financial services risk and regulation...december 2017 basel iii post-crisis regulatory reforms and...

Financial Services Risk and Regulation

Regulatory updates newsletterFebruary 2019

PwC · 2Regulatory Updates Newsletter — February 2019

Contents

Executive Summary 3

Updated framework for Pillar 3 disclosure requirements 4

SFC authorisation of Leveraged and Inverse Products 5

SFC concludes consultation on OTC derivatives and conduct risks 6

SFC review of internal controls and supervision of account executives 7

Guidance on misconduct risks in selling of investment funds 8

Fair Valuation of Fund Assets considerations 9

Mutual Recognition of Funds with Luxembourg 10

Supervision for Bank Culture 11

Revised Guideline on Enterprise Risk Management 12

Other Regulatory Updates 13-15

Glossary 16

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary

Executive Summary

Emily LamPartner+852 2289 1247PwC HK FS Risk and Regulation

“The beginning of 2019 and the close of 2018 saw numerous regulatory developments in Hong Kong. With this newsletter, we will continue to keep you up to speed with significant regulatory developments across the financial services industry.”

2019 has begun with a strong momentum for financial services regulations in Hong Kong with all supervisory regulators continuing their focus on building resilience.

In this month’s edition, we report on developments from the end of 2018 and beginning of 2019.

• The BCBS published updated Pillar 3 disclosure requirements, which, together with the updates published in January 2015 and March 2017, completes the Pillar 3 framework. The implementation deadline for the disclosure requirements related to Basel III is 1 January 2022.

• The SFC issued the circular under which it would consider authorisingleveraged and inverse products (“LIP”)structured as exchange traded funds (ETFs) for public offering in Hong Kong under sections 104 and 105 of the SFO.

• On 12 December 2018, the SFC issued consultation conclusions on proposals to enhance the over-the-counter (OTC) derivatives regime and to address perceived conduct risks posed by dealings with group affiliates and other connected persons. The risk

mitigation requirements will become effective on 1 September 2019.

• The SFC reported their findings from a high-level review of control measures for protecting client assets and a thematic review of brokers’ internal controls, including their supervision of account executives (AEs).

• The HKMA issued a circular to draw attention to misconduct risks in the selling of investment funds, and to provide guidance on prevention and management of such misconduct risks.

• The SFC issued a circular providing guidance to management companies of SFC-authorised funds on the valuation policies and procedures of SFC-authorised funds, particularly where the market value of a fund asset is unavailable or unreliable or becomes illiquid or hard-to-value as a result of significant market events.

• Moreover, the SFC and the Commission de Surveillance du Secteur Financier (CSSF) signed a Memorandum of Understanding concerning Mutual Recognition of Covered Funds and Covered Management Companies and related cooperation.

• The HKMA announced supervisory measures for bank culture in December 2018, following consultation with the industry.

• And finally, the IA issued the revised draft Guideline on Enterprise Risk Management for further consultation in January 2019.

For further details on these developments and other updates such as the SFC circular to intermediaries on distribution of complex and high-risk products, ‘cyber-resilience: range of practices’ report by the BCBS, please refer to the following sections in this publication.

Wish you all Happy Chinese New Year of the Pig!

Emily LamFS Risk and Regulation+852 2289 [email protected]

Regulatory Updates Newsletter — February 2019 PwC · 3

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary

PwC · 4

Updated framework for Pillar 3 disclosure requirements

Pillar 3 of the Basel framework seeks to promote market discipline through regulatory disclosure requirements

The BCBS has published updated Pillar 3 disclosure requirements. These requirements, together with the updates published in January 2015 and March 2017, complete the Pillar 3 framework.

The revised Pillar 3 framework reflects the Committee's December 2017 Basel III post-crisis regulatory reforms and pertains to the following areas:

• credit risk, operational risk, the leverage ratio and credit valuation adjustment (CVA) risk;

• risk-weighted assets (RWAs) as calculated by the bank's internal models and according to the standardisedapproaches; and

• an overview of risk management, RWAs and key prudential metrics.

In addition, the framework sets out new disclosure requirements on asset encumbrance and, when required by national supervisors at the jurisdictional level, on capital distribution constraints.

The implementation deadline for the disclosure requirements related to Basel III is 1 January 2022, which accords with the implementation of the Pillar 1 (minimum capital requirements) framework.

The implementation deadline for the disclosure requirements for asset encumbrance, capital distribution constraints and the prudential treatment of problem assets has been extended by one year to end-2020, taking account of feedback received from the recent consultation.

The HKMA plans to consult the industry in due course on the relevant implementation proposals to give effect to the disclosure requirements of the Pillar 3 disclosure requirements – updated framework.

Brian YiuPartner+852 2289 [email protected]

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary

Regulatory Updates Newsletter — February 2019

PwC · 5

SFC authorisation of Leveraged and Inverse Products

This is the first time that leveraged and inverse products may seek authorisation from the SFC for public offering

This SFC circular, issued on 17 December 2018, sets out the requirements under which the SFC would consider authorisingleveraged and inverse products (LIP) structured as exchange traded funds (ETFs) for public offering in Hong Kong under sections 104 and 105 of the SFO.

In view of their novelty and the technical complexity, to protect the interests of the investing public of Hong Kong and to maintain the integrity of the Hong Kong market, L&I Products that are seeking SFC authorization for public offering in Hong Kong should meet the additional requirements set out in this circular.

The key requirements are:

Product naming

• In view of the day trading nature of LIPs as opposed to the investment nature of conventional ETFs, LIPs that have been authorised by the SFC should not be named “ETFs”. Instead,

these products must be named “Leveraged Products” or “Inverse Products”, as the case may be

Product Structure

• L&I Products to track indices with constituent securities which are sufficiently liquid and broadly based. Given the novelty of these products in the Hong Kong market and their technical complexities:

a) at this stage, the SFC will only accept applications for L&I Products tracking (i) liquid and broadly based Hong Kong and non-Mainland foreign equity indices, (ii) on a case by case basis, non-equity indices.

b) the SFC will continue to keep in view the eligible indices of LIPs but, at this stage, the SFC has no plan to accept applications for LIPs tracking Mainland indices.

Offering documents disclosure

• The offering documents of LIP Products shall contain upfront disclosure of the following in the product key facts:

a) A warning against holding LIP for longer than the rebalancing interval, typically one day;

b) LIPs are designed as a trading tool for short-term market timing or hedging purposes, and are not intended for long term investment;

c) LIPs are only suitable for sophisticated trading-oriented investors who constantly monitor the performance of their holdings on a daily basis; and

d) The performance of LIPs, when held overnight, may deviate from the underlying indices.

Performance simulator

• The provider of an LIP is required to make available a “performance simulator”, which allows investors to select a historical time period and simulate the performance of the LIP during that period.

• The designated section for L&I Products on the HKEX website will contain hyperlinks to the performance simulator of each L&I Product authorised by the SFC.

Distribution

• As LIPs are derivatives products, intermediaries are subject to the applicable requirements under the Code of Conduct when they provide services to clients with respect to LIPs.

Carlyon Knight-EvansPartner+852 2289 [email protected]

Helen LiPartner+852 2289 [email protected]

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


PwC · 6

SFC concludes consultation on OTC derivatives and conduct risks

Michael FootmanPartner+852 2289 2747 [email protected]

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary

Risk mitigation requirements will become effective on 1 September 2019

On 12 December 2018, the SFC issued consultation conclusions on proposals to enhance the over-the-counter (OTC) derivatives regime and to address percieved conduct risks posed by dealings with group affiliates and other connected persons.

The paper only covers the proposed requirements under the SFC's main code of conduct. Conclusions on legislative amendments with respect to the new types 11 and 12 regulated activities will be published separately.

Key highlights of the amendments to the risk mitigation requirements in relation to non-centrally cleared OTC derivative transactions are:

• Trading relationship documentation: LCs should execute written trading relationship documentation (including credit support arrangements where applicable) with its counterparties prior to, or contemporaneously with, executing a non-centrally cleared OTC

derivative transaction.

• Trade confirmation: LCs may use one-way confirmation instead of two-way confirmations if both parties have agreed in advance to confirm trades using this process, such that the outcome is legally binding on both parties.

• Valuation: LCs with material exposures to non-centrally cleared OTC derivative transactions should perform periodic reviews of the agreed-upon valuation process to take into account any changes in market conditions.

• Portfolio reconciliation: Frequency of portfolio reconciliation with each counterparty should be commensurate with the risk exposure profile of the counterparty.

• Portfolio compression: LCs should, in respect of non-centrally cleared OTC derivative portfolios, establish and implement policies and procedures to regularly assess and engage in portfolio compression. It should be proportionate to the level of exposure or activity of the LC.

• Dispute resolution: LCs should agree in writing with its counterparties, other than counterparties who are individuals, the mechanism or process for determining when discrepancies in trade populations, material terms, valuations and margins should be considered disputes. This should also include how such disputes should be resolved as soon as practicable.

In terms of proposed conduct requirements to address risks posed by group affiliates and other connected persons, the SFC believes that client interests would be better protected with the Regulated client facing affiliates (CFA) Requirement in place. Moreover, to help market participants prepare for compliance with the proposed conduct requirements, the SFC have provided a list of deemed comparable overseasjurisdictions in the paper.

To allow the industry reasonable time to implement the necessary operational and system changes to comply with the requirements, the risk mitigation requirements will become effective on 1 September 2019.


PwC · 7

SFC review of internal controls and supervision of account executives

Thematic review across 35 brokerage groups was completed by the SFC

The SFC conducted a high-level review of control measures for protecting client assets and a thematic review of brokers’ internal controls, including their supervision of account executives (AEs).

The review focused on five areas: staff-related corporate policies, the handling of client accounts, monitoring of dealing activities, safeguarding of client assets and the handling of trade documents.

The key regulatory concerns identified in the reviews are:

• Misaligned incentives in remuneration systems

• Insufficient segregation of duties

• Inadequate controls to protect client accounts

• Insufficient compliance checks of client accounts

Some examples of internal control

policies and procedures which LCs should implement and enforce to protect their operations and clients from financial loss arising from theft, fraud and other dishonest acts, professional misconduct or omissions are:

• Implement a remuneration system for AEs which takes into account both sales and non-sales-related factors to encourage a good compliance culture and client experience.

• Enforce the physical and functional segregation of incompatible duties. In particular, AEs should not be allowed to handle client assets or have access to client databases as well as blank and printed trade documents.

• Establish and enforce written policies and procedures for key operational areas, communicate them to staff, monitor staff’s adherence and keep them updated to reflect changes in risks, operations or other circumstances.

• Ensure that compliance checks, including reviews of telephone records and confirmation exercises

for client account activities and balances, sufficiently cover client accounts and AEs. Independent staff should follow up on any discrepancies identified in compliance checks.

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary



PwC · 8

Guidance on misconduct risks in selling of investment funds

RIs should ensure any recommendation for fund subscriptions, redemptions and switching is suitable and in the best interest of the customer

The HKMA issued a circular to draw attention to misconduct risks in selling of investment funds, and to provide guidance on expected standards for prevention and management of such misconduct risks.

Frequent subscriptions, redemptions and switching of funds may incur substantial commissions and/or other fees and charges, which may significantly undermine the customers’ investment returns.

Registered Institutions (RIs) should ensure any solicitation or recommendation for fund subscriptions, redemptions and switching is suitable and in the best interest of the customer.

The HKMA also detailed the following expected standards for RIs:

• Management supervision: Senior management should assume full responsibility in ensuring that appropriate policies and procedures as well as systems and controls are in place, and that they work effectively to guard against any potential investment fund churning.

• Monitoring and review: Carry out independent monitoring and review, and ensure that their monitoring and review mechanisms (including the scope and methodology) are effective for the purpose of identifying suspicious trading pattern of investment funds and potential investment fund churning activities.

• Incentive systems: Ensure that any sales targets are realistic, especially amidst the challenging business environment, and that sales targets on specific investment products should be avoided.

• Feedback mechanism: An effective feedback mechanism, including

whistleblowing and escalation policy, should be in place to encourage timely reporting of any misconduct or malpractice identified by staff.

• Staff training: Provide adequate and appropriate training to relevant staff, including front line and control functions, to ensure that they have adequate understanding of regulatory requirements and ethical standards concerning investment fund churning.


Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


PwC · 9

Fair valuation of fund assets considerations

New guidance applicable to valuation of all types of assets of a fund including equities, fixed income and other investments

This circular provides guidance to management companies of SFC-authorised funds (the Managers) on the valuation policies and procedures of SFC-authorised funds (the funds), particularly where the market value of a fund asset is unavailable or unreliable or becomes illiquid or hard-to-value as a result of significant market events.

