provisions, the SFC can institute proceedings in the MMT (sections 252 and 252A of the SFO). The MMT is an alternative to criminal prosecution for market misconduct offences, Under section 307 of the SFO, the institution of proceedings bars the taking of criminal proceedings against a person in relation to the same conduct. The MMT is an independent quasi-judicial body established under section 251 of the SFO. It is chaired by a judge or former judge of the High Court who sits with two members. MMT jurisdiction covers all six types of market misconduct listed above, and is empowered to make various orders. Decisions are reached using the civil burden of proof (i.e., has the case been proven on the balance of probabilities). The SFC can also institute proceedings in the MMT for listed corporations’ breaches of the requirements to disclose price sensitive information. The MMT can make various prohibition and cease and desist orders (section 257 of SFO), but cannot impose fines. It can make a disgorgement order for an amount not exceeding the amount of any profit gained or loss avoided as a result of the market misconduct. The MMT may also give a copy of the report of its proceedings to anybody (such as the SFC) which may take disciplinary action against that person. Failure to comply with orders made by the MMT is an offence and the maximum sanction is a fine of $1,000,000 and imprisonment for 2 years (section 257(10) of SFO). Civil proceedings The SFC has the power to initiate civil proceedings by applying to the civil court for injunctive or other remedial civil orders (section 213 of the SFO). These orders include injunction and remedial orders, and any ancillary order which the court considers necessary (including freezing of assets or the appointment of an administrator or receiver). The court can also make an order that a transaction be reversed (in effect a statutory rescission power). The powers under section 213 apply to both regulated and unregulated persons. The SFC also has the power to apply for orders to remedy unfair prejudice in a listed company, including injunction orders, disqualification orders, order to pay compensation to the company, and order to the listed company to bring action against directors of the listed company (section 214 of the SFO). The SFC may also present a petition to court for a bankruptcy order against a licensed or registered person or apply to the Court of First Instance for a company to be wound up (section 212 of the SFO). Administrative/Disciplinary proceedings The SFC has administrative power to impose disciplinary sanctions against persons licensed or registered with the SFC. Sections 194 and 196 give SFC the power to take disciplinary action against regulated entities (including LCs and their responsible officers (ROs) and representatives, and RIs and their EOs and ReIs) for failure to supervise properly subordinate personnel whose activities violate the securities laws. These include the power to: a. revoke a license or registration wholly or in part; b. suspend or partially suspend a license or registration; c. revoke approval to be a RO; d. suspend approval to be a RO; e. prohibit a person from applying for a license or registration; f. prohibit a person from applying to become a RO, EO or ReI; g. impose a fine (up to the maximum of HK$10 million or 3 times of the profit gained/loss avoided, whichever is the higher); h. reprimand. The SFC has power to impose restrictions on a licensed or registered person as regards its business activities or dealing with assets or maintenance of assets (sections 204 to 210 of the SFO). The SFC does not have the power to impose disgorgement or to require compensation of clients that have suffered losses. Power to enter remedial agreements Section 201(3) of the SFO also gives SFC formal power to enter into an agreement with an LC, and RI or a licensed individual who is the subject of administrative or disciplinary proceedings under section 194, 195, 196 or 197 of the SFO. These agreements allow the SFC to seek undertakings from regulated entities to achieve outcomes it could not achieve under its other statutory powers, notably the payment of compensation and the appointment of auditors to conduct an internal control review. These agreements can be enforced. Takeovers Panel Under the Hong Kong Takeovers Codes (the Takeovers Code and the Share Repurchase Code), the SFC, acting as the Executive, may refer suspected breaches of the Codes to the Takeovers Panel (a committee of the SFC made up of independent persons). The Panel can inquire into the breach and impose various penalties, such as public censure or “cold shoulder” orders, on regulated entities and individuals (paragraphs 12.1-12.3 of the Introduction to the Takeovers Codes). A cold shoulder order is an order that denies any person who has failed to comply with the Takeovers Codes access to the securities markets for a specified period. The SFC also has the power to impose cold shoulder orders. Suspension of trading SFC has the power to suspend trading in a security listed on the stock exchange if the SFC believes that: a. there has been inadequate disclosure; b. it is necessary or expedient to maintain a fair and orderly market; c. it is in the public interest, the interest of the investing public or appropriate for the protection of investors; or d. there has been a breach of a condition imposed by the SFC when allowing a previously suspended security to recommence trading (Rule 9 of the Securities (Stock Exchange Listing) Rules). If an exchange fails to comply with certain statutory requirements, the SFC may direct the exchange to be closed for the transaction of dealings (section 28 of the SFO). HKMA enforcement powers As indicated above the SFC is the main authority responsible for taking enforcement actions for breaches to securities laws. Thus, in general, the HKMA refers cases involving the securities activities of its regulated entities to the SFC. HKMA has two powers which are specific to its securities regulation functions: a. Under section BO 71C of the BO HKMA has the power to consent to the appointment of EOs by RIs. In circumstances set out in the section, which include misconduct by an EO, it may withdraw or suspend that consent after consultation with the SFC; b. Under section 58A of the BO, the HKMA has power to remove or suspend ReIs (staff of RIs engaging in regulated activities) from the register in the prescribed circumstances after consultation with the SFC. HKMA does not have a power to impose fines on individuals or on ReIs, but it can use “naming and shaming” as a disciplinary measure. Further, as stated above the HKMA can refer cases to the SFC, which in turn can impose fines on executive directors and ReIs of banks in relation to securities breaches under section 196 of the SFO. Private rights of action Private persons can seek their own remedies for misconduct relating to the securities laws. Under section 281(1) of the SFO, an affected person has the right to bring an action to recover compensation whether the loss arises from having entered into a transaction or dealing at a price affected by market misconduct. There need not be market misconduct proceedings before the MMT and a person need not have been found by the MMT to have engaged in market misconduct to be liable under section 281(1) (section 281(5) of SFO). In addition, section 305 of the SFO gives a person who suffers pecuniary loss as a result of any form of market misconduct the right of civil action to seek compensation. The SFC has power to intervene in proceedings between private litigants (section 385 of the SFO). Information sharing SFC’s investigatory powers under Part VIII of the SFO are generally sufficient for it to obtain all the information it needs for its investigatory purposes. The SFC rarely has to rely on other authorities in Hong Kong to obtain information for it. As described under the Principles on Co-operation, SFC has broad power to share information with other authorities, including other financial market regulators, the Commissioner of Police, the Commissioner of the ICAC, the MMT and the SFAT, and prosecutorial authorities. Other regulators can provide information to SFC if it is required. In particular, HKMA has power to share information with SFC about RIs and individuals acting for RIs such as EOs and ReIs. Information sharing arrangements are set out in MoUs, but there is no requirement for there to be an MoU for an exchange of information to take place.
Assessment	Fully implemented
Comments	Overall the assessors consider that the regulatory authorities have been given broad licensing, supervisory powers and investigative powers vis-à-vis their respective mandates.
	The assessors acknowledge that the SFC can make use of different avenues to seek enforcement actions, including criminal and MMT proceedings, and civil and administrative/disciplinary proceedings. Further from a formal perspective the enforcement powers afforded to the SFC are in line with the Principles –as they do not require regulatory agencies to have disgorgement or restitution powers. However, there have been practical challenges with the use of these avenues that could have an impact on the effectiveness of enforcement. As this is an issue of effectiveness, rather than formal powers, it has been taken into consideration for the grade of Principle 12. The assessors took note of the difference in investigative and enforcement powers of the HKMA vis-à-vis the SFC. The assessors concur with the HKMA that the absence of broader investigative powers does not create a gap in the system given the current allocation of responsibilities. A similar conclusion applies in connection with HKMA enforcement powers over ReIs and ReIs. While the HKMA cannot impose certain penalties on them, in particular fines, cases can be referred to the SFC which in turn can impose these penalties. Taken altogether the system can be considered “complete”. Therefore, no downgrade was applied. However, the assessors would recommend the authorities consider granting the HKMA with fining powers over EOs and ReIs as this would allow for more efficient prosecution of breaches.
Principle 12.	The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.
