Hong Kong: SFC Compliance Forum 2019: The SFC Outlines Its Key Supervisory Priorities For The Year Ahead

The Securities and Futures Commission (SFC) held its third annual Compliance Forum (Forum) on 17 June 2019 – a series of six panel discussions with industry participants:

  1. Morning plenary panel: Digital journey of client onboarding, act on red flags of improper client activities
  2. Morning breakout session 1: Vaccines of client protection – internal controls and supervision of account executives
  3. Morning breakout session 2: Securities margin financing
  4. Afternoon plenary panel: Governance framework as a driving force for a culture of accountability and behavioural change
  5. Afternoon breakout session 1: Gearing up for distribution of investment products in an evolving world
  6. Afternoon breakout session 2: Regulatory obligation and risk management function of prime brokerage in Hong Kong as Asia's hub

Key points communicated by the SFC over the course of the full-day event provided insights into what we expect will be at the core of the SFC's approach to the supervision over the next 12 months:

  • A 'front-load' approach will remain firmly at the forefront.

    The SFC indicated that it will stay focused on early targeted intervention to 'pre-empt the fallout from emerging threats'. Some examples of this front-load approach that was discussed during the Forum include the SFC's approach to notifications under the new Securities Margin Financing (SMF) Guidelines (see section 3), and moves to halt the 'rolling' of 'bad apples' within the financial services industry (see section 4).

  • The use of technology to sharpen the SFC's regulatory toolkit.

    The SFC is continuing its efforts to use 'Suptech' innovations to enhance its gatekeeping function and keep up with rapid adoption of new technologies within the financial services industry. For example, the SFC is currently considering the feasibility of an online platform which uses biometric technology to facilitate remote on-boarding of clients (see section 1) and described the new online licensing forms introduced in February as a 'software update' to allow the regulator to better collect and analyse data (see section 4).

  • A client-focused approach to regulatory compliance.

    The SFC highlighted the key areas where, in its view, the industry had fallen short in ensuring protection of investors in Hong Kong – including in relation to selling practices and product suitability assessments (see section 5) and internal controls for the protection of client assets and supervision of account executives (see section 2). The SFC made clear that firms with highly sophisticated offshore clients will not be let off the hook – for example, prime brokers (PBs) are expected to comply with the applicable rules and regulations in Hong Kong, regardless of where the risk positions are booked (see section 6).

1. Morning plenary panel: Digital journey of client onboarding, act on red flags of improper client activities

One of the SFC's current priorities is to facilitate more efficient remote onboarding of clients under current regulations:

  • Use of biometrics: in addition to the protocol of establishing a client's identity through a designated bank account which is currently provided for under the circular titled 'Online client onboarding' dated 12 July 2018, the SFC is studying an online approach to onboard individual clients overseas, which uses biometrics along with safeguards for mitigating technology risks. The SFC indicated that it will be publishing more guidance in this area.
  • Client identification guidance: paragraph 5.1 of the SFC's Code of Conduct (Code) provides guidance on the procedural steps in relation to client identification which a firm should take where an account opening procedure other than a face-to-face approach is used. Given the principles-based nature of the Code, the SFC plans to remove the detailed procedural steps from the Code and house them in a dedicated page on the SFC's website. This will provide more flexibility when the SFC introduces other acceptable client identification means for digital client onboarding in the future without the need to amend the Code every time.
  • Dealing with 'red flags', such as third party deposits and payments: the SFC made a few clarifications in relation to the circular titled 'Third-party deposits and payments' recently issued on 31 May 2019. For example, the SFC confirmed that the requirement for the acceptance of third party payments be subject to the approval by the Manager-in-Charge of AML/CFT or Money Laundering Reporting Officer applies to all third party payments, including where the third party payor is an immediate family member of the client. When asked whether firms are expected to obtain documentary evidence to ascertain the relationship between the client and the third party payor in these circumstances, the SFC confirmed that firms should take a risk-based approach based on their level of knowledge about their client.

Back

2. Morning breakout session 1: Vaccines of client protection – internal controls and supervision of account executives

The SFC highlighted some of the regulatory concerns identified from its recent thematic review of brokers' internal controls for the protection of client assets and supervision of account executives:

  • Client information: some licensed corporations (LCs) have chosen to comply with the requirement to check the accuracy of client information by periodically confirming personal information and instructions with clients via SMS. The SFC considered this to be an effective and flexible approach.
  • Knowledge and training: LCs, particularly those with a high employee turnover rate, have found it difficult to keep up with constantly-evolving laws and procedures. In light of this, the SFC suggested that LCs update their internal procedural manual from time to time, and provide sufficient staff training.
  • Segregation of duties: the SFC reminded LCs that the segregation of duties is one of the requirements under the Code. The SFC acknowledged the fact that some clients have developed a very strong relationship with their respective account executives, and they might refuse to confirm their information or orders with other employees. To ensure there is proper segregation of duties, the SFC suggested that LCs could arrange a call between the client and the account executive, but also require an independent staff member to sit-in and witness the confirmation.
  • Checklist for conducting a self-assessment: the SFC has compiled a self-assessment checklist following its thematic review on internal controls. One of the suggestions is for LCs to allow employees to take block leave. The SFC acknowledged that it may be difficult for smaller LCs to implement this, especially if there are only 1-2 employees in certain departments. As such, the SFC emphasised that the checklist is not exhaustive and it only acts as a health check tool.

