Farewell to paper share certificates?

Since the mid-1960s, jurisdictions around the world have been phasing out paper share certificates. Hong Kong has been slow to join this trend, but the government has now put forward a set of detailed proposals designed to transition the HKSAR to an electronic or ‘scripless’ securities regime. CSj looks at the implications for company secretaries.

T he proposal to implement a paperless securities regime has had, even by Hong Kong standards, a very ‘extended’ consultation period – namely 26 years and counting. ‘Dematerialisation’ – abolishing paper share certificates – was one of the proposals of the Ian Hay Davison Report back in 1988. The Securities and Futures Commission (SFC) conducted its first consultation on moving to scripless shares in 2002, followed by another consultation by Hong Kong Exchanges and Clearing (HKEx) in 2003. Both of these consultations failed to drum up sufficient support from investors and brokers for the operational model proposed.

Then, in 2009, a working group from the SFC, HKEx and the Federation of Share Registrars was formed to put forward new proposals. A public consultation on these proposals was conducted from December 2009 to March 2010 and, according to the consultation conclusions published in September 2010, found general support for the revised operational model. It seems, then, that Hong Kong is ready to join the many other jurisdictions around the world (including Mainland China) to go ‘scripless’. The government is currently finalising a Bill for introduction into the Legislative Council in the second quarter of 2014.

Bad news for termites?

Hong Kong already has a settlement system where shares can be electronically traded. The Central Clearing and Settlement System (CCASS) enables investors to trade their shares electronically, but only via a legally convenient sleight of hand. The shares are considered to be still in paper form and held by the operator of CCASS – the Hong Kong Securities Clearing Company Nominees Ltd (HKSCC) – in a central depository linked to the settlement system. The paper securities are ‘immobilised’ in this central depository and do not need to be moved or reregistered every time they are bought or sold. In fact, only the beneficial interest in the securities is transferred when the shares ‘change hands’ – legal ownership of the securities remains with HKSCC.

This system has been in operation for over 20 years, but some fairly obvious disadvantages have emerged. First of all, the CCASS arrangement has been a hurdle to better shareholder engagement. Companies don’t always know who their actual investors are since the legal title for their shares within the CCASS system remains with HKSCC. Moreover, investors do not always receive corporate communications and proxy voting materials as they are not the registered holders of the shares.

One of the main drivers of the dematerialisation reform, therefore, has been to facilitate direct ownership, shareholder transparency and enhance corporate communications. In addition to these motives, however, there are other reasons why dematerialisation makes sense. Perhaps most obviously, moving to electronic ownership of shares reduces the risk of loss or destruction. Investors who choose to stash their shares under their bed or in their bedroom closet, which is not as unlikely a scenario as it may seem, may find their hard-earned investments fall prey to hungry termites and other household insects – particularly in subtropical Hong Kong.

There are also significant efficiency gains to be made by going scripless. Changes of ownership are far easier, cheaper and quicker to implement. The government has also made the point that dematerialisation will harmonise links with other scripless securities markets.

What will this mean for company secretaries?

Company secretaries will need to bring to the attention of the board a number of issues raised by the introduction of scripless securities. In particular, companies will have new opportunities for improving shareholder transparency and corporate communications, but they will also have to change their internal control systems to accommodate the necessary changes to the company’s share register and corporate actions.

According to the government’s latest operational proposals, the reform will split the share registers of listed companies offering paperless shares into two parts – one recording paperless shares held in CCASS, and the other recording paper shares which will be kept and maintained by the relevant share registrar as an agent of the company outside CCASS. Participating companies’ share registers will therefore be more complex than presently, but investors will have more options in terms of the form, type of ownership and extent of control over their holdings (see Figure 1 on page 13).

Investors will be able to choose between:

  1. holding their securities in paper or paperless form
  2. holding their securities in their own names or in the name of a nominee CCASS participant (this could be a broker, a bank or a custodian), and
  3. holding their securities through an account that they can control directly, or through an account controlled by their broker, bank or custodian.

One potential problem area highlighted by the HKICS is that this model will require an efficient and coordinated interaction between many different parties – such as HKSCC, the share registrar, and the SFC. At a meeting in January this year with the Financial Services and Treasury Bureau (FSTB) and the SFC (see ‘Scripless securities: the HKICS view’ below), the Institute suggested that it may be appropriate to consider implementing a cost-effective mechanism to resolve disputes arising from any errors in the new system. The government is considering this alongside proposed security measures, in particular arrangements to ensure the accuracy and safety of shareholders’ information in a scripless environment.

New rules

The implementation of scripless shares will have regulatory implications company secretaries need to be aware of. Currently, the proof of ownership of a share in Hong Kong is a share certificate. Enabling the new regime will require amendments to any legislative references that currently (either expressly or implicitly) require the issue of certificates and the use of paper instruments of transfer.

The government proposes to have regulatory and operational matters relating to the new paperless securities market environment overseen by the SFC. To this end, it proposes to create a new part in the Securities and Futures Ordinance (SFO) defining the key concepts and principles. In particular it will define what ‘prescribed securities’ are, and how they may be evidenced and transferred without paper documents. It will also define what an ‘uncertificated securities system’ is and require that such a system may only be operated by a recognised clearing house (RCH) that is approved by the SFC. To complement this, the SFC’s existing powers in respect of RCHs will be correspondingly expanded to cover the operation of such systems.

