ComplianceOne Newsletter - December 2023
The topics discussed in this monthly newsletter are as follows:
1. SFC issued key regulatory work and market data in quarterly report
2. SFC would consider authorising spot virtual asset ETF funds for public offering
5. SFC banned Amy Chow Bik Sum for life for conviction of bribery offence
7. SFC suspended Hau Bing Leung for 15 months for unauthorized third-party operated securities account
MARKET NEWS
1.SFC issued key regulatory work and market data in quarterly report
On 7 Dec 2023, the SFC published its latest Quarterly Report to provide operational and financial highlights for the quarter from July to September 2023. Encouraging achievements are as follows.
(1) On asset management, exchange-traded funds (“ETFs”) were a bright spot with robust net inflow of HKD16.2 billion, while their average daily turnover (“ADT”) recorded with a healthy growth of 12% to HKD14.8 billion.
(2) Besides ETF figures, the number of open-ended fund companies (“OFCs”) was also recorded with an encouraging growth of 87% year-over-year to 187. Hong Kong-domiciled funds recorded net inflows ($11.7 billion) for another quarter.
(3) For the listing market, the SFC processed 39 new listing applications in the quarter,
including four from pre-profit biotech companies.
(4) For licensed activities, the SFC witnessed growth in the number of licence applications received, up 13% from the quarter before and 6% from a year ago. It also granted 33 corporate licences during the quarter, mainly for asset management (Type 9) and advising on securities (Type 4).
(5) On the VA front, the SFC stepped up information dissemination on virtual asset
trading platforms (“VATPs”) by publishing several VATP lists online, including a list of applicants.
SIGNIFICANCE:
Though fraught with negative comments that the status of Hong Kong as an international financial centre was fading away, the figures and achievements stated above demonstrate to the world how resilient Hong Kong can be from the previous economic drawback due to COVID-19 epidemic!
2. SFC would consider authorising spot virtual asset ETF funds for public offering
A circular dated 22 Dec 2023 set out the requirements under which the SFC would consider authorising investment funds with exposure to virtual assets (“VA”) of more than 10% of their net asset value (“NAV”) for public offerings in Hong Kong (SFC-authorised VA Funds) under sections 104 and 105 of the Securities and Futures Ordinance (“SFO”).
In the light of rapid evolvement of the VA landscape and the increasing demand for investment products providing exposure to VA, and VA-related ETFs offered in major overseas markets, where accesses to both retail and professional investors are available; the SFC has introduced regimes that allow the offering of certain VA products to the Hong Kong public with appropriate investor protection safeguards.
The SFC put forward requirements for SFC-authorized funds with regard to two categories: (i) funds investing directly in the same spot VA tokens tradable on the SFC-licensed VATPs (i.e., direct exposure); and (ii) funds acquiring indirect investment exposure to such VA (i.e., indirect exposure) through futures traded on conventional regulated futures exchanges.
A snapshot of the requirements on SFC-authorized VA Funds
Pre-requisites to start with are that the Funds should meet the applicable requirements in the Overarching Principles Section and the Code on Unit Trusts and Mutual Funds (“UT Code”) in the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products.
Additional requirements are applicable to the followings (please refer to original for details):
(a) Management companies: good compliance record with competent staff knowledgeable in VA product.
(b) Eligible underlying VA: accessible on SFC-licensed VATPs.
(c) Investment Strategy:
(i) funds with direct or indirect exposure in eligible VA tokens;
(iii) only for those traded on conventional regulated futures exchanges;
(iii) no leverage in exposure to VA at the fund level
(d) Transactions and direct acquisitions of spot VA:
(i) transactions and acquisitions of spot VA by SFC-authorised VA Funds should be conducted through SFC-licensed VATPs, or authorized financial institutions where subscriptions can be in form of “in-cash” or “in-kind” types;
(ii) both in-kind and in-cash subscription and redemption are allowed for SFC-authorised spot VA ETFs.
(e) Custody:
(i) the custodian function of the VA Fund should only be delegated to SFC-licensed VATPs or any authorised financial institutions ("AIs”);
(ii) VA holdings owned by clients should be segregated, and stored most in cold wallet for safety purpose;
(iii) the private keys should be securely stored.
(f) Valuation: an indexing approach based on VA trade volume across major VA trading platforms should be adopted.
(g) Service Providers: it is necessary to ensure all service providers are competent.
(h) Disclosure and Investor education: the offering documents, including the product key facts statements (“KFS”), of SFC-authorised VA Funds should disclose the investment limits and key risks related to the funds’ VA exposures.
(i) Distribution: refer to the relevant requirements for intermediaries and distribution of SFC-authorised VA Funds as set out in the Joint Circular (dated 22 Dec 2023
SIGNIFICANCE:
Hong Kong maybe the first pioneer in allowing the public offering of spot VA ETF, and it further consolidates the status of Hong Kong being the international financial centre for licensing regime of digital assets.
The HKEX should also ensure the infrastructures should be adaptable and aligned to keep pace with the rapid and ever-evolving VA landscape in order to maintain the competitiveness and attractiveness of Hong Kong as an international financial centre as well.
In an announcement on 27 Dec 2023, the Financial Services and the Treasury Bureau (“FSTB”) and the HKMA jointly issued a public Consultation Paper on the legislative proposal for implementing the regulatory regime for stablecoin issuers in Hong Kong. An executive summary for your glance as below.
Virtual assets and stablecoins
Virtual assets (“VA”), often referred to as crypto-assets, are digital representations of value that are cryptographically secured, typically through the use of distributed ledger technology (“DLT”), like blockchain. Given the intrinsic high price volatility which suffocate the growth of VA, the emergence of stablecoins seems to offer a solution to tackle the problem.
Stablecoins can be visualized as a VAs which aim to maintain a stable value with reference to certain asset such as fiat currencies. It can be envisaged as exchanging fiat currency with a stablecoin issuer in return or stablecoins of equivalent value, or vice versa. These tokens with stable value on blockchain could help mitigate the abovementioned issues of high volatilities, which could in turn improve the overall efficiency of “on-chain” transactions.
Potential use cases and risks of stablecoins
With the use of DLT, payment and settlement via stablecoins could become more efficient and transparent, and when used in conjunction with smart contracts, stablecoins could also function as “programmable money” and be used to execute complex transactions.
The VA market is still far from maturity and will likely continue to evolve, and stablecoins could become the interface between traditional finance and the VA markets. Yet, from the users’ perspective, they could suffer financial losses and disruption in their supposedly smooth daily payment routines if stablecoin issuers fail to maintain adequate reserve assets to uphold the stable value of the stablecoin, especially in redeeming back to fiat currencies.
Formulation of a regulatory regime
In the light of the potential risk of stablecoins, under our proposed regime, an issuer of stablecoins would be required to obtain a licence from the HKMA if it issues a stablecoin that references the value of one or more fiat currencies (“fiat-referenced stablecoin”) in Hong Kong. The licensee would be required to put in place an effective stabilisation mechanism, such as maintaining a pool of high-quality and highly-liquid reserve assets; and would also need to comply with relevant governance, risk management and AML/CFT measure. In particular, only stablecoins issued by licensed issuers could be offered to retail investors.
In an ever-changing and evolving market, there is always a dilemma of safeguarding financial stability and embracing innovation. With this in mind, the HKMA plans to roll out a “sandbox” to facilitate the communication of our supervisory expectations with entities that are interested in issuing stablecoins in Hong Kong.
SIGNIFICANCE:
According to the Consultation Paper, we have the key takeaways:
(1) The consultation period will expire on 29 February 2024.
(2) There is a transitional period arrangement. It is proposed that the commencement date will be effective one-month upon gazettal of the proposed new ordinance. The pre-existing fiat-referenced stablecoin (“FRS”) issuers currently conducting FRS issuance activities may continue to operate under a non-contravention period of 6 months, on condition that they have submitted an application to the HKMA within 3 months of the commencement of the regime; or otherwise, the FRS issuers will have to close down its business by the end of the 4th month.