The key highlights for fair valuation of assets are:

• Assets of a fund should be valued according to current market prices provided that those prices are available, reliable and frequently updated based on transactions in an active market.

• Where the market value of an asset is unavailable or where the Manager reasonably believes that no reliable

price exists or the most recent price available does not reflect a price the fund would expect to receive upon the current sale of the asset, the Manager should value the asset at a price which reflects a fair and reasonable price for that asset in the prevailing circumstances (the fair value price / fair value adjustment).

• The Manager should establish comprehensive policies and procedures in relation to the use of the fair value price for valuing assets of a fund.

• The process and conduct of fair value adjustment (including any decision to use or not to use fair value price) should be done by the Manager with due care, skill and diligence and in good faith, in consultation with the trustee or custodian of the fund.

• The valuation method, the implementation plan and underlying rationale should be clearly documented and subject to appropriate review and approval by a pricing committee or senior management of the Manager. This is

to ensure that any conflicts of interest are appropriately identified and mitigated.

• Senior management of the Manager of a fund should constantly review the fair value adjustment policies and procedures to ensure their continued appropriateness and effective implementation, particularly where there are material changes in circumstances and market conditions which may affect the fund or its investments.



Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


PwC · 10

Mutual Recognition of Funds (MRF) with Luxembourg

The MoU was signed on 15 January 2019

The SFC and the Commission de Surveillance du Secteur Financier (CSSF) signed a Memorandum of Understanding concerning Mutual Recognition of Covered Funds and Covered Management Companies and related cooperation (Memorandum).

The key requirements applicable to all Luxembourg Covered Funds are:

• Must appoint a firm in Hong Kong as its representative in compliance with the Code on Unit Trusts and Mutual Funds (UT Code).

• Remain authorised by the CSSF for offering to the public in Luxembourg on an ongoing basis.

• Changes to a Luxembourg Covered Fund must be made in accordance with the applicable Luxembourg and Hong Kong laws and regulations and the provisions of its constitutive documents.

• The disclosure of information

relating to a Luxembourg Covered Fund must be complete, accurate, fair, clear, and effective. It must be capable of being easily understood by investors.

• The offering documents and notices to Hong Kong investors of a Luxembourg Covered Fund must be provided in English and Chinese.

Other key requirements are:

• In the event of a breach of Luxembourg domestic laws or the requirements set out or referred to in this circular, which is notifiable to the CSSF and which could affect Hong Kong investors in a Luxembourg Covered Fund, the Luxembourg Covered Management Company must endeavour to notify the CSSF and the SFC at the same time and rectify the breach promptly.

• Following SFC authorisation of a Luxembourg Covered Fund, if its Luxembourg Covered Management Company no longer wishes to maintain the authorisation of the

fund, it should apply for withdrawal of authorisation of the fund from the SFC and provide notice to Hong Kong investors of its intention not to maintain such authorisation in accordance with the relevant Hong Kong laws and regulations.

• The sale and distribution of a Luxembourg Covered Fund in Hong Kong must be conducted by intermediaries properly licensed by or registered with the SFC.



Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


PwC · 11

Supervision for Bank Culture


Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


The HKMA would first commence the self-assessment exercise

In March 2017, the HKMA issued the Bank Culture Reform circular with the aim of fostering sound culture at AIs, with a focus on governance, incentive systems and the assessment and feedback mechanism.

With a view to gauging the progress of bank culture reform and providing further guidance to the industry where necessary, the HKMA announced that they would implement the following supervisory measures:

• Requiring AIs to conduct self-assessment: AIs will be required to review and report their governance arrangements as well as policies and procedures in relation to corporate culture and implementation of the enhancement measures in fostering a sound bank culture with respect to the circular last year. The HKMA has designed a template to assist AIs in conducting this self-assessment.

• Conducting focus reviews: The HKMA will, through site visits and/or off-site reviews, assess and benchmark AIs’ practices with respect to key areas of bank culture.

• Undertaking culture dialogues: The HKMA will meet with senior management and/or board members of AIs responsible for bank culture to gather insights and lessons learnt.

The HKMA expects AIs, when conducting their self-assessment, to also make reference to the findings of major conduct or other serious misbehaviourincidents outside Hong Kong as they review and assess whether there are any potential similar issues that may apply to the AI, benchmark their culture and behavioural standards against community standards and expectations, and report the findings to their boards as appropriate.

