## 1hkgea2021003 ## Source details **Canonical URL:** [1hkgea2021003](https://www.imf.org/-/media/files/publications/cr/2021/english/1hkgea2021003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1hkgea2021003.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1hkgea2021003.pdf.json) --- ### Executive summary — market structure and linkages - Hong Kong SAR is an equity trading hub for domestic and foreign investors, increasingly including investors from Mainland China. - Stock Connect introduced in 2014 enabled direct investment across Hong Kong, Shanghai and later Shenzhen, increasing linkages. - Mainland companies account for over 60 per cent of market capitalization of equities traded on the Stock Exchange of Hong Kong (SEHK) (section-level summary) and: - Mainland companies accounted for 50 per cent of listings, 68 per cent of total market capitalization and 59 per cent of market turnover in 2018. - Out of the US$36.5 billion equity funds raised through IPOs in Hong Kong in 2018, 95 per cent were raised for Mainland companies. - Number of listed companies (end-2018): Total (Main Board + GEM) 2,315 100%; Mainland companies 1,146 50%. - Market capitalisation (end-2018, HK$ bn): Total (Main Board + GEM) 29,909 100%; Mainland companies 20,193 68%. - Market turnover in 2018 (HK$ bn): Total (Main Board + GEM) 26,423 100%; Mainland companies 15,480 59%. - Transactions executed by ALPs accounted for about one per cent of the total turnover of the securities market as of April 2019. - There are currently 43 overseas exchanges and electronic trading facilities authorized by the SFC. ### Regulatory and supervisory developments and impacts - The Securities and Futures Commission (SFC) revamped regulation of intermediaries providing ATS via guidelines and Code of Conduct sections, consolidating prior licensing-condition-based requirements. - Outcomes of revamp: - Framework clearer, more consistent, more level-playing field. - Supervision of ATS providers is more risk–based and granular, using comprehensive data analysis and thematic reviews. - Supervision of recognized exchange companies enhanced: - Several on-site inspections since 2015 focused on trading and clearing functions, leading to improved oversight of members and rules. - Listing supervision improved via: (i) enhanced ongoing oversight and risk-based periodic reviews; (ii) more proactive vetting and early intervention on listing applicants and major transactions; (iii) more intrusive supervision of sponsor due diligence. - Enhancements helped control misuse of backdoor listings and shell companies. ### Cooperation with Mainland counterpart and cross-border supervision - SFC has deepened cooperation with the China Securities Regulatory Commission (CSRC) through multiple agreements and increased frequency of formal and informal exchanges. - Cooperation improved mutual market understanding and efficiency in tackling misconduct. - Stock Connect-specific arrangements: - 2014 MoU on exchange of information under Stock Connect; updated December 2018 to introduce the Northbound Investor ID regime and to provide for regular receipt of securities account numbers/unique IDs for Southbound orders/trades. - Without Southbound Investor ID, Southbound trades are reported under broker IDs of SSE and SZSE subsidiaries, complicating surveillance. - A market surveillance agreement is used currently; an Investor ID regime would be a swifter mechanism. ### Risk, market integrity and stability assessment - The regulatory and supervisory framework for trading systems has been strengthened and better contributes to financial stability. - Key elements for financial-stability-supporting markets: efficient, fair and transparent markets; strong investor protection; transparency; risk monitoring; strong enforcement. - Improved listing supervision contributes to price transparency, fraud reduction and investor protection. - Risk-based supervision of exchanges and ATS plus targeted enforcement promotes fair and efficient markets. - Robust international cooperation is key for monitoring risks and prosecuting misconduct. ### SFC operational approach: “front-loaded” regulation (summary) - Motivation: - Significant rise in misconduct and fraud in the GEM board strained enforcement and prompted a shift in SFC approach. - Elements: - Use supervisory tools traditionally reserved for enforcement (e.g., requests under Section 179 of the SFO) for routine supervision; impose conditions outside licensing; proactive use of subsidiary legislation powers. - Prioritize a few major themes to free enforcement resources for most serious offences. - Communicate changes to market via circulars, supervisory reports and speeches. - Enhance collaboration among licensing, supervision and enforcement functions without structural changes. - Outcomes: - Improved SFC effectiveness, correction of excessive weighting toward small and mid-cap segments, improved public perception. ### Main recommendations (summary) - 1. Consider consolidating requirements for recognized exchange companies into the regulatory framework — Priority: Medium term - 2. Enhance transparency and accountability of the FS consultation framework in relation to approval/withdrawal of recognition of exchanges/clearing houses. — Priority: Medium term - 3. Continue enhancing the surveillance function, particularly through: - (i) finalizing the Southbound Investor ID regime in cooperation with Mainland authorities, and — Priority: (i) Short term - (ii) continuing SFC’s ongoing work on OTC trading to enable the monitoring of those trades, or otherwise address the issue based on overall risks and safeguards. — Priority: (ii) Medium term - 4. The SFC to ensure that HKEX’s program to monitor members’ compliance with its rules continues to be adequate going forward or otherwise needs further improvements. — Priority: Medium term - 5. Expand enforcement powers over recognized exchange companies and clearing houses, and Part III ATS providers. — Priority: Medium term - 6. Continue to deepen cooperation with the CSRC in line with increasing interlinkages with the Mainland. — Priority: Medium/Long term - 7. As part of its work on OTC trading, the SFC is encouraged to consider the potential risks for market integrity of this type of trading and whether there are compelling reasons and sufficient safeguards in place for it to continue to be allowed. — Priority: Medium term ### Market structure and trading venues (detailed) - Most securities trading in Hong Kong takes place through recognized exchange companies. - SEHK is the only recognized securities exchange company in Hong Kong and is wholly owned by the HKEX; HKEX is controller of the Hong Kong Futures Exchange Limited (HKFE). - ATS landscape: - Legislation permits trading through ATS providers; most ATS are brokers operating internal crossing systems (ALPs). - Another ATS category used by overseas exchanges/ATS providers allows direct access to foreign-product trading platforms. - Part III ATS operate more like an exchange or clearing house and are authorized under Part III of the SFO. - Part V ATS provide ATS services incidental to a dealing function and are licensed/registered under Part V of the SFO. ### Market participants and concentration - There are 594 licensed intermediaries who are members of SEHK. - Trading concentration: - Top 14 brokers account for 55 per cent of the total volume of trades. - About 65 members account for more than 90 per cent of the trading volume. ### Stock Connect trading statistics - Shanghai-Hong Kong Stock Connect launched in 2014; Shenzhen-Hong Kong Stock Connect launched in 2016. - Southbound trading reached about 6 per cent of total trading in Hong Kong in 2018. - Northbound trading was about 3 per cent of total trading in the Mainland in 2018. - Stock Connect Average Daily Turnover (RMB bn), Northbound: 2018 20.4; 2017 9.6; 2016 3.3; 2015 6.4; 2014 5.6. Southbound: 2018 10.8; 2017 8.6; 2016 3.2; 2015 2.7; 2014 0.8. ### Regulation, authorization and financial-resources requirements - SFO sections 19 and 59 empower SFC recognition of exchange companies and exchange controllers. - Financial-resources requirements: - For recognized exchange companies in 2015 the SFC requested SEHK and HKFE maintain at all times: - net current assets funded by equity sufficient to cover projected total operating expenses for at least the following six months; and - net current assets funded by equity or long-term loans from HKEX sufficient to cover projected total operating expenses for at least the following 12 months. - According to HKEX’s 2018 Annual Report, SEHK holds approximately HK$ 1,362 million in net current assets and approximately HK$ 2,725 million in net current assets funded by equity or long-term loans from HKEX. - Part V ATS providers with only a Type 7 license must maintain minimum paid-up share capital and