HONG KONG 2004 - Financial and Monetary Affairs

Hong Kong maintains a three-tier system of deposit-taking institutions, namely, licensed banks, restricted licence banks and deposit-taking companies. They are collectively known as authorised institutions (AIs) under the Banking Ordinance. The Hong Kong Monetary Authority (HKMA) is the licensing authority for all three types of AIs.

Only licensed banks may conduct full banking services, including in particular the provision of current and savings accounts and acceptance of deposits of any size and maturity. Restricted licence banks may take deposits of any maturity of $500,000 or above. Deposit-taking companies may take deposits of $100,000 or above with an original maturity of at least three months. Many deposit-taking companies are owned by, or otherwise associated with, licensed banks.

Hong Kong has one of the highest concentrations of banking institutions in the world. As at December 2004, there were 133 licensed banks, 40 restricted licence banks and 35 deposit-taking companies, which included operations of banks from 31 countries around the world. These 208 AIs maintained an extensive network of 1 285 local branches. In addition, there were 85 representative offices of overseas banks in Hong Kong. A local representative office is not allowed to engage in any banking business. Its role is confined to liaison work between the bank and its customers in Hong Kong.

The total deposit liabilities of all AIs to customers and the total loans and advances extended by these institutions at year-end were $3,866 billion and $2,156 billion, respectively. The total assets of all AIs amounted to $7,137 billion.

Hong Kong has a robust interbank payment system, which operates through the Real Time Gross Settlement (RTGS) system. The Hong Kong dollar RTGS system has a single-tier settlement structure, with all banks maintaining settlement accounts with the HKMA. All RTGS payment transactions are settled in real time across the books of the HKMA. Intraday liquidity can be obtained by the banks through the use of their Exchange Fund Bills and Notes for intraday repurchase (repo) agreements with the HKMA.

Leveraging on the experience with the Hong Kong dollar RTGS system, the HKMA introduced the US dollar RTGS system in August 2000. The system allows participants to settle US dollar transactions real-time in the Asian time zone, thereby reducing or eliminating foreign exchange settlement risk caused by any time gap. Since its full implementation, the system has been operating smoothly and has attracted an increasing number of participants. As at December 2004, there were 68 direct participants and 164 indirect participants. Among the indirect participants, 119 were from overseas. Turnover of the system grew to 5 000 transactions per day with a total value of over US$5.5 billion.

With a view to further enhancing the financial infrastructure in Hong Kong, the HKMA launched a euro RTGS system in April 2003. Similar to the technology used for the Hong Kong dollar and US dollar RTGS systems, the euro RTGS system is built on the same infrastructure and offers a range of advanced and sophisticated clearing functions. The key functions include the real-time gross settlement for euro payments and for payment versus payment (PvP) between euro and US dollar or euro and Hong Kong dollar foreign exchange transactions. The system also maintains a seamless interface with the Central Moneymarkets Unit (CMU) to cater to the delivery versus payment (DvP) of euro denominated debt securities and repo facilities. At the end of 2004, there were 23 direct participants and 21 indirect participants, of which 11 were outside Hong Kong. In 2004, the euro RTGS system registered an average turnover of EUR923 million on a daily basis.

The CMU Service, established in 1990, is operated by the HKMA to provide a clearing and custodian system for Exchange Fund Bills and Notes, as well as private sector debt issues. There are 172 CMU members, most of which are financial institutions in Hong Kong. At year-end, there were 1 326 issues with a total value of $237.2 billion equivalent lodged with the CMU. The CMU system accepts both Hong Kong dollar and foreign currency denominated debt instruments. It has been fully integrated with interbank payment systems, and is linked up with international central securities depositories like Euroclear and Clearstream to enable overseas investors to trade CMU securities. It also has established links with the regional central securities depositories in Australia, New Zealand and the Republic of Korea.

Through a seamless interface with the US dollar and euro RTGS systems, the CMU enables members to settle US dollar and Euro securities on a DvP basis, thereby enhancing settlement efficiency and eliminating settlement risk. The interface also enables automatic intraday repo to provide intraday liquidity to participants of the US dollar and euro RTGS systems.

To further eliminate settlement risks, the HKMA facilitated inclusion of the Hong Kong dollar into the Continuous Linked Settlement (CLS) System in December 2004, providing an additional channel to settle foreign exchange transactions in a safe and efficient manner. The CLS System is a global clearing and settlement system for cross-border foreign exchange transactions. Inclusion of the Hong Kong dollar into the CLS System enables foreign exchange transactions involving the Hong Kong dollar to be settled through the CLS System on a PvP basis, thus removing the settlement risk in these transactions.

