SFC Consultation Paper Concerning the Regulation of Alternative Liquidity Pools
Release Date: 2014-04-25
Response from the Hong Kong Securities and Futures Professionals Association regarding the 'Consultation Paper on the Regulation of Alternative Trading Platforms':
Q1
Do you agree that the proposed requirements are sufficient to ensure that an ALP operator effectively manages and adequately supervises the design, development, deployment and operation of the ALP it operates? If not, why not?
We contest the adequacy of the proposed measures outlined in the consultation document to ensure effective operation and regulation of 'Alternative Trading Platforms.' These platforms inherently lack transparency and are susceptible to conflicts of interest, thus failing to uphold the principles of fairness, equity, and transparency. Moreover, the absence of real-time, effective reference prices compromises investor protection regarding information and privacy rights, leaving them vulnerable to exploitation. Our association strongly opposes these platforms. Should regulators move forward with their implementation, we advocate for a strict prohibition on operators and intermediaries engaging in transactions via proprietary trading accounts. This measure aims to minimize conflicts of interest and curb issues such as price manipulation, insider trading, and order front-running. Additionally, given the involvement of valuable trading data, there is a risk of subtle corruption through the illicit transfer of benefits.
Furthermore, if effective reference prices are sourced from regulated trading platforms, all trading rules should align with those of these regulated platforms. For instance, concerning products traded on the Hong Kong Exchange, relevant 'Alternative Trading Platforms' must report transactions within one minute of trade execution, ensure timely physical settlement, and comply with short-selling regulations, including margin requirements. These measures are crucial to mitigating counterparty default risk and preventing systemic crises that could jeopardize financial and economic stability.
Q2
Do you agree that only the orders of institutional investors should be permitted to be transacted in ALPs? If not, why not?
We agree that participation should be restricted to institutional investors. These investors typically have a more developed comprehension of operations and risk management, as well as enhanced access to hedging strategies and requirements, which contribute to more sophisticated and secure risk management practices. Conversely, retail investors, even after receiving detailed explanations and risk disclosures during the account opening process, often engage with only a limited grasp of the complexities involved. This lack of understanding can result in emotional responses and unwarranted political fallout in the event of losses, as illustrated by the Lehman minibond crisis. In fact, the demand for such transactions among retail investors is not as robust as is often assumed.
Q3
Do you think that the definition of “institutional investor” set out in the draft paragraph 19.2 of the Code of Conduct is appropriate? If not, why not?
We agree. Despite varying levels of operational insight, risk management, and hedging strategies, there exists a significant demand for and a professional execution of these practices, which is often absent among typical investors.
Q4
Do you agree that ALP operators should be obliged to ensure that all orders placed with them by their group companies originate from institutional investors before they may be transacted in their ALPs? If not, why not?
We agree. Operators are clearly obligated to establish and apply screening procedures, a task that is not particularly challenging. Similar to the eligibility criteria that investors must satisfy when opening accounts for GEM (Growth Enterprise Market) and derivative products, these requirements are entirely justifiable. The technology for screening is well-developed and practical, necessitating only the incorporation of identification filters within the computer system.
Q5
Do you agree that a licensed or registered person who routes orders to an ALP on behalf of its clients should be obliged to ensure that such orders originate from institutional investors only? If not, why not?
We agree.
Q6
Do you agree that ALP operators should be allowed to conduct transactions in their ALPs in all types of exchange listed or traded securities, irrespective of whether they are listed or traded in Hong Kong or elsewhere? If not, why not?
Not Opposed
While we generally stand against "alternative trading platforms" due to the absence of fair, unbiased, and transparent reference transaction prices, we may reconsider our stance if the exchange offers reference data in these areas.
Q7
Do you agree that ALP operators should be allowed to conduct transactions in their ALPs in securities listed or traded on overseas markets / exchanges without restriction as to the time when they may do so? If not, why not?
We disagree. Without reliable reference prices from exchanges, trading may turn opaque, increasing the risk of market manipulation, exploiting traders, and even facilitating money laundering activities.
