Semester
:
March 2007
Week
:
Subject
:
Hong Kong Corporate Law
Topic
:
Financial Services Legislations
Lecture
Readings
1. Hong Kong Business Law, Anne Carver, Longman
1 of 22
Lecture Outlines
1. Introduction
1. The financial services sector covers those companies and their
employees involved in stock dealings e.g. the sale and purchase of
company shares and debentures, banking, insurance and money
lending.
2. The establishment of the Securities and Futures Commission (SFC)
was in 1989.
3. The Securities and Futures Ordinance (Cap 571) was passed and
gazetted in March 2002, and came into operation on 1 April 2003.
2. The Securities
Commission
and
Futures
1. The Securities and Futures Commission (SFC) was established in
1989 to regulate the securities and futures markets in Hong Kong.
2. The Securities Ordinance established the office of the Commissioner
of Securities, and provides a regulatory framework within which the
stock exchange operates. It protects investors in securities by
requiring registration of dealers, investment advisers and
representatives and by regulating trading practices. It also empowers
the Securities Commissioner to investigate malpractices. At the same
time, the Stock Exchanges Compensation Fund was created to
compensate clients of defaulting stockbrokers.
2 of 22
3. The Protection of Investors Ordinance attempts to protect investors
by prohibiting fraudulent and reckless advertisements and requiring
the vetting of advertisements inviting members of the public to invest
in securities.
2.1 The Commission of SFC
1. The Securities and Futures Commission Ordinance, was enacted in
accordance with the Committee’s recommendations, and the SFC
was established on 1 May, 1989.
2. Under the SFC Ordinance, the SFC is established as a corporation
with a considerable degree of autonomy from the Government.
2.2 Functions of SFC
1. The SFC’s basic function is to administer the laws relating to the
trading of ‘securities’ and ‘futures contracts’ in Hong Kong.
2. The SFC now has power under section 38D of the Companies
Ordinance to approve and register prospectuses and power under
section 38A to exempt prospectuses from certain requirements that
otherwise would apply.
3. Section 47 of the SFC Ordinance empowers the SFC to make
‘transfer orders’ whereby it can transfer its powers, so far as they
relate to companies listed on the SEHK to the SEHK. Pursuant to that
section, the SFC has partially transferred to the SEHK its powers in
relation to prospectuses where a prospectus is in relation to a
company listed on the SEHK. The SFC has retained the power to
review prospectuses for other companies.
3 of 22
2.3 Powers of SFC
1. To enable the SFC to carry out these functions, the SFC is given
statutory powers under its own ordinance — the Securities and
Futures Commission Ordinance. It is also given the powers
previously provided to the Com-missioner of Securities under the
Securities Ordinance, and the Protection of Investors Ordinance.
2. The SFC also has power under section 51 of its Ordinance to make
an order suspending the functions of the directors or chief executives
of the SEHK and HKFE. It may do this only after consulting the
Financial Secretary, and if it is satisfied that:

it is in the interest of the investing public or in the public interest
to do so; or

it is appropriate to do so for the protection of investors or for the
proper regulation of the SEHK or the HKFE.
3. Suspension orders have a maximum duration of six months.
4. The SFC, as described in the unit, is a statutory organization
empowered to enforce securities market regulations and oversee the
market operation of the Stock Ex-change of Hong Kong Limited
(SEHK), the Hong Kong Futures Exchange Limited (HKFE) and the
Hong Kong Securities Clearing Company Limited (HKSCC), which
were integrated under a single umbrella com-pany, the Hong Kong
Exchanges and Clearing Limited (HKEx), in 2000. Currently, the
SEHK, the HKFE, and the HKSCC are subsidiaries of the HKEx,
which itself is a public listed company.
4 of 22
3. Regulations of financial services
companies
The purpose is to ensure that investors, depositors, insurance policy
holders and borrowers have confidence in the people and organisations
participating in the financial services sector.
3.1 Regulations of securities
Securities and Futures Ordinance dealing with the following matters:
1. Registration of dealers
1.1 The Securities and Futures Ordinance provides for the registration
of dealers, investment advisers and repre-sentatives to ensure that
only fit and proper persons are involved in the sale of securities and
investment schemes.