The HKMA was established in April 1993. The Exchange Fund (Amendment) Ordinance 1992 provides for its establishment.

The HKMA's policy objectives are to maintain currency stability, within the framework of the Linked Exchange Rate system, through sound management of the Exchange Fund, monetary policy operations and other means deemed necessary; to promote safety and stability of the banking system through the regulation of banking business and the business of taking deposits, and the supervision of AIs; and to promote efficiency, integrity and development of the financial system, particularly payment and settlement arrangements.

The HKMA is an integral part of the Government, but can employ staff on terms different from those of the Civil Service to attract personnel of the appropriate experience and expertise. Its staff and operating costs are charged directly to the Exchange Fund instead of the general revenue. The HKMA is accountable to the Financial Secretary, who is advised by the Exchange Fund Advisory Committee on matters relating to the control of the Exchange Fund.

The HKMA seeks advice on policy matters routinely from the Banking Advisory Committee and the Deposit-taking Companies Advisory Committee. Both committees are established under the Banking Ordinance. They are chaired by the Financial Secretary and comprise members from the banking industry and other relevant professions. Members of the committees are appointed by the Financial Secretary under the authority delegated by the Chief Executive.

The Banking Ordinance provides the legal framework for banking supervision in Hong Kong. Under the ordinance, the HKMA is the licensing authority responsible for granting and revoking the authorisation of all AIs, as well as the approval and revocation of money broker licences. The HKMA seeks to maintain a regulatory framework that is fully in line with international standards. The objective is to devise a prudential supervisory system to help preserve the general stability and effective working of the banking system while at the same time providing sufficient flexibility for AIs to make commercial decisions. Hong Kong's framework of banking supervision is in line with the Core Principles for Effective Banking Supervision promulgated by the Basel Committee on Banking Supervision (BCBS).

The HKMA's supervisory approach is based on a policy of 'continuous supervision' through a combination of on-site examinations, off-site reviews, prudential meetings, cooperation with external auditors and meetings with boards of directors. Since 2000, the HKMA has been using a risk-based supervisory framework for all AIs. This approach puts emphasis on evaluation of the quality of risk management practices and internal controls in respect of various types of risks faced by AIs. On-site examinations are typically focused on areas of higher risk at AIs.

On the international front, the HKMA continues to promote cooperation among central banks in the region, principally through the Executives' Meeting of East Asia-Pacific Central Banks (EMEAP)⁶, whose activities cover supervisory liaison and cooperation, development of financial markets and infrastructure, and various areas of central bank operations. The HKMA currently chairs the EMEAP Working Group on Financial Markets, and continues to participate in various regional and international forums for banking supervisors. These include the Core Principles Liaison Group established by the BCBS, the EMEAP Working Group on Banking Supervision, the Offshore Group of Banking Supervisors, as well as the South-East Asia, New Zealand and Australia (SEANZA) Forum of Banking Supervisors. To facilitate supervisory training in the region, the HKMA is active in organising seminars for regional bankingsupervisors in collaboration with the BIS Financial Stability Institute. In addition, Hong Kong is an active member of both the Financial Action Task Force on Money Laundering (FATF), and the Asia/Pacific Group on Money Laundering, which are inter-governmental bodies charged with the objective of developing and promoting legal, law enforcement and financial regulation policies to combat money laundering.

In line with its policy of adhering closely to international regulatory standards, the HKMA is committed to adopting the new Basel capital adequacy framework promulgated by the BCBS (commonly referred to as "Basel II") in Hong Kong from January 1, 2007 in accordance with the BCBS timetable. In view of the complexity of Basel II, the HKMA has been working closely with the industry to ensure that the implementation approach is both practicable and appropriate for Hong Kong. Following the publication of Basel II in June 2004, the HKMA issued for public consultation in the third quarter of 2004 a detailed package of implementation proposals. The banking industry endorsed the proposals as a pragmatic means of implementing the new standards in Hong Kong. Recognising the importance of cross-border supervisory cooperation to the implementation of Basel II, the HKMA will continue to interact with overseas supervisors through the exchange of views and experience on relevant practical issues.

The HKMA continued with its efforts to enhance the supervisory framework for the prevention of money laundering and terrorist financing. In June 2004, the HKMA issued a statutory guideline to supplement the existing guideline on Prevention of Money Laundering, together with a set of Interpretative Notes. The supplementary guideline incorporates the latest international standards in this area. The Interpretative Notes were produced in collaboration with the banking industry to provide practical guidance to AIs on implementing the requirements of the supplementary guideline.

