HKEx Publishes Guide on Enhancing Regulation of the Listed Structured Products Market

Market Operations

27 Jul 2012

Hong Kong Exchanges and Clearing Limited (HKEx) announced today (Friday) the publication of its Guide on Enhancing Regulation of the Listed Structured Products Market. The Guide serves to foster high standards across structured products issuers, enhance service levels of liquidity providers and promote the healthy long-term development of Hong Kong’s listed structured products market.

The Guide

The Guide covers a number of regulatory enhancement measures in three main areas: (a) enhancement of issuers’ internal controls and standardisation of listing documents, (b) improvement of liquidity provision standards and (c) management of issuers' credit risks. The proposed measures are in line with on-going efforts to strengthen protection for investors and support market development.

Industry Principles on Liquidity Provision for Listed Structured Products

The Guide includes the Industry Principles on Liquidity Provision for Listed Structured Products which were developed jointly by a working group of listed structured products issuers, the Securities and Futures Commission and HKEx after extensive discussions.

The Industry Principles were formulated to enhance service levels for investors, in particular, through the introduction of active quote standards for listed structured products with a local index or an actively traded stock as underlying instrument in most market situations. This means in general issuers will proactively provide quotes and save investors from the inconvenience of making quote requests. The bid-offer spreads for active quotes will also be tighter than the current quote request standards.

Meanwhile, the Guide also tightens the liquidity providing obligations for quote requests.

The Guide and the Industry Principles adopt a comprehensive and transparent approach by clearly stating the requirements on structured products issuers, criteria for active quotes, specifications on spread limits and possible scenarios for short interruptions. The clarity facilitates investors' understanding of the new liquidity provision service standard and provides a clear benchmark for performance measurement. HKEx will monitor the results following the implementation of the Guide and the Industry Principles to identify any other necessary enhancements.

Both the Guide and the Industry Principles are available for viewing on the HKEx website.

Highlights of the key actions under the Guide and the implementation timetable are attached.

Structured products are synthetic products whose investment returns are linked to the performance of the underlying instrument. Derivative warrants and Callable Bull/Bear Contracts, or CBBCs, are the two most popular listed structured products in Hong Kong.

Highlight of Key Actions/Improvements of the Guide and Industry Principles

Key Areas

Key Actions / Improvements

Implementation timetable

A. Enhancement of issuers’ internal controls and standardisation of listing documents

1.	Standardise listing documents

Standardise supplemental listing documents to enhance readability and facilitate clear comparison of competing product offering

No later than
31 October 2012

2.	Enhance issuers’ internal controls and systems

Require issuers to ensure they have adequate internal controls, a sound risk management system and sufficient market surveillance capability, and ensure their reporting to the Exchange is timely

Immediate

3.	Advocate good issuers' conduct

Reinforce the standard of issuer conduct – Issuers should act in the best interests of the integrity of the market and not bring the market or the Exchange into disrepute

The Exchange may suspend new issuance of structured products by issuers failing to comply with the Guide and commence a review of their suitability to act as listed structured product issuers

Immediate

B. Improvement of liquidity provision standards

4.	Introduce new active quotes

Introduce new active quote standards to promote price transparency and save investors from the inconvenience of making quote requests

Active quotes will be provided for products with an active underlying in most market conditions*. Active quotes may not be continuous. It is expected that active quotes will be provided for at least 90% of the time of a trading day and that each pause will not exceed 10 minutes

Based on trading data for May 2012, application of the active quotes criteria would have covered 2,396 active derivative warrants (DW)/ Callable Bull/Bear Contracts (CBBCs) out of a total of 5,080 products, representing 92% of the total turnover of structured products

Bid-offer spreads for active quotes which are tighter than quote request standards are:

	5 spreads for warrants with local index underlying
	10 spreads for warrants with an actively traded stock underlying
	10 spreads for CBBCs with local index underlying
	15 spreads for CBBCs with an actively traded stock underlying

*	An active underlying means (i) any local index; or (ii) any stocks eligible for the issuance of CBBCs published by the Exchange from time to time representing stocks with highest turnover in the market. Criteria for active quotes are set out in Section 4 of the Industry Principles

No later than
31 December 2012

5.	Tighten liquidity provision for quote request

Tighten quote request parameters to improve minimum service level

	Tighten maximum response time to 10 minutes (around half of the active issuers currently have response time of 15 minutes)
	Tighten maximum bid-offer spread to 20 spreads (majority of existing maximum spreads under current practice is 25 spreads)
	Introduce a five minutes minimum holding time for quotes
	Double minimum quote size from 10 board lots to 20 board lots

No later than
31 October 2012

6.	Enhance liquidity provision performance monitoring

Strengthen Exchange's liquidity provision monitoring capability

Increase transparency of liquidity providers’ performance (i.e. by carrying issuers' announcements regarding failure to provide liquidity on the HKEx website)

Q4 2012

7.	Promote understanding on liquidity provision standards

Promote investor understanding of liquidity provision standards by requiring issuers to publish industry frequently asked questions, or FAQ, to address some common questions about the quote provision services

Q4 2012

C. Managing issuers’ credit risks

8.	Establish protocol for issuers' credit rating downgrade

Set up protocol that issuers must follow when they fall below issuer eligibility, e.g. announcement publication, cessation of new issues and withdrawal of products with no outstanding positions in the market

Immediate

9.	Risk disclosure in listing documents

Strengthen risk disclosure about product risks including issuer credit risks in listing documents

Immediate

10.	Warnings in marketing materials

Reinforce investors' awareness of credit risks by requiring issuers to clearly state in marketing materials that structured products are not backed by collateral. If the issuer is insolvent or in default, investors may not be able to recover all or even part of the amount due

Immediate

Ends

Updated 27 Jul 2012