T he US subprime crisis shone a spotlight on opaque markets that operate in the shadow of regulated markets. The failure of Lehman Brothers was a wake-up call to the reality that financial institutions operate globally, while regulation stops at national borders. The financial tsunami that Lehman's failure unleashed sparked an international debate on the fundamental role of financial institutions and calls for a return to basics. The G20 Leaders promptly initiated global financial reforms that go beyond traditional boundaries of regulation. There is a new focus on systemic risk, macro-prudential regulation and international cooperation, and more intrusive micro-prudential regulation.

Hong Kong's securities market is global, it has a vibrant domestic dimension, and it is plugged into the Chinese mainland. Hong Kong's investor profile is split almost evenly between Hong Kong and international investors. Two-thirds of investors are institutional; retail investors are significant, representing about one quarter of investors. Funds from non-Hong Kong investors account for more than 60 percent of the Hong Kong asset management business. International brokers operate alongside a large pool of local stockbrokers to serve their respective clients. Getting the regulatory balance that suits the needs of global and domestic players is a challenge.

The collapse of Lehman Brothers affected many investors in Hong Kong who had invested in structured products linked to Lehman group entities, or where Lehman group entities were counterparties to transactions underpinning the products. The Hong Kong Monetary Authority and the Securities and Futures Commission (SFC) received tens of thousands of complaints, the most common of which was about misrepresentation, complexity and suitability of the structured products.

SFC's reforms after global financial crisis

The SFC investigated the complaints of investors on the selling practices of the intermediaries, took appropriate enforcement action, and introduced necessary reforms to enhance the protection of investors. Reforms include enhancing the disclosure requirements for investment products, fine-tuning the conduct requirements of intermediaries regarding the sales process, and introducing a new structured products code.

As a member of the Financial Stability Board, Hong Kong is committed to implement the G20 financial reforms. The SFC's engagement in international work increased considerably as a result of the work of International Organization of Securities Commissions (IOSCO), the international standards setter for securities regulation, and the G20 reforms. As part of global reforms, the SFC introduced a new Type 10 regulated activity, for credit rating agencies. A new regulatory regime for the over-the-counter (OTC) derivatives market in Hong Kong is in the pipeline, which will require certain specified OTC derivatives to be centrally cleared, or to be reported to a trade repository. On its own initiative, the SFC introduced a short position reporting regime, to monitor more closely short selling activities, and increase market transparency through the publication of aggregate short positions of individual stocks.

Beyond global reforms and managing the impact of Lehman on Hong Kong investors, the SFC has stepped up its day-to-day regulation and enforcement, market facilitation and investor education to meet the challenges and expectations of the market place. On regulation, the initiatives include strengthening the sponsorship regime, a statutory regime for the disclosure of Price Sensitive Information, the institution of direct proceedings by the SFC before the Market Misconduct Tribunal, and implementing a scripless securities regime.

Enforcement action has been significantly strengthened over the years, and since 2007 there are more cases involving novel or complex regulatory policies, legal issues, or innovative solutions. The SFC has had a number of successful convictions for insider dealing, sending a powerful deterrent to those who may be tempted to defraud the market. We have also commenced a number of civil cases to secure remedial outcomes from perpetrators of fraud and misconduct.

An important aspect of market facilitation is cooperation with the mainland, which has enabled Hong Kong to play its unique role as the platform for the mainland's "going-out" strategy and as the proxy for the mainland market. The SFC has also been active in facilitating the flow of qualified personnel between the mainland and Hong Kong, and in providing opportunity to the subsidiaries of mainland financial institutions to operate and experience the market dynamics and market conduct in Hong Kong. Other recent initiatives include the introduction of RMB products between the two markets and working with the HKEx on streamlining regulation relating to other overseas companies seeking new listing in Hong Kong.

Investor education is an important regulatory tool for empowering the investor with the basic knowledge of products and risks, and of their own rights and responsibilities. The SFC has deployed multiple means and channels to educate investors, including outreach to different segments of the community. The establishment of the Investor Education Centre will provide a holistic investor education body covering the entire financial services sector.

Technological advancement has enabled the rapid expansion of trading venues other than the traditional stock exchange platform, such as dark pools and alternative trading systems, dramatically improved the speed, capacity, and sophistication of trading functions, and allowed customers direct access to markets. Currently, such activities are prevalent in the US and Europe, but are not significant in Hong Kong. This development has sparked international debate on the potential impact on fragmentation of liquidity, price discovery, orderly markets and fair treatment of investors. Separately, the SFC has just finished consulting the market on the regulation of electronic trading, which encompasses Internet trading, direct market access and algorithmic trading, with the objective to provide clarity on internal control and risk management of electronic trading.

Looking ahead

The global and domestic financial reforms will revamp the tool-kit of regulators. Regulators will need to re-equip themselves with the necessary capacity and skill sets, to effectively utilize these new regulatory powers amidst the sea of change. Regulation will have to take on a more holistic approach, with greater coordination and cooperation among regulators, including on a cross-border basis.

Equally important is the need to maintain open channels of communication with stakeholders for the exchange of views and feedback. Engaging market participants on emerging market trends and developments that may be of regulatory concern would help to enhance the effectiveness of regulation for the maintenance of fair, orderly and efficient markets.

The SFC is cognizant of the challenges that lie ahead for Hong Kong, and constantly reviews its resource requirements to cope with existing and new demands, which are likely to grow in a rapidly changing market place.

Recruitment of talent from Hong Kong and overseas would help to provide market insights and an international perspective to our work. It is important that the SFC is sufficiently and appropriately resourced to effectively discharge its functions and achieve its regulatory objectives.

The SFC will continue to remain vigilant in the regulation of the securities and futures market in Hong Kong and adopt or adapt its regulatory regime, as appropriate, to maintain investor confidence and trust in the Hong Kong market.

The author is chairman of the Securities and Futures Commission.

(HK Edition 10/12/2012 page4)