Description	Inspection, surveillance and compliance monitoring Licensed intermediaries SFC’s general approach to supervision of intermediaries is set out in the SFC’s publicly available Approach to Supervision. How it uses its powers to carry out supervision of licensed entities, including its risk-based approach, is described under Principles 24 and 31. HKMA’s approach to supervision of RIs is also described in detail under Principle 31. SFC and HKMA use both robust off site monitoring and regular on-site inspections. SFC regularly carries out thematic inspections as well as routine and for-cause inspections. HKMA has focused heavily in recent years on the selling practices of RIs in the distribution of investment products, including products such as ILAS that do not fall under the definition of securities under the SFO. Referrals to Enforcement Division resulting from SFC on-site inspections and off-site monitoring 2008/2009 2009/2010 2010/2011 2011/2012 2012/2013 Referrals to Enforcement 19 34 27 22 29 Source: SFC Corporate finance SEHK reviews all prospectuses and offer documents for listed securities and listed structured products. SFC reviews all IPO prospectuses and listing documents, and, where SEHK asks it to do so, listing documents for listed structured products and debt securities, including where listing is sought for novel structured products or debt securities. In many cases the disclosure is improved as a result of these reviews. SFC directly monitors issuers’ obligations to disclose inside information, disclosure of substantial shareholdings, related derivatives and short positions, and directors and executives shareholdings. SFC staff, as the Takeovers Executive, review all documentation relating to takeovers and other changes of control transactions. Financial statements of issuers are reviewed by HKEx, HKICPA and the FRC on a risk based selection process (see under Principle 18). Investment activity All disclosure documents for investment products, including CIS, structured products, ILAS and MPF products are reviewed by the SFC’s Investment Products Division. Unusual transactions on regulated markets The SFC uses dedicated automated systems, using adjustable parameters, to detect any unusual orders and transactions. A specialized team of staff within the SFC monitors and follows up exception reports generated by these systems. A 2001 MoU between the HKEx and SFC sets out arrangements and procedures for facilitating the performance of each organization’s functions. SFC has real time electronic access to HKEx’s SMARTS system, and to daily Market Surveillance System (MSS) data containing trading and other information; and for options and futures trading SFC has real time access to HKEx’s CIBOIS terminal and a daily data feed. Requirements for supervisory and compliance systems Intermediaries (LCs and RIs) are required to have adequate supervisory and compliance systems. In particular, paragraph 14.1 of the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) requires the senior management of intermediaries to manage properly the risks associated with their business, including by performing periodic evaluation of its risk management processes. Part I of the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC (ICG) requires an effective management and organizational structure which ensures that the operations of the business are conducted in a sound, efficient and effective manner to be established, documented and maintained. It requires that there are regular and effective communication within the firm which ensures that management is continually and timely apprised of the status of the firm’s operations and financial position, including qualitative and quantitative risks posed or weaknesses detected, non-compliance with legal and regulatory requirements, and the overall adherence to the firm’s defined business objectives. Part V of the ICG requires intermediaries to have policies and procedures to ensure the firm’s compliance with all applicable legal and regulatory requirements and the firm’s internal policies, and sets out detailed requirements for the policies and procedures, and organizational arrangements. These include, where practicable, an independent compliance function. For further details, see under Principle 31. SFC tests the adequacy of these arrangements, and their functioning in practice, in on-site inspections. Supervision of employees Under Paragraph 4.2 of the Code of Conduct (Capabilities – Staff supervision), a licensed or registered person must ensure that it has adequate resources to supervise diligently and does supervise diligently persons employed or appointed by it to conduct business on its behalf. Sections 194 and 196 give SFC the power to take disciplinary action against regulated entities and their management for failure to supervise properly subordinate personnel whose activities violate the securities laws. These powers under these section is described in Principle 11 Mechanisms to detect and investigate insider trading and other forms of market abuse The SFC has a team in the Enforcement Division dedicated to market surveillance. They use specialized systems with adjustable parameters to monitor market activity and staff review and follow-up exception reports in real time. The team also holds daily and regular meetings to discuss market news and intelligence. If staff members consider further enquiries should be made, they prepare a recommendation for the head of the team, who may commence a formal enquiry under section 181 of the SFO to seek details about the identity of persons involved in and other details about the trade. If, after a section 181 enquiry, it is considered that there is suspicion of market or price manipulation, the RO of surveillance team will prepare a case assessment report to set out the suspicions and recommend referring the matter to the Division’s investigation team. Intelligence and investor complaints Intelligence received by the SFC is logged in its Investigation Management System. The Investigation Management System is a case management and intelligence system that provides an integrated platform for users to create, maintain and enquire about cases. It also provides electronic filing function for case related documents and for intelligence database. All public complaints received are logged in the Investigation Management System by the External Relations Department of the SFC, along with a summary of the complaint prepared by officers that department. Complaints are tabled at the Complaints Control Committee (CCC), which meets weekly. The CCC is comprised of senior executives from each operational division and is chaired by the Senior Director of Corporate Affairs. During the meeting, the CCC discusses, assesses and decides how each complaint should be dealt with, for instance whether further enquiries should be made by Intermediaries Supervision, or an investigation should be commenced by Enforcement. Minutes of the meetings are distributed to the Complaints Liaison Officers of each division, who log the case and send details to the case officers assigned for further action. SFC also receives intelligence from the Joint Financial Intelligence Unit of the Hong Kong Police Force (JFIU), other domestic law-enforcement agencies and overseas regulators. The JFIU manages the suspicious transaction reports (STRs) regime for Hong Kong and its role is to receive, analyse and store STRs and disseminate them to the appropriate investigative unit. When SFC receives referrals from JFIU or other agencies and regulators, the intelligence is logged and an assessment prepared. The assessment is referred to senior management to decide if further action is warranted, such as commencing a formal investigation. SFC Enforcement Investigations Enforcement at SFC has four teams - Surveillance, Investigation, Disciplinary, and Policy & International. As of August 2013, there are 145 staff members in Enforcement. Enforcement staff members come from multidisciplinary backgrounds with legal, accounting, finance and forensic and investigative skills. The SFC’s Legal Services Division provides professional legal advice and support. The IT Department also has a team of forensic IT experts who provide assistance to investigators. When an SFC division detects possible breaches of regulatory requirements in their inspections or other monitoring activities, they assess the matter and may recommend referring the case to Enforcement for investigation. The SFC has internal criteria to assist staff members to make decisions about what should be referred. If, after gathering information through use of sections 180 or 181 of the SFO, the SFC suspects an actionable breach of legislation, code or guideline may have occurred (such as market or price manipulation, intermediary misconduct or the unauthorized conduct of regulated business), the relevant SFC staff member prepares a case assessment report to set out the suspicions and recommend referring the matter to the investigation team in Enforcement. The case assessment report is considered by the Enforcement Steering Committee (ESC) of the SFC which is comprised of senior executives from the investigation, surveillance, policy & international and disciplinary teams in Enforcement. ESC meets weekly. Once approved by ESC, the investigation can be commenced under section 182 of the SFO. The investigation case officer then prepares an investigation plan, which sets out the detailed investigations steps, timeline and resources required to complete the investigation. This plan is also presented to the ESC. Once the investigation plan is approved by the ESC, a section 182 Direction to Investigate is issued by a senior executive (Director or above) in the investigation team. A team of investigation staff is appointed and these officers are empowered to exercise SFC’s investigative powers to elicit evidence, including those under section 183 of the SFO (such as compelling the production of information and documents, and compelling the attendance of interviews and taking of statements). In urgent cases, a section 182 direction authorising investigation can be issued before the ESC approves an investigation plan under the authorization of the most senior staff within Enforcement. ESC receives regular reports about the progress of investigations and monitors and gives directions as an investigation proceeds. When an investigation has gathered enough evidence to show that there is an actionable breach of the legislation, code or guideline, a decision is made about what action should be taken. Number of SFC investigations – by type of misconduct Financial year 2009-2010 2010-2011 2011-2012 2012-2013 Nature Opened Completed Opened Completed Opened Completed Opened Completed Corporate governance issues 19 14 27 19 28 16 27 22 Disclosure of interests 26 16 23 27 23 24 22 18 Insider dealing 23 21 28 24 33 20 37 28 Intermediary misconduct 68 73 63 47 74 58 65 68 Market manipulation 50 34 35 36 58 33 51 59 Unlicensed activities 44 26 32 46 18 17 19 17 Total 230 184 208 199 234 168 221 212 Source: SFC Enforcement remedies - strategy As a general principle, SFC’s approach is that if the evidence suggests a criminal offence can be proved, it will not take administrative or civil proceedings as a substitute for taking criminal action. In important cases, both types of remedy may be necessary and are used. SFC does not have a power, as part of a formal disciplinary process against an intermediary, to require it to compensate clients for losses resulting from the intermediary’s misconduct (such as mis-selling). The maximum fine it can impose in disciplinary proceedings is only HK$10 million or 3 times of the profit gained/loss avoided, whichever is higher. It has therefore adopted a policy that, where client losses are significant, it is prepared to use its power under section 201 of the SFO to enter into agreements with an intermediary to achieve client compensation and other remedial actions (such as the appointment of independent experts to review internal controls, compliance systems etc). To reach agreement, it has proved necessary for the SFC to agree not to take formal disciplinary action in these cases. The fact of these agreements and their contents are made public. Enforcement remedies – criminal enforcement The current SFO came into operation on 1 April 2003. The SFC and the DPP agreed in 2007 that the SFC would refer the more serious cases and in particular those related to market misconduct to the DPP. In practice, SFC submits a brief of evidence and often a recommendation as to whether the case should be prosecuted by the DPP in the District Court or a higher court, or by the SFC in the Magistrates Court. The DPP reviews the evidence provided by the SFC and in each referral makes a decision as to whether a prosecution should be initiated in accordance with the prevailing prosecution policy (currently called “Prosecution Code”) and if so, whether the case should be tried summarily in the Magistrates Court (with jurisdictional limit of 3 years’ imprisonment for market misconduct cases) or on indictment in the District Court or above. In this process, the DPP will advise on the sufficiency of evidence contained in the brief. If the DPP decides that the trial venue should be the Magistrates Court then the case is referred back to the SFC to conduct the prosecution. If the DPP decides that the trial venue should be the District Court or above, then the DoJ will prosecute the case. Among the criteria used for this decision is whether in the DPP’s view there is a reasonable prospect of conviction, whether it is in the public interest to initiate a prosecution and whether it is likely that the sentence will be one only a higher court can impose. These criteria are set out in detail in the established and published prosecution policy known as the Prosecution Code. (See DoJ’s official website at http://www.doj.gov.hk/eng/index.html for the current Prosecution Code.) Similar arrangements are in place between the DoJ and other law enforcement agencies such as the Police, the ICAC and the Customs and Excise Department, albeit in these cases the DoJ conducts all the prosecutions. The DoJ considers these arrangements a healthy check and balance on the law enforcement agencies required in a democratic society. In the first few years after these arrangements commenced, the DPP prosecuted a number of cases on indictment and some substantial prison sentences were achieved (including a sentence of six years for insider trading). However, in the last 2 years or so, the former DPP has decided not to prosecute any new cases on indictment as the DDP was of the view that none of the cases warranted such a course. The former DPP highlighted that the subsequent sanctions imposed by the magistrates were well within the maximum limits available to the Magistrates courts. The SFC disagreed with this assessment, and considered that the relatively low sentences were just a reflection of the limited jurisdiction of the courts rather than the degree of general deterrence required for such offences. Further, the SFC noted that market misconduct cases are complex, and, that in recent cases, the SFC has had to appeal what it considered to be poor decision by magistrates, with the High Court sending back the cases to magistrates for retrial. In its opinion this demonstrates that these cases should be decided by courts that are experienced in handling difficult cases. These differences in opinions resulted in a very public disagreement between the SFC and the former DPP. The SFC and the current DPP are taking constructive steps to strengthen coordination. Number of SFC cases referred to DOJ 2008 2009 2010 2011 2012 2013 Up to 6 Sept Number of cases referred 10 13 17 17 9 5 Number of cases DPP decided to prosecute on indictment 3 3 1 1 0 0 Number of SFC cases prosecuted by DOJ 2008 2009 2010 2011 2012 2013 District Court cases (date of plea) 5 1 1 − − − Convictions (date of conviction) − 3 2 1 − Acquittals − − − − 1 − Source: DoJ Number of SFC cases prosecuted – by offence category 2008 2009 2010 2011 2012 2013 Market manipulation 2 1 1 − − − Insider dealing 2 − − − − − Other 1 − − − − − Source: DoJ Charges, convictions, imprisonment and acquittals in higher courts 2008 2009 2010 2011 2012 2013 Number of people charged 13 1 1 − − − Number of people convicted − 11 4 − 1 − Number of people sentenced to imprisonment 0 8 4 − 1 − Number of people acquitted − − − − 1 − Note: The total number of people convicted is larger than the total number of people charged because one person was convicted in two separate cases in two years. Source: DoJ The SFC emphasized that it has conducted over 300 criminal prosecutions in the Magistrates Courts in the period from January 2007 to March 2013. While many of such cases involve relatively minor criminal offences, including some strict liability offences such as the failure to lodge a disclosure notice on time, 50 of such cases involve more serious securities crimes (insider dealing and market manipulation). Out of such 50 cases, in 21 imprisonment sentences were ordered, of which (i) 16 involve sentences of less than 6 months, (ii) 4 of less than 1 year and (iii) 1 case a sentence between 1 and 2 years. Immediate custodial sentences were only imposed in 4 cases, and suspended sentences in 17. Number of entities on trial and convicted Criminal Proceedings 2008/09 2009/10 2010/11 2011/12 2012/13 No. of entities (individuals and non-natural persons) on trial 36 35 52 40 40 No. of entities convicted 33 32 51 37 36 No. of entities acquitted 3 3 1 3 4 Enforcement remedies – civil The following tables illustrate SFC’s activity in using civil remedies. Applications for civil remedies - by type of remedies sought 2008/09 2009/10 2010/11 2011/12 2012/13 Injunction and other remedial orders (section 213 of SFO) 6 24 6 5 6 Listed companies: banning and other remedial orders (section 214 of SFO) 9 10 6 13 8 Others 2 3 1 0 2 Total 17 37 13 18 16 Source: SFC Court orders granted 2008/09 2009/10 2010/11 2011/12 2012/13 Section 213 orders 1 2 1 0 7 Section 214 orders 2 9 5 13 5 Others 2 3 1 0 0 Total 5 14 7 13 12 Source: SFC These civil cases deal with insider dealing, market manipulation, failures by listed companies to keep the market properly informed, undisclosed related party dealings and other breaches of duty by listed company directors. The SFC has secured various orders under this route including rescission orders to reverse the consequences of misconduct. For instance, in the Hontex case, a section 213 of SFO proceeding, the SFC secured orders reversing the share subscriptions of several thousand investors who had subscribed for shares on the basis of a prospectus that contained false or misleading information. Around HK$1 billion was returned to shareholders under these court orders. Enforcement remedies – administrative SFC disciplinary actions Number of licensees disciplined By type of misconduct Type of Misconduct 2008/09 2009/10 2010/11 2011/12 2012/13 Improper trading activities in breach of Code of Conduct 5 13 8 3 2 Other trading malpractices 6 9 7 1 2 Internal control weaknesses 21 8 9 9 5 Misappropriation 5 3 1 2 3 Facilitating unlicensed activities 0 6 1 7 0 Breach of client identity rules 0 1 7 2 1 Corporate finance related matters 6 1 0 0 3 Breach of Financial Resources Rules 0 2 2 2 0 Other miscellaneous misconduct 11 15 13 12 12 Total 54 58 48 38 28 Note: Licensees includes individuals, such as representatives, as well as LCs. Source: SFC Fines and costs recovered from defendants SFC disciplinary actions ($HK) Type 2008-09 2009-10 2010-11 2011-12 2012-13 Disciplinary fines 63,648,65 2 26,125,49 6 21,438,80 0 35,210,00 0 83,500,00 0 Prosecution fines 1,519,000 25,032,53 5 677,000 1,159,000 1,420,455 MMT-fines 7,981,156 − 74,474 − 21,167,91 3 MMT-costs orders 7,792,470 6,780,013 1,800,863 4,180,270 8,365,043 Total 80,941,27 8 57,938,04 4 23,991,13 6 40,549,2 70 114,453,4 11 Source: SFC The SFC has meted out fines ranging from HK$100,000 to HK$6 million for corporations and from HK$1,500 to $1.46 million for individuals. In three cases the fines exceeded HK$10 million. These cases involve multiple and separate acts of misconduct. MMT Proceedings (insider dealing, market manipulation, etc) Number of people found culpable by MMT 2008/09 2009/10 2010/11 2011/12 2012/13 Insider dealing 3 3 2 1 2 Market manipulation 6 0 0 0 2 Disclosure of false or misleading information 3 0 0 0 0 Total 12 3 2 1 4 Source: SFC Use of agreements under section 201 of the SFO A number of large compensation agreements have been entered into using section 201 of the SFO. For example, from 2008 to 2011, compensation payments of around HK$10 billion were made to clients of distributors of Lehman related investment products. In two separate cases in 2012, parties agreed to make compensation to clients of more than HK$85 million. HKMA enforcement HKMA’s Enforcement Department deals with investigation and enforcement actions in relation to AIs, including those who are RIs. The Department consists of approximately 100 people. It currently has around 800 outstanding cases. Some of these are general banking complaints, but most are investigations into mis-selling by AIs and RIs of investment products, including securities and ILAS. Cases are referred to the Enforcement Department by the Banking Conduct and other supervisory areas of the HKMA. Criteria used for referrals include whether the offending conduct is continuing, the number of complaints received and the impact on customers. In conducting investigations, HKMA routinely uses both its powers under the BO and powers under section 180 of the SFO. Because of the current allocation of responsibilities, enforcement of breaches of conduct rules by firms and by former EOs and ReIs are dealt with by the SFC, and HKMA focus on current EOs and ReIs. HKMA enforcement staff will ordinarily carry out the investigation of all conduct, and then pass appropriate cases to the SFC. Procedures for the referral of cases and their investigation were set up as a result of the commencement of the SFO in 2003. HKMA Enforcement Department handles the cases in accordance with the Disciplinary Procedures Manual, which mirrors the SFC procedures as far as practicable. In general, HKMA Enforcement will assess the information available and submit the case to an internal standing committee (Event Review Committee) to decide whether an investigation should be opened. If the Event Review Committee considers it appropriate to open an investigation, HKMA Enforcement will notify the SFC and keep the SFC informed of the progress and result of the investigation. In determining whether to take a disciplinary action and the level of disciplinary sanctions, the Disciplinary Committee of the HKMA applies the criteria set out in the Disciplinary Proceedings at a Glance issued by the SFC and consider the actions taken by the SFC or the HKMA in precedent cases. HKMA’s Enforcement Department is still dealing with a large backlog of cases from the Lehman’s issue, but is in the process of reducing that backlog. It is also streamlining procedures in the light of its experience in dealing with these cases. HKMA referrals to SFC 2010 2011 2012 To August 2013 Number of referrals 6911 7 22 12 1 Lehman minibond related referrals Source: HKMA A number of these referrals resulted in significant enforcement remedies being obtained by the SFC. Mechanisms in place that seek to ensure consistent outcomes at the enforcement level There are several mechanisms designed to ensure consistent outcomes, as described below: Under the law, the HKMA will consult the SFC before exercising disciplinary powers or refer the cases to the SFC for taking disciplinary actions. Similarly if the SFC initiates an investigation or proposes to impose disciplinary sanction on a registered institution (RI) or its staff, the SFC will consult the HKMA. The SFC and the HKMA will exchange views and share information on major investigations cases from time to time during regular MoU meetings. For cases closed by the HKMA the SFC may from time to time, review samples of such cases to ensure consistency of standards In addition, persons aggrieved by a decision of the SFC or the HKMA may apply to the SFAT for review. Decisions of both authorities are also subject to the review of the Office of the Ombudsman, the Court of Appeal as well as judicial review (where appropriate) depending on the subject matter of the decision.
Assessment	Broadly implemented
Comments	The grade for this Principle stems from challenges to the effectiveness of the enforcement process in connection with Q 9 of the Methodology. There are two key considerations. The first concerns the effectiveness of the system in producing robust outcomes in cases of serious misconduct, especially market misconduct, such as market manipulation and insider trading. As indicated in the description, there has been a public disagreement between SFC and the former DPP in connection with the handling of criminal cases, and in particular whether the cases referred met the threshold to be prosecuted in higher courts –which could lead to higher sentences. The SFC and the current DPP are taking constructive steps to strengthen cooperation on matters of enforcement. The assessors acknowledge that the DPP should be free to decide on prosecutorial matters and that, as the DoJ commented, the independent exercise of its prosecutorial powers is a healthy and necessary check and balance on law enforcement agencies. Further, it is not the assessors’ role to assess the adequacy of DPP decisions. Looking strictly from an outcomes perspective, the assessors note that criminal enforcement is being used; however what is a cause of concern is that the strong deterrence message that it should have might not be effectively conveyed, given the relatively low level of sanctions imposed and the fact that, in the majority of the cases, suspended sentences were imposed. The assessors, however, note that in common law jurisdictions such as the Hong Kong SAR, the prosecutors do not seek any particular sentence, and that sentencing is a matter for the court. The second issue affecting the grade goes more to the practical challenges that the SFC faces in connection with licensed or registered intermediaries who are in breach of the Code of Conduct in circumstances where the conduct does not also involve a contravention of the law enabling the SFC to seek remedial orders from the civil courts, and its ability to secure both remedial and punitive actions. As explained in the description, the SFC does not have powers to require disgorgement or restitution. The result is that in cases where client losses are significant, the SFC has used its power under section 201 of the SFO to reach negotiated agreements as a means of securing compensation for affected clients. Some remedial actions such as changes to internal controls and compliance arrangements are often part of the agreement, but it is invariably necessary for the SFC to agree not to take disciplinary action against the LC/RI and its management and staff. This means that, to secure the very proper outcome of ensuring clients are compensated, the opportunity to take disciplinary action has to be foregone. In appropriate cases, it is highly desirable that both routes – compensation and disciplinary sanctions – be available in a practical way to the regulator. Otherwise, the message that the disciplinary sanctions are intended to send is fettered. In addition, the assessors note the backlog of cases at the HKMA, and encourage it to continue its efforts to address this situation. Two other matters should be mentioned in this Principle. The cross border character of Hong Kong’s financial markets and in particular its close interactions with the Mainland pose significant and continuing challenges in maintaining a robust and effective enforcement process. The challenge results not from a lack of willingness to act on the part of both Hong Kong and Mainland regulators and authorities. It relates more to the inherent complexity of running enforcement cases in this environment, such as obtaining evidence in a country as large and diverse as the Mainland, and the interaction between two systems of law. This is and will continue to be an important issue for the effectiveness of the enforcement process as a whole in the Hong Kong securities markets. Because responsibility for supervision of securities market activity by intermediaries is divided between SFC and HKMA, it is important to ensure a level playing field between the banks supervised by HKMA and the securities firms supervised by SFC. To achieve this, there needs to be a high level of transparency between the regulators and a continuing flow of information about regulated entities and supervisory strategies. There also needs to be a high level of confidence that the same approach is taken in response to non-compliance with obligations. There appears to be a good flow of information between SFC and HKMA. However, it is important that from time to time an assessment is made to ensure that consistency is being achieved in practice.
Principles for Cooperation in Regulation
Principle 13.	The regulator should have authority to share both public and non-public information with domestic and foreign counterparts.
Description	Domestic information sharing and co-operation Section 378 of the SFO imposes an obligation on SFC and its staff to preserve the secrecy of information that comes into its possession in the performance of its functions. This obligation is subject to exceptions. These exceptions give the SFC authority to share information with a variety of domestic authorities including: prosecutorial authorities (section 378(2)(b)) a variety of financial regulators such as HKMA, the IA and MPFA (section 378(e) and (f)); the MMT and the SFAT (section 378(3)(c) and (d)); and a recognized exchange company, a recognized clearing house, a recognized exchange controller and a recognized investor compensation company (section 378(3)(f). Information in the SFC’s possession that can be shared includes information about: matters of investigation and enforcement; determinations in connection with licensing and authorization; surveillance; market conditions and events; client identification, including beneficial ownership information; regulated entities; and listed companies and companies seeking listing; This information can be shared without the need for external approval. SEHK is also bound by the secrecy provisions in section 378 relation to its supervisory functions under the legislation. It has more limited power to share this information but can provide it to prosecutorial authorities and others mentioned in sections 378(2) of the SFO, as well as to SFC. To share information in these circumstances, it does not require SFC’s approval. International information sharing and cooperation The SFC is responsible for responding to all requests for information from foreign regulators in the area of securities markets. Section 378(3)(g) of the SFO permits SFC to share any information in its possession with foreign regulators. To do so, SFC must be satisfied that the overseas regulatory authority: performs a function similar to a function of the SFC or the Registrar of Companies, or regulates, supervises or investigates banking, insurance or other financial services or the affairs of corporations; and is subject to adequate secrecy provisions (section 378(6) of the SFO). The SFC can only disclose information to an overseas regulatory authority if satisfied that: the information is disclosed in the interest of the investing public or the public interest; or the disclosure will enable or assist the overseas regulatory authority to perform its functions and it is not contrary to the interest of the investing public or the public interest that the information should be so disclosed (section 378(5) of the SFO). In practice, overseas requests are likely to satisfy the second of the two alternatives. Using this provision, SFC can share all the information described above under domestic information sharing. External approval No external approval is required for the SFC to share information in this way. Unsolicited information SFC can provide information to domestic and foreign regulators on an unsolicited basis. No requirement for breach of domestic laws SFC can share information with foreign counterparts even if the alleged conduct would not constitute a breach of the laws of Hong Kong if conducted within Hong Kong. There are no “dual illegality” requirements for information sharing under section 378(3)(g)(i) of the SFO or for investigatory cooperation under section 186 of the SFO. Bank account information SFC can share with domestic regulators information and records identifying the person or persons beneficially owning or controlling bank accounts related to securities and derivatives transactions and brokerage accounts as well as the information necessary to reconstruct a transaction, including bank records (sections 378(2)(b), (3)(e), (3)(f), (3)(g)(ii) and 378(3)(i) of SFO). Using 378(3)(g)(i) of the SFO, SFC can also share information of this kind with foreign regulatory organizations. Confidentiality See under Principle 14.
Assessment	Fully implemented
Comments
Principle 14.	Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.
Description	Power to enter into information sharing agreements Section 5(1)(h) of the SFO provides that one of the functions of the SFC is to co-operate with and provide assistance to regulatory authorities or organizations, whether formed or established in Hong Kong or elsewhere. To carry out this function, the SFC can, and has, entered into MoUs with both domestic and foreign regulators. Information sharing mechanisms Domestic SFC has entered into MoUs with HKMA, HKEx and IA. It is also a party to an MoU between the MPFA, SFC, IA and HKMA on the regulation of MPF intermediaries, and a tripartite MoU with the HKMA and the FDRC. International SFC has been a full signatory to the IOSCO MMoU since March 2003. In addition, it has entered a large number of bilateral MoUs and other information sharing arrangements with foreign regulators: 37 MoUs, 11 confidentiality understandings or arrangements, and nine market or product-related arrangements with foreign securities regulators. Confidentiality The legislation provides for the confidentiality of information shared by, and received by, the SFC to be maintained, other than in specified circumstances. Domestic regulators Under section 378(7) of the SFO, domestic authorities receiving confidential information from the SFC must not disclose except if: a. the SFC consents to the disclosure; b. the information or the part thereof (as the case may be) has already been made available to the public; c. the disclosure is for the purpose of seeking advice from, or giving advice by, counsel or a solicitor or other professional adviser acting or proposing to act in a professional capacity in connection with any matter arising under any of the relevant provisions; d. the disclosure is in connection with any judicial or other proceedings to which the person or the recipient is a party; or e. the disclosure is in accordance with an order of a court, or in accordance with a law or a requirement made under a law. Foreign regulators Section 378(6)(b) of the SFO requires that before the SFC discloses non-public information to foreign regulators, the SFC has to be satisfied that the foreign regulator is subject to adequate secrecy provisions. To satisfy this requirement, the SFC assesses the secrecy provisions before disclosing non-public information to a foreign regulator. For those regulators with which the SFC has co-operative agreements, this assessment is performed during the negotiation stage of bilateral co-operative arrangements or by the IOSCO MMoU Screening Group (for IOSCO MMoU signatories). For those regulators with which the SFC does not have co-operative arrangement, the SFC will assess the secrecy provisions of the foreign regulator on a case-by-case basis. For every disclosure, the SFC specifies the permissible use of the information disclosed and reminds the recipient authority of its duty to preserve the confidentiality of the information and that prior written consent from the SFC is required before any onward disclosure by the recipient overseas authority other than in the circumstances set out in the IOSCO MMoU or the bilateral co-operative agreement. SFC Information received by the SFC from foreign regulators is subject to the general obligation of confidentiality under section 378(1) of the SFO. If it is required to disclose information contained in the request from a foreign regulator in order to give effect to the request, the SFC will first consult with the requesting authority. In the event of a legally enforceable demand for disclosure, the SFC will notify the requesting foreign authority prior to making the disclosure, and will make use of available legal exemptions and privileges to resist disclosure. Recipients of SFC’s notices to produce issued under section 183 of SFO, such as banks or brokers, are people assisting the SFC. Under section 378 of the SFO, they too are prohibited from informing their clients about the existence and content of the notice to produce. Practice The International & Policy team in SFC’s Enforcement Division handles and acts as the liaison point for requests for assistance from overseas regulators. If investigatory assistance is requested, the International team refers the request to the Investigation team for further actions. During the three years from 1 April 2009 to 31 March 2012, the SFC handled 306 licensing-related requests for assistance from foreign regulators and made 2,879 licensing-related requests for assistance. In the three years from 1 April 2009 to 31 March 2012, the SFC handled 370 requests for assistance, and made 179 requests of assistance to overseas regulators.
Assessment	Fully implemented
Comments
Principle 15.	The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.
Description	Assistance to foreign regulators Any information that SFC holds or can acquire through the use of its information gathering powers (described under Principle 10) can be shared with foreign regulators. In addition, section 186 of the SFO enable the SFC to use its powers of investigation (sections 182 and 183 of the SFO) to obtain information, including documents and records, and require both regulated and unregulated persons to answer questions and make statements under oath. These powers enable SFC to require the production of books and records that permit the reconstruction of securities and derivatives transactions, and records of funds and assets transferred into and out of banks accounts and details of securities and derivatives transactions. Court orders SFC cannot obtain court orders (such as injunctive and other remedial orders under section 213 of the SFO) if only a breach of a relevant law in a requesting foreign jurisdiction is suspected or alleged. But it could provide assistance to a foreign regulator in these circumstances, such as assisting a foreign regulator to secure local legal representation. No requirement for independent interest As noted under Principle 13, the use of SFC’s powers to compel the production of documents or to require persons to provide information does not require it to have an independent interest in the subject of a foreign regulator’s request for information. Information on regulatory processes SFC can provide information about regulatory processes, including the authorization process, investigations in progress and sanctions imposed. Financial conglomerates SFC can provide information in its possession, and use its information gathering and investigation powers to obtain information from regulated entities. Its investigation powers also allow it compel information from unregulated persons. These powers can be used to compel information about financial conglomerates subject to its supervision. Information from other domestic authorities If information is held by other domestic authorities, SFC can assist by asking the relevant authority on a foreign regulator’s behalf. Under domestic information sharing arrangements and in accordance with applicable laws, other regulators can supply this information if requested by SFC.
Assessment	Fully implemented
Comments
Principles for Issuers
Principle 16.	There should be full, accurate and timely disclosure of financial results, risk and other information that is material to investors’ decisions.
Description	Background Market context Most Hong Kong listed companies are incorporated outside Hong Kong and are “overseas issuers” under the CO and the Listing Rules. As at 31 January 2013, about 87 percent (1,346 out of 1,555) of Hong Kong listed companies were incorporated outside HK: 11 percent in the Mainland; 42 percent in the Cayman Islands; and 32 percent in Bermuda. A further 2 percent were incorporated in other jurisdictions. Most of the Cayman Islands and Bermuda incorporated listed companies are Chinese companies that have operations and headquarters in Hong Kong or the Mainland. HKEx operates a Main Board, and a Second board, the GEM. Around 200 companies are listed on GEM. Public issues of shares or debt by non-listed entities (other than for structured products) are rare - there were ten issues in the period 2005–2010, most of them bond issues. There have been none since 2010. Structured products issued and traded in HK are mostly equity linked products such as derivatives over stock indices etc. Legislative and rule framework The CO is the source of the legislative obligation to issue a prospectus for any offer of securities to the public. Although it generally applies only to HK incorporated companies, Part XI (establishment of place of business in HK) and Part XII (prospectuses) specifically apply to overseas companies. Public offers of securities are governed by: a. Parts II and XII of the CO – Part II applies to Hong Kong incorporated companies; Part XII to overseas companies; b. Part IV of the SFO which applies to public offers of structured products (defined in section 1A of Schedule 1 of the SFO); c. the Listing Rules of HKEx, being the Main Board listing rules and the GEM listing rules. These rules apply to all listed companies, regardless of their place of incorporation, and to listed structured products. Chapter 15A of the Listing Rules deals specifically with structured products. Overseas issuers seeking a primary listing on the SEHK must satisfy the SEHK that they are incorporated or otherwise established in a jurisdiction where the standards of shareholder protection are at least equivalent to those in Hong Kong. The SEHK accepts Hong Kong, the Cayman Islands, Bermuda and the Mainland, as “Recognized Jurisdictions”. Issuers incorporated in these jurisdictions can meet the equivalence requirement by complying with the additional contents requirements for their constitutional documents set out in Main Board Listing Rule Appendix 13 (GEM Listing Rule Appendix 11). Regulatory responsibilities A prospectus for securities must be authorized for registration and registered with the Registrar of Companies. The SFC is empowered to authorize prospectuses for registration under Sections 38D or 342C of the CO. The formal power to authorize prospectuses offering shares in or debentures of companies that are to be listed has been delegated to the SEHK. The SFC is responsible for vetting and considering applications for authorization to prospectuses in respect of public offers of unlisted shares or debentures. For structured products, SEHK approves listing documents for listed products under the Listing Rules, and SFC approves public offering documents for unlisted products. Under the “dual filing” regime established by the SMLR, an applicant for listing of its securities for trading on the SEHK must file copies of its listing application with the SFC after it is submitted to the SEHK. The SFC may seek further information about the listing application by asking SEHK to request the information, and may object to the listing if the applicant fails to comply with requirements, if it appears to the SFC that the applicant has supplied false or misleading information in its application, or the listing is not in the interest of the investing public. The SMLR provides similar dual filing requirements for public announcements and other ongoing public disclosure of information by listed corporations pursuant to requirements under the Listing Rules or other applicable laws. Disclosure requirements For securities, the public offering regime includes disclosure and reporting requirements consisting of: a prospectus for public offerings of equity and debt securities; annual reporting requirements; half-yearly reporting requirements; for some listed entities, quarterly reporting requirements; inside information (material event) disclosure obligations. Public offerings of securities An offer to the public of shares or debentures of a company must be made through a prospectus that complies with Part II (for Hong Kong incorporated companies) or Part XII (for foreign companies) of the CO. Requirements for prospectus content are set out in detail in the Third Schedule of the CO. There also is a general requirement that the prospectus must contain sufficient particulars and information to enable a reasonable person to form as a result thereof a valid and justifiable opinion of the shares or debentures and the financial condition and profitability of the company at the time of the issue of the prospectus, taking into account the nature of the shares or debentures being offered and the nature of the company, and the nature of the person likely to consider acquiring them. Where an issuer is seeking a listing of its equity or debt securities on the SEHK, it must also comply with the disclosure requirements in the Listing Rules. These are set out in Appendix 1 to the Listing Rules and comprise detailed requirements for issuers new to listing (Part A), for already listed issuers (Part B), for debt securities where listing is sought (Part C), and for depositary receipts (Parts E and F). Rule 11.07 requires listed companies to include in their listing documents, as an overriding principle, such particulars and information which, according to the particular nature of the company and the securities for which securities is sought, are necessary to enable an investor to make an informed assessment of the activities, assets and liabilities, financial position, management and prospects of the company and its profits and losses and of the rights attaching to such securities. Disclosure requirements in Appendix 1 of the Listing Rules is largely the same as those of the Third Schedule of the CO, but in some areas additional disclosure is required, for example about group activities and finances. Some additional disclosures are also required for companies incorporated in the Mainland (see Chapter 19A of the Listing Rules and in particular Rule 19A.42). All new applications for listing of equity securities must have a sponsor (Rule 2.09 and Chapter 3A of the Listing Rules). The sponsor must be a corporate adviser licensed under the SFO and must use reasonable endeavors to ensure that all information provided to SEHK during the listing application process is true in all material respects and does not omit any material information. New provisions in the SFC’s Corporate Finance Adviser Code of Conduct require the sponsor, among other things, to review compliance with all relevant rules and regulations. Structured products are subject to a separate, specific regime, both in the legislation and the Listing Rules. Before an unlisted structured product can be offered to the public it must be authorized by the SFC under section 104A of the SFO. SEHK approves listed structured products. Part D of Appendix 2 of the Listing Rules contains specific disclosure requirements for structured products. In addition, Rule 15A.66 of the Listing Rules requires that listing documents must, as an overriding principle, contain such particulars and information necessary to enable an investor to make an informed assessment of the assets and liabilities and financial position of the structured products issuer and of the structured products. Disclosure requirements for unlisted structured products to be authorized for public offering are set out in a Code issued by the SFC under section 399 of the SFO, the Code on Unlisted Structured Investment Products (the SIP Code). Under paragraph 6.1 of the Code, an offering document must contain the information necessary for investors to be able to make an informed judgment of the investment which is the subject matter of the authorization. Paragraph 6.3 of the Code also requires every offering document to contain a Product Key Fact Statement, which forms part of the offering document and must contain information to enable investors to comprehend the key features and risks of the product. If, after a prospectus or listing document has been issued, there are significant changes affecting any matter in the prospectus or new matters arise which require disclosure, an issuer must provide the disclosure in a supplemental prospectus or listing document approved by the SEHK. Annual reports Section 122 of the CO requires directors of public companies to lay before its shareholders at its annual general meeting a profit and loss account and a balance sheet. The accounts must not be more than 6 months out of date. By section 129D, the balance sheet must include a directors’ report containing the information specified in that section. This requirement applies only to HK incorporated companies. Overseas companies that are registered with the Companies Registrar must deliver their latest published accounts which comply with the laws of their place of incorporation to the Registrar. For listed companies (both Main board and GEM), Rule 13.46 of the Listing Rules requires every listed company to send to its shareholders a copy of either: a. its annual report including its audited annual or group accounts; or b. its summary financial report (provided that it complies with Section 141 of the CO and the Companies (Summary Financial Reports of Listed Companies) Regulation); not less than 21 days before the company’s Annual General Meeting and in any event not more than four months after the end of the financial year to which they relate. The company’s annual report must comply with the disclosure requirements set out in Appendix 16 to the Listing Rules. For structured products: a. for listed products, Rule 15A.21 of the Listing Rules requires the annual report of the issuer and, where appropriate, the guarantor, to be submitted to SEHK within 4 months after the date to which the financial statements relate. The issuer must also make the reports publicly available; b. for unlisted products, SIP Code 7.6 (a) requires the issuer to make available to investors not later than four months after the date to which they relate, the annual report and audited financial statements in respect of the issuer, the guarantor and/or the key product counterparty, as applicable, and where group accounts are prepared, the relevant group accounts, together with the auditor’s report. Half yearly and quarterly reports The Listing Rules require listed companies to send to shareholders either an interim report or a summary interim report that complies with the Companies (Summary of Financial Reports for Listed Companies) Rules. For main board companies this must be done within 3 months after the end for the half year. However they are required to publish their preliminary half-year results announcements within two months from the end of the half-year. The main difference between the contents of the half-year results announcement and the half-year report is that the half-year report will contain the cashflow statement and a statement of changes in equity, and comparative figures for the corresponding previous period. Generally the half-year report and the results announcement will contain similar information, except for the Chairman’s statement. The authorities explained that HK listed companies require more time to issue their half-year report as they are required to send hard copies of their half-year report to their shareholders (although shareholders have the choice of receiving electronic copies instead of printed copies). For companies listed on GEM, the report must be published within 45 days of the end of the relevant half year. Main board companies are not required to prepare quarterly reports, but it is one of the recommended best practices under the Corporate Governance Code and Corporate Governance Report in Appendix 14 to the Main Board Listing Rules (Recommended Best Practices C.1.6 and C.1.7 of the Corporate Governance Code). Companies are encouraged to but not required to comply with recommended best practices. Companies listed on GEM must provide to shareholders quarterly reports for each of first 3 and nine month period of the financial year by no later than 45 days after the period end. Content requirements for quarterly reports are set out in GEM Listing Rules 18.68–18.77. For listed structured products, Rule 15A.21 of the Listing Rules requires the annual report and half yearly report of the issuer and, where appropriate, the guarantor, to be submitted to SEHK within 4 months after the date to which the financial statements relate. The issuer must also make the reports publicly available For unlisted structured product issuers must provide half yearly reports, to investors as soon as practicable and not later than four months after the close of the relevant period (SIP Code 7.6(a)(ii)). In practice, many unlisted structured products are short dated instruments, with a life of 6 to 9 months. The material adverse event disclosure regime has more application to these products (see below). Disclosure of inside information (material events) Part XIVA of the SFO sets out requirements for listed companies to disclose material information as soon as reasonably practicable when the information has, or ought to reasonably have come to the knowledge of their directors, managers or company secretary. Section 307B of the SFO requires listed companies to disclose to the public price sensitive information (called “inside information”) as soon as reasonably practicable. “Inside information” is defined to mean specific information that: a. is about: i. the corporation; ii. a shareholder or officer of the corporation; or iii. the listed securities of the corporation or their derivatives; and b. is not generally known to the persons who are accustomed or would likely to deal in the listed securities of the corporation but would if generally known to them be likely to materially affect the price of the listed securities. (See Section 307A of the SFO) The requirement to disclose inside information under Part XIVA came into effect on 1 January 2013. The Listing Rules also provide for material event disclosure in terms broader than the SFO definition of inside information, as they require an issuer to announce any information needed to correct or prevent a false market in its securities (Listing Rule 13.09(1)). SFC senior staff indicated that the main reason for bringing the requirement to disclose price sensitive information under the SFO has been to provide “teeth” to the regime, as under the Listing rules strong enforcement actions are not available. Market participants interviewed indicated that the change in the regime has in fact translated into more rigorous processes in issuers to determine what type of information needs to be communicated to the market. For structured products a. for listed products, the provisions of Part XIVA of the SFO apply. The Listing Rules also require an issuer to announce information necessary to avoid a false market in the securities. A specific rule in the Listing Rules applies to guaranteed products and requires the guarantor to make announcements about any information that may have a material effect on its ability to meet obligations (Paragraphs 2 and 2A of Appendix 7H); b. for unlisted products, SIP Code 7.6 requires the issuer to inform the SFC and all investors in the structured products as soon as reasonably practicable of changes in the financial condition of the issuer or other circumstance which could reasonably be expected to have a material adverse effect on the ability of the issuer or, if applicable, the guarantor or a key product counterparty, to fulfill its commitments of the structured product. Shareholder voting decisions Sections 114 and 116 of the CO set out the timing requirements for notices of general meetings: a. annual general meeting - 21 days’ notice in writing; b. meetings at which it is proposed to pass a special resolution - 21 days; and c. meetings that are neither an annual general meeting nor a meeting for the passing of a special resolution - 14 days. For listed companies, the Listing Rules provide detailed provisions dealing with disclosure to shareholders in relation to matters requiring shareholder approval. These include certain types of “notifiable transactions” (Chapter 14 of the Listing Rules) and “connected transactions” (Chapter 14A). Notifiable transactions include major and very substantial transactions (as defined in the Listing Rules) that require shareholder approval. Connected transactions are related party transactions (see further under Principle 17). If a transaction requires shareholders’ approval, the listed company concerned must send a circular to its shareholders at the same time or before the company gives notice of the general meeting to approve the transaction. Rule 14.41 of the Listing Rules require that the circular to be dispatched to shareholders at the same time as or before the listed company gives notice of the general meeting to approve the transaction. If any material information comes to the directors’ attention after the issue of the circular on the transaction, a listed company must send to its shareholders a revised or supplementary circular and provide at least 10 business days before the date of the relevant general meeting (see Rules 13.73, and 14.42 of the Listing Rules). Detailed content requirement for circulars about transactions requiring shareholder approval are set out in Listing Rules 14.66–14.71A. (See further description in Principle 17) Rule 13.39 of the Listing Rules requires listed companies to announce the results of their general meetings as soon as possible, but in any event at least 30 minutes before the earlier of either the commencement of the morning trading session or any pre-opening session on the business day after the meeting. Advertising The SFO, the CO and the Listing Rules all contain provisions relating to advertisements. Section 103(1) of the SFO makes it an offence to issue advertisements, invitations or documents which are or contain a public offer of securities or structured product unless it falls within one of the safe harbors in Section 103(2) or (3) of the SFO. Safe harbors include a complying prospectus or an advertisement, invitation or document relating to securities the listing of which SEHK has approved and which comply with the Listing Rules. Section 38B of the CO makes it unlawful to publish an advertisement unless it has been approved by the SFC or it is within the exemptions in Schedule 19 of the CO. The Schedule sets out the contents and publication requirements for advertisements. The advertisement must contain: a. a statement to the effect that the advertisement is issued by the company to which the advertisement relates; b. a warning statement that potential investors should read the prospectus for detailed information about the company and the proposed offering before deciding whether or not to invest in the shares or debentures concerned; and c. a statement that the advertisement does not constitute an offer or an invitation to induce an offer by any person to acquire, subscribe for or purchase the shares or debentures concerned. Rules 9.08 and 24.08 of the Listing Rules require all publicity material released in HK relating to an issue of securities and debt securities by a new applicant to be reviewed by the SEHK before release. The publicity materials must not be released until the SEHK has confirmed to the applicant that it has no further comments on the materials. For structured products: a. for listed products, Rule 15A.53 of the Listing Rules permits issuers to release publicity material relating to their products if it complies with all relevant legislation and rules. Issuers are required to adopt the disclosure and presentation principles in the SEHK’s Guidelines on Marketing Materials for Listed Structured Products; b. for unlisted products, under Part IV of the SFO, advertisements in respect of publicly offered structured products must be authorized by the SFC. The criteria for authorisation are set out in the “advertising guidelines applicable to unlisted structured investment products” set out in Appendix D to the SIP Code (the SIP Advertising Guidelines). Responsibility for information in regulated offer documents Civil Liability Sections 40 and 342E of the CO those responsible for the issue of a prospectus liable to pay compensation to any person who subscribes for shares or debentures for their losses or damages as a result of any untrue statement in the prospectus. Those made liable are: a. directors of the company at the time of the issue of the prospectus; b. every person named in the prospectus as a director or prospective director; c. promoter of the company; and d. every person who authorized the issue of the prospectus. This includes any experts whose statements are incorporated in the prospectus; they will only be liable for any untrue statement they make as an expert. Section 108 of the SFO provides a statutory right for persons to seek compensation for any pecuniary loss sustained as a result of their reliance on any fraudulent, reckless or negligent misrepresentation made to induce that person to invest in an unlisted structured product. Criminal liability Provisions in the SFO make it a criminal offence to provide false or misleading information or omissions in offer documents, or in offers to induce transactions in securities under the SFO and the CO. See especially sections 107 and 298 of the SFO; and sections 40A and 342E of the CO. Offences under the SFO carry penalties of fines up to HK$1 million or imprisonment of up to 10 years (under the CO HK$700,000 and 3 years). Disciplinary penalties also apply under the listing rules (Rules 2A.09 and 2A.10). Under the CO provisions, criminal liability attaches to any person who authorized the issue of the prospectus. The SFC has publicly consulted about and is currently working on legislative proposals to amend the CO to clarify that sponsors have criminal and civil liability for false statements in a prospectus. MMT jurisdiction The MMT has jurisdiction over the inside information disclosure provisions in the SFO. Derogations Prospectuses SFC can grant an exemption from the prospectus disclosure requirements in sections 38 and 342 of the CO if it considers that the exemption will not prejudice the interest of the investing public and compliance with any or all of those requirements: a. would be irrelevant or unduly burdensome; or b. is otherwise unnecessary or inappropriate. (section 38A of the CO). In practice, this exemption power is used only in narrow circumstances, for example the period covered by the latest audited financial statements to be included in a prospectus if the prospectus is expected to be issued within a short time after the end of a company’s fiscal year. Under Rule 2.04, SEHK can also grant a waiver from Listing Rule requirements, but a waiver of general effect applying to more than one company requires the prior approval of the SFC. Inside information Section 307D sets out certain exceptions when listed companies would not be required to disclose any inside information: a. if and so long as the disclosure is prohibited under, or would constitute a contravention of a restriction imposed by, an enactment or a court order; b. if and so long as the company takes reasonable precaution to preserve the confidentiality of the information and the confidentiality is preserved where: i. the information concerns an incomplete proposal or negotiation; ii. the information is a trade secret; iii. the information concerns the provision of liquidity support from the Exchange Fund or the HKMA or other monetary authorities which perform the functions of a central bank to the company or a member of its group of companies; or c. the SFC has waived disclosure of the information under Section 307E of the SFO. These safe harbor exceptions are subject to a condition requiring the company to take reasonable measures to preserve the confidentiality of the information. The SFC has not used its powers to grant waivers. Suspension of trading The inside information provisions in Part XIVA of the SFO do not provide for mandatory suspension of trading. But Rule 13.10A of the Listing Rules requires a company to apply for a trading halt as soon as reasonably practicable where it cannot make an announcement promptly about information necessary to correct or prevent a false market (as required by Rule 13.09) or confidentiality has been lost in respect of information within the inside information safe harbor. If a listed company fails to publish periodic financial information within reporting deadlines in the Listing Rules, SEHK normally suspends trading in the company’s securities until the information is published (see Listing Rule 13.50). Under Listing Rule 6.01 SEHK can also direct a trading halt or suspend trading in specified circumstances, including when the SEHK considers that the company materially fails to comply with the Listing Rules. In addition, under sections 7 and 8 of the SMLR, SFC has power to direct SEHK to suspend dealings in securities of a listed company. This power can be exercised where it appears to SFC that: a. a document issued in connection with the listing of the securities, or an announcement, is materially false, incomplete or misleading information; or b. a suspension is necessary in the interest of maintaining an orderly and fair market in the securities, or in the interest of the investing public or for the protection of investors. Restrictions on trading by persons with superior information The insider dealing trading provisions in sections 270 and 291 of the SFO prohibit a person with superior inside information from trading in the securities of the relevant company, and from disclosing that information to a third party. Cross border matters Given the international character of the listed company sector in Hong Kong, SFC and SEHK have made special provisions relating to listings in Hong Kong by companies domiciled elsewhere. The prospectus provisions and the continuous disclosure provisions apply in full to all companies, regardless of their domicile. In addition, companies seeking a listing on the SEHK must satisfy the SEHK that it is incorporated or is otherwise established in a jurisdiction where the standards of shareholder protection is at least equivalent to those in Hong Kong (see Rule 19.05(1)(b) of the Listing Rules). In 2007, the SFC and the SEHK clarified the Listing Rules requirements regarding primary listing of companies incorporated outside Hong Kong or any of the three jurisdictions recognized under the Listing Rules (Mainland, Bermuda and the Cayman Islands). They issued a Joint Policy Statement setting out a list of shareholder protection standards that are expected of an overseas company when seeking a primary listing on the Main Board or GEM. An overseas applicant is expected to benchmark the shareholder protection standards of its home jurisdiction to those standards of Hong Kong, and in case of any shortfall in the standards of the applicant’s home jurisdiction, an overseas applicant can compensate for such shortfalls by making changes to its constitutional documents. Hong Kong regulators must have reasonable access to information relating to the conduct of a listed overseas company in its home or governing jurisdiction to facilitate the taking of any regulatory action against a non-complying listed overseas company. To ensure this, a key requirements for an overseas company to list in Hong Kong is that it must be incorporated or otherwise established in a jurisdiction where the statutory securities regulator has adequate arrangements with the SFC for mutual assistance and exchange of information for the purpose of enforcing and securing compliance with the laws and regulations of that jurisdiction and Hong Kong either by way of the IOSCO MMoU or an adequately comprehensive bilateral agreement with the SFC. The SEHK has published guidance about the jurisdictions which are acceptable places of incorporation for the purposes of the Listing Rules. The SEHK lists these acceptable overseas jurisdictions and the companies incorporated in these jurisdictions that have listed on the Main Board. Currently there are no overseas companies listed on GEM. Regulatory practice Prospectus disclosure Under the dual filing system, listing applicants file copies of their listing applications (including the prospectus) with the SFC at the same time as they submit it to SEHK. Prospectuses and other listing information are reviewed both by the SFC and SEHK. SFC queries and comments are channeled through the SEHK. The formal decision to approve listing is made by the SEHK’s Listing Committee which takes into account SFC’s comments when making its decision. The SEHK has a staff of more than 40 people dealing with listing applications, and the IPO team of the SFC’s Corporate Finance Division has 20 staff. In addition, the Primary Market Information, Fixed Interest and Structured Products teams at the SEHK consists of 35 people, 10 of whom deal with applications for listed structured product. The SFC has a team of 13 staff dealing with unlisted structured products. The SFC’s review of draft prospectuses or listing documents focuses on the adequacy of information in the prospectuses or listing documents. The SEHK’s reviews a listing application and the associated prospectus or listing document to ascertain whether the listing applicant meets the eligibility and suitability for listing requirements and compliance with the Listing Rules, including the adequacy of disclosure. Annual and periodic reports Reviews of the financial reports of listed entities are carried out HKEx, HKICPA and the FRC – see under Principle 18. Inside information SFC oversees the inside information disclosure regime. A team of 6 staff monitors compliance with the requirement, for example by reviewing monitoring market announcements and other information, and making written inquiries of companies. They make written inquiries of companies to clarify the content of announcements or query whether an announcement should be made. Some announcements, such as those relating to major transactions, are prevetted by the HKEx. By agreement with SFC, the HKEx plays the front line regulatory role in relation to enquiries concerning unusual movements in the price or trading volume of an issuer’s listed securities, the possible development of a false market in its securities, or any other matters under Listing Rule 3.10. The HKEx makes daily reports to the SFC on these disclosure issues. Cross border enforcement The SFC has been active in monitoring issuers’ compliance with their obligations, including overseas issuers. In this regard, the remedies available to the SFC under the SFO and the CO are applicable to any foreign issuer listed in HKSAR. In recent years the SFC has taken an important number of enforcement actions involving listed issuers incorporated outside HKSAR. These actions include civil remedial actions against the companies and/or their major shareholders and winding up petitions. For example, against Tack Fiori International Group Limited, Gome Electrical Appliances Holding Limited, China Metal Recycling (holdings) Limited, Qunxing Paper Holdings Company Limited, Hontex International Holdings Company Limited, Styland Holdings Ltd.
Assessment	Fully implemented
Comments	The CO allows annual reports to be made available to shareholders up to 6 months after balance date. This is not timely reporting for the purposes of Key Question 2(c). However, the assessors note that for listed companies, the Listing Rules require the report and related financial statements to be made available within 4 months of balance date. This is in line with other jurisdictions such as those in the EU. While it is acknowledged that the CO allows a longer deadline, in practice all companies who have raised funds from the public are listed and are therefore subject to the shorter deadlines under the Listing Rules. The assessors also note that semi-annual reports for main board companies must be made available within 3 months of the close of the relevant period. However, announcements must be made within two months which is comparable to other jurisdictions. As the content of the announcement is substantially similar than that of the interim report, the assessors do not consider this a deficiency that should trigger a downgrade. Further, the assessors acknowledge that material information about a company’s financial position would need to be disclosed as soon as practicable. There is significant concern in the market about the quality and reliability of disclosure by companies from the Mainland, and the capacity of the SFC to enforce compliance with disclosure obligations, including through the use of enforcement actions. The reforms to the sponsor regime seek to address some of the challenges arisen from the cross border nature of these companies. The SFC has demonstrated that it uses the tools as its disposal to enforce compliance of issuers with their obligations, even in the context of overseas companies. However, SFC staff acknowledges that on the enforcement side there are still challenges for effective cooperation, which stem from practical aspects (for example the sheer size of China) rather than from legal impediments or lack of will of the Chinese authorities to cooperate. These issues have been further explained under Principle 12.
Principle 17.	Holders of securities in a company should be treated in a fair and equitable manner.
Description	Rights and equitable treatment of shareholders The CO provides the general framework for the relationship between a company and its shareholders. These general provisions are supplemented by detailed provisions in the Listing Rules. For listed companies, it is a general principle under the Listing Rules that all holders of listed securities must be treated fairly and equally (Rule 2.03(4)). Rule 13.75 of the Listing Rules also requires listed companies to ensure equality of treatment of all holders of securities of the same class who are in the same position. Some special provisions apply to clarify the position of holders of HK traded shares in Mainland companies (H shares), for example by providing for arbitration to resolve disputes between an H share holder and the company or its directors. The Takeovers Code also has a general principle that all shareholders are to be treated even-handedly and all shareholders of the same class are to be treated similarly (see General Principle 1 of the Takeovers Code). Election of directors Section 157A of the CO provides that all appointments of directors of companies other than a private company or a company not having a share capital must be voted on individually (i.e., slate voting is prohibited). For listed companies, rule 13.70 of the Listing Rules requires that, when a listed company receives a notice from a shareholder proposing a person for election as a director at a general meeting, the company must publish an announcement or issue a supplementary circular where such notice is received after the publication of the notice of the meeting. The company must include particulars of the proposed director in the announcement or supplementary circular. Fundamental corporate changes Changes to a company’s constitutive documents and other fundamental corporate changes (such as variation of rights attaching to a class of shares), require approval at a shareholders meeting (see sections 8, 13 and 63A of the CO). These changes are determined by special resolution (requiring at least 75 percent majority vote in favor) rather than ordinary resolution (simple majority of over 50 percent). Dissenting members are entitled to apply to the court to cancel a resolution relating to: a. an alteration to the company’s objects, b. an alteration to the articles of association, c. a variation of class rights, d. giving financial assistance to a company in acquiring its own shares; e. payment out of capital for the redemption or purchase of a private company’s shares, or f. any arrangement upon liquidation. A proposal to delist a company which has its primary listing in Hong Kong requires approval by a special resolution of shareholders if its only listing is on Hong Kong or by ordinary resolution if the company has an alternative listing on another stock exchange (Listing Rules 6.11–12). Companies with only a secondary listing in Hong Kong do not require shareholder approval to delist in Hong Kong but must give at least three months’ notice to shareholders (Rule 6.16). Corporate transactions requiring shareholder approval Chapter 14 of the Listing Rules requires shareholder approval for specified types of transactions (major acquisitions and disposals, very substantial disposals or acquisitions, and certain reverse takeovers). Detailed threshold tests for determining transactions that are subject to shareholder approval are set out in the Chapter. Connected transactions Chapter 14A of the Listing Rules deals with transactions or continuing transactions with connected parties. A connected transaction is any transaction between a listed company and a connected person (Rule 14A.13). A connected person is defined in Rule 14A.11 to include directors, ex-directors who were directors within the previous 12 months, the chief executive, a substantial shareholder, the supervisor of a Mainland company, and their associates and relatives. Connected transactions and continuing connected transactions above specified minima require approval by independent shareholders on a simple majority basis. General meetings Sections 114 and 116 of the CO provide that a company must provide notice of at least: a. 21 days’ notice in writing for annual general meeting and extraordinary general meetings at which a special resolution is called; and b. 14 days’ notice in writing for any other general meetings. Rule 13.73 of the Listing Rules requires listed companies to provide shareholders any further material information that arose after the circular at least 10 business days before the general meeting. After a general meeting, Rule 13.39(5) of the Listing Rules requires a listed company to announce voting results as soon as possible, but in any event at least 30 minutes before the earlier of either the commencement of the morning trading session or any pre-opening session on the business day after the meeting. When shares have different rights from those of ordinary shares, section 63A of the CO requires that resolutions adopted by the general meeting of shareholders that prejudice the rights of their holders must also be approved by the special meeting of the holders of these shares. Section 113 of the CO gives members who hold at least 5 percent of the paid up capital of a company a right to requisition a general meeting. Voting at the general meeting By Section 114C of the CO, any member of a company entitled to attend and vote at a meeting of the company is entitled to appoint another person (whether a member or not) as his proxy to attend and vote at shareholder meetings. Rule 13.38 of the Listing Rules requires an issuer to send with the meeting notice to all persons entitled to vote proxy forms, with provision for either directing the proxy to vote in a particular way, or giving the proxy discretion. Investors who hold and trade securities in HK listed companies through their stock account (either an Investor Account or a Stock Segregated Account with Statement Service) in the HKEx’s Central Clearing and Settlement System (CCASS) can either give voting instructions or arrange to attend and vote at a listed company’s general meetings electronically through the CCASS Internet System. Ownership registration and transfer of shares: By section 28 of the CO, a member of a company is a member by virtue of having their name entered in its register of members. Section 68 provides for registration of transfers of shares. Rule 8.13 of the Listing Rules requires securities for which listing is sought to be freely transferable. Rule 8.13A requires all securities for which listing is sought to have been accepted as eligible by Hong Kong Securities Clearing Company for deposit, clearance and settlement in CCASS, in accordance with the General Rules of CCASS. Shareholding (at broker level) in each security listed on the SEHK is publicly accessible through the HKEx’s website. Rules 13.59 and 13.60 of the Listing Rules require an issuer (or its share registrar) to provide registration services and set out the minimum service levels and maximum fees that can be charged for these services. Share registrars must be members of an association of share registrars that is approved by the SFC under Sections 12–14 of the SMLR. Overseas issuers must make provision for a register of holders to be maintained in Hong Kong (see Rules 19.05(3) and 19.30(4) of the Listing Rules). Dividends Generally a company’s articles of association provide that while directors may recommend a dividend to shareholders of the listed company, the declaration of dividends must be approved by shareholders at a general meeting (see article 115 in the model articles of association in Table A set out in the First Schedule to the CO). All common shareholders of the company are entitled to the distribution once the dividend is declared. There is no requirement when a dividend must be paid after it is declared. Disclosure to shareholders Rule 2.13 of the Listing Rules requires announcements and corporate communication to be accurate and complete in all material respects, not misleading or deceptive, and be clearly presented in plain language. Rules 14.63 and 14A.58 of the Listing Rules require listed companies to provide in their circulars to shareholders, in respect of transactions that must be disclosed under the Listing Rules (notifiable transactions) and connected transactions that require shareholder approval: a. a clear, concise and adequate explanation of the subject matter; b. all information necessary to allow shareholders to make a properly informed decision; c. emphasis of the importance of the document and advice to shareholders to consult appropriate independent advisers; d. a recommendation from directors (or the independent board committee, in the case where independent shareholders’ approval is required) as to the voting action that shareholders should take, indicating whether or not the proposed transaction described in the circular, is in the directors’ opinion, fair and reasonable and in the interests of the shareholders as a whole; and e. a separate letter from any independent financial adviser (required where independent shareholders’ approval is required - see Rules 13.39(7) and 14A.58(3)(d)). Directors of listed companies must also confirm in circulars relating to notifiable transactions that require shareholders’ approval that, to the best of their knowledge, information and belief having made all reasonable enquiry, the counterparty and the ultimate beneficial owner of the counterparty are third parties independent of the listed company and its connected persons (see Rule 14.63(3) Takeover bids and other changes of control transactions Takeovers and other change of control transactions are governed by the Takeovers Code and the Share Repurchase Code1. These Codes were adopted in 1992, and have as a primary purpose the fair treatment for shareholders who are affected by takeovers, mergers and share repurchases. They are intended to achieve fair treatment by requiring equality of treatment of shareholders, mandating disclosure of timely and adequate information to enable shareholders to make an informed decision as to the merits of an offer and ensuring that there is a fair and informed market in the shares of companies affected by takeovers, mergers and share repurchases. (See Introduction to the Codes section 1.2.) The Codes apply to takeovers, mergers and share repurchases affecting public companies in Hong Kong, companies with a primary listing of their equity securities in Hong Kong and REITs with a primary listing of their units in Hong Kong. The Takeovers Code does not have the force of law and there are no statutory powers to enforce its provisions. However, SFC can exercise its powers of investigation where a breach is suspected. A team of 14 SFC staff are the “Takeover Executive” responsible for the daily administration of the Takeovers Code. This includes vetting takeovers-related announcements and documents and giving rulings on applications under the Takeovers Code. The Takeover Executive’s decisions are subject to review by the Takeovers Panel at the request of a dissatisfied party. Members of the Takeovers Panel are appointed by the SFC and currently consist of 31 members drawn from the financial and investment community. A Panel consists of at least 5 persons, including a chairman (who is a legally qualified person) and 4 experts. Disciplinary hearings are held in public, other than in exceptional circumstances. The Panel has heard only 1 or 2 cases a year in recent years. The Takeover Executive may also refer a matter to the Takeovers Panel if it is considered to be novel, important or difficult. The Takeover Executive can initiate proceedings in the Takeover Panel seeking sanctions for breaches of the Takeovers Code. These range from public criticism or public censure to a “cold shoulder” order which denies a person direct or indirect access to the Hong Kong securities markets for a stated period. The Takeovers Panel will give a ruling after the hearing and where appropriate impose sanctions. If the other party agrees, the Takeover Executive can impose these sanctions directly, as an alternative to Panel proceedings. See section 12 of the Introduction to the Takeovers Code. If the bidder is a listed company, the SFC could approach a court to seek remedial or injunctive orders under section 214 of the SFO. Takeovers Rule 26.1 of the Takeovers Code requires a person who acquires 30 percent or more of the voting shares in a company to make a takeover bid addressed to all holders. Partial bids require the consent of the Takeover Executive (Rule 28.1). An offer must also be made by a person who holds between 30 percent and 50 percent of shares, and increases their holding by more than 2 percent in any 12 month period. These rules apply also to persons acting in concert who collectively meet the thresholds. The offer must be posted within 21 days of the announcement of the terms of the offer (35 days for share exchange offers), Rule 8.2 of the Takeovers Code. The offer must be open for at least 21 calendar days following the date on which the offer document is posted. Rule 26.3 of the Code applies to mandatory offers and requires that the price offered must be not less than the highest price paid by the bidder, and by persons acting in concert with the bidder, for shares acquired during the offer period and within 6 months prior to its commencement. If no purchase against payment of securities of the same class was made in the period indicated, the takeover bid is implemented for that class of securities at a price no less than the weighted market average over the previous twelve months or shorter available period. General Principles 5 and 6 of the Takeovers Code provide that shareholders should be given sufficient information, advice and time to reach an informed decision; and that there should be full and prompt disclosure of all relevant information and precaution should be taken to avoid the creation or continuance of a false market. The Code sets out required content for the bidder’s statement and the target statement (Schedules 1 and 2). The Code requires the target company to establish an independent board committee comprised only of independent directors to make a recommendation to the shareholders as to whether the offer or other transaction is fair and reasonable and as to acceptance and voting. It also requires the appointment of an independent financial adviser to advise the independent board committee. The written advice of the independent financial adviser and the recommendations of the independent board committee must be set out in the circular to shareholders. The Code (Rule 9.3) also requires all announcements and documents to shareholders to include a statement stating that all directors of the company issuing the announcement or document jointly and severally accept full responsibility for the accuracy of information and confirm that there is no omission of facts which would make any statement in the announcement or document misleading. Rule 4 of the Code prohibits the use of frustrating actions by a target company. General Principle 8 requires directors, in providing advice to shareholders, to act only in the interests of shareholders and to disregard personal and family shareholdings. Schedule 9 of the CO provides for “squeeze out” of minority shareholders if a purchaser acquires not less than 90 percent of the shares for which the offer is made, within four months from the date of the offer. Other changes off control transactions The Takeovers Code also applies to other change of control transactions which are typically subject to shareholders’ approval at a general meeting. At these general meetings, the Takeovers Code requires voting to be conducted by way of poll. In general, the principles and rules under the Takeovers Code are equally applicable to these transactions. Examples of other change of control transactions which require shareholders’ approval at a general meeting are: a. privatizations by way of a scheme of arrangement under companies law; b. “whitewash” transactions involving a waiver of a general offer obligation arising as a result of the issue of new shares by the company (e.g. through subscription of new shares or acquisition of assets by the company with issuance of new shares as consideration etc.); and c. waivers of general offer obligation arising from a share repurchase - the same procedure as for “whitewash” transactions are used. Where a person is seeking to use a scheme of arrangement or capital reorganization to acquire or privatize a company, the scheme or capital reorganization may only be implemented if, in addition to satisfying any voting requirements imposed by law: a. the scheme or capital reorganization is approved by at least 75 percent of the votes attaching to the disinterested shares that are cast either in person or by proxy at a meeting of disinterested shareholders; and b. the number of votes cast against the proposed scheme or capital reorganization is not more than 10 percent of the votes attaching to all disinterested shares. Rule 2.10 of the Takeovers Code. Schemes of arrangement are under the supervision of the court. Holding the company and its directors responsible in case of violations of law Part IVAA of the CO sets out the provisions for statutory derivative actions. Under sections 168BA to 168BI, a member of a company has a statutory right to bring proceedings on behalf of the company or to intervene in proceedings to which the company is a party if: a. the cause of action or right to continue, discontinue or defend the proceedings is vested in the company and relief is sought on behalf of the company; b. the bringing of proceedings is in respect of misfeasance committed against the company (misfeasance is defined under section 168BB(2) to include fraud, c. negligence, default in compliance with any enactment or rule of law or breach of duty); d. the company fails to bring proceedings or diligently continue, discontinue or defend the proceedings; and e. leave is granted by the Court to bring or intervene in such proceedings. The SFC has the power to apply to intervene in proceedings between private litigants (section 385 of the SFO). SFC can apply to the court for civil orders including injunctions, disqualification orders and other remedial orders if in its view the business or affairs of a listed company have been conducted in a manner: a. that is oppressive to its members or any part of its members; b. involving defalcation, fraud, misfeasance or other misconduct towards it or its members or any part of its members; c. resulting in its members or any part of its members not having been given all the information with respect to its business or affairs that they might reasonably expect; or d. that is unfairly prejudicial to its members or any part of its members (Section 214 of the SFO). The SFC also has power to apply to the court for injunctive and remedial orders (including rescission and restitution orders) and any ancillary order which the Court considers necessary (including injunctions, freezing of assets or the appointment of an administrator or receiver) (see Section 213 of the SFO). This power is not limited to persons licensed or registered by the SFC, and the power applies to unregulated persons as well. Bankruptcy or insolvency of the company The CO provides detailed procedures for the winding up of companies, including in the event of their insolvency (Part V of the CO). Any surplus capital after settling all a company’s debt is distributed pari passu to its shareholders pursuant to Rule 143 of the Companies (Winding-up) Rules. Insiders and substantial holdings disclosure of interests in shares of listed corporations Prospectus disclosure Paragraph 30 of the Third Schedule of the CO requires a prospectus to contain a statement of the holdings of persons holding or beneficially interested in a substantial part of the share capital of the company. Although the CO does not define a substantial holding for these purposes, in practice the 5 percent threshold used in Part XV of the SFO is used. Listing applicants are required to disclose in their listing documents the interests (which include interests in the underlying shares of equity derivatives) and short positions of each of their directors and chief executives and any associated companies in accordance to the disclosure of interest requirements in Part XV of the SFO (Paragraph 45 of Part A of Appendix 1 to the Listing Rules). Part XV of the SFO contains detailed provisions requiring disclosure of substantial shareholdings in listed companies. A substantial shareholding is 5 percent or more of any class of voting shares. In counting shareholdings for these purposes, derivatives over shares are taken into account (sections 311). Further disclosure is required where increases above specified thresholds occur (for example, a 1 percent change). Disclosure is also required of short positions held by substantial shareholders (section 312). The disclosure requirements in Part XV apply where there is an agreement between two or more persons which includes provisions for the acquisition by any one or more of them of interests in shares in the relevant share capital of a particular listed corporation (see Sections 317 to 319). Holdings of voting securities by directors and senior management Section 341 of the SFO requires directors and chief executives of a listed corporation to disclose their interests, and short positions in any shares and any debentures they in the listed company and its associated companies. These disclosures are made public through the SEHK’s website. Holdings of this kind must be disclosed in a prospectus and listing document, and in annual reports. Timing of disclosure Listed companies are required to disclose in annual reports the interests and short positions of substantial shareholders (Listing Rule 13.47 and paragraph 13 of Appendix 16). Upon listing, directors, chief executives and substantial shareholders must disclose their interests within 10 business days of a company being listed. After that, disclosure must be made within 3 business days after the day on the duty to disclose arises (see Sections 325 and 348 of the SFO). Supervision The SEHK regularly forwards to the SFC details of SFO Part XV disclosures that appear to be late. A team of SFC staff handle late disclosure referrals from the SEHK. SFC officers first check whether the information to which the disclosure relates is already in the public domain, and whether the calculation on the percentage figure of the interest is correct by reference to the issued share capital at the time of the notification. The officer will also check the disclosure history of the director/substantial shareholder. The staff member will make an assessment of each referral and recommend any further actions. The SFC may commence investigation with a view to prosecution if: a. the person was involved in late disclosure on a previous occasion; b. the time delay is significant and the aggregated value of the interests is more than HK$1 million; or c. the late disclosure concealed materially price sensitive information. The SFC has achieved a large number of convictions in the Magistrates Courts for breaches of these obligations. Cross border The prospectus provisions, the Listing Rules and the SFO apply to overseas as well as domestic companies. The listing documents of overseas issuers must contain: a. a summary of all provisions of the constitutive documents of the overseas issuer in so far as they may affect shareholders’ rights and protections and directors’ powers (see Rule 19.10(2)); and b. a summary of the relevant regulatory provisions (statutory or otherwise) of the jurisdiction in which the overseas issuer is incorporated or otherwise established (see Rules 19.10 (3) and 19.34(2)). The SFC Takeovers Code applies to public companies in Hong Kong, companies with a primary listing of their equity securities in Hong Kong and REITs with a primary listing of their units in Hong Kong. Whether a company is a public company in Hong Kong is determined by applying an economic or commercial test which involves the consideration of factors such as the number of shareholders in Hong Kong, the extent of share trading in Hong Kong and so on (Section 4.2 of the Introduction to the Takeovers Code).
Assessment	Fully implemented
Comments	It is common for Hong Kong listed companies to have a dominant shareholder, frequently a family. In these circumstances, the rules relating to connected transactions play an important role in regulating the potential conflict between the dominant shareholder and other investors. The rules are strongly policed by SFC and there is good evidence of its willingness to use enforcement remedies to deal with non-compliance. The number of takeovers in Hong Kong is small relative to the size of the market. There were 29 takeovers in 2010–11, 29 in 2011–12, and 24 in 2012–13. Contested takeovers are rare. Privatization transactions – especially with a dominant shareholder taking a company private – are achieved through schemes of arrangement. Notwithstanding the non-statutory nature of the Takeovers and Share Repurchase Codes, the system appears to work effectively in the Hong Kong environment. Appeals to the Takeovers Panel against decisions of the SFC are uncommon.
Principle 18.	Accounting standards used by issuers to prepare financial statements should be of a high and internationally acceptable quality.
Description	Audited financial statements Audited financial statements must contain all the detail required by the applicable accounting standards (HKFRS, IFRS or CASBE), including a statement of financial position, a statement of operational results and statement of cash flow, and details about changes in equity ownership. Public offers of securities As stated in Principle 16, issuers of public offering and listed structured products, as well as issuers of unlisted structur