Q8
In respect of transactions conducted in ALPs involving securities which are listed on SEHK, do you agree that ALP operators should be allowed to conduct these transactions in their ALPs during the periods that trading is conducted on SEHK and also at other times when trading is not being conducted on SEHK? If not, why not?
We disagree.
Q9
Do you agree that orders received from the users of ALPs should have priority over proprietary orders of the types referred to in paragraph 34? If not, why not?
We disagree. We supports the ban on all proprietary trading activities to reduce conflicts of interest and prevent electronic price manipulation tactics, including "rat trading" and "front-running," which stem from these conflicts.
Q10
Do you agree that ALP operators should be obliged to provide prospective users of their ALPs with ALP Guidelines that are comprehensive and accurate and that their ALP Guidelines must include the matters referred to in paragraph 38? If not, why not?
We agree. Certain content must adhere to exchange regulations, which include restrictions on short selling, requirements for real-time physical delivery, prompt trading reports, and extensive disclosure obligations.
Q11
Do you agree that ALP operators should bring their ALP Guidelines to the attention of all prospective users of their ALPs? If not, why not?
We agree. Transactions executed via 'alternative trading platforms' can potentially initiate associated hedging activities or provoke psychological responses.
Q12
Do you agree that an ALP operator should be obliged to obtain formal acknowledgement from prospective users of its ALP that its ALP Guidelines have been brought to their attention and that they consent to their orders being transacted in the ALP, before such transactions are permitted to occur? If not, why not?
We agree. Given the considerable shortcomings of 'alternative trading platforms' in fulfilling the fairness, impartiality, and transparency standards expected of exchanges, it is essential for all potential users to thoroughly comprehend the trading models and the associated risks involved. Proceeding without a clear understanding can result in disputes and complications.
Q13
Do you agree that a licensed or registered person which, on behalf of its clients, routes agency orders to an ALP operated by a third party ALP operator should be obliged to ensure that its clients have formally acknowledged that the ALP Guidelines have been brought to their attention and that they consent to their orders being transacted in the ALP, before their orders are routed to the ALP? If not, why not?
We agree. The reason same as above point 12.
Q14
Do you agree that an ALP operator should adopt measures to ensure the integrity and/or system adequacy of its ALP and have appropriate contingency measures in place? If so, are the proposed requirements sufficient? If not, why not?
We agree. The proposed requirements must meet or exceed the regulatory standards applicable to the BSS brokerage's provision of electronic trading systems.
Q15
Do you agree that an ALP operator should keep the SFC informed as to the identity of its staff having access to trading and other information relevant to its ALP, the basis upon which such access is permitted, and any change made in relation to the staff to whom such access is permitted and the basis for such change? If not, why not?
We agree. The availability of pertinent information plays a crucial role in ensuring fairness, transparency, and equity in trading. Without strict regulation, this can lead to situations where participants might face unfair disadvantages.
Q16
Do you agree that the person responsible for originating a proprietary order in an ALP should be restricted from access to trading information or data concerning orders placed, or transactions conducted, in the ALP? If not, why not?
Prohibit proprietary trading activities. It is important to note that no system can completely eliminate the risk of proprietary traders accessing transaction data, particularly given the advancements in high-speed computer access technologies.
Q17
Do you agree that an ALP operator should keep proper records concerning the design, development, deployment and operation of its ALP? If not, why not?
We agree. The regulations under their supervision encompass various trading activities, including aspects of regulation, investigation, review, mediation, and enhancement initiatives.
Q18
Do you agree that an ALP operator should keep proper records concerning all transactions conducted on its ALP, including details of authorized traders? If not, why not?
We agree. The reason same as above point 17.
Q19
Are the records that the SFC proposes be kept by ALP operators in relation to the transactions conducted in their ALPs sufficient and appropriate? If not, why not?
We agree. The reason same as above point 17.
Q20
Do you agree with the proposed periods for the keeping of these records? If not, why not?
We agree. That’s enough. Can it be reviewed regularly.
Q21
Do you agree that the proposed requirements for risk management and post-trade reviews of transactions conducted in ALPs are sufficient to maintain the fair and orderly operation of the market? If not, why not?
