증권 및 선물 조례에 따른 규제 대상 활동 / Regulated activities under the SFO

8 Regulated activities under the SFO
8.1 This section addresses specific requirements pertaining to the ten types of SFO-regulated activity.

Dealing in securities (Type 1 regulated activity)
8.2 Securities are defined in Schedule 1, SFO, to cover a wide range of instruments, including:
(a) shares, stocks, debentures, loan stocks, funds, bonds or notes;

(b) rights, options or interests in the above instruments;

(c) certificates of interest or participation in, or warrants to subscribe for or purchase, the above instruments;

(d) interests in CISs;

(e) interests, rights or property, whether in the form of instruments or otherwise, commonly known as securities;

(f) interests, rights or property which are prescribed by the Financial Secretary under s. 392, SFO as securities; and

(g) structured products that do not fall within (a) to (f) above but are the subject of an offer to the public which is authorized or required to be authorized under s. 105(1), SFO.

Note: Although not all structured products are regarded as securities under this definition, some will be . see Topic 8 sections 3.27 to 3.31 for a discussion of what is a structured product and when it will fall into this definition.

8.3 The above definition of securities specifically includes derivatives such as options (and implicitly warrants) in respect of underlying shares, stocks, etc.

8.4 “Derivatives” are defined (for the purposes of market misconduct) in s. 245, Part XIII and s. 285, Part XIV, SFO, in relation to listed securities (whether or not the derivatives themselves are listed), to mean:
(a) rights, options or interests in, or in respect of, listed securities;

Note: These are also securities per the definition of securities.

(b) contracts for the purposes of making a profit or avoiding a loss, by reference to the price of listed securities or rights, options or interests in listed securities;

(c) rights, options or interests in respect of (a) or (b); and

(d) instruments or other documents creating, acknowledging or evidencing any of (a) to (c), including certificates of interest or participation in receipts in respect of, or warrants to subscribe for or purchase, listed securities or rights, options or interests in respect of (a) or the contracts in respect of (c).

8.5 Options and warrants are normally considered as derivatives anyway, and it might therefore seem more logical to study them with other derivatives such as futures. However, warrants and options on listed securities are traded on the SEHK and will therefore be studied under the operations of the SEHK, while options on futures contracts which are traded on HKFE will be studied in HKFE section. This is one of the anomalies of the Hong Kong market, contradicting the customary references to the SEHK as the “Cash Market” and HKFE as the “Derivatives Market”.

Definition of dealing in securities (see Schedule 5, SFO, for formal definition)
8.6 A person deals in securities if he makes or offers to make an agreement, or induces or attempts to induce another person to enter into an agreement:
(a) for acquiring, disposing of, subscribing for or underwriting securities; or

(b) for the purpose of making profits from securities.

8.7 Excepted from the definition are:
(a) a recognized stock exchange, clearing house and authorized ATS;

(b) a person dealing in securities as defined above through a licensed securities dealer or registered institution (see Note below, which applies only to this category of persons);

(c) a person acting as principal with certain types of PIs, or in the acquisition, disposal, subscription or underwriting of securities;

(d) the issuing of prospectuses and forms of application for shares with prospectuses;

(e) the issuing of an advertisement or invitation authorized by the SFC;

(f) a trust company registered under the Trustee Ordinance acting for a CIS; and

(g) certain Type 4, Type 6 and Type 9 regulated activities.

Note: Nevertheless, such persons will be regarded as dealing in securities if in return for remuneration they:

(i) communicate agreements or offers as mentioned above from a third person to a securities dealer;

(ii) make such an agreement or offer on behalf of a third person with a securities dealer;

(iii) accept an offer from a third person for a securities dealer; or
(iv) make introductions between a securities dealer and a third person.

Categories of persons licensed or registered for Type 1 regulated activity
8.8 To conclude this initial definition section, the categories of persons conducting Type 1 regulated activity include:
(a) a participant of the SEHK, whether it engages in activities on the SEHK or outside it;

(b) another securities dealer carrying out dealing in securities in Hong Kong;

(c) a licensed representative of the above;

(d) an AFI registered with the SFC for this activity (and its staff who deal with the public and are on a register maintained by the HKMA as engaged in such activity);

(e) a portfolio manager who is licensed (as a securities dealer) for Type 1 regulated activity; and

(f) a securities introducing agent (see section 8.13 below). This list is not exhaustive.