A ‘dealer’ is any person who carries on a business of dealing in
‘securities’ (which was defined in the previous section) or any
direc-tor or manager of a company that deals in securities.
An ‘investment adviser’ is any person who, for remuneration, carries
on a business of advising others on securities, issuing analyses or
reports on securities or undertakes to manage a portfolio of securities.
A ‘representative’ is the employee or agent of a dealer or investment
adviser who is engaged to carry out any of the functions of a dealer
or investment adviser.
5 of 22
1.2 Dealers, investment advisers and representatives must be registered
before they may carry on their businesses. The power to register is
granted to the SFC. In general terms, in order to gain registration, an
applicant must prove that he or she is a fit and proper person and
has sufficient financial resources. The SFC may take into account
any matter which it considers to be relevant in determining whether
an applicant is fit and proper. The SFC must, however, also consider
the applicant’s:




financial status
educational or other qualifications or experience ‘having regard to
the functions which, if the application is allowed, he will perform’
ability to perform such functions ‘efficiently, honestly, and fairly’
reputation, character, financial integrity and reliability.
2. On-going requirements
2.1 These include requirements to keep proper accounts and records, to
meet the capital requirement and to keep a register of the securities
in which they have an interest. All registered persons are also
required to provide annual reports to the SFC detailing their
activities during the preceding year and their continuing compliance
with the legislation.
2.2 To enforce these and other requirements, the SFC has powers to
enter a registered person’s place of business and to inspect records.
The SFC can also require registered persons to disclose details of
securities transactions.
2.3 Where a registered person fails to comply with the relevant
legislation or is guilty of misconduct, the SFC may move to
de-register the person. In order to ascertain whether any breach or
misconduct has occurred, the SFC is also empowered to conduct
investigations.
6 of 22
3. Trading in securities
3.1 These principally include requirements that:




a dealer may only transact dealings in securities at or through the
SEHK
dealers may not tout for business or hawk securities door-to-door
every contract entered into by a dealer for the purchase or sale of
securities must be evidenced in a contract note that must be delivered
to the client for whom the transaction was entered into
dealers may not engage in ‘option’ or ‘forward trading’ or in ‘short
selling’.
Option trading refers to transactions whereby a dealer confers on a
client the right to purchase from or sell to the dealer any securities of
a listed company. Forward trading occurs when a dealer enters into a
contract to buy or sell securities on a future date. Short selling is the
highly dangerous practice of selling securities that are not presently
owned by a dealer or his client.
3.2 Dealers are prohibited from using their clients’ shares as security for
loans without the permission in writing of the relevant client.
4. Compensation Fund
The Fund may be used to pay claims arising against stockbrokers where
the broker has failed to produce money or securities entrusted to him or
purchased by him on behalf of a client.
5. Investigations.
5.1 The SFC is provided with wide powers under Part XI of the
Ordinance to appoint an inspector to investigate:


any alleged breach of trust, defalcation, fraud or misfeasance
any matter concerning dealing in securities or the giving of
investment advice.
7 of 22
5.2 On completion of an investigation, an inspector reports his findings
to the SFC and delivers a copy to the Department of Justice, which
may institute criminal proceedings.
3.2 Protection of investors
1.
The Securities and Futures Ordinance attempts to provide some
measure of protection to persons investing in ‘securities’, property
other than securities, and ‘investment arrangements’ in property
other than securities. In this context, ‘investment arrangements’
means arrangements which have the purpose of enabling investors
to derive income from or participate in the profits from
non-securities property.
2. These protections are provided in two main ways:
Firstly, the Securities and Futures Ordinance bolsters existing
common law remedies. A person who induces another to enter into a
contract by making a fraudulent misrepresentation may be liable to
damages in tort. The Securities and Futures Ordinance bolsters the
common law remedy of damages by also making it a criminal
offence for a person to make fraudulent or reckless
misrepresentations to induce another to buy or sell securities. In tort,
the circumstances in which a plaintiff may receive damages for
negligent misrepresentations causing pecuniary loss are limited. The
Securities and Futures Ordinance seeks to alleviate this by, in effect,
deleting the need to prove a special relationship where it is alleged
that a negligent misrepresentation induced an investor to buy or sell
securities or enter into an investment arrangement.
Secondly, the Securities and Futures Ordinance makes it an offence
to issue, or to be in possession of for the purpose of issuing, an
advertisement which is or which contains an invitation to the public
to buy or sell securities or enter into an investment arrangement.
8 of 22
3.3 Banking Ordinance
1.
The new Banking Ordinance (Cap 155) came into effect on 1
September 1986 as an amalgamation of the previous Banking
Ordinance and of the Deposit-taking Companies Ordinance.
According to its long title, the purpose of the Ordinance is “To
regulate banking business and the business of taking deposits and to
make provision for the supervision of authorized institutions so as
to provide a measure of protection to depositors and to promote the
general stability and effective working of the banking system . . . .”
2.
In 1993, the Hong Kong Monetary Authority (HKMA) was set up
taking over the functions of the Office of the Banking
Commissioner as well as the Office of the Exchange Fund.
3.
The Banking Ordinance attempts to achieve these objectives in five
ways:
3.1 HKMA.
HKMA has the primary function of promoting the general stability
and effective working of the monetary and banking system. HKMA
is also given responsibility for a wide range of functions, includ-ing
the suppression of illegal, improper or dishonourable practices, and
the promotion of proper standards of conduct and sound and prudent
practices by authorised institutions.
3.2 Prohibitions.
Firstly, the Ordinance places restrictions upon persons carrying on
‘banking business’ and ‘the business of taking deposits’. The
meaning and effect of these prohibitions will be explored further in
the next topic. In general terms, only authorised institutions are
permitted to carry on the businesses of borrowing money or
operating cheque ac-counts in Hong Kong.
9 of 22
3.3 Authorisation.
1.



Secondly, the Ordinance provides for the licensing and registration
of ‘authorized institutions’. This authority is mainly vested in
HKMA. Authorized institutions mean:
banks
restricted licence banks (previously, licensed deposit-taking
companies)
deposit-taking companies (previously, registered deposit-taking
companies).
2.
The difference between the three types of authorised institutions is
that only banks can carry on ‘banking business’. This means the
business of receiving from the general public money on current or
savings account that is repayable on demand or on less than three
months’ notice. Also, only banks can operate cheque accounts. A
restricted licence bank can take deposits of any amount over
$500,000 for any term. A deposit-taking company can take deposits
of over $100,000 for terms of more than three months. The purpose
of these restrictions is to ensure that only banks deal directly with
the general public, while restricted licence banks and deposit-taking
companies are effectively confined to non-consumer depositors.
3.
To be granted a banking licence, a company must have a minimum
paid-up share capital of at least $300 million. HKMA is empowered
to grant licences to companies wishing to become restricted licence
banks if they have paid-up capital of $100 million. It is given power
to register deposit-taking companies if they have paid-up capital of
$25 million.
10 of 22
3.4 On-going requirements
1.
The Banking Ordinance therefore requires all authorised institutions
to comply with on-going prudential requirements intended to ensure
that it remains sound and financially viable. Authorised institutions
must maintain minimum levels of reserves and capital before they
are permit-ted to pay dividends. They must provide ‘adequate’
provisions for bad and doubtful debts, and maintain the minimum
level of paid-up capital.
2.
A second principle of banking regulation is to ensure that authorised
institutions operate prudent lending practices. This means,
essentially, that they should lend to persons and companies that are
good credit risks and should not lend too much to any single
borrower. Section 81 provides, in part, as follows:
“(1) The financial exposure of an authorized institution to (any
single borrower or group of related borrowers) shall not exceed
an amount equivalent to 25% of the paid-up capital and reserves
of the institution.
(2) The financial exposure of an authorized institution to any
(singleborrower or group of related borrowers) shall, for the
purposes of this section, be taken to be the aggregate of(a) all advances, loans and credit facilities (including letters of
credit) given to;
(b) the value of the institution’s holdings of shares and debentures
and other debt securities issued by . . . .”
11 of 22
4. The Ordinance also tries to ensure that authorised institutions do not
over-extend their lending and other financial commitments. They do
so by maintaining a ‘capital adequacy ratio’ of at least 8%.
Capital base
Capital
adequacy ratio
=
_____________ =
Share capital +
reserves
_____________ > 8%
Risk weighted
index
Loans + other
sundry debtors
In other words, an authorised institution may not lend any more than
12.5 times its capital.
4.
Finally, all authorised institutions are required to maintain their
assets in such a manner that they can be liquidated into cash to
repay deposits in an emergency. All authorised institutions must
maintain a ‘liquidity ratio’ of at least 25%.
4.1 On-going scrutiny
1.
Much of the Ordinance is concerned with the requirements for
authorised institutions to provide on-going information to HKMA to
ensure continued compliance with the Ordinance and continued
financial health.
2.
The Ordinance imposes is the requirement that all institutions keep
HKMA informed, in advance, of any change of their ‘controllers’.
HKMA has a power to object to the appointment of a controller; in
this way, HKMA can ensure that unfit persons, such as persons who
have convictions for dishonesty, do not control authorised
institutions.
12 of 22
3.4
Insurance
Ordinance
Companies
1. Insurance Authority: The Ordinance firstly establishes the office of
the ‘Insurance Authority’ who is a civil servant.
2. Prohibition: The Ordinance then prohibits anyone other than an
authorised insurer from carrying on ‘insurance business’ in Hong
Kong.
3. Authorisation: Thirdly, the Ordinance empowers the Insurance
Authority to authorise insurers if all the persons who are directors,
the chief executive, managing directors or are in control of one third
of the voting power of the company are ‘fit and proper’.
4. Section 8 of the Ordinance provides that the nature of those criteria
depends on whether the applicant company is intending to carry on
‘general’ or ‘long-term’ business.
5. In general terms, general insurance includes all of those types of
insurance for which annually renewable policies are issued. This
includes automobile accident, fire, theft, medical and property
contents insurance. Long-term insurance is insurance, usually in the
form of an investment, that is entered into in the expectation that a
claim, if any, will not be made for a considerable time into the future.
Therefore, long-term insurers must keep considerable reserves to
ensure that they can pay claims or investment returns in the future,
whereas general insurers can operate and determine their profits on a
year-by-year basis. Insurers can be authorised only to carry on longor short-term classes of insurance.
13 of 22
6. On-going requirements: Each insurer must appoint an account-ant as
the company’s auditor. Also, if the company carries on long-term
business, it must also appoint a qualified person as its actuary. An
actuary is a professional who solves monetary problems involving
interest and probability calculations. In relation to a long-term insurer,
the appointed actuary’s most important responsibility will be to
calculate the company’s liabilities. These include its contingent
liabilities to pay death and other claims in the future. Based on the
actuary’s calculations, an insurer (and the Insurance Authority) will
be able to ascertain whether the insurer has sufficient assets to meet
those claims. Insurers carrying on long-term business are required to
conduct an investigation of their financial condition every year. The
investigation must include a valuation by the appointed actuary.
7. In addition, all insurers are required to keep and preserve ‘proper
books of account’ for at least seven years. Each year they must
submit to the Insurance Authority the report of the investigation
referred to in the previous paragraph, as well as their annual
accounts.
8. All such insurers are required to keep a ‘long-term business fund’
which is a fund consisting of assets acquired using receipts from its
long-term business.
9. Separate accounts must be kept for the long-term business fund
which show the assets representing the fund and the liabilities
attributable to that business. At all times the insurer must ensure that
the value of the assets exceed the liabilities by at least $2 million. By
section 23, the long-term business fund may only be used for the
purposes of that business, and cannot be applied generally by the
insurer. Equally, section 23 (4) states that any mortgage or charge of
the long-term business fund shall be void unless it is made for the
purposes of the long-term business. Furthermore, the long-term
business of one insurer can be transferred to another insurer only
with the permission of the court.
14 of 22
10. On-going scrutiny: Each authorised insurer is required annually to
provide accounts and a financial report to the Insurance Authority.
Additionally, the Insurance Authority is empowered by Part V to
require further information accounts and actuarial reports from
insurers.
11. In an extreme case the Insurance Authority may de-authorise an
insurer, or apply to the court for the winding-up of the insurer on
grounds that:




the insurer is insolvent;
the insurer has failed to comply with the requirements of the
Ordinance;
the insurer has failed to keep and maintain proper books of account;
or
it is otherwise just and expedient to do so in the circumstances.
12. Under section 46, where a long-term insurer is wound up, the
liquidator is required to continue carrying on the long-term business
with a view to transferring that business to another insurer.
3.5 Money Lenders Ordinance
1. The purpose of this short Ordinance is to regulate money lending
transac-tions and to ensure that persons involved in the business of
money lending are reputable and comply with minimum standards.
Firstly, the Ordinance provides for the licensing of ‘money lenders’,
who it defines as: “. . . every person whose business (whether or not
he carries on any other business) is that of making loans . . . but does
not include- “[authorized insurers, banks or subsidiaries of banks and
deposit taking companies, nor does it include loans made to
companies under a registered debentures, for the export or import of
goods or services, by a company’s holding company, or if the
borrowing company has paid-up share capital of $1 million or more
or is listed on the SEHK.]”
15 of 22
2. The Ordinance states that all moneylenders must be licensed. Under
section 11, on receiving an application in an approved form, the
licensing court may grant a licence only if the Commissioner of
Police or the Registrar of Money Lenders has made no objection to
the application, and the applicant and all others involved in the
management of the proposed money lending business are fit and
proper. All licences are renewable annually.
3. Secondly, the Ordinance prescribes that a loan by a money lender
will not be enforceable unless, within seven days of the loan, the
lender provides to the borrower a note stating:







the names and addresses of the lender, the borrower and the guarantor,
if any
the amount in figures and words of the loan
the date of the loan
the terms of repayment
the form of security, if any
the rate of interest expressed as a percentage per annum
the place that the loan was made.
On demand, the money lender is required to provide a copy of the
loan agreement to the borrower.
4. Thirdly, the Ordinance prohibits certain types of loans by money
lenders. Section 22 (1) states: “ Any agreement for the loan of money
by a money lender shall be illegal if it provides directly or indirectly
for
the payment of compound interest;

prohibiting the repayment of the loan by instalments;

the rate or amount of interest being increased by reason of any
default in the payment of sums due under the agreement . . . .”
16 of 22
5. Next, section 23 of the Ordinance provides that a loan by a money
lender may not be recovered in court proceedings unless the lender
proves to the court that when the loan was contracted he was licensed.
Section 33 also provides that where in court proceedings it is alleged
that a lender is unlicensed the burden of proof shall be upon him to
prove that he is licensed or is not a money lender. Consequently,
borrowers attempting to defend court proceedings brought by lenders
often claim that the lender is, in fact, an unlicensed money lender.
6. Fifthly, and most importantly for everyday commercial life, sections
24 and 25 of the Ordinance contain provisions that apply to all loans,
not just to loans by money lenders. Section 24 states that no loan at a
rate of interest exceeding 60% per annum, nor any security on such
loan shall be enforceable. Section 25 says that where proceedings are
before any court for the enforcement of any loan or security and the
court regards the transaction to be ‘extortionate’ the court may:
“reopen the transaction so as to do justice between the parties having
regard to the circumstances . . . and give such directions in respect of
the terms of the transaction or the rights of the parties thereunder as
the court thinks fit.”
7. By section 25, the courts treat as extortionate loans at rates of interest
exceeding 48% per annum; a loan could also be regarded as
extortionate if its terms were grossly unfair to the borrower. For
instance, a loan on terms that required the borrower to pay an
excessive ‘consultant’s fee’ or ‘establishment fee’ to the lender might
be regarded as extortionate.
17 of 22
4. Restrictions on companies
4.1
Banking
deposit-taking
business
and
The main prohibitions imposed by the Banking Ordinance are as follows:
1. Section 11 — ‘No banking business shall be carried on in Hong
Kong except by a bank’
2. Section 12 — ‘No business of taking deposits shall be carried on in
Hong Kong except by an authorized institution’
3. Section 97 — this section makes it an offence for any person other
than a licensed bank to use the word ‘bank’ or ‘ngan hong’ in its title
or to represent that it is a bank.
The term ‘deposit’ is defined in the Ordinance as follows:
“deposit”(a) means a loan of money(i) at interest, at no interest, or at negative interest; or
(ii) repayable at a premium or repayable with any consideration in
money or money’s worth; but
(b) does not include a loan of money(i) upon terms involving the issue. by any company, of debentures or
other securities in respect of which a prospectus has been registered under
the Companies Ordinance (Cap. 32);
(ii) upon terms referable to the provision of property or services; or
(iii) by one company to another (neither company being an authorized
institution) at a time when one is a subsidiary of the other or both are
subsidiaries of another company, and references in this Ordinance to the
taking or the making of a deposit shall be construed accordingly.
18 of 22
4.2 Insurance business
1. Section 6 (1) of the Insurance Companies Ordinance provides that
“No person shall carry on any class of insurance business in or from
Hong Kong except . . . a company authorized under [this Ordinance]
to carry on that class of insurance business . . . .
2. Any person who carried on a business of entering into insurance
contracts would violate section 6.
3. An insurance contract, in the widest sense of the term, is any contract
whereby one party, the insurer, undertakes, in return for the agreed
consideration (called the premium), to pay to another person (called
