ComplianceOne Newsletter - November 2023
The topics discussed in this monthly newsletter are as follows:
1. SFC provided detailed guilelines on Tokenised Securities-related Activities
5. China treasury bond futures to be launced in Hong Kong
7. SFC commenced legal proceedings against First Credit Finance Group Limited (8215.HK) and its former directors
MARKET NEWS
1.SFC provided detailed guilelines on Tokenized Securities-related Activities
In the light of growing interest in tokenising traditional financial instruments in the global financial markets, and with an increasing number of intermediaries entering the space to explore the tokenisation of securities and the distribution of Tokenized Securities (“TKS”) to their clients; the SFC posted two circulars dated 2 November 2023 to providing guidance to intermediaries in addressing and managing the new risks arising from the use of this new tokenisation technology so that the tokenisation marketplace could be developed in a healthy, responsible and sustainable manner.
Tokenisation generally involves the process of recording claims on assets that exist on a traditional ledger onto a programmable platform, which includes the use of distributed ledger technology (“DLT”) in the security lifecycle.
For simplicity, TKS are traditional financial instruments (e.g. bonds or funds) that are “securities” as defined in section 1 of Part 1 of Schedule 1 to the Securities and Futures Ordinance (Cap. 571) (“SFO”) which utilise DLT (such as blockchain technology) or similar technology in their security lifecycle.
Given the nature of TKS are fundamentally traditional securities with a tokenisation wrapper, the existing legal and regulatory requirements governing the traditional securities markets continue to apply to TKS.
Some key takeaways to bear in mind:
(i) There are several common archetypes of DLT networks, including: (a) private-permissioned, closed-loop private network; (b) public-permissioned network with restricted access; (c) public-permissionless network with no restricted access. Ownership risks vary depending on the type of DLT network adopted.
(ii) Given that the intermediaries have the new technology in place where the risk of using technology has been mitigated, and tokenization itself should not alter the complexity of the underlying security; whether a Tokenised Security is a complex product or not is based on an assessment of the complexity of its underlying traditional security.
(iii) Intermediaries intending to engage in TKS-related activities should have the necessary manpower and expertise to perform due diligence on the TKS based on all the available information to identify the key features and risks involved.
(iv) In assessing the risks related to the technical and other aspects of TKS, an intermediary is suggested to take into account the list of non-exhaustive factors set out in Part A of the Appendix of the circular published by SFC for guidelines in details.
(v) Intermediaries should make adequate disclosure of relevant material information specific to TKS (including the risks of the TKS) and communicate such information in a clear and easily comprehensible manner to the clients.
(vi) The SFC is of the view that there would be no need to impose a mandatory Professional Investor (“PI”) only restriction; YET, it should also be noted that an offer of TKS that is not authorized under the Part IV of the SFO or which has not complied with the prospectus regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (“C(WUMP)O”) could only be made to PIs or pursuant to any other applicable exemption under the Public Offering Regimes;
(vii) The SFC would not impose the Terms and Conditions on fund managers managing portfolios investing in TKS meeting the “de minimis threshold” (i.e. 10% of the GAV of the fund) unless the portfolios also invest in virtual assets meeting the “de minimis threshold”;
(viii) The VATPs are required to put in place a compensation arrangement approved by the SFC to cover the potential loss of security tokens in compliance with paragraph 10.22 of the Guidelines for Virtual Asset Trading Platform Operators. And the VATP is also required to demonstrate to the SFC’s satisfaction that the risk of financial loss to its clients can be effectively mitigated if the TKS become lost.
(ix) TKS are a subset of a broader set of Digital Securities, and in case where Digital Sec which are not TKS are likely to be regarded as “complex products” not be accessible to retails investors.
SIGNIFICANCE:
Intermediaries which are interested in engaging in any activities involving any Digital
Securities (including TKS) should notify and discuss their business plans with their case officer in the SFC in advance.
They are further advised to have relevant personnel who possess the knowledge and experience in TKS to ensure compliance with the prevailing regulations and guidelines; and the technological knowhow required to tackle the intrinsic risks in the use of DLT networks as well as related remedial measure to mitigate the hacking risks exposed.
The Hong Kong Exchanges and Clearing Limited (HKEX) published a Consultation Paper on 30 Nov 2023 on the proposed operational model and related arrangements for Hong Kong's securities and derivatives markets to remain operational during severe weather conditions. The consultation will last for eight weeks, ending on 26 January 2024.
As HKEX Chief Executive Officer Nicolas Aguzin has said: “Hong Kong is a major global financial market, as well as being the go-to global risk management and asset allocation centre for the region. …There is proven trusted technology in place to facilitate safe, secure and seamless operations remotely, so it is now time to bring the market in-line with global peers."
Under HKEX's proposals, severe weather conditions will no longer have automatic consequential impact on the continuity of trading. HKEX intends for its securities and
derivatives markets, including Southbound and Northbound Stock Connect, derivatives holiday trading and afterhours trading, to be open and available to all local, regional and international investors during severe weather conditions.