We agree.
Q22
Are the proposed reporting and notification requirements appropriate? If not, why not?
It is appropriate but need to review regularly.
Q1
Do you agree that the proposed requirements are sufficient to ensure that an ALP operator effectively manages and adequately supervises the design, development, deployment and operation of the ALP it operates? If not, why not?
We contest the adequacy of the proposed measures outlined in the consultation document to ensure effective operation and regulation of 'Alternative Trading Platforms.' These platforms inherently lack transparency and are susceptible to conflicts of interest, thus failing to uphold the principles of fairness, equity, and transparency. Moreover, the absence of real-time, effective reference prices compromises investor protection regarding information and privacy rights, leaving them vulnerable to exploitation. Our association strongly opposes these platforms. Should regulators move forward with their implementation, we advocate for a strict prohibition on operators and intermediaries engaging in transactions via proprietary trading accounts. This measure aims to minimize conflicts of interest and curb issues such as price manipulation, insider trading, and order front-running. Additionally, given the involvement of valuable trading data, there is a risk of subtle corruption through the illicit transfer of benefits.
Furthermore, if effective reference prices are sourced from regulated trading platforms, all trading rules should align with those of these regulated platforms. For instance, concerning products traded on the Hong Kong Exchange, relevant 'Alternative Trading Platforms' must report transactions within one minute of trade execution, ensure timely physical settlement, and comply with short-selling regulations, including margin requirements. These measures are crucial to mitigating counterparty default risk and preventing systemic crises that could jeopardize financial and economic stability.
Q2
Do you agree that only the orders of institutional investors should be permitted to be transacted in ALPs? If not, why not?
We agree that participation should be restricted to institutional investors. These investors typically have a more developed comprehension of operations and risk management, as well as enhanced access to hedging strategies and requirements, which contribute to more sophisticated and secure risk management practices. Conversely, retail investors, even after receiving detailed explanations and risk disclosures during the account opening process, often engage with only a limited grasp of the complexities involved. This lack of understanding can result in emotional responses and unwarranted political fallout in the event of losses, as illustrated by the Lehman minibond crisis. In fact, the demand for such transactions among retail investors is not as robust as is often assumed.
Q3
Do you think that the definition of “institutional investor” set out in the draft paragraph 19.2 of the Code of Conduct is appropriate? If not, why not?
We agree. Despite varying levels of operational insight, risk management, and hedging strategies, there exists a significant demand for and a professional execution of these practices, which is often absent among typical investors.
Q4
Do you agree that ALP operators should be obliged to ensure that all orders placed with them by their group companies originate from institutional investors before they may be transacted in their ALPs? If not, why not?
We agree. Operators are clearly obligated to establish and apply screening procedures, a task that is not particularly challenging. Similar to the eligibility criteria that investors must satisfy when opening accounts for GEM (Growth Enterprise Market) and derivative products, these requirements are entirely justifiable. The technology for screening is well-developed and practical, necessitating only the incorporation of identification filters within the computer system.
Q5
Do you agree that a licensed or registered person who routes orders to an ALP on behalf of its clients should be obliged to ensure that such orders originate from institutional investors only? If not, why not?
We agree.
Q6
Do you agree that ALP operators should be allowed to conduct transactions in their ALPs in all types of exchange listed or traded securities, irrespective of whether they are listed or traded in Hong Kong or elsewhere? If not, why not?
Not Opposed
While we generally stand against "alternative trading platforms" due to the absence of fair, unbiased, and transparent reference transaction prices, we may reconsider our stance if the exchange offers reference data in these areas.
Q7
Do you agree that ALP operators should be allowed to conduct transactions in their ALPs in securities listed or traded on overseas markets / exchanges without restriction as to the time when they may do so? If not, why not?
We disagree. Without reliable reference prices from exchanges, trading may turn opaque, increasing the risk of market manipulation, exploiting traders, and even facilitating money laundering activities.
Q8
In respect of transactions conducted in ALPs involving securities which are listed on SEHK, do you agree that ALP operators should be allowed to conduct these transactions in their ALPs during the periods that trading is conducted on SEHK and also at other times when trading is not being conducted on SEHK? If not, why not?
