Consultation on a Proposed Operational Model for a

Scripless Securities Market

Mr Paul Chow

Chief Executive, HKEx

24 October 2003

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Contents

Background

Principles underlying the Proposed Model

Purpose of the Consultation

The Consultation Period

Key Features of the Proposed Model

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Background

An Implementation Working Group (IWG) was formed in March 2002 by the SFC to implement the scripless securities market.

A Technical Working Group (TWG) and three Focus Groups were formed under the IWG to develop a scripless model.

Members of the IWG, TWG and the Focus Groups include SFC, FSTB, HKEx, share registrars, brokers, custodians, issuers and legal practitioners.

Model proposed by HKEx has taken into account discussions at the meetings of these fora, especially the TWG.

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Principles of the Proposed Operational Model

Maintain investor choices in share registration;

Enhance market efficiency and reduce costs;

Facilitate fair cost allocation through user-pays principle;

Improve investor protection and lower misappropriation risk; and

Uphold market integrity and system reliability levels.

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Purpose of the Consultation

A major infrastructure initiative for Hong Kong;

Potential impact on the operations of different market players;

Raise issues for attention and open discussion;

Seek market views on the model and key features; and

Provide input to finalising the scripless operational model and the way forward of the scripless initiative for consideration by government and SFC.

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The Consultation Period

24 October – 23 December 2003

Implementation subject to legislation

Key Features of the Proposed Operational Model

Mr Bryan Chan

Acting Head, Clearing Business Unit

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Current Shareholding Structure

Shareholder AShareholder B . .XXX Nominee . . . HKSCC Nominees

CCASS Depository

ShareRegistrars

……

….….

Register of MembersCCASS Participant sShareholding Records

Broker ABroker B . .YYY Securities . . . .Custodian ACustodian B . .KKK Custodian . .

Registered in the name of HKSCC Nominees

All depositedinto CCASS in the name of YYY Securities

Customer ACustomer B . . . .

YYY Securities

Client Shareholdings Records

All deposited into CCASS in the name of KKK Custodian

Customer ACustomer B . . . .

Client Shareholdings Records

KKK Custodian

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Overview of the Proposed Model

Issuer Register

Complete ROM

CCASSParticipants

CCASS Participant Sponsored Accounts *

Non-disclosed IPs

Beneficial Owners

InvestorParticipants

(IPs)

HKSCC Nominees

CCASS Register

CertificatedShareholders

UncertificatedShareholders

ShareRegistrarsHKSCCHKSCC

- Names on registers

- Boundary of ROM - Person/ institution/ account

- Register

- Subject to further discussion

* Shareholdings of the CCASS Participant Sponsored Accounts will be separately registered on the CCASS Register from the shareholdings of the sponsoring CCASS Participants.

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Key Features

Uncertificated Shares

Uncertificated shares will be allowed through amendments to Companies Ordinance.

Uncertificated shares will co-exist with scrip during a transitional period. Date of completion of scripless to be determined by Government/SFC.

Shareholders may dematerialise their scrip or rematerialise their uncertificated shares during the transitional period.

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Key Features (Cont.)

Registers of Members

Split registers – the Issuer Register (maintained by share registrars) and the CCASS Register (maintained by HKSCC). Both will be recognised under law as registers of members.

Issuer Register plus CCASS Register equals COMPLETE Register of Members.

Issuer Registers and CCASS Register will not overlap.

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Key Features (Cont.)CCASS Register

Include only uncertificated shares deposited into the CCASS Depository.

CCASS Participants become registered shareholders on the CCASS Register.

Settlement of CCASS transactions changes legal title on CCASS Register simultaneously and will be final.

Registration at investor level remains optional.

CCASS Depository will be progressively dematerialised upon implementation of scripless.

Ultimately, CCASS will become completely scripless.

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Key Features (Cont.)CCASS Participantship Structure

The existing categories of CCASS Participants will be maintained under the scripless market model. They include –

Broker Participant;Clearing Agency Participant;Custodian Participant;Stock Lender Participant;Stock Pledgee Participant; and Investor Participant (IP). (After scripless, IP can elect

to be either disclosed or undisclosed on the ROM)

In addition, the following is proposed upon the implementation of Scripless on CCASS :

a new account type - CCASS Participant Sponsored Account; and

a new participant type - Registrar Participant.

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Key Features (Cont.)

Inter-register Activities

Electronic transmission of CCASS Register to share registrars to produce COMPLETE registers of members.

Electronic transfers of uncertificated shares between CCASS Register and the Issuer Registers.

Dematerialisation and rematerialisation requests.

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Key Features (Cont.)

Shareholder Reference Numbers (SRN)

SRN is proposed by share registrars and used in Australia.

Each uncertificated shareholding on Issuer Register will be given a unique SRN generated and managed by share registrars.

SRN works like PIN of ATM card.

To transfer uncertificated shares from Issuer Register to CCASS Register (e.g. for trade settlement), an investor will have to inform his/her broker the relevant SRN. The broker will through CCASS submit the transfer request to share registrars. Request will be accepted if the SRN and the shareholder name are correct.

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Key Features (Cont.)

Shareholder Servicing

Share registrars will continue to send corporate communications to ALL shareholders (including shareholders on CCASS Register).

Share registrars will provide corporate action services (proxy voting, rights issues, dividend distribution, bonus share election etc.) to shareholders on Issuer Registers.

It is proposed that HKSCC will provide corporate action services to all CCASS Participants (or shareholders on CCASS Register).

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CCASS Dematerialisation Programme

Time

Pilot Run

6 - 12 months1 month

Bi-weekly Demat Batches

HKSCC will progressively dematerialise all shares deposited into its Depository, with a view that ultimately the Depository will become completely scripless. This will take place in phases.

A Pilot Run will be launched in which a few stocks with lower turnover will be dematerialised. The Pilot Run will be conducted over a weekend to minimise inconvenience to the market.

The whole dematerialisation process is expected to take about six to twelve months.

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Issues Highlighted in Consultation Paper

Shareholder Reference Numbers (SRN)

Concerns about security and investor-friendliness. Investor education programme needed. More discussion and work to refine system with market p

articipants and stakeholders.

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Issues (Cont.)

Dematerialisation Charges

Estimated a total of 25 mn to 30 mn share certificates in HK.

Uncertain as to what fees would be charged to market users and investors on dematerialising certificates.

Unreasonable charges could act as a disincentive to scripless. More discussion on the charges needs to occur.

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Issues (Cont.)

 Potential Increased Costs to Issuers

Increased number of registered shareholders would increase costs to issuers.  Possibly higher retainer fee to share registrars.

Possibly higher printing costs for corporate communications.

Acceptable cost for good corporate governance?

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Issues (Cont.)

 

Removal of Immediate Credit

At present, CCASS Depository credits shares deposited by Participants immediately on the same day. HKEx proposes to end immediate credit under the scripless model.

Immediate credit technically not possible under split register model.

Also better manage the risks of defective securities to HKSCC.

Working with share registrar industry to shorten the transfer period below 3 working days.

More discussion and work to be done with the market before making a decision.

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Issues (Cont.)

Corporate Action Services

The issue of how corporate action processing will be handled needs to be addressed.

HKEx proposes to retain services by HKSCC to its Participants on corporate actions using CCASS for the CCASS Register.

Share Registrars will do the processing for the Issuer Register.

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Processing of Inter-register Transfers

Scripless share movements between the CCASS Register and Issuer Register may take overnight to complete.

HKEx proposes to process inter-register transfers in day end batch mode initially upon launch.

Multiple batch processing during the day or real-time processing also being considered.

Trade-off between efficiency on one hand and costs and system dependency on the other.

Market feedback important to HKEx.

Issues (Cont.)

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Electronic Deposit Instructions (EDIs)

1. Investor discloses the SRN to a CCASS Participant;2. Participant inputs EDI to CCASS;3. HKSCC checks if the EDI contains all the required information. If not, the EDI will be rejected. (Note:

HKSCC will not be able to verify if the SRN and the shareholder details are valid as it does not have such information).

4. At day end, HKSCC creates EDI Files by stock encompassing all validated EDIs of the same stock;5. Registrar downloads the EDI File from CCASS at day end;6 Registrar verifies the EDIs and checks if the delivering shareholder has adequate stocks on the Issuer Register.

If so, the relevant shareholding record will be debited. If not, or if the information contained in the EDI (such as wrong SRN or wrong shareholder name or wrong address) does not match the record on the Issuer Register, the EDI will be rejected;

7. Registrar creates a Confirmed EDI File and a Rejected EDI File;8. Registrar uploads both files to CCASS; and9. HKSCC credits the receiving CCASS Participant accounts in accordance with the confirmed EDIs and sends

Rejected EDI messages to the initiating Participants.

Brokers/Custodians

Investors

CCASSCCASS

5

Share Registrar

7

4

1 8

2 3

6

Rejected EDI file

Confirmed EDI file

EDI file

9

SRN

Appendix

Q & A