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Asia – International trends and local operational developments

Internationally, the U.S. Foreign Account Tax Compliance Act (FATCA), Basel III, and anti-money laundering legislation remain of central concern to financial institutions in Asia.

Non-U.S. institutions are struggling to anticipate the likely effects of this legislation and manage transaction documentation in the light of new requirements. FATCA is moving up the agenda rapidly, given the looming start date. Basel III is also more sharply in focus as institutions try to come to terms with the operation of the new regime. Anti-money laundering remains an important area of focus for regulators, particularly where there is an overlap with market misconduct and manipulation.

How these international developments knit into the day-to-day operations of an institution in combination with local requirements remains a key challenge. Indeed, given the volume of material that needs to be digested, overloaded Legal and Compliance staff in this region may themselves constitute an area of potential risk in institutions.

In Hong Kong, the regulators have recently initiated a consultation to explore the future treatment of "professional" investors. Although the access of professional investors to "private placements" is to be undisturbed, the regulators want to consider who should be classified as a "professional" for these purposes. Should individuals or corporate professionals still be able to participate in such activities, or should it be left to true institutional investors? Should monetary thresholds (a crude marker for qualification) as to who can qualify as a professional be increased? Suitability and other Code of Conduct requirements are potentially going to be applied to all individual investors and their vehicles, not to institutions or, (where sufficiently knowledgeable and experienced) corporations.

It is clear that there will be a swathe of practical classification and operational issues that will need to be addressed to manage risks in this area of the industry which has, in recent times, become much more of a target for regulators.

Into this mix there is a further contemplated change to client documentation under which the suitability requirement would be incorporated into that documentation as a contractual term. Of all the various measures under consultation, this proposal is particularly problematic. An attempt to give legal effect to an inherently uncertain area of operational practice seems to be a recipe for dispute with regulators and clients.

It echoes recent attempts by claimants to treat all or part of the "Conduct of Business" requirements on an intermediary as a term in the contractual relationship (an approach the courts have not yet endorsed).

Given the difficulties of interpreting and implementing the professional investors' regime in the Hong Kong market, there is an argument that the proposed changes will not make a great deal of practical difference. Many private bankers and wealth managers have tended to ignore the professional inventor classification under the business Conduct of Code due to the inherent uncertainties. Ironically, the tougher suitability requirements may do no more than codify what is already practised in the market. The imposition of a contractual term as to suitability would create more risks, particularly given that in Hong Kong there is no private cause of action for breach of a regulatory obligation, meaning breach of the "suitability" requirement will not currently enable clients of an intermediary to claim compensation. Inclusion of the suitability requirement as a contractual term will radically change this landscape.

It has also been proposed that it would be a breach of a regulatory obligation for an intermediary to conclude a contract which contains a clause that is either inconsistent with its obligations under the Code (eg that is not under any obligation to assess suitability when making a recommendation), or which mis-describes the actual services to be provided to the client (eg by stating that no advice or recommendation has been or will be given when in fact it has). Many could sympathise with the desire to protect the interests of unsophisticated investors, but the need for legal certainty should remain paramount. Financial institutions rightly draw certainty from reaching an agreement as to what services are to be provided. The prospect of a breach of a regulatory obligation should a sales representative stray outside those terms during a call some years after the agreement was signed is far from welcome.

In any event, the outcome of the consultation and the revised regime introduced as a result will need to be considered, not just in the light of the impact on the local market and operations of institutions, but also at a more regional level, as other regulators take an interest in developments in their neighbourhood.

In the same vein, one further area which may need to be monitored going forward is the extent to which regulators may take a heightened interest in the activities of consultants in the financial services industry and the nature of their relationships with institutions. The regulators' desire to ensure that consultants speak with an independent voice in relation to systems and controls investigations and recommendations for reforms or sign-offs for current practices, is likely to create further operational difficulties for banks.

This measure further demonstrates the transportability of regulatory and enforcement concepts across international boundaries.

Legal and Regulatory Risk Note