Hong Kong Bar Association's

HONG KONG BAR ASSOCIATION'S

COMMENTS ON SFC’S DRAFT GUIDELINES FOR THE

REGULATION OF AUTOMATED TRADING SERVICES

INTRODUCTION

Part 1 of Schedule 6 to the Securities and Futures Bill (“the Bill”) lists 9 types of regulated activities. Type 7 deals with activities providing automated trading services (“ATS”), the definition of which is contained in Part 2 of Schedule 6.

Clause 114 of the Bill prohibits any person from carrying on a business in a regulated activity unless that person:-

(1)is licensed by the SFC for such activity under Clause 115 or Clause 116 of the Bill;

(2)is an authorised financial institution exempt under Clause 118 of the Bill; or

(3)is authorised by the SFC under Clause 95 of the Bill in the case of ATS activities.

Clause 95(1) of the Bill prohibits a person from providing ATS unless the person:-

(1)is authorised under Clause 95(2) of the Bill; or

(2)is licensed or exempt for ATS activities.

The present Draft Guidelines for the Regulation of Automated Trading Services (“the Draft ATS Guidelines”) are made under Clause 95(5) of the Bill (see paragraph 1 of the Draft ATS Guidelines).

SCOPE OF THE DRAFT ATS GUIDELINES

According to Clause 95(5) of the Bill, the SFC shall prepare and publish in the Gazette or otherwise guidelines setting out the principles, procedures and standards in relation to “authorization for providing automated trading services under this section”. In order words, the guidelines made pursuant to this provision are confined to authorisation in respect of ATS under Clause 95 of Part III of the Bill.

However, apart from the issue of authorisation, the Draft ATS Guidelines also cover matters such as licence and exemption under Part V of the Bill in the AST (see section D and section E of the Draft ATS Guidelines). There is a question whether the SFC has power to cover those matters in the Draft ATS Guidelines, given the scope of Clause 95(5).

KEY ISSUES

It appears from the Draft ATS Guidelines that the key issues arise in connection with:-

(1)licence for ATS activity under Part V;

(2)exemption for ATS authority under Part V;

(3)authorisation for ATS authority under Part III.

LICENCE FOR ATS

According to paragraph 38 of the Draft ATS Guidelines, after enactment of the Bill, the SFC will assess the activities of existing licensees and determine which of the nine types of regulated activity they will be licensed to carry out under Part V. It does not expressly state whether an existing licensee is required to make an application. Under Clause 115, the SFC “may, upon application…grant to the applicant a licence to carry on one or more than one regulated activity”.

Paragraph 39 raises an example of a person licensed for dealing in securities or futures contracts (i.e. Types 1 and 2 regulated activities). Given its ability to provide services through electronic facilities, in addition to licensing it for Type 1 and Type 2 related activities, the SFC will also consider licensing it for Type 7 activities. It may be argued that in the light of this paragraph, the corporations licensed for Type 1 and Type 2 regulated activities, with the ability to provide electronic services, have a legitimate expectation that they will be licensed for Type 7 activities.

As stated above, a person may be allowed to provide ATS if it is licensed under Part V of the Bill or authorised under Part III. Paragraphs 44 and 54 of the Draft ATS Guidelines state that persons who provide ATS and traditional dealer functions should seek a Part V licence whilst those who do not engage in traditional dealer activities should seek authorisation under Part III.

As stated in paragraph 42 of the Draft ATS Guidelines and Clause 117(1)(c) of the Bill, in the case of Type 7 ATS activities, it shall be a condition of a licence granted that if the SFC in its absolute discretion requires that the licensed corporation shall apply for an authorisation under Clause 95, the licence shall be deemed to be revoked if the requirement is not complied with.

What Clause 117(1)(c) means is that even if a corporation has already been granted a licence for Type 7 ATS activities under Part V, the SFC can still require the corporation to obtain authorisation under Part III. In other words, the position of those who have obtained authorisation under Part III is more advantageous than that of those who have obtained a licence under Part V. The applicants should be entitled to know the relevant guidelines as to the circumstances in which the SFC will exercise such a discretion. The Draft ATS Guidelines do not at present seem to throw any light on the factors that the SFC will take into account in deciding whether to exercise the discretion.

