SECTION 1: Market outlook
1.1 Please clarify which products or markets your jurisdiction hosts that are affected by Mifid II.
Hong Kong is a significant trading hub for a large number of financial institutions, asset managers and other investment firms, including group companies that include Mifid firms and branches of Mifid firms.
The products and services offered by Hong Kong-based firms include the entire range of equities, fixed income, derivatives, funds and structured products as well as investment advisory services.
SECTION 2 (b) – Non-EU countries
2.1 How prepared is your market for Mifid II?
The level of preparedness varies greatly between different sectors within the industry.
Those firms that are branches or affiliates of Mifid firms (primarily international banking institutions but also some of the larger international asset managers) are generally well advanced in assessing the impact of Mifid II on their business operations and are putting in place steps to implement it.
On the other hand, those institutions that have limited connection with the EU (for example, fund managers whose sole nexus with the EU is via EU broker-dealers and other trading counterparties) are less prepared. This is understandable as they will not be directly impacted by Mifid II. However, the lack of information on the precise impact on the terms of their brokerage and other trading and product distribution documentation is cause for concern.
Generally, Hong Kong based firms are expecting to be guided by their Mifid firm counterparties as to what their new requirements will be and how this will affect existing documentation and trading arrangements.
2.2 In which areas are market participants most in need of guidance/certainty over the rules?
The issues being focused on under Mifid II differ depending on the sector of the financial markets. However, in summary, the main areas of focus include:
(a) Trading obligations: including accessing EU markets and transaction reporting obligations.
(b) Research and inducements: including whether non-Mifid firms will, in practice, be expected to pay for research (notwithstanding there being no obligation for non-Mifid firms to pay) and the sharing of research within corporate groups that include Mifid firms.
(c) Product distribution: including the new terms expected to be applicable to distribution agreements providing for the distribution of products into the EU.
There are other areas that are relevant to market participants in Hong Kong, and the relevance of any specific area is driven in large part by the corporate structure of the relevant participant and the extent of its activities in the EU.
SECTION 3: Research
3.1 Please summarise the challenges Mifid II will pose in your jurisdiction with regards to research.
The requirements being introduced pursuant to Mifid II through the relevant Delegated Act with respect to inducements and, in particular, the introduction of the requirement for Mifid firms to pay for research received from brokers and other market providers, are among the most significant of the Mifid II reforms.
The changes will principally effect the following three categories of firm based in Hong Kong:
(i) Hong Kong based firms that include Mifid investment firms as part of their group: These firms are not, themselves, directly subject to the Mifid II requirement to pay for research. However, any Mifid firm that is a member of the group that receives a copy of that research (for example, the circulation of equity research disseminated to various management businesses within the group, including a Mifid firm based in the EU) would then be required to pay for that research, notwithstanding that the original recipient, based outside the EU and, accordingly, not a Mifid firm, was not under such an obligation.
Firms falling in this category will need to implement clear procedures and processes to identify the research it expects to receive and how, based on the structure and policies of the Mifid firm group member, such research may be distributed within the group. This will require clear internal policies and may impact existing trading relationships.
(ii) Hong Kong based firms that generate research for distribution to clients that include Mifid firms: The obligation to pay for research is an obligation imposed on the Mifid firm. Accordingly, brokers and other market participants based in Hong Kong, for example, that prepare and distribute research to Mifid firm clients will be required to charge for such research and, accordingly, change their charging model.
This will require rate cards for different types of research to be prepared and the implementation of appropriate monitoring infrastructure to ensure that they can enable their Mifid clients to meet their obligations to pay for research.
(iii) Hong Kong based firms that currently receive research for free: Even though non-Mifid firms are not required to pay for research in Hong Kong, there has been some industry concern that brokers and other market participants will start charging all clients for research, regardless as to whether the firm is subject to Mifid II (and so obliged to pay) or not, so as to minimise the costs involved in operating a bifurcated model for the provision of research, among other reasons.
However, it seems that current market view is that most brokers and market participants involved in the provision of research intend to provide a split model enabling them to continue to provide free research to non-Mifid firms on a similar basis to their current arrangements. This being noted, it is possible that this may change in future as either regulatory requirements in other jurisdictions, including Hong Kong, impose similar obligations or brokers and other market participants look to provide a standardised client offering including 'paid-for' research.
3.2 Is pricing research compatible with market practices and existing legal frameworks?
It is not common market practice in Hong Kong for providers of research to charge separately for it where there is a related trading relationship between the parties.
3.3 Is there clarity on how to resolve challenges in unbundling research and complying with Mifid II in this respect?
There are a limited number of options available to Hong Kong based firms that will be effected by the changes to the rules applicable to inducements and, in particular, potential charges for research.
As indicated above, Hong Kong based firms that consume research will not directly be subject to the requirements under Mifid II to pay for research and should not need to change their existing models (particularly given the expectation that research providers will continue to provide research to non-Mifid firms on a free of charge basis).
Those firms however that are members of groups that include Mifid regulated firms are putting in place policies to identify the research they receive and what, if any, of such research may be disseminated to the group Mifid entity and be charged for.
Similarly, Hong Kong based firms that generate and distribute research to clients that include Mifid II firms are having to develop charging models for the various types of research they provide and implement operational infrastructure to appropriately identify the nature of the entity to whom they are providing the research. As many of these firms are part of larger financial institutions that have operating centres located in the EU, the policies and operational infrastructure their Hong Kong based branches and/or entities are implementing will largely be guided by the policies and infrastructure implemented by the main European hub for the firm.
SECTION 4: Trading/market structure
4.1 Which areas of trading / type of instruments will be most impacted by Mifid II in your jurisdiction and how might they be impacted?
The impact for Hong Kong based firms (that are not branches of Mifid regulated firms) that trade financial instruments covered by Mifid II will be relatively limited.
Such Hong Kong based firms will not be directly subject to the obligations of Mifid II. The main legal effects are expected to be in respect of the terms and conditions of the brokerage and related documentation they have entered into with their EU broker counterparties. It is expected that these changes will principally cover specific information sharing provisions as well as enhancing the rights of the EU brokers to suspend trading and other areas of oversight.
One aspect of trading that is expected to impact relevant firms are those that have direct electronic access rights to trade financial instruments on EU markets and/or which engage in algorithmic trading via their EU brokers or EU trading venues. Under Mifid II, EU brokers and trading venues will be required to conduct proper due diligence on trading strategies and algorithms (including, in certain instances, obligations to share such information with their local EU competent authorities). This will require these EU institutions to have rights to require such Hong Kong based firms to disclose details of their trading strategies and/or algorithms.
There are also certain specific issues for which the market generally is looking for a resolution, including obligations relating to the trading of dual-listed securities and whether any non-EU trading venues that are recognised as the primary markets for those securities will be recognised as equivalent (and thus enabling execution of trades on such markets in compliance with the Mifid II requirements to execute trades for securities admitted to trading on an EU trading venue (or equivalent trading venue) to be executed on such venue.
4.2 What will be the key challenges with regards to transaction reporting and pre-trade transparency?
Hong Kong based firms are unlikely to be directly impacted by the transaction reporting or pre-trade transparency obligations as, for the most part, this will be an obligation imposed on their Mifid EU counterparty, and/or related EU trading venue, as applicable.
However, it is expected that Hong Kong based firms will need to have appropriate infrastructure in place to assist their EU counterparties with their transaction reporting obligations. They will also need to obtain appropriate legal identifiers, as this is a requirement for trading in the EU markets following the implementation of Mifid II.
The main relevance to Hong Kong based firms of the increased range of instruments to which pre-trade transparency will apply is most likely to be in connection with the nature of the markets themselves. The derivatives and fixed income markets, for example, may, as a result, start to behave in a similar manner to the equities markets which may present the market with opportunities and challenges with respect to their existing trading strategies.
4.3 What are the main considerations that trading venues and exchanges will have to make?
Please see response to Question 4.2 above.
SECTION 5: Investor protection
5.1 Explain the impact of heightened investor protection obligations in your jurisdiction.
The issue of investor protection is a live topic in Hong Kong with a variety of regulatory and legal changes having been effected to enhance the levels of investor protection.
That said, the regime in Hong Kong has significant differences from the regime being introduced pursuant to Mifid II and, as such, Hong Kong based firms looking to execute transactions on behalf of Mifid clients and/or to distribute products and/or services into the EU will need to familiarise themselves with the various product governance and other aspects of Mifid II that they will be subject to (either directly, to the extent that they provide the products or services directly via a Mifid entity or indirectly).
5.2 Which area of focus within investor protection is of most concern/importance to your jurisdiction?
The issue of investor protection needs to be considered holistically and requires compliance with principles as well as with specific regulatory or legal obligations. A particular key area of focus in Hong Kong recently has been around the areas of suitability and appropriateness. In this respect, some of the obligations applicable to product manufacturers and distributors under Mifid II are conceptually similar (although different in detail) to those being implemented in Hong Kong.
SECTION 6: Outlook 2017
6.1 What are the overall risks or opportunities that Mifid II might bring to your market? Will Mifid II impact the competitiveness of your market?
For many Hong Kong based firms, the impact should be relatively limited, with Mifid II having only indirect effect on the operations of their businesses. However, there is still a significant repapering and infrastructure exercise that many Mifid firms will have to undergo and delays in the completion of these steps may disrupt the ability of Hong Kong based firms from accessing and dealing in the EU markets and servicing EU based clients.
6.2 What are the next steps – what should market participants be doing now to best prepare themselves?
Hong Kong based firms that are not branches of Mifid firms or members of groups with Mifid entities, should identify in what manner they have any nexus with the EU (for example, is it limited to trading with EU counterparties, do they distribute products into the EU and so on). This will then enable them to determine which specific aspects of Mifid II will be relevant to their business. These firms should also contact their EU Mifid II regulated counterparties as soon as possible to discuss with them what changes they expect to make to their existing documentation.
Hong Kong based firms that are either branches of Mifid firms or members of groups with Mifid entities should, in addition to the above steps, also coordinate with their Mifid entity to determine which policies, infrastructure and operational requirements that the Mifid entity will be implementing will be relevant to them and/or to which they will need to comply.
|About the author|
Jason Valoti is a recognised leading practitioner in the Singapore and Hong Kong legal markets and acts for leading international investment banks in relation to structured and OTC derivative transactions and related regulatory matters. He has a particular focus on highly structured equity, credit and fund-linked transactions and has developed bespoke product solutions and platforms for a number of clients.
Valoti also acts for fund and asset managers in respect of their transactional and trading requirements, including Prime Brokerage, ISDA and other documentation.
|About the author|
Simon McKnight is a derivatives and structured products specialist whose work spans a wide range of products, including equity, credit and commodity linked products in OTC, loan and notes format. He has particular expertise in equity derivatives (such as margin loans and collar financings), credit derivatives, stock loans/repos and repackagings.