The HKMA continued to work closely with the SFC in 2004 on implementation of the new securities regulatory framework, which aims, among other things, to uphold a level playing field between banks and non-bank financial intermediaries in the securities market. In 2004, the two regulators held five meetings in accordance with the arrangements set out in the Memorandum of Understanding between them. There was also reciprocal secondment of staff between the two regulators to facilitate transfer of knowledge and experience. Under the transitional arrangements of the Securities and Futures Ordinance (SFO), AIs with deemed registration status are required to lodge migration applications to become Registered Institutions (RIs) by March 31, 2005 if they intend to continue to carry on regulated activities after this date. As of end-2004, 21 of the 90 AIs with deemed registration status and seven other AIs (being new registrants) had been registered as RIs under the SFO, and the HKMA had granted consent to 99 executive officers (who are responsible for supervising securities-related activities) of these AIs. So far, the names and particulars of over 20 000 securities staff of AIs have been recorded on the HKMA electronic public register. A dedicated enforcement team of HKMA staff was established to deal with AIs' securities-related incidents with potential disciplinary concerns. An enforcement approach consistent with that of the SFC was adopted to ensure that actions taken against individuals and executive officers of RIs were based on the same yardstick used for SFC licensed individuals.

The HKMA continued to implement the policy initiatives contained in the reform programme announced in 1999. The bill to implement the proposed Deposit Protection Scheme was passed by the Legislative Council in May 2004 and the Hong Kong Deposit Protection Board was formed in July to oversee establishment of the scheme. A Commercial Credit Reference Agency (CCRA), through which credit information about small and medium-sized enterprises (SMEs) are shared among AIs, was launched in November 2004. The establishment of the CCRA is an important addition to the banking infrastructure. It will help strengthen the credit risk management of AIs and assist SMEs with good credit history to obtain bank finance.

In view of the increasing number of suspected Automatic Teller Machine (ATM) skimming fraud cases reported in the second half of 2003, the HKMA worked closely with the banking industry and the Hong Kong Police Force to implement measures to combat such fraud. By mid-2004, all ATMs in Hong Kong were adequately protected by measures as recommended in a circular issued by the HKMA on October 14, 2003. All reported ATM fraud cases were satisfactorily settled and no new case has been received since November 2003. To help prevent future ATM fraud, an ATM Fraud Prevention Task Force (comprising the banking industry, the Hong Kong Police Force, ATM network operators and the HKMA) has been established to explore additional ATM security measures and develop a consumer education programme to increase public awareness of ATM security.

Separately, there has been an upsurge of reports concerning fraudulent bank websites and phishing e-mails since mid-2004. Up to the end of 2004, the HKMA has received 42 reports in relation to fraudulent bank websites. The HKMA has taken the matter seriously and issued a circular in June 2004 recommending that AIs introduce two-factor authentication for high-risk retail Internet banking transactions by June 2005 to further strengthen Internet banking security. So far the number of customers who have fallen victim to these phishing scams and suffered financial losses has not been significant in Hong Kong. The HKMA will continue to work with the banking industry and the Hong Kong Police Force to promote awareness of Internet banking fraud through a multi-channel consumer education programme, including educational leaflets, a series of TV episodes and radio segments, and an interactive computer programme on Internet banking security.

One of the functions of the HKMA is to promote and encourage high standards of conduct and sound and prudent business practices among AIs, primarily by way of the Code of Banking Practice. The code is issued by the industry associations and endorsed by the HKMA. It sets out the minimum standards to be followed by AIs in their dealings with personal customers. In 2002, the industry established the Code of Banking Practice Committee, in which the HKMA is represented, to provide guidance on the interpretation of the code and to undertake future reviews from time to time.

On developing financial infrastructure, an inbound link from the China Government Securities Depository Trust & Clearing Co Ltd (CDC) to CMU was established in April 2004 to foster cross-border debt securities settlement between Mainland China and Hong Kong. This is a one-way link facilitating CDC Members (including banks, trust companies and other financial institutions in the Mainland) that are authorised to invest in foreign debt securities to settle and hold Hong Kong and foreign debt securities through the CDC's account with the CMU.