(3) Making a reference from international practices, it is proposed that the minimum paid-up share capital will be either HKD25,000,000 or a fixed percentage at 2% of the par value of FRS in circulation, whichever is higher will be applied.
ENFORCEMENT NEWS
On 4 December 2023, the SFC reprimanded and fined Ruifeng Securities Limited (“RSL”) HK$5.2 million over failures relating to its fund management activities and account opening procedures.
It was found that RSL invested about 90 per cent of the fund’s US$94.5 million net asset value into financial instruments which was identified as having various downside factors in their own analysis and such material information was not disclosed in the fund.
It was also found that RSL had failed to adopt acceptable account opening procedures for verifying the identities of clients who opened their accounts on a non-face-to-face basis through RSL’s mobile application between 26 November 2018 and 31 July 2020.
As a result of this investigation, the SFC also suspended the licence of Mr Fang Zhi for 10 months from 1 December 2023 to 30 September 2024 for failing to discharge his duties as a responsible officer of RSL in charge of its fund management activities.
5. SFC banned Amy Chow Bik Sum for life for conviction of bribery offence
It was announced on 13 December 2023 that the SFC had banned Ms Amy Chow Bik Sum, a former assistant customer service manager of OCBC Wing Hang Bank Limited (“OCBC”), from re-entering the industry for life following her conviction of bribery offence.
The Kwun Tong Magistrates’ Court found that on 15 July 2021, Chow, who handled residential mortgage applications at OCBC, offered an employee of OCBC Wing Hang Credit Limited (“OCBC Credit”) a rebate of referral fees from an external party as a reward for referring OCBC Credit’s clients to that party, who would in turn arrange mortgage refinancing from other banks or financial institutions.
The SFC considers that Chow is not a fit and proper person to be licensed or registered to carry on regulated activities as a result of her criminal conviction.
On 18 December 2023, the SFC reprimanded and fined Central Wealth Securities Investment Limited (“CWSIL”) $1 million for failures in complying with the Securities and Futures (Financial Resources) Rules (“FRR”). It was found that CWSIL made various accounting and calculation errors in the financial returns submitted to the SFC under the FRR which resulted in overstating its liquid capital between April 2019 and December 2020 (Relevant Period) which was otherwise records of deficits after eliminating the errors.
CWSIL’s failure to ensure accuracy in the FRR was mainly attributable to its failure to appoint qualified and competent persons to prepare and review the FRRs, coupled with the fact that its responsible officers were not familiar with the FRR requirements as well.
SIGNIFICANCE:
The assurance of a qualified and competent staff to conduct the financial returns was a prerequisite to ensure compliance with the FRR under the SFC. With the rapid development and fast-changing regulatory regime in the financial industry, particularly in the recent and buoyant environment with the virtual assets and non-conventional businesses under the regime of regular regulated activities, a precise and accurate financial return prepared by competent staff is of high priority for senior staff with respect to risks management which is the pillar for sustainability of a licensed corporation.
7. SFC suspended Hau Bing Leung for 15 months for unauthorized third-party operated securities account
On 27 December 2023, the SFC had suspended the license of Mr Hau Bing Leung (“HAU”), former account executive of Chee Tak Securities Limited (“CTSL”), for 15 months from 22 December 2023 to 21 March 2025.
It was found in the investigation that between 1 July 2018 and 5 March 2020, Hau had allowed a third party to operate the securities account of a client at CTSL without obtaining the client’s written authorisation. Having been verbally authorized by the client, the third party and HAU also even carried out personal trades in the client’s securities account; even worse was that HAU prevented CTSL from monitoring the operation of that client’s account and his personal dealings.
SIGNIFICANCE:
The incidence revealed the deficiency in risk control and trades monitoring, and subsequently exposed the client to potential loss from unauthorized trading and CTSL to potential liability in case of disputes arising from trades in the account concerned.
For more details, please click on the title of the topic above.
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