Hong Kong Law of Offshore

The legal profession in Hong Kong bears a strong resemblance to that of the UK, on which it is modelled. Thus, it is a split profession, with barristers and solicitors. It is largely autonomous, and its rights to be self-regulating were explicitly preserved in the Basic Law introduced in 1997 when Hong Kong reverted to Chinese rule.

There are about 565 practising barristers and 3,300 practising solicitors in Hong Kong. Barristers have a right of audience in all courts, whereas solicitors' rights of audience are generally limited to the lower courts; a client must approach a barrister through a solicitor; and a solicitor must be present when a barrister is in court, takes instructions from a client or interviews a witness.

As in the UK, this antiquated system needs loosening up, but the lawyers who benefit from it will not accept change very readily. A relaxation of the differences between solicitors and barristers would increase competition, improve access to barristers and lead to reduced costs.

While recognizing that there is a need to retain and develop a strong group of specialist advocates, the Administration thinks that rights of audience should be based on competence, not on whether a lawyer is a barrister or solicitor. There are proposals for change:

Retaining the two branches of the profession but eliminating the practices that can no longer be justified would both benefit consumers and continue to provide a choice for legal practitioners. However, barristers have continued to oppose modernisation of the profession, and so far these proposals have only been adopted to a small extent.

In addition to its structural problems, Hong Kong's legal sector is plagued by under-capacity. The average waiting time between a request for a court date and the actual hearing is 216 days in the civil court, although time spent on preliminary matters means that the average litigant will have to wait for about 400 days to have a case heard.

A recent paper on civil justice reform said the number of judges in Hong Kong had not changed significantly in the past decade despite sharp increases in workload.

The caseload of the High Court has increased 82% since 1991, so that judges have thus had to cope with higher pressure and bigger workloads. The panel of Masters will deal with work in the High Court that encompasses summary judgments, where a case is instantly disposed of, and interlocutory applications, ie technical queries that don't require a court hearing as such. They will also dealing with so-called 'taxation', meaning the scrutiny of legal bills to allocate costs between litigants.

Evidently wanting yet more work, in September, 2003, the Hong Kong Bar Council met with the Chinese Ministry of Justice, in order to attempt to persuade the Chinese authorities to allow Hong Kong's barristers the same rights to practice on the mainland as have been afforded to the territory's solicitors.

Under the auspices of the Closer Economic Partnership Agreement (CEPA), Hong Kong lawyers will be permitted to study for qualifications as mainland lawyers with a view to practicing there. However, SAR-based solicitors are prohibited from practising any kind of litigation work, and barristers have been excluded from the agreement altogether.

Alan Leong SC, head of the Bar Council's mainland practice relations committee suggested that there were several reasons, both socio-economic and political, why barristers have been excluded from the draft agreement thus far. He observed that: 'Litigation is the bread and butter for most mainland China lawyers,' and went on to explain that: 'The Chinese mainland does not practice adversarial or hostile litigation like we do. I do not rule out that our style and concepts of litigation would have an impact.' However, he added that in light of the fact that the SAR is prepared to allow mainland lawyers to practice litigation in the territory, a degree of reciprocity should be expected.

In December, 2003, it was announced that, as from 1st January, 2004, Hong Kong law firms will be permitted to form alliances with Chinese firms. Major international law firms took great notice of this development, which should lead to a major increase in the size and prestige of the Hong Kong legal profession. However, only lawyers born in Hong Kong will be allowed to re-qualify to practice local law on the mainland, and even they will only be permitted to practice commercial law. Many US and UK law firms are nonetheless said to be looking to register locally as Hong Kong practices in order to take advantage of the opening-up of the Chinese legal sector.

Finally, in June, 2004, a working party was established to examine the ending of the monopoly held by the territory's barristers on conducting trials in the High Court. Although the announcement that a think-tank will examine the issue was cautiously welcomed by solicitors, many within the legal community are doubtful that this new initiative will yield positive results, or even cover new ground compared to earlier reviews. Among other concerns, solicitors fear that the choice of appointments to the working party is likely to influence its conclusions, with the possible appointment of more traditional judges likely to swing the debate in favour of barristers retaining their monopoly.

