HKSI Paper 3 (Regulation of Derivatives) English Free Trial

Licensed corporations are required to give their staff appropriate training on money laundering issues, and on a frequency sufficient to maintain their knowledge and competence. Staff should be aware of:
(a) the obligations of both the licensed corporation and the individual, and the possible consequence of failing to comply with these obligations under applicable legislation;
(b) the policies and procedures of the licensed corporation relating to anti-money laundering, including the identification and reporting of suspicious transactions; and
(c) new and emerging ways that money laundering might be engaged in, to the extent such information is needed by the staff to carry out their roles

Price rigging takes place when a person:
(a) enters into a sale or purchase of securities that does not involve a change in the beneficial ownership of those securities, which has the effect of maintaining, increasing, reducing, stabilizing or causing fluctuations in the price of securities; or
(b) enters into or carries out a fictitious or artificial transaction or device, intentionally or recklessly, which has the effect of maintaining, increasing, reducing, stabilizing or causing fluctuations in the price of securities or futures contracts.

Certain persons are exempt from this prohibition (i.e. persons on whom an intermediary may make an unsolicited call) and they include:
(a) existing clients;
(b) licensed persons;
(c) registered institutions;
(d) PIs;
(e) solicitors or certified public accountants acting in their professional capacity; and
(f) money lenders.

There are four categories of HKFE Participants for which HKFE will grant authorisation.
The four categories are:
(a) Trader – entitled to trade in contracts on its own account only;
(b) Broker – entitled to trade in contracts on its own account and may also act as the agent of an HKFE Participant for the sole purpose of concluding trades but cannot carry a trading account for such participant;
(c) Futures Commission Merchant – entitled to trade in contracts on its own account, for the account of other HKFE Participants and for the account of any other persons; and
(d) Merchant Trader – entitled to trade in contracts only on its own account and only ancillary to its principal business or that of its holding company.

A licensed or registered person should ensure adequate testing of the algorithmic trading system and trading algorithms it uses or provides to clients for use, and any subsequent developments and modifications before deployment to ensure that:
(a) the system and trading algorithms will operate as designed;
(b) foreseeable extreme market circumstances and the characteristics of different trading sessions have been taken into consideration in their design and development; and
(c) the operation of a fair and orderly market would not be interfered with.

The procedures related to dealing practices should include:
(a) ensuring that staff trading activities are not prejudicial to the interests of clients; this is usually achieved by requiring:
(i) staff members to disclose to the intermediary, on joining and regularly afterwards (at least semi-annually), details of securities and futures contract holdings and trading activities in which they have an interest;
(ii) staff members to trade through staff accounts; and
(iii) all transactions for staff accounts to be separately recorded and monitored by independent senior management;
(b) defining the limits to staff accepting gifts, rebates, benefits-in-kind or “soft-dollar” benefits from clients or other business contacts;
(c) enforcing the disclosure of any interest in a transaction to clients; and
(d) ensuring that order handling procedures are clearly followed by staff.

The objective of the AMLO is to enhance the anti-money laundering regime in Hong Kong for the financial sector, including banking, securities, insurance and remittance, and money changing.

The conditions for the granting of a licence are set out in ss. 116 and 118, SFO. The basic requirements are that the applicant:
(a) is a company; will be able to comply with the Securities and Futures (Financial Resources) Rules (“FRR”);
(b) is fit and proper to be licensed for that regulated activity (the matters that the SFC will consider when deciding whether a company or an individual is fit and proper are covered later in this Topic);
(c) has either lodged the required security or carries insurance that complies with the Securities and Futures (Insurance) Rules, which the SFC has made under s. 116, SFO;
(d) has suitable premises; and
(e) has at least one responsible officer to be available at all times to supervise the business of the regulated activity for which the corporation is licensed.

Cash trading functions include:
(a) serving and recruiting cash market exchange participants and structured product issuers;
(b) managing the business and operations for the trading of cash market products such as equities, derivative warrants, callable bull/bear contracts, debt securities, exchange traded funds and other listed equity instruments;
(c) developing the rules and policies for secondary market trading;
(d) administering and monitoring the cash trading system;
(e) ensuring the trading environment is transparent, fair, orderly and efficient as in accordance with the relevant rules and regulations of the exchange; and
(f) administering the admissions for exchange and clearing participants.