liquid capital of HK$5,000,000 and HK$3,000,000 respectively. - Part III ATS generally expected to comply with home-regulator financial resource requirements; they must report material changes in regulatory requirements or material changes in Hong Kong operations. ### Market monitoring, surveillance and member supervision - HKEX duties under SFO and Supervision MoU include ensuring orderly, informed and fair markets; monitoring and controlling risks; overseeing participants; promoting market transparency; cross-market surveillance; and notifying the SFC of serious matters. - Surveillance expectations for ATS providers: - Level of surveillance determined by SFC and varies by ATS nature and risks. - ATS Guidelines require surveillance consistent with Hong Kong and international practices; SFC can set specific surveillance requirements via licensing conditions. - ALP operators expected to have controls to monitor/prevent erroneous or illegal crossings and to conduct regular post-trade reviews. - Pre-trade transparency: - Exchanges required to provide real time best bid and ask quotations and market depth; no pre-trade transparency derogations for recognized exchanges. - No pre-trade transparency requirements for Part V ATS providers; SFC monitors dark pool trading (currently at 1% compared to peak 2.7% in 2013) and may impose pre-trade requirements if dark pool volumes rise to compromise integrity. - Post-trade transparency and reporting timelines: - SEHK direct business: report within 15 minutes after conclusion and in any event before close of trading for same-day transactions; outside trading hours, report within first 15 minutes of next trading session. - For ATS transactions via ALPs, exchange participants required to report immediately and in any case within one minute after conclusion. - SEHK ALP operators must provide SFC monthly reports recording the volume of trades by each of the 10 largest users within 10 business days after month-end or as requested. ### Licensing, authorization and rule approval - SFC may recognize a company as an exchange company if in the interest of the investing public and for proper regulation; SFC may attach conditions and withdraw recognition after consultation with the FS. - Part III ATS authorization typically requires a supervisory MoU with the home regulator and conditions may be imposed; Part V ATS/Type 7 applicants must demonstrate fitness and properness and meet core standards in the ATS Guidelines, with specific conditions set case-by-case. ### Supervision: organization, resources and activities - SOM Division supervises HKEX operations (excluding listing) with about 50 staff; Corporate Finance Division supervises SEHK listing functions with about 36 staff (day-to-day) and around 8 staff (periodic reviews). - SFC on-site inspections of HKEX: - First in 2015 (cash market trading operation), second in 2016-2017 (cash market clearing operation), third started mid-2018 (derivatives trading, clearing, risk management). - HKEX implemented improvements, including enhanced monitoring of members’ compliance and annual self-declarations. - SFC surveillance uses live trading data via HKEX’s NASDAQ SMART system and suspicious transaction reports. - Estimated non-reported OTC trades volume around ten per cent of SEHK trading volume (estimate may be overstated). ### Supervision of Part III and Part V ATS providers - Part III ATS: - Supervised primarily by home regulator; SFC requires MoU and ongoing reporting; SFC can impose new/additional conditions or withdraw authorization but cannot impose monetary penalties on Part III ATS providers or their executives. - Part V ATS: - Supervision more granular and data-driven; SFC conducted data analysis trials in on-site inspections to detect irregularities (order-cycle reviews, dark pool execution price comparisons, timing vs research reports/staff dealings). - Thematic reviews: algorithmic trading review (2015-2016) and ALP review (2016-2017) identified insufficient pre-trade controls and other concerns; follow-ups and circulars issued. - Enforcement outcomes: in past three years, three investigations into ATS provision (ALPs), two resulted in disciplinary actions including reprimands and serious monetary penalties; misconduct had ceased and remedial actions had begun at investigation commencement. ### Reporting, notification and contingency planning - SEHK must submit Listing Rule amendments to the SFC with explanations of purpose and likely effect. - SFC receives daily monitoring, daily/weekly operational statistics, monthly trading systems performance statistics and ad hoc reports for new initiatives; SFC staff have access to live trading data. - Part III ATS must notify SFC of material changes to activities/operations before changes take effect per authorization conditions. - ALP operator reporting obligations include monthly volume reports for top 10 users, prior notification of changes affecting operations/users, notification of breaches, and notification of causes of material delays/failures. - SFC has a market contingency plan and recently conducted an internal exercise reviewing tools for extreme market scenarios. ### Enforcement powers, international cooperation and market risk monitoring - SFC enforcement powers over intermediaries (Part V) include suspension/revocation of license, fines up to HK$10 million or 3 times profit gained/loss avoided, reprimands and prohibitions, and ability to seek undertakings for remedial actions. - SFC signed IOSCO MMoU in 2003 and Enhanced IOSCO MMoU in 2018; has more than 50 bilateral MoUs and cooperation arrangements. - Tri-party MoU with CSRC and Chinese Ministry of Finance for exchange of audit records in enforcement investigations. - Market risk monitoring covers market-wide, segment and entity perspectives and coordinates with HKEX and domestic authorities via standing committees. - SFC monitors order-to-trade ratio, system response time, clearing house exposures, collateral balances, liquidity requirements and financial-status updates from HKEX. ### Conclusions and prioritized recommendations (supervision, reporting, enforcement) - Conclusions: - Significant enhancement of SFC supervision of HKEX since 2014 FSAP, with on-site inspections from 2015 onward. - Listing supervision significantly revamped with more control over approvals, reporting and periodic reviews. - Supervision of Part V ATS providers is more granular and risk-oriented, aided by data analytics and thematic reviews. - Recommendations (selected/prioritized): - Continue improving market surveillance to ensure comprehensive and adequate trading data access; finalize Southbound trading investor ID and engage CSRC for prompt implementation. - Prioritize work on non-reported OTC trading and explore means to collect trading information on OTC trades executed by non-exchange members. - Ensure HKEX implements inspection-driven improvements and maintain close oversight of HKEX member-compliance monitoring; consider adequacy of Rule Enforcement Team and possible increase in member inspections. - Consider expanding SFC enforcement powers over Part III ATS providers and recognized exchange companies/clearing houses, including monetary penalties for for-profit exchanges; pair any extension with review of fine levels in the SFO. - Continue deepening cooperation with CSRC and foreign counterparts to enable surveillance and prosecution of cross-border misconduct. _ People’s Republic of China—Hong Kong SAR, INTERNATIONAL MONETARY FUND_ ### EXECUTIVE SUMMARY __________________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Key findings on market structure and linkages - Hong Kong SAR has become an equity trading hub catering to domestic and foreign investors, including increasingly to investors from Mainland China. - The introduction of Stock Connect in 2014 enabled investors from Hong Kong (including domestic and foreign) to directly invest in the Shanghai and later Shenzhen markets and investors from the Mainland to directly access the Hong Kong market. - Trading via Stock Connect has seen a steady rise over the last few years, increasing the linkages between Hong Kong SAR and the Mainland. - Mainland companies currently account for over 60 per cent of market capitalization of the equities traded on the Stock Exchange of Hong Kong (SEHK). - Most trading is conducted on markets operated by recognized exchange companies, with limited domestic trading happening via automated trading services (ATS) providers in the form of alternative liquidity pools. ### Regulatory and supervisory developments and impacts - The Securities and Futures Commission (SFC) has improved its regulatory and supervisory framework for ATS since the previous FSAP in 2014: - Regulation of intermediaries providing ATS has been revamped with the introduction of guidelines and specific sections in the intermediaries’ code of conduct to consolidate regulatory requirements that previously were mostly imposed via licensing conditions. - The framework is now clearer and more consistent and provides a more level-playing field for different service providers. - Supervision of ATS providers has become more risk–based and granular, with the SFC engaging in more comprehensive data analysis as part of on-site inspections and obtaining a better understanding of firms’ practices via thematic reviews. - Supervision of the operations of recognized exchange companies has been significantly enhanced: - The SFC conducted several on-site inspections of the recognized exchange companies and clearing houses since 2015, focusing on their respective trading and clearing functions and leading to visible improvement in their oversight of members and rules. - Supervision of the listing function of the securities exchange has improved through: - (i) enhancement of SFC’s ongoing oversight of the listing function and periodic reviews, with more in-depth reviews and a more risk-based selection of audit themes; - (ii) a more proactive SFC approach to vetting listing applicants and monitoring major transactions and corporate actions by listed issuers, intervening earlier and focusing on the most serious conducts; and - (iii) a more intrusive approach to supervision of the due diligence role of sponsors of listing applicants. - These enhancements enabled the SFC to more effectively control misconduct such as the misuse of backdoor listing and shell companies. ### Cooperation with Mainland counterpart and cross-border supervision - The SFC has dedicated great efforts to creating a closer work relationship with the China Securities Regulatory Commission (CSRC). - The SFC and the CSRC have stepped up cooperation by entering into a number of agreements on market oversight, supervision and enforcement, and by significantly increasing the frequency of formal and informal exchanges of information, meetings and other joint events. - Regular and deepened cooperation between the SFC and CSRC has improved their understanding of each other’s markets and contributed to greater efficiency in tackling misconduct. ### Risk, market integrity and stability assessment - Overall, the regulatory and supervisory framework for trading systems has been strengthened toward a more solid one that better contributes to financial stability. - Efficient, fair and transparent markets are identified as key to financial stability, with strong investor protection standards, transparency, risk monitoring and strong enforcement being important elements to mitigate systemic risk from erosion of market trust. - Improvements in supervision of the listing function contribute to more transparent markets and better formation of prices, together with a reduction of fraud and better protection of investors. - A more risk-based supervision of exchanges and ATS providers, together with a more targeted enforcement approach, help ensure markets remain fair and efficient. - Robust international cooperation with relevant counterparts is key to ensuring both better monitoring of risks and more efficient prosecution of misconduct. ### SFC operational approach: “front-loaded” regulation (summary of Box 1) - Motivation: - A significant rise in misconduct and fraud in the GEM board led to an overburden of the SFC’s enforcement function and prompted the SFC to shift its approach. - Elements of the front-loaded approach: - Use of supervisory tools traditionally reserved for enforcement (e.g., requests for books and records under Section 179 of the SFO) for regular supervisory purposes; imposition of conditions on corporations outside of licensing to request swift correction of issues; more proactive use of subsidiary legislation powers. - Prioritization of a few major themes to ensure a more effective enforcement program, freeing enforcement resources to deal with the most serious offences. - Open communication of changes to the market via circulars, supervisory reports or speeches to ensure awareness of the SFC’s expectations. - Breaking down silos across the SFC through enhanced collaboration among licensing, supervision and enforcement functions without structural internal changes. - Outcomes: - Clear improvement in SFC effectiveness, correction of excessive weighting toward small and mid-cap segments, and improved public perception of the SFC as a more operational authority. ### Main recommendations (Table 1) - 1. Consider consolidating requirements for recognized exchange companies into the regulatory framework — Priority: Medium term - 2. Enhance transparency and accountability of the FS consultation framework in relation to approval/withdrawal of recognition of exchanges/clearing houses. — Priority: Medium term - 3. Continue enhancing the surveillance function, particularly through: - (i) finalizing the Southbound Investor ID regime in cooperation with Mainland authorities, and — Priority: (i) Short term - (ii) continuing SFC’s ongoing work on OTC trading to enable the monitoring of those trades, or otherwise address the issue based on overall risks and safeguards (see recommendation 7 below). — Priority: (ii) Medium term - 4. The SFC to ensure that HKEX’s program to monitor members’ compliance with its rules continues to be adequate going forward or otherwise needs further improvements. — Priority: Medium term - 5. Expand enforcement powers over recognized exchange companies and clearing houses, and Part III ATS providers. — Priority: Medium term - 6. Continue to deepen cooperation with the CSRC in line with increasing interlinkages with the Mainland. — Priority: Medium/Long term - 7. As part of its work on OTC trading, the SFC is encouraged to consider the potential risks for market integrity of this type of trading and whether there are compelling reasons and sufficient safeguards in place for it to continue to be allowed. — Priority: Medium term *This technical note was prepared by Cristina Cuervo (IMF/MCM). The FSAP mission took place in September 2019. The information in this note is current as of January 2020.* ### 9. Most of the securities trading in Hong Kong takes place through recognized exchange ### 1hkgea2021003 - 9. Most of the securities trading in Hong Kong takes place through recognized exchange ### Market structure and trading venues - Most securities trading in Hong Kong takes place through recognized exchange companies. - The SEHK is the only recognized securities exchange company in Hong Kong and is wholly owned by the HKEX. - The HKEX is controller of the Hong Kong Futures Exchange Limited (HKFE). - Legislation permits trading through ATS providers; most ATS are brokers operating internal crossing systems in the form of alternative liquidity pools (ALPs). - Transactions executed by ALPs accounted for about one per cent of the total turnover of the securities market as of April 2019. - There is another category of ATS used by overseas exchanges and overseas ATS providers to allow direct access to their trading platforms for trading foreign products. - There are currently 43 overseas exchanges and electronic trading facilities authorized by the SFC. ### Mainland issuers in SEHK (listings, market capitalization, turnover) - Mainland companies accounted for 50 per cent of listings, 68 per cent of total market capitalization and 59 per cent of market turnover in 2018. - Out of the US$36.5 billion equity funds raised through IPOs in Hong Kong in 2018, 95 per cent were raised for Mainland companies. - Table 2. Hong Kong SAR: Mainland Issuers in the SEHK - Number of listed companies (end-2018) - Total (Main Board + GEM) 2,315 100% - Mainland companies 1,146 50% - Market capitalisation (end-2018, HK$ bn) - Total (Main Board + GEM) 29,909 100% - Mainland companies 20,193 68% - Market turnover in 2018 (HK$ bn) - Total (Main Board + GEM) 26,423 100% - Mainland companies 15,480 59% - Source: SFC. ### Market participants and concentration - There are 594 licensed intermediaries who are members of SEHK. - Trading is concentrated: the top 14 brokers account for 55 per cent of the total volume of trades. - About 65 members account for more than 90 per cent of the trading volume. ### Stock Connect - Shanghai-Hong Kong Stock Connect launched in 2014; Shenzhen-Hong Kong Stock Connect launched in 2016. - Northbound trading is conducted through SEHK’s subsidiaries in Shanghai and Shenzhen; southbound trading through SSE and SZSE’s subsidiaries in Hong Kong. - In 2018, southbound trading reached about 6 per cent of total trading in Hong Kong. - In 2018, northbound trading was about 3 per cent of total trading in the Mainland. - Table 3. Hong Kong SAR: Stock Connect Trading- Average Daily Turnover (RMB bn) - Northbound: 2018 20.4; 2017 9.6; 2016 3.3; 2015 6.4; 2014 5.6 - Southbound: 2018 10.8; 2017 8.6; 2016 3.2; 2015 2.7; 2014 0.8 - Source: SFC. ### Regulation and authorization of trading systems - The SFO regulates two types of trading systems: recognized exchange companies and ATS providers. - Sections 19 and 59 of the SFO empower the SFC to recognize a company as an exchange company and an exchange controller, respectively. - The SFO regulates two types of ATS: - Part III ATS: those which operate more like an exchange or a clearing house are authorized under Part III of the SFO. - Part V ATS: those where the provision of ATS services is incidental to the performance of a dealing function are licensed or registered under Part V of the SFO. - Any person providing services in Hong Kong by means of electronic facilities (not being facilities provided by a recognized exchange company or a recognized clearing house) to trade in or clear securities or futures contracts will require authorization, registration or licensing as an ATS provider. - Two types of licenses are envisaged by the SFO under Part III and Part V, depending on whether provision of ATS is a core function or incidental to a dealing function. ### ATS Guidelines, Code of Conduct and supervisory approach - The principles, standards and procedures for ATS provision are set out in the Guidelines for the Regulation of Automated Trading Services (ATS Guidelines). The latest version of the ATS Guidelines was published in 2016. - The ATS Guidelines do not have the force of law, but failure to follow their spirit may reflect adversely on fitness and properness for authorization, registration or licensing. - The SFC’s approach to ATS regulation is pragmatic and tailored on a case-by-case basis, taking into account all relevant facts and circumstances. - The Guidelines allow the SFC discretion in setting the intensity of regulation of ATS providers depending on type and risks; in appropriate cases, the level of regulation of an ATS provider can be similar to that of a recognized exchange company. - For Part III ATS providers, the SFC allows regulatory deference once it has assessed the appropriateness/equivalence of the relevant overseas regulatory regime at the time of authorization. - Part V ATS providers are intermediaries licensed or registered to provide ATS (Type 7) regulated activities under Part V of the SFO and are bound by the Code of Conduct for Persons Licensed or Registered with the SFC (Code of Conduct). - Paragraph 18 and Schedule 7 of the Code of Conduct: general principles and specific requirements for licensed or registered persons conducting electronic trading of securities or futures. - Paragraph 19 and Schedule 8 of the Code of Conduct: general principles and specific requirements for licensed or registered persons operating an alternative liquidity pool or routing client orders to an ALP. - Prior to 2015, requirements on Part V ATS providers were imposed via licensing conditions, resulting in inconsistent regulation; paragraphs 18 and 19 and Schedules 7 and 8 to the Code of Conduct codified a uniform set of requirements for ALP operators and persons conducting electronic trading. ### Licensing conditions and transparency - The SFC retains discretion to tailor licensing conditions; licensing conditions are displayed on the public register of the SFC’s website. - When imposing licensing conditions on a Part V ATS provider, the SFC considers particular facts and circumstances, makes reference to conditions imposed on existing licensed ATS providers with similar businesses, and documents reasoning for any variations in internal memos. - Before granting a license, the SFC seeks comments from applicants and provides sufficient time for responses before imposing licensing conditions. ### Financial resources requirements - The SFO does not detail specific financial resources requirements for recognized exchange companies; the SFC determines prudential and capital requirements when granting recognition. - Section 21(1)(b) of the SFO stipulates that recognized exchange companies have to manage risks associated with their business and operations prudently. - In 2015 the SFC determined it was appropriate to impose specific capital requirements and requested that both SEHK and HKFE maintain at all times: - net current assets funded by equity sufficient to cover their projected total operating expenses for at least the following six months; and - net current assets funded by equity or long-term loans from HKEX sufficient to cover their projected total operating expenses for at least the following 12 months. - Similar requirements were imposed for the four recognized clearing houses under HKEX. - According to HKEX’s 2018 Annual Report, SEHK holds approximately HK$ 1,362 million in net current assets and approximately HK$ 2,725 million in net current assets funded by equity or long-term loans from HKEX. - For Part V ATS providers, minimum financial resources requirements are set in the Securities and Futures (Financial Resources) Rules (the Financial Resources Rules). - Section 129 of the SFO requires the SFC to have regard to financial resources and solvency in determining fitness and properness. - ATS providers should have sufficient financial resources for proper performance of operations and obligations and demonstrate resources sufficient to provide services on an on-going and continuous basis. - After licensing, Part V ATS providers must maintain at all times financial resources required under the Financial Resources Rules. - Part V ATS providers with only a Type 7 license must maintain minimum paid-up share capital and liquid capital of HK$5,000,000 and HK$3,000,000 respectively. - For those with more than one license apart from Type 7, the minimum paid-up share capital and liquid capital shall be the highest amount required amongst those licenses. - For Part III ATS, the SFC generally expects compliance with financial resources requirements set by the home regulator; Part III ATS providers must report material changes in regulatory requirements or material changes in their Hong Kong operations. ### Market monitoring, surveillance and member supervision - HKEX duties (per SFO and Supervision MoU) include: - ensure an orderly, informed and fair market for securities or futures traded on markets it operates; - monitor and control risks on any market operated by HKEX or a recognized exchange company; - oversee activities of participants in trading and clearing systems; - promote market transparency by monitoring price and turnover movements on a real-time basis and requiring prompt disclosure of price-sensitive information to the public; - conduct cross-market surveillance and implement appropriate risk management measures and monitor compliance with rules; - notify the SFC of serious matters (e.g., defaults by participants, forced liquidation of open positions of participants, suspension of trading); - notify the SFC of any detected trading malpractices in markets operated by HKEX or a recognized exchange company. - Surveillance expectations for ATS providers: - Level of surveillance determined by the SFC and varies by the nature of the ATS. - ATS Guidelines require surveillance consistent with relevant market regulation practices in Hong Kong and internationally. - Proper surveillance of activities conducted via an ATS should be performed by the ATS provider, a regulatory authority (including potentially the SFC) or another competent person. - Examples where particular surveillance activities are expected include ATS suspending trading in coordination with the primary market or having mechanisms to detect unusual activity that may create a disorderly or unfair operating environment. - The SFC expects all ATS providers to carry out proper surveillance and can set specific surveillance requirements via licensing conditions. - Code of Conduct monitoring requirements for electronic trading and ALP operators: - ALP operators expected to have controls reasonably designed to monitor and prevent crossing of orders that are erroneous or illegal or otherwise interfere with fair and orderly market operation. - ALP operators should regularly conduct post-trade reviews of transactions to identify suspicious market manipulative or abusive activities, market event or system deficiencies or other market misconduct. - Detailed requirements on pre-trade controls and risk management specified for internet trading, DMA providers, and algorithmic traders. - Member access and supervision: - HKEX expected to have objective and transparent member admission criteria and ongoing requirements to enable open and fair access by market participants. - Requirements and application procedures of SEHK and HKFE regarding membership and access must be stipulated in their rules. - All rules and rule amendments of SEHK and HKFE, including those on market access and membership, are subject to review and approval by the SFC. - The Supervision MoU states that