the insured) a sum of money, if in the future a specified but uncertain
event happens. The term ‘insurance business’ would also be
sufficiently broad to catch transactions associated with the servicing
of insurance contracts such as accepting claims, paying benefits and
taking premiums in Hong Kong.
4. Section 2 (3) states that “For the purposes of this Ordinance, a person
shall be deemed to carry on a class of insurance business in or from
Hong Kong if(a) he opens or maintains an office or agency in Hong Kong for the
purpose of carrying on that class of insurance business in or from
Hong Kong; or
(b) he holds himself out as carrying on that class of insurance
business in or from Hong Kong.”
19 of 22
4.3 Money lending
1. Section 7 provides that “No person shall carry on business as a
money lender . . . without a licence.”
2. The term ‘loan’ is defined as including advances, forbearance to
require payment of money owing on any account, money paid for
another person and every agreement that is in substance a loan.
3. In Kirkwood v Gadd [1910] AC 422 the House of Lords considered
the meaning of those words as used in the English Moneylenders Act
1900. Lord Loreburn L C, after noting that it would always depend
on the facts of each case, said: “ What is carrying on business? It
imports a series or repetition of acts.” Lord Atkinson, Lord James and
Lord Shaw refused to formulate any principle to explain the phrase
noted that a single transaction could amount to carrying on business
if it was evident that it was intended to be the first of many similar
transactions.
20 of 22
Tutorial
Question 1
You are a director of Mo Chuen Mo Laan Limited, a Hong Kong
company that operates a chain of fashion boutiques throughout Hong
Kong. Sales have recently been down, so the sales manager proposes a
scheme to attract new business. Under the scheme customers will be able
to:
1
2
3
‘Lay by’ items of clothing by depositing 10% of the purchase price
with the boutique. The boutique will then hold the clothing for the
customer for one week. At the end of the week, if the customer does
not buy the goods, the money will be refunded.
Purchase clothes with a credit card issued by Mo Chuen Mo Laan
Limited. The terms of the credit card will be that half of the balance
owing must be repaid each month.
Obtain a full refund of the purchase price if any clothes bought from
Mo Chuen Mo Laan Limited are stolen or de-stroyed by fire within a
month after purchase.
Advise, giving a short statement of your reasons, whether these
arrangements might breach the Banking Ordinance, the Insurance
Companies Ordinance or the Money Lenders Ordinance.
21 of 22
Tutorial Answers
This is a skeleton answer, only main points are covered. Students are
expected to have a more detailed answer or different approach when
facing the same or similar question in the examination. If you believe
this is a model answer and copy it directly to your answer book you will
score no marks or even fails.
Question 1
1
The Banking Ordinance prohibits persons from carrying on the
busi-ness of taking ‘deposits’, that is loans of money. It is possibly
that the lay-by system proposed by Mo Chuen Mo Laan could
constitute a business of taking loans. However, the term does not
apply to loans upon terms referable to the provision of property. The
lay-by system is referable to the sale of clothing and therefore seems
not to be deposit taking.
2
The Money Lenders Ordinance prohibits any unlicensed person from
carrying on the business of a money lender, that is the business of
making ‘loans’. The proposed credit card system appears to
constitute a business of making loans as it involves making advances
to customers to purchase clothes and also constitutes a forbearance
to require payment of money owing by customers. Unless Mo Chuen
Mo Laan Limited becomes a licensed money lender, the credit card
system will be illegal.
3
The system of providing refunds could also constitute a breach of the
Insurance Companies Ordinance. That Ordinance prohibits any
person other than an authorised insurer from carrying on insurance
business in Hong Kong. Insurance business is the entering into of
insurance contracts. It is arguable that the undertaking to be given by
Mo Chuen Mo Laan — to refund the purchase price if a customer’s
clothes are stolen or damaged by fire — is an insurance contract.
22 of 22