In June 2022, the Hong Kong Securities and Futures Commission (SFC) proposed a number of sweeping enforcement-related reforms which would have, among others, significantly enhanced the SFC’s ability to obtain investor compensation orders against regulated persons who had committed wrongdoing if enacted (please refer to our June 2022 briefing).
The package of reforms related to three parts of the Securities and Futures Ordinance (SFO) and raised a number of concerns in the financial services industry. The SFC received 27 written submissions in response to the June 2022 public consultation, including submissions from industry associations.
Our firm led the working group of the Alternative Investment Management Association in preparing its submission to the SFC. The SFC published its consultation conclusions on 8 August 2023.
In light of industry feedback, the SFC will now proceed with broadening the territorial scope of the SFO’s insider dealing provisions, but will put on hold the other proposed amendments.
Key takeaways
Territorial scope of insider dealing provisions broadened
- The SFC will proceed with the proposed amendments to the insider dealing provisions under the SFO, which will allow the SFC to tackle cross-border insider dealing activities.
- In the consultation conclusions, the SFC clarified the scope and applicability of the proposed amendments, which we have outlined below. The industry will have an opportunity to review the draft amendments to the SFO during the legislative process.
- The SFC stated that once the legislative amendments have been published, firms will have sufficient time to update their internal compliance policies and manuals and therefore a transition period will not be required.
Other proposed amendments put on hold
- Given the concerns and complexities raised by the majority of respondents, the SFC will put on hold the proposals to (i) expand the basis on which the SFC may apply for court orders under section 213 of the SFO, and (ii) amend the professional investor (PI) exemption to the offer of investments regime under section 103 of the SFO.
- In relation to the proposed amendments to section 213, the SFC will further assess the adequacy of the current avenues for seeking financial redress by or for aggrieved investors and study a full range of other options to achieve the policy objective of enhancing the prospects of investors getting fair compensation in intermediary misconduct cases, including strengthening the SFC’s disciplinary regime.
- Regarding the proposed amendments to section 103, the SFC have decided not to proceed with the proposal in its current form, but will continue to monitor the need to introduce new policies over the longer term. The SFC may consult the industry again.
- The SFC reminds the industry that anyone who wishes to invoke the PI exemption should be able to demonstrate a clear intention to dispose of the investment product only to PIs. In the SFC’s view, to demonstrate this intention, at a minimum, the issuer of an advertisement should ensure it is plainly apparent from the face of the advertisement that the investment product is intended only for disposal for PIs. The SFC considers that the clear display of an appropriate message or warning on all advertising materials would go a long way to helping an issuer of an advertisement establish this intention. Anyone who issues advertisements will need to determine how best to present this message or warning and put in place related processes and safeguards to ensure the investment products will not be sold to retail investors. In the meantime, the SFC is considering providing further guidance to the market on this matter.
(1) Broadening the territorial scope of SFO insider dealing provisions
The current regime applies to insider dealing of (a) Hong Kong-listed securities and their derivatives and (b) securities dual-listed in Hong Kong and another jurisdiction and their derivatives. However, it does not expressly cover insider dealing of Hong Kong-listed securities or their derivatives which takes place outside of Hong Kong.
In addition, the SFC has been restricted in tackling suspected insider dealing of overseas-listed securities. They are able to provide intelligence to overseas securities regulators, and have also sought to enforce against insider dealing of overseas-listed securities perpetrated in Hong Kong through seeking civil remedies under section 213. In such cases, the SFC established that the activities contravened section 300 of the SFO, which prohibits fraudulent or deceptive conduct in a transaction involving securities.
These limitations are at odds with other major common law jurisdictions and therefore the SFC proposed expanding the insider dealing regime to cover:
- insider dealing perpetrated in Hong Kong with respect to overseas-listed securities or their derivatives; and
- insider dealing perpetrated outside of Hong Kong involving any Hong Kong-listed securities or their derivates.
The SFC received broad support for its proposal and will proceed with the amendments outlined in the consultation paper.
The SFC also addressed the respondents’ requests for clarification in the consultation conclusions:
- The amended provisions will stipulate that the misconduct would also need to be unlawful in the relevant overseas jurisdiction (it was noted in the consultation that a new subsection would be added to section 282 (civil regime) and section 306 (criminal regime) to that effect). The SFC will not prescribe a list of selected overseas markets to which the amended provisions will apply, given that the purpose of the proposal is to enable the SFC to take action against cross-border insider dealing.