In August, 2004, Hong Kong law firm Woo Kwan Lee & Lo became the first SAR-based organisation to create an alliance with a Chinese law firm under the auspices of the Closer Economic Partnership Arrangement (CEPA) between the jurisdiction and the mainland. Woo Kwan and the Beijing-based Grandall Legal Group will share office costs, resources, and staff. The move is likely to be closely watched by the various international law firms who see the alliances permitted under CEPA as a potential gateway into the Chinese market, which has traditionally been off-limits to them due to restrictive practice rules.

Hong Kong solicitors earn interest on clients' money held by them and usually retain this by virtue of a contractual provision entitling them to do so. In the absence of such a provision, the interest belongs to the client.

This situation is anomalous, since in England there have been rules since 1965 requiring solicitors to pay interest to clients when it is reasonable for them to do so, while in many other common law jurisdictions interest on client monies is paid to a central fund and used for improvement of the profession.

There is no statutory client protection or indemnity fund in Hong Kong. Solicitors are required to have professional indemnity cover, but barristers are not. It is proposed that barristers should fall into line with solicitors, and also that a compensation fund should be set up.

Solicitors are generally under no duty to explain to a client the amount of fees he will be charged, or the basis on which they will be charged.

Solicitors' fees relating to non-contentious work (such as the sale and purchase of a flat) are charged according to the standard scales laid down by a statutory committee. The committee is chaired by a High Court Judge. Half of the members are solicitors. At present, a person buying a flat for $3 million, with a 70% mortgage, would pay scale fees of about $36,500.

Conditional fees were not permitted in Hong Kong until 2005 (see below). Notarial fees, where relevant, are included in the final bill to the client.

The two professional bodies do not have a general power to provide a remedy for shoddy work that does not amount to professional misconduct. The English Law Society has had such a power since 1985 and the English Bar plans to create a similar power. In addition, English solicitors are required to have complaints-handling procedures. It is proposed that the two professional bodies in Hong Kong should have the power to provide a remedy for shoddy work, and solicitors' firms should be required to establish complaints-handling procedures.

A consultation paper released in September, 2005, by the Law Reform Commission of Hong Kong recommended that existing prohibitions against the use of conditional fee arrangements should be lifted for certain types of litigation, thereby helping improve access to the law for middle income groups.

Conditional fees are a form of “no-win, no fee” arrangement. If the case is unsuccessful, the lawyer will charge no fees. In the event of success, the lawyer charges his normal fees plus a percentage “uplift” on the normal fees. Conditional fees are different from the American form of contingency fee, where the lawyer’s fee is calculated as a percentage of the amount of damages awarded by the court.

At present, conditional fees, like other forms of “no win, no fee” arrangements, are unlawful for civil legal proceedings involving the institution of legal proceedings. The restriction has its origins in the ancient common law crime and tort of champerty and maintenance.

Given the high cost of litigation in Hong Kong, those in the middle-income group whose means are above the limits set down by the Legal Aid Scheme and the Supplementary Legal Aid Schemes would have difficulty financing litigation.

The consultation paper recommends that lawyers should be allowed to use conditional fees in certain types of civil litigation, including: personal injury cases, family cases not involving the welfare of children, insolvency cases, employees’ compensation cases, professional negligence cases, some commercial cases, product liability cases and probate cases involving an estate.

The paper cautioned against the introduction, at least initially, of conditional fee arrangements for defamation cases, criminal cases, and cases in which an award of damages is not the primary remedy sought.

To maintain a healthy balance between the rights of claimants and defendants, the sub-committee also recommended some mechanisms to safeguard defendants against nuisance claims.

The consultation paper points out that conditional fee arrangements cannot function properly without the availability of “After-the-Event” insurance (“ATE insurance”). However, the indications are that it is possible that ATE insurance may not be available at an affordable level and on a long-term basis in Hong Kong.

To cater for the possibility that conditional fees cannot be successfully launched without ATE insurance, the sub-committee recommends that the Government should increase the financial eligibility limits of the Supplementary Legal Aid Scheme, as well as expanding the types of cases covered by the scheme.

The sub-committee has further recommended the setting up of a “non-government contingency legal aid fund” (“CLAF”), which would probably be run by an independent body, and that applicants would have to satisfy a “merits” test in respect of their proposed litigation, but would not be subject to any means test. The scheme would take a share of any compensation recovered, so that it would be self-financing. Lawyers working for the scheme would be paid on a conditional fee basis. The scheme would also pay the defendants’ legal costs in unsuccessful cases and so would, in effect, take over the role of ATE insurance.

