"If it isn't broken, why fix it". This is wise advice when the repair work is costly and time consuming and the benefits only marginal. But when it comes to the framework of rules that underpin Hong Kong's securities and futures industry, like the old washing machine, unless you have the latest model, the dirtiest and the most delicate loads will not be properly laundered.
So it was when financial markets were approaching the top of their cycle that the Securities and Futures Commission chose to ignore this old adage and took a long and hard look at the regulatory machinery that supports our securities industry. What it saw through the frothy to and fro of daily trading did not bode well. Whilst the system worked - indeed, compared with our neighbours, very well most of the time - it was beginning to show its age.
The existing framework is a patchwork of ten Ordinances, haphazardly assembled, often overlapping in scope, and lacking the guiding principles needed to navigate through the labyrinth of complex rules and regulations. In international terms it is just off the pace: more rigid and constraining in some areas; missing clarity in others. More alarmingly, it had clearly not kept pace with the rapid developments in trading technology, in the globalisation of markets or the increasing sophistication of financial products. This could only signal the steady decline to an age - or perhaps the return to one - where market manipulation went largely undetected or, if spotted and caught, the available sanctions were inadequate to deter repeat offenders.
Fortunately, the results of that long (there was nothing inappropriately quick about this new legislation) and detailed review are encouraging.
The reform process itself was an iterative one, and whilst there were several heated moments, not least the level playing field discussion between banks and brokers, the SFC maintained a steady arm on the tiller. It saw the need for a consistent and clear approach in the new law. It also saw the sense of retaining much of what was good in the old, so minimising unfamiliarity and the potential for disruption when the new is introduced.
There is also wisdom in the approach to future development. Financial markets do not stand still. New laws are frequently out of date the moment they are enacted. The new Securities and Futures Ordinance has in-built flexibility which permits more easy to enact subsidiary legislation to keep pace with changes in the nature of financial products and practices. Terminology in the new law has been carefully chosen to ensure that it is the nature of the activity and not just its outer appearance that is addressed. Although there are several new or more modern features, including a tightening of the rules for disclosure of interests in listed companies, the area of most dramatic change comes in the unveiling of a new regime to deal with market misconduct.
Numerous aspects stand out.
The most noticeable is the establishment of a special tribunal to deal with all forms of manipulative behaviour, not just insider dealing. The test of what is and is not outlawed has been clarified. Although the definition of market misconduct is broader than previously - and will include a prohibition on, rather appropriately termed "wash sales" - there are also some helpful safe harbour rules, including a proposal at long last to bring the Hong Kong initial public offering market in step by permitting price stabilisation activities to occur.
The Market Misconduct Tribunal will, like its earlier more limited forerunner, the Insider Dealing Tribunal, have powers to receive any evidence, whether or not admisable in civil or criminal proceedings as well as to compel the giving of evidence. Coupled with broader surveillance and investigatory powers for the SFC and the granting of immunity for auditors reporting fraud or other malpractice, there will be in place a clear, modern and well equipped system for detecting market misconduct. And with an armoury of tougher civil and criminal sanctions to deal with those who cross the line, a more effective means of discouraging it.
The new law is not just there for the regulators and market participants. The public too gets in on the act. One of the more innovative measures is to create personal rights of action through the civil courts for losses caused by market misconduct or by false or misleading public statements concerning securities. There is also a new and more investor-friendly compensation fund covering an extended range of defaults. It will also be mandatory for the SFC to release drafts of all rules proposed to be made under the SFO for public consultation and to publish an account of the comments received.
There is no doubt that it will take some time to get used to the new law. The next few weeks and months will see a number of public familiarisation exercises led by the SFC. There are also generous transitional arrangements reflecting the extra administrative and financial burden of applying for the new licence, raising capital adequacy and tightening up compliance procedures. However, as the largest and most comprehensive piece of legislation in Hong Kong's history, its introduction on 1 April will certainly be no light-hearted affair.
Robert Ashworth is Head of the Asia Corporate Practice at Freshfields Bruckhaus Deringer in Hong Kong. This article first appeared in the SCMP on March 31, 2003.