Back

3. Morning breakout session 2: Securities Margin Financing

The law relating to the regulation of SMF activities came into effect in 2000, and it has remained a regulatory focus for the SFC given the risks associated with SMF activities:

  • Trends of margin loan quality and risk management practices: the SFC has recently conducted a review on the SMF brokers and published its findings in August 2018, revealing that the SMF brokers' total margin loans trended upward significantly nine times from 2006 to 2017, but the risk management practices of these SMF brokers were below the SFC's expected standards.
  • Guidelines for Securities Margin Financing Activities: the new 'Guidelines for Securities Margin Financing Activities' (SMF Guidelines), which will take effect on 4 October 2019, aims to provide guidance on the risk management practices expected of brokers (Type 1 and Type 8) when they provide SMF to their clients (in addition to the existing requirements under Schedule 5 of the Code of Conduct for Persons Licensed by or Registered with the SFC).
  • Notifications to the SFC: the SMF Guidelines make clear that brokers should report to the SFC immediately if it does not comply with or exceeds the benchmark in certain provisions under the SMF Guidelines, or fails to pass the stress test. The SFC has specifically noted that notifying a non-compliance or failure to pass a stress test under the SMF Guidelines does not automatically amount to a breach – the SFC is more keen to be made aware of the difficulties faced by the brokers from managing the risks associated with its SMF activities, in order to facilitate discussions with the SFC regarding any remedies or contingency plans which the brokers may have.

Back

4. Afternoon plenary panel: Governance framework as a driving force for a culture of accountability and behavioural change

The SFC's focus on individual accountability shows no sign of abating:

  • Reflections on the Manager-in-Charge (MIC) regime: the SFC observed that the MIC regime has been successful in enhancing the SFC's oversight over how firms are driving a culture of accountability from top to bottom. The SFC observed that the Licensing Division now receives much more detailed information on the internal governance structures and senior management in place throughout various levels within an organisation (as opposed to the upper echelons of management only). While the SFC initially stated that it did not see the MIC regime as an enforcement tool, it clearly moved away from this position. During the session, the SFC referred to activities of the Enforcement Division in investigating whether certain MICs had appropriately discharged their responsibilities in supervising regulated activities within the firm.
  • Tracking of 'bad apples': the SFC remarked that the most commonly asked question it has received in relation to its new licensing forms and processes introduced in February, is how to define 'internal investigation'. The SFC made clear that providing an exhaustive list of disclosable internal investigations is impractical, and that firms should look to the 'spirit' of the regulation when assessing whether an internal investigation should be disclosed. In describing the spirit of the regulation, the SFC referred to its recent frequently-asked questions, and reminded firms that the requirement forms part of a broader focus by the SFC on the integrity, fitness and properness of licensed individuals.

The SFC also confirmed that it will not disclose information obtained under the new obligation to any other persons, including the outgoing employee and his/her prospective employer, unless otherwise permitted by law. However, the SFC did acknowledge that, under certain circumstances, it may refer matters to Enforcement for further investigation.

Back

5. Afternoon breakout session 1: Gearing up for distribution of investment products in an evolving world

Selling practices continue to be a key focus area for the SFC, particularly compliance with the suitability requirements. While the SFC did acknowledge that defining a 'complex' product will always remain a challenge, the SFC set out five areas of repeated failures in selling processes it has observed within firms:

  • Inadequate product due diligence: inadequate to rate the risk of products as a class or rely on the credit rating of products given by external credit agencies.
  • lnsufficient record keeping: making it difficult for the SFC to assess if adequate product due diligence has been performed.
  • Inadequate risk profiling and know-your-client procedures: suitability questionnaires treated like a box-ticking exercise with firms ignoring inconsistencies therein or allowing changes to risk ratings without justification.
  • Improper risk disclosures: insufficient communication of risks and downsides to products.
  • Lack of holistic assessment of suitability of the sales process: focussing only on certain aspects of the sales process, e.g. whether an order is made via a recorded telephone line.

Back

6. Afternoon breakout session 2: Regulatory obligation and risk management function of prime brokerage in Hong Kong as Asia's hub

The SFC answered questions from the audience on regulatory expectations following the recent release of its 'Report on the Thematic Review of Prime Services and Related Equity Derivatives Activities in Hong Kong' (Report) and the circular titled 'Prime services and related equity derivatives activities' (Circular) on 10 June 2019:

  • Governance and supervision: when asked 'how can [global institutions] identify which activities shall be governed by SFC Codes, and other related regulatory requirements?', the SFC reminded PBs that if clients are serviced in Hong Kong or if PBs are carrying out their prime services in Hong Kong, PBs are expected to comply with the applicable rules and regulations in Hong Kong regardless of where the risk positions are booked. PBs in Asia should also have controls and procedures in place to follow the standards established by their group companies, and ensure that the group-wide standards are no less stringent than Hong Kong regulatory requirements.
  • Differentiated client service offerings and conflicts of interest: when asked 'how does the SFC view PBs classifying clients into tiers (with higher tiered clients receiving better service offerings), as opposed to equal treatment of all clients?', the SFC indicated that it was generally comfortable with certain clients receiving premium service offerings, so long as the PB had effective policies and procedures in place to manage potential conflicts of interest.
  • Grace period for compliance: the SFC confirmed that it will allow PBs a grace period to comply with the guidelines and expected standards outlined in the Circular and Report. However, the SFC did not comment on how long this grace period would last for.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions