Consultation on a Proposed Operational Model for a Scripless Securities Market

1. Consultation on a Proposed Operational Model for a Scripless Securities Market Mr Paul Chow Chief Executive, HKEx 24 October 2003

2. Contents • Background • Principles underlying the Proposed Model • Purpose of the Consultation • The Consultation Period • Key Features of the Proposed Model

3. 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.

4. 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.

5. 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.

6. The Consultation Period 24 October – 23 December 2003 Implementation subject to legislation

7. Key Features of the Proposed Operational Model Mr Bryan Chan Acting Head, Clearing Business Unit

8. Current Shareholding Structure YYY Securities Share Registrars CCASS Depository … … …. …. Client Shareholdings Records Customer A Customer B . . . . CCASS Participant s Shareholding Records Register of Members All deposited into CCASS in the name of YYY Securities Broker A Broker B . . YYY Securities . . . . Custodian A Custodian B . . KKK Custodian . . Shareholder A Shareholder B . . XXX Nominee . . . HKSCC Nominees KKK Custodian Client Shareholdings Records Registered in the name of HKSCC Nominees Customer A Customer B . . . . All deposited into CCASS in the name of KKK Custodian

9. Overview of the Proposed Model HKSCC Share Registrars Complete ROM CCASS Register Issuer Register HKSCC Nominees CCASS Participants Investor Participants (IPs) Uncertificated Shareholders Certificated Shareholders Non-disclosed IPs Beneficial Owners CCASS Participant Sponsored Accounts * - Subject to further discussion - Boundary of ROM - Person/ institution/ account - Names on registers - Register * Shareholdings of the CCASS Participant Sponsored Accounts will be separately registered on the CCASS Register from the shareholdings of the sponsoring CCASS Participants.

10. 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.

11. 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.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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).

17. CCASS Dematerialisation Programme 6 - 12 months 1 month Time Pilot Run 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.

18. 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 participants and stakeholders.

19. 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.

20. 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?

21. 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.

22. 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.

23. Issues (Cont.) 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.

24. Electronic Deposit Instructions (EDIs) Appendix 2 Brokers/ Custodians EDI file CCASS 3 4 9 5 SRN 8 1 Confirmed EDI file 6 7 Investors Share Registrar Rejected EDI file 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; and 9. HKSCC credits the receiving CCASS Participant accounts in accordance with the confirmed EDIs and sends Rejected EDI messages to the initiating Participants.

25. Q & A