FINANCIAL LAW AND

REGULATIONS
WEEK 8

Business Conduct and Client Relations

Business Operations and Practice

1
 Business Conduct & Client
Relations
Code of conduct for persons licensed by or
registered with the SFC

- Primary code form which others are developed

- Based on nine principles
- Effectively deal with the external relationships
of an intermediary
- Codes in themselves are not law but can be
enforced
- Exemptions for discretionary management of
collective investment schemes
2
 Principles
- Principle 1 – Honesty and Fairness

- Representations and information to clients should

be accurate and not misleading

- Charges to clients should be reasonable

- Invitations and advertisements should not contain

information that is false, misleading or deceptive,
and not contain negative comments about
competitors

- Awareness of Prevention of Bribery Ordinance

3
 Principles
- Principle 2 – Diligence

- An intermediary should take reasonable steps to

execute client orders promptly and in accordance
with clients, instructions ( prompt execution)

- An intermediary should execute client orders on the

best available terms (best execution)

- Orders executed for clients should be promptly and

fairly allocated to those clients (prompt and fair
allocation)

- Advice to clients should be given with due skill, 4

care and diligence
 Principles
- Principle 3 – Capability

- An intermediary should have all the resources

needed for operating the business and employ
them effectively

- The principle refers to the internal operations of the

intermediary and is covered in ore detail later

5
 Principles
- Principle 4 – Information about clients

- Know your client – not only his/her true identity

but also his/her real financial strength, investment
experience and investment objectives

- Client agreements should contain full name and

address of both parties, undertakings to notify any
changes, full description of services and charges
and risk disclosure statements

- Discretionary accounts should be in writing,

terms and authority should be clear, be renewed
annually, opening should be approved by senior
management and they must be properly supervised 6
 Principles
- Principle 5 – Information for clients

- An intermediary must provide information to its

clients in order to maintain transparency and inform
them of transactions

- Information about the intermediary includes

adequate and relevant information about its
business, including details of client contact persons

- Audited financial statements should be provided to

clients upon request

- Other information includes prompt confirmation of 7

transactions and statements of account
 Principles
- Principle 6 – Conflicts of Interest

- An intermediary should avoid conflicts and if

unavoidable should act fairly – disclosure

- Priority in handling and recording orders – client order

should have priority over those of the intermediary or
an employee or agent of the intermediary

- Priority in allocation of orders – if aggregated orders

cannot be fulfilled in one transaction priority must be
maintained in a follow-up transaction

- An intermediary should not engage in front-running

and not engage in insider dealing 8
 Principles
- Principle 7 – Compliance

- An intermediary must have a written policy specifying if

employees can deal for their own accounts in securities
or futures contracts

- Such activities must be transparent, separately managed

and supervised

- An intermediary is responsible for acts and omissions of

employees and agents

- An intermediary must handle client complaints in a timely

and prompt manner

- The code specifies when reports should be made to the 9

SFC. Also covered by the SFO in parallel legislation
 Principles
- Principle 8 – Safeguarding of Client
Assets

- An intermediary or a third party acting on its behalf

should account for client assets promptly and
properly and ensure adequate safeguard

- This principle is in addition to the Client Securities

Rules and Client Money Rules as laid out in the
SFO

- Scope of care in code is wider than that in the

legislation and clients should be warned of the
risks of assets received or held overseas
10
 Principles
- Principle 9 – Responsibilities of Senior
Management

- They are primarily responsible for ensuring

adherence to the code

- They should properly manage the risk associated

with the business:

- Nature of the business, internal control systems,

risk management policies and the extent of their
authority and responsibilities

- They should have access to all relevant information 11

on a timely basis and necessary advice

 Professional Investors “PIs”

- It is recognized that because some persons

are very skilled and experienced investors,
they do not require the level of protection that
the ordinary retails investor might need

- PIs are defined in the SFO

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 Professional Investors “PIs”
- Intermediaries and similar investment service
providers

- AFIs and similar overseas institutions

- Insurers regulated under the Insurance Companies

Ordinance

- Collective authorized investment schemes

- MPF and ORSO schemes

- Governments, central banks and multilateral 13

agencies
 Professional Investors “PIs”
- All PIs are excluded from:

- The unsolicited calls provision of s174, SFO

- Requirements for offers as specified in s175, SFO

- The professional investor rules extend the above

Category 1 PIs to so-called Category 2 PIs:

- Trustee companies responsible for total assets of not less than

HKD 40 million

14
 Professional Investors “PIs”
- High net worth individuals (HNWIs) having a
portfolio of not less than HKD 8 million

Corporations or partnerships having either a

portfolio of not less than HKD 8 million or total
assets of not less than HKD 40 million

- Corporations that act solely as investment holding

companies and are wholly owned by individuals
who are professional investors

- Intermediary must inform client of consequences of

being treated as a PI and secure written declaration
15
 Professional Investors “PIs”
- For all PIs’ intermediaries do not have to:

- Establish a client’s experience and objectives and ensure

suitability of recommendation

- Enter into a written contract or provide risk disclosure

statements and obtain prior authority for transacting
discretionary accounts

- Explain and confirm written authority annually

- Provide information about itself or make prompt

confirmation of transactions

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 Risk Disclosure Statements
- Must be included in client contracts and be
discussed with clients

- They deal with the particular risks of carrying out

the respective activities, need fro obtaining
professional advice and degree of protection given
by limits the client may put on trades

- There are several forms of risk:

- Risk of securities trading

- Risk of trading futures and options

17
 Risk Disclosure Statements
- Risk of Growth Enterprise Market (GEM) stocks

- Risks attaching to clients assets received or held

outside Hong Kong

- Risk of providing an authority to repledge (give as

security) clients’ collateral

- Risk of providing an authority to hold mail or direct

it to third parties

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 Risk Disclosure Statements

- Risk of margin trading

- Risk of trading in leveraged foreign exchange

contracts

- There are additional schedule specifying

requirements for dealings on the SEHK and HKFE,
in securities margin financing and in leveraged
foreign exchange contracts

19
 Business Operations and
Practices
Code of conduct for persons licensed by or
registered with the SFC

- Focus is on internal operations of an intermediary

rather than on clients as in client relations

- Expand on capabilities, competence, compliance

and supervision by senior management

- Also review implications of money laundering /

terrorist financing, on-line trading activities,
additional short selling requirements, unsolicited
calls and insurance cover
20
 Management, Supervision and
Internal Control Guidelines

- These ICG comprise eight key areas

- They match the nine general principles of the code

of conduct

- The ICG are like codes in that they do not have the
force of law and a failure to observe them will not
be an offence leading to prosecution

- However, failure to observe them will impact

adversely on the fitness and properness of the
intermediary
21
 Management, Supervision and
Internal Control Guidelines

- Internal control and internal management

systems

- Are used by intermediaries to operate a business in

an orderly and efficient manner

- To safeguard the assets of its clients as well as its

own assets

- To maintain proper records and to rely on the

financial and other information they produce

- To comply with all applicable laws and statutory 22

requirements
 Management, Supervision and
Internal Control Guidelines

- 1 - Management and Supervision

- Active management which takes responsibility

- Regular and effective reporting to management

- Clear assignment of responsibilities and line

reporting

- Clear definition of authorization levels

- Supervision is carried out competently 23

 Management, Supervision and
Internal Control Guidelines

- 2 – Segregation of Duties and Functions

- Reduce opportunities for abuse

- Prevent errors from being undetected

- Avoid potential losses to clients

- Functions such as sales, dealing, accounting and

settlement should be segregated from each other

- Compliance and internal audit should report direct 24

to senior management
 Management, Supervision and
Internal Control Guidelines

- 3 – Personnel and Training

- Should be adequate to ensure that employees are

able to comply with all applicable regulations, the
internal systems, controls and laid down
procedures

- Employment of competent staff

- Clear communication to staff

- Provision of adequate training including continuing

professional training (CPD) 25
 Management, Supervision and
Internal Control Guidelines

- 4 – Information Management

- Ensure integrity, security, availability, reliability and

completeness of all information relating to business

- Staff should be qualified

- Systems should be adequate – access controlled

- Information reporting needs should be clear

- Systems are documented and back ups made

26

- Effective record retention

 Management, Supervision and
Internal Control Guidelines

- 5 – Compliance

- Intermediary and staff should be aware of all applicable

laws and regulations

- Establish and maintain effective compliance function

- Ensure competence of compliance staff

- Ensure access to all areas of business by compliance

- Establish proper complaints handling procedures

27

- Promptly report any material non-compliance

 Management, Supervision and
Internal Control Guidelines

- 6 – Internal Audit

- Purpose is to independently examine, evaluate and

report on the adequacy, effectiveness and efficiency of
the intermediary’s management, internal controls and
operations

- Should be established by senior management and be

independent of operations

- Senior management should ensure adequate planning,

control and recording of the internal audit work

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 Management, Supervision and
Internal Control Guidelines

- 7 – Operational Controls

- Effective policies, procedures and controls over the day-

to-day business operations

- Confirm true identity of each client, beneficial owner,

person authorized to give instructions and know your
client information

- Establish precise terms for discretionary accounts

- Investment advice supported by contractual agreement

29
- Minimize conflicts of interest - disclose interests to client
 Management, Supervision and
Internal Control Guidelines

- 8 – Risk Management

- Ensure proper management of risks

- Identify and quantify such risks

- Provide timely and adequate information to

management to enable it to take necessary action

- Establish a competent risk management function

- Monitor
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 Money Laundering and
Terrorist Financing

- Process by which money obtained through criminal

activities is cleaned so as to disguise its origins and
give the appearance that it comes from a legitimate
source

- Cash transactions are preferred as they do not

create bank records

- Cash is difficult to distinguish unless all banknote

serial numbers can be identified

- Cash can be broken down into smaller sums which

are less noticeable 31
 Money Laundering and
Terrorist Financing

- SFC produced the Money Laundering and Terrorist

Financing Guidance Note (MLGN) under s399 of
the SFO

- Applies to licensed corporations, licensed

representatives and associated entities that are not
AFIs

- HKMA issued similar guidelines to AFIs

- Both guidelines do not have the force of law but

failure to follow their spirit may adversely affect on
fitness and properness 32
 Money Laundering and
Terrorist Financing

- Three stages identified:

- Placement – the first stage is the physical disposal

of the illegal money

- Layering – the second stage is the separation of

the money from the illegal source by creating a
number of financial transactions (layers)

- Integration – Final stage is when the money has

obtained the appearance of being legal and can be
used openly without fear of being connected with a
crime 33
 Hong Kong Legislation

- The Drug Trafficking (Recovery of Proceeds)

Ordinance – (DTRPO) – makes it an offence to
deal with property which is known or believed to be
the proceeds of drug trafficking

- The Organised and Serious Crimes Ordinance –

(OSCO) – gives the police powers to obtain a court
order to secure information and conduct searches

- The United Nations (Anti-Terrorism Measures)

Ordinance (UNATMO) makes it a criminal offence
to supply funds or make funds or financial services
available to terrorists or their associates
34
 Money Laundering Terrorist
Financing Guidance Note

- Client identification

- Record keeping and retention

- Recognition and reporting of suspicious

transactions

- Procedures for disclosure

- Education and training

35
 Examples of Suspicious
Transactions
- Large or unusual cash settlements

- Buying and selling financial instruments with no obvious

purpose

- A number of different buy transactions which are then

sold in one transaction to another person

- Cash provided by parties from countries with a

reputation for drug trafficking

- Parking idle funds with no trading activity. Engaging in

wash trades

- Changes in staff lifestyle and or behaviour

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 Class work
 Evelyn de Rothschild is the former chairman
of NM Rothschild & Sons, a very famous
investment bank based in London, founded in
1811. He wrote an article in FT and
suggested “one must go back to basics” for
the financial institutions in trouble
 Read the article.
 What are these “basics”?

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Appendix

38
 Online Trading and Advising
- Guidance Note on Internet Regulation

- Circular to all Registered and Licensed Firms on

Internet Trading and Advising

- Guidance for Registered Persons using the Internet to

Collect Applications for Securities in an Initial Public
Offering (IPO)

- Circular on Provision of Financial Information on the

Internet

- CIS Internet Guidance Note (for persons advertising or

offering CIS on the Internet)
39
 Automated Trading Services
(ATS)

- Such services describe any automated system that

provides by means of electronic facilities a trading
mechanism for securities and futures contracts other
than the operations of SEHK and HKFE

- They include trade matching systems, broker run ATSs,

exchange run ATSs, broker to broker to broker
automated linkages and internet systems

- A person may be authorised under s95 SFO to provide

ATS services

- A person may be licensed or registered under Part V

SFO
40
 Short Selling Requirements
(additional)

- Securities and Futures (Short Selling and Securities

Borrowing Lending (Miscellaneous)) Rules

- Guidance Note for Short Selling Reporting and Stock

Lending Record Keeping Requirement

- Short Selling Requirements in Schedule 3, the Code of

Conduct

- Short Selling regulations in the Eleventh Schedule of the

SEHK

41
 Securities and Futures
(Unsolicited Calls Exclusion) Rules

- An intermediary may during an unsolicited call to a

person who is already a shareholder of a corporation:

- Enter into an agreement to buy or sell securities of that

corporation, and

- Make a permissible communication

- However, communications only permissible if NOT

made in the course of a visit in person, a telephone
conversation or any other interactive dialogue consisting
of statements and responses exchanged immediately

42
 Securities and Futures
( Insurance) Rules

- Maintenance of insurance cover by a licensed

corporation (or security deposit with SFC) which is an
exchange participant (SEHK or HKFE) and holds clients
assets is a necessary condition for the granting of a
licence by the SFC

- SFC may approve master policies for specified

regulated activities. Risks covered include:

- Fraudulent or dishonest acts of employees, robbery or

theft of client assets, forgery, fraudulent use of
information systems and forged or fraudulent
instructions relating to client assets

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