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

Customer risk
(i) background or profile of the customer (e.g. a politically exposed person);
(ii) unduly complex ownership structure without good reason;
(iii) nature, scope and location of the customer’s business that generate the funds/assets, having regard to sensitive or high-risk activities; and
(iv) means and types of payment (e.g. cash-intensive businesses).

CRAs must be careful to observe the CRA Code’s requirements and ensure that (i) rating decisions are not influenced by the presence or absence of ancillary services, and (ii) actual or potential conflicts of interest are dealt with in the manner required by the CRA Code.

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.

A core principle of the approach taken by the International Organization of Securities Commissions (“IOSCO”), which is reflected in the Code of Conduct for Persons Providing Credit Rating Services (“CRA Code”), concerns independence and conflicts of interest. In particular, a CRA should “implement procedures designed to identify and eliminate conflicts of interest inherent in its business activities”1.

Where a CRA provides ancillary services, the potential for conflicts of interest may be higher, depending on the nature of the ancillary business.

The CRA Code requires the CRAs, namely, communicating a rating to the rated entity prior to its issue or revision, provided it is feasible and appropriate to do so. When doing so, CRAs should:
(a) inform the rated entity of the critical information and principal considerations the rating is based on;
(b) give the rated entity an opportunity to clarify any possible factual misperceptions or other considerations which are relevant to the accuracy of the rating; and
(c) duly evaluate the rated entity’s response.

The CRA Code, together with the Code of Conduct, requires CRAs and its representatives to:
(a) deal fairly and honestly with issuers, investors, market participants and the public; and
(b) maintain high standards of integrity.

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 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.

the SFC exercises its regulatory mandate to supervise the industry through several mechanisms:
(a) licensing: that only fit and proper persons are permitted to engage in regulated activities;
(b) supervision and monitoring: that intermediaries comply on an ongoing basis with applicable laws and regulations; and
(c) discipline: that persons in breach of laws or regulations are suitably dealt with.

A licensed corporation, including a CRA, must notify the SFC (s. 146, SFO and s. 55, FRR):
(a) as soon as reasonably practicable if it fails to meet the RLC and paid-up share capital requirements, and cease to conduct regulated business unless permitted by the SFC to continue;
(b) within one business day of becoming aware that its liquid capital falls below 120% of the RLC or below 50% of the liquid capital last reported;
(c) within one business day of becoming aware that it exceeds any borrowing limits, is unable to meet any repayment demands from lenders (for three consecutive business days), or any lenders have liquidated or have notified an intention to liquidate any collateral security;
(d) within one business day of becoming aware that the aggregate of its commitments, etc. or claims made against it exceeds HK$5 million or, if deducted from its liquid capital, would reduce it to below 120% of the RLC; or
(e) within one business day of becoming aware that the information submitted in earlier returns has become materially false or misleading.

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.

Disclosures of suspicious transactions under the DTRPO, OSCO or UNATMO should be made to the JFIU.

A licensed corporation commits an offence if it fails within the specified periods:
(a) to appoint an auditor; or
(b) to notify the SFC

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.

A core principle of the approach taken by the International Organization of Securities Commissions (“IOSCO”), which is reflected in the Code of Conduct for Persons Providing Credit Rating Services (“CRA Code”), concerns independence and conflicts of interest. In particular, a CRA should “implement procedures designed to identify and eliminate conflicts of interest inherent in its business activities”1.

Where a CRA provides ancillary services, the potential for conflicts of interest may be higher, depending on the nature of the ancillary business.

 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.

