CSj looks at the latest proposals for implementing a paperless securities market in Hong Kong.
On 28 January 2019, the Securities and Futures Commission (SFC), Hong Kong Exchanges and Clearing Ltd (HKEX) and the Federation of Share Registrars Ltd (FSR) issued a joint consultation paper on a model for implementing an uncertificated securities market (USM) – a paperless securities market in which investors can hold and transfer securities in their own name without share certificates or other paper documents – in Hong Kong.
The model put forward in the 2019 consultation aims to address the market concerns that sunk the previous model for implementing the USM initiative – the 2010 Model. Feedback on the consultation indicated support for the proposals and, in April 2020, the SFC, HKEX and the FSR released their consultation conclusions. They hope to further develop the Revised Model and the regulatory framework to support it with a view to implementing the USM regime from 2022.
The new proposals
The Revised Model builds on the 2010 Model but retains some of the existing structures in the market. Currently, most investors in listed securities hold and transfer their securities through the Central Clearing and Settlement System (CCASS) where the securities are held under the name of a single nominee – HKSCC Nominees Ltd (HKSCC). This means that investors only hold and transfer the beneficial interest in the securities and not the legal title to them. Under the Revised Model, investors will continue to be able to hold their securities via the same account types available in CCASS and holdings in these accounts will continue to be registered in the name of HKSCC as they are now.
The Revised Model proposes, however, to create two new account categories – ‘USI’ accounts for ordinary investors and ‘USS’ accounts for institutional investors – which will allow investors to hold uncertificated securities in their own names. The USI accounts will be housed in the relevant issuer’s share registrar’s systems outside the HKEX system. The USS accounts will be sponsored and managed by a clearing or custodian participant (CP) within the HKEX system. The USS account is specifically designed to meet the needs of institutional investors (such as global funds) who, for regulatory or other reasons, may need to hold securities in their own name but also have them managed by a local custodian.
Both USI holders and USS holders will receive regular statements of their registered holdings. In the case of USI holders, these will be provided by the relevant issuer’s share registrar that has been approved by the SFC under the new share registrar regime (see below). In the case of USS holders, these will be provided by its sponsoring CP via the HKEX system.
Additionally, the Revised Model proposes to require issuers to send an electronic confirmation to investors to whom uncertificated securities have been successfully allotted or transferred in their own name. This requirement is designed to provide added comfort to investors that the allotment or transfer process has been duly completed and that the securities in question have been duly registered in their names.
Under the Revised Model, there will be no need to split the the register of members (ROM) into two parts as was proposed under the 2010 Model. This is because the movement of securities between accounts within the HKEX system will, in most cases, entail no change in legal title, which means there is no need for the records of such movements to constitute part of the ROM. The ROM will therefore continue to be kept and maintained solely by the issuer’s share registrar as is the case today.
The new share registrar regime
Under the Revised Model, share registrars will take on the role of evidencing, and effecting transfers of, legal title to listed securities without paper documents. As such, they will be critical to establishing and tracing investors’ proprietary rights in such securities. A new participant category will be introduced in the HKEX system – registrar participants. Given that the role and functions of share registrars are very different from those of other clearing or custodian participants, it follows that their rights and obligations within the system will also be very different.
Their systems will also need to interface with the HKEX system. Regulators are therefore keen to ensure that they have sufficient supervisory, investigatory and regulatory powers to be able to monitor the management of share registrars’ systems and processes. Currently, there is no requirement for share registrars to be approved by the SFC. Instead, the SFC has only an indirect regulatory handle over them by virtue of Part 4 of the Stock Market (Listing) Rules (SMLR). That Part requires every corporation whose securities are, or are to be, listed to be or employ a share registrar who is a member of an association approved by the SFC. Only one association has been approved by the SFC to date – the FSR.
The Revised Model proposes that the approval and regulation of share registrars be set out in a new piece of subsidiary legislation and that:
- the SFC’s investigation and supervision powers under Part VIII of the Securities and Futures Ordinance (Cap 571, SFO) be suitably expanded so as to cover the regulation of share registrars, and
- the rule-making powers under the SFO that provide for the approval and regulation of share registrars be more specifically set out for better clarity and certainty.
The governance implications
In 1988, the Ian Hay Davison Report proposed ‘dematerialisation’ – abolishing paper share certificates – for the first time in Hong Kong. Three consultation exercises and a raft of primary law amendments later, Hong Kong investors are still denied the ability to hold their shares in paperless or uncertificated form.
The failure to implement this reform has significant governance implications. The current settlement system in Hong Kong means that companies don’t always know who their actual investors are. Shares can be traded electronically, but they are considered to be still in paper form and held by HKSCC in a central depository linked to the settlement system. The paper securities are ‘immobilised’ in this central depository and do not need to be moved or re-registered every time they are bought or sold. Only the beneficial interest in the securities is transferred when the shares ‘change hands’ – legal ownership of the securities remains with HKSCC.
This arrangement has been a hurdle to better shareholder engagement. Corporate communications and proxy voting materials often do not reach the actual owners of the shares since they are not the registered holders of the shares. Moving to a system where share owners have legal title to their shares will mean that companies will have new opportunities for improving shareholder transparency and corporate communications. The primary aim of the USM initiative therefore is to make it easier for investors to hold securities in their own names.
More information is available on the websites of the Securities and Futures Commission (www.sfc.hk), Hong Kong Exchanges and Clearing Ltd (www.hkex.com.hk) and the Federation of Share Registrars Ltd (www.fedsrltd.com).
1988 – The Ian Hay Davison Report proposes ‘dematerialisation’ – abolishing paper share certificates.
2002 – The Securities and Futures Commission (SFC) conducts its first consultation on paperless shares.
2003 – Hong Kong Exchanges and Clearing Ltd (HKEX) conducts its first consultation on paperless shares – both the SFC and HKEX consultations fail to drum up sufficient support from investors and brokers for the operational model proposed.
2009 – The SFC, HKEX and the Federation of Share Registrars Ltd (FSR) set up a Working Group to put forward new proposals. Public consultations on these proposals are conducted from December 2009 to March 2010.
2010 – The conclusions to the 2009 consultation are published.
2015 – Primary law amendments are enacted to support the 2010 Model. These amendments are not subsequently implemented since the 2010 Model fails to be adopted by the market.
2019 – The SFC, HKEX and the FSR issue a joint consultation paper on a revised operational model for implementing an uncertificated securities market in Hong Kong.
2020 – The conclusions to the 2019 consultation are published.
2022 – Proposed implementation date for the USM regime.