Recent examples include the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in Australia and the Prudential Inquiry into the Commonwealth Bank of Australia by the

Australian Prudential Regulation Authority.

In terms of implementation timeline, the HKMA considers it appropriate to implement the self-assessment by phases. The first phase will cover about 30 AIs including all major retail banks and selected foreign bank branches with substantial operations in Hong Kong.

These self assessments should be completed under the guidance of the AI’s board and should be signed off by an independent non-executive director that chairs the board-level committee responsible for culture related matters as well as the Chief Executive.

PwC · 12

Revised Guideline on Enterprise Risk Management

The revised draft Guideline is proposed to be effective on 1 January 2020

Following a consultation on the draft Guideline on Enterprise Risk Management (“Guideline”) in May 2018, the IA has issued the revised draft Guideline for further consultation in January 2019.

The key highlights of the revised draft Guideline are:

• The principle-based approach has been further elaborated. An insurer may adopt other appropriate ways to comply with the requirements of the Guideline rather than follow the same Enterprise Risk Management (“ERM”) processes and procedures as set out in the Guideline.

• Three-tier Group-wide Supervisory Approach. Given the IA will develop a holistic Group-wide Supervisory framework for insurance groups in Hong Kong and detailed proposals would be consulted later in

2019, this Guideline has been revised to focus, in relation to group risk, on requirements at the solo level.

• With emphases on insurers’ own processes on risk quantification and risk management techniques, the revised draft Guideline replaced “internal economic capital” with “Pillar 2 Capital amount”.

• Applicable insurers are required to prepare and submit an ORSA Report to the IA. The ORSA Report should cover the entire company and must include specifics to cover Hong Kong operations.

• The Guideline allows more flexibility for Hong Kong branches to leverage its head office or company ORSA for submission to the IA of the ORSA Report in relation to Hong Kong operations, provided that the part of the company ORSA Report in relation to Hong Kong operations must meet the minimum requirements of the Guideline.

• Prescribed scenarios in Stress and Scenario Testing (“SST”) in ORSA. For SST, insurers carrying on

long term insurance business should perform scenarios as provided in the Actuarial Guidance Note 7 (“AGN7”) on Dynamic Solvency Testing issued by the Actuarial Society of Hong Kong as prescribed scenarios and include the results in the ORSA Report.

• Insurers should apply the whole set of calculation methodology in the most recent Quantitative Impact Study as benchmark for their “regulatory capital requirements” in their ORSA Report during the Initial period.

• Relief measures in early years of implementation of the Guideline. During the Initial Period, an insurer may a) submit its ORSA Report using a valuation date other than its financial year-end date, but in no event more than three months earlier than the financial year-end date; (b) submit its ORSA Report within six of the valuation date.

Billy WongPartner+852 2289 [email protected]

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


Other Regulatory Updates

PwC · 13

Circular to Management Companies of SFC-authorised Exchange Traded Funds (“ETFs”)

The SFC provided a list of Potential Events Triggering Ongoing Disclosure.

To assist management companies of ETFs to comply with the disclosure obligations under the UT Code and Listing Agreement and without prejudice to the notification obligation under 11.1A of the UT Code, the following are non-exhaustive examples of events that may trigger the above on-going disclosure requirements where any of them would have a material impact on an ETF:

• Changes falling within 11.1 or 11.1B of the UT Code;

• Filing of winding up petitions, the issuing of winding up orders or the appointment of receivers or provisional liquidators, or the institution of disciplinary proceedings in respect of its licence or registration to conduct any regulated activity, or proceedings analogous to the above, against any of the trustee, custodian, or management company;

• Replacement of the underlying index or indices, or changes of the index calculation methodology;

• Litigation brought against the ETF or any of the trustee, custodian, or management company;

• Where the ETF adopts a synthetic replication strategy;

• the cessation of market making activity (including the resignation of the last market maker) for units (traded in any counter) of the ETF;

• Suspension of creation and / or redemption of units in the ETF;

• Changes in tax or regulatory requirements that may impact upon the net asset value of the ETF; or

• Material breaches of the constitutional documents of the ETF.

