HKSI Licensing Examination Paper 1 (Regulation) — All Questions

Which body is the statutory regulator of Hong Kong's securities and futures markets?

• a.The Financial Services and the Treasury Bureau
• b.The Securities and Futures Commission (SFC)✓
• c.Hong Kong Exchanges and Clearing Limited (HKEX)
• d.The Hong Kong Monetary Authority (HKMA)

The SFC is the independent statutory body established under Part II of the SFO to regulate Hong Kong's securities and futures markets. The HKMA regulates banks, HKEX operates the exchanges and clearing houses, and the FSTB is a government policy bureau.

Which of the following is a regulatory objective of the SFC under the SFO?

• a.To maintain the fairness, efficiency, transparency and orderliness of the securities and futures industry✓
• b.To set interest rates for the banking sector
• c.To manage the Exchange Fund
• d.To guarantee that ordinary investors always earn a positive return on any listed securities bought through a Hong Kong intermediary

SFO s.4 sets out the SFC's regulatory objectives: maintaining fair, efficient, transparent and orderly markets, protecting the investing public, minimising financial crime and reducing systemic risk. It does not guarantee profits, set interest rates, or manage the Exchange Fund (an HKMA function).

What is the principal role of Hong Kong Exchanges and Clearing Limited (HKEX)?

• a.It licenses individual securities dealers
• b.It operates the Stock Exchange of Hong Kong and the Hong Kong Futures Exchange and their clearing houses✓
• c.It administers the Investor Compensation Fund
• d.It investigates and prosecutes insider dealing and other market misconduct in the Hong Kong criminal courts on its own authority

HKEX is the recognised exchange controller that owns and operates SEHK and HKFE together with the clearing houses (HKSCC, SEOCH, HKCC). Licensing is done by the SFC, criminal prosecution by the courts, and the Investor Compensation Fund is administered by the SFC under Part XII of the SFO.

A Hong Kong bank that carries on regulated activities does so as a 'registered institution'. Which regulator is its front-line supervisor for that securities business?

• a.The Investor Compensation Company
• b.The Stock Exchange of Hong Kong
• c.The Hong Kong Monetary Authority (HKMA)✓
• d.The Companies Registry

Banks that carry on regulated activities are registered institutions, and the HKMA is their front-line regulator under a memorandum of understanding with the SFC. SFC conduct standards such as the Code of Conduct still apply to their securities business.

Hong Kong's legal system is based principally on:

• a.The civil-law codified system of Mainland China
• b.Purely customary Chinese law
• c.The common law, preserved under the Basic Law after 1997✓
• d.Religious law

Under Article 8 of the Basic Law, the common law, rules of equity, ordinances and customary law previously in force are maintained. Hong Kong retains a common-law system separate from the Mainland's civil-law system.

Under Hong Kong company law, a document offering a company's shares to the public must generally:

• a.Be exempt from any content requirement if the company is private
• b.Be published only in a single newspaper
• c.Be approved personally by the Financial Secretary
• d.Be registered as a prospectus complying with statutory content requirements✓

A public offer of shares requires a registered prospectus meeting the statutory content and registration requirements under the Companies (Winding Up and Miscellaneous Provisions) Ordinance. A private company is prohibited by its constitution from offering shares to the public.

Under s.114 of the SFO, a person who carries on a business in a regulated activity in Hong Kong must:

• a.Be licensed by, or registered with, the SFC unless an exemption applies✓
• b.Obtain approval from the HKMA in every case
• c.Simply notify HKEX before starting
• d.Register the business name with the Companies Registry only

SFO s.114 prohibits any person from carrying on (or holding out as carrying on) a business in a regulated activity unless they are a licensed corporation or an authorised institution registered with the SFC. Breach is a criminal offence.

Schedule 5 to the SFO defines the categories of 'regulated activity'. Type 9 refers to:

• a.Securities margin financing
• b.Dealing in securities
• c.Advising on corporate finance
• d.Asset management✓

Under Schedule 5 to the SFO, Type 9 is asset management. Type 1 is dealing in securities, Type 6 is advising on corporate finance, and Type 8 is securities margin financing.