In November 2004, the Clearing and Settlement Systems Ordinance (CSSO) became effective. Under the CSSO, the Monetary Authority is empowered to designate and oversee clearing and settlement systems that are material to the monetary or financial stability of Hong Kong or to the functioning of Hong Kong as an international financial centre. The ordinance also provides statutory backing to the finality of settlement for transactions made through systems designated under the ordinance by protecting the settlement finality from insolvency laws or any other laws. To this end, the Monetary Authority issues certificates of finality to designated systems that meet criteria specified in the ordinance. By the end of 2004, five clearing and settlement systems, including the CMU and Hong Kong dollar Clearing House Automated Transfer System (CHATS), CLS System, US dollar CHATS and euro CHATS, have been designated, and each was issued a certificate of finality.

The securities and futures markets in Hong Kong are operated by the SEHK and the HKFE, respectively. Both the SEHK and the HKFE are wholly owned subsidiaries of HKEx. At year-end, there were 490 exchange participants on the SEHK and 126 exchange participants on the HKFE.

At year-end, there were 892 companies listed on the Main Board of the SEHK with a total market capitalisation of $6,629.2 billion, raising an aggregate of $265.7 billion within the year.

New products continued to be launched in 2004. To meet market demand created by the growth of the H-shares market, an option contract on the H-shares index was launched in June 2004 to complement the H-shares index futures contract (introduced in December 2003). Additional stock options and futures contracts on four H-shares were introduced in June 2004. Two Exchange Traded Funds (ETFs), the Hang Seng Index ETF and the iShares FTSE/Xinhua A50 China Tracker, were also listed on the SEHK.

Securities transactions on HKEx's securities market are executed by the Third Generation Automatic Order Matching and Execution System (AMS/3) which provides facilities and investor access channels that make securities trading more accessible. The system has maintained 100 per cent uptime record for four consecutive years since its launch in October 2000. The AMS/3 provides an electronic platform for trading of equities, debt securities, exchange traded funds, unit trusts/mutual funds, derivative warrants and equity linked instruments.

The Hong Kong Securities Clearing Company Limited (HKSCC), a wholly owned subsidiary of HKEx, operates the third generation of the Central Clearing and Settlement System (CCASS/3) for clearing and settlement of securities transactions at the SEHK. In addition to brokers and custodians, certain CCASS services are also available to retail investors. For example, investors may open Investor Participant Accounts with CCASS to keep their securities separately. The CCASS/3 is an automated book-entry system that operates on an open architecture. The CCASS/3 network is connected to FinNet, which was built to provide a single connection to access major financial services in Hong Kong and improve straight-through processing of financial transactions.

In April 2004, HKEx introduced an integrated clearing and settlement system for its derivatives market, known as the Derivatives Clearing and Settlement System (DCASS), to replace the two separate systems for stock options and futures markets. DCASS shares the same common database and system infrastructure as the Hong Kong Futures Automated Trading System (HKATS). The implementation of DCASS has not only harmonised clearing arrangements for the derivatives market, but also improved the operational efficiency from trading to settlement.

The SFC was established in May 1989 following enactment of the Securities and Futures Commission Ordinance (SFCO). This represented the first important phase in overhauling the regulation of securities and futures markets in Hong Kong, and the implementation of one of the most important recommendations made by the Securities Review Committee in May 1988.

The regulatory objectives of the SFC, as set out in the SFO that came into effect on April 1, 2003, include:

Established as an autonomous statutory body outside the Civil Service, the SFC is responsible for regulating the securities and futures markets in Hong Kong. At end-2004, the SFC had a governing body of 12 directors (five of them executive, with one of them doubling up as Executive Director of Corporate Finance and Chief Operating Officer) appointed by the Chief Executive. The Government is not involved in the day-to-day regulation of the securities and futures industry.

The SFC is funded by the market. No government funding has been sought since 1993. The revised estimate of its operating expenditure budget for 2004-05 (including depreciation) was $477 million.

The SFC seeks advice on policy matters from its Advisory Committee, which comprises three executive directors of the SFC and 11 independent members. The independent members are appointed by the Chief Executive and are broadly based and representative of market users.

Exercise of powers by the SFC is subject to a range of checks and balances. For instance, a wide range of SFC decisions are subject to appeal to the independent Securities and Futures Appeals Tribunal (SFAT) chaired by a High Court judge. In November 2000, a Process Review Panel for the SFC (PRP) was established to undertake an ongoing review of the fairness and consistency of the SFC's internal operational procedures. Members of the PRP are appointed by the Chief Executive. In May 2004, the Government published the PRP's third Annual Report, which concluded that the SFC had generally followed its internal procedures in handling cases and that there was no serious deficiency in the SFC's operational processes. The PRP has made recommendations for improvement in certain area and the SFC has been positive in adopting them.