Circular to intermediaries on distribution of complex and high-risk products

The SFC reminds intermediaries to observe the requirements governing selling practices, including the suitability obligations under the Code of Conduct, when they distribute structured products and corporate bonds with complex features or high risks. The SFC noted from its recent survey that sales volumes of these products by licensed corporations have increased.

When distributing complex products, intermediaries should:

• Conduct product due diligence taking into account, amongst other factors, their features7, risks and any restrictions on their sale or target customers, and in what aspects they are considered suitable for clients;

• ensure that the products’ risk-return profiles match the client’s financial situation, investment objectives,

investment experience, risk tolerance and other specific circumstances;

• provide clients with sufficient and accurate information about the products, including their features and risks, and always present balanced views and not focus solely on the products’ advantages; and

• provide staff with adequate training on the products they distribute and how to appropriately disclose the products’ features and risks to clients.

Revisions to leverage ratio disclosure requirements

This consultative document seeks comments on revisions to leverage ratio Pillar 3 disclosure requirements to include, in addition to current requirements, mandatory disclosure of the leverage ratio exposure measure amounts of securities financing transactions, derivatives replacement cost and central bank reserves as calculated using daily averages over the reporting quarter.

The Basel III leverage ratio standard comprises a 3% minimum level that banks must meet at all times, a buffer for global systemically-important banks and a set of public disclosure requirements. For the purpose of disclosure requirements, banks must report the leverage ratio on a quarter-end basis or, subject to approval by national supervisors, report a measure based on averaging (eg using an average of exposure amounts based on daily or month-end values).

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary



PwC · 14

Minimum capital requirements for market risk

The standard has been revised to address issues that the BC identified in the course of monitoring the implementation and impact of the framework. This final standard incorporates changes that were proposed in a March 2018 consultative document and has been informed by a quantitative impact based on data as of end-December 2017.

Revisions to the January 2016 framework include the following key changes:

• a simplified standardised approach for use by banks that have small or non-complex trading portfolios;

• clarifications on the scope of exposures that are subject to market risk capital requirements;

• refined standardised approach treatments of foreign exchange risk and index instruments;

• revised standardised approach risk weights applicable to general interest rate risk, foreign exchange and certain exposures subject to credit spread risk;

• revisions to the assessment process to determine whether a bank's internal risk management models appropriately reflect the risks of individual trading desks; and

• revisions to the requirements for identification of risk factors that are eligible for internal modelling.

This revised standard comes into effect on 1 January 2022.

Cyber-resilience: range of practices

The BCBS published the report identifying and comparing the observed bank, regulatory and supervisory cyber-resilience practices across jurisdictions. Key findings include:

• Despite convergence in high level expectations, the technical specifications and supervisory practices differ across jurisdictions.

• Regulators generally do not require a specific cyber strategy, however institutions are expected to ensure that systems are "secure-by-design" and that emphasis is placed on resilience in light of current threats rather than compliance to a standard.

• In most jurisdictions broader IT and operational risk management practices are more mature and are used to address cyber risk and supervise cyber resilience.

• Models such as "three lines of defence" are widely adopted, but cyber resilience is not always clearly articulated across the technical, business and strategic lines, which hampers their effectiveness.

• Skills shortage leads to recruitment challenges. A few jurisdictions have implemented or leveraged specific cyber certifications to address this.

• Protection and detection testing is evolving and

prevalent; response and recovery less so.

• Although an incident management framework is not required, incident response plans are.

• Although some forward-looking indicators of cyber resilience are being picked up through the most widespread supervisory practices, no standard set of metrics has emerged yet.

• The content and use of information collected or shared by banks and supervisors varies across jurisdictions.

• Regulatory frameworks for outsourcing activities across jurisdictions are quite established and share substantial commonalities.

Joint consultation on the model for an uncertificated securities market

The SFC, Hong Kong Exchanges and Clearing Limited (HKEX) and the Federation of Share Registrars Limited (FSR) today jointly issued a consultation paper proposing a revised operational model for implementing an uncertificated securities market in Hong Kong.

The proposed model strikes a balance between preserving existing efficiencies in the clearing and settlement process and providing options for investors to hold securities in uncertificated form. Implementation would be conducted in phases.