The SFO addresses insider dealing and other market misconduct through:

• a.Only a single criminal regime, under which all cases are prosecuted by the Department of Justice in the ordinary criminal courts
• b.Arbitration administered by HKEX
• c.Only civil proceedings before the SFC
• d.A dual civil (Market Misconduct Tribunal) and criminal regime, though not both for the same conduct✓

Part XIII (civil, before the Market Misconduct Tribunal) and Part XIV (criminal, in the courts) create parallel routes for the same forms of market misconduct. The SFC may pursue one route or the other for the same conduct, but not both.

Under Part XV of the SFO, a person becomes a 'substantial shareholder' of a listed corporation, triggering a disclosure obligation, when they become interested in:

• a.Any single share, if they are a retail investor
• b.5% or more of any class of the corporation's voting shares✓
• c.10% or more of the corporation's total shares
• d.3% of the corporation's non-voting shares

Part XV of the SFO sets the substantial-shareholder threshold at 5% of a class of voting shares. Notification is required within 3 business days of the triggering event and again on crossing each whole percentage level up or down.

A substantial shareholder whose interest crosses a notifiable threshold under Part XV of the SFO must file notice within:

• a.7 calendar days
• b.3 business days✓
• c.1 month
• d.24 hours

Part XV requires notification within 3 business days of the relevant event, such as first reaching 5% or crossing a whole percentage level. Short positions of 1% or more are also disclosable and cannot be netted against long positions.

Every licensed corporation must appoint responsible officers (ROs) for each regulated activity it conducts. The minimum requirement is:

• a.At least two ROs per regulated activity, at least one of whom is an executive director✓
• b.A single responsible officer for the firm as a whole, who need not be a director or be actively involved in supervision
• c.Three ROs, all of whom must be executive directors
• d.One RO for the whole firm regardless of activities

A licensed corporation must have at least two responsible officers for each regulated activity, and at least one RO must be an executive director available to supervise the business at all times.

In deciding whether to grant a licence, the SFC applies the 'fit and proper' test. Which factor is relevant?

• a.Whether the applicant banks with a specific institution
• b.The applicant's political affiliation
• c.The applicant's financial status, competence, reputation and reliability✓
• d.The number of social-media followers and public endorsements the applicant has accumulated within the industry

The Fit and Proper Guidelines require the SFC to consider an applicant's financial status and solvency, qualifications and experience (competence), and reputation, character, reliability and financial integrity. Commercial or political preferences are irrelevant.

Licensed individuals must keep their knowledge current through Continuous Professional Training (CPT). Under the SFC's current regime this means:

• a.A minimum number of CPT hours each calendar year for each regulated activity, including compliance and ethics content✓
• b.A one-off course taken only at the time of licensing
• c.No formal requirement, only encouragement
• d.A single fixed total of forty hours completed once every five years, none of which needs to relate to regulatory compliance

The SFC's CPT regime requires ongoing annual CPT hours for each regulated activity, with a defined minimum devoted to regulatory-compliance and ethics topics (currently 10 hours per year, of which at least 5 relate to compliance). Verify the current figures against the SFC's guidelines before relying on them.

The Securities and Futures (Client Money) Rules require a licensed corporation to:

• a.Lend client money to its directors
• b.Remit all client money to the SFC
• c.Hold client money in a segregated account with an authorised institution, separate from the firm's own money✓
• d.Treat client money as part of the firm's own working capital, pooling it with corporate funds to meet day-to-day expenses

The Client Money Rules require client money to be held in a segregated client account with an authorised institution, kept separate from the firm's own assets so clients are protected if the firm fails. Parallel Client Securities Rules apply to client securities.

Which activity would generally require a licence for Type 1 regulated activity (dealing in securities)?