An intermediary is expected to demonstrate that it is competent, in accordance with the Guidelines on Competence, and to conduct its regulated activity efficiently and effectively. The criteria include:
(a) proper organisational structure based on good corporate governance principles and incorporating clear lines of responsibility and authority;
(b) risk management policies, controls and procedures established as an independent function under a competent risk manager;
(c) effective internal control systems and independent internal audit and compliance functions staffed by qualified and experienced personnel;
(d) effective information technology support;
(e) appropriately qualified employees with supervisory staff having at least three years’ relevant experience and appropriate academic qualifications; and
(f) suitable training policies and programmes

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 CRA Code requires the CRAs, namely, communicating a rating to the rated entity prior to its issue or revision, provided it is feasible and appropriate to do so. When doing so, CRAs should:
(a) inform the rated entity of the critical information and principal considerations the rating is based on;
(b) give the rated entity an opportunity to clarify any possible factual misperceptions or other considerations which are relevant to the accuracy of the rating; and
(c) duly evaluate the rated entity’s response.

As a means of promoting transparency and enhancing the investor’s ability to evaluate the performance of their ratings, CRAs should, where sufficient historical data exists, publish verifiable and quantifiable historical information about the performance of their rating opinions, including:
(a) the historical default rates of rating categories;
(b) ratings transition frequency; and
(c) whether the default rates of rating categories have changed over time.

A person dealing or counselling or procuring another person to deal, in the Hong Kong listed securities of a corporation or its related corporation or their derivatives where the first-mentioned person:

(i) is connected with the listed corporation and knowingly has inside information in relation to the listed corporation; or
(ii) is contemplating (or has contemplated) making a take-over offer for the listed corporation, which is known to the person as inside information in relation to the listed corporation (and the dealing or counselling or procuring to deal is done otherwise than for the purposes of the take-over); or
(iii) has received such information which he knows is inside information directly or indirectly from a person known to be connected with the listed corporation

In determining the risk profile of customers, the following factors, among others, should be taken into account:
(a) Product/service risk
Services that provide more anonymity.
(b) Customer risk
(i) background or profile of the customer (e.g. a politically exposed person);
(ii) unduly complex ownership structure without good reason;
(iii) nature, scope and location of the customer’s business that generate the funds/assets, having regard to sensitive or high-risk activities; and
(iv) means and types of payment (e.g. cash-intensive businesses).
(c) Country risk
Nationality, citizenship and residence status of the customer (place of incorporation for a corporate customer), and its place of business (e.g. non-cooperative countries and territories identified by the Financial Action Task Force to have critical deficiencies in their anti-money laundering systems).

Disclosures of suspicious transactions under the DTRPO, OSCO or UNATMO should be made to the JFIU.

Having regard to the general concepts set out by the OECD, some of the ways a company may improve its governance are as follows:
(a) installing appropriate checks and balances, such as separating the functions of Chairman and chief executive officer; appointment of independent non-executive directors; establishment of independent audit committees; setting up committees to control the remuneration and benefits of directors and senior management;
(b) increasing transparency and disclosure to shareholders, stakeholders and the public;
(c) adopting international accounting and auditing standards;
(d) installing strong protective structures for minority shareholders, creditors and other lenders; and
(e) identifying and penalising corporate wrongdoing.

A licensed corporation commits an offence if it fails within the specified periods:
(a) to appoint an auditor; or
(b) to notify the SFC

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.

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.

The CRA Code requires the CRAs, namely, communicating a rating to the rated entity prior to its issue or revision, provided it is feasible and appropriate to do so. When doing so, CRAs should:
(a) inform the rated entity of the critical information and principal considerations the rating is based on;
(b) give the rated entity an opportunity to clarify any possible factual misperceptions or other considerations which are relevant to the accuracy of the rating; and
(c) duly evaluate the rated entity’s response.

The SFC, in carrying out its functions as the lead regulator for securities and futures, is also charged, together with the HKMA and government departments, with maintaining Hong Kong’s position as an international market. In particular, this means acting so as to:
(a) facilitate innovation in financial products;
(b) avoid restricting competition;
(c) act in a transparent manner; and
(d) use resources efficiently.

The obligations arising under the CRA Code in relation to confidential information are concerned with:
(a) its protection; and
(b) its proper use.