Professor Edward K Y Chen, chairman of the LRC’s Conditional Fees Sub-committee. stressed that the recommendations in the consultation paper were put forward for discussion and did not represent the sub-committee’s final conclusions. The sub-committee invites and views, comments and suggestions on any issues discussed in the consultation paper.

This is a non-exhaustive list of the main Hong Kong statutes affecting international business and investors. The statutes are listed in alphabetical order – click on the statute for a fuller description of the statute or the legal regime it forms part of.

In September, 2005, the Jersey Financial Services Commission and Hong Kong’s securities and futures market regulator, the Securities and Futures Commission, signed a Letter of Intent which provides a framework for enhanced cooperation between the two regulatory authorities.

The Letter of Intent will provide a formal basis for both regulators to work towards several goals, including:

equivalence of regulatory frameworks in place in each jurisdiction in the areas of regulation, supervision and marketing of investment products;
the mutual recognition of investment products; and
further strengthening of regulatory cooperation and assistance in matters pertaining to cross-border supervision of fund management activities.

The authorities have agreed to establish a bilateral working group to work towards the achievement of objectives set out in the Letter of Intent.

Both the Commission and the SFC are members of the International Organisation of Securities Commissions (IOSCO) and signatories of the IOSCO Multilateral Memorandum of Understanding. The Letter of Intent is signed in the spirit of mutual cooperation between securities regulators fostered by IOSCO.

David Carse, Director General of the Commission noted that: “I am delighted to sign this Letter of Intent with the Hong Kong SFC. The Commission considers that co-operation under the Letter will facilitate access to Hong Kong’s markets for Jersey investment products, and also help to develop the range of products that are available for distribution in Jersey. It will also provide a more formal basis for exchanging views with an important Asian supervisor on matters of common interest.”

Meanwhile, Andrew Sheng, Chairman of the SFC added that: “The SFC is committed to facilitating the development of deeper and broader investment markets globally. We are delighted to sign this Letter of Intent with the Jersey Financial Services Commission, our second non-Asian partner in this endeavour. Jersey is strategically located and plays an important role in the European investment products market, and therefore ideally placed to explore with the SFC the means of achieving cross-border distribution of investment products between our respective markets to our mutual benefit.”

In May, 2004, Hong Kong's Intellectual Property Department, the Hong Kong Trade Development Council, and the Guangdong Provincial Intellectual Property Office joined forces on Tuesday to stage a one-day seminar on improving intellectual property (IP) cooperation between the territory and the Chinese mainland.

The seminar looked at the protection of IP with particular reference to small and medium enterprises (SMEs), and topics under discussion included seeking patent protection for new inventions in the Chinese mainland, trademark protection issues, and the protection of intellectual property rights in overseas markets.

Speaking to attendees, deputy director of Hong Kong's Intellectual Property Department, Peter Cheung explained that: "Dongguan (a major city within the Guangdong Province) is an international processing and manufacturing base as well as an important city for foreign export of the Mainland. Hong Kong enterprises, therefore, have already established a strong investment base in the city."

He went on to add that: "Dongguan was deliberately chosen for the seminar to allow government officials from Hong Kong and Guangdong to gather together to introduce their respective intellectual property regimes to SMEs in the region. This is a significant step to deepen our business sector's awareness on intellectual property protection and management, and foster co-operation on intellectual property matters in the Pearl River Delta Region."

Money Laundering Law

Hong Kong has two major pieces of legislation to control money laundering: the Drug Trafficking (Recovery of Proceeds) Ordinance ("DTRPO"); and the Organised and Serious Crimes Ordinance ("OSCO")

Since being enacted, these Ordinances have been amended in order to:

extend the government's power to attack money laundering associated with drug trafficking and other serious offences; and
impose statutory duties on providers of financial and professional services to disclose and to make proper inquiries into suspicious transactions.

The amendments make it an offence for professionals such as bankers, lawyers or accountants to deal with property that they know or have reasonable grounds to believe represents, directly or indirectly, the proceeds of drug trafficking or other serious crimes. The maximum penalty for the offence is 14 years imprisonment and/or a fine of HK$5m.

It is also an offence if a person who knows or suspects that any property represents the proceeds of drug trafficking does not report his knowledge or suspicion to the authorities.