Despite what is stated in paragraphs 44 and 54 of the Draft ATS Guidelines, there is nothing in the Bill which prohibits a person who provides both ATS and traditional dealer functions from applying in the first place for ATS authorisation. To avoid the uncertainty and possible disruption which may arise from Clause 117(1)(c), such a person may consider applying for a licence under Part V for all types of regulated activities except those of Type 7 and for authorisation under Part III for Type 7 activities in the first place. However, the lack of information as stated under paragraph 12 above makes it difficult for an applicant to make a decision.

EXEMPTION FOR ATS

Similar to what has been stated above in the context of licence for ATS, it is not clear from paragraph 46 of the Draft ATS Guidelines as to whether an existing exempt person is required to put in an application for such an exemption. However, Clause 118 states that the SFC “may, upon application by an authorised financial institution…grant a declaration of exemption to the applicant for carrying on one or more than one regulated activity”.

The issue as to legitimate expectation as raised in paragraph 9 above applies to paragraph 47 of the Draft ATS Guidelines.

As in the context of licence, Clause 118(8) of the Bill states that in the case of Type 7 regulated activities, it shall be a condition of an exemption that if the SFC in its absolute discretion requires the exempt person to apply for an authorisation under Clause 95, the exemption shall be deemed to be revoked where the requirement is not complied with. Again, the Guidelines are silent on the factors that the SFC will consider in determining whether it should exercise its discretion or not.

Further, given the condition imposed by Clause 119(8), it is natural for authorised financial institutions to become more inclined to an application for authorisation under Clause 95 rather than an application for an exemption under Clause 118. However, the Draft ATS Guidelines are silent on whether an authorised financial institution should apply for an authorisation or an exemption. Paragraph 51 simply provides:-

“In these circumstances, it is possible for an exemption to be granted under Part V or authorization to be given under Part III. The decision as to which process to follow will be made on a case-by-case basis and in consultation with the HKMA.”

AUTHORISATION

Paragraph 55 states that an application under Clause 95(2)(a) of the Bill should be accompanied by information including the names and biographies of corporate directors and employees and the qualifications and experience of key personnel. It is believed that this should not contravene the Personal Data (Privacy) Ordinance because it apparently falls within the exemptions in the Personal Data (Privacy) Ordinance Cap 486 (see ss. 58(1)(f) and 58(3)).

However, unease may be caused by the fact that the SFC, in considering an application for an authorisation, may have regard to any information in its possession “whether provided by the applicant or not” (see Clause 96(3) and paragraph 56 of the Draft ATS Guidelines). There is therefore a likelihood that an application may be refused due to certain information provided by a third party, which an applicant has no control over or even access to. It is suggested that there be a mechanism whereby the SFC should notify the applicant in the event that it receives information from a third party, which has a material bearing on the application. The applicant should also be given an opportunity to comment on such information.

According to paragraph 58 of the Draft ATS Guidelines, if the SFC is minded not to grant the authorisation, the applicant should have a right to be heard. However, the Draft ATS Guidelines do not provide whether it is necessary to have an oral hearing for that purpose. Further, it is recommended that apart from having a right to be heard, the applicant should be entitled to know the reason why the SFC is minded not to grant the authorisation (see Pearl Securities Ltd v Stock Exchange of Hong Kong [1999] 1 HKC 448). Otherwise, a right to be heard will not serve any useful function if the applicant does not know what matters he has to deal with.

The matters raised in paragraph 20 above equally apply to the withdrawal of an authorisation (see Clause 98 of the Bill and paragraph 59 of the Draft ATS Guidelines).

Further, the matters raised in paragraphs 20 and 21 equally apply to paragraph 68 of the Draft ATS Guidelines.

Date: 25th May 2001