During a severe weather event, the trading, post-trade and listing arrangements will be substantially the same as those during regular trading days, with some necessary
adjustments needed to ensure the market’s operational resilience, and the safety of
market participants, as the provision of some services provided via physical outlets would be unavailable
HKEX, along with the SFC and HKMA, and with the support of the HKSAR Government, formed a Severe Weather Trading Task Force (“Task Force”) in 2023 to solicit responses from the market participants for feasibility of continuous trading under severe weather conditions.
In working with the Task Force, the Hong Kong Association of Banks and the Hong Kong Interbank Clearing Limited have confirmed that, during a severe weather event, relevant banking services, such as e-cheque clearance and electronic money transfer channels, will be available from the designated banks and settlement banks of relevant clearing houses of HKEX, to fully support Clearing Participants' operations and money settlement requirements.
SIGNIFICANCE:
Despite the need to maintain aligned with global markets for a seamless operation of the financial markets under severe weather conditions, personnel safety remains a key consideration in the consultation; and market participants have to work remotely where possible during severe weather events given such devices are in place for the LCs.
The priority here for HKSAR as an international financial centre is to ensure a regime of seamless and continuous trading arrangement where investors over the world are able and continue to manage their portfolios and relevant risks, particularly when other overseas underlying markets are still open.
According to paragraph 103 of the Consultation Paper, the effective implementation time of the Severe Weather Trading will be in July 2024, allowing a six-month preparation lead time beforehand. A Summary of the Arrangements is enclosed as APPENDIX I for reference in details in the original circular.
In the circular 8 November 2023, the SFC reminded licensed corporations (“LCs”) to prudently manage their risks in providing initial public offering (“IPO”) subscription services and financing to clients with the newly launched “Fast Interface for New Issuance” (“FINI”) on 22 November 2023.
Despite the modifications of the pre-funding mechanism under the FINI, LCS are required to ensure a prudent risk management and control when providing IPO subscriptions and financing services to their clients. The relevant measures should cover the following areas:
I. Prudent credit risk management:
(i) ensure that clients have sufficient financial resources to settle obligations related to their IPO subscriptions in full by imposing upfront deposits before accepting the subscription orders;
(ii) formualte a prudent credit policy by setting appropriate credit limits for clients having regard to financial capability of the LC, and prevailing market atmosphere amid the IPO process;
(iii) properly justify any deviation from the existing credit policy
II. Liquidity risk management and safeguarding client subscription deposits:
(i) prepare sufficient cash and credit facilities with banks to avoid any settlement defaults;
(ii) enusre that house money is sufficient to finance the clients in case the value of shares alloted far exceed the amount of the subscription deposits of the clients;
(iii) adequately safeguard clients' subscription deposits by keeping in segregated bank accounts of the LCs.
III. Financial risk management:
(i) avoid excessive bank borrowing and IPO financing beyond financial capability of the LCs;
(ii) critically assess the potential impact of IPO on the liquid capital position, especially the financial resources requirements of the SFO.
SIGNIFICANCE:
Under the FINI, a clearing participant will only have to arrange its designated bank to confirm the availability of funding for settlement of its subscriptions without actual fund transfer to the issuer until after pricing and balloting.
Though benefitted by the FINI arrangement which provides financial facility and flexibility to LCs in IPO business, the LCs should have prudent risk management policies and control procedures in place in return, and the designated banks are also supposed to follow suit for fear that the contingent liabilities from settlement defaults of any clients of the LCs are spilt over to counterparty banks as well.
On 14 November 2023, the Hong Kong Institute of Certified Public Accountants (“HKICPA”) released a study which found that among the 31 December 2022 year-end companies, amounting to 1882 companies, 141 (7.5%) of the companies had adopted external assurance, compared with the only 85 companies in 2021. The increase was even more obvious in large-market-capitalized companies, jumping from 20% (2021) to 41% (2023), indicating that larger companies are more responding to the fast-moving ESG environment.
While the HKICPA pointed out that the slow take up from listed companies can be attributed to the following factors: (i) the assurance is not mandatory; (ii) they are not confident in their own ESG data analysis and collection process; (iii) so far, there has been no widely-adopted set of international standards for ESG reporting.
In addition, there are some key findings:
(1) The largest companies tend to set clear carbon targets, in particular the HSI companies, which have greater visibility and face more pressure from investors and stakeholders for commitment to sustainability and EGS practices.
(2) CPA firms tend to act as external assurers on EGS reports due to their intrinsic training and expertise in the relevant areas.
(3) It is suggested to have a board-level ESG committee with an executive director with accounting qualifications to ensure an appropriate priority to ESG issues and their alignment with company values, strategies.
SIGNIFICANCE:
The findings are extracts from ESG Assurance in Hong Kong 2023: An evolving landscape which provides an indispensable reference for EGS assurance with insightful quantitative findings and guidelines.
