1. Hong Kong’s securities and futures industry has developed significantly over the last decade. Hong Kong is well recognised as non-Japan Asia’s premier financial centre and as a significant player on the international stage. However, the global securities and futures industry is evolving rapidly and exchanges are facing increasing competition from each other and from independent trading systems which bypass traditional exchanges. As technology advances, the threats to the traditional exchange structure will only increase.
Business will migrate to those markets with high transparency and liquidity, low costs of intermediation, diversified product base, sound regulation, high quality of service and robust infrastructure. 2. Increasingly, the power of markets will be determined by technology. Intermediation costs have been driven down, eroding the profit margin of traditional franchises. The most liquid and high quality markets must have critical mass of products, active participation of intermediaries and investors and sophisticated infrastructure to be able to compete effectively.
3. Against this background, exchanges worldwide are rethinking their strategies and operations to improve their services, reinforce their competitive position and optimise their performance. Overseas, markets are rapidly integrating vertically (e. g. linking together trading, clearing and settlement functions into a single transaction chain) and horizontally (e. g. combining securities and futures products into a single organisation) and developing alliances with other exchanges. Consolidation is the order of the day.
The prospects for growth in Asian and global securities and futures markets are considerable. Hong Kong has the added advantage of its role as the premier international financing gateway to the Chinese mainland. However, others are fast moving to seize a share of this business. Hong Kong needs to move in step with the other leading world markets and address the demands of investors, intermediaries and issuers. In the face of increasing competitive pressure, Hong Kong must take decisive steps to maintain and reinforce its lead as an international financial centre.
5. The Government believes that the current ownership and governance structure of the Exchanges and the associated Clearing Houses must change to compete. The membership association structure of the Exchanges produces inherent conflicts between the interests of the members and the market as a whole. Conflicts between the multiple roles of the Exchanges as membership associations, service providers, regulators and public bodies are particularly apparent in such areas as development of products and services and regulation of issuers and intermediaries.
6. Every major market is rapidly consolidating and upgrading its competitive capacity. Several international exchanges have demutualised, including those in Frankfurt, Stockholm, Amsterdam and Australia. The Toronto Stock Exchange and LIFFE in London have announced plans to follow suit. The exchanges in Amsterdam and Australia have additionally become publicly listed companies and Deutsche Borse in Frankfurt is considering this step. The Australian Stock Exchange is also now in discussions to merge with the Sydney Futures Exchange.
In the US, NASDAQ recently acquired the American and Philadelphia stock exchanges, partly for their business in the trading of equity-linked options. Within Asia, the Singapore Government has announced that the Stock Exchange of Singapore and SIMEX are to demutualise, merge and, in due course, list the shares of the merged entity. 7. The Government believes that the reform necessary for Hong Kong is best achieved by demutualisation, merger and listing of the Exchanges and the Clearing Houses under one single holding company (NewCo).
Under the new market governance structure, the stock and futures markets as well as the clearing operations will be integrated and subsumed under this single commercial and service-oriented entity. Ownership and management of NewCo would be formally separated from user interests and the inherent conflicts in the traditional structure would thereby be greatly reduced. Trading rights on the Exchanges would not be restricted and would be subject only to meeting the qualifications set under the relevant legislation and paying applicable fees, thus enhancing competition within the markets.
8. The benefits of the reform are many-fold. First, consolidation of the Exchanges and Clearing Houses within a single entity would bring economies of scale in terms of operational efficiency, savings in infrastructure investment, facilitation of risk management, and financial strength to meet external competition. An integrated structure would also be able to develop the critical mass to create new services and opportunities to compete in the new global environment.
Demutualisation and public listing would ensure that the Exchanges and Clearing Houses would act not only in their members’ interests, but also be responsive to market forces. Demutualisation would also streamline professional management and organisation. Public listing should encourage these market institutions to raise funds and subject themselves to transparency, accountability and market discipline. 9. Secondly, by separating ownership from trading rights and making NewCo also subject to market discipline, existing members of the Exchanges will benefit directly.
At present, the members cannot realise any value from their shares in the Exchanges without giving up their trading rights. The separation of ownership and trading right will bring greater financial flexibility to the Exchange members. After the reforms, an existing member would have the choice, without affecting its trading rights, to sell all or part of his shares to raise much-needed capital for investment in technology to improve his competitiveness in the market.
Thirdly, demutualisation and listing will benefit its shareholders including existing members of the Exchanges in terms of profit sharing. At present, members of the Exchanges have no right to receive dividends or other distributions except on a liquidation and, accordingly, the profits of the Exchanges are not available to them. Demutualisation will confer on shareholders, including existing members of the Exchanges, the ability to share the success of the Exchanges and participate in their profits.
Fourthly, the market as well as the investors will benefit from the increased competition in the intermediary industry unleashed by the unrestricted access to the Exchanges permissible under the new governance structure of the market. It is expected that competition will bring better services and products, lower costs and create new value-additions in the brokerage industry. 12. Fifthly, the listing of NewCo on the stock market would also add to the market a new world-class, professionally run financial institution that would broaden the investment base of quality companies in Hong Kong.
Through the listing and a public market of its shares, the investing public would also be able to participate directly in a flagship institution in Hong Kong and share its success. 13. Moreover, even though the traditional monopolies of exchanges are being eroded by alternative trading systems, there are benefits to transparent centralised stock exchanges and clearing houses. The impact of systemic risk and market infrastructure failure on the financial stability of Hong Kong requires the Government to ensure that public interests and the interests of the overall economy are safeguarded.
14. In addition to providing efficient and competitive services to issuers, intermediaries and investors, NewCo may enhance its role as a commercial entity by retaining certain regulatory functions. The regulatory functions presently shared between the Exchanges and the Securities and Futures Commission (SFC) would be reviewed in the context of the new market structure with a view to rationalising the division of such functions between the SFC and the Exchanges.
As a continuing monopoly and in the light of the public functions NewCo is expected to perform, its governance structure should be capable of ensuring that the public interest is best protected. In addition to shareholders’ interests, the board of NewCo should also include market users, investors, related professionals as well as independent directors. The Government would appoint directors to the board, and retain oversight of NewCo to ensure that it operates and functions consistently with public interest.
The board would be responsible for NewCo policy-setting and strategic decision-making. The independence of NewCo would be protected by limits on shareholdings, so as to prevent any acquisition of a controlling stake. 16. The Government is aware that the Exchanges and their members would have views on the valuation of the relative interests in the Exchanges and accordingly their relative allocation of shares in NewCo. The Government believes that there should be transparency, consultation and due process for the valuation and relative allocation of shares.
The Government therefore proposes that the Exchanges and their members should consult together and agree this between themselves. 17. The Government firmly believes that this reform is in the best interests of Hong Kong as a whole. Given the importance of the matter for the future of Hong Kong, including the strategic and competitive position of Hong Kong as an international financial centre, the Government is firmly committed to the necessary reforms and will put in place a suitable framework for this process to proceed.
The Government is aware that this reform needs to happen swiftly. Accordingly, the Government is setting a timetable for the reforms. It has fixed 30 September, 1999 as the date by which the prices and share allocations must be agreed, the reforms must be approved by the requisite votes of the shareholders of the Exchanges and all steps other than the requisite legislative changes must be taken by the members of the Exchanges and other parties involved. 18. Legislation will be required to enable certain steps of the reforms to be taken.
While enactment of legislation is expected to be the last step in the process and would follow the members’ votes to approve the reform, the Government will facilitate this by proceeding with the drafting of the necessary legislation forthwith. Legislation would be targeted for late 1999 or early 2000, and in any event by 31 March, 2000. Upon the relevant legislative action being taken, the reforms would be implemented and the NewCo structure would come into effect, with the members of the Exchanges becoming shareholders in NewCo.
Listing of NewCo on the stock exchange would be targeted for as soon as practicable thereafter, with the intention that it be no later than 30 September, 2000. 19. The Government will set up an appropriate mechanism under the Financial Services Bureau to promote and assist in the implementation of the reform and monitor its progress. As the securities and futures market regulator, the SFC will be closely involved in the implementation of this major reform.
In overseeing the implementation of the demutualisation of the Exchanges and the listing of NewCo, the SFC will also seek to ensure that the existing market structure continues to operate effectively during the period of transition. 20. Much is at stake. Either Hong Kong goes with the flow of markets, or they will pass us by. The competitive position of Hong Kong is ours to lose. If we do not change, competition from other financial centres or alternative trading technology will rapidly erode our competitive advantages.
These are reforms dictated by global market forces, as well as domestic voices for change. Many of these reforms were contemplated by the present and past boards and management of the Exchanges and Clearing Houses, but were frustrated by the current governance structure. The Government will spare no effort to work with the Exchanges and Clearing Houses to effect these important strategic reforms. 21. The Government does not underestimate the difficulties in the reforms but it believes the problems are not insurmountable. Maintaining the status quo is not an option for Hong Kong.
If these reforms are not implemented and in accordance with the timetable set out, then, in the larger interests of Hong Kong, the Government will pursue alternative action that will achieve the primary objectives of the reforms. This may include, among other things, review and necessary reform of the current market environment and governance structures of the Exchanges and the Clearing Houses. Meanwhile, the Government will continue to pursue its established policy objective to improve and strengthen the clearing infrastructure in Hong Kong through the integration of the currently sector-based clearing and settlement systems.
This is very much needed to improve risk management, enhance market stability and integrity, and generally better protect investors’ and public interests. 22. The people of Hong Kong value innovation and competition, and demand change. The Government is confident that with the joint efforts of the Exchanges and the Clearing Houses, the securities and futures industry, the SFC and the Government, Hong Kong will remain at the forefront of the international financial markets and emerge from the growing global competition as one of the most competitive financial centres of the region and the world.