Regulating Securities Misconduct Across Borders: The Mainland China-Hong Kong Case

Abstract

With the increasing globalization of the capital markets, there has been a heightened need for effective regulatory cooperation between jurisdictions to facilitate detecting, investigating, and prosecuting cross-border securities misconduct such as insider trading and market manipulation. A useful case study in this regard is the regulatory cooperation between Mainland China and Hong Kong, owing to the accelerated process of market integration and transformation. This paper aims to provide a comprehensive and critical examination of how Mainland China and Hong Kong cooperate to regulate cross-border securities market misconduct, and based on the examination, make suggestions for improvement. While the Mainland-Hong Kong cooperation has made good achievements, there remain many important issues, which can be broadly divided into two categories: substantive rules on the definitions of market misconduct and penalties for such misconduct; enforcement mechanisms in relation to information exchange; regulatory architecture; and extradition arrangement. This paper suggests that the substantive rules be harmonized to the extent possible and the enforcement mechanisms be unified as a long term goal. Despite its peculiarities, the Mainland-Hong Kong case can contribute to the international discourse on the regulation of cross-border securities misconduct.

Keywords: Cross-border listings, securities market misconduct, regulatory cooperation, China, Hong Kong, IOSCO

Introduction

As investment and securities trading persists across the globe, it follows that market misconduct activities that disrupt normal market order and reap illegal profits from law-abiding investors, garnering the likes of insider trading, price rigging, market manipulation, and so on will increase as well. While the internationalization of securities listing and trading enhances the liquidity of global markets and provides investors with wider choices, cross-border market misconduct activities simultaneously pose new and increasingly complex challenges for securities regulators around the world. There is a wide consensus among governments, regulators, and international bodies that enforcement and collaboration are needed to regulate cross-border securities law contravention. Inadequate regulation of such cross-border misconduct will give rise to market performance issues. Studies show that effective cooperation between jurisdictions is greatly beneficial to the integrity and performance of their markets, resulting in higher earning quality, as well as an increased volume of international portfolio investment for these jurisdictions. On the flip side, a hindrance to cross-border securities law enforcement brings adverse effects on market integrity and performance—it is shown that abnormal trading in shares is especially abundant before the announcement of cross-border corporate deals, as compared to domestic ones.

The internationalization of securities listing and trading takes place on both the issuer’s side and the investor’s side. Securities issuers increasingly seek to raise capital internationally, as companies themselves are now able to list, cross-list, or have their shares otherwise traded in foreign markets. Investors diversify their portfolios across geographic regions by trading and holding an increasing proportion of securities issued by foreign companies. The marketplaces for trading these instruments can then also easily traverse borders as the advancement of market linkages and information technology greatly facilitate trading. In terms of trading volume, cross-border listing and trading activities are especially prominent for the highly globalized US market, trading within the EU, as well as trading between the Mainland China and Hong Kong markets.

The defining characteristic of a cross-border market misconduct case is that there can be multiple nationalities at different loci. First, it is the nationality of the offender, i.e., the inside trader or tipper. Second, it is the nationality of the issuer whose shares are involved. Then, it is the location of the information, where evidence on the case can be obtained, as well as the location of the market where the trading occurred. Also relevant may be the nationality of investors who were harmed by the acts of market misconduct. In an increasingly fragmented global investment market, these locations can often be found across multiple national borders. For instance, a case may involve a US national obtaining insider information about a potential M&A deal of a Chinese company, which then acts on the information by trading on the Hong Kong market. This was the case in the Tiger Asia case which was prosecuted by regulators both in the US and in Hong Kong.

Different regulators from various jurisdictions face a similar problem of dealing with the enforcement of securities law against cross-border personnel and activities. While market offenders travel around the world in their respective trades, market misconduct behaviour is similar and persistent across time, asset type, and jurisdictions. A core set of behaviours recurs over time and can be grouped into seven broad clusters. This includes insider dealing; price manipulation; circular trading; misrepresentation; influencing reference price; collusion in information disclosure; and improper order handling. These patterns of market misconduct tend to adapt to new technologies and market structures and are now increasingly prevalent across borders.

Bringing about effective cross-border market regulation—and thereby curbing disruption of market misconduct—is therefore a highly important policy issue for securities regulators and investors around the world. This article will analyse the issues in law enforcement related to cross-border market misconduct, as well as the legal and institutional arrangement of a cross-border regulatory regime. In particular, as a case study, this article will focus on the experience of China’s and Hong Kong’s markets in dealing with the issues faced by both jurisdictions when conducting cross-border investigations and enforcement. Regulatory cooperation between the two jurisdictions is highly relevant in the analysis of global responses to cross-border market misconduct activities for several reasons. First, there has been an increasingly strong connection between the two markets in the form of Stock-Connect and Bond-Connect programs. Second, as a specific example of in-depth mutual regulatory assistance, the two jurisdictions have entered into a series of bilateral agreements on regulatory cooperation. Third, the experience of Chinese and Hong Kong regulators also bears significance on further market linkages that will be seen increasingly across major markets, for instance, the Shanghai-London Stock Connect which was launched in 2019.

I. Background

A. Regulatory Goals

An effective regulatory regime would have two limbs. First, there would be enforcement in actual cases of misconduct, including case detection, investigation, and prosecution. Yet, while exposing market misconduct and pursuing subsequent prosecution is the most visible work of a securities regulator, they only form part of successful market regulation. Second, the enforcement can create and maintain a credible level of deterrence against market misconduct. The overarching policy goal is to create a market environment with certainty and credibility in enforcement, and thus deter potential offenders from committing offences. When damage is prevented ex ante, the policy objectives of maintaining market order and protecting investors’ interests are best served. This deterrence requires successful sanctioning of any detected cases in the first limb, but it goes beyond case numbers and prosecution of specific acts. Proper consideration is required on a range of other legal and institutional factors. It relies on the infrastructure and public knowledge of a sufficient cross-border enforcement and cooperation regime, in order to signal to potential offenders the risk and consequence of them being exposed and prosecuted.

If there is oversight of cross-border market misconduct, either in terms of enforcement or in terms of deterrence, a regulatory gap is left open. Potential offenders may then try to engage in regulatory arbitrage—i.e., evading regulations of one place, and seeking illegal gains by picking locations where such a gap exists. The International Organization of Securities Commissions (IOSCO) has identified a number of factors that contribute to credible deterrence, including legal certainty; the capacity to obtain information; agency cooperation; resolute enforcement action; strong sanction; public understanding; and good regulatory governance. All these factors tie into the expectations of the persons who are contemplating committing market misconduct, such as whether such an act is expected to be detected, whether that detection would be rigorously investigated, prosecuted against and punished for, and how severe the consequence would be. In a cross-border setting, these factors have added layers of complexity because more than one regulator and jurisdiction are involved.

B. Detection and Investigation

As connections between markets multiply and investors are presented with a wider choice of asset classes and trading channels, the need for cross-border market surveillance strongly increases. Detection must be done in a timely manner in order to facilitate enforcement. Access to multiple streams of information in domestic and foreign exchanges, ideally in real-time, can enhance regulators’ abilities to detect abnormal trading, especially in a cross-border setting. A good example of cross-border surveillance is the Transaction Reporting Exchange Mechanism (TREM), set up by the European Securities and Markets Authority to facilitate the aggregation and exchange of transaction data amongst regulators within the EU. The public is also an important source of information leading to case detection, and a well-rounded detection regime will include effective mechanisms to receive tips and complaints from the public.