5. China treasury bond futures to be launced in Hong Kong
On 24 November 2023, the SFC announced that China treasury bond futures contracts would be launched in Hong Kong. Hong Kong Exchanges and Clearing Limited (“HKEX”) is making preparations for the launch, including proposing amendments to relevant rules, details and the launch date will be announced soon.
The amount of China treasury bonds held by offshore investors has increased steadily since the launch of Bond Connect in 2017. The Mainland Government and regulators strongly support the launch of the China treasury bond futures in Hong Kong as it provides an important risk management tool to facilitate further participation by offshore institutional investors in the Mainland treasury market.
SIGNIFICANCE:
As Ms Julia Leung, Chief Executive Officer of the SFC, has said, “This is a key milestone in developing Hong Kong as a premier risk management centre, especially for hedging equities and fixed income products with Mainland assets underlying.” The launch of futures contracts in line with its underlying instruments provides effective risk and hedging tools for easier risk assessment and management, and more opportunities for institutional investors to participate.
ENFORCEMENT NEWS
In any announcement on 22 November 2023, the SFC reprimanded and fined Lion Futures Limited (“LFL”) HKD2.85 million for failures in complying with anti-money laundering and counter-terrorist financing (“AML/CFT”) and other regulatory requirements between May 2017 and July 2019.
The SFC’s investigation found that LFL did not conduct any due diligence on the customer supplied systems (“CSSs”) used by five clients for placing orders during the material time. Since these CSSs were connected to LFL’s broker supplied system (“BSS”) through the APIs where LFL was not in a position to properly assess and manage the money laundering and terrorist financing risk as users of the sub-accounts under the CSS cannot be easily monitored.
In addition, the SFC also found that LFL’s failure to put in place an effective ongoing monitoring system to detect suspicious trading patterns in client accounts resulted in its failure to detect 1,098 self-matched trades in five client accounts.
SIGNIFICANCE:
LFL is the 7th broker involved in the CSS issues which was connected with a software called Xinguanjia (XGJ) developed and/or provided by Hengxin Software Limited through which a number of sub-account users can operate and trade under the camouflage of an account maintained by a single client of the licensed corporation.
A common observable audit trail detectable of this CSS scenario is a large number of self-matched trades under a single account with no discernible trading purposes. The AML Guideline specifies the entry of matching buys and sells in particular securities and futures as an example of situations that might give rise to suspicion of money laundering, as it might create the illusion of trading and be an indication of market manipulation.
7. SFC commenced legal proceedings against First Credit Finance Group Limited (8215.HK) and its former directors
On 22 November 2023, the SFC announced its decision to commence legal proceedings under section 214 of the SFO in the Court of First Instance to seek disqualification orders against five former directors (Mr Sin Kwok Lam, Mr Tsang Yan Kwong, Mr Leung Wai Hung, Ms Ho Siu Man, Mr Tong Tai Man Hin) and a former de facto director (Mr Cho Kwai Chee) of First Credit Finance Group Limited (“First Credit”) for allegedly breaching their fiduciary duties.
The SFC’s investigation found that from December 2015 to June 2017, Cho acted as a de facto director of First Credit. In January 2016, Cho was a placee in a share placement conducted by First Credit, and himself with his brother were also a subscriber; yet First Credit’s respective announcements stated that all the placees and subscribers were independent third parties.
The investigation led to the SFC’s allegations that Sin, Tsang, Leung, Ho and Cho breached their duties towards First Credit by (i) failing to disclose Cho’s de facto directorship; and (ii) causing the company to publish false and/or misleading information in the announcements regarding the independence of Cho and/or his brother.
As part of the legal action, the SFC was also seeking an order for First Credit to publish the court’s findings in the proceedings so that shareholders of the company would be informed of Cho’s former de facto directorship in the company and the false and/or misleading disclosures made by the company in the announcements.
On 23 November 2023, the SFC announced its decision to commence legal proceedings asking the Court of First Instance to inquire into the circumstances of non-compliance by AMTD Global Markets Limited (“AMTD”, currently known as orientiert XYZ Securities Limited) and its former executives with the SFC’s notices in initial public offerings (IPOs)-related investigations.
The SFC’s investigations related to suspected employment of fraudulent or deceptive schemes and/or disclosure of false or misleading information in the IPOs of certain listed companies where AMTD was involved as bookrunner, lead manager and underwriter. The SFC issued notices to AMTD seeking records, and AMTD did not fully comply with the notices.
If the Court was satisfied with the petition from SFC, AMTD would be ordered to produce the specified records and its former executives to attend interviews, and the Court could punish them as if they had been guilty of contempt of court.
For more details, please click on the title of the topic above.
=================================
~ Make It Right Today, Better Tomorrow ~
=================================
The Newsletter is for general information purpose only and is not intended to constitute legal or other professional advice.
For enquiries, please email to support@complianceone.hk or WhatsApp us at (852) 95164607.
Unit 1104, 11/F, 299QRC, 287-299 Queen's Road Central, Sheung Wan, Hong Kong
Tel: (852) 39550277 www.complianceone.hk
To unsubscribe, please click “unsubscribe”.