Therefore the onus is on financial institutions and professionals to act as watchdogs and control systems have been established by many companies to ensure that they are fulfilling their responsibilities under the new amendments. However, no offence will have been committed if proper disclosure is made before the prohibited act occurs and the act is done with the consent of the authorised officer. Similarly, if disclosure is made to an authorised officer voluntarily and soon after the act has been committed, there is no offence. It is an offence to disclose anything which is likely to prejudice an investigation into the suspected money laundering.

The new amendments ensure that disclosures will not be treated as a breach of any restriction imposed by contract (such as a bank's duty of confidentiality to its customers). Those making any disclosures will not be liable for any loss arising from the disclosure even if the suspicion is later shown to have been unfounded, although reasonable.

Furthermore, the amendments require money changers and remittance agents to follow anti-money laundering measures such as customer identification and keeping transaction records for transactions over HK$20,000. This has helped to prevent criminals from using non-bank financial busineses as conduits for money laundering.

Informants are not required to reveal in civil or criminal proceedings that they have made disclosures under the legislation.

The Hong Kong Monetary Authority, Hong Kong Stock Exchange and Securities and Futures Commission have also established guidelines for their members aimed at helping them to avoid facilitating money laundering.

In February, 2004, the Hong Kong Monetary Authority (HKMA) urged banks in the jurisdiction to be alert to the possibility of money laundering as they gear up to offer yuan-denominated banking services. "Participating banks are requested to heighten the awareness of their staff involved in such business to possible money laundering transactions," the regulator announced.

In order to reduce the possibility of money laundering activity taking place, the HKMA ordered banks to record whether yuan deposits are made in cash, or via the conversion of other currencies. It also urged the financial institutions to keep track of multiple accounts opened by the same customer, and to ensure that the 20,000 yuan per day exchange limit is not breached by spreading the transactions across several accounts.

In June, the HKMA issued a supplement to the territory's anti-money laundering guidelines, setting out the latest "Know-Your-Customer" principles, taking account of the requirements of the paper on "Customer Due Diligence for Banks" issued by the Basel Committee on Banking Supervision in October 2001 and the revised Forty Recommendations issued by the Financial Action Task Force on Money Laundering in June 2003.

Under the new guidelines, banks and financial service providers are urged to subject the transactions of higher risk customers to enhanced due diligence. Those deemed by the HKMA to fall into the high risk category include politically exposed persons, correspondent banks from "non-cooperative jurisdictions", and offshore companies established in order to disguise beneficial ownership.

In February, 2005, Financial Secretary, Henry Tang revealed that the territory's government is seeking to raise its game in combating money laundering and terrorist financing. He said: "We have already started to put in place the latest recommendations of the Financial Action Task Force (FATF), which will become the new international standard on anti-money laundering."

The Financial Secretary also stressed the need for cross-border cooperation, explaining that: "While New York, London and Hong Kong must do our best individually to protect their markets against money launderers or terrorists, none of us can really succeed on our own. To be effective, all jurisdictions around the world must work together to create a security network so strong and so tight that criminals cannot breach our defence."

Until 1964 there were virtually no regulations governing the financial sector in Hong Kong. A banking crisis in the 1960s led the authorities to enact the Banking Ordinance 1964, which introduced basic standards such as minimum capital requirements and rudimentary disclosure laws. However, bank failures, caused by poor management and excessive investment in the real estate market in the early 1980s, coupled with the stock market crash in 1987, resulted in a complete overhaul of Hong Kong financial market regulations. The country now has a transparent legal and regulatory environment that has facilitated its role as a modern regional and international financial center.

Under the Sino-British Joint Declaration on the Future of Hong Kong, Chinese authorities were committed to enact the Basic Law of the Hong Kong Special Administrative Region. The Basic Law is the legal basis for the "One Country, Two System" guarantee and provides for the continuance of Hong Kong’s system of common law and free market economic system after 1 July 1997.1 The Law stipulates that the Hong Kong dollar will remain freely convertible; that markets for foreign exchange, securities, futures, and other financial products will remain open; and that no controls will be placed on the flow of capital into or out of Hong Kong.

Three government agencies are responsible for regulating Hong Kong’s financial market: the Hong Kong Monetary Authority (HKMA), the Securities and Futures Commission (SFC), and the Insurance Authority. In addition to being regulated and supervised by the HKMA, banks are required to become members of and adhere to the rules of the Hong Kong Association of Banks (HKAB).

The Hong Kong Monetary Authority

Hong Kong has no central bank as such, but the HKMA does assume many of the responsibilities typically assigned to a central bank, including ensuring the safety and soundness of the banking system and the stability of the currency.

