23 Mar 2018

A new “front-loaded” approach by the SFC – What are the implications for companies and licensees?

In July 2017, Mr. Ashley Alder, the Chief Executive officer of the Securities and Futures Commission (“SFC”) introduced a new approach to regulate licensed corporations, listed companies and companies that are applying to be listed on the Stock Exchange of Hong Kong. This new approach, often called the “front-loaded regulation”, aims to identify risks and minimise harm to the investing public from market misconduct and irregularities. It places a strong emphasis on “earlier, more targeted intervention”.

Conventional approach

There are three main arms of the SFC’s regulatory work. The first arm is education. The SFC would issue reports, circulars and guidelines periodically to provide regulatory guidance for the investing public, companies (listed and non-listed), and licensees. The second arm is the Intermediaries Division, which carries out licensing and supervisory functions. Regarding its supervisory role, it acts as a ‘good cop’ to perform regular inspections on regulated licensees with a view to protect the investing public. When material irregularities are found during inspections, the Intermediaries Division would refer the case to the Enforcement Division. The final arm is the Enforcement Division, which takes criminal, civil and disciplinary actions against offenders following investigations into the alleged irregularities or market misconduct.

Issues with the conventional approach

Traditionally, the SFC has primarily relied on the Enforcement Division to carry out its regulatory enforcement functions. On top of that, enforcement powers may only be exercised through a Court or the Market Misconduct Tribunal (“MMT”). This approach can be very time-consuming because all sanctions and remedies were dependent on the approval from the Court or MMT. Once the Intermediaries Division has referred a case to the Enforcement Division, the Enforcement Division would carry out further in-depth investigation into the alleged irregularity before commencing proceedings. The ensuing proceedings in the Court or MMT would also take a considerable amount of time.

Moreover, the transition of cases from the Intermediaries Division to the Enforcement Division may not always be smooth, due to the difference in their investigation approach and evidence gathering methodology causing unnecessary delay that may risk losing the opportunity for timely fact-finding. As a result, the irregularities or market misconducts might usually be needlessly prolonged.

New approach – “early intervention”

Under the new approach, the SFC will take pre-emptive measures to tackle market irregularities and “interact directly with the market at an early stage”.

In terms of administrative measures, the Intermediaries Division will now issue more thematic guidance to licensees and companies on how the SFC intends to deal with specific issues under the Securities and Futures Ordinance (“SFO”) and the Securities and Futures (Stock Market Listing) Rules (“SMLR”). Such thematic guidance will require licensees and companies to conduct internal control reviews regularly to check for irregularities. The active review will be done by the company/licensee so that irregularities can be identified and dealt with immediately.

The SFC may also issue a restriction notice pursuant to ss. 204 and 205 of the SFO. This gives the SFC powers to prohibit the targeted company or licensee from carrying out specific regulated activities that would create irregularities. The issue of restriction notice aims to preserve the assets of the licensee and its clients, and protect the interest of those clients and the investing public. While the SFC has been issuing restriction notices long before the adoption of the new approach, we can expect the SFC to exercise such powers more readily in the future in light of the new approach.

Regarding the disciplinary actions and proceedings brought by the Enforcement Division, the SFC will now be able to exercise enforcement powers without prior approval from the Court/MMT. Under the SMLR, the SFC could suspend a listed company without the need to seek Court approval. The SFC has indicated that it would use such power of suspension as an “exceptional early protective action” during an investigation pending further investigation or legal action.

Furthermore, the SFC will now give credit to the people and/or licensees who are willing to cooperate with the SFC in their investigations. Forms of cooperation may include, inter alia, voluntarily and promptly reporting any breaches or failings to the SFC, acceptance of liability, and taking rectification measures. In both disciplinary matters and Court/MMT proceedings, the SFC may reduce the sanctions imposed if the person/licensee is cooperative. In particular, the SFC has divided its disciplinary process into three stages, with sanction reduction up to 30%, 20% and 10% respectively. These changes to the SFC’s cooperation policy may give rise to more constructive solutions in resolving irregularities, while keeping the daily operations of the company intact. These benefits should help to provide more incentive for people and licensees to cooperate with the SFC.

Overall, the Intermediaries Division will be more proactive in exercising its supervisory powers, meanwhile, the Enforcement Division will only focus on the most serious issues, such as fraud and corporate misfeasance, which would have serious ramifications to the integrity of the capital markets of Hong Kong.

Implications to companies: the changes that will affect your business

The new approach may increase the efficiency of the SFC in handling investigations into the irregular conduct of licensees, companies, and also individuals. The cooperation between the SFC and the licensed entities is also going to be tighter.

However, this approach may also cause the compliance cost of licensees and companies to soar. Licensees and companies may need to conduct excessive internal reviews and monitoring in order to meet the requirements of the regulators, albeit there may not be any material findings on any misconducts.

The lack of universal standards for internal reviews conducted by licensees and companies may also be problematic, as the standard of review would vary from one licensee/company to another, making it difficult for licensees and companies to fully understand how to comply with the SFC’s requirements.

The expansion of enforcement powers of the Intermediaries Division may also be seen as a misplacement of resources. In essence, the roles of the Intermediaries Division and the Enforcement Division are distinct. The “front-loaded” approach delegates more enforcement power to the Intermediaries Division, despite the fact that the Division may not have enough expertise to conduct thorough investigations and obtain material findings for imposing preliminary sanctions.

To tackle such changes, listed companies and regulated activities licensees should be prepared that the SFC may take aggressive strategies to handle any irregularities spotted even at an early stage when the Enforcement Division has not been engaged. Professionals should be engaged to conduct ‘health checks’ on the entities’ internal control on a regular basis.

What we can provide to help you

  1. Handling enforcement actions, including:
    a) interviews with regulators and enforcement agencies
  2. b) handling dawn raids and subsequent actions
    c) disciplinary and regulatory proceedings
  3. Handling enquiries and investigations from regulators
  4. Conducting internal compliance review
  5. Assist in lifting trade suspension for listed companies


Key contact

Stephen Wong
Tel: +852 2533 2525
Email: stephenwong.office@sw-hk.com