Broadly speaking, the SFC's work involves licensing, supervision and monitoring of intermediaries; regulation of the public marketing of unit trusts, mutual funds and other collective investment products; regulation of takeovers, mergers and other corporate activities; listing regulation under the dual filing system for IPO applicants and issuers; supervision of markets including the exchanges and clearing houses; enforcement of securities laws and rules; and investor education.

As at year-end, there were 22 373 licensed persons, including securities brokerage firms, futures dealers, and securities margin financiers, as well as their representatives, and 97 registered institutions, such as banks, engaging in regulated activities like dealing and advising on securities and futures.

The SFC considers investor education the first important step to investor protection. In 2004, the SFC produced a documentary-drama series, Foundations in Wealth Management, on investment advisory services and niche products, and jointly produced a television drama series called All About Stock Investing on wide-ranging topics of stock investment with Radio Television Hong Kong (RTHK). It also joined hands with RTHK and the Salvation Army to make an investor education radio programme, Invest Wisely for Seniors.

The SFC introduced the Smart Investor Awards in 2004 to encourage the public to report financial scams to regulators. It also continued to publish the monthly Dr Wise's column to discuss with investors key issues of investing and regulatory thoughts. During 2004, the column covered topics such as IPO investing, concept stocks, warrants, Real Estate Investment Trusts, and fees and charges for holding and trading Hong Kong stocks.

The SFC also maintains an Alert List to warn investors about suspected 'boiler room' operators, scam websites (e.g. copycat websites) and phishing scams. In November, the SFC introduced the new SFC corporate website (www.sfc.hk) and revamped Electronic Investor Resources Centre (www.eirc.hk) to provide the market and investors with more regulatory and educational information.

As in previous years, the SFC also organised a series of investor education workshops for secondary school teachers of Economics, Commerce and related subjects to facilitate their teaching work. Moreover, it has for the first time partnered with Lingnan University to launch a credit-based investor education course for undergraduates.

In the meantime, the SFC remained active in external relations and international activities. During the year, the SFC signed a Letter of Intent each with Indonesia's Ministry of Finance Capital Market Supervisory Agency (Bapepam) and Thailand's Securities and Exchange Commission on the establishment of regulatory cooperation on cross-border trading and the supervision of regulated funds. The SFC also signed a Memorandum Of Understanding with the Philippine Securities and Exchange Commission to establish a framework for mutual assistance and facilitate the exchange of information to enable better market regulation.

The SFC continued to participate in the work of the International Organisation of Securities Commissions (IOSCO), and has chaired the IOSCO Technical Committee since October 2003. Given the importance of effective client identification processes, and to complement the work of the Financial Action Task Force regarding its newly revised Forty Recommendations to combat money laundering, the Technical Committee adopted a statement of Principles on Client Identification and Beneficial Ownership for the Securities Industry, which was endorsed by the Presidents' Committee in May 2004, representing the commitment of the global community of securities regulators to robust standards of client identification for the securities sector.

The IOSCO Technical Committee, together with the Committee on Payment and Settlement Systems of the central banks of the Group of 10 countries (CPSS), released a report entitled Recommendations for Central Counterparties in November 2004. The report sets out comprehensive standards for risk management of central counterparties for both securities and derivatives markets. The SFC participated in the Task Force on Securities Settlement Systems, jointly established by the Technical Committee and the CPSS to formulate these standards.

In December 2004, IOSCO published its Code of Conduct Fundamentals for Credit Rating Agencies (CRAs), which aims to promote investor protection by safeguarding the integrity of the rating process. The SFC actively participated in the Chairmen's Task Force of the IOSCO's Technical Committee, which was responsible for developing the Code.

The Insider Dealing Tribunal has been an important feature of the regulatory framework for the securities market in Hong Kong. Established under the Securities (Insider Dealing) Ordinance, the tribunal looks into cases involving suspected insider dealing referred to it by the Financial Secretary. Since the commencement of its operation in 1994, the tribunal has concluded 16 cases.

With the commencement of the SFO on April 1, 2003, the Insider Dealing Tribunal had been replaced by a Market Misconduct Tribunal (MMT), which covers five other types of market misconduct (namely false trading; price rigging; disclosure of information about prohibited transactions; disclosure of false or misleading information inducing transactions; and stock market manipulation) in addition to insider dealing. The MMT decides cases on the civil standard of proof and can impose a range of civil sanctions, such as ordering the disgorgement of profits, banning a person from trading in SFC regulated financial products and disqualifying a person from directorship or management of a company.