While the trend of cross-border trading and the attendant market misconduct is on the rise, the number of prosecuted cross-border cases nonetheless represents a small fraction of all market misconduct prosecutions. There can be several explanations for this lesser number of reported cases: firstly, there are smaller portions of offenders taking the international route; secondly, the complexity of cross-border market misconduct may have caused a lower detection rate; thirdly, the difficulties involved in successfully prosecuting a cross-border case dissuade regulators to pursue such cases, even if abnormal trading is detected. If the latter two explanations are reasonably true to some extent, much has yet to be done to improve case detection and enforcement cooperation between regulators.

When an incident of cross-border market misconduct is detected, there is next the problem of ascertaining the case jurisdiction of that offence. A national regulator can potentially claim jurisdiction if any of the locations or nationalities involved falls within its jurisdiction. As a result, multiple regulators may be able to claim jurisdiction in a case involving two or more locations. As such, securities regulators often have regulatory interests that extend beyond their borders. As the benefit of spending regulatory resources becomes diffused across multiple jurisdictions, there can potentially be a “free rider” problem for regulators. Most often regulators take the approach of looking at the site of the transaction and will intervene only if the trade occurred within its border. This is sensible as this serves to maintain the integrity of a regulator’s domestic market. But problems arise as trading can now easily occur in foreign locations, and the listing of shares to a particular stock exchange is becoming less of the geographical attribute of a company. In practice, it is often not a straightforward exercise to determine which regulator should enforce its jurisdiction when multiple jurisdictions are involved simultaneously. This gives rise to uncertainty, or worse, lack of oversight on cross-border market misconduct. The decision to exercise jurisdiction carries further relevance than the prosecution process faced by the defendant. For instance, depending on the venue of the trial, there may be different treatment for people who are eligible for civil rights of action pertaining to a particular case.

Another relevant consideration is the issue of giving credit to the performance of a regulator. Caseload numbers and the handling of high-profile cases are important for a regulator’s goodwill and record. These numbers can be used as a form of assessment metric for the agency’s budgeting and as performance indicators for its personnel. Meanwhile, landmark cases are also often important when promulgating a regulator’s policy objective and determination within its local market. Although it cannot be ascertained, these factors may inherently affect a regulator’s decision to take up or give up a case. The decision process is internal to the regulators and is not visible, except for the result. Thus, it is unclear if regulators discuss among themselves or have a set of underlying rules.

C. The Role of IOSCO

A regulator who claims jurisdiction over a case then needs to initiate an investigation to obtain the information it requires for a successful prosecution. In a cross-border case, the information may be located in overseas jurisdictions, and international assistance from overseas regulators is needed. The primary form of international enforcement cooperation is through the Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information (MMoU), which was created in 2002 by the IOSCO and has since become the global standard for enforcement cooperation with 124 signatories. The MMoU gives regulators around the world a mutual understanding in terms of how they should consult, cooperate, and exchange information with one another for securities enforcement purposes. As evidence of its effectiveness, joining the MMoU regime has been associated with increased cross-border enforcement and enhanced market liquidity.

But the MMoU has its limitations. To the extent that global standards are not translated into legislation in a local jurisdiction, the MMoU is not binding on a particular regulator as it is not based on enforceable treaty obligations. Further, it specifically omits cooperation in instances of criminal prosecution, as such inclusion would complicate the adoption of the multilateral agreement itself. The MMoU has the feature of being task-oriented and does not emphasize wider enforcement cooperation. The agreement is designed to facilitate specific evidence collection and exchange, which may not be useful for sharing less tangible information, such as strategic information concerning market situations. Also, it is only concerned with information sharing, but not joint investigation and enforcement.

The IOSCO’s MMoU has brought about a level of global convergence in regulations adopting similar types of market governance. Yet, there often exist discrepancies and conflicts with respect to the substantive law regulating market misconduct; the procedure of prosecution; the legal liabilities to be imposed; the severity of sanction; the availability of remedies; and so on. These discrepancies make cross-border enforcement far more complicated and less effective as compared to purely domestic enforcement. To reduce the effect of regulatory arbitrage, the scope and definition of market misconduct offences need to be refined and harmonized between jurisdictions. Some of these differences can be harmonized by implementing rule changes, but it is not without difficulties due to the distinct legal traditions in jurisdictions around the world.

Over the years, the IOSCO has taken a more active and expanded role in setting standards and recommendations for cross-border regulatory cooperation, especially following the global financial crisis. The original MMoU was revised in 2012, followed by the setting up of a Task Force in 2013. Since 2018, an enhanced version of the MMoU has been put in place, which is neatly named the “Enhanced Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information” (EMMoU). The EMMoU addresses some weaknesses of the original agreement. For example, while criminal prosecution is precluded from the scope of the MMoU, the new memorandum specifically includes criminal prosecution under one of the permissible uses of the information exchanged.

The EMMoU provides its signatories with greater power in enforcement assistance, including enabling them to share audit work papers, compel physical attendance for testimony, freeze assets, obtain phone and internet service records, and more. According to the IOSCO, all signatories to the original MMoU are expected to eventually migrate to the EMMoU. Yet, this increased scope and power in the EMMoU also makes it harder to be widely adopted—at present only ten countries’ regulators have signed the agreement. Short of wide adoption of the EMMoU, and with the benefit of maintaining market integrity and fostering cooperation, the IOSCO encourages member regulators to enter into bilateral agreements with deeper commitments to share oversight responsibility and take joint enforcement action.

Adding to the omission of criminal proceedings from the MMoU, in many jurisdictions, there are also protections from criminal prosecution. This protection in itself also results in wide discrepancies between different jurisdictions. For example, in the United Kingdom, it is explicitly provided that information obtained by securities regulators under certain circumstances cannot be used in criminal proceedings. Australia further provides for self-incrimination privileges to be extended to civil penalty proceedings. Even where information is nevertheless exchanged between regulators, such protection might render the criminal prosecution unsuccessful in court if it is challenged. Such protection from criminal prosecution may impede the sharing of evidence and information amongst regulators, especially for regulators in places where there is less distinction between a civil or criminal sanction.

II. The Mainland-Hong-Kong Case: Market and Regulation

A. Market Integration and Transformation

The securities markets in Hong Kong and Mainland China are deeply intertwined and increasingly integrated. On the Hong Kong Stock Exchange (HKEX), the term “Mainland China enterprises” is used to refer to companies listed in Hong Kong but are based in Mainland China. Depending on the domicile and the type of controlling shareholders, Mainland China enterprises can be divided into three categories, including H Shares, Red Chip companies and Mainland private enterprises. Firstly, H shares are shares issued by a company domiciled/registered in the Mainland, the par value of which is denominated in Renminbi, and which are subscribed for and traded in Hong Kong dollars. Secondly, “Red-chip Stock” companies are companies domiciled/registered in an overseas jurisdiction such as the Cayman Island, which have more than fifty percent of total business incomes from Mainland China and which meet one of the following two criteria about controlling shareholders: 1) the company has at least thirty percent shareholding held in aggregate directly by Mainland China entities, and/or through companies which are controlled by Mainland China entities; or 2) the company has below thirty percent but twenty percent or above shareholding held in aggregate directly by Mainland China entities, and/or through companies which are controlled by Mainland China entities and, there is a strong influential presence, on a judgmental basis, on the company’s board of directors. Importantly, “Mainland China entities” are narrowly defined to mean state-owned organisations and entities controlled by China’s state, provincial or municipal authorities. If the controlling shareholders of the companies are Chinese private entities which are outside the scope of “Mainland China entities”, they would fall into the third category of “Mainland Private Enterprises”, which is sometimes referred to as “P-chip Stock” in practice. In more recent years, Red-chip companies and Mainland China entities have been collectively referred to as Non-H share Mainland enterprises.

The above three types of Mainland China enterprises collectively make up the majority of the Hong Kong securities market, in terms of the number of listed companies, the amount of market capitalization and the value of turnover. As of the end of November 2024, there were a total of 2624 companies listed on the HKEX, 56.1% of which (1472) were Mainland China enterprises, including 358 H Shares, 1114 Non-H share Mainland enterprises. Further, Mainland China enterprises accounted for 79.3% of the total market capitalization and 90.55 of the total turnover value.

The risk factor of cross-border market misconduct is thus compounded by the fact that the business operations of Chinese companies listed in Hong Kong occur mostly within the Mainland, and not Hong Kong where the stock exchange and the government regulator are situated. It is also worth noting that the same company can cross-list both in the Mainland market as A Share and in the Hong Kong market as H Share, a model which has become increasingly common in recent years, particularly for large companies.

Next, there are newly added avenues of cross-border securities trading. The launch of the Shanghai-Hong Kong Stock Connect in November 2014 provided new channels through which investors in China and Hong Kong can directly trade stocks listed on each other’s market. This has been followed a similar stock connect program between Shenzhen and Hong Kong, namely the Shenzhen-Hong Kong Stock Connect in 2016. These Connect programs provide a two-way traffic of securities trading. In the northbound direction, a Hong Kong-based investor can place an order in Hong Kong through a Hong Kong intermediary. The order will be placed onto the Mainland markets and will be denominated and transacted in Renminbi. In a southbound direction, a Mainland-based investor will order through either a Shanghai or Shenzhen intermediary, with the trade being denominated in Hong Kong dollars and cleared in Renminbi. The Connect programs provide an easier and more direct way for overseas investors to access the Chinese capital market, as compared to the traditional route of the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programs.

Since the launch of the [above two Stock Connect programs], total Stock Connect turnover has continued to hit new records, with strong participation from both Mainland and international investors. As of September 2024, [which marked the Stock Connect’s 10th anniversary,] the market capitalisation of securities portfolios held in Hong Kong by Mainland Chinese investors through Stock Connect was over HK$3.3 trillion, more than 200 times that at the end of 2014.

Northbound and Southbound Stock Connect average daily turnover (ADT) reached RMB136.3 billion and HK$43.9 billion respectively in the first 10 months of 2024, accounting for 7.3 per cent and 17.2 per cent of the total turnover of the Mainland China and Hong Kong markets. Besides enhancing liquidity, the implementation of the Shanghai-Hong Kong Connect brings about beneficial changes in corporate behaviour, such as Chinese companies improving information disclosure to attract foreign investment. Due to the success of the Stock Connect programs, the Connect programme has gradually “expanded into other asset classes, [such as the Mainland-Hong Kong] Bond Connect in 2017, ETF Connect in 2022, and Swap Connect in 2023.”

The deep linkage of issuers and investors across the two markets gives rise to particularly heightened stakes for cooperation between regulators. The closeness of social connection and personnel travel between the two places further adds to the risk factors of any cross-border market misconduct behaviour. In summary, there are ample cross-border activities and linkages in terms of capital investment, listing, corporate operation, cross-market trading, and personnel movement. Possible scenarios of cross-border market misconduct are as follows: the perpetrator may be a person situated in either Hong Kong or Mainland China; the company whose shares are involved may be listed on the Hong Kong market, the Chinese market, or both; for insider trading, the information involved may be generated in either jurisdiction; for other types of market misconduct, the location involved may be in either jurisdiction or both, for instance when a group of traders simultaneously manipulate a particular share listed on both markets. The new channel of cross-border trade through the Stock Connect is also a potential avenue for market misconduct. The convenience of trading shares listed on one market through another allows for a potential offender to pick which jurisdiction to trade in. This has already been seen in the first insider dealing case through the Stock Connect in 2016.

B. Framework for Regulatory Cooperation

Despite the handover of Hong Kong to China, the cooperation and coordination between regulators of the two jurisdictions should not be taken for granted. The Chinese government constantly encourages the rapid development of its own onshore financial markets, particularly that of Shanghai and Shenzhen. Due to the uniqueness of Hong Kong’s history and economic system, Hong Kong’s economy has been viewed as independent and “foreign” to China since the handover. Hong Kong is a city with a special self-governing status within China due to its British colonial background. Its market economy has developed over a long period of time, and its common law system is in much parallel with English Law. When Hong Kong was handed over to China in 1997, the city already had a world-leading securities market, whereas the Chinese market was still in its early transitioning stage at the time. All of Hong Kong’s economic infrastructure and common law system have been kept in place constitutionally since then, under the “One Country-Two Systems” arrangement.

This constitutional arrangement effectively puts the Chinese securities market and the Hong Kong securities market under two legal jurisdictions and the oversight of two securities regulators. The former is regulated by the China Securities Regulatory Commission (CSRC), and the latter by Hong Kong’s Securities and Futures Commission (SFC). The SFC participates in international regulatory conventions, such as the IOSCO, in its own right. Therefore, it is more appropriate to view the regulators and exchange owners of the two sides as approaching each other on the basis of dealing as foreign entities, with both cooperation and competition in mind.

Regarding agreements relevant to investigatory assistance, there are four sets of regulatory agreements in place between China and Hong Kong. The mutual trust between the Chinese and Hong Kong governments and their respective regulators enables deep cooperation initiatives. This stems from the long-term relationship between the CSRC and SFC, with the SFC being one of the earliest overseas regulators to connect with CSRC and assist with the development of the Chinese stock market. The first agreement is the Memorandum of Regulatory Cooperation entered early in 1993. Then, in 2003, Hong Kong became a signatory of the IOSCO MMoU, with China also joining in 2007. Because both Hong Kong and China are signatories, the MMoU is one of the legal avenues for information exchange between regulators of the two sides. The third agreement is the Strengthening of Regulatory and Enforcement Cooperation under the Mutual Access between the Mainland and Hong Kong Stock Markets (“Stock Connect MoU”) signed in 2016 after the opening of the Shanghai-Hong Kong Stock Connect. The fourth one is especially related to enforcement cooperation concerning stock futures.

The Stock Connect MoU created an in-depth cooperative framework between CSRC and SFC, which is especially needed because of its extra market linkage. There is first the element of active notification, where the regulators would immediately alert one another about any information concerning suspected misconduct in the other’s market once it is identified. Each would notify the other when it commences a cross-border investigation. There is then the element of assistance. The parties agree to actively facilitate, provide support, and coordinate with each other in respect of the use of information. Furthermore, there is a mechanism for joint investigation. In respect of significant and urgent cases relating to both jurisdictions or where the suspects, witnesses, or evidence are located in both jurisdictions, the two agencies might commence a joint investigation. Once a joint investigation is commenced, a joint task force will be set up to tackle the case. Hence, under the various agreements and the Stock Connect MoU, there are two routes to investigate cross-border market misconduct, namely seeking investigatory assistance or conducting a joint investigation. The existence of this joint investigation mechanism takes the potential cooperation between the two much deeper than the scope of the IOSCO MMoU.