HKEX must administer its rules fairly. - SFC expects SEHK and HKFE to have comprehensive rule enforcement programs to oversee members’ compliance with SEHK and HKFE rules. *People’s Republic of China—Hong Kong SAR, INTERNATIONAL MONETARY FUND* ### 25. ATS providers are expected to have objective, risk-based and transparent criteria for ### 1hkgea2021003 - 25. ATS providers are expected to have objective, risk-based and transparent criteria for ### Access and Participation Criteria - ATS providers are expected to have objective, risk-based and transparent criteria for participation, permitting fair and open access. - The ATS Guidelines specify that the criteria and requirements should be monitored and enforced on an on-going basis. - Where continued access by non-qualified users may adversely affect other market participants and the efficiency and integrity of the ATS, monitoring and enforcement are particularly relevant. - As regards ALPs, only qualified investors are permitted to be users of these services and ALP operators are expected to have measures in place to ensure this requirement is met. - ALP operators need to ensure compliance with SFC requirements regarding client identity (including identity, address and contact details of the users of its ALP). ### Dealing with Disorderly Trading Conditions - A recognized exchange controller must ensure orderly, informed and fair markets in securities or futures contracts. - A recognized exchange controller which is a controller of a recognized clearing house must also ensure orderly, fair and expeditious clearing and settlement arrangements for transactions cleared or settled through the facilities of the recognized clearing house. - Under the SFO, exchange controllers must manage risks prudently and: - (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 controller. - The Supervision MoU requires the HKEX to maintain an orderly and fair market by implementing systems to minimize interruption or systemic impact in the event of trading, settlement and operational systems failure. ### System Reliability, Transparency and Controls - ATS providers are expected to set up and maintain electronic facilities to achieve a high degree of reliability, availability and security in respect of their systems, data and networks. - Expectations include: - adequate capacity and contingency arrangements; - appropriate policies, procedures and controls to ensure a high degree of reliability, availability and security at all times; - proper documentation and change management of system software, hardware and network configuration; - sufficient backup and recovery facilities for rapid recovery and resumption of business after a major system disruption. - ATS providers must make available to members/users information on: - how the ATS operates, including systems for order processing and execution; - list of products that may be traded or cleared through the ATS; - rules or other operating requirements; - clearing and settlement arrangements; - margin or collateral requirements; and - all fees and charges. ### Code of Conduct: System Adequacy and Risk Management - The Code of Conduct contains detailed provisions on system adequacy and risk management for electronic trading and ALP operators, including specific requirements on system controls, reliability, security, capacity and contingency plans. - Specific requirements: - a. Internet trading or Direct Market Access (DMA) service providers must ensure all client orders are transmitted to the infrastructure used by the licensed or registered person and are subject to appropriate automated pre-trade risk management controls, as well as regular post-trade monitoring. - b. ALP operators must have controls reasonably designed to monitor and prevent crossing of orders in its ALP which may be erroneous or illegal or interfere with a fair and orderly market; they should also regularly conduct post-trade reviews to identify suspicious market manipulative or abusive activities, market events, system deficiencies or other market misconduct. - c. Algorithmic trading system operators should have controls reasonably designed to ensure the integrity of their algorithmic trading system and that it operates in the interest of market integrity. ### Pre-Trade Transparency - The SFC requires the exchanges to provide appropriate levels of pre-trade transparency on a timely and equitable basis, including real time best bid and ask quotations and market depth. - Market participants can access pre-trade information directly via exchange market data systems or indirectly through information vendors. - No pre-trade transparency derogations are made available to recognized exchanges. - There are no pre-trade transparency requirements for Part V ATS providers; the Code of Conduct does not include any pre-trade transparency requirement for electronic trading services under Part V ATS. - The SFC monitors the level of dark pool trading: - currently at 1% compared to the highest peak in recent years registered at 2.7% in 2013. - The SFC would consider imposing pre-trade transparency requirements should dark pool volumes rise to a level where market integrity could be compromised. ### Post-Trade Transparency and Reporting Timelines - The SFC requires exchanges to provide timely and equitable post-trade transparency including last traded price, day high, day low, closing price and trading volume. - No delay is allowed for post-trade transparency of transactions executed on the HKFE/SEHK. - Reporting obligations for trades executed off-exchange: - a. Pursuant to SEHK rules: - direct business transactions must be reported within 15 minutes after the conclusion of the transaction and in any event before the close of trading for transactions conducted on that day; - for transactions conducted outside trading hours, they shall be reported within the first 15 minutes of the commencement of trading on the next trading session; - for ATS transactions via ALPs, exchange participants are required to report immediately, and in any case within one minute after the conclusion of the transaction. - b. Under the HKFE rules: - a block trade must be negotiated during the trading hours of the block trade contract concerned and be executed immediately on HKATS via the block trade facility; - the time difference between the input of one side of the trade and the input of the other side of the trade must be within five minutes; - any block trade order entered but not matched within the prescribed time period will be cancelled automatically. - Part V ATS providers are required to report trades on instruments traded on the SEHK immediately; SEHK rules require reporting to SEHK immediately and in any case within one minute after conclusion. - ALP operator reporting and disclosure obligations: - ensure transactions required to be reported to SEHK or to any exchange or regulator outside of Hong Kong are properly reported in the manner and within the time limit required; - make regular transaction reports available to users of its ALP concerning transactions conducted on their behalf in the ALP; - provide the SFC with a report recording the volume of trades conducted by each of the 10 largest users of its ALP on a monthly basis within 10 business days after the end of each calendar month or as otherwise requested by the SFC. ### Conclusions and Recommendations (ATS regulation and supervision) - Improvements and observations: - The regulation of ATS providers has been significantly improved via the ATS Guidelines and Code of Conduct. - Part V ATS providers now have more consistent principles and requirements set out in the ATS Guidelines and the Code of Conduct, clarifying expectations and improving transparency and the level-playing field. - The ATS Guidelines now refer specifically to requirements for overseas exchanges or clearing houses to obtain authorization to provide services in Hong Kong, and clarify regulatory implications for ATS providers versus recognized exchange companies. - Regulatory framework assessment: - While mostly principles-based, the regulatory framework for trading systems in Hong Kong is comprehensive and presents no significant enforceability challenges. - The SFO provides high-level requirements for recognized exchange companies, with details provided through regulatory conditions or supervisory actions and MoUs. - Detailed guidance for ATS providers is provided via non-legally binding instruments like the ATS Guidelines and the Code of Conduct. - The SFC's enforcement ability is underpinned by general powers under the SFO and is deemed sufficient for supervisory duties. - Recommendations: - a. The ATS regulatory package provides the SFC with flexibility to ensure adequate supervision of ATS providers in a manner commensurate with their risks. The SFC should continue to ensure the ATS Guidelines are reviewed and updated on a regular basis to remain appropriate and that individual licensing conditions are in line with the baseline set by the Guidelines. - b. The principles-based approach does not hamper adequate supervision of the HKEX in the current context of a single securities exchange and a single futures exchange. However, supervision of multiple trading systems under this regime may prove more challenging; the SFC should consider whether moving towards a more prescriptive approach would be appropriate in the future should market expansion be discussed. In that case, new guidelines or a code of conduct similar to those applicable to ATS may be useful. ### Licensing and Authorization - The SFC may recognize a company as an exchange company if satisfied that doing so is in the interest of the investing public and for the proper regulation of markets. - In considering recognition, the SFC will regard its regulatory objectives and general duties and consult with the FS; it will consider the applicant's capability to carry out statutory duties and the readiness and integrity of trading or clearing systems. - Pursuant to the SFO, the SFC can attach conditions to recognition and can withdraw recognition after consultation with the FS; the consultation process is not legally prescribed and typically involves submission of a letter and meetings as needed. - Authorization/licensing conditions are important in the SFC’s approach to regulating ATS; the SFC exercises discretion at authorization/licensing/registration phases by imposing regulatory conditions. - Part III ATS: - The SFC may grant a Part III ATS authorization subject to conditions. - This regime has been used by foreign exchanges and foreign ATS providers to set up platforms giving access to foreign products. - The SFC assesses whether the ATS provider is properly regulated in its home jurisdiction and comparable to Hong Kong’s regime and normally requires a supervisory MoU with the home regulator. - The ATS Guidelines outline regulatory differences between recognized exchange company and Part III ATS regimes to guide applicants; applicants are expected to engage in early discussions with the SFC. - Part V ATS / Type 7: - Intermediaries can submit an application for a license to provide ATS services (Type 7 regulated activity) as part of their Part V license. - Applicants for Part V license or registration to provide ATS services must demonstrate fitness and propriety as established by the SFO, the Fit and Proper Guidelines and the Guidelines on Competence issued by the SFC. - For obtaining a license or registration to provide ATS services as a Type 7 regulated activity, the ATS Guidelines serve as reference and the SFC expects applicants to meet core standards and principles in the Guidelines. - Given the high-level nature of the Guidelines, the SFC can determine more specific requirements via licensing conditions on a case-by-case basis; the Intermediaries Division consults the Supervision of Markets (SOM) Division when determining particular conditions. ### Supervision: Organization, Resources and Rule Approval - Supervisory organization: - The SOM Division supervises HKEX operations and functions other than listing, including two recognized exchange companies and four recognized clearing houses, with about 50 staff and dedicated teams for trading, clearing and settlement, infrastructure and risk management functions. - The Corporate Finance Division supervises the SEHK’s listing functions with a team of about 36 staff for day-to-day supervision and around 8 staff for periodic reviews. - The SOM Division is responsible for supervising Part III ATS providers; typically 3 to 4 executives form a team to review an ATS authorization application and continue to supervise the same ATS providers after authorization. The ATS supervisory team currently has 8 core members. - Staff resources of the Intermediaries Division conduct on-site review and off-site monitoring of licensed ATS providers, engage with the SOM Division as needed, and can perform joint inspections. - Rule approval and change management: - All rules and amendments of rules of recognized exchange companies must be approved by the SFC before taking effect. - The HKEX engages the SFC at an early stage on proposed initiatives including new market infrastructure, new products, system upgrades and changes to admission criteria. - Depending on nature and impact, the SFC may require detailed assessments, stakeholder consultation, market readiness testing and market rehearsals prior to major initiatives. - The HKEX is required to provide adequate technical support and a fallback plan during initial launches of major system changes. - SFC staff regularly meets with the HKEX to discuss potential rule amendments. *Source: 1hkgea2021003 - 25. ATS providers are expected to have objective, risk-based and transparent criteria for* ### 42. Additionally, the SFC reviews any amendments to the Listing Rules. The SEHK is ### Supervision, Reporting, and Enforcement of HKEX, SEHK, and ATS Providers ### Reporting and Notification Requirements - SEHK must submit to the SFC any amendments to the Listing Rules, together with explanations of their purposes and the likely effect, including their effect on the investing public, in sufficient detail to enable the SFC to decide whether to approve them or not. - Part III ATS providers must notify the SFC of any material changes to their activities and operations in Hong Kong before the changes can take effect; this obligation is imposed via regulatory conditions upon authorization and includes notifying the SFC of the launch of any new products and the admission of any Hong Kong participants as members. - The SFC receives both periodic and ad-hoc reports from the HKEX: - Daily monitoring of the orderly functioning of trading and clearing operations of recognized exchange companies and recognized clearing houses. - Daily and weekly reports on operational statistics relating to trading and clearing of the cash and derivatives markets. - Monthly reports on trading systems performance statistics. - For new initiatives, the SFC may require ad hoc reports to facilitate monitoring of rollout and identify regulatory issues at an early stage. - SFC staff have access to live trading data via the HKEX’s NASDAQ SMART system; the HKEX also submits an end-of-day report including issues (if any) that have affected market operations. - Reporting requirements for Part III ATS providers are imposed through authorization conditions; they are generally required to provide periodic reports on trading and participantship statistics, particularly those relating to Hong Kong participants. - Part V ATS reporting specifics: - Electronic traders should promptly report any material service interruption or other significant issues related to the electronic trading system provided to clients. - ALP operators must provide the SFC with: - (i) a report recording the volume of trades conducted by each of the 10 largest ALP users on a monthly basis; - (ii) notification of any proposed change that may affect the operation of its ALP or its users prior to implementation; - (iii) notification of any breach of any regulatory obligations (by both the ALP and its participants) or the ALP Guidelines upon its occurrence; - (iv) notification of the causes or possible causes of material delay or failure to the operation of its ALP affecting the users of its ALP upon its occurrence; and - (v) any updated review report (e.g. internal audits) concerning its ALP as soon as it becomes available. ### Supervisory Activities — HKEX and SEHK - On-site inspections of the HKEX by the SFC: - First on-site inspection in 2015 (focused on cash market trading operation). - Second inspection in 2016-2017 (cash market clearing operation). - Third inspection started in mid-2018 (trading, clearing and risk management of its derivatives market). - Inspections combine on-site and off-site activities, including interviews and visits; HKEX conducts self-assessments and submits reports prior to inspections. - Preliminary findings are shared with HKEX executives; the SFC follows up on findings and recommendations. Implementation by the HKEX has been generally swift and in line with SFC’s expectations. - Improvements implemented by HKEX following inspections: - Enhanced monitoring of members’ compliance with HKEX’s rules, including an annual self-declaration requested by the Rule Enforcement Team and on-site inspections of members as needed. - Regular meetings: - The SFC holds regular meetings with HKEX’s operating divisions to stay appraised of new initiatives, projects, and issues relating to trading, clearing and risk management operations. - Supervision of listing matters under the Listing MoU (amended March 2018 via First Addendum): - Periodic reviews focus on: (a) whether SEHK is discharging its duties under the SFO (including Listing Rules work and monitoring/enforcement); (b) adequacy of SEHK’s systems, processes, procedures and resources for performing its listing function; and (c) effective management of conflicts of interest within the SEHK as a regulator and as part of a for-profit organization, including supervisory functions performed by the Listing Committee of the SEHK. - The SFC conducts general audits of SEHK operational activities and detailed reviews of selected areas related to market behavior or trends observed in monitoring (review of written policies and procedures, file records of a significant number of selected cases, and interviews). All periodic audit reports are published on the SFC’s website. - Ongoing supervision: SEHK agreed to submit to the SFC (i) a report relating to its responsibilities in listing-related matters on a monthly basis and (ii) any information or report that the SFC may reasonably require within 14 days after the SFC gives written notice. The SFC and the SEHK will hold monthly meetings to discuss matters arising from reports and supervisory issues. ### Market Surveillance - The SFC regularly performs market surveillance of trading activity in the HKEX via the Enforcement Division in collaboration with the SOM Division, reviewing daily live trading data from the exchanges reported through SMARTS and suspicious transaction reports from intermediaries. - A potentially sizeable volume of trades happens over the counter by intermediaries that are not exchange members and are therefore not reported and with no visibility for market surveillance. - The volume of non-reported trades is estimated to be around ten per cent of the SEHK trading volume; this estimate is based on the amount of stamp duty collected on the transfer of shares and includes share transfers as a result of settlement of derivatives products, private placement and gifts. Therefore, the estimate may be overstated. - Southbound trades from the Mainland into Stock Connect are reported under the respective broker ID of the SSE and SZSE subsidiaries, which makes effective market surveillance difficult; the introduction of the Southbound trading investor ID is expected to enhance surveillance of Stock Connect flows. ### Supervision of Part III and Part V ATS Providers - Part III ATS: - Overseas ATS providers authorized under Part III are subject to supervision by their home regulator; the regime is premised on regulation primarily in the home jurisdiction by an authority with comparable standards to the SFC. - At authorization, the SFC generally requires an MOU between the SFC and the ATS provider’s home regulator permitting exchange of supervisory information. - The SOM Division reviews ongoing reporting material and maintains regular contact to follow up on authorization conditions. - If Part III ATS providers fail to comply with authorization conditions, the SFC can impose new or additional conditions or withdraw the authorization; the SFC does not have the ability to impose monetary penalties against Part III ATS providers or their executives. No major breaches of conditions by Part III ATS were noted in the past three years. - Part V ATS: - Supervision of Part V ATS provision by intermediaries licensed or registered under Part V to perform Type 7 regulated activity is carried out as part of routine on-site inspections and has recently become more data-driven. - The SFC has, over the last three years, performed data analysis on a trial basis when conducting routine on-site inspections of brokerage firms engaged in algorithmic trading and dark pool operation, analyzing large volumes of trading-related data to: - (i) review order cycles to spot change of order capacity (e.g. from agency to principal); - (ii) compare dark pool execution price to prevailing bid and ask in the lit market; - (iii) examine timing of transactions compared to issue of research reports and staff dealings. - This approach has enabled identification of irregularities, systemic control deficiencies and instances of non-compliance that would otherwise go undetected; the SFC is working with industry to ensure production of data by firms is adequate to analyze the whole order cycle. - The SFC has conducted thematic reviews: - Algorithmic trading review in 2015-2016 found insufficient pre-trade controls to prevent generation of algorithmic orders that may adversely affect market integrity; SFC issued a circular and followed up with entities. - ALP review in 2016-2017 identified concerns including routing orders to third party ALPs without appropriate disclosure and simultaneous posting to ALP and the exchange; findings and best practices were disclosed and followed up with relevant entities. ### Conclusions, Recommendations, and Enforcement Powers - Conclusions: - The SFC has significantly enhanced its supervision of the HKEX since the previous FSAP, including regular on-site inspections starting in 2015, improving understanding of HKEX operations and identification of areas for improvement. - Supervision of the listing function of SEHK has been significantly revamped, with the SFC exercising more control over approval of new listings, more detailed reporting requirements and a programmatic approach to periodic reviews. - Supervision of Part V ATS providers has become more granular and risk-oriented; thematic reviews and introduction of data analytics have improved supervision and helped identify misconduct that would have otherwise gone undetected. - Recommendations: - The SFC is encouraged to continue improving the market surveillance function to ensure access to comprehensive and adequate trading data. - The introduction of the Southbound trading investor ID will enhance surveillance of Stock Connect flows and the SFC should continue engaging with the CSRC to ensure prompt implementation. - The SFC should prioritize work on non-reported OTC trading and explore avenues to, at a minimum, collect trading information on OTC trades executed by non-exchange members (see related recommendation in paragraph 74). - The SFC should ensure continued follow-up on HKEX’s implementation of inspection-driven improvements, and maintain close oversight of HKEX’s monitoring of members’ compliance with its rules; consider whether the Rule Enforcement Team and the rule enforcement program are sufficient, including possible increases in member inspections. - Enforcement powers and practices: - The SFC can amend or revoke a recognized exchange company’s recognition conditions or withdraw its recognition, but it does not have the power to impose monetary sanctions on recognized exchange companies. - The SFO provides for withdrawal of recognition of an exchange where it fails to comply with any requirement of the SFC or with a condition of recognition (section 28(4) of the SFO); service of a notice of withdrawal can only be done after consultation with the FS. - The SFC can take supervisory actions including approving rules, imposing financial resource requirements, making suspension orders on the functions of the board of directors, a governing body, a director or the CEO, serving restriction notices to amend/supplement/withdraw/revoke rule provisions, and amending/revoking/withdrawing recognition. - For Part III ATS providers, the SFC may impose new/additional conditions or withdraw authorization for non-compliance; it cannot impose monetary penalties against Part III ATS providers or their executives. No regulatory non-compliance relating to the HKEX or recognized exchange companies was noted in the past three years; a number of recommendations were made following on-site inspections (e.g., setting up a Regulatory Compliance Team and a Rule Enforcement Team), and the SFC has generally been satisfied with adequacy and speed of implementation by the HKEX. *People’s Republic of China—Hong Kong SAR, INTERNATIONAL MONETARY FUND* ### Part V ATS ### Part V ATS ### Enforcement and disciplinary actions for Part V ATS providers - The SFC is empowered under the SFO to impose a wide range of disciplinary sanctions against intermediaries, including partial or full suspension or revocation of license or registration, fines, reprimands and prohibitions of applications for license or registration or to become responsible officers, executive officers or relevant individuals. - For serious misconduct, the SFC may suspend or revoke the intermediary’s registration or license for a prescribed period and/or impose a fine of up to HK$10 million or 3 times the profit gained, or loss avoided, whichever is higher. - The SFO allows the SFC to enter into agreements with subjects of a disciplinary procedure to seek undertakings for remedial actions (e.g. payment of compensation to affected investors, commissioning independent reviews). - Recent supervisory outcomes: - Deployment of data analytics for on-site inspection led to investigations into Part V ATS providers. - Examples of misconduct discovered: executed price of crossed trades in one ALP falling beyond the best bid and ask at the prevailing lit market; opaque trading patterns leading to client mis-representation incidents in the equity sales trading business of a licensed firm; retail client orders executed by an ALP provider in violation of the ALP regime. - In the past three years, the SFC conducted three investigations into the provision of ATS (in the form of ALPs), two of which resulted in disciplinary actions, including reprimands and serious monetary penalties. - In all three investigations it was found that the misconduct had ceased, and the ATS providers were taking remedial actions at the commencement of the investigation. ### International cooperation and cross-boundary enforcement - Rationale: - Increased connectivity with overseas markets and the Mainland requires strong international cooperation arrangements to adequately supervise markets and enforce rules. - Hong Kong markets are an important gateway between international investors and the Mainland; Stock Connect has increased Mainland investor access to the Hong Kong stock market and many Chinese companies list on the SEHK. - Multilateral and bilateral arrangements: - The SFC signed the IOSCO Multilateral Memorandum of Understanding (MMoU) in 2003 and the Enhanced IOSCO MMoU in 2018; these channel most enforcement cooperation requests and maintain close liaison with securities regulators worldwide. - The SFC has entered into more than 50 bilateral MoUs and other cooperation arrangements with securities regulators around the world and actively submits and responds to requests from foreign regulators. - Mainland cooperation: - The SFC maintains an active exchange of information with the CSRC and has formed a close partnership to tackle cross-boundary corporate fraud and market manipulation. - For most enforcement requests the SFC and the CSRC actively use the IOSCO MMoU. - The SFC entered into a tri-party MoU with the CSRC and the Chinese Ministry of Finance for exchange of audit records of Chinese companies in enforcement investigations. - The SFC and the CSRC have a number of agreements for market surveillance and enforcement in relation to Stock Connect and conduct regular seminars and both high-level and working-level meetings. ### Stock Connect arrangements and cooperation (Box 2) - Purpose: Stock Connect increased cross-market access and thus the need for arrangements to exchange information for supervision and enforcement. - Key market monitoring and surveillance arrangements: - The SFC signed an MoU with the CSRC in 2014 on exchange of information under Stock Connect to allow requests for detailed information on particular trades, relevant investors and relevant brokers during market monitoring and surveillance. - This MoU was updated in December 2018 with the introduction of the Northbound Investor ID regime; under this regime the CSRC regularly obtains information on Hong Kong intermediaries placing each particular Northbound order/trade and their immediate client. - The updated MoU also provides that the SFC will be able to receive securities account number and corresponding unique identification numbers of Mainland investors in their Southbound orders/trades regularly to facilitate market surveillance. - Without the Southbound Investor ID, all Southbound trades are reported under the respective broker ID of the SSE and SZSE subsidiaries, which makes market surveillance challenging. - The SFC currently uses a market surveillance agreement (the Agreement on the Provision of Information under Mutual Access between the Mainland and Hong Kong Stock Markets) to obtain information; a swifter mechanism like the Investor ID regime would improve the SFC’s market surveillance function. - Emergency communication and enforcement cooperation: - The SFC and the CSRC signed a communication agreement in emergency situations and major events for Stock Connect in 2014 to facilitate prompt communication, including providing market situation reports in times of high volatility with analysis and outlook assessment. - An enforcement cooperation agreement under Stock Connect provides for notification of investigations with cross-boundary elements, provision of investigation assistance and commencement of joint investigations to combat market misconduct where needed. ### Market risk monitoring - SFC monitoring framework: - The SFC monitors market activities and developments from three perspectives: market-wide, by segments and by individual entities. - Market-wide monitoring includes size, performance and volatility, trading, valuation, leverage, capital flow, short selling and short positions, changes in sentiment and currencies, interest rates and commodity prices. - Segment monitoring covers exchange-traded market segments such as futures, options, ETFs, derivative warrants and callable bull/bear contracts, as well as OTC equity derivatives on Hong Kong underlyings. - Entity monitoring focuses on sizes and changes in positions and concentration. - Coordination with HKEX and other authorities: - The SFC keeps close coordination with the HKEX for analysis of market information and monitoring of trading systems; key monitored information includes order-to-trade ratio and system response time. - The HKEX provides regular reports to the SFC on clearing house exposures, collateral balances, liquidity requirements and resources, and updates on financial status to help identify changes in market structure and potential accumulation of risk. - Domestic cross-sectoral cooperation is overseen by the FS and the Financial Services and the Treasury Bureau (FSTB) via standing committees; formal committees include the Financial Stability Committee, the Council of Financial Regulators, the Financial Leaders Forum, and the MPF Intermediaries Regulation Co-ordinating Committee. - Contingency planning: - The SFC has a market contingency plan with guidance on measures and procedures to deal with emergency scenarios, including procedures to contact/consult the FSTB and other market regulators; exercise of certain statutory tools requires consultation with the FS. - The SFC recently conducted an internal exercise to review its available tools for potential extreme market scenarios and discussed deployment implications with other domestic authorities. ### Conclusions and recommendations - Enforcement scope: - While enforcement powers over Part V ATS providers are appropriate, the SFC should consider expanding enforcement powers over Part III ATS providers and the exchanges (recognized exchange companies and clearing houses) so the SFC has not only supervisory but also adequate enforcement powers over these entities. - The ability to impose penalties on recognized exchange companies would assist in achieving credible deterrence; monetary penalties are highlighted as a particularly effective tool for for-profit exchanges, compared with the unlikely practical implementation of withdrawal of recognition. - Any initiative to extend enforcement powers should be paired with a review of the appropriateness of the levels of fines contained in the SFO to ensure sufficient flexibility and commensurateness with the gravity of misconduct. - Enforcement effectiveness: - The SFC has a sound enforcement program and takes prompt action on material concerns; it has specialized on matters considered more serious and improved cooperation among functional departments, notably between the SOM Division and the Intermediaries Division. - The SFC has investigated and taken enforcement action against intermediaries in relation to sponsor activities and provision of ATS, and cooperation with the CSRC has been important for cross-border market abuse investigations. - Surveillance of OTC trading: - To ensure a comprehensive picture of trading activity in Hong Kong, the SFC should consider risks for market integrity of OTC trading carried out by non-exchange members. - Given the estimated size of OTC trading, it could raise investor protection and price transparency concerns; the SFC is encouraged to consider whether there are compelling reasons and sufficient safeguards for OTC trading to continue to be allowed. - Continued cooperation with Mainland and foreign counterparts: - Continued active dialogue and cooperation with the CSRC and other counterparts is key to enable adequate market surveillance and prosecution of fraud and misconduct as connections with the Mainland are likely to continue growing. - The SFC is encouraged to continue deepening its relationship with the CSRC through formal and informal channels to enhance identification of potential risk build-ups. *People’s Republic of China—Hong Kong SAR: Part V ATS* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1hkgea2021003.pdf_