A Review of Asian Regulators

Starting off the new year, we may as well do a recap of last year’s events. To summarize the equities market saw glimmers of hope at last year’s dawn but the mood later relegated. The US stock market saw itself flash crashed in the second quarter and Eurozone has been stranded in quicksand. Fund houses and banks alike have started to find themselves confronted with more urgent regulatory demands.

The FT published an interesting viewpoint recently concluding that Asia may be pioneering financial regulatory developments and can set example for its European counterpart. In fact some of the industry professionals quoted go as far to observe that elements of Basel III might have drawn inspirations from Asian precedents.

It did point out that there were still some problems with the framework of regulation in Asia and Asia’s regulators are less coordinated and have limited reach beyond their borders to chase the non-compliant. 

In our view, the FT quote that acquiring a license in Hong Kong may take upwards of 12 months was off the mark and the processing time is much shorter than that.  Likewise the Hong Kong versus Singapore story is old news and the new rules for licensing of fund management companies widely expected to be introduced in Singapore in the first half of this year will level the playing field between the 2 cities even further.

The Financial Times article can be accessed here.

Resource Review: Financial Regulators Gateway

What is it?

The Financial Regulators Gateway is a directory of financial regulators throughout the world, as well as a directory of the relevant statutes and regulations in each jurisdiction.  According to the website, the University of Toledo College of Law originally developed it, but the website is now maintained independently by Prof. Emeritus Howard M. Friedman.

Why would I use it?

Searching through Google, or any other search engine, for a particular financial regulator can be onerous.  If you are unsure whether a country’s securities regulator is an independent entity or part of a consolidated financial regulator, searching can be particularly frustrating.

This directory will point you in the right direction.  It generally lists separate securities, banking, and insurance regulators.  However, in some jurisdictions, the same body regulates one or more of these regulatory functions.  The directory will help you to identify whether a particular regulator is in charge of all the financial activities, as in Singapore, or, whether individual agencies regulate each broad type of activity, as in Hong Kong.

Where can I find it?

The website address or URL is: http://financialregulatorsgateway.com

How do I use it?

From the homepage, there are two possibilities.  You can either select the geographic area you wish to investigate and gradually narrow your search to the appropriate jurisdiction, or you can browse for specific jurisdictions alphabetically.  As an index with a finite number of jurisdictions, the designers have not included a search feature, so you must find a regulator by browsing for its jurisdiction.

For American and Canadian jurisdictions, you can also find the regulators for particular states or provinces.  This feature reflects the type of federalism that exists in those jurisdictions, where the state or provincial governments have substantial authority in regulating financial activities.

What is good?

• Indexing.  Listing the jurisdictions by both geographic area and alphabetical order makes finding a particular jurisdiction easy.  This type of resource is particularly amenable to the web and navigation through hyperlinks.
• Persistence.  The website appears to have stable funding, and thus it appears that it will continue to exist for the foreseeable future.
• Simplicity.  The sole purpose of the website is to serve as a directory.  There is very little, if any, extraneous information.
• Scope.  The scope of the coverage is worldwide, and there is an entry for every country where a regulatory body exists (with the exception of jurisdictions where the publishers failed to find a regulator, or in some jurisdictions where sovereignty is in dispute).
• Cost. The website is free to use, and probably will remain so given its origins and affiliation with the University of Toledo.

What could be better?

• Currency.  At the time of writing many of the jurisdictions have been updated as recently as August 2011.  However, since the website is now maintained by an individual rather than an organization, the time that Dr. Friedman can spend updating the directory is understandably limited.  The difficulty may not be quite so pronounced in jurisdictions where the agencies are relatively persistent, but some jurisdictions change radically in a matter of years.  Even a relatively stable country such as the United Kingdom will soon need to have its listing updated to reflect the sweeping changes occurring there.
• American-centric.  It is understandable that an American university would have a particular interest in highlighting American jurisdictions.  However, the small inconsistency is that Canadian provinces can be found from the listing for Canada’s federal regulators or under the listing for North America, while the American state regulators can neither be found under the listing for the United States’ federal regulators nor under the listing for North America.  Instead the state regulators have their own listing in a separate section of the website, which is accessible from the menu at the top left of all pages.
• Search.  There is no search option, which could be useful if you were trying to find a particular jurisdiction right away.  On one hand, there are not too many jurisdictions to make browsing difficult.  On the other hand, searching might help to find jurisdictions where the user does not know the continental affiliation of the jurisdiction.  For example, is Mauritius in Africa or Asia?  Is Papua New Guinea in Asia or Oceania?
• Interactivity of the map.  Although a small feature, it would be useful to be able to click on the continent or a country on the map to be taken to the part of the website for that area.  Such a feature may not be a priority for people working on the website, and as borders change, could be quite difficult to implement and maintain.

Summary

As a directory of worldwide regulatory agencies and the legislative basis of their activities, this website is both ambitious and successful.  For anyone researching the regulations of a particular jurisdiction, this website is a great starting point.  The caveat is that it is incumbent upon users of the directory to help this initiative stay current by notifying the site’s administrator of any corrections.  Additions and corrections should be sent to the e-mail address listed on the page entitled About This Web Site.

MF Global faces Escalated Inquiry

The House Financial Services Committee has asked Mr. Corzine to attend a hearing scheduled for Dec 15 to inquire events leading up to MF Global’s collapse. Some observers are ringing the question whether the three major rating agencies had been clouded by Corzine’s star power to give a fair rating that realistically reflected its ailing conditions; the pending collapse of MF Global had only become obvious when Moody’s downgraded the broker-dealer to the edge of “junk territory”. As Deloitte’s forensic accountants appointed by the trustee are wrapping up with their reconstruction of books, it has found that missing client funds far exceeds the originally estimated USD600 million and can shoot beyond USD1.2billion.  