The provisions of the Code of Conduct in this area cover obligations under the Financial Dispute Resolution Scheme (“FDRS”), employee dealings, responsibility for acts of employees, and complaints and circumstances calling for reports to the SFC.

The following information of all omnibus accounts is required to be kept:
(a) the name of the client and an indication as to whether it is an exchange participant of HKFE ;
(b) the title of the account in the books of the licensed or registered person;
(c) the client’s address;
(d) whether a transaction in the account is an HKFE trade or a non-HKFE trade; and
(e) whether the client is a registered dealer and whether the client is authorised to operate an omnibus account under the SFO or the laws of its relevant jurisdiction.

A client agreement should contain at least the following:
(a) the full name and address of the client (verified by a reliable proof) and the licensed or registered person;
(b) undertakings by the licensed or registered person and the client to notify material changes of information to each other;
(c) a full description of the services to be provided and the charges to be paid by the client, with details of any special services (e.g. margin financing, discretionary account and/or derivatives trading;
(d) in the case of derivative products, including futures contracts or options:
(i) a statement that related product specifications and any prospectuses or other offering documents will be provided to the client on request; and
(ii) a full explanation of margin procedures, including situations where the client’s positions may be closed without the client’s consent, as well as the need to report to HKFE and the SFC, if margins are not paid on time

the minimum voting power at general meetings of a corporation for a person to be a controlling entity of that corporation is 20%

Guidelines on CPT set out the following as relevant topics for CPT purposes.
(a) For licensees generally:
(i) applicable compliance, legislative and regulatory standards;
(ii) business conduct and ethical standards;
(iii) new financial products in the industry and the associated risk management systems;
(iv) business communication skills and trade practices;
(v) general law principles;
(vi) computer knowledge;
(vii) basic accounting theories; and
(viii) fundamental economic analysis.

(b) For responsible officers, in addition to the above topics:
(i) business management;
(ii) risk management and control strategy;
(iii) general management and supervisory skills;
(iv) macro and micro economic analysis; and
(v) financial reporting and quantitative analysis.

Within one business day of receiving or holding client money, the licensed corporation or associated entity should pay the money:
(a) into a segregated account;
(b) to the client directly;
(c) in accordance with a written direction; or
(d) in accordance with a standing authority

Examples of assets that cannot be included as liquid assets (even with a haircut) are:
(a) assets owned by the licensed corporation but provided to others as security for its liabilities or obligations (unless the security interest is granted to a bank or another licensed corporation or for margin); and
(b) assets in a foreign currency that cannot be freely remitted to Hong Kong.

A licensed corporation must:
(a) as soon as reasonably practicable, notify the SFC in writing if it is unable to comply with the specified amounts of capital, and immediately cease to carry on the regulated activity, unless otherwise permitted by the SFC; or
(b) within one business day, notify the SFC in writing if it is unable to comply with other requirements of the FRR.

The SFC has issued three important guidelines in this regard:
(a) Fit and Proper Guidelines;
(b) Guidelines on Competence; and
(c) Guidelines on CPT

The only products of significance for the present Topic are those that meet the definition of futures contracts, which include:
(a) contracts for differences (which meet either the futures contract or options on futures contract definitions);
(b) forward contracts (but only when they are traded on an exchange); and
(c) futures contracts and option contracts (where these are options on futures contracts and traded on an exchange).

Enforcement Division
(a) enforces the SFO;
(b) monitors the trading of Hong Kong’s stock and derivative markets and inquires into irregularities;
(c) disciplines dishonest regulated intermediaries and those who are responsible;
(d) inspects the books and records of listed companies if impropriety is suspected, which may involve directors, officers or substantial shareholders etc.;
(e) reports suspected market misconduct to the Financial Secretary; and
(f) co-operates with domestic and overseas regulatory bodies in local and overseas investigations

HKEX, HKFE and HKCC (the associated clearing house) are required to ensure that:
(a) an orderly, informed and fair market in securities or futures contracts traded on the stock market or futures market is operated by HKEX or through its facilities;
(b) an orderly, informed and fair market in over-the-count (“OTC”) derivative products traded through the facilities of HKEX;
(c) there are orderly, fair and expeditious clearing and settlement arrangements for any transactions in securities, futures contracts or OTC derivative products cleared or settled under its auspices;
(d) the risks associated with its businesses and operations are managed prudently; and
(e) any legal requirement imposed on HKEX or its associated clearing houses is complied with.

Products traded on SGX-DT include:
(a) Eurodollar futures and options;
(b) Euroyen LIBOR futures and options;
(c) Nikkei 225 futures and options;
(d) MSCI Taiwan index futures and options; and
(e) Straits Times index futures

Products traded on Eurex Exchange include:
(a) interest rate derivatives;
(b) equity derivatives;
(c) equity index derivatives; and
(d) volatility derivatives.

A guarantee company is one that:
(a) does not have a share capital; and
(b) the liability of its members is limited by the company’s articles to the amount that the members undertake to contribute to the assets of the company in the event of its being wound up.

HKFE Participants must not:
(a) carry out or take part in any transaction that is or are likely to create or maintain an artificial price in futures contracts;
(b) do anything that might create a false or misleading appearance of active trading in futures contracts;
(c) enter into or carry out any fictitious or artificial transaction or device to maintain, increase or reduce the price of futures contracts;
(d) create or attempt to create a corner (appearance or actual harbouring of positions) or otherwise deal for the purpose of manipulating prices (whether of futures contracts or underlying instruments); or
(e) allow their company to be used as a conduit for any unlawful dealing in differences in market quotations of commodities (including gambling or gambling with respect to such items).

Cash trading functions include:
(a) serving and recruiting cash market exchange participants and structured product issuers;
(b) managing the business and operations for the trading of cash market products such as equities, derivative warrants, callable bull/bear contracts, debt securities, exchange traded funds and other listed equity instruments;
(c) developing the rules and policies for secondary market trading;
(d) administering and monitoring the cash trading system;
(e) ensuring the trading environment is transparent, fair, orderly and efficient as in accordance with the relevant rules and regulations of the exchange; and
(f) administering the admissions for exchange and clearing participants.

A block trade must be executed in a prescribed manner, within the prescribed trading hours and satisfy prescribed criteria to be considered as a valid trade by HKFE and be registered and cleared by HKCC. The criteria to be satisfied are as follows:
(a) The block trade must be transacted in block trade contracts designated by HKFE.
(b) The order must be at or above the minimum volume threshold and the participant must have received instructions (or been specifically authorised) to execute the order as a block trade. The minimum volume thresholds are different for different products

A block trade must be executed in a prescribed manner, within the prescribed trading hours and satisfy prescribed criteria to be considered as a valid trade by HKFE and be registered and cleared by HKCC. The criteria to be satisfied are as follows:
(a) The block trade must be transacted in block trade contracts designated by HKFE.
(b) The order must be at or above the minimum volume threshold and the participant must have received instructions (or been specifically authorised) to execute the order as a block trade. The minimum volume thresholds are different for different products

If an HKCC Participant fails to meet its delivery and/or payment obligations, HKCC reserves the right to:
(a) impose a penalty on the defaulting HKCC Participant for any late settlement; and/or
(b) execute a buy-in, for the defaulting selling HKCC Participant, to purchase the required quantity of the underlying commodity or instrument for delivery; and/or
(c) effect, for the defaulting selling HKCC Participant, a borrowing of the required quantity of the underlying commodity or instrument for delivery; and/or
(d) purchase or borrow on behalf of the defaulting buying HKCC Participant the required amount of currency to fulfil the payment obligation.

Transactions arising as a result of this process will be exempt from the clearing obligation provided that:
(a) the prescribed person was not subject to a clearing obligation in respect of the original transaction;
(b) the compression cycle is multilateral (i.e. between more than two persons); and
(c) the compression cycle is carried out by an operator of multilateral portfolio compression cycles in accordance with counterparty credit risk tolerance levels set by the participants in the cycle.