Introduction

Currently, securities transactions which are not recorded by the Stock Exchange of Hong Kong Limited (“SEHK”) as on-exchange orders nor required to be reported to SEHK as off-exchange trades (“OTC Securities Transactions”) have been used in many manipulation schemes investigated by the Securities and Futures Commission (“SFC”). On 4 December 2020, the SFC issued a consultation paper (the “Consultation Paper”) for the proposal to introduce an over-the-counter securities transactions reporting regime for shares listed on the SEHK (the “OTC Securities Transactions Reporting Regime”) by around Q3 of 2022. The consultation period will end on 4 March 2021.

Background

Under the current market surveillance regime, the SEHK trading system only records information for an exchange participant (“EP”) which inputs a securities order. In order to identify the underlying client and obtain information of a suspicious order or trade, at least two rounds of notices have to be issued by the SFC under section 181 of the Securities and Futures Ordinance (Cap. 571) to the relevant EP or other intermediaries. As such, the SFC proposed to implement an investor identification regime at the trading level, which enhances market surveillance of on-exchange orders and off-exchange trades which are reportable to SEHK.

Pursuant to the Consultation Paper, OTC Securities Transactions take up a considerable portion of total securities trading, which commonly involve beneficial ownership changes made via bought and sold notes. The SFC notes that some of the OTC Securities Transactions are carried out in exceptionally large sizes or at prices significantly lower than the market price. It is expected that the OTC Securities Transactions Reporting Regime would enable regulators to obtain information on suspicious transactions on a timely basis and contribute to a more effective and complete market surveillance regime.

The Proposal: OTC Securities Transactions Reporting Regime

Securities subject to the reporting regime

Based on the proposed OTC Securities Transactions Reporting Regime, only ordinary shares of a company or units of a real estate investment trust are covered. In other words, other securities such as preference shares, rights, company warrants, derivative warrants, callable bull/bear contracts, OTC derivatives, and exchange traded funds would not be within the scope of the OTC Securities Transactions Reporting Regime.

Obligation to report

Under the proposed OTC Securities Transactions Reporting Regime, the reporting obligation will be imposed on the SFC-licensed corporation or registered institution (the “Regulated Intermediary”). The obligation to report arises when:

1.        the Regulated Intermediary, whether as principal or agent, makes a transfer of shares in connection with an OTC Securities Transaction in respect of which stamp duty is chargeable in Hong Kong; or

2.        there is a deposit to or withdrawal from the Regulated Intermediary, whether as principal or agent, of physical certificates of shares.

Based on the proposed regime, the following transactions would not be reportable:

1.        a share transfer in respect of which stamp duty in Hong Kong is not chargeable, such as probate transactions;

2.        a share transfer between two accounts held by the same individual in the same EP;

3.        a share transfer between two EPs for the same individual; and

4.        a share transfer which takes place without the involvement of Regulated Intermediaries.

Time to report

The reporting should be done within one Hong Kong trading day after the day of the share transfer, deposit or withdrawal.

Transfer of shares between two Regulated Intermediaries

Where shares transfers are made between two Regulated Intermediaries, the SFC proposes that both the delivering Regulated Intermediary and the receiving Regulated Intermediary shall separately report the transaction to the SFC, in order to provide more complete and accurate OTC Securities Transactions information to the SFC. In such an event, the SFC would receive two reports for a single share transfer.

However, if both the delivering Regulated Intermediary and the receiving Regulated Intermediary are the same Regulated Intermediary, the transfer would need to be reported only once.

No additional reporting for on-exchange trades

There is no additional reporting obligation under the proposed OTC Securities Transactions Reporting Regime for a transfer of shares effected by a transaction which has been conducted on-exchange or is required to be reported to SEHK in accordance with the Rules of the Exchange of SEHK.

Submission System

The SFC proposes to build a system for submission of information in relation to the proposed OTC Securities Transactions Reporting Regime (the “Submission System”). For instance, in respect of a share transfer, the following information may be required to be submitted to the SFC:

1.        stock name and stock code of the shares transferred;

2.        transaction price per share of the shares transferred;

3.        quantity of shares transferred;

4.        share transfer date;

5.        transaction date;

6.        CE number (i.e., the reference number assigned by the SFC to a regulated entity) and the role of the Regulated Intermediary; and

7.        the full name of each of the transferor and transferee.

The Submission System allows market participants to efficiently provide information to the SFC under the proposed regime.

Conclusion

The introduction of the proposed OTC Securities Transactions Reporting Regime will be a major development in Hong Kong’s market surveillance regime. It enables greater oversight of OTC Securities Transactions not previously supervised. We will keep you updated on any future development in this regard.