INTRODUCTION
1. The Consumer Council is pleased to submit its views on the consultation paper issued by the Securities and Futures Commission (SFC) on proposals for a scripless securities market in Hong Kong.
COUNCIL RESPONSE
2. The Council notes that the proposal to establish a scripless trading system is based on claims that such a system can increase efficiency, lower costs and reduce risk, thereby enhancing the competitiveness of Hong Kong as an international financial center. Notwithstanding these benefits, the Council would like to raise a number of issues regarding the proposals that raise some concerns from a consumers' perspective.
3. The Council considers that for scripless trading to gain investors' acceptance the following issues require further consideration by the SFC.
- Some form of physical documentation be provided upon investor's request, and that the cost of obtaining documentation should not be prohibitive.
- In view of the increasing trend for small retail investors to participate in the securities market, substantial efforts should be made to educate this class of investors to build confidence and trust.
- Benefits of cost reduction in scripless trading be passed on to consumers.
- The integrity of the system should be maintained and not compromised.
Physical documentation
4. The Council is of the view that adopting a transitional approach is necessary to allow shifting from a physical share certificate system to a scripless system as this would provide market participants with time to adjust to the changes and lead to a more managed restructuring of the securities market.
5. However, notwithstanding the fact that a completely scripless system will eventually evolve, the Council considers that some consideration should be given to retaining a facility whereby retail investors are still able, upon request, to obtain some form of physical documentation as to their holdings.
6. For some investors, an inability to possess a form of physical share certificate may cause panic and a loss of confidence in the system, regardless of the accuracy of the system. This is particularly the case in circumstances of broker default. The Council is therefore of the view that consideration should be given as to whether physical certificates registered in, for example, the name of the CCASS, can be made available for investors to withdraw upon request, for a reasonable fee.
7. For example, in the UK, share certificates in physical form can be "rematerialized" and withdrawn from the electronic system at the request of the investor. Singapore also allows some form of share certificate to be withdrawn from the electronic system. This will provide a degree of comfort to certain investors who still prefer some form of physical certificate.
Education of retail investors
8. Given the significant change in documentation, and the scope for confusion, the Council considers it is extremely important that the workings of the scripless system should be as transparent as is practicable.
9. The Council is pleased to note that an Implementation Working Group will be formed to assist in a widespread community education plan to prepare market participants for the scripless proposals. The Council stresses it is of utmost importance to take into account views of shareholders, in particular small shareholders, when considering implementation details for a scripless market. The Council is willing to provide whatever assistance it can in this regard.
Costs of the system
10. The consultation paper recommends that for scripless transfers within CCASS and on the Issuer register, there should be no registration fee payable by shareholders to the registers. This proposal is in line with overseas practice, i.e. scripless transfers would be covered within the service contracts between listed companies and share registrars, subject to competitive forces.
11. The Council supports the proposal and trusts that shareholders will derive a benefit from subsequent cost reductions.
Maintaining integrity of the system
12. There are two issues the Council would raise in respect of the need to maintain integrity of the system.
Shareholders' Options for Scripless Holdings
13. As noted in the Consultation Paper, scripless registration provides new ways for shareholders to hold securities, in particular as registered shareholders on a scripless register. Paragraph 5 (c) notes that shareholders would have three options for scripless holdings:
- Hold, as beneficial owners, through a broker, custodian or other nominee and not have their names appear on the register,
- Be registered shareholders on the CCASS register or on the Issuer register and have full control of their holdings, or
- Be registered shareholders similar to (ii) above but give a broker or custodian the authority to make transfers for ease of trading or for pledging purposes (see also paragraphs 30(f) and 40).
14. The Council would not recommend option (i) because both the shareholdings and the titles are not in the hands of the shareholders. Given the risk of broker defaults, it is important that shareholders should retain the option of keeping scripless holdings under their own control and registering them in their own names.
15. Registration in shareholders' own names would enable the shareholders to directly receive corporate communications which are not normally available to investors who are not registered shareholders. This facilitates communications between listed companies and their member shareholders.
16. As discussed in paragraph 45 of the Consultation Paper, retaining control of holdings involves a trade-off between trading efficiency and risk of misappropriation by an intermediary. With option (ii), if shareholders retain control of their shareholdings, the risk of misappropriation by intermediary would be reduced, but would still exist in the settlement process. With option (iii), if shareholders give control of their registered shareholdings to an intermediary, trading efficiency would be enhanced, but there would still be a risk of misappropriation.
Auditing of the system
17. The integrity of the scripless system is of the utmost importance and should not be placed in a position where it could be compromised through either error or malpractice. The Council considers that the integrity of the system should be maintained up to a standard that ensures it is a 'trustworthy system'; i.e. one with clear guiding principles and high standards of security and risk management. Appropriate independent auditing procedures should be developed to ensure a high degree of trustworthiness in the system.
18. The Council suggests the Electronic Transactions Ordinance could be used as an example. This legislation has provisions that require an assessment report to be prepared by a qualified and independent person approved by the Director of the Information Technology Services Department, under a Code of Practice for Recognized Certification Authorities. The report covers matters regarding the trustworthiness of each Recognized Certification Authority's digital signature certification service; including assurances on technical aspects of the system used for the certification process, as well as procedural issues.
19. Recent high profile failures on the integrity of auditing processes, such as the Enron case, have heightened public concerns on the trustworthiness of auditing systems generally. It is in the Government's interest that the public's perception of the trustworthiness of the scripless system does not suffer a loss of confidence, from the absence of appropriate auditing safeguards.
20. The Council suggests that similar provisions to those found in the Electronic Transactions Ordinance could be introduced to require assurances as to the trustworthiness of the scripless system.