C. Two Case Studies

Two landmark cases, one civil and one criminal, serve to illustrate cross-border market misconduct and the ensuing enforcement actions between Mainland China and Hong Kong.

The first cross-border administrative sanction case involving Stock Connect was pursued two years after its launch and led to a constitutional challenge against the use of cross-border evidence. In the Tang Hanbo case, the CSRC investigated Tang, a Chinese private speculator, for alleged price manipulation in the Mainland market in relation to shares of Zhejiang China Commodities City Group and four other companies. Tang and his two accomplices manipulated stock prices over a period of around five months by self-dealing and artificially creating a fake price hike. Tang and his team deliberately came to Hong Kong to evade regulatory oversight. The trades were executed through the northbound Stock Connect channel using multiple accounts, while Tang and his team stayed at Tang’s Hong Kong home and hotels. Concurrently, the Hong Kong SFC commenced an investigation into Tang concerning the disclosure of interest issues. The SFC obtained a search warrant before a magistrate court in respect of the disclosure matter and seized several notebook computers. On the next day of the search, the CSRC also took simultaneous action on the Mainland to control Tang’s accomplices. The computers were later transferred to CSRC for their market manipulation investigation.

Tang launched a judicial review challenge in the Hong Kong courts, alleging that the search warrant had been obtained illegally because it was requested based on an unrelated disclosure of interest, and thus the evidence in the case was also transferred illegally. In essence, Tang hoped that the procedural deficiencies that existed within the enforcement of cooperation between the CSRC and SFC would favour him in court. The court instead put the uncertainty to rest, ruling that the regulators had legally followed the protocol in their cooperation, and there was no hidden motive in obtaining the search warrant. Even if the evidence collected by the SFC was not for a particular case, transferring any information to the CSRC in fulfilling assistance requests is within the power and mandate of the SFC based on the MMoU and Stock Connect MoU. This case clarified and significantly strengthened the position of enforcement cooperation between regulators on both sides. The CSRC administrative sanction was finally handed down in March 2017, with Tang receiving a heavy fine of RMB ninety million plus the confiscation of a sum equal to his calculated illegal gains of RMB 240 million.

The first criminal sanction relating to the Shanghai-Hong Kong Stock Connect came in 2019. The defendants in the case again utilized the new channel to trade across borders. The defendant, Sang Renzhao, was an investment banker at UBS Securities based in Shanghai. In May 2017, Sang participated in the advising of the Chinese shipping giant COSCO’s plan to take over OOCL, a Hong Kong carrier. He immediately purchased shares of COSCO on the Mainland market using a third-party account and sold them all when the takeover announcement was made public. At the same time, Sang leaked the information to the second defendant, Chen, who then traded through thirty-six different accounts in the Hong Kong market on a much larger scale through the Stock Connect channel. The illegal profit he made amounted to RMB 125 million, from which Sang was paid five million. Separately, Sang also tipped off his university classmate, Wang, who traded on both the Mainland and Hong Kong market: first on the Mainland market for shares of the acquirer company to reap a profit of RMB 320,000, and then on the Hong Kong market for shares of the target company, returning a RMB 1.4 million surplus.

The series of insider trading was not detected by regulators but was rather exposed by Sang’s girlfriend on an internet posting as their relationship turned sour. Regulators quickly followed up on the tip and unearthed the trades above. Throughout the investigation and the court trial, both Sang and Chen denied their guilt and did not return the illegal gains. At sentencing, the court stated that their market misconduct acts were particularly serious, and both were sentenced to nine years imprisonment. Sang was also fined RMB 12 million and Chen RMB 240 million. Further, the two were ordered to return the illegal gains of RMB 5.13 million and RMB 125 million. The third defendant, Wang, admitted his wrongdoing, was given a suspended sentence, and was fined of RMB 1.7 million. Unlike the Tang case above, this case was investigated entirely by Chinese agencies. The fact that the market misconduct in this case involves both the Chinese and Hong Kong markets raises questions about the decision as to which regulator should exercise jurisdiction and its implication on the investigation, sanction, and remedy. These questions, along with other issues, will be explored in the next section.

III. Discrepancies in Substantive Rules

A. Misconduct Definition

The regulation of market misconduct is generally similar between the two jurisdictions but with some differences. These differences should not affect the overall and general operations against market misconduct, except in specific cases where conflict may arise. These discrepancies in law may lead to “regulatory arbitrage,” such that potential perpetrators of market misconduct will choose a jurisdiction where there is less chance of prosecution or less severe consequences if convicted. Some of these differences stem from the distinct legal systems of the two places. The Securities Law of China was first passed in 1998, with a recent substantial amendment in 2019. There are substantial additions in the regulation on insider trading, market misconduct, and marked increases in the punishment for contravention. There is an added explicit expansion of the jurisdiction of the regulatory authority in overseas listings and trading. Altogether there are newly expanded powers and scope of regulation for Chinese authorities. At the same time, the Chinese legal regime is usually couched in broad terms, leaving details to be fleshed out later via administrative rules and regulations. Hong Kong’s Securities and Futures Ordinance (SFO) has a longer history of revision, and it was also modeled after the relevant laws of other major common law jurisdictions, notably Australia and the U.K.. Its provisions are much longer and more specific; as such, some legal differences may arise between Hong Kong and the Mainland, as Hong Kong law provides for more specific rules applicable to different circumstances.

Potential legal conflict between the two jurisdictions concerns the scope and definition of market misconduct activities. Hong Kong’s regulation of insider trading provides for specific statutory defences to insider dealing in nine circumstances, including where the insiders conduct trades among themselves. It also contains a general exempting provision if it can be proven that the purpose of any trade “is not for securing or increasing a profit or avoiding or reducing a loss by using inside information.” Another example of the exemption from insider dealing prohibition is where one deals in the listed securities for the sole purpose of acquiring shares required to be qualified as a director of a corporation. Some of these exemptions may find parallels in the judicial interpretation of the Chinese Securities Law issued by the Supreme People’s Court, but most exemptions are unclear whether they apply in the Mainland. In a cross-market trading scenario, it remains unclear, for example, whether some Hong Kong exemptions are applicable for a person trading Hong Kong stock on the Mainland or vice-versa. Similar situations of discrepancies between exemptions can be found in the regulation of market manipulation, price rigging, and false trading.

Another potential discrepancy is the geographic reach of the securities laws. This is relevant and should be ascertained if regulators from either side have jurisdiction over a particular case. The Chinese Securities Law specifies its extraterritorial jurisdiction, stating that where the offering and trading of securities outside China “disrupt[s] the order of the domestic market” and “infringe[s] upon the lawful rights and interests” of Chinese investors, the perpetrator of such market misconduct will fall within the jurisdiction of Chinese law. Being China’s formal message in asserting her extraterritorial jurisdiction, this article was newly inserted under the 2019 amendment. It is written in a general manner and encompasses all types of market misconduct found in the law. Given that the amendment to the Chinese Securities Law only came into force recently, on March 1, 2020, it remains to be seen how it will operate to regulate market misconduct outside its jurisdiction. There may be difficulties in reaching foreign traders, and although the most likely overseas market the Chinese authorities could exert jurisdiction over seems to be that of Hong Kong, it would overlap with Hong Kong’s regulator, as well as be subsumed into the existing cooperation agreements of the two sides. Therefore, an application of China’s new extraterritorial jurisdiction may not be observed until test cases arise in the future.

As for Hong Kong’s SFO, most of its provisions on market misconduct do not provide for jurisdiction over overseas parties and misconduct. For instance, the offense of insider dealing is concerned only with shares listed on the Stock Exchange of Hong Kong. As cross-border trading is now highly convenient, this raises uncertainty as to whether the statutes provide Hong Kong’s regulator with jurisdiction over a particular cross-border case. For instance, if the perpetrator plans and executes trades within Hong Kong but through foreign markets concerning foreign securities. The SFC has sought to extend its jurisdiction by relying on a general catch-all provision in the SFO. The relevant wording of the catch-all provision does not mention geographical reach but simply provides that “a person shall not . . . engage in any act, practice or course of business which is fraudulent or deceptive.” In Securities and Futures Commission v. Young Bik Fung, during a secondment to a bank in Hong Kong, a lawyer who had access to classified information came to knowledge about a proposal to take over a bank in Taiwan. The defendant and his three relatives then gathered a large sum to acquire shares in the Taiwanese bank, which was listed on the Taiwan Stock Exchange. In court, it was challenged whether the SFC had the jurisdiction to prosecute this cross-border insider trade.

The Hong Kong court held that if the fact pattern of market misconduct is seen to have a sufficient connection to Hong Kong, then a court may apply common law principles and extend its jurisdiction in specific cases, and it did so in this case. The Court of Appeal first confirmed that this provision has no extraterritorial jurisdiction per se. The court went on to apply a common law test to determine whether a crime can be put under Hong Kong’s jurisdiction based on its substantial element. Where a criminal act has been committed, the common law test asks whether a “substantial measure of the activities constituting [the] crime” took place within the local jurisdiction. If so, local jurisdiction is applicable. In the Young Bik Fung case, although the company, the exchange where the stock was traded, and the account used were all located overseas, the court ruled that the acts of gathering the funds in Hong Kong, including borrowing and liquidating other assets, already constituted a “substantial part” of the trade, and thus local jurisdiction could apply. When we compare this legal position on jurisdiction with that of the Chinese Securities Law’s stated extraterritorial jurisdiction, there is a clear disparity in terms of the legal certainty of jurisdiction. Although the SFC’s jurisdiction was recently supported by the court in the abovementioned case, as compared to Chinese law, it remains highly case-sensitive and subject to legal challenge.

B. Misconduct Liability

There is a wide gap in terms of the severity of sanctions between Mainland China and Hong Kong, and the enforcement outcome of a case may differ based on where it is pursued. This includes the severity of the sentencing, civil sanctions, and civil remedies available to any investors. On top of any fine imposed, the extent of civil liability that may be realistically claimed in court will form part of a person’s consideration when they contemplate committing an offence. Therefore, it is an integral part of the deterrence against market misconduct. Comparatively speaking, a case sentenced in Hong Kong may face a lighter punishment. The maximum sentence in a criminal prosecution is ten years imprisonment and a HKD ten million fine. The court also has the power to order a convicted person to pay a sum not more than the gain or potential loss evaded from the market misconduct. This sanction applies to all types of market abuse defined under the SFO, including insider dealing, false trading, price rigging, disclosure of false or misleading information, and market manipulation, resulting in these types of market misconduct being sentenced similarly based on the maximum penalty.

Under the Mainland’s criminal code, the level of punishment for the different types of market misconduct is provided separately. The offence of insider trading attaches a higher level of penalty, with the perpetrator liable to a maximum of ten years imprisonment, and a fine of two to a maximum of five times the illegal gains. For the offence of disseminating false information to disrupt the market, the maximum fine is RMB 100,000. For the offence of market manipulation, the maximum fine is not specified. Empirically, the fine issued is often in specific multiples of the illegal gains, depending on the severity of the case, and is most often issued at two times the illegal gains. In some judgments from the Mainland Courts, the sum of illegal gains is to be separately confiscated on top of the fines, while some were not so stated.

Setting a fine as multiples of the presumed illegal gains has the benefit of not having to determine the exact amount of illegal gains, which could be a difficult task in some cases. However, this method of fine setting may give rise to a considerably higher fine than that of Hong Kong. For example, in the Sang case, after being sentenced to nine years imprisonment the defendant was fined RMB 240 million, which is twenty-four times the maximum fine in Hong Kong. Another subtle factor that may be at play in sentencing is the relative severity attached to a particular monetary sum. Taking the disparity of price and income level into consideration, an equal numerical amount could be felt as heftier in Mainland China.

As for the availability of civil compensation, it is a changing and developing regime for both Mainland China and Hong Kong. In the Chinese Securities Law, there are provisions stating the right to claim compensation from parties dealing with insider information. Similar rights of action to claim compensation caused by market manipulation are also provided. In practice, however, it is not easy to obtain compensation in court due to the lack of details in the bringing and hearing of cases of insider trading and market manipulation. To be sure, a private right of action could be theoretically based on the existing law of contract or the tort regime; however, due to the special nature of insider trading, such as the impersonality and anonymity of exchange transactions, it is extremely difficult, if not impossible, to assert insiders’ liability on these conventional grounds. The Supreme People’s Court of China issued a circular in 2003 to provide more detailed rules on the hearing of securities civil cases, but it only applied to cases against securities misrepresentation, and excluded other types of securities fraud such as insider trading. Overall, the Chinese civil compensation regime is in a state of flux, and sizable uncertainty lies in the actual handling of these claims by different courts.

The first civil compensation case concerning insider trading came before the court in September 2008, arising out of an administrative sanction. But, it was seen as not properly pursued and was thus withdrawn. Investors had to wait until 2015 to witness the first successful compensation claim. In that case, in a series of 507 claims each assessed by the court over three years of litigation, 354 of them were, in the end, approved by the court. The inside trader finally paid up to RMB forty million in damages. This case was hailed as a pioneering test case and sparked heated discussion concerning the proper legal criteria for investor compensation. For example, in regard to the method of ascertaining loss, one provision in a previous Chinese Securities Law’s amendment draft circulated in 2015 purported to set the loss caused by insider trading as the “difference between the price for which an investor bought or sold the shares, and the average market price within a 10 days after the disclosure of the insider information.” This blunt proposal was later dropped in the final amendment and the current method of calculation is still not specified. Within the geography of China, there is also a disparity in the likelihood of obtaining investor compensation, as empirical observations suggest it is more likely to receive civil compensation in courts of more economically advanced provinces.

Another important new development for the Chinese civil compensation regime is a class action lawsuit system specifically set up for investor protection. The Supreme People’s Court of China has launched this class action lawsuit system by issuing further provisions in 2020. Investors who have sustained losses may start an “Ordinary Representative Litigation” in a private lawsuit, or join a “Special Representative Litigation” initiated by an investor protection agency. Participation in this class action scheme seems to be convenient and is expected to significantly lower the cost burden of individual investors. Given the newness of the system, its actual effects are still waiting to be observed.

In Hong Kong, class action lawsuits are not available, and the steep legal cost makes it hard for individual investors to seek civil compensation against losses arising from market misconduct. However, there is another channel of civil compensation through litigation by the SFC. In 2013, the SFC utilized a general order provision under the SFO to seek compensation from a defendant for an insider trading lawsuit for the first time. The provision allows the SFC to petition the court to issue various orders designed to remedy and prevent the recurrence of breach. Where a person has contravened a provision of the SFO, the court may direct a party to take steps at the court’s discretion, “including steps to restore the parties to any transaction to the position in which they were before the transaction was entered into.” The Court of Final Appeal affirmed the use of this provision as a free-standing remedy to compensate up to more than 1800 investors who incurred losses due to insider trading. The compensation is calculated by the difference between the actual price of the underlying stocks sold by the insider, and the value of those shares taking into account the insider information as assessed by expert evidence.

While this approach taken by the SFC seems expedient for individual investors in Hong Kong, it also means that the availability of compensation is dependent upon positive action in seeking compensation by the regulator, compared to the method in Mainland China of claiming through private lawsuit or collective lawsuit after an official sanction is made. It is not known whether the SFC has sought another compensation order to date. Taken together, the generally lower level of fine and sentencing length, plus the lesser availability of civil remedy, at least in theory, means a comparatively lower sanctioning strength for Hong Kong as compared to China.

IV. Challenges to Legal Enforcement

A. Difficulties with Information Exchange

Against the background of the closely connected markets of Hong Kong and the Mainland, an important step for case detection is to achieve cross-border and cross-market surveillance. A holistic scope of market surveillance would ideally include cross-market, cross-border and cross-asset surveillance. Cooperative efforts for regulators in Mainland China and Hong Kong regarding regular joint-detection have yet to be established. Under various agreements, regulators of both sides have agreed to communicate if and when cross-border market misconduct is detected and investigated by either side. In 2018, the CSRC disclosed a total of around 20 alerts from Hong Kong and 12 instances of investigation assistance requests made by the CSRC. But the primary focus of the MOUs lies in case handling, and there is little guidance as to the issue of detection. The MOUs mainly facilitate the request and exchange of information for investigation after the market misconduct has been detected, instead of being a regular or day-to-day information exchange, as is required by cross-market surveillance.

One barrier to cross-market surveillance is the consolidation of market data across different markets. The market data of Hong Kong, Shanghai, and Shenzhen markets are not consolidated into a single system for easy monitoring. Regulators in the United States faced this issue with its multiple decentralized domestic markets, and the failure to effectively monitor them has been attributed as one of the main reasons for some major market crashes, especially the 2008 global financial crisis. In response, the SEC required all US exchanges to adopt common standards and centralize data, i.e., the consolidated audit trail which began its implementation in 2017.

A crucial requirement for cross-market and cross-border monitoring is to have common reporting standards across jurisdictions. For instance, in the Mainland market, each market participant can directly hold shares, whereas in Hong Kong, a large portion of trading and holding are on a nominated basis, i.e., conducted by trading brokers on behalf of the actual owner. In particular, to resolve monitoring issues in this regard, new cooperative measures are being put in place. Regulators are trying to ride the wave of the development of Regulatory Technology (RegTech) to improve regulatory efficacy. For example, the Mainland securities markets have adopted a system where “all orders must bear the respective securities account numbers linked to the corresponding investors, which will be further carried to the clearing end.” This allows for more efficient market surveillance and enables quicker response. This however did not exist in Hong Kong. Hence in 2018, a Northbound Investor ID Model was implemented for the Stock Connect, so that every Hong Kong investor trading in the Mainland-bound direction now has a unique ID number that can be traced in real-time. The southbound identification was later announced in October 2019, whereby the Investor ID of the Mainland investors trading through the channel would be sent over to SFC. This common reporting standard initiative is expected to facilitate cross-border abnormal trading detection and enforcement actions.

It could be hard to tell whether or not, and why, a case is handled one way and not another. In the Tang case, the illegal gains involved amounted to RMB 40 million, but Tang was never criminally charged for cross-market misconduct. In a later case, Tang himself was criminally charged in a separate market misconduct offence that occurred domestically in Shanghai and was sentenced to three years and six months imprisonment. The illegal gains in this later case were at a much lower figure of RMB twenty-four million, thus it is unclear why the former case was not prosecuted as a criminal case despite the much larger sum involved. One possible reason could be the cross-border nature of the first case, creating certain hindrances to the availability of evidence vis-a-vis different enforcement agencies. The SFO provides that the SFC cannot transfer information collected via powers under section 179 or section 183 (to compel a person to provide evidence) for use in criminal prosecution if a person claims he might be criminally charged by a foreign regulator. In a cross-border setting, this may bring about some uncertainty in information exchange and enforcement.

B. Differences in the Regulatory Architecture

Firstly, in terms of the main regulator, both Mainland China and Hong Kong adopted a sector-based structure of financial regulation, with the CSRC and the SFC being the main securities regulators in both regions, respectively. But there are significant differences in the institutional environments in which the two securities regulators operate. For instance, the CSRC does not enjoy the same measure of independence as the SFC and is subject to more serious issues of resource constraints and regulatory capture. As will be discussed below, the institutions for law enforcement are also different, and apart from the two main regulators, other actors may also play a role in the regulatory landscape. These differences may have an impact on the willingness and ability of the securities regulators on either side to cooperate.

Hong Kong has some special institutions for securities law enforcement, which are not present in Mainland China. For certain types of market misconduct such as insider trading and market manipulation, the SFO lays down a dual system of regulation, namely a civil penalty route and a criminal prosecution route. Under the civil penalty route, the case will be brought by the SFC before the Market Misconduct Tribunal (MMT), which is an independent body established under the SFO. Each panel of the MMT when hearing a case is chaired by a judge or former judge of the High Court assisted by two lay members who are usually prominent members of the business and professional community in Hong Kong. All decisions are determined by the majority of the panel members, but questions of law are determined by the Chairman alone. The MMT applies civil procedures, including the civil standard of proof, but can impose a range of orders which are not remedial but punitive in nature. In respect of criminal prosecutions, the SFC can prosecute summary offences under the SFO in its name before the Magistrates’ Court but must refer more serious and indictable offences to the Department of Justice for prosecution.

In line with the principle against ‘double jeopardy’, the SFC can only choose to employ either the civil or criminal route, but not both. Once a civil or criminal proceeding is commenced, it cannot be withdrawn to initiate proceedings through the alternative route. Hence, choosing a route has enforcement implications for the SFC, and the calculus of such a choice can be quite complex. If the market misconduct is less serious and/or the evidence is not sufficiently strong for a criminal prosecution, the SFC may choose the civil penalty route. But there is also the risk that the SFC may shirk its responsibility by choosing the easy way of handling the case, namely the civil route, even if the misconduct is very serious and/or the evidence is sufficiently strong. To avoid this issue, the SFC must obtain the consent of the Secretary for Justice to institute the MMT proceedings. According to empirical research, from 2003 to 2015, there were twelve cases concluded via the civil penalty route and twelve criminal cases during the same period, suggesting that the two routes had been used in a generally balanced and appropriate manner.

While the SFC can choose to investigate and pursue securities law offences in a criminal prosecution with the Department of Justice’s consent, a criminal case may at the same time also fall under the functions of the Hong Kong Police. SFC and the Hong Kong Police signed a MoU to set out their cooperation and relationship in such cases. Whether it is the SFC or the Police that should be responsible for a case is determined by asking which agency is in a better position to handle the case, and whether it would be duplicative for the other agency to conduct a parallel investigation. It is also possible to set up a joint task force to commence a joint investigation. In terms of assistance, because the SFC does not have the power of arrest if the SFC has obtained an arrest warrant from a magistrate, it may request the Police for help in its execution. The SFC may also request the Police for assistance to conduct searches under a search warrant if there is a threat to the safety of SFC personnel. In practice, however, due to the relative independence of the two agencies, the two agencies have little communication with each other in the conduct of securities cases.

In turn, for Mainland China, the division of responsibility in investigating a securities law crime is more clear-cut between the securities regulators and the police. While cases of administrative punishment are handled by the CSRC, if it is determined that a case of market misconduct is of a particularly serious nature, the case will be referred to the police department for investigation and where appropriate, further referred to the procuratorate for criminal prosecution. The guidance for handling a criminal case of market misconduct can be found in its 2011 Notice. Where a case is “significant, complicated or difficult”, the CSRC may request reference opinions, and assistance in arrests from the police, or transfer the case altogether to the police. Upon investigation of a criminal case, if it is found that the acts do not constitute a crime and the procuratorate decides not to prosecute, the matter shall then be transferred back to the CSRC for administrative sanctions. In a cross-border enforcement setting, if a case is handled as a criminal case, it is unclear whether the SFC has direct cooperation mechanisms with China’s police department, or if it is to be done through the CSRC. Under the agreements between Mainland and Hong Kong regulators, the transfer of information onward to other agencies is not specifically mentioned, although one side can ask for the consent of the other if the information is to be used for purposes other than that originally stated in a request.

One important implication for the institutional structure is that the investigative powers given to agencies across borders are different. These differences in power accorded by the law of both places affect the investigative power of agencies of both sides and are again a source of regulatory arbitrage. The CSRC and the SFC have similar powers to enter premises, seize records, etc., except the SFC is required to obtain a magistrate’s warrant before exercising these powers. On top of that, the CSRC has the power to restrict a suspected person from leaving the territory and to restrict further dealing in securities by the person. On the other hand, the SFC is given a wide power of compelling information from persons under investigation, which is not present for their Chinese counterparts.

Section 183 of the SFO allows the SFC to require a person to produce any record or document that may be relevant to an investigation, to give an explanation in respect of any record, to attend a meeting with an investigator at a time and place required by the SFC, and to give the investigator “all assistance.” The main point about this compelling power is that if one fails to comply with a Section 183 request, it would constitute a criminal offence in itself. In a recent investigation, the SFC issued a Section 183 Notice not only requiring a person to produce specific emails in an email account but also to provide the login names and passwords to email accounts and other digital devices seized. This far-reaching notice was challenged in a judicial review for being disproportionate, but the Hong Kong court upheld this overarching power of the SFC.

C. Lack of Extradition Arrangements

Further, effective cross-border enforcement entails the transfer of the accused between jurisdictions in suitable cases. In between overseas jurisdictions and between Hong Kong and other jurisdictions, extradition is possible and is the usual practice. But as of now, there is no extradition arrangement between Hong Kong and the Mainland despite their geographical proximity. This is perhaps not a small deficiency in the enforcement cooperation between the two jurisdictions. Without an arrangement to transfer an accused person, the focus of regulators could be restricted only to offenders who are physically present within their respective jurisdictions. In at least two cases, the SFC has failed to put an insider trading offender onto the court because the accused reportedly fled back to Mainland China. The accused in one case, Pan Caihong, was a Mainland lawyer and frequently travelled to Hong Kong. It was alleged that she sold shares in a company after she became aware of negative inside information about the company. She failed to attend a hearing at the court and a warrant was issued by the court for her arrest. In another case, a finance manager of a listed company subsidiary was suspected of insider dealing. Similarly, she did not appear for the hearing and left Hong Kong. An arrest warrant was issued for her in 2016. In both cases the SFC could not take further action across borders and the arrest warrants could not be enforced.

The first effort at legislative change was in mid-2019 when the Hong Kong government proposed a bill to amend the existing law on extradition. The current law in Hong Kong provides for the mechanism of wanted person transfer, but it explicitly states that it is not applicable to any arrangement between Hong Kong and Mainland China. The amendment sought to change that and allow extradition to the Mainland. At the same time, however, it was strongly viewed that the extradition bar is an important safeguard of Hong Kong’s unique judicial system, and the bill soon drew widespread social and international attention until it was finally retracted due to an unfavourable response. But even in the early stages of the legislative process, in order to smoothen its acceptability in the Legislative Council, a number of commercial crimes were already removed from the bill after intense lobbying from the business sector. When the bill finally reached the legislative body, it excluded crimes related to taxes, securities and futures trading, intellectual property, and company law offences. In this form, even if the bill was passed, it would not have assisted with extradition regarding market misconduct enforcement. Two observations may be made from this episode. First, the preferable legal regime for the business sector is overwhelmingly the Hong Kong legal system. Second, the government agreed with the business sector in this regard and did not rush to change the current law on extradition regarding crimes of a commercial nature. As such, the lack of cross-border transfer of market misconduct offenders may not be resolved soon.

V. Suggestions and Implications

A. General Observations

The above sections assessed the status of cooperation between regulators in Mainland China and Hong Kong and examined the factors affecting the effectiveness and legal certainty of cross-border enforcement. It should first be noted that the overall assessment concludes that good infrastructure for cross-border enforcement cooperation is in place. There is a deep level of cooperation between the two regulators: the CSRC and SFC. Seeing as most of the world’s regulators cooperate on the basis of the IOSCO MMoU, the bilateral engagement between China and Hong Kong is much more comprehensive. On top of the large volume of cross-border trade between the two places, this engagement is made possible due to the close political ties of the two governments.

Besides the information exchange mechanism, the MoU between China and Hong Kong provides for the added mechanism of joint investigation, which is encouraged by the IOSCO, but is not present in the multilateral MMoU. In the case of information exchange and investigative assistance, the bilateral Stock Connect MoU does not rule out cooperation between the two sides in regard to criminal prosecution, which is omitted in the IOSCO MMoU. Although cooperation is being pushed forward by the EMMoU, it has received little interest as of now. Because the process of up-take in such a large-scale multilateral agreement is gradual and slow, bilateral arrangements such as the one between China and Hong Kong serve an important function; especially for jurisdictions with close connections and lower risks of market misconduct activities.

The above analysis also reveals some weaknesses that call for further adjustment to create and maintain a high level of credible deterrence. While the enforcement cooperation framework provides for a joint operation mechanism, there has yet to be an instance where a joint operation has been undertaken in the six years since the Shanghai-Hong Kong Stock Connect came into operation. The prosecuted cases up until this point were still collaborated by the two sides but only through the usual information exchange mechanism. It was not that there were no instances where joint investigation was possible as some previous cases could have been investigated jointly. Under the Stock Connect MoU, it states that a joint investigation may be commenced in respect of a “significant and urgent case[] relating to both jurisdictions, or where any of the suspects, witnesses or evidence are located in both jurisdictions . . . .”

In the Tang case, the SFC and CSRC could have opted for the joint investigation route instead of the investigatory assistance route. The relevant case facts are: Tang conducted the trade physically in Hong Kong; the trade was done through the Hong Kong market; and the evidence of the trade was found on Tang’s computer in Hong Kong. Hence, it would seem that there were ample grounds that conform with the requirement under the Stock Connect MoU for a joint investigation. This was mentioned in the trial as Tang complained that the SFC and CSRC had conducted a de facto joint investigation on market manipulation but fell short of carrying out a formal one. If it was a joint investigation, the constitutional challenge episode–where Tang complained about procedural irregularity–could have been spared. In fact, given the sufficient connection to both jurisdictions provided by trades through the Stock Connect channel, every case that trades through this channel would likely come under the simultaneous jurisdiction of both regulators. For now, it remains to be seen when the two agencies will undertake a formal joint investigation. A possible reason for the lack of such a joint investigation could be that the two sides are waiting for a perfect first case to set a good precedent. It could also be that a joint operation, while agreed in principle, is nonetheless difficult to conduct in practice, not least in part due to the many legal and operational differences between the two jurisdictions.

B. Specific Proposals

Some legal discrepancies concern the scope of offence and their exemptions. Given the close connection of listing and trade between the two jurisdictions, discrepancies in the law may give rise to confusion and uncertainty for any cross-border enforcement action. The disparity in the availability of civil remedies may also create fairness issues between investors across borders. Both of these can be resolved in future amendments (and/or judicial interpretation by the Mainland) if the laws of both sides can be harmonized. The European Union has provided a good example in this regard: it has issued the first Market Abuse Directive (MAD) in 2003 and the second Market Abuse Directive (MAD II) in 2014, to develop consistent definitions of market misconduct as well as consistent penalties for such misconduct amongst the member states.

It is certain that inherent differences, such as the discrepancies in the scale of fines and sentencing, would be harder to harmonize. Even if their laws were harmonized into the same or similar wording, inherent differences in their legal system would still differentiate the enforcement outcome across the two places. The criminal sentencing practice in the Hong Kong courts is rooted in the common law court system, giving the judge wide discretion in deciding the length of imprisonment for a specific defendant, after taking into account a series of personal circumstances. Furthermore, a conventional discount of one-third of the prison term will be readily applied if a defendant pleads guilty to a crime before the trial begins in a Hong Kong court. The same customary discount is not available in a Mainland court, and the extent of leniency upon a guilty plea depends on each judge. These differences stemming from the court system itself are not easy to reconcile through the harmonization of securities law.

A longer-term solution to these sanctioning discrepancies across borders is perhaps to establish a common regulatory and sanctioning agency, but this would be an ambitious goal. Short of a unified agency, some part of the sanctioning regime could be harmonized to a certain extent, especially in regard to administrative sanction as it is civil in nature and does not involve the criminal prosecution regime or court sentencing regime. For instance, the EU common market has often tried to tend towards harmonizing various aspects of their financial regulations, including the sanction regime for financial misconduct. While acknowledging the autonomy of each EU member state to determine their sanctioning scale and method, the EU Council passed directives to set guidelines for various levels of maximum fines imposed on insider trading, market manipulation, and so on. These guidelines and recommendations for harmonization cannot be made without first conducting in-depth studies and dialogues into the sanctioning practices of all the jurisdictions involved, which is also one initial preparatory step that regulators and policy researchers in Mainland China and Hong Kong should embark on.

The absence of an extradition arrangement is another critical shortfall for establishing a credible cross-border enforcement regime between Mainland China and Hong Kong, and this factor could also be a subtle reason why some cases are pursued in one jurisdiction and not the other. Presently, once a perpetrator crosses borders, there is no legal and practical way of apprehending a suspect, no matter how serious a case is or how strong the evidence is on hand. This problem is significant, especially for Hong Kong as it is a tiny financial city, and crossing the Mainland and Hong Kong borders is very convenient. Most residents of both sides can easily cross the border with minimal visa requirements and the daily volume of mutual personnel traffic is enormous. Without extradition, one way to enforce securities law is for either side to exercise extra-territorial jurisdiction and to prosecute a case in each jurisdiction’s courts. But, this is not an adequate solution, as there is great uncertainty about such a method of case handling, and it will not be suitable for every case. An optimal solution would be for Mainland China and Hong Kong to agree on some form of extradition. Given the political backlash as mentioned previously, the two regulators of the two sides could push for a more limited kind of extradition, for example, one that requires proper judicial safeguards and applies only to a limited number of specific market misconduct offences.

A rapidly developing innovation in the regulatory effort is the use of information technology to aid market surveillance and monitoring, termed RegTech. In essence, RegTech utilizes technologically advanced tools such as big data analytics, cloud computing, and machine learning. There are important advantages of utilizing RegTech in market surveillance. For instance, it is generally more reliable and capable of identifying more complex behavioural patterns and detecting cases of misconduct. The securities regulators in China and Hong Kong have started to explore ways of using RegTech in relation to cross-border enforcement, but more needs to be done. First, as RegTech is based on big data analysis, its efficacy would be undermined where data is hard to come by. It is thus important for the two sides to improve the mechanism for data sharing and exchange, and even consider establishing a common data centre. Second, there is a need for more investment and development in the field of RegTech. Indeed, despite the importance of RegTech, it has largely remained a fancy concept, seeing quite limited use in practice. As cross-border securities transactions involve highly complex legal issues, it calls for specialized rather than general RegTech and thus requires close collaboration between technical and legal experts as a development strategy.

Lastly, looking beyond the bilateral setting between China and Hong Kong, it should be noted that between a global convention like the IOSCO MMoU that includes most of the world’s securities regulators, and a small-scale model of bilateral cooperation as detailed above, there can be other types of multi-jurisdictional groups. Canada’s regulator has been coordinating response to market fraud by the US and Canada, through their Cross-Border Market Fraud Initiative (CPMFI). The initiative seeks to use innovative, coordinated, and timely actions to detect and deter penny stock abuses. The German regulator BaFin also joined the Initiative in 2019, creating a transatlantic task force. Such functional grouping may allow regulators to coordinate on specific issues without casting the net too wide so that more in-depth cooperation remains on the table. Moving forward from a bilateral setting between China and Hong Kong, the two regulators can build on the existing cooperative framework and explore the possibility of enlarging this framework to other relevant markets, for example, Singapore or London.

Conclusion

Due to the increasing integration of securities markets at regional and international levels, there is a pressing need to examine the regulatory arrangements for cross-border securities misconduct. This requires regulators to have well-functioning infrastructure for information exchange and enforcement cooperation and ideally harmonized legal rules and sanctioning practices in order to minimize regulatory arbitrage.

A case in point is the interaction of the securities markets in Mainland China and Hong Kong. The two markets are highly connected in terms of capital and personnel movement, corporate activities, as well as securities listing and trading through various connected channels. At the same time, the regulators of the two jurisdictions act independently and their legal system differs distinctively. The CSRC and SFC have signed a number of bilateral agreements for regulatory cooperation, ranging from information exchange to mutual assistance in prosecution. Nevertheless, due to various reasons, these cooperative arrangements have not been as effective as expected in practice.

Significant discrepancies exist in relation to the scope of offences, the severity of punishment, the power of agencies, and the institutional structure of regulation. This has the effect of weakening the certainty and effectiveness of enforcement action with respect to cross-border market misconduct. Efforts should be made to minimize these discrepancies by harmonizing the substantive rules on the definition of and the liability for market misconduct. It will also be useful for the regulators on both sides to jointly issue guidelines on specific issues relating to cross-border regulatory cooperation. In the long term, it is worth exploring the possibility of setting up a unified monitoring, investigating, and sanctioning regime. While the Mainland-Hong Kong case has its distinctive features, it exhibits some issues of general application and thus can contribute to the international discourse on the regulation of cross-border securities misconduct.