HKSI Paper 4 (Regulation of Credit Rating Services) English Free Trial

the GAML requires senior management to exercise oversight of anti-money laundering concerns including the following:
(a) that the systems of the licensed corporation are capable of addressing identified money laundering risks;
(b) that a director or a senior manager should be appointed as a compliance officer responsible for the establishment and maintenance of anti-money laundering systems; and
(c) that a senior member of staff should be appointed as the money laundering reporting officer

Once a person is licensed by or registered with the SFC, s. 135, Securities and Futures Ordinance (“SFO”) requires certain events to be reported by that person to the SFC, including the following cases:
(a) notice of intention to cease conducting the regulated activity should be given in writing as soon as reasonably practicable and in any event not later than seven business days prior to the intended cessation date;
(b) at least seven business days’ advance notice in writing should be given of an intended change of business address;
(c) notice in writing of any changes to information supplied to the SFC in the prescribed circumstances should be given within seven business days of the change (this will include changes concerning a licensed corporation or registered institution including its representatives, responsible officers or executive officers and substantial shareholders (refer to Schedule 3, Securities and Futures (Licensing and Registration) (Information)
Rules (“Information Rules”) for details); and
(d) notice that a person has become or ceased to be a director of the licensed corporation should be given in writing no later than seven business days thereafter, with the name, address and position of the person.

The auditor’s report should, according to the Accounts and Audit Rules, contain a statement as to whether in the auditor’s opinion:
(a) the profit and loss account and the balance sheet are in accordance with the records kept by the licensed corporation under the Keeping of Records Rules and satisfy the requirements of those rules;
(b) the balance sheet and the profit and loss account give a true and fair view of the state of affairs of the licensed corporation at the financial year-end, and of its profit or loss for the financial year, respectively;
(c) the returns specified in section 4.10 above have each been compiled correctly from the records of the licensed corporation and, if not, the nature and extent of the incorrectness; and
(d) there appears to have been any contravention of the FRR by the licensed corporation during the financial year.

3.21 The CRA Code expressly prohibits a CRA from providing the following consultancy or advisory services to entities that it rates or to that entity’s related parties, presumably as such activities give rise to obvious and unavoidable potential conflicts of interest:
(a) regarding the corporate or legal structure of that rated entity or related party;
(b) regarding the assets or liabilities of that rated entity or related party; or
(c) regarding the activities of that rated entity or related party.

The following disclosures are required for credit ratings assigned to specific rating targets:
(a) the key elements underlying the rating – this applies to a new rating as well as to its revision, and should be explained in its press releases and reports;
(b) the attributes and limitations of the credit rating;
(c) the limits to which the CRA has verified information provided to it by the rated entity;
(d) the extent to which the CRA has examined the quality of information used in the rating process and whether it is satisfied with the quality of such information;
(e) a clear indication of when it was last updated;
(f) a clear and prominent statement identifying the name and job title of the lead rating analyst responsible for the rating;
(g) a clear and prominent statement identifying the name and the position of the person primarily responsible for approving the rating;
(h) the principal methodology or methodology version that was used in determining the rating and where a description of that methodology can be found
(i) the time horizon used when making a rating decision;
(j) whether or not the rated entity (or any related party of that rated entity) participated in the credit rating process;
(k) if the rating is an unsolicited rating, whether the CRA had access to the accounts and other relevant internal documents of the rated entity or its related party;
(l) financial statement adjustments that deviate materially from those contained in the rating target’s published financial statements, if any;
(m) all material sources used to prepare the credit rating are identified (this would include the rated entity and, where appropriate, any related party of the rated entity);
(n) whether the credit rating has been disclosed to the rated entity or to its related party and, if so, whether the credit rating was amended before it was publicly issued;
(o) if it is a rating of a debt security or a preferred security, whether the security is newly issued and whether the CRA is rating the debt security or a preferred security for the first time; and
(p) such other information as is required to enable a clear understanding of the assigned rating.

Criminal sanctions imposed by the courts (s. 303, SFO)
The criminal sanctions prescribed by the SFO are:
(a) ten years’ imprisonment and HK$10 million on conviction on indictment; or
(b) three years’ imprisonment and HK$1 million on summary conviction.

The following indicates some typical conflict and independence problem areas concerning a CRA’s representatives that CRAs must be careful to avoid and/or manage in a compliant manner:
(a) representatives who own securities or derivatives of the rated entity;
(b) representatives dealing in the securities of an entity they rate;
(c) representatives participating in fee negotiations with an entity they rate; and
(d) representatives being remunerated according to fees generated from a rating target.

Enforcement Division: monitors trading in the markets for irregularities and possible market misconduct; undertakes inquiries into alleged breaches of the SFO and codes; inspects listed companies suspected of impropriety; and enforces laws covering the securities and futures industry, including those relating to collective investment schemes and disclosures of interest in listed companies.

The CRA should have written internal procedures and mechanisms to:
(a) identify; and
(b) eliminate, or manage and disclose, as appropriate, any actual or potential conflicts of interest that may influence either:

(i) the ratings the CRA makes; or
(ii) the judgement and analyses of the representatives who are involved in the preparation of ratings.

“Providing credit rating services” is defined as preparing credit ratings for:
(a) “dissemination to the public, whether in Hong Kong or elsewhere, or with a reasonable expectation that they will be so disseminated; or
(b) distribution by subscription, whether in Hong Kong or elsewhere, or with a reasonable expectation that they will be so distributed.”

The Code of Conduct provides more general conduct requirements applicable to CRAs. The Code of Conduct is sometimes referred to as the “Mother Code” as it applies to all persons licensed by or registered with the SFC.

A CRA should establish a rigorous and formal review function for the purpose of reviewing, on at least an annual basis:
(a) the CRA’s methodologies and models;
(b) any significant changes it has made to its methodologies and models; and
(c) the adequacy and effectiveness of its systems and internal control mechanisms

The SFC has made the Securities and Futures (Licensing and Registration) (Information) Rules (“Information Rules”) under ss. 128 and 397, SFO, specifying the information which should be provided in connection with applications for any licensing-related matters under Part V, SFO including:
(a) licensing of corporations or individuals;
(b) approval and transfer of accreditation of individuals;
(c) approval to be a responsible officer;
(d) variation of the type of regulated activity for which a person is licensed;
(e) approval of premises for storing records;
(f) approval to become or continue to be a substantial shareholder; and
(g) modifications or waivers

Conduct not constituting market misconduct (safe harbour rules) (ss. 282 and 306, SFO)

The SFC is empowered to make rules to exclude certain acts from the definition of market misconduct. The SFC has made the Securities and Futures (Price Stabilizing) Rules under these provisions to permit and regulate price stabilizing action by issuers or underwriters in respect of public offerings. These rules permit specified stabilizing activities to be engaged in lawfully, which would otherwise be regarded as stock market manipulation (or possibly false trading or price rigging).

Corporate mis-governance

This is a term used to cover all forms of misconduct by the board or management of a company towards the company and its members. It includes fraud, misfeasance and failures to adhere to duties of disclosure. Regulators internationally are taking an increasing interest in corporate mis-governance.

 The MMT consists of three members, a judge and two other members.
 The MMT can compel witnesses to give evidence.
 The MMT will apply civil standard of proof, i.e. the balance of probabilities test.
 The MMT may disqualify a person found guilty of market misconduct from holding office as a director, liquidator or receiver or from taking part in the management of a corporation, or from investing or trading in Hong Kong markets, for up to five years.
 The MMT may make a disgorgement order for an amount up to the profit made or loss avoided as a result of the misconduct.

The SFC sets minimum capital requirements for all licensed corporations. This is to ensure that a licensed corporation has enough capital itself (or enough available to it from external sources):
(a) to support the level of its business activities;
(b) to meet its liabilities as they fall due; and
(c) to provide a buffer in the event that there is a sudden run against it to cover the period during which it is putting other strategies in place.

Credit ratings play an important role in international capital markets. The preparation, dissemination and use of credit ratings takes place in the context of markets, issuers, products and investors that span many jurisdictions.

Part XIV specifies other types of market misconduct, including the following which are relevant to this manual:
(a) fraudulent or deceptive acts or the use of fraudulent or deceptive devices in Type 1,
Type 2 or Type 3 regulated activity (s. 300, SFO); and
(b) false representations to a person of having dealt in futures contracts on his behalf (s. 302, SFO).

Licensed corporations are required to give their staff appropriate training on money laundering issues, and on a frequency sufficient to maintain their knowledge and competence. Staff should be aware of:
(a) the obligations of both the licensed corporation and the individual, and their potential liabilities for failing to comply with their obligations under applicable legislation;
(b) the policies and procedures of the licensed corporation relating to anti-money laundering, including the identification and reporting of suspicious transactions; and
(c) new and emerging ways that money laundering might be engaged in, to the extent such information is needed by the staff to carry out their roles.