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Regulatory import controls – balancing international commitments and local problems

Asian regulators are acutely conscious of both local financial market risks and how their respective jurisdictions are affected by foreign developments.

This broad perspective is demonstrated by the range of risk issues that are currently being addressed and include structural (recovery and resolution), operational (electronic trading) and enforcement (the increasing levels of focus on FX and other rate-fixing scandals).

Ultimately, the various threads come down to business management and how a business is conducted (and seen to be conducted) and how it is lived and breathed by everyone in that organisation. This point is underlined in the latest Annual Report of the Hong Kong Securities and Futures Commission (SFC), where the text of the Chairman's and CEO's respective statements is dominated by references to "good corporate governance" and "conduct in financial firms". There was also reference made to "tone from the top". It has been made abundantly clear in Asia (and elsewhere) that these things matter, not least in terms of assessing financial penalties and reputational damage when problems arise.

The SFC has conducted 296 risk-based inspections of regulated entities in the past year, with particular attention paid to client asset protection, internet trading and intermediaries' selling practices.

The SFC also instituted a heat mapping based internal risk register for it to bring to bear its internal resources to tease out what the regulators consider to be the highest risks to target across the markets, covering entities, infrastructures and activities.

As a result of all the above, a series of layers of risk-based regulations can be divined:

  • At a higher level, public consultations are on foot concerning recovery and resolution to conform with international requirements for the implementation of a suitable regime by the end of next year. That is also in line with Singaporean and Australian moves to meet the deadline. There are significant challenges to arrive at a coherent, compliant (but suitable for domestic purposes) regime within the time limit. As a result, the need for business certainty haunts the system and policy, and possibly structural, changes that need to be planned for at management level. Asia is late in the game in this area, so although there is a degree of second-mover advantage, there is also a degree of haste that needs to be kept under control.
  • The introduction of mandatory trading, clearing and reporting again highlights local and cross-border issues, and the uncertainties and risks created by piecemeal regulatory development. Planning for the set-up of business operations is made again more complicated in Hong Kong by the multiple stages of implementation, including the proposed introduction of additional regulated activities for OTC derivatives trading and advisory services and clearing services. The interconnection among the various current and future activities and exemptions, and the lack of any set timetable for launch of the regulated activities, make forward planning highly challenging, particularly for new businesses which can be caught in a situation where they may need to apply for a licence that will no longer be required by the time their application would otherwise have been processed. There will need to be flexibility and pragmatism shown by the regulators to smooth the path.

The impending Hong Kong-Shanghai Connect initiative and PRC-Hong Kong mutual fund recognition, display the need to assess issues on a cross-border basis.

In the context of corporate finance and the markets, there is a continuing emphasis on proper conduct in IPOs and the conduct of listed companies. Direct action has been taken in relation to misleading listing particulars and faulty announcements in the wake of deficient IPO applications, which has resulted in stalled listings. Increased activity in relation to takeovers, including the perennial topic of concert parties, adds a further dimension to the need for careful management of transactions from the beginning to ensure mandatory general offer and enforcement risks are mitigated.

On the enforcement side, the lesson is the same. The recent Consent Order (the Order) entered into by the New York State Department of Financial Services and Standard Chartered Bank New York provides a good example. The Order was agreed after an independent monitor (appointed pursuant to the terms of a past consent order) identified risks related to compliance with anti-money laundering (AML) laws related to U.S. Dollar clearing for clients of SCB UAE and SCB Hong Kong. The Hong Kong Monetary Authority (the HKMA) issued a press release the day after the order was made. The HKMA noted that it had been monitoring SCB HK's AML controls closely and, although it had identified some areas for improvement, they were not issues that caused significant supervisory concerns. The HKMA also reported that it had required SCB Hong Kong to take appropriate actions regarding the affected customers.

Time will tell whether the trend towards what might be called "dynamic supervision" in the U.S., placing ongoing tailored compliance conditions or independent monitors on firms to combat perceived previous failings, is adopted enthusiastically in Hong Kong. That would effectively lead to an increased use of regulators' intervention powers – as a straitjacket or a guiding hand, depending on your perspective. But the days are long gone when regulatory risks can be assessed purely from the perspective of the "home" or "substantive" jurisdiction alone.

Although the above round-up is weighted towards recent developments in, and implications for, the Hong Kong market, as a (necessarily limited) proxy for Asia it is consistent with how these types of issues arise in other Asian jurisdictions. They have a universal quality in terms of how they affect the financial markets and how policies and procedures need to be tackled on a global rather than parochial basis.

Legal and Regulatory Risk Note