Three private banks—the Hongkong Shanghai Bank, the Bank of China, and Standard Chartered—are authorized to issue HK dollars. Under the currency board system, these banks are allowed to issue HK dollars only upon depositing US dollars in the Exchange Fund, which is regulated by the HKMA. In 1990, the HKMA began to issue Exchange Fund Bills and, in 1993, Exchange Fund Notes, which are both HK dollar debt securities. The issuance of debt securities through open-market operations provides the HKMA with a mechanism for adjusting interbank liquidity.

The clearing and settlements system in Hong Kong changed in April 1997. Until that time, the Hong Kong Shanghai Bank managed the Clearing House of the Hong Kong Association of Banks and settled interbank payments. The Clearing House is now managed by Hong Kong Interbank Clearing Limited, which is jointly owned by HKMA and HKAB. Under the new system, interbank payments are cleared through the Exchange Fund.

In a circular released in July, 2002, HKMA outlined the principal points of new regulations governing securities business undertaken by banks.

Currently, Hong Kong's banks are known as 'exempt dealers', because their securities departments are not regulated by the Securities and Futures Commission. However, under the Banking (Amendment) Ordinance 2002 and the new Securities and Futures Ordinance implemented in 2003, a raft of new rules governing banks' securities business have been introduced.

The main points of the new regulations, as outlined in the HKMA circular are as follows:

Under the new regulatory regime, the Monetary Authority will be in charge of the day-to-day supervision of banks' securities divisions, but cases of suspected malpractice will be handed to the Securities and Futures Commission for investigation.

'This is in line with the concept that the SFC remains the ultimate authority to regulate the securities and futures industry,' the circular explained.

The Stock Exchange of Hong Kong (SEHK) operates as a private entity. Thus when the stock market crashed in 1987, the Securities Commission had no legal authority to intervene in the affairs of the SEHK. The regulatory infrastructure for the securities industry has since been revamped and, in 1989, the Securities and Futures Commission Ordinance was enacted. The Ordinance provides the legal basis for the SFC to supervise and regulate the securities industry. The SFC now has the authority to take actions necessary to protect the safety of the securities market and to prosecute individuals who breach securities market ordinances and codes.

There were four stock exchanges in Hong Kong until 1986, when the four were merged into the Stock Exchange of Hong Kong (SEHK) in an effort to consolidate management and control of the market. By the end of 1996, the SEHK was the second largest stock exchange in Asia and the seventh largest stock exchange in the world, with total market capitalization of US$446 billion. The Hong Kong Futures Exchange offers futures contracts in finance, properties, utilities, and commerce and industry.

After the stock market crash of 1987, the SFC was charged with overhauling the regulations that govern securities market participants. Applicants for a license to deal in securities or operate as an investment adviser are now required to meet the "fit and proper person" criterion. Applicants seeking a dealer’s license must also have minimum net capital of HK$5 million. Although there is no deposit insurance for bank customers, there is a compensating fund for individuals whose brokers default on funds owed.

In 1991 the Securities (Insider Dealing) Ordinance was amended, resulting in higher penalties for insider trading. Fraud and misrepresentation are also punishable by the SFC. Another ordinance enacted in 1991 calls on a company’s directors and executives, as well as those who acquire more than 10 percent of a company’s voting shares, to publicly disclose their dealings. Firms seeking to list on the SEHK must make a prospectus publicly available. The SFC has the authority to determine which clearinghouses are permitted to settle accounts and their rules of operation in order to ensure a sound clearinghouse system.

Foreign-owned financial services firms can engage in securities market activities in Hong Kong in one of two ways. Firms that do not deal in the securities market as their primary business may engage in securities market transactions through an "exempt" license. Foreign-owned securities firms are also free to establish branches or subsidiaries in Hong Kong subject to approval from the SFC. Securities firms offer a wide range of services, from managing portfolios to selling foreign mutual funds to administering local pension plans.

In the late 1990's the HKMA conducted a thorough study of the SAR's banking sector and drew up a package of policy measures which are being installed over a three-year period beginning in 2000. The details of these reform measures and the implementation timetable are contained in the HKMA's Policy Response to the Banking Sector Consultancy Study.