• a.A company issuing and selling only its own shares to raise capital
• b.A newspaper that publishes general share-price tables and routine market commentary for its ordinary readership
• c.A firm that, for a commission, receives and transmits clients' orders to buy listed shares✓
• d.A person giving investment views to family members, not as a business

Receiving and transmitting client orders in listed securities for a commission is dealing in securities (Type 1) and requires a licence. An issuer selling only its own securities, incidental media reporting and non-business private views fall outside the licensing net.

General Principle 1 of the SFC Code of Conduct requires a licensed person, in conducting business, to act:

• a.In the firm's own commercial interest first, provided the client is not deliberately deceived during the process
• b.Only within the letter of the law, ignoring fairness
• c.So as to maximise commission income
• d.Honestly, fairly, and in the best interests of clients and the integrity of the market✓

General Principle 1 (Honesty and fairness) requires licensed persons to act honestly, fairly and in the best interests of their clients and the integrity of the market. It is the foundational conduct principle of the Code of Conduct.

Before providing services, the Code of Conduct requires an intermediary to take reasonable steps to establish the client's identity, financial situation, investment experience and objectives. This 'know your client' duty is found in:

• a.Part XV of the SFO
• b.The tipping-off offence in the AMLO
• c.Paragraph 5.1 of the Code of Conduct (Know your client)✓
• d.The Listing Rules

The know-your-client duty is set out in paragraph 5.1 of the Code of Conduct, supporting General Principle 4 (Information about clients). It underpins the suitability obligation in paragraph 5.2.

A licensed representative recommends a complex derivative product to a retail client. The Code of Conduct's suitability obligation (para 5.2) requires that the recommendation be:

• a.Approved by HKEX in advance
• b.Treated as suitable only where the client signs a waiver giving up all rights and protections under the Code of Conduct
• c.Reasonably suitable for the client given their financial situation, investment experience and objectives✓
• d.The product carrying the highest commission

Paragraph 5.2 requires that when making a recommendation or solicitation, the intermediary ensures its suitability for the client in all the circumstances. The suitability obligation is also incorporated into the client agreement through the mandatory Suitability Clause.

An intermediary that trades as principal against a client's order must, under General Principle 6 of the Code of Conduct:

• a.Manage the conflict fairly, disclose its capacity, and give priority to the client's interests✓
• b.Charge the client a penalty
• c.Always refuse the trade
• d.Conceal its principal position from the client so as not to discourage the client from proceeding with the transaction

General Principle 6 (Conflicts of interest) requires a licensed person to avoid conflicts where possible and, where they arise, to ensure clients are fairly treated, including disclosing whether it acts as principal and giving client orders priority.

The Code of Conduct requires an intermediary to enter into a written client agreement. That agreement must:

• a.Be signed only by the responsible officer
• b.Be in a form the client can understand and must not contain terms inconsistent with the Code✓
• c.Waive the firm's duty of suitability
• d.Be filed with, and individually approved by, the SFC before the intermediary executes any trade for the client

A client agreement must be clear, fair and not misleading, and cannot contain provisions inconsistent with the Code. Clauses that purport to override the suitability obligation are unenforceable.

Under the AMLO and the SFC's AML/CFT Guideline, a licensed corporation opening an account for a new client must first:

• a.Carry out customer due diligence to identify and verify the client and any beneficial owner✓
• b.Obtain the SFC's written consent
• c.Wait 90 days before any transaction
• d.Report the prospective client to the police as a criminal suspect before opening any account or accepting funds

The Anti-Money Laundering and Counter-Terrorist Financing Ordinance requires customer due diligence (CDD): identifying and verifying the customer and beneficial owners and understanding the purpose of the relationship, on a risk-based approach, with enhanced due diligence for higher-risk clients such as politically exposed persons.