8.9 For clarity, dealing in securities for the purposes of the SFC licensing regime will include dealing in securities traded on the SEHK and other securities, where the activity is conducted in Hong Kong.

8.10 Thus, it is common for larger entities to typically structure themselves to include one or more of the following:
(a) a securities dealing company which transacts the major part of dealing in securities in Hong Kong and elsewhere for the group (Type 1 licence);

(b) a participant of the SEHK through which securities dealing on the SEHK is channelled

by the first company (Type 1 licence);

(c) a participant of HKFE through which dealing in futures contracts on HKFE is channelled by the first company (Type 2 licence);

(d) an asset management company which may manage and/or market and distribute funds (Type 9 licence);

(e) an SMF company which lends money for SMF direct to investors (Type 8 licence); the use of this vehicle is diminishing after the SFC tightened the requirements on SMF;

(f) a finance company which may engage in treasury functions for the group; and

(g) a group holding company.

8.11 The various entities must comply with the regulatory requirements of the SFC regime in accordance with their licences and with the exchange/clearing house rules according to the type of participantship. The exchanges/clearing Houses rules can be very detailed, and it is not proposed to set them out in full in this manual.

Approved introducing agent
8.12 Approved introducing agents form a sub-set of dealers in securities and futures, not defined in the SFO but created under s. 58(4), FRR to cover introducers of securities or futures business to other securities or futures dealers.

8.13 The SFC may approve a licensed corporation as an approved introducing agent if it can satisfy the SFC that it only conducts the business of:
(a) receiving from a client offers for dealings in securities and passing on the offers in the name of the client to an exchange participant, or another licensed dealer; or

(b) introducing a client who wishes to trade in securities to an exchange participant, or another licensed dealer; and

(c) does not handle client assets and incurs no legal liability in respect of the introduced business except for its own negligence, wilful default or fraud.

8.14 In view of the limited risk borne by an approved introducing agent, it is allowed to maintain a lower level of liquid capital and is not required to maintain paid-up capital.

Dealing in futures contracts (Type 2 regulated activity)
8.15 According to Schedule 1, SFO, a futures contract means:
(a) a contract or an option on a contract made under the rules or conventions of a futures market; and

(b) interests, rights or property prescribed by the Financial Secretary under s. 392, SFO as futures contracts; but

(c) does not include interests, rights or property prescribed by the Financial Secretary under

s. 392, SFO as not being regarded as futures contracts.
Definition of a futures market in SFO (Schedule 1, SFO)
8.16 A futures market is defined as a place where facilities are provided for persons to negotiate or conclude sales or purchases of, or for bringing together on a regular basis sellers and purchasers of:
(a) contracts, the effect of which is:

(i) that one party agrees to deliver to the other party at an agreed future time an agreed property, or an agreed quantity of a property, at an agreed price; or

(ii) that the parties will make an adjustment between them at an agreed future time according to whether at that time an agreed property is worth more or less, or an index or other factor stands at a higher or lower level, than a value or level agreed at the time of making of the contract; or

(b) options on such contracts, where:

(i) such contracts or options are novated (see Note below) or guaranteed by a central counterparty under the rules or conventions of the market on which they are traded; or

(ii) the contractual obligations under such contracts or options are normally discharged before the contractual expiry date under such rules or conventions.

The term “future market” excludes the office of a recognized clearing house.
Note: “novation” refers to the legal change of counterparty in a contractual transaction.

Definition of dealing in futures contracts (Schedule 5, SFO)
8.17 A person deals in futures contracts if he:
(a) makes or offers to make an agreement with another person to enter into, acquire or dispose of a futures contract; and

(b) induces or attempts to induce another person to enter into, acquire or dispose of a futures contract.

8.18 Excepted from the definition are:
(a) recognized clearing houses;

(b) persons engaging in the above acts through a person licensed or registered for Type 2 regulated activity or who are registered by the HKMA as so engaged (see Note below, which applies to this category of persons only);

(c) persons acting as principal and who deal with PIs in dealing in futures contracts traded otherwise than on a recognized futures market;

(d) persons engaged in the above acts only on markets referred to in specified sections of the Commodity Exchanges (Prohibition) Ordinance;

(e) persons who are members of a commodity exchange in operation on 20 June 1973, and only perform the above acts on such an exchange.