In November 2000 the Hong Kong Government introduced the Composite Securities and Futures Ordinance which combines and replaces all ten existing pieces of securities and futures legislation. The new law, which was passed in 2002 and came into effect in 2003 gives the Securities and Futures Commission (SFC) the power to regulate Internet trading. In addition the SFC will also be able to seize the working papers of market professionals during investigations.

An independent non-statutory body, known as the Process Review Panel, has been established to ensure that the SFC's internal operations, including its investigative and disciplinary procedures, are fair and consistent.

The Ordinance makes the SFC responsible for regulating the securities business of banks; their securities departments are currently regulated by the Hong Kong Monetary Authority, not by the SFC, which regulates brokers. The new law allows the SFC to penalise banks if their securities businesses are found to be in breach of regulations while allowing the HKMA to continue to operate as the frontline regulator conducting routine inspections.

In May, 2004, the SFC agreed for the first time to accept a monetary settlement in order to end a disciplinary action against one of the territory's senior brokers, revealing that Raphael Blot, head of SG Securities' equity derivatives sales department, had agreed to pay the regulator $750,000 in order to settle a market manipulation case dating back to 1998.

"On 19th November 2003 the SFC determined that Mr. Blot’s licence...should be suspended for the period of six months by reason of his use of “placing schemes” from October 1998 to May 1999 in order to meet the placing requirements of the former 15A.67 and Appendix 6A, of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Ltd. The Listing Rules were amended to remove these requirements with effect from 10th December 2001. The SFC refers to its announcement dated 7th June 2001 in this regard."

"Mr. Blot appealed the SFC’s decision to the Securities and Futures Appeals Tribunal and was granted leave by the High Court to judicially review the SFC’s decision. Both these sets of proceedings have now been withdrawn as part of a compromise between the SFC and Mr. Blot on the basis that Mr. Blot pays HK$750,000 to the SFC, without admitting any liability and Mr. Blot’s licence will not be suspended. The SFC will pay the sum to the government revenue."

Although such settlements are common practice in the United States, this is the first such agreement in Hong Kong, and has prompted calls for clarification from the territory's other brokerages and financial institutions.

In August, 2005, the SFC released the consultation conclusions of a review of the territory's Code on takeovers, mergers and share repurchases, the main revisions to which took effect on October 1, 2005.

The SFC also consulted the public about whether the Code should be amended to provide for whitewash waivers of general offer obligations triggered as a result of on-market share repurchases.

The majority of respondents disagreed that such waivers should be permitted. Some suggested that the uncertainties as to the price and timing of on-market repurchases contributed to the undesirability of such an amendment.

One respondent emphasised that, in light of the prevalence of the controlling shareholder environment in Hong Kong, Hong Kong regulations have historically and justifiably placed greater attention on ensuring that the interests of minority shareholders are not unfairly prejudiced than regulations in other markets.

There is a concern that minority interests may be prejudiced in the guise of increasing shareholder value if the proposal were allowed. The Takeover Executive agrees with these concerns and believes that it is in the overall best interests of minority shareholders not to amend the Code in this respect.

Mr Peter Au-Yang, SFC’s Executive Director of Corporate Finance, noted that: "By keeping the Code up-to-date with market developments and international practice, the changes help to ensure continued fair treatment for shareholders who are affected by takeovers and mergers."

The Banking Ordinance is the basis of the legal framework governing the banking sector. The Bank Advisory Committee, which is composed of members of public-sector and private financial institutions, advises government authorities on issues concerning the Banking Ordinance.

The Banking Ordinance was amended in 1986 to authorize the Commissioner of Banking to regulate the banking sector, set minimum capital standards, and limit loans to customers and bank employees. Amendments to the Ordinance in 1995 gave the HKMA broader powers, including responsibility for all matters pertaining to the authorization of banks. The HKMA can suspend or revoke the license of a bank found to be in violation of regulations designed to protect the safety and soundness of the financial system. It is also authorized, after consultation with the Financial Secretary of Hong Kong, to take over a financial institution that is unable to make payments or if it is deemed in the public interest to take control of the firm.

There is a three-tier banking system of "authorized institutions" in Hong Kong: licensed banks, restricted-license banks, or deposit-taking companies. Only licensed banks are permitted to accept deposits of any size and maturity and to offer checking and savings accounts. They effectively function as commercial banks. Restricted-license banks are limited to accepting deposits of more than HK$500,000 and thus offer investment banking services. Deposit-taking companies are only authorized to accept deposits over HK$100,000 that have an initial maturity of at least three months. Hong Kong adheres to the Basle principles for bank supervision.