A licensed representative forms a suspicion that a client's transaction involves proceeds of crime. The representative must:

• a.Immediately warn the client of the concern and ask them to explain the source of the funds before doing anything else
• b.File a suspicious transaction report with the Joint Financial Intelligence Unit (JFIU)✓
• c.Report only at the year-end audit
• d.Reverse the transaction without keeping a record

Suspicious transactions must be reported to the Joint Financial Intelligence Unit (JFIU). Warning or 'tipping off' the client that a report has been or may be made is a criminal offence under the AMLO and OSCO.

Handling of clients' personal data by an intermediary is governed principally by:

• a.The Stamp Duty Ordinance
• b.The Personal Data (Privacy) Ordinance and its data protection principles✓
• c.The Companies Ordinance
• d.The Listing Rules of the Stock Exchange, which set out how the personal data of investors must be collected and stored

The Personal Data (Privacy) Ordinance (PDPO) and its six Data Protection Principles govern the collection, use, security and retention of clients' personal data, and are referenced in the business-operations topic of the Paper 1 syllabus.

Under the Management, Supervision and Internal Control Guidelines and General Principle 9, ultimate responsibility for a firm's proper controls and compliance rests with:

• a.The firm's senior management✓
• b.The SFC's enforcement division
• c.The most junior compliance clerk
• d.The external auditor

General Principle 9 (Responsibility of senior management) and the Internal Control Guidelines place ultimate responsibility for maintaining appropriate standards of conduct, controls and compliance on the firm's senior management.

Securities traded on the Stock Exchange of Hong Kong are normally settled through CCASS on a:

• a.A rolling ten-business-day (T+10) basis, with paper certificates delivered physically between the brokers involved
• b.Same-day (T+0) basis
• c.Monthly netting basis
• d.T+2 basis (two business days after the trade)✓

Exchange trades in HK-listed securities settle through the Central Clearing and Settlement System (CCASS), operated by HKSCC, on a T+2 basis, with money settlement following the same cycle.

A general offer to acquire control of a Hong Kong listed company is regulated principally by:

• a.The Codes on Takeovers and Mergers and Share Buy-backs administered by the SFC✓
• b.The Companies Registry's internal administrative rules, which set the terms on which control of a listed company may change
• c.The Stamp Duty Ordinance
• d.The Basic Law

Takeovers, mergers and share buy-backs of public companies are governed by the SFC-administered Codes on Takeovers and Mergers and Share Buy-backs. Though non-statutory, they are enforced through the SFC's powers, and a mandatory general offer is triggered at 30% of voting rights.

Insider dealing under the SFO occurs when a person connected with a listed corporation deals in its securities while in possession of:

• a.A rumour circulating on social media
• b.Any information about the company at all, whether or not it is already public and whether or not it affects the price
• c.Only information published in the annual report
• d.Relevant, price-sensitive information that is not generally known to the market✓

Insider dealing turns on a 'connected person' dealing while in possession of 'relevant information': specific, price-sensitive information not generally known that, if known, would likely materially affect the price. Publicly available information cannot found the offence.

Entering matched buy and sell orders that involve no genuine change in beneficial ownership, in order to create a misleading appearance of active trading, is:

• a.A permitted market-making technique
• b.False trading, a form of market misconduct under the SFO✓
• c.Lawful if disclosed to the broker
• d.Only a breach of the Listing Rules

Wash sales and matched orders that create a false or misleading appearance of active trading constitute false trading, which is prohibited under both Part XIII (civil) and Part XIV (criminal) of the SFO.

When the Market Misconduct Tribunal (MMT) finds market misconduct under Part XIII of the SFO, it may:

• a.Levy criminal fines
• b.Cancel the company's listing automatically
• c.Impose a term of imprisonment on the individuals found to have engaged in the market misconduct in question
• d.Order disgorgement, disqualification, a cold-shoulder order and a cease-and-desist order✓

The MMT is a civil tribunal chaired by a judge. It can order disgorgement, disqualification (director bans), cold-shoulder and cease-and-desist orders, but it cannot impose imprisonment or criminal fines, which require criminal prosecution under Part XIV.