FISD General Meeting in Asia Regulation in a Changing Industry: The Drive Towards Transparency Andrew Sheng Chairman Securities and Futures Commission 23 September 2004 1
What is market transparency? ♦ Timely access to accurate and reliable information is a market fundamental. ♦ In stock market terms, wide and timely availability of both pre-trade and post-trade information, e.g. price, order size, trading volume, should be available to traders and investors. ♦ Ability to identify the beneficial owner depends on The willingness of participants to show; The exchange’s ability to publicly display; and The regulatory requirements to publish trade and order information 2
Why is market transparency important? ♦ Central to both the fairness and efficiency of a market (ie price discovery and market integrity) ♦ The more complete and more widely available is trading information, The more efficient the price discovery process; and The greater the public’s confidence in its fairness ♦ Timely access to trading information allows investors to better look after their own interests, make the right judgment and reduces risks of manipulative or other unfair trading practices 3
Transparency can be a two-edged sword … ♦ Some traders may stay out of the market because they prefer anonymity ♦ Those interested in larger trades may see immediate disclosure as likely to turn the market against them ♦ Appropriate level of transparency in any particular product market is a regulatory question 4
Drivers of market transparency ♦ Globalisation of financial markets (increasing cross-border trading) ♦ Proliferation of electronic order routing and electronic trading platforms ♦ Increasing retail participation in OTC markets ♦ Increasing regulatory requirements on client and beneficial owner identification 5
Securities and Futures Ordinance enshrines market transparency SFC Regulatory objectives: ♦ To maintain and promote its fairness, efficiency, competitiveness, transparency and orderliness; ♦ To promote understanding by the public of its operation and functioning; ♦ To provide protection for members of the public investing in or holding financial products; ♦ To minimize crime and misconduct; ♦ To reduce systemic risks; and ♦ To assist the Financial Secretary in maintaining the financial stability of Hong Kong. 6
IOSCO’s three core objectives of securities regulation includes transparency ♦ The protection of investors ♦ Ensuring that markets are fair, efficient and transparent ♦ The reduction of systemic risk Principle 27: ♦ Regulation should promote the transparency of trading. 7
Global transparency requirements varies ♦ In scope, statutory backing and degree of enforcement ♦ Some jurisdictions (eg Hong Kong) set high-level requirements only and address them primarily through main market operators, i.e. exchanges ♦ Others (eg U.S.) establish broader and more detailed requirements through broker-dealers or their bank equivalents 8
SFC Initiatives on Improving Market Transparency ♦ Dual Filing on IPO Prospectuses ♦ Statutory backing for Listing Rules ♦ Consultation on the regulatory framework for addressing analyst conflicts of interest ♦ Review of the regulatory framework for public offering of securities 9
OTC markets are less transparent … but this is changing ♦ Increasing retail participation in OTC markets (e.g. bond markets) driving need for greater transparency ♦ The International Securities Market Association (ISMA) upgraded TRAX, originally a trade matching system, to enable its subscribers to comply with transaction reporting obligations to regulatory authorities and exchanges ♦ In the U.S., TRACE was launched by NASD to enhance regulatory reporting and market transparency by capturing and disseminating post-trade information on more than 4,200 bonds. 65% of the reported trades are “retail trades” (representing less than 2% of the total value) 10
IOSCO’s recommended core measures to promote transparency in the corporate bond market ♦ Transparency To assess the appropriate level of transparency to facilitate price discovery and market integrity ♦ Regulatory framework To obtain information regarding its characteristics To implement trade reporting requirements To have in place appropriate information gathering and surveillance methods or systems ♦ Consolidation To determine whether there are any impediments to consolidation and whether regulatory action is required, if trading data is not consolidated 11
Transparency alone insufficient for market integrity in fragmented market ♦ In a fully centralized market with a single method of trading (such as Hong Kong), there should be little dispute as to what constitutes best execution Best execution (GP2 of Code of Conduct) - A licensed or registered person when acting for or with clients should execute client orders on the best available terms. Retail and institutional investors are now demanding best execution terms 12
Client Due Diligence process is important to fighting fraud & market abuse ♦ Client Due Diligence (“CDD”) process is today key securities regulatory requirements for control of credit and reputational risks (eg Anti-money laundering, terrorist funding etc) ♦ CDD encompasses: Client and beneficial owner identification and verification Know your client (“KYC”) – obtain adequate information about your client’s circumstances and investment objectives Maintaining records of related data ♦ Should be carried out by authorized securities services providers (“ASSPs”) 13
Recent FATF 40 recommendations 2003 + 8 Special Recommendations on Terrorist Financing ♦ Apply to money laundering + terrorist financing ♦ Enhanced due diligence measures for: Beneficial owner / Omnibus accounts Non-face-to-face transactions Politically exposed persons ♦ Simplified CDD in certain circumstances ♦ Impose specific conditions where third parties reliance is placed ♦ Basic obligations under CDD and keeping of client identity record to be included in law and regulation 14
SFC follows these requirements … Obligations of licensed persons with the SFC: ♦ Client identification GP4 of Code of Conduct - A licensed or registered person should be satisfied on reasonable grounds about: the identity, address and contact details of the person ultimately responsible for originating the transaction; and the person that stands to gain and/or bear risk; and the instruction given by the person ♦ Know your client KYC is an integral part of fair dealing requirements GP4 of Code of Conduct - A licensed or registered person should seek from its clients information about their financial situation, investment experience and investment objectives relevant to the services to be provided. ♦ Record keeping and retention ♦ Customer due diligence and suspicious transactions reporting ♦ Continuous education and training 15
Process automation and global standards can help meet these requirements ♦ Transparency ♦ Best execution ♦ Client identification and verification ♦ Beneficial owner identification ♦ Know your client 16
A shorter settlement cycle? ♦ T+2 settlement in Hong Kong ♦ Time difference with the rest of the world ♦ Efforts to shorten settlement cycle have slowed down ♦ The focus is now on further straight-through processing which requires Further process automation Communication standards harmonization/convergence 17
SFC role in promoting process automation and adoption of global standards 1999 SCEFI REPORT identified process efficiency and global standards key to Hong Kong competitiveness SFC: ♦ Chairs Technical Committee of the IOSCO ♦ Chairs Asia Regional Monitoring Committee of G30 recommendations on clearing and settlement ♦ Member, CPSS-IOSCO Task Force on Recommendations for CCPs ♦ Participates in Financial Stability Forum ♦ Promoting Hong Kong EDGAR (website of websites to allow investor access to market information) 18
FinNet in Hong Kong Standard Internet technolog y ⇒ Interoperability Secure private B2B & G2B network ⇒ e-transactions ⇒ sensitive information exchange Robust & reliable ⇒ Guaranteed uptime ⇒ on-time delivery Single network multiple services ⇒ Convenient ⇒ Low cost ⇒ Facilitate STP 19
G30 Recommendations – Global marketplace should have global norms ♦ We have global markets, but local processes, laws, systems, customs and market practices ♦ For efficiency and robustness, global users and providers of clearing and settlement services anxious for the emergence of global standards ♦ G30 recommendations focus on building a strengthened, interoperable global network; mitigating risk; and, improving governance ♦ Key is to increase safety, reduce investor costs and strengthen market efficiency for international clearance and settlement of securities ♦ Implementation of G30 recommendations adds transparency to the global system 20
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