The new part of the SFO will also enable the SFC to prescribe offences for contravention of the requirements. Additionally, as it is envisaged that share registrars will take on a more active and involved role in the paperless environment, the government proposes to empower the SFC to authorise and regulate share registrars who wish to provide share registrar services in respect of participating companies. The SFC’s new rule-making powers will include the authorisation and regulation of such share registrars.

These new rules will take the form of subsidiary legislation made by the SFC and, as such, will be subject to negative vetting by the Legislative Council.

Fees and charges

The government seeks to ensure that fees arising from the scripless securities regime will be reasonable for all parties concerned and commensurate with the services provided. To that end, any fees charged by an RCH will be subject to the SFC’s approval.

Currently, a HK$5 fixed rate stamp duty is chargeable on the instrument of transfer in respect of any sale or purchase of Hong Kong stock. Under the scripless securities market regime, participating securities may be transferred without an instrument of transfer in certain circumstances, and consequently, the $5 fixed duty will no longer be chargeable on such transfers.

The chargeability of the ad valorem stamp duty will not be affected, however. In general, ad valorem stamp duty is chargeable on all transfers of shares listed in Hong Kong involving a change in beneficial interest. Under the uncertificated securities market regime, ad valorem stamp duty would be collected electronically through the stock exchange for all on-exchange transfers in the same manner as the current situation.

Farewell to paper shares?

The wheels are now in motion for Hong Kong’s transition to a scripless securities regime. As mentioned at the beginning of this article, the latest public consultation on the government’s revised operational model found general support and the necessary legislative amendments will be presented to LegCo in the second quarter of 2014.

Does this mean we will soon be saying farewell to paper share certificates in Hong Kong? Well, no. The government is not proposing to make the paperless securities regime compulsory, at least initially. It proposes to allow the existing paper-based system to operate in parallel with the paperless system until the market is ready.

This might mean that the number of companies participating in the paperless securities scheme will be quite low, at least in the early stages. This is borne out by the overseas experience. Taiwan, for example, opted for a dual regime and found that uptake was disappointingly low. It subsequently moved to a compulsory scripless securities regime. The UK also opted for a dual regime and there are still an estimated nine million paper share certificates in the UK, despite the fact that dematerialisation was launched in 1996.

Moreover, the scope of the new regime will be quite limited in the early stages. It will only be applied to listed companies and the government will focus initially on Hong Kong-incorporated companies as these are governed by Hong Kong law.

That will mean that the majority of Hong Kong-listed companies, being domiciled abroad, will not have to participate. Companies coming to list in Hong Kong, however, would be required to provide the option of scripless securities to investors.

The government hopes that the many benefits of the proposed scripless securities regime will provide a powerful incentive for companies to participate, and, looked at in the context of the digital revolution which has been transforming many different aspects of our lives, the transition does seem to be inevitable. The SFC will also launch educational programmes to familiarise market participants with the scripless regime, and Hong Kong Exchanges and Clearing is considering measures to encourage market participants to use the model.


Kieran Colvert, CSj Editor


Scripless securities: the HKICS view

The Hong Kong Institute of Chartered Secretaries supports the introduction of a scripless securities regime in Hong Kong. ‘This is in line with international developments and will enhance the position of Hong Kong as a leading international financial centre,’ says April Chan FCIS FCS(PE), Company Secretary of CLP Holdings and Chair of the Institute’s Technical Consultation Panel. The Institute does, however, have some concerns about its implementation. At a meeting in January this year with the Financial Services and Treasury Bureau and the Securities and Futures Commission, the Institute raised the following points:

  • there should be equality of treatment for all shareholders, whether their shares are held in paper or paperless form
  • there should be proper checks and balances relating to the functions of the share registrar and the clearing houses for investor protection
  • it may be appropriate to consider some cost-effective mechanism to resolve disputes, and
  • the principle should be that the user bears the costs.


Why has it taken so long?

One of Hong Kong’s key competitive advantages as an international financial centre is its excellent legal system. It has well drafted and administered laws and an independent judiciary. In this context, we should perhaps not be too quick, if you’ll excuse the pun, to berate the glacial pace of the law reform process in Hong Kong.

The extended consultation process which has delayed Hong Kong’s adoption of scripless securities is by no means unique. It took 10 years, for example, to partially implement the proposal to give statutory backing to key listing rules. First proposed in 2003, this reform made it onto the statute books in the form of the revised Securities and Futures Ordinance implemented in January 2013, although by that time it had been whittled down to apply only to information disclosure. Similarly, implementing a statutory corporate rescue procedure has so far taken 18 years. That reform was first suggested in 1996 and has yet to make it out of the consultation stage.

While this contrasts rather starkly with the speed at which reforms can be adopted in Mainland China, there are credible reasons for caution. Regarding scripless securities, for example, some investors want to retain their share certificates as tangible evidence of their ownership. ‘How can I trust just a number on the computer screen to show my stock holdings?’ says 78-year-old housewife Chan Ng-fong, interviewed by the South China Morning Post. In the article – ‘Hong Kong investors turn away from paperless scrip’ (4 January 2010), she was quoted as saying: ‘This is my entire life savings. I need the share certificates with my name written on them to show my ownership.’

Other investors want paper share certificates for their historic value. April Chan, Company Secretary of CLP Holdings and Chair of the Institute’s Technical Consultation Panel, points out that investors in long-standing businesses such as CLP might keep share certificates dating back many years.

The government hopes its proposed model will be a win-win situation. Those investors who prefer to hold on to their share certificates will be able to do so, but the reform will allow investors holding electronic shares in CCASS to be able, for the first time, to register their securities in their own names and enjoy the full benefits of legal ownership.