Press Release
LCQ1: Brokerage-free internet securities trading
Wednesday, June 14, 2000
Following is a question by the Hon Fung Chi-kin and a reply by the Secretary for Financial Services, Mr Stephen Ip, in the Legislative Council today (June 14):
Question:
Recently, a securities company provides brokerage-free Internet securities trading services to its new clients. The company is a registered securities dealer, but not an Exchange Participant of the Stock Exchange of Hong Kong. In this connection, will the Government inform this Council:
(a) whether the rules and regulations that should be observed by securities dealers who are not Exchange Participants and the level of supervision on them are the same as those for Exchange Participants; if not, of the reasons for that;
(b) given that investors involved in such brokerage-free Internet securities trading are not covered by the Unified Exchange Compensation Fund, how the authorities can ensure that these investors are properly protected; and
(c) whether it has assessed if these brokerage-free securities trading services will lead to vicious competition in the securities industry; if the assessment result is in the positive, of the measures it will adopt; if the result is in the negative, of the justifications for that?
Reply:
Madam President,
(a) Under the Securities Ordinance, any business entity which carries on a business of dealing in securities or giving advice on investment in securities in Hong Kong is required to be registered as a dealer or an adviser with the Securities and Futures Commission ("SFC"). The registration requirements relating to securities dealers and investment advisers are set out in Part VI of the Securities Ordinance. Persons who are responsible for the supervision of business of dealing in securities or that of business as an investment adviser are also required to be registered as dealers or advisers. Also, no person can act as a dealer's representative or act as an investment representative unless he is registered as such. At the same time, any person or business entity intending to engage directly in the trading of securities directly on the Stock Exchange of Hong Kong ("SEHK") must first become an "exchange participant", formerly known as a member of the SEHK before the merger of the exchanges, and comply with the rules made by the SEHK. Securities dealers who are not exchange participants can only trade securities on the SEHK through an exchange participant.
All securities dealers registered with the SFC, be they exchange participants or not, must observe the relevant ordinances and subsidiary legislation and are subject to the same rules and regulations laid down by the SFC. Both exchange participant dealers and non-exchange participant dealers are subject to the same level of supervision by the SFC.
(b) The Unified Exchange Compensation Fund ("UECF") is established and managed according to the provisions of the Securities Ordinance. It is basically an SEHK-based compensation mechanism for investors, covering only clients of exchange participants. Under the Ordinance, the SFC is responsible for maintaining and administering the operation of the UECF. The SEHK is required to deposit a sum of $50,000 with the UECF in respect of each trading right of each of its exchange participant as the basic source of funding for the UECF. Between 1991 and 1994, the SEHK also injected into the UECF 0.001 percentage point of its receivable income from the transaction levy, with a view to raising the reserve of the Compensation Fund to a prudential level. In early 1998, following the collapse of several securities companies, the SEHK and the SFC agreed to make additional injections totaling $600 million into the UECF to meet compensation claims from the affected clients.
A securities company has recently offered to provide brokerage commission-free Internet securities trading services. Although the securities company concerned is associated with another securities firm which is an exchange participant, the company itself is not an exchange participant. Therefore, clients of the securities company are not covered by the UECF.
The SFC and the SEHK have recently reminded investors through the media that clients of non-exchange participants are not covered by the UECF. Under the Code of Conduct for registered dealers issued by the SFC, a registered dealer is required to disclose adequate information in its dealing with its clients, thus enabling investors to know the extent of protection they have. At the same time, each exchange participant is required by the Rules of the SEHK to display at its place of business its exchange participant certificate or branch certificate issued by the SEHK, as the case may be, for identification purpose.
The SFC issued a consultation document in September 1998 to consult public views on new investor compensation arrangements. The Securities and Futures Bill currently published in the form of a White Bill for public consultation provides a flexible framework for the future compensation scheme, enabling it to cover other types of market intermediaries, including non-exchange participant dealers, in addition to exchange participants. The SFC is now undertaking a detailed study of the new compensation scheme in order to work out its mode of operation, financial requirements and substantive compensation arrangements. It is envisaged that the new compensation scheme would be put in place as soon as possible after the enactment and implementation of the Securities and Futures Ordinance.
I must however emphasis that the spirit of protecting investors does not lie in the establishment of a compensation mechanism for them. It is more important to enhance the integrity of the dealers and avoid defaults as far as possible by way of effective regulation. To ensure that all securities dealers (whether they are exchange participants or not) carry out trading for clients and manage their assets properly and honestly, securities dealers are required under the existing regulatory framework to meet the Fit and Proper Criteria laid down by the SFC. They are also required to observe all the relevant regulations including the Financial Resources Rules and the Internal Control Guidelines. The Financial Resources Rules stipulate that all registered securities dealers should maintain a certain amount of current assets to ensure that they are financially sound and capable to run their business. These Rules apply to both exchange participant dealers and non-exchange participant dealers. All of them are required to issue agreements and trading contracts to their clients, keep the documents and records relating to the transactions properly and deposit the clients' funds in designated trust accounts. The new Financial Resources Rules, effective from 12 June further raise the requirement on the financial resources of intermediaries and strengthen supervision over them to provide better protection for investors.
(c) The existing Rules of the SEHK stipulate that all its exchange participants should charge their clients brokerage commission at a minimum rate of 0.25% of the transaction value. Securities companies which are not exchange participants are however not bound by this requirement. Although the company providing brokerage-free services recently is associated with another securities firm which is an exchange participant, it is not an exchange participant itself. We understand that their mode of operation is to receive clients' orders through the non-exchange participant and have the transactions carried out on the SEHK through the associated company which is an exchange participant. The brokerage commission is paid by the non-exchange participant for the clients to the exchange participant. This practice does not violate any relevant legislation or rule. Some members of the brokerage industry have expressed concern over such business strategy and are worried that this might lead to vicious competition in the securities industry. Our stance is that the Government should not interfere with any legitimate commercial activities or inhibit free competition in any sector. The US and UK experience suggests that the removal of minimum commission does not necessarily mean that the small brokers would not survive. One of the special features of the Hong Kong market is that there is a very active retail sector. The local small brokers have over the years established their retail network and provided relatively more personalised services, which would be difficult to substitute regardless of the level of commission. To avoid being replaced under the force of free competition, it is important for the industry to enhance both its competitiveness and the value of the services it offers to clients.
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