INTRODUCTION
1. The Council welcomes the Securities and Futures Commission (SFC) initiative to undertake a public consultation on various aspects of the proposed new investor compensation arrangements. In prior consultations on investor compensation, the Council took the opportunity to submit comments in 1998 and again in the Securities and Futures Bill 2000. In its previous submissions, the Council expressed full support for proposals to establish a new and independent Investor Compensation Company (ICC) and a new per investor level of compensation.
2. In general, the Council expressed the opinion, with regard to the proposed per investor level of compensation, that the new compensation arrangements should not reduce the overall level of protection available under the existing scheme. The Council also gave its support to the recommendation that both industry and public interest representatives should be included in the make up of the ICC.
COUNCIL COMMENT ON THE PROPOSALS
3. The following Council comments are directed at the following proposals, and questions raised in the current consultation paper:
- Expanded Coverage
- Cause for Action
- Per Investor Limit
- A New Single Compensation Fund
- The Investor Compensation Company
- Investor Winding Up Preferences
Expanded Coverage
Coverage to all dealers
4. The SFC seeks comments on whether coverage should be expanded to cover all securities and commodity dealers and margin financiers who receive and hold clients securities and / or money whether or not they are exchange participants.
5. The Council approaches this issue from the viewpoint of the retail investor. When a retail investor deals with a group of companies comprising exchange and non-exchange members, margin financiers or similar market participants, it is often difficult for the investor to know which party the investor is actually dealing with, and therefore whether the arrangement is protected by the compensation fund.
6. In these circumstances, a retail investor would find it difficult to discern the extent to which coverage is provided and thereby be in a position to adjust investment decisions accordingly. The Council therefore supports the expanded coverage of intermediaries, irrespective of whether they are exchange members, to bring about a degree of certainty for retail investors as far as the compensation arrangements are concerned.
Exempt authorised institutions
7. On the question as to whether coverage should extend to retail investors who deal through authorized persons under the Banking Ordinance, the Council considers it important to protect retail investors doing business with exempt authorized institutions (AIs) as the share of securities transactions made through AIs is not inconsiderable. Moreover, the inclusion of exempt authorized institutions is also supported in recognition of the principle of 'user pays' and 'equal treatment'.
Whether coverage should extend to other products, including overseas products
8. The SFC proposes that the coverage of compensation will be limited to products traded with Hong Kong Exchange and Clearing Ltd (HKEx) i.e. stock listed or traded on Hong Kong Stock Exchange and futures contracts traded on Hong Kong Futures Exchange. Comments are specifically sought on whether coverage should extend to other products, including overseas products.
9. As a matter of principle, taking into consideration the fact that the proposed bank deposit insurance does not cover booked amounts of foreign branches of Hong Kong banks, the Council does not consider that investor compensation should extend to non HKEx products.
10. The extent to which this principle should be overturned depends on the level of involvement in non HKEx products by Hong Kong retail investors, and the extent to which those products can fund the Hong Kong compensation arrangements.
11. On the first point, it is noted that the SFC conducts regular retail investor surveys. The Council suggests that the results of the surveys could serve as a vehicle to identify the extent to which Hong Kong retail investors have substantial involvement in products not traded in HKEx, and whether there is a potential problem.
12. With regard to the second point, the Council can appreciate that expanding coverage would have cost implications and would lead to cross subsidisation because non HKEx products would not be levied to fund the compensation arrangements.
13. If for example the retail investor market develops to a stage where there is substantial interest in the shares traded in the Shenzhen and Shanghai stock exchanges, then the SFC may want to consider making arrangements with those stock exchanges to bring their products within the Hong Kong compensation arrangements.
Excluded products/intermediaries
14. The Council requests that the SFC consider the best means to inform retail investors on the lack of compensation arrangements with regard to products or intermediaries that do not come within the compensation arrangements. For example, by taking appropriate measures in its education work through its Electronic Investor Resources Centre, and considering to what extent it can influence the wording of marketing material, that is directed at retail investors, to warn investors of limitations to coverage.
Cause of Action
15. Under the new arrangements, a person will be empowered to have a cause for action for compensation in relation to a default by a covered intermediary. As proposed in the consultation paper, default would mean bankruptcy or winding up of the covered intermediary; or any breach of trust, defalcation, fraud or misfeasance committed by the intermediary or any person employed by the intermediary.
16. In addition to the above mentioned rights to claims, the Council would like to put forward for consideration one other type of claim to which an investor may legitimately make on the ICC. For example, if a stockbroker has sold quoted securities on behalf of a client but the client has not been paid the sale proceeds within a reasonable time after the sale.
Per Investor Limit
17. The consultation paper notes that a limit of compensation per investor will be set initially at $150,000 and will be reviewed by the SFC as necessary.
18. As noted in its previous submissions, the Council fully supports the proposed setting of a per investor level of compensation, as this will provide certainty for retail investors as to the amount of compensation available to them. This support is on the understanding that the new compensation arrangements should not reduce the overall level of protection available under the existing scheme.
19. Whilst understanding the difficulty of assessing where any cut off point should be set, it is noted that compensation levels in other jurisdictions are comparatively higher than that of the proposed limit in Hong Kong. For example, the compensation limits for an investor in Canada, are CAN$1,000,000 (HK$5,000,000) in the UK, 48,000 maximum (HK$600,000) and the United States, US$500,000 (HK$4,000,000) respectively.
20. The Consultation Paper indicates that the method of assessing the risk of loss to the new Investor Compensation Fund Council was based on historical losses under the per broker compensation limit. The Council suggests that the SFC keep the $150,000 compensation limit under periodic review, to ensure that the amount is appropriate when measured against, for example, typical retail investor portfolios.
A New Single Compensation Fund
21. The Council supports SFC's proposal for a new single Investor Compensation Fund which would consolidate the existing compensation schemes operated under the Unified Exchange Compensation Fund, the Commodity Exchange Compensation Fund and the Dealers' Deposit Schemes for non-exchange participant dealers. This will provide a single point of access for investors.
22. The Council trusts that the transition from the various existing compensation schemes to the new single compensation scheme will be transparent, efficient and cost effective, in order to minimise uncertainty and bring the existing arrangements to an orderly conclusion.
The Investor Compensation Company
23. The Council welcomes the proposals on governance and structure of the Investor Compensation Company (ICC). It is noted that the new arrangements will be regulated by the SFC, and the ICC will be a public body. The Council considers that the ICC should be an independent body comprising both industry and public interest representatives.
Investor Winding Up Preferences
24. It is noted in the paragraph 27 of the consultation paper that the SFC does not propose that the investor compensation arrangements involve winding up preferences for investors. The Council supports this approach, given that investors will have access to the compensation fund amount of $150,000 and that where brokers hold investor's property in trust, these assets are protected in a winding up.