- The current definition of “derivatives” and the applicability of the insider dealing regime to over-the-counter transactions in listed debt securities will remain unchanged. The expanded insider dealing regime will apply to such transactions in both Hong Kong-listed and overseas-listed debt securities, unless one of the statutory defences applies. In other words, it is the territorial scope which is being changed.
- A transition period will not be provided on the basis that the SFC stated that firms will have sufficient time to update their internal compliance policies and manuals once the legislative amendments have been published.
- Firms are also reminded that the notification requirement under the Code of Conduct for Persons Licensed by or Registered with the SFC will also apply as the amendments are made to some market misconduct provisions within Parts XIII and XIV of the SFO. Firms should submit a report when they become aware of any suspected breaches.
- In relation to concerns over cross-border data transfer restrictions, the SFC responded that firms should use their best endeavours to obtain data located overseas to submit in their report to the SFC.
(2) Putting on hold proposed amendments to SFO section 213
The SFC proposed amending section 213 of the SFO to broaden the basis upon which the SFC may apply for court orders, including compensation orders, by allowing the SFC to apply for such orders after having exercised its disciplinary powers under sections 194 or 196 of the SFO.
Most of the respondents expressed concerns about the proposed amendments. Although the SFC does not agree that the existing legal framework already provides adequate protection to aggrieved investors, they have decided to put the proposal on hold in light of the responses. The SFC will further assess the adequacy of the current avenues for seeking financial redress by or for aggrieved investors and study a full range of other options to achieve its policy objective, including strengthening the SFC’s disciplinary regime.
There are five major themes across the responses and the SFC addressed these in the consultation conclusions:
- Legal and jurisprudence concerns;
- Implementation and practical issues arising from perceived conflation of the disciplinary regime and section 213;
- Fairness and proportionality concerns;
- Competitiveness and status of Hong Kong as an international financial centre; and
- A broader and more holistic review of compensation orders as a remedy in Hong Kong.
Our overview of the SFC’s analysis in relation to these themes can be found here.
(3) Not proceeding with proposed amendments to SFO section 103 on PI exemption in its current form
Many respondents expressed concerns about the proposal to amend the PI exemption in section 103(3)(k) of the SFO. While the respondents were generally supportive of the objective underpinning the proposal to enhance investor protection, common concerns related to:
- whether the amendments are necessary; and
- the operational difficulties and the impact on business development and marketing processes.
Our overview of the SFC’s views in relation to these concerns can be found here.
Having considered the respondents’ views and concerns, the SFC decided not to proceed with the proposal in its current form. The SFC will continue to monitor the need to introduce new policies over the longer term and, if necessary, the SFC will consult the industry again.
In the consultation conclusions, the SFC reminded the industry that anyone (whether a licensed intermediary or not) who wishes to invoke the PI exemption should be able to demonstrate a clear intention to dispose of the investment product only to PIs.
The SFC stated that it takes a strong view against anyone who misuses this exemption to push unsuitable investment products to retail investors. Furthermore:
- To demonstrate and evidence a genuine intention to dispose of an investment product only to PIs, the issuer of an advertisement should, at a minimum, ensure it is plainly apparent from the face of the advertisement that the underlying investment product is intended only for disposal to PIs.
- In this regard, the SFC considers that the clear display of an appropriate message or warning on all advertising materials would go a long way to helping an issuer of an advertisement establish this intention.
- Anyone who issues advertisements will need to determine how best to present this message or warning and put in place related processes and safeguards to ensure the investment products will not be sold to retail investors.
- The SFC is considering providing further guidance to the market on this matter.
It is interesting to note that in the Pacific Sun case, the CFA agreed with the appellants’ contention that section 103(3)(k) does not require that it be made apparent on the advertisement itself that it is made in respect of PIs – but only require a person relying on the exemption to demonstrate that the relevant investment is in fact intended solely for PIs. Whilst current market practice is arguably sufficient to protect against the sale of complex and risky products to retail investors, issuers of advertisements should still carefully consider how best to demonstrate and evidence a genuine intention to dispose of an investment product only to PIs in light of the SFC’s latest comments.