The MMT inquires into market misconduct that occurred on or after April 1, 2003. The Insider Dealing Tribunal continues in existence to inquire into cases of insider dealing that occurred before April 1, 2003.

As an alternative to civil proceedings, market misconduct is subject to criminal prosecution, which, if successful, may result in more severe penalties on conviction, including up to 10 years' imprisonment or a fine of up to $10 million.

The Government, together with the SFC, strives to continue to provide a favourable environment for introducing new financial products, and for their intermediaries.

The SFC published in July 2003 a Code on Real Estate Investment Trusts (REITs) following market consultation. In 2004, based on recommendations of the Taskforce on Overseas Real Estate Investment by REITs, the SFC worked on proposed benchmarks for overseas investments by REITs for public consultation in the first quarter of 2005.

To give greater investment flexibility to funds authorised under the Code on Unit Trusts and Mutual Funds, the SFC relaxed in November the prohibition on investment in real estate after consulting the Committee on Unit Trusts. REITs that are authorised by the SFC are permissible investments following the relaxation.

By the end of 2004, the SFC had authorised 13 retail hedge funds with assets under management of US$1.13 billion. The SFC will review the Guidelines on Hedge Funds within this financial year to strengthen the disclosure standards and provide more flexibility in administering the Guidelines, such as accepting a wider range of experience as qualifying experience in respect of management companies of retail hedge funds.

To facilitate an orderly migration of European funds in Hong Kong to the Undertakings for Collective Investment in Transferable Securities III (UCITS) regime, the SFC proposed to adopt an interim approach to process UCITS III fund applications, provided that investors were fully informed of the new features and risks of UCITS III funds. The SFC will continue to work closely with the fund industry. Extensive investor education and market consultation on UCITS III funds will also be conducted.

In November, the SFC published the consultation conclusions on proposed measures to address analyst conflicts of interest and the final guidelines, having regard to comments made by the industry. The market in general supports the issuance of clearer and specific guidelines, which are scheduled to become effective on April 1, 2005 so that the industry has sufficient time to establish the necessary compliance systems.

In September, the SFC released a consultation paper on proposed measures to strengthen the regulatory framework for licensed firms involved in securities margin financing (SMF). To reduce the risks arising from excessive pooling and re-pledging of margin clients' collateral and aggressive lending by SMF providers, the SFC proposed to introduce a per-firm re-pledging limit and to adjust the haircut percentages under the Financial Resources Rules. Supplementary measures were also proposed. Respondents to the public consultation, which ended in October, generally accepted that the proposed reform was to enhance investor protection. The SFC will continue its dialogue with the industry to identify suitable measures to minimise the risks and allow an appropriate transitional period.

In 2004, the SFC also completed a theme inspection of investment advisers who market financial products to the public. Structural and conduct issues of Hong Kong's financial advisory services sector have been identified and the SFC aims to publish its views in early 2005.

After consulting the public, new guidelines on disclosure of securities services-related fees and charges by banks and brokers were released in November 2004 and will take effect in January 2005. The guidelines recommend disclosure under six standardised categories. Investors will find it easier to understand what they pay for and compare fees and charges of different intermediaries.

In 2004, the SFC began to see positive results from focusing its enforcement resources on fighting corporate misgovernance, market misconduct and intermediaries who are dishonest or put clients at risk. Listed company investigations have substantially increased in number. In the first prosecution under the dual filing regime in September 2004, the SFC successfully prosecuted a listed company and one of its directors for providing false or misleading information. Successful market manipulation prosecutions and referrals to other law enforcement agencies have also been on the increase. For intermediaries, the SFO enables the SFC to impose proportionate and flexible sanctions against misconduct with a disciplinary fining power. The SFC may also settle its disciplinary actions against licensees in appropriate cases, provided it is in the public interest to do so.

Hong Kong is one of the most open insurance centres in the world. At year-end, there were 180 authorised insurers, 91 of which were incorporated in Hong Kong while the remaining 89 were incorporated in 22 countries outside Hong Kong, with the United States taking the lead.

Notwithstanding the economic slowdown, the total gross premiums of the insurance industry reached $102 billion in 2003, representing 14.6 per cent growth over 2002. Gross premiums of the general insurance sector increased by 5.6 per cent to $24.8 billion in 2003. General Liability and Property Damage business attained considerable premium growth. Underwriting performance improved from a profit of $1,243 million in 2002 to $1,343 million in 2003.

The long-term insurance business continued to attain double-digit annual growth from 1991 to 2003, with office premiums increasing by 17.9 per cent to $77.2 billion in 2003. The office premiums in force of Individual Life business amounted to $61.8 billion, accounting for 80.0 per cent of the total office premiums. The number of Individual Life policies in force grew by 7.3 per cent to 5.6 million in 2003.

At year-end, there were 31 683 insurance intermediaries, including 31 207 agents (of whom 1 989 were agency firms) and 476 brokers.

The Commissioner of Insurance, appointed by the Chief Executive as the Insurance Authority (IA), has the principal function (under the Insurance Companies Ordinance (ICO)) to regulate and supervise the insurance industry for the promotion of the general stability of the insurance industry and for the protection of existing and potential policy holders.

The ICO, which prescribes a comprehensive regulatory framework for all classes of insurance business, has the two main objectives of ensuring the financial stability of all insurers authorised in Hong Kong and the fitness and propriety of their management. These objectives are achieved through the prescription of, inter alia, the minimum share capital and the solvency margin requirements, and the requirement for directors and controllers of insurers to be fit and proper persons.

A general business insurer is also required to maintain assets in Hong Kong to meet the claims of Hong Kong policy holders. For life insurance business, a full-fledged appointed actuary system has been implemented to ensure that the insurer would be able to meet its obligations.

Prudential supervision of insurers is carried out mainly through examination of the financial statements, reports of actuaries and other returns submitted by insurers and regular on-site visits. The IA may take appropriate action against an insurer, under the ICO, to safeguard the interests of policy holders. These measures include the limitation of premium income, placing of assets in the IA's custody, assumption of control by a manager appointed by the IA or petitioning for the winding-up of the insurer.

Insurance intermediaries have been brought under the regulation of the ICO since 1995. An insurance agent must be properly appointed by an insurer and an insurer is required to comply with the Code of Practice for the Administration of Insurance Agents in appointing and controlling its agents. An insurance broker must meet certain minimum requirements before he can be authorised.

Self-regulatory measures are in place to strengthen market discipline in the insurance industry. These measures, formulated by the insurance industry in consultation with the IA, include the adoption of a Code of Conduct for Insurers governing the writing of insurance contracts and insurance benefit illustration standards for life insurance policies.

As a member of the International Association of Insurance Supervisors (IAIS), Hong Kong endeavours to ensure that its supervisory standards are in line with the principles and standards developed by the association. It has also established an Insurance Advisory Committee with representatives from the industry as members. The committee was set up pursuant to Section 54 of the ICO for advising the Government on matters relating to the administration of the ICO and the carrying on of insurance business in Hong Kong.

The IA reviews from time to time the regulatory regime of the insurance sector, in relation to operational experience, market development and international trends to ensure its effectiveness. In the process, it maintains close liaison with industry bodies and overseas regulators. In 2004, the IA also issued guidelines for enhancement of the regulatory regime. It issued in June a Guidance Note on Asset Management by Authorized Insurers (GN13). The Guidance Note aims to tighten up control over investment/asset risks and to ensure that the asset management system of authorised insurers complies with the minimum standard.

The existing self-regulatory system for insurance intermediaries has been in operation since 1995. In recent years, there have been rapid developments in the industry, such as the growing number of insurance intermediaries and the increasing sophistication of insurance products. There is also a rising public expectation for better protection for the insured. The IA considers that there is a need to enhance the existing system. The relevant self-regulatory organisations (SROs) were consulted on possible improvements to the existing regulatory regime. On the basis of the industry's comments, the IA is in the process of liaising with the SROs to implement a number of proposals. These include the strengthening of on-site compliance inspection of insurance intermediaries and reinforcement of the requirements relating to policy replacement. The IA will continue to liaise with the industry and parties concerned to enhance the regulatory system for insurance intermediaries and further protect the interests of the insuring public.

In the light of international regulatory trends and developments of the insurance industry, the Government is reviewing the institutional set-up of the IA. The review entails a study on turning the IA into a regulatory agency independent of the Government.

The IA has commissioned a consultancy study on the need and feasibility of establishing Policyholders' Protection Funds (PPFs) in Hong Kong. Stage 1 of the study comprises a review of the existing regulatory regime and a feasibility study on establishing PPFs in Hong Kong. The Consultant is working on the final report for Stage 1 for consideration by the Government, which keeps an open mind on the matter.

To examine the need for enhancing the supervisory framework of the assets of long-term business insurers, the IA commissioned another consultancy study in September 2003. The study focuses on the appropriate framework for asset valuation and the need for a mechanism that better safeguards the interest of Hong Kong policy holders in the event of failures of long-term insurers. The first stage of the study includes a review of the existing regulatory framework as well as international practice. Stakeholders will be consulted in the process.