We disagree.
Q9
Do you agree that orders received from the users of ALPs should have priority over proprietary orders of the types referred to in paragraph 34? If not, why not?
We disagree. We supports the ban on all proprietary trading activities to reduce conflicts of interest and prevent electronic price manipulation tactics, including "rat trading" and "front-running," which stem from these conflicts.
Q10
Do you agree that ALP operators should be obliged to provide prospective users of their ALPs with ALP Guidelines that are comprehensive and accurate and that their ALP Guidelines must include the matters referred to in paragraph 38? If not, why not?
We agree. Certain content must adhere to exchange regulations, which include restrictions on short selling, requirements for real-time physical delivery, prompt trading reports, and extensive disclosure obligations.
Q11
Do you agree that ALP operators should bring their ALP Guidelines to the attention of all prospective users of their ALPs? If not, why not?
We agree. Transactions executed via 'alternative trading platforms' can potentially initiate associated hedging activities or provoke psychological responses.
Q12
Do you agree that an ALP operator should be obliged to obtain formal acknowledgement from prospective users of its ALP that its ALP Guidelines have been brought to their attention and that they consent to their orders being transacted in the ALP, before such transactions are permitted to occur? If not, why not?
We agree. Given the considerable shortcomings of 'alternative trading platforms' in fulfilling the fairness, impartiality, and transparency standards expected of exchanges, it is essential for all potential users to thoroughly comprehend the trading models and the associated risks involved. Proceeding without a clear understanding can result in disputes and complications.
Q13
Do you agree that a licensed or registered person which, on behalf of its clients, routes agency orders to an ALP operated by a third party ALP operator should be obliged to ensure that its clients have formally acknowledged that the ALP Guidelines have been brought to their attention and that they consent to their orders being transacted in the ALP, before their orders are routed to the ALP? If not, why not?
We agree. The reason same as above point 12.
Q14
Do you agree that an ALP operator should adopt measures to ensure the integrity and/or system adequacy of its ALP and have appropriate contingency measures in place? If so, are the proposed requirements sufficient? If not, why not?
We agree. The proposed requirements must meet or exceed the regulatory standards applicable to the BSS brokerage's provision of electronic trading systems.
Q15
Do you agree that an ALP operator should keep the SFC informed as to the identity of its staff having access to trading and other information relevant to its ALP, the basis upon which such access is permitted, and any change made in relation to the staff to whom such access is permitted and the basis for such change? If not, why not?
We agree. The availability of pertinent information plays a crucial role in ensuring fairness, transparency, and equity in trading. Without strict regulation, this can lead to situations where participants might face unfair disadvantages.
Q16
Do you agree that the person responsible for originating a proprietary order in an ALP should be restricted from access to trading information or data concerning orders placed, or transactions conducted, in the ALP? If not, why not?
Prohibit proprietary trading activities. It is important to note that no system can completely eliminate the risk of proprietary traders accessing transaction data, particularly given the advancements in high-speed computer access technologies.
Q17
Do you agree that an ALP operator should keep proper records concerning the design, development, deployment and operation of its ALP? If not, why not?
We agree. The regulations under their supervision encompass various trading activities, including aspects of regulation, investigation, review, mediation, and enhancement initiatives.
Q18
Do you agree that an ALP operator should keep proper records concerning all transactions conducted on its ALP, including details of authorized traders? If not, why not?
We agree. The reason same as above point 17.
Q19
Are the records that the SFC proposes be kept by ALP operators in relation to the transactions conducted in their ALPs sufficient and appropriate? If not, why not?
We agree. The reason same as above point 17.
Q20
Do you agree with the proposed periods for the keeping of these records? If not, why not?
We agree. That’s enough. Can it be reviewed regularly.
Q21
Do you agree that the proposed requirements for risk management and post-trade reviews of transactions conducted in ALPs are sufficient to maintain the fair and orderly operation of the market? If not, why not?
We agree.
Q22
Are the proposed reporting and notification requirements appropriate? If not, why not?
It is appropriate but need to review regularly.