Regulatory trends in Asia
There is increasing anxiety in the financial industry in Asia concerning the levels of regulation at not just domestic, but at regional and international levels. These layers of increasing regulation create significant legal, regulatory and reputational risks for organisations.
A recent regional regulatory summit held in Singapore, which was attended by speakers from a wide range of Asian regulators, pinpointed some of the issues at the heart of market players’ fears. We were the sole law firm to participate in this summit.
It is not only the Foreign Account Tax Compliance Act (FATCA) – which highlights the extraterritorial reach of regulation – but tax compliance closer to home, which is high on institutions’ worry lists. The potential for “son of FATCA” measures to be introduced by local jurisdictions, mirroring the Italian and Spanish moves, and the added complexities that would create from a compliance perspective, are making the market nervous.
The continuing enthusiasm of the regulators to pursue wrongdoing in the market (with the focus remaining on corporate governance, insider trading, market manipulation and intermediary misconduct), and the ingenuity which they are prepared to employ to achieve satisfactory enforcement outcomes, remains a high risk point for institutions. An example of this is the use by the SFC in Hong Kong of s213 of the Securities and Futures Ordinance to pursue civil proceedings against offshore parties where criminal proceedings cannot be brought except following an extradition request. Section 213 enables the SFC to obtain injunctions, freeze assets and unwind transactions. In the Hontex IPO case, where false statements were made in the company’s prospectus, the SFC used s213 to unwind the subscriptions and return investment monies to investors. The SFC has stated that their use of s213 is not to punish misconduct but a mechanism to seek recovery for victims of misconduct.
Regulators in the region are also focusing on senior management, strengthening boards of directors, increasing board oversight of operations and aggressively pursuing enforcement action against those in senior positions. The Hong Kong Monetary Authority (HKMA) now holds face-to-face meetings with potential candidates for directorships at financial institutions. While no candidates have been directly rejected, the HKMA has asked a number of institutions to reconsider the candidates proposed. As a result, there have been a number of withdrawals. The SFC has indicated that senior management responsibility must extend to all key operations and functions areas of institutions, including controls, and the SFC will look for evidence that senior management were aware of issues that subsequently became the subject of investigation. Settlement offers are often made if no such evidence can be found.
This is above and beyond any structural changes that could otherwise minimise risk through ring fencing or other means. Reflecting this perception, MAS in Singapore does not intend to implement any structural changes but will ensure that institutions’ risk management initiatives are commensurate.
Regulatory infrastructure related risks
The introduction of central counterparties in major Asian jurisdictions, their inter-relationship and how they will work with the U.S. and European initiatives, means a level of uncertainty on how the rules will be implemented and interpreted, with the inevitable risks created by that uncertainty. The introduction in Hong Kong of new layers of regulated activity to cover OTC derivatives dealers and advisers and clearing agents, further demonstrates the bolt-on nature of new regulation and how there will be an adjustment period for how the market participants will accommodate the new requirements. This is particularly true given the hitherto essentially unregulated nature of OTC derivatives businesses.
Cross-border activity risks
The SFC in Hong Kong has proved to be consistently focused on unlicensed activity as an area for vigorous enforcement, demonstrating the need to be vigilant as regards cross-border business models into Asian jurisdictions. The lack of “passporting” in Asia on a broad scale has never been more obvious or relevant.
While there are pockets of development on this front, for example the potential for China-Hong Kong mutual fund offerings in the future and ASEAN initiatives in relation to securities, the regulatory risks for international financial institutions operating across multiple jurisdictions continue to create significant risk management issues. There is a need to calibrate marketing and sales activities to comply with a range of jurisdictions at a “highest common denominator” level, which is fraught with potential issues in terms of the gaps, and the tension becomes more evident where there are changes in laws in individual jurisdictions on a regular basis tracking the changes and building the implications into systems and controls becomes more than a full-time job.
Given the various levels of regulation in Asia, increased resourcing of compliance staff by itself will not mitigate the legal, regulatory and reputational risks. Crucially, financial institutions need to ensure they have robust information management systems within their organisation, including at multi-jurisdictional levels, to assist in risk management. Even then, there are no guarantees, for example when LIBOR is considered: that is not an issue that would have been on the risk management radar of banks 18 months ago; now, it is a troubling issue across the banking industry, not just of course in terms of the London rate, but across Asia.
Ultimately, regulators are looking to ensure that institutions have an effective culture of risk management where excessive risk-taking is minimised.
The SFC in Hong Kong has proved to be consistently focused on unlicensed activity as an area for vigorous enforcement...