(f) licensees for Type 9 regulated activity who engage in such activities solely for the purposes of the Type 9 regulated activity; and

(g) persons entering into market contracts.

Note: Nevertheless, such persons will be regarded as dealing in futures contracts if, in return for remuneration, they:

(a) communicate offers or invitations to enter into futures contracts from a third person to the futures dealer;

(b) effect an acquisition or disposal of a futures contract for a third person through a futures dealer;

(c) make an offer for a futures dealer to a third person to acquire or dispose of futures contracts;

(d) accept for a futures dealer an offer by a third person to acquire or dispose of futures contracts; or

(e) make introductions between a futures dealer or his representative and a third person so that the third person may engage in futures contracts dealing.

Leveraged foreign exchange trading (Type 3 regulated activity)
Foreign Exchange Trading
8.19 Foreign exchange trading relates to a contract or arrangement, where one person undertakes to:
(a) exchange currency with another person;

(b) deliver foreign currency to another person; or

(c) credit the account of another person with foreign currency.

8.20 The act of entering into, or offering to enter into, or inducing or attempting to induce a person to enter into such a contract is defined to be foreign exchange trading (Schedule 5, SFO).

8.21 LFET is a subset of foreign exchange trading as it relates only to trading in LFE contracts (see below).

LFE contract
8.22 An LFE contract is a contract or arrangement the effect of which is that one party agrees or undertakes to:
(a) make an adjustment between himself and another person according to whether a currency is worth more or less than another currency;

(b) pay an amount of money or to deliver a quantity of any commodity determined by reference to the change in the value of a currency in relation to another currency to another person; or

(c) deliver to another person at an agreed future time an agreed amount of currency at an agreed consideration (Schedule 5, SFO).

8.23 Basically, on value date, settlement of the contract may be deferred indefinitely until:
(a) the client agrees to take physical delivery; or

(b) enters into a netting contract with the result that the obligation under the original contract becomes one of net settlement.

8.24 The contract is not executed on an exchange.

LFET
8.25 LFET means the act of trading in LFE contracts on a discretionary basis or otherwise, or the act of providing financial accommodation to do so (Schedule 5, SFO gives a full definition).

Exempted transactions and persons
8.26 There are a large number of exemptions to the definition of LFET in Schedule 5, SFO. Examples include:
(a) transactions by an AFI or a central bank;

(b) exchange transactions under the Money Changers Ordinance (Cap 34); and

(c) transactions executed on a stock exchange or a futures exchange by or through a person who is licensed for Type 1 and Type 2 regulated activities respectively or wholly incidental to such transactions, etc.

Market Intermediaries
LFE traders
8.27 Corporations that wish to undertake LFET must apply for and obtain Type 3 licences from the SFC. Persons exempted from obtaining licences are those who carry out exempted transactions.

Approved Introducing agents
8.28 These act merely as introducers, passing on clients’ orders to other traders. They do not hold or control client assets or handle discretionary accounts. They are consequently allowed to have lower capital requirements than full LFE traders. Nevertheless, they must hold Type 3 licences as well.

Recognized counterparties
8.29 A recognized counterparty means (Schedule 1, SFO):
(a) an AFI;

(b) in relation to a particular transaction conducted by a Type 3 licensee, another such licensee with whom it conducts the transaction; or

(c) an institution that has been recognized as such by the SFC (s. 397, SFO gives the SFC the power to do this).

8.30 Recognized counterparties are generally substantial institutions who may be licensed LFE traders or exempted as indicated above. Transactions carried out by LFE traders with recognized counterparties are given special treatment, e.g. the latter will not be considered clients of the LFE traders.

AFIs
8.31 These are regulated by the HKMA and carry out large volumes of interbank foreign exchange business and deal in foreign exchange trading generally for a wide range of customers, as well as LFET for retail clients. They have been exempted from the SFC’s licensing requirements and have been outside its jurisdiction from the inception of the SFC’s LFET regulatory regime. They continue to be exempted under the SFO.

Arbitration
8.32 Section 118(1)(b), SFO specifies that it is a condition of granting a licence for carrying on LFET that, if a client requires a dispute between himself and the licensed trader about any matter concerning the carrying on of LFET to be settled by arbitration, the licensed trader is obliged to have it so settled.

8.33 The SFC has made arbitration rules, the Securities and Futures (Leveraged Foreign Exchange Trading) (Arbitration) Rules under its rule-making powers. These rules prescribe the procedures for the settlement of disputes by arbitration, including the constitution of the Arbitration Panel, the selection of an arbitrator from the panel to hear a dispute, and the rules relating to the arbitration proceedings, their termination and the making of awards.

Advising on securities and futures contracts (Type 4 and Type 5 regulated activities)
8.34 There are two activities defined in Schedule 5, SFO as constituting advising on securities or futures contracts. They are:
(a) the giving of advice; or

(b) the issuing of analyses or reports, for the purposes of facilitating the recipients to make decisions on the acquisition or disposal of securities or entering into futures contracts.

8.35 They include advice or decision on:
(a) whether;

(b) which;

(c) the time at which; or

(d) the terms or conditions on which

securities/futures contracts are/should be acquired or disposed of/entered into. However, the advice that falls within the meaning of “advising on corporate finance” or “providing credit rating services” is excluded.

8.36 Persons holding licences to advise on securities and futures contracts are comparable in number to dealers in securities and futures contracts, so they form a significant group.

8.37 Persons exempted from requiring a licence to advise on securities and futures contracts generally include:
(a) solicitors, counsel, professional accountants, trust companies and persons licensed to carry out asset management who give such advice wholly incidental to their professions;

(b) financial journalists and broadcasters who give investment advice or issue analyses or reports on investments to the public on subscription or otherwise;

(c) corporations giving such advice or issuing such analyses or reports solely to their wholly owned subsidiaries or holding companies holding all their issued shares or other wholly owned subsidiaries of the holding company;

(d) persons licensed to deal in securities and give such advice wholly incidental to the carrying on of such dealing activity; and

(e) persons licensed to deal in futures contracts and give such advice wholly incidental to the carrying on of such dealing activity.

Advising on corporate finance (Type 6 regulated activity)
8.38 In this section, we consider the regulations applicable to the regulated activity of advising on corporate finance, which means, according to Schedule 5, SFO, giving advice:
(a) concerning compliance with or regarding rules made under s. 23, SFO (by a recognized exchange company, effectively the SEHK) or s. 36, SFO (by the SFC) in respect of the listing of securities and codes issued by the SFC regarding takeovers, mergers and share repurchases;

(b) concerning offers to dispose of securities to or acquire them from the public;

(c) concerning the acceptance of such offers insofar as the advice is given to holders of such securities or a class of such securities; or

(d) to a listed corporation or public company (or its subsidiaries, officers or shareholders) regarding corporate restructuring in respect of securities.

8.39 Persons advising on corporate finance are required to obtain a licence from the SFC. The regulatory aspects of corporate finance activities in Hong Kong are mainly covered in the SFO, the CO, the Listing Rules and The Codes on Takeovers and Mergers and Share Repurchases issued by the SFC.

8.40 The analysis in this manual will be limited to the Listing Rules and The Codes on Takeovers and Mergers and Share Repurchases. The Listing Rules are administered by the SEHK under the overall supervision of the SFC and the two codes are administered directly by the SFC.
The Listing Rules and the two codes will be touched upon in later sections. The activities of the SFC and its related Committees, Panels and Tribunals, including those relevant to corporate finance advising, were referred to in section 3 of Topic 1.

Providing automated trading services (Type 7 regulated activity)
8.41 ATS in Hong Kong are used to describe any automated system that provides, by means of electronic facilities, a trading mechanism for securities and futures contracts other than the operations of a recognized exchange company or a recognized clearing house (at the moment this would only cover the SEHK, HKFE and their related clearing houses). The services provided include, for example:
(a) trade confirmation and matching systems provided by brokers; and

(b) full trading and settlement systems for non-local securities.

References to ATS in the SFO
8.42 The provision of ATS is covered in two places in the SFO. First, a person may be authorized under s. 95(2), SFO to provide ATS similar to the services provided by a recognized exchange or recognized clearing house.

8.43 Second, a person may be licensed, or in the case of an AFI, may be registered to provide ATS as a regulated activity, under Part V, SFO. In these cases, all the provisions of the SFO and subsidiary legislation, codes and guidelines applicable to licensed persons and registered persons will apply as appropriate.

Securities margin financing (Type 8 regulated activity)
Definition of SMF
8.44 SMF is defined in Schedule 5, SFO as the provision of financial accommodation in order to facilitate:
(a) the acquisition of securities listed on any stock market, whether in Hong Kong or elsewhere; and

(b) (where applicable) the continued holding of such securities;

whether or not those securities are pledged as security for the accommodation.
8.45 Excepted is the provision of such accommodation:
(a) for underwriting, sub-underwriting and acquisition under a prospectus;

(b) by a Type 1 licensee to enable the licensee to engage in SMF for his clients;

(c) by a CIS, which is a corporation specified in the SFO, to finance investment in the CIS it issues;

(d)
by an AFI to facilitate acquisitions or holdings of securities by its clients;

(e) by an individual to a company in which he holds more than 10% of its issued share capital, to facilitate SMF; or

(f) by an intermediary who effects an introduction between a person and the intermediary’s related corporation to enable the corporation to provide SMF to that person.

Special conduct requirements for SMF
8.46 Standards of business practice expected by the SFC of securities margin financiers, dealers conducting SMF and their representatives are principally stated in the Code of Conduct (including Schedule 5) and the Contract Notes Rules, and include the following:
(a) vetting the credit-worthiness of clients; setting margin lending limits, lending ratios, and margin call policies and procedures;

(b) prudent risk management and internal controls, including limits on borrowing from banks against SMF clients’ securities collateral, and the setting of controls on the use of clients’ securities collateral, and on concentration of exposure to clients’ and to securities collateral;

(c) efficient monitoring through ongoing management reports showing material client loan balances, details of collateral held, margin ratios and loan balances which are at risk because of concentrations of exposure to securities collateral;

(d) disclosure to clients of the status of their accounts in contract notes and statements of account as required by the Contract Notes Rules, e.g.

(i) an indication in the contract notes and monthly statements of account that the client’s account is a margin account;

(ii) the disclosure in all statements of account of details of all financial accommodation provided to the client, including the nature, credit limit and expiry date of the accommodation, and the basis of interest calculations; and the quantity, market value, margin value and margin ratio of securities collateral held at the end of the day or month, etc.; and

(e) segregation of margin and cash client accounts.

8.47 The securities margin financier may allow a client to draw against his margin account to facilitate the continued holding of securities acquired under the margin account. However, it must be noted that the securities margin financier is subject to the sole business requirement and can only provide financial accommodation for facilitating the acquisition and continued holding of listed securities. Any advance in excess of the realizable value of the securities collateral would generally fall outside the above scope.

Clients’ securities and clients’ authorizations
8.48 As discussed in section 3 above, securities dealers and securities margin financiers must observe the Client Securities Rules in the treatment of client securities and securities collaterals, including obtaining clients’ written authorization before they can re-pledge client securities collaterals.

8.49 Pooling of client securities is permitted but securities dealers and securities margin financiers are only permitted to deal with the client’s securities in a limited number of ways pursuant to the Client Securities Rules, and subject to the client’s written authorization.

Margin agreements
8.50 A licensed corporation must not start trading on margin for a client before entering into a clear, written margin client agreement with the client. The client agreement must be prepared in a language understood by the client with a clear risk disclosure statement. A licensee should ensure that the client understands the terms and conditions of the margin account, such as:
(a) how the interest on the margin loan is calculated;

(b) when and how the loan must be repaid;

(c)
usage of collateral permitted by client’s authorization;

(d) the permitted loan limit and lending ratio, and whether there are different lending ratios

for different types of securities;

(e) the margin call procedures, e.g. when a margin call will be made, the consequences of failing to meet a call; and

(f) what notice, if any, the securities margin financier will give to the client before selling client securities collaterals to cover a margin deficiency.

Re-pledging clients’ securities collateral
8.51 There are additional requirements for securities dealers and securities margin financiers licensed for Type 8 regulated activity that re-pledge clients’ securities collateral:
(a) a limit of 140% on re-pledging client securities collateral;

(b) certain changes to relevant haircut percentages; and

(c) requirements for additional disclosures to margin clients about the risks of pooling and pledging.

Asset management (Type 9 regulated activity)
8.52 The principal ordinances applicable to the asset management industry are the SFO, the Mandatory Provident Fund Schemes Ordinance (“MPFSO”), the Occupational Retirement Schemes Ordinance (“ORSO”), the Insurance Companies Ordinance and, to a lesser extent, the Banking Ordinance, the Employment Ordinance, the Inland Revenue Ordinance and the Trustee Ordinance.

Definition of asset management
8.53 Under Schedule 5, SFO, “asset management” means:
(a) real estate investment scheme management; or

(b) securities or futures contracts management.

8.54 “Real estate investment scheme management”, in relation to a person, means providing a service of operating a CIS for another person by the person, where:
(a) the property that is being managed under the scheme consists primarily of immovable property; and

(b) the scheme is authorized under s. 104, SFO.

“Securities or futures contracts management” in relation to a person means providing a service of managing a portfolio of securities or futures contracts for another person by the person otherwise than certain excluded persons.
8.55 Before leaving the definition of asset management, note that it speaks of managing “securities”, which specifically includes interests in any CIS; but does not include any interest in a CIS that is:
(a) a registered Mandatory Provident Fund scheme under the MPFSO or its constituent fund;

(b) an occupational retirement scheme under the ORSO; or

(c) a contract of insurance in relation to any class of insurance business under the Insurance Companies Ordinance.

8.56 The functions of the SFC in relation to asset management are two-pronged:
(a) it authorizes CISs, including, for example, unit trusts, managed funds and retirement

schemes, and supervises the marketing of these CISs, and

(b) it licenses and supervises intermediaries engaged in asset management (Type 9 regulated activity) as well as others engaged in providing advisory services in the industry (Type 4 and Type 5 regulated activities); if they choose to be licensed as dealing in securities and/or futures contracts (Type 1 and/or Type 2 regulated activities), the respective regulatory regime will be applied to them.

The first of these functions is derived from Part IV, SFO and the second from Part V, SFO.

Providing credit rating services (Type 10 regulated activity)
Definitions of credit ratings and providing credit rating services
8.57 Schedule 5, SFO provides definitions for what constitute “credit ratings” and also what constitute “providing credit rating services”. It is important to understand the scope of both terms.

8.58 “Credit ratings” is defined as “opinions, expressed using a defined ranking system, primarily regarding the creditworthiness of:
(a) a person other than an individual;

(b) debt securities;

(c) preferred securities; or

(d) an agreement to provide credit”.

Note: “Debt securities” is defined as “debenture stocks, loan stocks, debentures, bonds, notes, indexed bonds, convertible debt securities, bonds with warrants, non-interest bearing debt securities, and other securities or instruments acknowledging, evidencing or creating indebtedness”. “Preferred securities” is defined as “preference shares, preferred shares or preferred stock”.

8.59 “Providing credit rating services” is defined as “preparing credit ratings for:
(a) dissemination to the public, whether in Hong Kong or elsewhere, or with a reasonable expectation that they will be so disseminated; or

(b) distribution by subscription, whether in Hong Kong or elsewhere, or with a reasonable expectation that they will be so distributed.”

Excluded activities
8.60 The SFO specifically excludes from the definition of providing credit rating services the following activities:
(a) “preparing, pursuant to a request made by a person, a credit rating which is exclusively prepared for, and provided to, the person and that is neither intended for dissemination to the public or distribution by subscription, whether in Hong Kong or elsewhere, nor reasonably expected to be so disseminated or distributed; or

(b) gathering, collating, disseminating or distributing information concerning the indebtedness or credit history of any person.”

Accordingly, a person engaging in any of the activities mentioned in (a) and (b) above does not need to be licensed or registered as a result only of those activities. It should be noted this is not an exemption: if a person also conducts other activities falling into the definition of “providing credit rating services”, then a licensing or registration requirement would arise in respect of those regulated activities. Examples of activities that would not incur a requirement to be licensed or registered include: (i) a firm that prepares credit ratings for its internal use, such as a bank might do when assessing counterparty risk, and (ii) consumer credit reference agencies that prepare opinions regarding the creditworthiness of individuals.

Note: The SFC has posted on its website a section on “Frequently Asked Questions” as practical guidance to the licensing requirements for CRAs.

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