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary



PwC · 15

Interest Rate Risk in the Banking Book (IRRBB): Local Implementation

The HKMA issued a revised version of the Supervisory Policy Manual (SPM) IR-1 with an updated title “Interest Rate Risk in the Banking Book” better reflecting its nature, a new return “MA(BS)12A –Interest Rate Risk in the Banking Book” (IRRBB return), and a revised return “MA(BS)12B – Interest Rate Risk in the Banking Book (Supplementary Information)” that will replace the existing MA(BS)12(i) return.

As specified in the HKMA circular to all AIs dated 31 August 2018, AIs incorporated outside Hong Kong are generally exempt from the local IRRBB framework in cases where the parent group of the AIs is not additionally represented in Hong Kong through any locally incorporated AI.

The exempted AIs should continue to report their interest rate risk exposures through the existing return of “MA(BS)12 – Interest Rate Risk Exposures”.

ESMA consultations on integrating sustainability risks and factors in MiFID II, AIFMD and the UCITS Directive

The European Securities and Markets Authority (“ESMA”) launched on 19 December 2018 three public consultations to seek input on:

• its draft technical advice for the integration of sustainability risks and factors into:

• the Markets in Financial Instruments Directive II (“MiFID II”) as regards securities trading, and

• the Alternative Investment Fund Managers Directive (“AIFMD”) and the Undertakings in Collective Investment in Transferable Securities (“UCITS”) Directive as regards investment funds

• credit rating agency (“CRA”) guidelines aimed at improving the quality and consistency of disclosures of environmental, social and governance (“ESG”) factors when considered as part of a credit rating action.

Update on the Processing of Virtual Banking Applications

The HKMA has announced that about one-third of the 30 virtual banking applicants did not submit sufficient information on certain critical aspects of authorisationcriteria. Therefore, the HKMA has informed these applicants that their applications will not be further processed.

The HKMA will shortlist about one-third from the remaining applications for the next stage of assessment which will involve evaluation of their business models, technology platforms and financial capability, etc.

The HKMA aims to start granting virtual banking licence(s) in the first quarter of 2019.

Circular to licensed corporations -Revised financial return

The Securities and Futures (Financial Resources) (Amendment) Rules 2018 were enacted on 12 December 2018. Some amendments which relate to the exclusion of certain lease liabilities from licensed corporations’ (LCs) liquid capital calculations came into operation on 1 January 2019.

The first return for which LCs will be required to report their liquid capital calculations in accordance with these amendments is for the position ended 31 January 2019.

Form 2 of the financial return is revised to enable LCs to report excluded lease liabilities.

The SFC published a Gazette notice to specify the electronic form of the revised financial return. With effect from 1 February 2019, this form supersedes all previous versions and shall be used for a return required to be submitted under section 56 of the Securities and Futures (Financial Resources) Rules.

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


Glossary

AI Authorised Institutions ICO Initial Coin Offering

AML Anti-Money Laundering IFRS International Financial Reporting Standard

BC Basel Committee IOSCO International Organization of Securities Commission

BCBS Basel Committee on Banking Supervision IR-1 Interest Rate Risk Management

CFT Counter-Financing of Terrorism IRR Interest Rate Risk

CG-1 Corporate Governance of Locally Incorporated Authorized Institutions IRRBB Interest Rate Risk in the Banking Book

FinTech Financial Technology LC Licensed Corporation

FMCC Fund Manager Code of Conduct MAS Monetary Authority of Singapore

FI Financial Institutions MoU Memorandum of Understanding

FSB Financial Stability Board RO Responsible Officer

HKMA The Hong Kong Monetary Authority RE-1 Recovery Planning

IA The Insurance Authority SFC The Securities and Futures Commission

IAF Internal Audit Function SFO Securities and Futures Ordinance

IC-1 Risk Management Framework SPM Supervisory Policy Manual

IC-2 Internal Audit Function

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PwC · 16

Executive

Summary

Updated

framework for

Pillar 3

disclosure

requirements

SFC

authorisation of

Leveraged and

Inverse

Products

SFC concludes

consultation on

OTC

derivatives and

conduct risks

SFC review of

internal controls

and supervision

of account

executives

Guidance on

misconduct

risks in selling

of investment

funds

Fair Valuation

of Fund Assets

considerations

Mutual

Recognition of

Funds with

Luxembourg

Supervision for

Bank Culture

Revised

Guideline on

Enterprise Risk

Management

Other

Regulatory

Updates

Glossary


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