The approach is one of ongoing supervision and includes on-site reviews of operations and financial records and off-site reviews of financial statements and reports. Banks are required to be incorporated and publish detailed audit reports as well as monthly returns showing assets and liabilities. In addition to information on their balance sheet and quality of assets, banks are required to disclose inner reserves, realized profits, and net assets. Authorities meet annually with internal and external auditors to review each institution’s audit and determine if the institution is in compliance with prudential standards and the Banking Ordinance. The Banking Ordinance, in turn, provides a legal basis for enforcing the Basle standards. Violation of the Banking Ordinance is punishable by fines, imprisonment, or both.

The Banking Ordinance restricts the use of the word "bank" to those institutions that are either licensed or restricted-license banks. In the latter case, the word "bank" must be accompanied by either "merchant" or "investment." Only a "fit and proper person" can be issued a banking license, and there exist controls regarding the ownership and management of an authorized financial institution. An authorized institution is required to inform the HKMA if it makes changes to any documents that outline the institution’s procedures. Approval is also required before there can be any changes in a bank’s ownership.

The Banking Ordinance also sets forth minimum capital requirements for authorized institutions. Locally incorporated banks must have paid-in capital equal to US$388 million and net assets of US$518 million dollars for authorization to operate a licensed bank. Applicants for a restricted-license bank must have paid-in capital equal to US$12.8 million.

Authorized institutions are not permitted to lend more than 25 percent of their capital base to a single customer or group of related customers, nor are they allowed to hold more than 25 percent of shares in other companies. No more than 10 percent of an authorized institution’s capital base may be used for unsecured loans.

The HKMA adopted BIS capital-adequacy guidelines in 1989. The minimum standard according to BIS recommendations is a capital-adequacy ratio of 8 percent. The national requirement in Hong Kong is also 8 percent, although some banks are required to maintain 12 percent and some nonbanks at least 16 percent. The actual risk-based capital-adequacy ratio at the end of 1995 was 17.5 percent. In December 1996, the HKMA implemented reporting requirements that direct banks to address market risk in calculating their capital-adequacy ratio.

In August, 2006, the Hong Kong Monetary Authority released a draft of new Banking (Capital) Rules for public consultation.

They are scheduled to come into effect in January, 2007, and are the implementing Rules for Basel II, the new international standard for banks' capital adequacy.

The proposals set out in detail the different approaches that can be adopted for calculating the capital charge for credit, market and operational risks.

They will be issued under a new rule-making power provided under the Banking (Amendment) Ordinance 2005, and will replace the current regulatory capital regime set out in the third schedule to the Banking Ordinance.

The consultation on the draft rules will end on September 2, and a similar consultation will soon be undertaken on the Banking (Disclosure) Rules.

Foreign-owned commercial banks can enter the Hong Kong banking industry by establishing a branch or by acquiring ownership of a local bank. Foreign-owned firms must apply for a license to enter the financial services market. License approval is subject to four criteria: foreign-owned firms must (1) have net assets of US$16 billion, (2) be incorporated in a country that applies the Basle principles for bank supervision, (3) have approval from their home country to operate a branch in Hong Kong, and (4) come from a country that offers reciprocal access to Hong Kong banks. Of the 224 authorised institutions in Hong Kong in 2004, 197 are beneficially owned by interests from over 30 countries. In addition, there are 89 local representative offices of overseas banks in Hong Kong.

Hong Kong does maintain restrictions on the number of branches that foreign banks are permitted to operate. In 1994, authorities relaxed the one-branch limit for foreign banks, allowing them to open one additional office in a separate building from the location of their main branch; however, the additional office is to be used only for "back office" functions such as processing and settling transactions conducted in the main branch office. Fully licensed banks (commercial banks) are allowed to establish operations in Hong Kong only as a bank branch. Restricted-license banks (investment banks) are permitted to open branches or subsidiaries. Licenses for deposit-taking companies are extended only to locally incorporated subsidiaries.

In the light of China's accession to the WTO, in December 2001 the Hong Kong Monetary Authority announced that it intended to scrap the US$16 billion minimum asset requirement for foreign banks, bringing the amount needed down to HK$5 billion, in line with the requirements for local institutions. As well as encouraging foreign financial institutions to put down roots in the SAR, the authorities hope that this move will encourage the mainland to reduce its minimum asset requirements - currently set at US$16 billion - which would make it easier for Hong Kong banks to establish there.

'These proposals would further open up Hong Kong's banking sector to allow a broader range of domestic and international institutions to participate in the Hong Kong markets as full licence banks,' explained the Deputy Chief Executive of the HKMA, David Carse, adding: 'We believe these incentives will help to rationalise the authorisation and market entry system in Hong Kong and will also enhance the status of Hong Kong as an international financial centre.'

Two new accounting standards which came into force in Hong Kong in January 2005 are likely to have a far-reaching effect on the banking industry. Hong Kong Accounting Standards 32 and 39 are detailed and prescriptive in nature, requiring banks to estimate loan provisions based on future cash flows rather than the current guidelines issued by the Hong Kong Monetary Authority, and review the basis for general provisioning.

Electronic Banking

As a bank regulator, the primary objective of the Hong Kong Monetary Authority (HKMA) in respect of the developments of electronic banking (e-banking) is to ensure that the regulatory framework for e-banking keeps up with the industry and technological developments without stifling innovation.

Since 1997, the HKMA has been issuing a series of circulars to set out its regulatory approach on e-banking services and to provide authorised institutions with recommendations on the risk management for these activities. While institutions do not need to seek formal approval from the HKMA to offer their e-banking services, they should discuss their plans and risk management measures with the HKMA in advance.

Among the issues discussed, the arrangements adopted by institutions to ensure adequate information security for their services are one of the key focuses of the HKMA. While absolute information security does not exist, institutions are expected to implement information security arrangements that are "fit for purpose", i.e. commensurate with the risks associated with the types and amounts of transactions allowed, the electronic delivery channels adopted and the risk management systems of individual institutions.

Furthermore, the HKMA expects senior management of institutions to commission periodic independent assessments of the information security aspects of their e-banking services. The HKMA expects such independent assessments to be carried out by trusted independent experts before launch of the services, and thereafter at least once a year, or whenever there are substantial changes to the risk assessment of the services or major security breaches. To provide further recommendations to the senior management of institutions on information security, the HKMA issued in July 2000 a Guidance Note on Management of Security Risks in Electronic Banking Services.

Internet Advertisements for Deposits

Under the Banking Ordinance, overseas-incorporated institutions (including virtual banks) intending to solicit deposits from members of the public in Hong Kong would not be required to be authorised, provided that the deposits are placed overseas. However, section 92 of the Banking Ordinance makes it an offence for any person, other than an authorised institution, to issue an advertisement or invitation to members of the public in Hong Kong to make a deposit, even if it is made outside Hong Kong, unless the disclosure requirements in the Fifth Schedule to the Banking Ordinance are complied with. They should include a warning in their advertisements that they are not authorised under the Banking Ordinance and hence are not subject to the supervision of the HKMA. The advertisements must also contain certain specified information about the overseas institutions and the deposit scheme being advertised. The objective is to ensure that material facts are available to enable prospective depositors to make their own judgement on whether to place a deposit with the institutions concerned.

The HKMA say that advertisements placed through the internet should be governed by the same principles.

Authorisation of Virtual Banks

A virtual bank is a company which delivers banking services primarily, if not entirely, through the internet or other electronic channels. The term does not refer to existing licensed banks which make use of the internet or other electronic means as an alternative channel to deliver their products or services to customers.

In May 2000, the HKMA issued a Guideline on the Authorisation of Virtual Banks under section 16(10) of the Banking Ordinance. The Guideline sets out the principles that the HKMA will take into account in deciding whether to authorise virtual banks. The main principle is that the HKMA will not object to the establishment of virtual banks in Hong Kong provided that they can satisfy the same prudential criteria that apply to conventional banks. In summary, virtual bank applicants must satisfy the following requirements:

The Intermediaries and Investment Products Division of the Securities and Futures Commission is responsible for regulating the marketing to the public of unit trusts, mutual funds and other collective investment schemes.

The Investment Products Department has regulatory responsibility for unit trusts, mutual funds, investment-linked assurance schemes, pooled retirement funds and immigration-linked investment schemes as well as other forms of investment arrangements. These products require authorisation by the SFC before they can be marketed to the public in Hong Kong. The Department vets applications for such authorisation and monitors ongoing compliance with regulatory requirements. The SFC has issued numerous sets of Rules and Codes of Practice for the guidance of the investment management sector, including: