A range of legal updates were made in 2018 focused around regulatory requirements for the capital and financial markets in Hong Kong, as well as legislative changes in corporate and employment law.
Measures to further develop Hong Kong’s bond market
A series of measures were announced as part of the Hong Kong 2018- 19 Budget to further develop and enhance the competitiveness of Hong Kong’s bond market. These include the implementation of a pilot bond grant scheme to promote corporate bond issuances (read more) and a green bond grant scheme to promote green bond issuances. In addition, certain tax incentives have been introduced, including expanding the qualifying debt instrument scheme to cover a more diverse range of debt instruments.
Extraterritoriality of EU MiFID II product governance rules
The new rules under MiFID II came into effect across EEA Member States. Although the product governance rules only apply to MiFID Firms, non-MiFID Firms (typically, these would be the local banks and securities houses in Asia) are indirectly impacted when (i) doing business with MiFID Firms (e.g. where financial instruments are to be sold within the EEA) or (ii) distributing financial instruments (both within and outside the EEA) manufactured by MiFID Firms.
Changes to the Hong Kong Takeovers Code
The SFC amended the Takeovers Code in July. The amendments span numerous aspects of the Takeovers Code, including to reform the powers of the Executive and Panel, narrow the definition of “associate” and revise the requirements for whitewash waivers and delistings. In addition, several administrative and clarificatory changes have been introduced.
Exchange allows the listing of biotech companies and innovative companies with weighted voting rights and the secondary listing of companies with a centre of gravity in Greater China and/or WVRs
In April, the Exchange added two new chapters to the Listing Rules which liberalised its listing platform and allows the listing of biotech companies that are pre-revenue and pre-profit and WVRs companies which are “innovative”. Xiaomi was the first WVR company which listed on the Exchange in September.
Exchange has tightened its grip on highly dilutive capital raising structures
Corporate governance advocates have been flagging concerns about highly dilutive capital raising structures. In July, the Exchange tightened the regulations which put a ban on capital raisings by listed issuers which are considered highly dilutive, prohibit the issue of warrants or options for cash under the authority of the general mandate and tighten the requirements on excess application arrangements for pre-emptive offers.
New obligation for unlisted Hong Kong companies to keep a register of their significant controllers
Since 1 March, Hong Kong companies need to maintain a register of persons having significant control over them. This obligation does not apply to overseas companies even if they have a Part 16 “non-Hong Kong company” registration status. Hong Kong companies with shares listed on the Exchange are exempt; however, their Hong Kong subsidiaries still need to comply.
Order of reinstatement or re-engagement of employees without employer’s agreement
Employment (Amendment) (No. 2) Ordinance 2018 came into force on 19 October. The main purpose of this legislation is to empower the Labour Tribunal to order the reinstatement or re-engagement of an employee in the absence of the employer’s agreement in the case of unlawful and unreasonable termination.
Competition Ordinance - enforcement reality
2018 has shown a more aggressive and rigorous approach to competition law enforcement. The Competition Commission has shown a strong determination to use the full force of its investigative powers and has launched a wide range of investigations across a number of sectors. The agency continues to use proceedings before the Competition Tribunal to be a default means of achieving an enforcement outcome. The first two competition trials took place in relation to alleged cartels, and the third case saw the Commission seek pecuniary penalties against individuals.
SFC warns asset managers on margin financing activities disguised as investments
The SFC has issued a circular stating that it believes some licensed corporations carrying out asset management may have assisted “unlicensed affiliates or third parties” to provide securities margin financing in the guise of investments and notes that this arrangement is illegal. In addition to the fact that the third parties involved are unlicensed for performing Type 8 activities, such arrangements also provide the parties involved with a way of avoiding compliance with capital, conduct and disclosure requirements associated with securities margin financing.
Changes to Fund Manager Code of Conduct take effect
The SFC Consultation Conclusions on Proposals to Enhance Management Regulation and Point-of-sale Transparency and Further Consultation on Proposed Disclosure Requirements Applicable to Discretionary Accounts (issued in November 2017) introduced changes to the Fund Manager Code of Conduct and the general Code of Conduct. These changes became effective in November and August, respectively. The main changes to the FMCC include: (i) the scope of its application; (ii) reports; (iii) custody of fund assets; (iv) liquidity risk management; and (v) leverage disclosure. The SFC also consulted on disclosure requirements applicable to discretionary accounts. A new paragraph 7.2 was added to the Code of Conduct with effect from 25 November.
SFC imposes new rules on licensed fund managers and distributors and considers the regulation of virtual asset trading platform operators
On 1 November, the SFC issued a policy statement on the Hong Kong regulatory framework for virtual asset portfolios managers, fund distributors and trading platform operators alongside a circular to intermediaries on the distribution of virtual asset funds.
SFC thematic review on best execution
The SFC has adopted a ‘front loaded’ regulatory approach to promote earlier and more targeted behavioural change and is increasingly conducting thematic reviews in high-risk areas. In January, the SFC published a circular to licensed corporations on best execution. An accompanying thematic report set out guidance on the standards of conduct and internal controls which the SFC expects of licensed corporations in delivering best execution.
New HKIAC administered Arbitration Rules came into force in November
The 2018 Rules are the result of a comprehensive review and consultation process which began in August 2017. The Rules introduce amendments relevant to the use of technology, third-party funding, multi-party and multi-contract arbitrations, the early determination of disputes, alternative means of dispute resolution, emergency arbitrator proceedings, and time limits for the delivery of awards.
In August, the European Commission updated the EU Blocking Regulation in light of US extra-territorial secondary sanctions re-imposed in connection with Iran. The Regulation makes it unlawful for EU persons to comply with those sanctions relating to Iran or Cuba.
First decision on the exclusion of competition rules
The Competition Commission made its first decision on the exclusion of the competition rules under the Competition Ordinance. The Commission found that the Code of Banking Practice is not excluded from the prohibition against anti-competitive arrangements as it is not legally required under Hong Kong law. The decision is obviously of particular note for the financial services sector.
New Government control agreements reinforce increased commitment to renewable energy
Hong Kong’s two main electricity providers, CLP and Hong Kong Electric, entered into new scheme of control agreements with the Government effective from October. The new scheme of control agreements will have a term of 15 years, and, in addition to including undertakings for CLP and Hong Kong Electric to provide electricity at a permitted rate of return, key provisions also take into consideration the Government’s long-term carbon reduction target for 2030. These provisions include (i) plans to gradually reduce coal-fired power generation units and replace with gas-fired units and (ii) a new feed-in tariff scheme to allow CLP and Hong Kong Electric to purchase electricity generated by grid-connected renewable energy power systems of customers. The two electricity providers are jointly developing an LNG import terminal to support the increased use of gas-fired generation.
CFA imposes narrow application of the innocent purpose defence in insider dealing cases
In the case of The Securities and Futures Commission v. Yiu Hoi Ying Charles & Ors  HKCFA 44, the CFA found in a majority four to one decision that the “innocent purpose” defence under s217(3) of the Securities and Futures Ordinance could not be made out by arguing that the inside information had not been “used” due to there being other factors that could be considered the sole motivating factor prompting the connected persons to trade whilst in possession of the inside information. The CFA reasoned that as a result of their possession of the inside information, the connected persons knew that the share price at which they sold their shares was artificially high, and in deciding to sell their shares whilst in possession of such knowledge, they had “used” the inside information to their advantage.
HKMA publishes Guideline on the Authorisation of Virtual Banks
The HKMA published an updated Guideline on the Authorisation of Virtual Banks, after consulting on an earlier version of the Guideline in February 2018. The updated Guideline defines a virtual bank as a bank which “primarily delivers retail banking services through the internet or other forms of electronic channels instead of physical branches.” An entity wishing to be licensed as a virtual bank will need to meet the criteria specified in the Guideline and the criteria for authorisation for conventional banks set out in the Banking Ordinance.
CFA upholds use of s300 in cases of insider dealing where shares are not listed in Hong Kong
In the case of The Securities and Futures Commission v. Young Bik Fung & Ors  HKCFA 45, the CFA held that conduct which would have amounted to insider dealing, but for the fact that the shares were not listed in Hong Kong, should be regarded as a crime, a species of fraud or cheating, and thus coming within s300 of the SFO. In forming its decision, the CFA observed that a “transaction in securities” under s300 would not be considered in isolation but would take into account the whole scheme or course of dealings relating to the transaction, and that provided substantive activities constituting the crime occurred within Hong Kong, s300 should cover the insider dealing in shares listed in Taiwan.
YEAR TO COME
HONG KONG LAW IN 2019
SFC consulted on margin requirements on non-centrally cleared derivatives
In June 2018, the SFC launched a two-month consultation on proposals to impose margin requirements on non-centrally cleared over-the-counter derivatives applicable to all licensed corporations. Certain differences between the SFC’s proposals and the HKMA’s margin rules (which are already in effect) exist; one notable difference is the SFC’s proposal to impose variation margin on physically-settled FX forwards and swaps in certain circumstances. Rule harmonisation and availability of full substituted compliance were the two major themes in the industry’s response to the SFC. The SFC has yet to publish the conclusions to its consultation.
Exchange proposes Listing Rule changes to crack down on backdoor listing
In June 2018, the Exchange published a consultation paper on backdoor listing, continuing listing criteria and other Listing Rule amendments. The proposals do not contain major surprises, many of which are already set out in guidance letters and listing decisions issued in the last few years, and therefore the proposed amendments can be viewed largely as an exercise to codify the previous guidance, with limited tightening and fine-tuning. The SFC has expressed support for the proposals. It is anticipated that the conclusions will be published in 2019.
Hong Kong strengthens banks’ resilience to shocks by implementing loss-absorbing capacity rules
Following the implementation of the Financial Institutions (Resolution) Ordinance (Cap. 628) in 2017 which gave the HKMA wide powers to intervene and manage a within scope bank in the event of non-viability, new rules on loss-absorbing capacity have been released. The LAC Rules prescribe minimum external and internal LAC requirements, the minimum components of LAC debt instruments, eligibility criteria for LAC debt instruments as well as restrictions on the sale and distribution of external LAC debt instruments. Under the current HKMA timetable, it is intended that certain domestic systemically-important banks will be required to comply with the LAC Rules within three months of their classification as classifiable entities in 2019. For other relevant authorised institutions, it is expected that compliance with the LAC Rules should occur by no later than 1 January 2022.
2019 is expected to be another year of growing competition law enforcement activity as the Competition Commission’s investigations result in further actions before the Competition Tribunal. The Government is expected to begin its process for considering amendments to the Competition Ordinance. It remains to be seen whether this would be tweaks around the edges on procedural issues or more significant reform on controversial issues, such as introducing merger control and permitting standalone civil damages actions. The Commission will likely reflect on its three years of practical experience in enforcing the law and consider refining its enforcement policies. The focus of the agency in targeting individual employees and directors is likely to continue.
Progressive increase in statutory employee benefits in Hong Kong
In 2019, we expect further amendments to the Employment Ordinance in order to provide for more family-friendly and pro- employee changes. The Legislative Council approved a legislative proposal to increase the number of paid statutory paternity leave days from three days to five days at the end of 2018 and this change is expected to come into force in 2019. The Chief Executive has also proposed in her latest policy address to implement the long-debated abolition of the MPF-offset mechanism (i.e. the statutory right of an employer to offset statutory severance or long service payment with the benefits derived from the employer’s contributions to the employee’s retirement scheme) and to provide four more weeks of paid statutory maternity leave (i.e. a total of 14 weeks).
Suitability in the online environment and in the offline sale of “complex products”
From 6 April, additional measures will apply to the online and offline sales of “complex products” (which are described by the SFC as products whose terms, features and risks are not reasonably likely to be understood by retail investors because of their complex structures). These measures include performing a suitability assessment on all complex products, regardless of whether there has been any solicitation or recommendation. The HKMA has extended some of these proposals to certain non-SFO regulated products.
Proposed guidelines for securities margin financing
The SFC believes that imprudent margin lending practices have exposed a number of brokers to unacceptable financial and concentration risks. The SFC is proposing a set of guidelines for margin financing activities, which would introduce quantitative benchmarks on specific key risk control areas. In particular, the SFC is proposing to set a quantitative benchmark called “total margin loans- to-capital multiple”, which would restrict a securities margin financing broker’s aggregate margin loans to a specified multiple of its capital. The SFC has proposed a six-month transition period (if the guidelines are introduced).
Proposed Hong Kong corporate rescue legislation and approach of Hong Kong courts
After many years of consultation and discussion, including an initial draft of legislation in 2003, the Financial Services and Treasury Bureau is in the process of preparing another draft amendment bill to introduce a new statutory corporate rescue procedure for Hong Kong and a wrongful trading law to incentivise directors to address financial difficulties earlier by making directors potentially liable for debts incurred without reasonable prospect of payment. Although the timing is uncertain, indications are that the amendment bill will be introduced into the Legislative Council in the 2018/2019 legislative year. In the meantime, the Hong Kong courts have been receptive to other methods of implementing cross-border rescue remedies. In Re Z-Obee Holdings Limited HCMP 1563/2017, the Hong Kong Court of First Instance granted an order sanctioning parallel schemes of arrangement in Hong Kong and Bermuda following the appointment of provisional liquidators in both Hong Kong and Bermuda to effect the restructuring of Z-Obee Holdings Limited, a Hong Kong-listed company incorporated in Bermuda. Under Bermuda law, provisional liquidators can be appointed for the purpose of exploring a restructuring even where there is no evidence of jeopardy to assets (such jeopardy being a requirement in Hong Kong following Re Legend International Resorts Ltd  2 HKLRD 192). In the recent case of Re China Solar  HK CFI 555, the Hong Kong Court of First Instance further confirmed that provisional liquidators could be granted restructuring powers and could be permitted to remain in office to complete a restructuring even where their asset preservation role may have concluded.