To strengthen the cooperation of insurance regulators in Hong Kong and the Mainland, the IA and the China Insurance Regulatory Commission (CIRC) entered into a Cooperative Agreement on insurance supervision in November 2004. The Agreement seeks to promote efficient, fair and stable insurance markets in both Hong Kong and the Mainland for the benefit and protection of policy holders, by providing a framework for cooperation, mutual understanding, the exchange of information and assistance.

The IA also regularly attends joint meetings of the insurance regulators of Guangzhou, Hong Kong, Macao and Shenzhen to discuss issues of common interest.

Retirement Protection Schemes: Mandatory Provident Fund Schemes and Occupational Retirement Schemes

On December 1, 2000, the Mandatory Provident Fund (MPF) System was implemented to help encourage the workforce to save and invest for their retirement protection. The system, which was formulated after extensive consultation, is a privately managed, employment-related mandatory system of provident fund schemes. Unless exempted, employees and self-employed persons aged between 18 and 65 are required to participate in MPF schemes.

The MPF system provides for joint contributions by the employer and employee, each contributing five per cent of the employee's relevant income to a registered MPF trust scheme, subject to the maximum and minimum levels of income for contribution purposes. The accrued benefits are fully vested in the scheme members and can be transferred from scheme to scheme when employees change employment or cease to be employed. A self-employed person has to contribute five per cent of his or her relevant income. In normal circumstances, benefits must be preserved until the scheme member attains the retirement age of 65.

By year-end, 97.9 per cent of employers (i.e. about 223 400), 96.2 per cent of relevant employees (1 817 400) and 79.6 per cent of self-employed persons (294 200) had enrolled in MPF schemes. Total MPF assets amounted to about $120.18 billion, with monthly MPF contributions amounting to around $2 billion.

Unlike the compulsory MPF schemes, occupational retirement schemes (ORSO schemes) registered under the Occupational Retirement Schemes Ordinance (ORSO) are voluntary schemes established by employers. The objective of the ORSO is to regulate such schemes through a registration system to ensure that they are properly administered and funded. All registered schemes must meet certain requirements, including asset separation, independent trusteeship, restricted investments, funding, independent audit, actuarial reviews, information disclosure and the submission of audited financial statements to the Registrar of Occupational Retirement Schemes.

To tie in with the implementation of the MPF System, ORSO schemes that fulfilled certain conditions were exempted from MPF requirements. Members of such schemes may choose to remain in the existing scheme or join an MPF scheme. At year-end, there were 5 317 MPF-exempted ORSO schemes covering over 500 000 employees.

The Mandatory Provident Fund Schemes Authority (MPFA) was set up in September 1998 under the Mandatory Provident Fund Schemes Ordinance (MPFSO). It is tasked with the responsibility of regulating and supervising the MPF System and ensuring compliance with the MPFSO. Two statutory committees, the MPF Schemes Advisory Committee and the MPF Industry Schemes Committee, have been established to advise the MPFA on the overall operation of the MPFSO and the Industry Schemes respectively. The MPF Schemes Appeal Board has also been set up under the MPFSO to hear appeals against relevant decisions of the MPFA.

To ensure that the interests of MPF scheme members are protected, the MPFA closely monitors the operation of MPF trustees and other service providers, investigates complaints about non-compliance and takes enforcement actions accordingly. Proactive inspections are carried out at business premises to ensure compliance of employers in enrolling their employees in MPF schemes and making contributions. The MPFA also educates the public on the need for retirement protection and on the MPF System, with an emphasis on investor education. Some of the educational activities were held in conjunction with other bodies (e.g. the Hong Kong Investment Funds Association and labour unions).

The MPFA is also the Registrar of Occupational Retirement Schemes.

To enhance the effectiveness and efficiency of the MPF System, the MPFA continues to review the MPF legislation in the light of operational experience. A number of amendments to the legislation related to operational and technical issues were enacted in 2002. The MPFA is continuing to deliberate on further proposed amendments covering investment regulation, scheme administration and enforcement.

The MPFA also initiated a project in late 2002 to review and improve the disclosure of information about fees, charges and fund performance of MPF products, to enable scheme members to make informed investment decisions. Having consulted the industry and other stakeholders, the MPFA issued a Code on Disclosure for MPF Investment Funds in June 2004 for phased implementation of key reforms, including those related to expense ratios, fee tables and fund fact sheets. Meanwhile, the MPFA is making proposals for improvements to member benefit statements.