CFTC first detected the missing client money managed by MF Global and issued subpoena for an investigation near the beginning of November. The agency then jointed hands with SEC and other exchanges such as the CME Group to see whether customer money was diverted at MF Global to meet its financial obligations. To date, MF Global has not accounted for the lost client money.

Upon joining in March 2010, Mr. Corzine was aspiring to turn MF Global into a full-fledged investment bank comparable to Goldman Sachs under his management. Anxious to realizing the vision, MF Global invested heavily in European debts under the Corzine’s directorship only to find itself entrenched in a downward spiral. Investors were alarmed about the health of the firm and its stock was in free fall by the last week of October.

WSJ report on rating firms’ role in the MF Global collapse can be accessed here.

Dealbook’s report on MF Global’s latest estimated shortfall can be accessed here.

The article from the New York Times Dealbook can be accessed here.

Ever-spreading are the US tentacles to uncover Offshore Assets

The US has been stretching its tentacles to uncover even non-Swiss offshore accounts. According to a Justice Department press release dated Nov 17, the federal grand jury had just indicted Desai of San Jose for failing to file two appropriate tax returns and Reports of Foreign Banks and Financial Accounts (FBFA) for his holdings in HSBC India and UAE. 

Probes of eight offshore banks issued by the Justice Department in its Offshore Compliance Initiative stages the pursuit of offshore private accounts. This league of banks including Credit Suisse (along with seven offshore banks) have been targeted for allegedly helping Americans evade tax, after Swiss banks had reached a settlement with US authorities over offshore banking services. In July Credit Suisse received a target letter from the Justice Department and thereafter earlier this month prompted its own Clariden Leu to send certain US clients letters informing that their names and account details (dating back to 2002) will be disclosed to the Internal Revenue Services (IRS). Though offshore banks may not have significant presence in the US, authorities try to interpret them to having “US presence”, as long as an access point such as a representative office or a phone number is present.

Still recalled by many fresh and green, the UBS was charged with a fine of 780 million in 2009 to avert indictment charges that it sold banking services which enable Americans to evade tax. The UBS later turned over some 4000 client names to US authorities. As a most recent reminder, Robert E Greeley, resident of San Francisco, was charged for evading tax of interest income of his two offshore accounts, through the help of a UBS Swiss banker. For the present UBS in particular, regulatory forces happen to squeeze them on two fronts – private banking and trader loss. The investigation this time reminds us once again about the eagerness of US authorities to trace the whereabouts of offshore assets.

As of now, industry professionals have noted the complexity of US regulatory measures. An offshore business thought to have little relation to US rules may be subject to regulatory oversight by multiple agencies (SEC, CFTC, FINRA, Dept of Justice, etc). Fund managers should alert investors especially on the US tax and asset reporting issues, even though they may not have expertise in the area. That way funds can reduce compliance risks exposed and costs which may be entailed, such as the loss of a core client base.

Reuters Nov 9 report on Clariden Leu, Credit Suisse can be accessed here.

Department of Justice Nov 17 release on non-Swiss holdings can be accessed here.

The Reuters Sept 20 report on eight offshore banks can be accessed here.

Robert E Greeley’s case settlement can be accessed here.

When Regulatory Reforms Become Political, and Personal

It is not breaking news that US regulatory reform has turned political, at least in the case of OTC derivatives reform. Most recently views of the SEC and CFTC diverge on how much this market should be regulated. On swap trades, for instance, CFTC wants users to request five quotes before they trade while the SEC only mandates users to obtain a quote from at least one bank, more aligned with the existing practice. The lighter SEC approach has earned allies in the Congress, with the passing of the Swap Execution Facilities (SEF) Clarification Act. It seems like the moderates are seeing a silver lining.

Previously, the disagreement between the Republicans and Democrats steals the limelight. In an attempt to bottle hatred against Wall Street (displaying in the form of the Occupy Wall Street movement), the Republicans were proposing seven new bills in attempt to limit, what in their view is, the uncapped expansion of CFTC jurisdictional reach in the $600 trillion OTC derivatives market.

The Republicans were concerned that the regulatory reforms introduced by the CFTC in recent months would significantly heighten the regulatory costs of funds which had relied on derivatives to merely hedge everyday risks. They contended that the CFTC reforms would further dampen the already depressed economy, with unemployment stubbornly fixed at a staggering 9 percent. One of the bills, for instance, will exempt commercial “end-users” such as utilities, manufacturers and airlines from posting cash reserves on swaps. Democrats continued to be skeptical if these bills would provide leeways for Wall Street to get around regulations. Gary Gensler at CFTC reiterates that the new regulations are not intended to harm business and merely are required for monitoring purposes; but in the eyes of the investment community, the toughened stance taken by Gensler is discomforting.

In spite of the most recent turn of tides, it is still difficult to deny that US regulatory reform has chartered into dangerous territory and can adversely affect the most routine operations of US financial institutions. For instance, the SEC has been bold enough to push through the Volcker Rule, which attempts to ban proprietary trading and investment of banks in hedge funds significantly if not altogether. If realized, the rule will kill off an important source of revenue for banks, potentially leading to an even more illiquid economy and recession. Indeed, some commentators think that US regulatory reforms have become retaliatory.

The Reuters article on Republicans taking aim at US derivatives reform can be accessed here.  

Reuters report on SEC proposing Volcker Rule, swap dealer plan can be accessed here.  

Financial Times report on swap execution facilities in November can be accessed here. 

SEC proposes further reforms on money market funds

The SEC is proposing to tighten regulations governing money market funds. Money market funds are traditionally a safe investment vehicle holding almost exclusively shorter-term, high quality bonds. They tend to offer higher returns than bank deposits and have experienced little failure. The regulator requires money market managers to maintain their funds above 1USD per share in net asset value.

The 2008 financial crisis was a watershed moment highlighting the potential dangers of money market funds.  Reserve Primary Fund, once a major money market fund, had invested USD785 million in Lehman Brothers and was unable to maintain the formula of 1USD NAV per share. This led to widespread redemption by risk-averse investors, and the fund later required government help to get through the crisis.

The new measures which the SEC is proposing will eliminate the taken-for-granted expectation of stability in money market funds. The SEC is considering implementing a floating NAV that moves away from the pre-established 1USD mark which may reflect the risk level more realistically. The industry is opposed to the new measures saying they will eliminate the appeal of money market funds.

Reuters’ report on SEC money market reforms can be found here.

Financial Times report highlighting history and industry view of money market reforms can be found here. 

US frustrated in streamlining Audit Practices Abroad

James Doty, chair of the Public Company Accounting Oversight Board (PCAOB), reiterated his concern on Chinese audit inspection, according to Reuters report on Nov 11(EST). He observed that some auditors merely follow existing business controls and fail to perform their monitoring roles. In the past weeks, he had proposed to have companies rotate their audit firms to avoid conflict of interest issues.  

Prior to these ongoing developments, talks between US and China on streamlining audit procedures for US-listed Chinese companies have been stalled since Oct 24, as Chinese representatives have put off meetings on the matter. Citing past meetings with Chinese counterparts, Doty then expressed worries that any Chinese moves to restrict the flow of audit work papers would go beyond keeping inspectors of his agency out of China.

There have been renewed concerns lately about the audit practices of Chinese companies particularly about their opacity and some investors are losing confidence in the prospects of Chinese companies with questionable corporate governance, such as in the case of Longtop. Chinese regulators are asking the Chinese arms of the world’s largest audit firms to review their audit work on Chinese-listed companies and the information which they might have provided to overseas, including US, regulators.

Doty believes that “U.S. markets and investors have been unfairly taken advantage of by those who want the benefits of American markets but not American rules." The US seems likely to consider implementing rules to apply to the Chinese arms of audit firms in their conduct and the standards used in reviewing companies with US investors. This may limit the phenomenal growth enjoyed by these audit firms in their Chinese operations in the years to come. 

The Reuters Nov 11 report can be accessed from here.

The Reuters Oct 24 report on the stalling of Sino-US talks on audit practices can be accessed from here. 

Basel III and Eurozone bank capital requirements

Fortune published an interesting discussion on calculating capital threshold in Europe and America on Nov 2 (EST). In anticipation of Basel III, banks will be required to meet new thresholds. Moreover, the definitions for qualifying capital in calculation of threshold will become stricter. This change reflects how some banks, including certain major ones, have exploited the looser definition under Basel to their advantage – according to advocates of the new Basel III changes, a catalyst for the financial turmoil we are now in.

European regulators have given much more leeway to bank managers in determining the riskiness of their assets and what can be counted as capital under Basel II. For this reason, European banks have been classified as bearing lower risks than its American counterpart for an unjustifiably long time, even after the financial crisis. European banks reportedly have bent the definition to basket those assets with high leverage as low risk due to the potential to take equity returns. Ironically these assets have become “safer” since the onset of the financial crisis; sovereign debts previously seen as low risk but are now being held responsible for furthering the damage to the global economy. The US by contrast has tighter rule sand requires banks to place 5% capital against assets, regardless of the risk level of their assets.  

Readers may access the full discussion on Eurozone crisis and banks here. 

Summary of the Olympus drama and the Japanese Economic Fate

No one would disagree that the Olympus drama has spiraled out of control. Some weeks ago Michael Woodford was fired from the company management for forcing an investigation of the company by releasing to media internal documents about investments that appeared to have gone wrong and demanding the entire board to resign. Since then the company has appointed an outside panel to investigate a hidden loss involving some USD687million, which had been paid as fees for acquiring British medical equipment maker Gyrus. This intriguing payout has invited joint investigation efforts by the FBI and SEC.

Olympus was also acquiring companies with little to do with their own business. They include a facial cream maker named Humalabo and a plastic container manufacturer News Chef. Credit agency Tokyo Shoko Research reported that both had not made money before being acquired. The external panel investigating Olympus losses reported that these acquisitions may be used to mask entrenched investment failures originating from the 1990s.

The scale of the Olympus fraud could turn out to be of behemoth size in the end. The anticipation of such has already unnerved investor confidence in the company and the wider Japanese equities market. The poor corporate governance displayed within Olympus is closely entwined with the economic fate of Japan. Japan’s economic stagnancy today was partly caused by lax accounting standards in the private sector from the bubbly late 1980s. Accounting reports for many Japanese companies during the early 1990s still used outdated but better-looking figures from late 1980s which poorly reflected reality. It wasn’t until the mid-1990s when the government stepped in to rectify the practice and admitted that Japan was entering long-term economic stagnation. Two decades have been lost in Japan but issues of corporate governance have seen little improvement to date.

Olympus stock fell from 1300 to 600 Yen from 11/2 to 11/9. Intriguingly, Nomura stock also fell 15 percent on November 8 alone in Tokyo. Investors suspect that Nomura was somehow involved in the Olympus rout. 

The Dealbook New York Times round-up can be found here. 

Bloomberg's report on Olympus, Nomura and the Japanese market can be found here. 

Korean FSC lifts short-selling ban on non-financial stocks

The Korean securities market regulator Financial Services Commission is lifting a three-year ban on short-selling of non-financial stocks, as reported by the Asian Investor today. As the domestic market has been up 9% for the past three months, the FSC thinks this would be an opportune time to end universal short-selling ban. The short-selling ban on financial stocks however has not been lifted. The hedge fund industry has not expressed much opposition yet and seems to agree with the decision insofar. As observed by Asian Investor, a consensus lingers among Korean industry professionals that the short-selling ban on financial stocks should not be lifted yet as the Eurozone woes persists.

It is no wonder why the continuation of such ban makes sense. Korean financial stocks have been reacting quite sensitively to Eurozone developments. The Korea Herald summarized yesterday the performances of domestic financial stocks (Woori down 5.31%, Shinhan down 6.23%, KB Financial down 6.45%), as Italian sovereign bonds yields shot above 7%. In light of such developments, the lifting of  the short-selling ban on financial stocks is generally viewed in Korea as untimely. The ban will continue to be effective for 110 financial stocks listed on KOSPI.

At the same time, there are concerns that the lifting of short selling ban on domestic non-financial stocks will add to the volatility of related futures and options contracts for months to come. And some professionals suggest that the universal short-selling bans should continue until uncertainties about the Eurozone and indeed the global outlook see signs of clearing (a day which unfortunately may not arrive anytime too soon). The easing of such short selling ban may be intended to coincide with the new hedge fund “welcoming policy” just put in force in September this year. By way of such “welcoming policy”, the FSC aspires to nurture home-grown hedge funds; the agency now allows individual investment in such funds (a relatively low threshold of USD459,000) and also had eased their borrowing limits (400 from current 300 percent). 

The Asian Investor’s report on the lifting of short-selling ban can be accessed here.

Korea Herald’s summary of financial stock performance (Nov 10) can be accessed here.

Reuter’s report on the hedge fund “welcoming-policy” can be accessed here. 

FSA presses Citigroup Japan on improving compliance infrastructure

The FSA in Japan is again pressing Citigroup to overhaul its compliance operations, according to Wall Street Journal’s report on Nov 6 (EST). The regulator has expressed dissatisfaction about the bank’s lax compliance, including anti-money laundering standards. This seems likely to lead to some major personnel shake-ups among the senior ranks of Citigroup Japan. Most recently the bank has hired a recruiter in attempt to replace its current league of senior management. Until Friday, Citigroup Japan had been reporting to the Hong Kong office, which oversaw the Asia-Pacific operations. Citigroup Japan now directly reports to John Havens, the Group’s COO in New York. It is expected that the FSA will issue sanctions against the group within the next 2 months.

Citigroup Japan has not met regulatory expectations on at least three widely publicized occasions to date. The first one occurred in 2004 when the bank was forced to close down its private bank operations over anti money laundering deficiencies. In 2009, two traders were charged with manipulating the London interbank rates (Libor) when the Japan FSA joined hands with the UK FSA and SEC in investigation efforts. Most recently, the FSA found that its retail operations did not make sufficient disclosures to clients about risks underlying investment trusts during the sales process nor did staff properly assess the suitability of products for customers. 

The WSJ report can be found here. 

FINRA ordered by the SEC to strengthen internal control

As reported by the Dealbook of New York Times on Oct 27 (EST), FINRA was asked by the SEC to overhaul its internal controls. The call has potentially damaged FINRA’s aspiration to become the foremost regulator of the US securities market and shake off the SEC’s established dominance. The issue arose in response to a routine inspection by the SEC of FINRA’s Kansas City office. Prior to the inspection, the director of the Kansas City office was alleged to have “caused alterations” of three staff meeting minutes just hours before the SEC team arrived.

Gerald Hodgkins, an enforcement official from the SEC, commented that internal compliance efforts at FINRA had not gone far enough to prevent such incidents. He noted that US law required FINRA to provide documents sought by the SEC in a complete and accurate form. FINRA was ordered by the SEC last week to hire an outside consultant to review its internal controls.

Ketchem from FINRA stressed that his agency had voluntarily reported the incident and had appointed a new leadership team for the Kansas City office and noted that the SEC had praised FINRA’s prompt reporting. 

See here for the Dealbook Report on SEC order 

HK ICAC takes action against former securities dealer

The Hong Kong anti corruption watch dog and enforcement body, the ICAC, often takes action against persons who are involved or were formerly involved in the securities industry.  Unlike the FCPA, the local legislation allows ICAC to take action in relation to purely private sector to private sector corrupt behaviour issues.

On Friday they announced the following on their website:

A former investment representative of a securities firm has been charged by the ICAC with accepting bribes totalling over $1.1 million from a businessman as rewards for assisting the latter in selling 50 million shares of a listed company.

Andy Pau Chin-hung, 35, formerly employed by KGI Hong Kong Limited (KGI Hong Kong), who was charged yesterday (October 27), faces two counts of agent accepting an advantage, contrary to Section 9(1)(a) of the Prevention of Bribery Ordinance.

The defendant will appear at Eastern Magistracy at 9:30 am on Monday (October 31) for transfer to the District Court for plea.

At the material time, the defendant was employed by KGI Hong Kong as an investment representative working for KGI Asia Limited (KGI Asia). He was responsible for opening securities accounts and conducting stock trading for clients of KGI Asia.

The charges allege that between April 23 and May 16, 2007, the defendant accepted a total of over $1.1 million from a businessman and/or his associate as rewards for assisting in disposing of 50 million shares of Warderly International Holdings Limited through certain accounts held with KGI Asia.

The defendant has been released on ICAC bail, pending his court appearance on Monday.

New Guidelines for FDI in China may mean more buoyancy for Renminbi

As reported by The Asset on Oct 19 2011, The Ministry of Commerce (MofCom) and the People’s Bank of China released new guidelines discussing procedures for how corporations wishing to execute FDI (foreign direct investments) should use Renminbi raised offshore and how banks should handle FDI-related China onshore Renminbi account management and transactional control. Some industry professionals view this as another step forward for the internationalization of Renminbi.

Though Renminbi FDI introduces greater flexibility for capital and investments offshore, onshore activities are still heavily regulated. Investment in items such as onshore stocks and derivatives (subject to QFII regulations) using the FDI channel is banned. Investment in certain industries, including some heavy industries in which the state wishes to retain its monopoly such as shipbuilding and steel, still require approval from MofCom before FDI is allowed.

Nevertheless the new measures are expected by some industry professionals to increase offshore Renminbi dynamics and introduce some fresh foreign capital onshore, especially for smaller Chinese firms. 

Report from The Asset can be assessed here. 

Hong Kong SFC issues consulation paper on regulating the OTC market

The Hong Kong SFC and the Hong Kong Monetary Authority today issued a joint consultation paper on a proposal to regulate over the counter derivatives in Hong Kong.

The HKMA would regulate banks, the SFC other financial firms and there would be a new category of SFC license for those involved in the OTC market that are not end users.

The proposed changes would be designed to come into effect prior to the end of 2012 subject to similar progress elsewhere in G20 countries.

The deadline for comments regarding the proposals is 30 November.

The full SFC announcement is as follows:

Consultation begins on proposed regulatory regime for OTC derivatives market

The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have issued a joint consultation paper on the proposed regulatory regime for Hong Kong’s over-the-counter (OTC) derivatives market. The HKMA and SFC have been working on developing a regulatory regime for the OTC derivatives market locally, in accordance with commitments the G20 Leaders made in September 2009 to carry out reform in that area (Note 1). “In line with the objectives of the G20 commitments, the proposed regime aims to improve overall transparency in the OTC derivatives market, reduce interconnectedness of participants, and generally reduce systemic risk in the financial system,” said Mr Eddie Yue, Deputy Chief Executive of the HKMA. The HKMA and SFC are mindful that the local OTC derivatives market is relatively small compared with other major markets and the OTC derivatives market is global in nature. Hence, the focus has been on developing a regime that is on a par with international standards but takes into account local market conditions and characteristics. “Given the cross-border nature of the OTC derivatives market, global effort is required to establish international standards. Hong Kong cannot drive the reform initiatives, but we will continue to coordinate with overseas jurisdictions to address some of the key aspects of the reform,” said Mr Ashley Alder, Chief Executive Officer of the SFC. As key aspects of the OTC regulatory reform are still under discussion in the global arena, the proposed regime for Hong Kong may be subject to further change. The joint consultation paper however sets out the HKMA’s and SFC’s current thinking on how the regime might be cast given the present status of the global reform efforts. In brief, the main proposals in the consultation paper are as follows – The proposed regime will be set out in the Securities and Futures Ordinance (SFO), and will be jointly overseen and regulated by the HKMA and SFC. Essentially, the HKMA will oversee and regulate the OTC derivatives activities of authorized institutions (AIs), while the SFC will oversee and regulate such activities of persons other than AIs (Note 2). OTC derivatives transactions will have to be reported to the trade repository, which is being set up by the HKMA. (Note 3). This reporting obligation will initially apply only to certain interest rate swaps (IRS) and non-deliverable forwards (NDF), but will subsequently be extended to other product classes (such as equity derivatives and other types of interest rate derivatives) after further market consultation. Standardised OTC derivatives transactions will have to be centrally cleared through a designated central counterparty (CCP) (Note 4). This mandatory clearing obligation will also initially be limited to only certain IRS and NDF, and subsequently extended to other product classes after further market consultation. Initially, OTC derivatives transactions will not be required to be traded on an exchange or electronic trading platform. Further study is needed to assess how best to implement such a requirement in Hong Kong. AIs' OTC derivatives activities are already subject to the HKMA's regulatory oversight in respect of capital, liquidity and other relevant requirements and should remain so under the proposed regime. In order to bridge the regulatory gap that would otherwise exist, there is a need to require non-AI entities that engage in OTC derivatives activities (other than as end users) to be licensed for a new Type 11 regulated activity under the SFO. Large players who are not regulated by the HKMA or the SFC may be subject to certain obligations and requirements, such as producing information regarding their OTC derivatives activities, and reducing their OTC derivatives positions, if so requested by the SFC in extreme situations. The HKMA and SFC are working towards meeting the G20 implementation deadline of end- 2012. However, much depends on external factors, including the progress of reform initiatives in other major markets, due completion of the legislative process, and the readiness of relevant market infrastructure and participants. The consultation period will end on 30 November 2011. The joint consultation paper can be downloaded from the HKMA website or the SFC website. Interested parties are invited to submit their comments to the HKMA or the SFC on or before the deadline. End Notes : 1. The G20 Leader’s September 2009 Communique called for all standardised OTC derivatives contracts to be traded on exchanges or electronic trading platforms, where appropriate and cleared through central counterparties by end-2012 at the latest; for all OTC derivatives contracts to be reported to trade repositories, and for non-centrally cleared contracts to be subject to higher capital requirements. 2. AIs refers to institutions that are licensed under the Banking Ordinance and regulated by the HKMA (i.e. banks, restricted licence banks, and deposit-taking companies). 3. The HKMA is in the process of establishing a trade repository for the collection of data relating to OTC derivatives transactions. 4. The HKMA and SFC propose that only clearing houses recognised under the SFO and providers of automated trading services authorised under Part III of the SFO will be eligible to be designated as CCPs under the new regime. The Hong Kong Exchanges and Clearing Limited announced on 10 December 2010 that it had decided to establish a clearing house in Hong Kong for the clearing of OTC derivatives transactions.

Proposing reforms on High Frequency Trading

Regulatory reform is seeing some fresh new turns. On Friday 14^th October regulators from around the world including from the US and Singapore congregated in London to discuss supervision of ultra fast computerized trading such as high frequency trading (HFT). Some regulators have viewed HFT as a potential tool for speculators which can increase risk in the financial markets. The matter of HFT comes into spotlight following the events of May 6 this year, when the Dow Jones blue chip index plunged some 700 points.

Gary Gensler from CFTC observed that some 80 or 85 %of the transactions are either day trading or spread trading – both trades occurring within one day. Gensler’s agency proposes curbing risks by supervising algorithms used in trading. Global regulators seem to welcome the idea of tightening regulations on HFT. The European Union’s executive European Commission in particular plans to publish a draft law by the end of October this year.

Details of the update can be found here in the Reuters update

SFC action this time relating to unlicensed activities

Mark Steward, the current Director of Enforcement at the SFC, has said publicly that he likes to have a case involving unlicensed activities conducted in Hong Kong in front of the courts at all times or as often as possible as they are a common source of concern for the Commission.

Today the SFC announced more fines and this time it related to a scenario where one licensed firm was facilitating unlicensed activities.  The full report is below:

SFC reprimands and fines Solomon Independent Financial Advisors Limited $1.5 million and suspends its responsible officer

The Securities and Futures Commission (SFC) has reprimanded Solomon Independent Financial Advisors Limited (Solomon) and fined it $1,500,000 for facilitating the unlicensed activities of employees of insurance broker Black Swan Capital (International) Limited (Black Swan) (Note 1 and 2).

The SFC has also suspended the approval granted to Ms Connie Leung Wing Kam to act as a responsible officer for Solomon and suspended her licence for seven months from 13 October 2011 to 12 May 2012 (Note 3).

The disciplinary action follows an SFC investigation which found that Solomon entered into an arrangement in which Black Swan referred clients to Solomon in exchange for Black Swan receiving commissions for trades executed by Solomon on behalf of the referred clients.

The Black Swan employees who made the client referrals to Solomon also performed services in regulated activities to the referred clients.

Solomon knew that the arrangement with Black Swan required participants to be properly licensed by the SFC and that none of the Black Swan employees had been granted a SFC license.

As Leung was primarily responsible for devising the arrangement with Black Swan, she bore direct responsibility for Solomon’s conduct.

In deciding the disciplinary actions, the SFC has taken into account all relevant factors, including Solomon and Leung have no previous disciplinary record and there is no evidence to suggest that clients have suffered losses.

The SFC’s Executive Director of Enforcement, Mr Mark Steward, said: “Licensees should ensure that any new staff, who are involved directly or indirectly in regulated activities, must be properly authorised to carry on these activities.”

End

Notes:
1. Solomon is licensed under the Securities and Futures Ordinance (SFO) to carry on Type 4 (advising on securities) and Type 9 (asset management) regulated activities.
2. Black Swan is a member of the Hong Kong Confederation of Insurance Brokers, but is not licensed under the SFO to carry on any regulated activity.
3. Leung is licensed under the SFO to carry on Type 4 (advising on securities) and Type 9 (asset management) regulated activities. Leung is a responsible officer of Solomon.

SFAT takes firm action against personnel involved as sponsors

The SFC website today released the result of a Securities and Futures Appeal Tribunal hearing where two individuals associated with sponsoring an IPO in Hong Kong were banned from the industry for substantial periods of time.  The SFC has been active over recent years in trying to improve the standards of sponsor work undertaken during IPO's and this case adds to the body of material in that area:

11 October 2011

Licensees disciplined for forgery and sponsor failures

The Securities and Futures Commission (SFC) has prohibited Mr Wan Ten Lok (also known as Philip Wan) and Mr Sunny Yan Kwok Ting from re-entering the industry, for six years from 7 October 2011 to 6 October 2017 and four years from 7 October 2011 to 6 October 2015 respectively, following the determination of the Securities and Futures Appeals Tribunal (SFAT) (Notes 1 & 2). Wan, as principal supervisor, and Yan, as his assistant, were accredited to Core Pacific-Yamaichi Capital Limited (CPYC) which was the sponsor for the listing of Tungda Innovative Lighting Holdings Limited (Tungda) on the Growth Enterprise Market (GEM) board in July 2002. Afterwards, CPYC continued to act as Tungda’s continuing sponsor until October 2003 (Note 3). Shortly after Tungda’s listing, the Hong Kong Stock Exchange (the Exchange) issued inquiry letters to CPYC in 2003 seeking a response to a complaint that Tungda had falsified invoices and overstated sales figures in its IPO prospectus. CPYC, as continuing sponsor of Tungda, was required to examine its due diligence work, in particular, the basis for the sales claimed by Tungda in the prospectus so as to give the Exchange a proper response. The SFC alleged that CPYC’s response, contained in three submissions, was prepared under the supervision of Wan and was both misleading and inaccurate giving the unjustified impression that CPYC had conducted sufficient due diligence when in fact the verification conducted by CPYC was severely limited and deficient. Wan on the other hand claimed that he had not been responsible for the due diligence work conducted by CPYC into Tungda and that he had signed the submissions given to the Exchange in a purely administrative capacity. He argued that he was entitled to rely upon the work of others within CPYC; that CPYC had no ongoing obligation to make any inquiry in responding to the Exchange and that CPYC could not have been expected to have detected fraud within Tungda given the auditors had not done so and responsible executives of Tungda were only charged with related criminal offences by the Police’s Commercial Crime Bureau (CCB) in 2010. During the SFC’s investigation Wan, with the assistance of Yan, also produced to the SFC a substantial volume of documents which purported to be CPYC records and, if genuine, would tend to demonstrate that Wan was neither involved nor responsible for CPYC’s due diligence work on Tungda. The SFC alleged these documents were not genuine CPYC records and had been fabricated to throw the SFC off the track. The Chairman of the SFAT, Hon Mr Justice Saunders, agreed with the SFC’s findings and found specifically that: It is untenable for Wan to claim that his signature on the submissions to the Exchange was merely administrative and he was not involved in the due diligence of Tungda; CPYC and Wan was under a continuing obligation to make inquiries in response to the Exchange’s inquiry; The fact that Tungda’s auditor had not uncovered any fraud at Tungda and no criminal charges against Tungda executives were laid until 2010 is irrelevant and does not mean Wan is not responsible for CPYC’s failure to conduct proper inquiries especially in the face of allegations that there had been falsification of sales; To distance himself from CPYC’s due diligence of Tungda, Wan was responsible for undertaking an extensive fabrication exercise with the assistance of Yan (Note 4). The Hon Mr Justice Saunders stated in his decision that “…had Mr Wan carried out a proper inquiry and properly responded to the Exchange, the Exchange would have been informed in July 2003 that Tungda were unable to substantiate the overseas sales they had claimed in their prospectus. From that the Exchange would have been able to take such steps as they considered appropriate in pursuit of the complaint of forgery. Instead Mr Wan muddied the waters and concealed the truth” (Note 5). Mr Mark Steward, the SFC’s Executive Director of Enforcement, said: “During the investigation, the SFC cast a cold eye on Wan’s claims and they turned out to be fabricated. Sponsors have an obligation to cast the same cold eye on claims that do not make sense when conducting due diligence inquiries.” “This decision makes it clear that sponsors have an important role to play in helping to protect the investing public and their obligations must be performed to a very high standard. Sponsors and their senior staff will be held accountable for negligent, cavalier or dishonest conduct,” he added. The SFAT directed the SFC to refer the case to the Director of Public Prosecutions for him to consider whether any further action may need to be taken. End Notes: 1. Wan was licensed under the Securities and Futures Ordinance (SFO) to carry on Type 1 (dealing in securities), Type 4 (advising on securities), Type 6 (advising on corporate finance) and Type 9 (Asset Management) regulated activities and was accredited to CPYC as a responsible officer from March 2000 to 30 August 2004. Wan currently does not hold a licence with the SFC. 2. Yan was licensed under the SFO to carry on business in Type 6 (advising on corporate finance) regulated activity and was accredited to Core Pacific-Yamaichi Capital Limited from October 2000 to October 2004. Yan currently does not hold a licence with the SFC. 3. Tungda was listed on the GEM board on 26 July 2002. The trading in the shares of Tungda has been suspended since 29 July 2004. The SFC previously took enforcement action against CPYC and related companies in relation to the same matter (see SFC press release dated 17 April 2008). On 2 September 2011, the chairman and a director of Tungda received jail sentences in relation to charges laid by the CCB following convictions of conspiracy to defraud in relation to false sales figures which falsely inflated the company’s sales results and turnover by $23 million and $300 million respectively. 4. See SFAT’s Decision (Wan Ten Lok and Yan Kwok Ting Sunny v SFC, Application No 8 and 9 of 2009) published on the SFAT’s website at http://www.sfat.gov.hk/english/determination/AN-8_9-2009-Determination.pdf, para 163, para 172-182, para 192-193, para 194 -204 respectively. 5. See SFAT’s Decision (Wan Ten Lok and Yan Kwok Ting Sunny v SFC, Application No 8 and 9 of 2009, para 197).

Naked Muppet appears on Bloomberg

Simon Lam, an Executive Director of the Hong Kong Securities Professionals Association said on Bloomberg that Hong Kong needed a short selling ban.  When pressed he said he wanted it to be a ban on naked short selling.

Simon, there is one.  Its in the SFO.  Has been for quite a while now.

Not sure what your association does in its spare time but a course or two on the laws of Hong Kong may be useful.

Its is rare that we hear such an ill informed opinion from a resprentative of the local broker community, but Mr Lam you are this week's muppet.

The SFC has commented on rumours that short selling - which by law, Mr Lam, must be covered - has lead to current market volatility in Hong Kong and the following announcement was on their website:

Short selling activities in Hong Kong

There has to date been no indication that recent declines in the Hong Kong stock market have been caused by short selling activities, the Chief Executive Officer of the Securities and Futures Commission (SFC), Mr Ashley Alder said, adding that the SFC will not hesitate to take immediate action to deter any manipulative or abusive short selling practices.

Mr Alder pointed out that stock markets around the world have seen significant downward adjustments and increased volatility in recent months against the background of an uncertain global economic outlook and the Eurozone sovereign debt crisis.

“Short selling is a trading and hedging tool commonly and legitimately used by a range of market participants. It is not unusual to see the level of short selling increase significantly in the market environment we have been experiencing in recent months,” Mr Alder said.

“Extreme volatility has reflected global concerns centred on an evolving financial crisis which started three years ago, and which is now centred on sovereigns and exposed banks, particularly in the Eurozone,” he added.

In relation to the market rally in the last two days, Mr Alder pointed out that markets are currently very sentiment driven. “We can see this from the market rebound following reports of greater political resolve in Europe to address the debt crisis, and news of further market stimulus by the Bank of England and the extension of unlimited liquidity by the European Central Bank to Eurozone banks.”

The SFC will remain vigilant and continue to closely monitor market developments to ensure that market integrity is maintained at all times, he added.

Mr Alder reiterated that Hong Kong has a robust short selling regulatory regime that is more stringent than most overseas markets, and that the SFC will be introducing legislation shortly to implement a short position reporting regime to further enhance the transparency of short selling activities (Note 1).

End

Note:
1. Short selling in Hong Kong is permitted only if it is “covered”, that is, at the time of the sale, the seller must have borrowed the stock or obtained a confirmation from the lender that he has the stock available to lend to the seller. The seller and his broker are required to confirm that the short selling orders were “covered” before executing the transaction, and short selling orders must be flagged when submitting to the Stock Exchange of Hong Kong (SEHK) for execution. Breaches of these statutory requirements may result in criminal prosecution.

In Hong Kong, only liquid stocks are permitted by the SEHK for short selling. In other major markets, short selling is generally allowed for all stocks listed on the respective markets. In addition, the “uptick rule” imposed by the SEHK requires that a short sale cannot be made on the SEHK below the best current ask price. Furthermore, the SEHK requires compulsory buy-in for failed trades if sellers cannot deliver the stocks for settlement.

More fines in Hong Kong, this time its Citi

The SFC announced a fine of HK$6m against Citigroup Global Markets Asia Limited and a suspension of a former RO because of a failure by Citi to report an alleged fraud to the SFC in a timely manner.

The facts as reported by the SFC are below and make interesting reading.

