Alan Ewins discusses the ever growing list of regulatory changes to the financial services industry in Hong Kong, and pieces together the key issues effecting Asian finance centres.
The Hydra, as depicted in Greek mythology, was a monster with many heads and each time one was cut off, two grew in its place. That seems a fitting model for considering financial services regulation in the modern world: a writhing mass of regulatory prohibitions, restrictions and requirements to grapple with at domestic, regional and indeed international levels. As soon as one stream of issues starts to take shape, more appear to challenge the industry.
Hercules slew the Hydra as one of his ‘Twelve Tasks’ in those Greek myths. Certainly, today, it is a Herculean task to identify, monitor and assimilate regulatory changes across the financial services industry generally, and particularly in Asia given the fragmented nature of the regulatory regimes.
Focusing on the Asian private wealth management industry (with particular emphasis on Hong Kong), this article is designed to piece together some key themes to take forward into the Chinese Year of the Snake.
Development of the Industry
Private wealth management is going through an evolutionary phase.
Given the publication of the Code of Conduct on Private Banking in Singapore (which admittedly is more of a wish list for good behaviour than a rigid regime), the long-running saga in Hong Kong of the development of essentially a blueprint for the private wealth industry, and increasing focus on what is seen to be a vibrant and complex area of the financial markets jigsaw, some fundamental issues need to be addressed.
How should private wealth customers be categorised and treated?
What types of products would it be reasonable to sell them?
How far is it permissible to allow the investment banking arms to push their products through their private banking/private wealth arms and affiliates?
Related to this is, of course, the perennial question for new entrants of whether to set up private wealth operations, and if so where, and should growth be organic or by way of acquisition.
There has been arguably less by way of acquisition and consolidation than might have been expected, but the M&A market seems set fair for more intense activity in the coming year.
Private Wealth Customers
Treatment of private wealth customers in Hong Kong should fall squarely within the Securities and Futures Commission's stated intention to revamp the ‘professional investors’ regime. That regime, although relatively straightforward in terms of marketing issues, has somewhat fallen into disrepair in the context of private wealth managers' conduct of business. They typically disregard the supposedly more flexible regime on the face of it available to them, given the painful operational issues that it throws up. Instead, they are more likely to treat such customers as purely ‘retail-equivalent’, which in the practical circumstances of the industry and the more bespoke needs of clients tends to be inappropriate and create friction and frustration for all parties in terms of the delivery of the service.
There have been moves at a practical level to improve the position, but an overhaul is clearly required, covering definitional issues, consistency of treatment of the term across the various relevant pieces of legislation, codes and guidance, and a manifestly joined up approach to an industry, which should be a winning formula for Hong Kong. All of this feeds into the types of products that can appropriately be served up for hungry private wealth clients, by private wealth managers exceedingly keen in the current markets environment to provide sustenance: equities, bonds, structured products and funds, all with their quirks in terms of architecture, sales and distribution, transparency, disclosures and holdings.
Private wealth managers need to ensure that from a housekeeping perspective they are sufficiently integrated with the other elements of their organisation to ensure disclosure of interests in securities held by or on behalf of clients. This needs to be taken into account at a group level in terms of the potential need for aggregation of positions across entities and business units, and the risks of failing to keep track are high - for example, disclosure of interests failings amount to criminal offences in Hong Kong.
Similar considerations are relevant in relation to takeovers regulations; and ownership levels must be appropriately identified, managed and reported across the region; levels of foreign direct investment and investments into sensitive industries, such as telecoms and media, and short selling reporting must be taken into account. In addition, anti-money laundering (AML) and sanctions issues, particularly where clients are sufficiently well-connected to become politically exposed persons (PEPs), are increasingly important - the recent introduction of AML legislation in Hong Kong, usually referred to as AMLO, which was implemented to upgrade AML requirements in line with international standards, needs to be factored in.
Often, private wealth clients are intimately connected with listed corporations, which when they are directors or chief executives can trigger issues when they wish to deal in securities or derivatives in respect of their listed corporation. The dreaded subject of insider dealing and market manipulation cannot be ignored in that regard, and rears its head like a cobra. In short, this barrel of inter-related issues is rather reminiscent of a snake pit, and given the nature of the private wealth industry can prove to be especially poisonous: the cross-border intricacies make it worse, since often competing or different reporting, etc regimes can be relevant.
As a related point, private wealth clients now or will, as for other customers, enjoy the benefit of enhanced fee disclosure requirements in Hong Kong (in terms of structured products and other investment products), Singapore's move towards increased "FAIR" treatment of customers (which will spill over across the industry, given the "good industry practice" message), and in Australia, the abolition of commission-based fees, looked at with keen interest by other regulators.
Confidentiality and Secrecy
In Singapore, data privacy legislation is finally in sight; in Hong Kong, following on from various legislative changes, which came into effect in October in respect of the Personal Data (Privacy) Ordinance, covering amongst other things the responsibilities of data processors, new strict direct marketing restrictions will come into force in the first half of 2013. The changes will limit direct marketing of all types of products, including financial products, and prevent unrestricted sales of customer data by organisations (in the wake of the Octopus case, and other issues that have been in the public eye in recent times). This naturally has implications for private wealth customers. In addition to the introduction of new criminal liability, the reputational and regulatory implications of major breaches and persistent breaches remains an important consideration for businesses, given the level of public dismay over various cases.
Hand in hand with the data privacy changes, it is important for institutions to ensure that they properly comply with their bank secrecy obligations to customers. An area to watch is the impact of Dodd Frank and other derivatives of regulatory reform legislation that impose very wide reporting requirements. Transfers of data across jurisdictions in relation to clients is vital to financial institutions, not only to allow for more precise targeting of products and resources, but also to allow for prompt responses to regulators' queries and reporting issues in a world where the regulators are increasingly connected. That type of cross-border transfer is often more troublesome than might first be thought, as a result of data protection, bank secrecy and related restrictions.
Much has been said and written about FATCA, but clearly preparation for FATCA is key. Various measures, including documentation modifications, can be put in place to improve the position of affected parties (‘foreign financial institutions’) to take advantage of the grandfathering regime before the full regime comes online in 2017. This potentially applies to fund documents, loan documentation and financial products, as well as potentially a raft of other documentation, all of which are relevant for private wealth clients.
Overall, the primary themes appear to be overall industry structure going forward, the way in which private wealth clients should be viewed and dealt with by private wealth managers, and how transparency in the markets should be catered for in the context of private wealth clients (balanced with privacy issues).
All in all, a twisting and turning path for the Year of the Snake, requiring a continuing battle with the fearsome ‘Regulatory Hydra’, before moving on no doubt to a wild regulatory bare-back ride in the following Year of the Horse.
Alan Ewins, a partner in Allen & Overy, experience includes advising numerous financial institutions on a wide range of product, risk management and compliance issues, on the regulatory aspects of sales and purchases of companies and businesses, and on establishing and offering interests in collective investment schemes. Alan also works closely with Allen & Overy's regulatory disputes and derivatives teams, particularly in Hong Kong, in the financial services area.