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SFC BULLETIN
ISSUE NO. 43
A bi-monthly communication between the SFC and intermediaries about
regulatory developments and practice NOVEMBER 2007
Introduction
Highlights This is the second issue of the new look SFC Bulletin. We hope that you have
found our new focus on regulatory development and practice relevant and useful.
Market welcomes Development of Hong Kong as a Financial Centre
changes to regime on
futures and options There have been two significant trends playing out in the financial markets over the
last year which may have significant long term implications for Hong Kong. One
position limits
has been competition between financial centres – between New York and London,
Flexible approach to between London and other European centres, between Hong Kong and Singapore,
Dubai and Qatar, etc. The competition is for the honour of being named the
investment management
leading International Financial Centre in the time-zone or even the global leader.
delegation It stems from a growing belief that there will only be a few winners – and this
Facilitating growth of will have significant impact on those countries’ GDP, tax revenue, etc., but also,
inevitably that there will be losers in the process. Everyone wants to be a winner
fund management
and hence the numerous surveys and consultancy reports aimed at distilling the
industry in the Mainland magic essence of what it takes to be a winner as an IFC.
and Hong Kong
Whatever the formula, the winners ultimately have more jobs, higher office rentals
First 130/30 UCITS III
and greater innovation in financial products and services. This brings with it a
fund authorised twist. The other great theme that has engulfed markets this summer is the high
price of financial innovation when it goes wrong, and the global effect of that. We
More observations on
are still seeing the repercussions of the sub-prime fallout in the US – it continues
sponsors' due diligence to reverberate around the world’s financial markets in ways that had not been
in IPO applications foreseen.
So while the need to innovate and compete brings benefits for those financial
centres, it brings risks as well. We want more companies to use our markets for
capital raising – but not at the cost of reducing protection for investors. We want
new and innovative products but want to avoid introducing unpredictable risks.
We want more hedge funds to choose our city to operate from but fear the effect of
rapid international capital flows.
As a regulator, our job is to balance the desire for growth in products and services
with the need to maintain quality and, ultimately, protect investors. It should be
that the two go hand in hand – but that is not always the case.
The securitisation of risk, which allowed the mortgage backed market to develop
and hence, ultimately has allowed the sub-prime market to grow, has delivered
SFC Bulletin November 2007 1
some benefits. It has allowed for a dispersal of risk, generally (though as we now see, not entirely) off the balance sheets
of banks to institutions that have been hungry for more risk. Often these have been hedge funds. The positive side of this
development has meant that risk in a broad range of instruments is widely shared and not concentrated in a single institution.
The bad side is that the holder of risk is so far away from the originator, and the instruments so complex, that he no longer
really understands how risky the product is and relies on somebody else’s credit rating which we now see was never really
designed for this purpose.
In this bulletin we highlight some of the changes that we have introduced to facilitate the growth of the market, bearing in the
mind the need for protection and stability. We have increased the size of the positions that Exchange Participants and their
clients can take in the derivatives market – but we have not abandoned the limits completely. We have streamlined some
of our licensing processes and we are very focused on the opportunities for the fund management industry that CEPA IV
represents – we will work hard to maximise the benefits. We have recently authorised a newer style of UCITS III fund which
can provide greater market exposure – but we have asked for a greater amount of disclosure as well.
This bulletin is intended to be a channel to enhance our communication with intermediaries and market practitioners. Please
send your comments and feedback to sfcbulletin@sfc.hk.
Changes to Position Limits to Promote Market Growth
In May 2007 we published a consultation paper on the proposed amendments to the position limits regime. This will enable
us to authorise Exchange Participants, or their affiliates, to exceed the statutory position limits for Hang Seng Index and H-share
Index futures and options contacts, by up to 50%, if required to serve their clients’ needs.
We have recently published the consultation conclusions. Respondents were largely supportive of the proposals although
many suggested that the regime be relaxed further which we do not consider to be advisable at this time, and we have agreed
to make certain other changes in light of the comments received. These include measures that will enable future adjustments
of the 50% upper limit to be made within a shorter time period and greater flexibility for positions held by group companies.
There will also be clarifications on how practitioners may apply to exceed the limits.
The changes to the Securities and Futures (Contracts Limits and Reportable Positions) Rules were gazetted on 26 October
and, subject to the Legislative Council’s negative vetting procedure, are expected to come into effect in December this year. A
further announcement will be made nearer the time. Corresponding changes will be made to our Guidance Note on Position
Limits and Large Open Position Reporting Requirements.
For more information, please follow this link to the consultation conclusions.
More Flexible Delegation of Investment Management Functions
We have recently introduced greater flexibility for managers of authorised funds to delegate their investment management
functions overseas.
For SFC-authorised funds, the investment management operations of the fund management company or those of the
investment delegates should be based in Hong Kong or an Acceptable Inspection Regime (AIR). Applications for delegation of
investment management functions to non-AIR jurisdictions have been considered on a case-by-case and exceptional basis.
SFC Bulletin November 2007 2
In response to the globalisation of fund management firms and the growing trend for fund houses to set up local affiliates close
to the markets they invest in, we have taken a flexible approach in allowing non–AIR delegation by managers of authorised
funds. Guidelines have been issued to fund management companies of SFC-authorised funds to explain the details.
It is expected that international fund houses will benefit from the greater flexibility in this enhanced approach. This in turn will
benefit investors owing to the greater selection of funds managed by experts who are close to the markets in which the funds
invest.
The circular and some FAQs are available on the SFC website under “Intermediaries, Licensing and Investment Products” –
“Investment Products Related Matters” – “Circulars” and “FAQs” respectively.
If you would like to discuss any planned delegation to non-AIR jurisdictions, please contact the Investment Products
Department.
Facilitating Growth of the Fund Management Industry in the
Mainland and Hong Kong
On 11 September 2007, a high-level seminar was organised in Hong Kong for senior representatives from 30 of Mainland’s
largest fund management and securities companies. This was held to support the CEPA IV arrangements which enable
Mainland asset managers to come to Hong Kong to operate, and to discuss how Hong Kong’s expertise can help them package
their investment products.
The Mainland delegation was led by Mr Gui Minjie, Vice Chairman of the China Securities Regulatory Commission. The
delegation exchanged views with more than 60 senior representatives of major international fund and securities houses,
investment banks and law firms operating in Hong Kong on their operating environment and opportunities. The delegation also
met senior SFC representatives, including SFC Chairman, Mr Eddy Fong. The seminar was the first such event held in Hong
Kong and was organised by Hong Kong Investment Funds Association and sponsored by us.
To complement the discussions, we organised on the following day a half-day seminar for the Mainland delegation to explain
the Hong Kong regulatory environment and our licensing requirements.
With the implementation of CEPA IV, more Mainland fund management companies will establish their operations in Hong
Kong. This will not only enable Mainland fund houses to widen the scope of their activities, but also increase the size of the
fund management industry in Hong Kong, thereby facilitating Hong Kong’s development into a wealth management centre for
Mainland investors.
130/30 UCITS III Funds
Since the enhanced investment flexibility permissible under UCITS III, we have seen a rapid development of investment styles
in retail funds. One example is the emergence of 130/30 UCITS III funds in Europe. We have recently authorised the first such
fund for offer to the Hong Kong public.
In essence, a 130/30 UCITS III fund combines long positions with a total value of up to 130% of the net asset value of the
portfolio, and short positions with a value of up to 30% of the portfolio. The fund may invest in financial derivative instruments
SFC Bulletin November 2007 3
(FDIs) such as forwards, futures, swaps and options to get the intended short exposure. As the long and short positions may
not be correlated, both positions may be exposed to untoward market movements at the same time.
With a gross exposure of up to 160%, the fund may be subject to higher risks than those encountered by traditional long-only
equity funds. Fund managers of a 130/30 UCITS III fund need to possess the expertise and experience in taking both long
and short positions for investment purposes. They must also put in place sufficient risk management processes to monitor
and manage related investment risks including those arising from the use of FDIs in terms of increased volatility, counterparty
exposure, valuation risk, etc.
In authorising the 130/30 UCITS III fund, we have requested enhanced disclosure in the fund’s offering document regarding
the potential risks and losses due to the use of such a strategy, in particular the exposure in short positions and investments in
FDIs.
We have issued FAQs and other investor education publications on the 130/30 investment strategy. Intermediaries are
welcome to use the materials available at www.InvestEd.hk to enhance their customers’ understanding of these products.
Proper Disclosure and Due Diligence by Sponsors
The importance of proper disclosure of listing applicants’ business arrangements with their principal operating companies and
sponsors’ due diligence in the preparation of listing applications is highlighted in the latest quarterly update on the Dual Filing
arrangements.
In several cases in the period under review (April to June 2007), the listing applicants obtained de facto control of their
principal operating companies by entering into contractual arrangements with the legal owners of these companies. However,
the applicants failed to clearly explain how these arrangements covered various essential matters of control such as day-to-
day operations and composition of the board of directors and senior management, nor was there proper disclosure of the
implications if the parties did not perform their obligations. The sponsors performed further due diligence on the issues only
after queries were raised by the regulators. In another case, the sponsor was not aware that incorrect data on the applicant’s
market share was being used until the regulators pointed out the mistake.
We would like to stress that sponsors are expected to have sufficient understanding of their clients’ business, and should not
rely us and the stock exchange to identify the necessary due diligence steps in preparing listing applications.
For more details of the update on Dual Filing, please following this link to our press release dated 12 September 2007.
Publications & Circulars
The following publications and circulars have been published since the release of the last newsletter. Publications are available
on the SFC website under ‘Speeches, Publications & Consultations’ – ‘Publications’. Circulars can be found under ‘Legislation
& Regulatory Handbook’ – ‘Regulatory Handbook’ – ‘Codes, Guidelines and Circulars’.
Publications
1. SFC Enforcement Reporter – October 2007 (26.10.2007)
SFC Bulletin November 2007 4
2. SFC Takeovers Bulletin – September 2007 (27.9.2007)
3. Consultation Paper on Proposed Amendments to the Codes on Takeovers and Mergers and Share Repurchases (19.9.2007)
4. Consultation Conclusions on Proposed Amendments to the Securities and Futures (Contracts Limits and Reportable
Positions) Rules and Proposed Corresponding Amendments to the Guidance Note on Position Limits and Large Open
Position Reporting Requirements (14.9.2007)
Circulars
1. Circular to All Licensed Corporations - Reminder of Importance of Prudent Risk Management (29.10.2007)
2. Circular to Licensed Corporations and Associated Entities - Anti-Money Laundering / Combating Terrorist Financing - FATF
Statement on Iran (23.10.2007)
3. Circular to Licensed Corporations and Associated Entities - Anti-Money Laundering / Combating Terrorist Financing - Good
Market Practices Identified from Self-Assessment Program (23.10.2007)
4. Circular to Fund Management Companies of SFC-authorised Funds - SFC facilitates delegation of investment management
functions to non-AIR jurisdictions (18.10.2007)
5. Circular to Management Companies of SFC-authorised Real Estate Investment Trusts (“REITs”) - Acquisitions by SFC-
authorised REITs (12.10.2007)
6. Circular to Licensed Corporations and Associated Entities - Anti-Money Laundering / Combating Terrorist Financing (1)
United Nations Sanctions (Iran) Regulation (“the Iran Regulation”) (11.10.02007)
7. Circular to Licensed Corporations and Associated Entities - Anti-Money Laundering / Combating Terrorist Financing (1)
United Nations (Anti-Terrorism Measures) Ordinance (2) United Nations Sanctions (Sudan) Regulation (5.10.2007)
8. Circular to Licensed Corporations licensed for Type 1 or Type 8 regulated activity and Associated Entity - Implementation of
140% Repledging Limit with Effect from 1 October 2007 (18.9.2007)
9. Circular to Licensed Corporations and Associated Entities - Anti-Money Laundering / Combating Terrorist Financing -
Enhancement of Website and Obligation to Report Suspicious Transactions (28.8.2007)
The SFC Bulletin is available under ‘Speeches, Publications & Consultations’ – ‘Publications’ of the SFC website
at http://www.sfc.hk.
Feedback and comments are welcome and can be sent to sfcbulletin@sfc.hk
Securities and Futures Commission, 8/F Chater House, 8 Connaught Road Central, Hong Kong
Phone : (852) 2840 9222 • Fax : (852) 2521 7836 • Investor Hotline : (852) 2840 9333 • Media : (852) 2842 7717
SFC website : www.sfc.hk • E-mail : enquiry@sfc.hk • InvestEd website : www.InvestEd.hk
SFC Bulletin November 2007 5