Fines in Hong Kong in 2011 are already greater than all of 2010.

In addition to the fine, Citi will need to pay for additional reports into its processes by consultants.

The announcement was as follows:

SFC reprimands and fines Citigroup Global Markets Asia Limited $6 million and suspends its former responsible officer

The Securities and Futures Commission (SFC) has reprimanded Citigroup Global Markets Asia Limited (Citi Asia), fined it $6 million, and suspended the approval granted to Ms Lisa Chan Sin Man, to act as a responsible officer. Her licence has also been suspended for eight months from 3 October 2011 to 2 June 2012 (Note 1 and 2).

Citi Asia has also agreed to offer to pay compensation to customers affected by a fraudulent scheme operated by a former licensed representative in the amount of any principal lost by such customers.

The disciplinary action follows an investigation into suspected misconduct of a former licensed representative of Citi Asia, Mr X, who was responsible for operating what appears to have been a fraudulent scheme involving 13 Citi Asia wealth management clients who invested through Mr X on the basis their money would be pooled and used to purchase US Treasuries and other products (Note 3 and 4).

Mr X’s scheme operated from 2004 until February 2009 when Citi Asia suspended Mr X while investigating the suspected misconduct. Shortly thereafter, Citi Asia dismissed Mr X for gross misconduct.

However, Citi Asia failed to report Mr X’s activities to the SFC in a timely manner as required by the Code of Conduct (Note 5).

After initially reporting to the SFC that Mr X had been dismissed for gross misconduct, Citi informed the SFC that an internal investigation was in progress, when in fact a preliminary report was already available which revealed important information in relation to Mr X’s apparent fraudulent scheme. Citi Asia did not provide the report to the SFC until after a follow-up investigation by Citi Asia’s external auditor was completed.

By the time these reports were provided to the SFC, Mr X had left Hong Kong. He has not returned since then. While this was not Citi Asia’s intention, the consequence of the delay in reporting details of the fraudulent scheme to the SFC meant the SFC and other law enforcement agencies had no opportunity to interview Mr X or to secure his whereabouts pending the completion of the investigation.

The SFC also found that Mr X was insufficiently supervised by Citi Asia with the result that his fraudulent scheme was undetected despite a number of “red flags” which should have caused those supervising Mr X to instigate inquiries.

At the material time, Chan was the supervisor of Mr X and a responsible officer of Citi Asia. The SFC found that Chan did not act sufficiently on a number of “red flags” brought to her attention which would have detected Mr X’s apparent misconduct much earlier (Note 6).

Citi Asia has agreed that it will pay for an external auditor, to be appointed by the SFC, to audit the accounts of affected customers and assess the amount of compensation required to make them whole. Citi Asia will also pay for an external expert to conduct a review of the internal and external detection, escalation and notification practices and policies in Citi Asia’s private banking division in relation to compliance with all applicable regulatory and legal requirements in its securities business, including:

• the identification and handling of red flags by all staff involved in regulated activities; and
• performance management of all staff engaged in supervision of staff conducting regulated activities, including calculation of compensation in respect to supervisory functions.

Citi Asia will implement all recommendations by the external expert and submit to a surprise audit of all detection, escalation, notification, red flag practices and policies at a time to be selected by the SFC within two years of today’s date.

“Citi Asia not only failed to detect a Ponzi scheme operating under its nose, despite having the opportunity to do so, but then failed to report the scheme to the SFC in a timely way, thus making the investigation of this case more difficult given Mr X’s decision to leave Hong Kong after he had been dismissed by Citi Asia, ” the SFC’s Executive Director of Enforcement, Mr Mark Steward said.

“Intermediaries know they have a duty to report misconduct to the SFC immediately upon discovery, not when they have plumbed the bottom of it. Delay in reporting simply helps the wrongdoer. This public reprimand should make it clear that the SFC condemns such delay in the strongest terms,” Mr Steward added.

End

Notes :
1. Citi Asia is licensed under the Securities and Futures Ordinance (SFO ) to carry on Type 1 (dealing in securities), Type 4 (advising on securities), Type 6 (advising on corporate finance) and Type 7 (providing automated trading services) regulated activities.
2. Chan is licensed under the SFO to carry on Type 1 (Dealing in Securities) and Type 2 (Dealing in Futures Contracts) regulated activities. Chan’s licence was accredited to Citi Asia from 1 December 1998 to 14 June 2011. Chan was also a responsible officer of Citi Asia from 31 May 2005 to 14 June 2011.
3. Mr X was licensed under the SFO to carry on Type 1 (dealing in securities) and Type 2 (dealing in futures contracts) regulated activities and was accredited with Citi Asia until he was dismissed by Citi on 16 February 2009. He was employed by Citi Asia’s private banking division at the time of the conduct in question.
4. It appears Mr X promised the affected customers that their principal was protected and returns were guaranteed. Instead, returns were funded wholly or partly from other affected clients induced by Mr X’s representations. In effect, Mr X appears to have been operating a Ponzi or Madoff-style scheme in which high returns are paid to investors out of the contribution by new investors. Ponzi Scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk.
5. Under paragraph 12.5 of the Code of Conduct, a licensed or registered person is required to notify the SFC immediately on the happening of any material breach, infringement, non-compliance with any rules, law, regulations and codes administered or issued by the SFC by itself or persons it employs to conduct business with clients giving particulars of the breach etc and relevant information and documents.
6. For example, Mr X issued correspondence under Citi Asia’s name referring to guaranteed returns contrary to Citi Asia’s internal guidelines. Some of this correspondence was brought to Chan’s attention but Chan accepted Mr X’s explanations and did not conduct any probative inquiry into the true nature of Mr X’s dealings on behalf of Citi Asia’s clients. The reference to guaranteed returns in Mr X’s correspondence was a very clear red flag. A quick check to verify the existence of the US Treasuries and other products supporting Citi Asia’s clients’ investments should have been conducted.